Q4 2021 Northrop Grumman Corp Earnings Call

January 27, 2022

Good day, ladies and gentlemen, and welcome to Northrop Grumman's fourth quarter here in 2021 conference call. Today's call is being recorded my name is Natalia and I will be your operator today at.

At this time all participants are in a listen only mode.

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 Ernst Treasurer, and Vice President Investor Relations. Mr. Ernst. Please proceed.

Thank you Natalia and good morning, everyone and welcome to Northrop Grumman's fourth quarter 2021 conference call.

Refer this morning to a powerpoint presentation that is posted on our IR webpage, but before we start just let you go through a couple of comments here the matters discussed on today's call, including 2022 guidance and beyond including our outlooks reflect the company's judgment based on information available at the time of this call.

They constitute forward looking statements pursuant to safe Harbor provisions of Federal Securities laws forward looking statements involve risks and uncertainties, which are noted in today's 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 results in our earnings release and on today's call are Kathy Warden, our chairman CEO and President and Dave Keffer, Our CFO at this time I'd like to turn the call over to Kathy Kathy. Thank you Todd Good morning, everyone and thank you for joining us.

We delivered another year of solid operating performance in 2021 and positioned our business for continued growth in 2022.

We are executing our strategy, which is to grow the business today and into the future maintain excellent performance and reduce costs to deliver strong margin rate and deploy our capital to create value.

We made significant progress in executing this strategy again in 2021.

Our organic sales growth for the year with 3% our segment operating margin was an exceptionally strong 11, 8%, which increased 40 basis points compared to 2020 with performance more than offsetting mix and COVID-19 related headwinds.

We grew our transaction adjusted EPS by 8% and generated a $3 1 billion of transaction adjusted free cash flow.

Regarding capital deployment, we returned a record $4 7 billion to shareholders through dividends and share repurchases, including a $500 million accelerated share repurchase that we announced in November of 2021.

We strengthened our balance sheet retiring over $2 2 billion of debt during the year and achieving an increased credit rating in the process.

And we continue to invest in our business with over $1 $4 billion in capital expenditures to create new technologies and support franchise program.

We also continue to add to our portfolio of franchise programs with competitive wins on programs like the integrated Battle command system or IV.

As well as hypersonic and ballistic tracking space sensor and next generation interceptor.

As we look forward to 'twenty, two and beyond we expect our organic growth will continue as we win new business and convert the robust backlog, we built over the past several years into sales growth.

And while we'll know more about the President's budget request in the coming weeks. We continue to believe that our portfolio is strongly aligned with the threat environment and the key investment priorities of our customers.

Further we expect strong margin performance as well as double digit free cash flow growth from 2022 through 2024.

2022 guidance reflects our confidence in our strategy, our broad portfolio and our ability to deliver continued growth and strong performance.

As reported the Covid pandemic continued to present challenges to labor availability parts supply and shipping delays across the economy, particularly in the second half of last year.

We have felt these effects and the challenges as both our supply chain and our own labor availability.

We will continue to take proactive steps to address such Covid risks, both to our employees and our business.

And looking forward our current guidance reflects the factors, we know today and our best estimates for the remainder of the year.

It's going to provide more details on the quarter, the full year and our guidance interest a few minutes.

Turning now to the budget environment. The federal government continues to operate under a continuing resolution that currently run through February 18th.

Negotiations on the fiscal year 2022 appropriations bills are continuing and we remain optimistic that Congress will reach an agreement by the end of the first quarter.

The National Defense Authorization Act contained a $25 billion increase to the defense budget. It represents 5% growth compared to fiscal year 2021.

Which we expect to also be supported in the appropriations Bill.

In the NDAA. There is continued support for our major programs and several of our programs received incremental funding above the president's budget request, including Triton each of the F 35, F 18, and Gator among others.

And finally, we expect the FY 'twenty three president's budget to be delivered to Congress in March of this year.

Reflecting this administration's priorities in areas such as mission system.

Missile defense advanced weapons.

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Focusing now on highlights in the quarter one of our proudest moments was the launch of the web based telescope on December 25th.

Northrop Grumman is the prime contractor for NASA on web and we're honored to have partnered with NASA to provide the world with this revolutionary technology.

Well hope here more than $13 5 billion years into the past when the first stars and galaxies were formed ushering in an exciting new era of space observation and expanding our understanding of the universe.

In addition to web we're also supporting NASA Artemis mission by producing the largest solid rocket motors ever built for the space launch vehicle system, which is being developed to send the first woman and next man to the Moon.

In the fourth quarter the space sector received a $3 2 billion dollar award to support Artemis mission four through eight.

Another important milestone in the quarter was the competitively awarded IPC up in our defense systems sector.

This program is a centerpiece of the U S Army modernization strategy for air and missile Defense and all domain command and control.

It's a prime example of our capabilities to integrate assets and the battle space, regardless of source service or to me.

This is one of many examples of how we are helping our customers share data between system and improve command and control in support of their jobs to vision.

In the area of missile defense, we had several milestones in the quarter, which position us to help our customers track and defend against hypersonic handful of stick missile threats.

In the fourth quarter, we announced that <unk> had passed its critical design review.

These satellites are planned to be part of a multi layered network of spacecraft that will detect and track hypersonic missiles.

Also in the quarter, we were selected by the missile Defense agency to design, a glide phase interceptor for regional hypersonic missile defense.

And our mission systems sector, we continue to see our customers prioritizing development of capabilities that will increase the effectiveness and survivability of legacy system as well as new technologies for next generation system.

In the fourth quarter MFS received an accelerated award for F 16 favors for approximately $200 million and full year awards of approximately $700 million.

We have now received total contract awards for nearly a thousand radars for this program in support of the U S Air Force and National Guard as well as several international customers.

In addition, our network information systems business area within mission systems received approximately $1 billion in award for advanced processing solutions.

This portfolio delivers strategic microelectronics focused on high performance computing, and security, which helps our customers with connectivity and processing solutions.

We anticipate additional awards in this segment of the portfolio for the next few years and we expect it will be a significant growth driver for MFS in 2022.

Finally in Aeronautics the military aircraft market is undergoing a transition of their customers focus their investment in next generation programs, while divesting some legacy platforms.

As we discuss certain programs in our portfolio at Aeronautics systems are maturing and experiencing headwind.

But there are also a number of exciting new opportunities that are emerging.

This includes next generation manned aircraft as well as new unmanned opportunities, which she loves Air Force Secretary Kendall recently announced.

In addition to pursuing these longer term opportunities, we remain focused on executing our program and delivering for our customers.

Another important aspect of our company's future is our strategy for sustainability.

Strongly believe that our environmental social and governance programs play an important role in sustainable profitable growth and long term value creation for our shareholders customers and employees.

Northrop Grumman is a leader in conservation activity with a 44% reduction in greenhouse gas emissions since 2010 in.

In the fourth quarter S&P released its global corporate sustainability assessment scores and we ranked in the 96 percentile.

We were included on the Dow Jones Sustainability Index, North America for the sixth consecutive year.

And we were included in the Dow Jones sustainability World Index for the first time.

Our ESG strategy also includes portfolio of management actions as.

As we've discussed on earnings calls last year, we committed to transition out of the small aging and surveillance contract that we had for cluster munitions and that contract is complete.

And while we continue to be an ammunition supplier as both a prime and the merchant supplier. We have made the decision to transition our prime role in depleted uranium. In addition to another provider. Following one final single production your contract.

We are currently working to establish our next set of sustainability goals and priorities specifically as they relate to greenhouse gas emissions water conservation and solid waste diversion with a stronger emphasis on renewable energy.

Overall, we're making substantial progress in our ESG journey, and we look forward to sharing more in our upcoming sustainability anti CFT report.

So with that I'll turn it over to Dave to provide more detail on our sector results and guidance and then I have a few additional comments before we move on to Q&A.

Great. Thanks, Cathy and good morning, everyone.

'twenty one was another strong year of performance for the company.

Before going through the details of our results and guidance I'd like to note a few items to keep in mind when comparing Q4 to the same period last year.

As we previewed in prior quarters, the divested it services business the equipment sale.

And for more working days in Q4 2020 represented over $1 $6 billion of sales when compared to Q4 2021.

That said sales per working day in 2021 were at their highest level in Q4.

Moving to sector results, we continued to see certain COVID-19 related effects on our labor and supply chain in Q4, and these effects were most significant in our aeronautics sector.

The Q4 decline in sales was partially driven by fewer working days in the 2020 equipment sale will also included a $93 million unfavorable EAC adjustments on F 35.

Turning to defense systems sales declined in Q4, and 2021, primarily due to the it services divestiture organic sales were down 9% in Q4 and 4% for the full year driven by the completion of our contract with the Lake City ammunition plant, which generated almost $400 million of sales in 2020.

Mission systems organic sales were down 3% in the fourth quarter, primarily due to the reduction in working days and.

Up 6% for the full year.

2021 sales were driven by increased volume on Gator GBS T Sabre J crew and restricted programs among others.

And lastly space systems, Q4, and full year organic sales rose by 6% and 24% respectively.

We continued to ramp significantly on franchise programs.

Including a $1 $1 billion increase on GBS D in 2021.

Growth was also driven by restricted space programs as well as in Gi and Artemis.

Moving to segment operating income and margin rate.

Operating margin decreased to eight 4% in the quarter and nine 7% for the full year due to the unfavorable EAC adjustments on F 35.

In our other three sectors segment operating margin rates met or exceeded the high end of our prior 2021 guidance ranges.

Vince systems operating margin rate increased 90 basis points to 12, 1% in the quarter.

And 80 basis points to 12% for the full year.

Higher operating margin rate was largely due to improved performance as well as recent contract completions.

Mission Systems' operating income grew in both periods.

As a result of higher EAC adjustments and business mix changes operating margin to 15, 9% in the fourth quarter 15, 6% for the full year.

Space systems operating margin rate was nine 6% in the quarter and 10, 6% for the full year.

Favorable EAC adjustments from strong performance from commercial space programs helped offset mixed pressures for the year.

And keep in mind that space along with some of this.

Benefited from the pension related overhead benefits that we recognized in the first quarter of 2021.

At the total company level segment operating margin rate in the fourth quarter was the same as Q4 2020, even with the F 35 charge in 2021 and.

And it increased 40 basis points for the full year to 11, 8%.

Turning to EPS or transaction adjusted EPS declined 9% from Q4 2020 to Q4 2021, primarily due to lower sales volume from the factors I described earlier.

For the full year EPS, we exceeded the high end of the EPS guidance range, we provided in October <unk>.

Transaction adjusted EPS grew 8% in 2021 due to strong segment performance and lower corporate unallocated costs.

Lower corporate unallocated was driven by two items, we've discussed in prior quarters.

The $60 million benefit from an insurance settlement related to the former orbital ATK business.

And lower state taxes.

Regarding our pension plans. That's the performance was strong again in 2021 at nearly 11%.

The third year in a row of double digit asset returns.

Our discount rate increased 30 basis points to 298%.

These factors resulted in a mark to market benefit of roughly $2 $4 billion in 2021.

In addition, our net pension funding status has improved by over $3 billion.

<unk> basis is now over 93% funded.

We continue to project minimal cash pension contributions over the next several years.

Also summarized our pension cost estimates for the years 2022 through 2024.

Because recoveries are projected to continue declining over the planning period.

This causes an EPS headwind, particularly in 2022, it makes our rates more competitive products more affordable.

Our Cas prepayment credit is approximately $1 7 billion as of January one of this year.

Now turning to cash we generated nearly $3 $6 billion of operating cash flow and $3 $1 billion.

So transaction adjusted free cash flow in 2021 in line with our expectations in.

In the fourth quarter, we made our final federal and state tax payments associated with the it services divestiture.

$200 million.

We also made our first payment of roughly $200 million.

Deferred payroll taxes from the cares Act legislation.

The remaining payment of the same amount will occur this December .

Looking ahead to 2022.

Sector guidance as shown on slide nine this outlook assumes that appropriations bills are passed by the end of Q1 and it assumes a relatively consistent level of impact from the effects of COVID-19 that we experienced in 2021.

At Aeronautics.

We expect sales in the mid to high $10 billion range. As we noted last quarter, we are projecting headwinds in our <unk> portfolio as well as lower sales on Jay stores.

<unk> in our restricted business.

Sales on F 35 are expected to be slightly higher in 2021 due to the EAC adjustments, we booked in Q4.

We expect a margin rate of approximately 10%, which is up 30 basis points year over year.

For defense systems, we expect sales to be in the high $5 billion range. As this business returned to modest organic growth following the it services divestiture and the completion of our Lake City contract.

Operating margin rate is expected to remain very strong in the high 11% range.

Mission systems sales are projected to be in the mid $10 billion range up from $10 $1 billion of organic sales in 2021, reflecting continued strength in demand for our products.

Operating margin rate is expected in the low 15% range.

This system is expected to remain our fastest growing business and to become our largest segment in 2022.

Sales are projected in the mid $11 billion range up from up about $1 billion from 2021.

With a margin rate in the low 10% range.

Turning to slide 10.

Our total revenue guidance is $36 2 billion to $36 6 billion.

Representing a range of 2% to 3% organic growth.

With the rate we estimated in October 2021.

This growth is enabled by our strong backlog, which stands at over $76 billion.

And covers more than two years of annual sales.

The 2021 book to Bill of <unk>, Nymex was lower than our prior expectation due to the S. F 35 award shift to 2022.

More importantly, our three year trailing average book to Bill is approximately one to two it remains the foundation of our current and future growth.

That's COVID-19 related headwinds that we experienced late in 2021 continue into early 2022.

We anticipate the first quarter 2022 sales will be less than 25% of the full year.

We are.

<unk> segment operating margin rate outlook that we provided in October as we now expect a rate roughly consistent with 2021 in the range of 11, 7% to 11, 9%.

This projection reflects our continued disciplined approach to cost management and our efforts to offset mix headwinds with strong program performance.

Altogether, we expect transaction adjusted earnings per share to be between $24 50 and.

And $25 10.

Based on approximately 155 million weighted shares outstanding.

As shown on slide 11. This includes roughly $2 a year to year EPS headwinds from lower net pension benefits driven by the reduction in Cas recoveries and higher corporate unallocated expense due to the onetime benefits in 2021.

Earnings volume from sales growth strong operating margin performance and a lower share count will help to offset those non operational items.

We project 2022 transaction adjusted free cash flow of $2 5 billion to $2 8 billion.

Assuming the R&D tax amortization law is deferred or repealed.

We continue to project about $1 billion of higher cash taxes should current tax law will remain in effect.

As I mentioned, our cash tax outlook includes the final payroll tax payment from the cares act of approximately $200 million.

Capex is expected to remain roughly consistent with 2021 on an absolute dollar basis and slightly lower as a percentage of sales.

Slide 12 provides our longer term outlook on cash.

The midpoint of our 2022 transaction adjusted free cash flow guidance is $2 $65 billion.

It includes roughly $375 million of lower recoveries in 2021.

From there, we expect a double digit free cash flow CAGR through 2024, driven by operational performance lower Capex and the absence of the payroll tax headwind.

Our base case again assumes deferral of the R&D tax for all periods.

Speaking of taxes, we're projecting an effective tax rate of approximately 17% going forward roughly consistent with 2021, excluding the divestiture or mark to market pension effects.

Also we anticipate the resolution of an appeals process for certain open years of legacy OE Teekay tax filings in 2022.

Other than appeals processes are underway, but in earlier stages for certain Northrop tax years, we refer you to our 10-K for additional details on the key items, both timing related and permanent in nature to be resolved in those processes.

Hosing, we're proud of our 2021 performance and we're focused on continuing to execute well in our business and financial strategy in 2022.

That I will turn the call back over to you Cathy.

In summary, we have strong franchise programs that are well aligned to budget priorities.

We're focused on capturing and investing in new growth opportunities, while also executing to drive earnings and cash flow growth.

We delivered a solid set of results in 2021, and we are well positioned to continue growing and performing in 2022 and beyond.

Our top priority for cash deployment remain shareholder return.

Adding a competitive dividend and share repurchases.

That in mind, our board of Directors recently approved an increase in our share repurchase authorization of $2 billion and based on our outlook today, we plan on returning at least one and a half a billion dollars to shareholders via share repurchase in 2022.

Before turning to your questions I'd like to thank the Northrop Grumman team for delivering solid operational results with dedication and perseverance.

We have extraordinary talent and this includes our leadership team.

As we announced in November Blake Larson, who is retiring after a 40 year career with Northrop Grumman and its heritage companies play.

Nick has helped to position our space business for incredible growth.

And as important our focus on performance and quality.

We are grateful for his contributions to our company and our country.

And I'd also like to welcome Tom Wilson to my leadership team as he succeeds Blake.

Tom brings strong experience in the space market. He was part of the space team and I'm confident in his ability to lead this business.

So with that we'll go ahead and open the call up for questions Natalya back to you.

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. Please limit your questions to one question and one follow up if your question has been answered or if you wish to ask the questions queue.

Press the pound key to exited the queue.

Press Star zero at any time for operator assistance.

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

Thanks.

Kathy can you elaborate more on the labor and supply chain issues experienced in the quarter Aeronautics.

Are these the same issues flagged last year.

How long do you expect these issues to persist.

Yes. Thank you Christine they are similar issues to what we flagged in the third quarter of last year and they are related largely to labor availability in our own workforce as well as what we're seeing in our suppliers.

And when I talk about labor availability, that's really with the Delta variance in the late part of the third quarter early part of the fourth quarter and then omicron again in the late part of the fourth quarter and now early part of 2022, we see higher levels of absenteeism.

Employee safety is our first priority, we encourage people to be out of work if they're experiencing any symptoms and we also isolate people who've been in close contact and so as a result absenteeism has been higher than these searches and it has an impact, particularly in our high rate high volume production line.

Where people are in closer proximity and where a whole work cells might be impacted if we have one person that core out and so that's why you see it more pronounced in our aeronautics sector, because that's where we have really only one high rate high volume production program. The F 35 and we've.

Talked specifically about the impact to that program.

The rest of the business, it's not that we arent experiencing these same conditions, but we're able to mitigate them better and you'll see less of a pronounced impact in any one period, but certainly we would have expected to see a stronger fourth quarter topline had we not experienced those two searches.

Great. That's very helpful color and I'll see you at like what sounds like a fairly comprehensive ESG strategy. When you look at your portfolio are there other areas, where you're reevaluating your exposure.

So we've taken a very comprehensive look not only at our strategy, but our portfolio in excess of cost what that exposure is I do want to be clear. We are a defense contractor and so we are supporting global security mission largely in areas of deterrence.

But also inclusive of weapons systems, and we expect to continue in those businesses because we believe they actually promote global security and human rights proliferation, not the contrary, but with that said we have evaluated some portions of our portfolio that I've talked about in the past like cluster munitions and today, making the.

<unk> that we plan to exit depleted uranium ammo as parts of the portfolio that we no longer wanted to support directly.

Your next question is from the line of Seth <unk> with J P. Morgan.

Hey, thanks very much.

I Wonder if you could talk a little bit about.

Where aeronautics goes from here and.

How much the headwinds that are coming in 2020 to persist into the out years and then.

At the risk of asking about a classified program when we think further out towards the middle of the decade and beyond if ever.

Every place that you are a prime contractor gets up to kind of the expected full rates of production.

No.

In very rough and.

Qualitative terms.

What that means in terms of the aeronautics topline several years down the line.

Thanks Seth.

Start and then Dave to provide a little more color and specificity.

I see our aeronautics sector as having.

Headwinds this year that will dissipate going into 2023. So we don't expect the same levels of decline as we move into next year.

And then that trend reversing in the 2024 time frame and I won't point to any particular program, but it is at that point in time that we expect.

Some.

Some of the headwinds that we've discussed to be largely behind us and the opportunities for growth and higher volume of production in aeronautics to start to kick in and so that would have both an upward.

Okay.

Trajectory for top line, but we also see their margin rate progressively improving over that period as well. So that gives you the macro view, Dave anything you'd like to add to that.

I think you've covered it well Kathy.

22 outlook is consistent both in.

The mid single digit decline in the sources of that decline with what we talked about in recent calls.

As you pointed out we expect 'twenty three to be more stable and have.

Growth opportunities beyond that.

The thing I'd point out is we're very focused on managing the business well in the meantime cost management are.

Managing our capital expenditures and so.

We're focused on execution on delivery every day in that business and looking to optimize that outlook.

Okay great.

Quick one this morning, thanks very much thanks Beth.

Your next question is from the line of Sheila <unk> with Jefferies.

Hey, good morning, everyone and thank you.

Kathy Thanks for the Aeronautics car I was wondering if maybe we could transition to space and if you could bridge us on the growth for space. It seemed like GBS D with maybe more additive in 2021 than prior expectations. So how do we think about that growth cadence and how do we think about the balance of growth across the other.

The space portfolio.

So in GBS see Hudson, a significant component of the states.

Growth in the last two years, and we expect that to start to level out, but GBS data continues to be a growth element in space for the foreseeable future.

But with that said Youre right to point out that there was significant growth in the rest of the base portfolio as well balancing about 50 50 with GBS C and contributing last year and we expect that same trend to continue this year with a $1 billion or so of sales growth that we're projecting in space.

And that really is broad based growth, it's coming from all areas of the business or propulsion satellites as well as component is coming from both restricted and classified work as well as the unclassified work and it's coming from a variety of customers.

For the U S Air force as well as NASA as I highlighted today. So we really are seeing base growth to be quite balanced.

Even in 2023 or 2022, but even more so as we look forward to 2023, and we expect it to continue to be one of if not the fastest growing sector for the foreseeable future.

Great. Thank you.

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

Yes, good morning.

I was wondering if you could speak to if you've seen some of the <unk>.

Harold help portfolio assets, maybe some of the legacy stuff start.

Start to fade away are there opportunities to replace that.

Whats out there in that world because it's hard to believe that.

That asset class is just going to go away. So if you could speak to are.

Are there opportunities for Northrop Grumman to replace those assets in the future.

Yes, Ron and thanks for that question, because we've talked a good bit about the headwinds in our <unk> portfolio and that's coming off of production of global Hawk, which was not only for the U S. Air Force with several international customers and then Triton, which is still early in its production.

And those headwinds were the plot, how we more of Triton and the production pause and then the global Hawk phasing out but the reality is autonomous systems are still an important part of both the U S Air Force and U S Navy strategies going forward as well as an important asset in the portfolio for international customers.

See that market is continuing to evolve with some specificity to your question I mentioned earlier in this call that the U S. Air Force Secretary Kendall has recently been more specific about launching some new effort in unmanned systems within the Air Force and we.

Do you see those as opportunities that we will pursue so there's starting to be some more meat on the bones as to what those specific opportunities will be but we do see the market is continuing to be attractive.

Great. Thank you.

Yeah.

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

Thank you and good morning.

Hmm.

You gave guidance today for cash free cash flow in 2022 23 2024.

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And I guess cash I mean, I understand you can project some things around pension the cash is really the most volatile quantity here and can you give us a sense of what type of sales and earnings profile actually drives those numbers in 'twenty three and 'twenty four.

Hey, Doug, it's Dave I'm happy to dig into that I appreciate the question.

I think youll find today's outlook is consistent again with what we had.

<unk> at a higher level on our October call I think it is important to provide some context when we talk about our free cash flow outlook over these next few years Ortez pension reimbursements were over $800 million just two years ago in 2020.

And we were projecting them to reach $1 billion by at this point in 2022 after new legislation in a couple of years of fantastic asset returns that cause reimbursement is now really just a de minimis benefit to us.

Along with much improved funded status on the <unk>.

Insurance side and that's the primary driver of the change over the last couple of years, but what that does for US is create a great foundation for us in 'twenty two to build off of and grow more rapidly over the next few years and that supports that 10 plus percent CAGR. We've been talking about so 21 free cash flow was around $3 1 billion and as we've talked about <unk>.

<unk> is down almost $400 million in 'twenty two from 'twenty one.

The working capital assumption over the next year is roughly unchanged.

Similar in 'twenty, three before creating more opportunity in 'twenty four and beyond.

We talked a bit about the payroll tax deferral that ends.

The payment in late 'twenty, two so that two creates a tailwind as we enter two three and four.

And the other is around lower capex, as we get into particularly 'twenty four and beyond.

That combined with the working capital opportunities, we see from performance based payment timing and incentive timing really make us optimistic about that really strong CAGR over the next couple of years. So of course, the corollary there as that puts us in a nice position to be able to return a healthy volume of cash to our shareholders and we've noted on this call and others.

That remains our top priority for cash deployment over the next couple of years with a 1 billion and a half as our repo target in 2022 for example, so well.

Wouldn't read too carefully into a specific sales or.

Our margin target in these out years related to cash will get more into that guidance as we get closer to those years, certainly will look to continue to grow the company and deliver strong performance along the way.

Yeah.

Okay.

Go ahead seconds are hard of what you are asking is what is our outlook and while we're not going to provide specific numbers as Dave said.

I'll point you to some of the comments that I made we expect continued top line growth in this business beyond 2022, and we expect the earnings expansion and so those are factored in both to our 2023 and 2020 for expectations for cash and you can draw some conclusions, but we see an accelerated.

Both profile going from 23% to 24 on earnings.

That would be a fair assumption to make as well based on what we've outlined for you.

And then just as a follow up on one piece of this if I go back a few years.

Missiles was one of the hottest areas in the budget.

And I know we've had this discussion around it really Northrop Grumman and working to become a third missile supplier.

But over that time period.

We've seen essentially missile budgets turnover and legacy certainly a lot of the large legacy programs.

Demand is considerably less.

<unk> got some important programs now in missiles development programs, but how do you see that market is this still the same kind of opportunity you were looking at a few years ago.

You know Doug when we were looking at this a few years ago I would say our expectations.

We're balanced between space and missile.

And what we've seen is spaces outperformed our expectation missiles has been more in line to date with expectation maybe not as much opportunity as we project out into the out years that faces more than offsetting that and we've always gotten a return on investment I will.

We continue to be a strong merchant supplier in the missile space and so as that market continues to grow and expand and we do expect it will particularly in hypersonic. We are partnered with the larger weapons providers to provide them important components of those weapons system and so we.

By no means believes that our return on investment is not maturing in the weapons space. It's just maturing more quickly.

More significantly in states.

Okay, great. Thank you.

Your next question is from the line of Robert Stallard with vertical research.

Thanks, so much good morning.

Good morning.

Can I follow up on Doug's question really on that slide 12, and you've got that.

Projected large pickup in free cash flow in 2024, and I'm wondering if you could maybe qualitatively actively walk through what some of the moving parts are the leading to that particularly strong growth in a couple of years' time.

Sure happy too like I mentioned that the.

10, plus percent CAGR over the next couple of years really shows up particularly strongly in that 2024.

Timeline and that's for a couple of the reasons that we've described and they'll go into a bit more detail on those one is around our expectation of lower capex in 2024, we've talked about that coming down gradually as a percentage of sales and we started to see that in R 22, and three guidance.

As we get to 'twenty four we expect that to continue to come down on a dollar basis and a percentage of sales as we see.

You know the level of demand for cabin beginning to decline a bit further in 'twenty four.

On the working capital side, we have a quite a few programs obviously none of them.

<unk>.

Too much significance in the overall sales.

Sales or balance sheet of the company, but when we aggregate all of that we see more opportunity for working capital.

Efficiency drives in the 24 timeline.

When we do in 'twenty, two or 'twenty three given the timing of some particular performance based payments milestones and incentives. So we're excited about the opportunity as we look at our 24 and beyond four.

For free cash improvement and of course for the <unk>.

Flexibility that that provides us on the deployment side as well I mentioned, the other factor earlier, which is more.

Just the timing of the payroll tax deferral that we had the benefit in 2020 that we're now paying half of in 'twenty, one and 'twenty. Two so that's the only kind of unique item I'd add to that mix.

That helps okay. Yes, that's helpful. So it doesn't sound like anything really on the operation side.

Massively accelerating in 'twenty four it sort of nonoperating items.

I think thats, a good way to characterize it I think Cathy covered well you know our expectations for growth and performance over the next couple of years in these.

Cash flow timing issues are layered onto that outlook yeah. Okay. And then just a quick follow up on the cash you.

You mentioned that the if it was supposed to have this R&D tax credit thing it could be a billion dollar hit in 'twenty two what's your latest thinking on the potential hit in 'twenty three 'twenty four if this legislation doesn't get changed.

Yes. Thanks for the follow up question on that I should note is.

Approximately 20% lower per year after 2022, not exactly given some of the.

Idiosyncrasies, and the timing and such but think of that $1 billion in 'twenty, two potential coming down to about $800 million and $600 million over the next two years as you can imagine it eventually levels off and normalizes when we get to 2026 or so so we are certainly still optimistic about.

Resolving section 174 through deferral of repeal in the meantime, there continues to be good broad broad bipartisan support for doing so it's really just a matter of finding the right legislative vehicle and of course that has proven challenging so far so that's why we wanted to give you.

Have a sense for that.

Volume on today's call.

Your next question is from the line of Noah <unk> with Goldman Sachs.

Hi, good morning, everybody.

Morning.

The profit margins in space have come down as you layered in a significant amount of new revenue.

As the growth rate sort of transitions there how should we think about.

How much recover you could see in the profitability in that business.

So now what.

Look at that business, we continue to layer in new development work, we talked about a few of those things today, but by foods interceptor.

In Gi program and so it's not just the GBS phenomena that is causing that mix headwind, but as GBS D transition from a development phase even into the early stages of production, we would expect to see that be the biggest driver.

In a tailwind to margin rate and that happened around the middle of the decade in the meantime.

<unk> continues to perform exceptionally well and the margin rates are.

Since now are very solid in comparison to others. So we're really pleased without performance.

We ensure that all of this development work.

I believe that we can maintain those rates in line with what we have projected for 2022.

See increases towards the middle of the decade.

Great understood.

And then Dave just quickly following up on that.

On the free cash flow math.

If I take.

Each of the years, you've now provided back out the Capex and then back out all the pension inputs you've provided.

Which sort of gets to a clean number relative to the business segments, excluding anything with cash tax or working capital that number.

<unk> as a ratio of the business segments is pretty low compared to where you've been in the past. So that would indicate that you are specifically assuming.

Working capital headwind or some other headwind.

Outside of the business segments is that the case or is my math wrong.

Sure happy to to get into those details another time, if you'd like to.

Dig further could be easier with the same numbers in front of us.

Right exactly in aggregate I think the important headline here is we've had great working capital performance over the last couple of years, we project more stable working capital performance over the next couple of years before seeing that opportunity expand again in 2024.

That may be the summary of what what Youre seeing is after a couple of years of just outstanding working capital performance, especially in 2020, when we have things like the progress payment improvement.

In other tailwind from the kind of.

Street perspective on on cash we're in a more normalized period in 2022, and 2023 before seeing that opportunity expand again in 'twenty four so again happy to follow up sometimes I think that gives you a feel for it.

But it is not youre not assuming an actual incremental working capital headwind 'twenty two 'twenty three it's just sort of relatively no change year over year.

Yes, that's correct okay.

Okay. Thanks, so much.

Thank you. Our next question is from the line of Cai von <unk> with Cowen and company.

Yes. Thank you so much so I mean, it's pretty clear that in space. Your mix is shifting towards the GBS and.

And in Gi and so I assume that's because they are in the development stage means lower margins 22, probably 'twenty three and therefore, maybe 24, they move up but that would be the profile for space and you mentioned, an aeronautical that you saw a reversal in 'twenty four.

But you mentioned dissipation in 23 of headwinds.

I read dissipation, meaning that margins can get better in 'twenty three but those dissipation mean, it's just going to go down but not quite at the same level. So I guess the.

Bottom line is.

Looking at the total company 2025, we can see the margins, maybe getting better but maybe they are flat to down over the next two years is that a fair assessment.

Yeah.

At the company level, what we are seeing is continued growth on the top line and margin expansion opportunity, but just as we've demonstrated right. We've seen 40 basis points of improvement going from 'twenty to 'twenty, one as we look at 2012.

Two we're holding that range constant with where we ended 2021 and that's largely because we have offset these mix pressures as we brought more development work into the portfolio and so we are suggesting is that that would continue to be the case until we move the mix more in the.

Directionally production, but we are having performance improvements and cost efficiencies that are providing tailwind on margin right. So you would expect us to continue to work those levers.

With this current mix.

And we see opportunity for margin.

We look into 2023.

Thank you very much.

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

Hey, good morning.

Kathy I was wondering if you could comment on the backlog and bookings opportunities in 'twenty two and.

35 in Gi I imagine you're a big movers, there, but do you expect the year to end at a higher backlog and then Dave just a clarification on the $1 7 billion of prepaid credit.

Not clear that you ever recover that based on the slide of funding and Cas recoveries can you just clarify.

Thanks, Myles I'll start with your question about that.

Your 22 awards and backlog expectations, we do not expect to have book to Bill of one and 2022, we see fewer new competitive opportunities. This year, it's just timing.

And we also see fewer multiyear award with the exception being the E. L. F 35 award, which has pushed them to this year.

We tend not to focus so much on singular year.

Our book to Bill, but instead, a longer term view because we have so many multiyear awards.

Dave mentioned when we look at the last three years, our average book to Bill was 122. So it established a really strong foundation for us to continue to grow as well.

We look at this year, we still expect to end this year with a four year trailing average of over $1. One. So it just gives you a sense that we expect to not only have a strong backlog, but an average book to bill that continues to support the growth that we are outlining into the future.

And then just briefly on the $1 7 billion Chez prepayment credit.

The next three years of current projections.

In a multi decade future for our pension plans, both from a Fas and Cas perspective, and so wouldn't indicate that wed expect that to be.

Anil the resolved over the next three.

Three years in this particular forecast period, we've got many many years.

Ahead of US there are a lot of market movement ahead of us there, but I think the bottom line on the pension side is where we're really enthusiastic about the continued.

Double digit return performance in 2021 and that has put us in a better funded position that we've been at in many years.

Really a good news story as of today on the pension side of things.

Alright, thank you.

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

Yeah.

Kathy David Todd Good morning.

I wanted to ask you if I could a capital deployment question.

In 2021.

You had adjusted.

Adjusted free cash flow of $3 1 billion, what you paid $4 7 billion of dividends and repurchases.

With respect to the long term care free cash flow guide and expectations to return.

The majority of free cash flow to shareholders I'm trying to get a sense of what majority means anti if your actions in 'twenty, one reflect how youre thinking long term about capital deployment.

For example, could you draw down the balance sheet cash a bit further given the.

Credit upgrade are you pointing any on retiring any more debt just was curious about.

Given your long term cash flow guide and how you might be thinking about capital deployment over the longer term.

Yeah, Thanks, Rich and let me just start with <unk>.

Last year, we had the I T.

Services divestiture, which generated cash, but we also deployed back into the business as we committed we would and so that's what drove that higher level of capital deployment opportunity even above our free cash flow in 2021.

Looking forward when we talk about the majority of our cash being returned to shareholders. We talked about at least one $5 billion of share repurchase this year and that is against a 2.6 system in points or so of our guide and free cash flow so the and of course.

Dividends on top of that which we have committed to continue paying a competitive dividend, which our board will take up again.

This year, so that gives you a sense of what we mean by majority.

There's also opportunity in that we have paid down debt and really solidified our balance sheet. So we currently have a cash balance that's higher than what we have stated our target to be which is around $2 billion and so that gives us some flexibility as we look at not only 2022, but beyond.

As well and we really don't have any major debt tranches coming to we have one in 2023 that we've outlined but we have flexibility on whether to refinance or to pay that at this point based on where our credit ratings.

So that's how we're thinking about capital deployment.

Okay.

Just real quick.

Your contract mix right now roughly 50 50 cost plus fixed price I'm. Just wondering if you can thinking longer term how do you think that might trend. When do you start might start thinking about when the portfolio starts leaning towards more fixed price contracts, because that's something that's a 'twenty three or possibly 24 event.

It gets a little higher over the next couple of years never significantly out of balance with that 50 50 ratio and then in 2025 is when we expect it to start to shift in the other direction.

Thanks, very much for all that I appreciate it.

We have time for one more question.

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

Hi, Good morning, this is actually touches on contract type Seth.

Seth asked about the longer term end of decade Aeronautics revenues I wanted to ask about the risk profile and classified aeronautics nearer term.

As certain programs transition from development to L. Rip and just especially in light of the cost pressures supply chain and so forth.

Thank you.

So as we look at our classified portfolio.

Just as we do on all of our programs we incorporate the low rate initial production lots that were priced into our.

Estimated complete process and so we're looking at that on an ongoing basis that risk is not only being monitored that reflected in our financial statements based on expectations as we know them today and so the production experience that we have even early on in test aircraft and that's all in.

Or how do we think about the low rate initial production lot.

Is there a way to talk about how the revenues transition in 'twenty two from cost plus to fixed price or is this all in 'twenty three.

So not a particular program level.

We do talk about that in aggregates and so as I said, our balance even in aeronautics being specific to the sector is about 50 50, and we expect that to continue to be the case in 2022.

So I think we are out of time I'm going to go ahead and wrap up thanks again for joining us today.

Again I wanted to thank our team also for another strong year in 2021 and for positioning us well for 2022 and beyond we have solid performance at our innovation and investments are positioning us to continue delivering the products that our customers want with the urgency that they need so thanks again for.

Your support we look forward to talking to you in April .

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

Yes.

[music].

Good day, ladies and gentlemen, and welcome to Northrop Grumman's fourth quarter here in 2020 . One conference call. Today's call is being recorded my name is Natalia and I will be your operator today.

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

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

Thank you and Italia and good morning, everyone and welcome to Northrop Grumman's fourth quarter 2021 conference call.

Today's call will include non-GAAP financial measures that are reconciled to our GAAP results in our earnings release.

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

Todd Good morning, everyone and thank you for joining US we delivered another year of solid operating performance in 2021 and positioned our business for continued growth in 2022, we are executing our strategy, which is to grow the business today and into the future maintain excellent performer.

<unk> and reduce costs to deliver strong margin rate and deploy our capital to create value.

We made significant progress in executing this strategy again in 2021.

Our organic sales growth for the year was 3% our segment operating margin was an exceptionally strong 11, 8%, which increased 40 basis points compared to 2020 with performance more than offsetting mix and COVID-19 related headwinds.

We grew our transaction adjusted EPS by 8% and generated a $3 1 billion of transaction adjusted free cash flow.

We strengthened our balance sheet retiring over $2 2 billion of debt during the year and achieving an increased credit rating in the process.

And we continue to invest in our business with over $1 $4 billion in capital expenditures to create new technologies and support franchise program.

We also continued to add to our portfolio of franchise program with competitive wins on programs like the integrated Battle command system or <unk> as well as hypersonic and ballistic tracking space sensor and next generation interceptor.

As we look forward to 'twenty, two and beyond we expect our organic growth will continue as we win new business and convert the robust backlog, we've built over the past several years into sales growth.

Further we expect strong margin performance as well as double digit free cash flow growth from 2022 through 2024.

2022 guidance reflects our confidence in our strategy, our broad portfolio and our ability to deliver continued growth and strong performance.

As reported the Covid pandemic continued to present challenges to labor availability parts supply and shipping delays across the economy, particularly in the second half of last year.

We have felt these effects and the challenges as both our supply chain and our own labor availability.

We will continue to take proactive steps to address such Covid risks, both to our employees and our business and.

And looking forward our current guidance reflects the factors, we know today and our best estimate for the remainder of the year.

It's going to provide more details on the quarter, the full year and our guidance interest a few minutes.

Turning now to the budget environment. The federal government continues to operate under a continuing resolution that currently run through February 18th.

Negotiations on the fiscal year 2022 appropriations bills are continuing and we remain optimistic that Congress will reach an agreement by the end of the first quarter.

The National Defense Authorization Act contained a $25 billion increase to the defense budget that represents 5% growth compared to fiscal year 2021.

Which we expect to also be supported in the appropriations Bill.

And finally, we expect the FY 'twenty three president's budget to be delivered to Congress in March of this year.

Reflecting this administration's priorities in areas such as mission system space missile defense advanced weapons EMS deterrent.

Focusing now on highlights in the quarter one of our proudest moments was the launch of the web based telescope on December 25th.

Northrop Grumman is the prime contractor for NASA on web and we're honored to have partnered with NASA to provide the world with this revolutionary technology.

Wed hope here more than $13 5 billion years into the past when the first stars and galaxies were formed ushering in an exciting new era of space observation and expanding our understanding of the universe.

In the fourth quarter the space sector received a $3 2 billion dollar award to support arguments mission four through eight.

Another important milestone in the quarter was the competitively awarded <unk> in our defense systems sector.

This program is a centerpiece of the U S Army modernization strategy for air and missile Defense and all domain command and control it's.

It's a prime example of our capabilities to integrate assets and the battle space, regardless of source service or domain.

This is one of many examples of how we are helping our customers share data between system and improve command and control in support of their chassis to vision.

In the area of missile defense, we have several milestones in the quarter, which position us to help our customers track and defend against hypersonic and ballistic missile threats.

In the fourth quarter, we announced that <unk> had passed its critical design review.

These satellites are planned to be part of a multi layered network of spacecraft that will detect and track hypersonic missiles.

Also in the quarter, we were selected by the missile Defense agency to design, a glide phase interceptor for regional hypersonic missile defense.

In the fourth quarter MFS received an accelerated award for up 16 favors for approximately $200 million.

And full year awards of approximately $700 million.

We have now received total contract awards for nearly a thousand radars for this program in support of the U S Air Force and National Guard as well as several international customers.

In addition, our network information systems business area within mission systems received approximately $1 billion in award for advanced processing solutions.

This portfolio delivers strategic microelectronics focused on high performance computing, and security, which helps our customers with connectivity and processing solutions.

We anticipate additional words in this segment of the portfolio for the next few years and we expect it will be a significant growth driver for MFS in 2022.

Finally in Aeronautics the military aircraft market is undergoing a transition of their customers focus their investment in next generation program, while divesting some legacy platforms.

As we've discussed certain programs in our portfolio at Aeronautics systems are maturing and experiencing headwinds.

But there are also a number of exciting new opportunities that are emerging.

This includes next generation manned aircraft as well as new unmanned opportunities, which U S Air Force Secretary Kendall recently announced.

In addition to pursuing these longer term opportunities, we remain focused on executing our program and delivering for our customers.

Another important aspect of our company's future is our strategy for sustainability.

We strongly believe that our environmental social and governance programs play an important role in sustainable profitable growth and long term value creation for our shareholders customers and employees.

Northrop Grumman is a leader in conservation activity with a 44% reduction in greenhouse gas emissions since 2010.

In the fourth quarter S&P released its global corporate sustainability assessment scores and we ranked in the 96 percentile.

We were included on the Delta in Sustainability Index, North America for the sixth consecutive year and we were included in the Dow Jones sustainability World Index for the first time.

Our ESG strategy also includes portfolio management actions.

As we've discussed on earnings calls last year, we committed to transition out of the small Adrian and surveillance contract that we have for cluster munitions and that contract is complete.

And while we continue to be an ammunition supplier as both a prime and the merchant supplier. We have made the decision to transition our prime role and depleted uranium. In addition to another provider. Following one final single production your contract.

Overall, we're making substantial progress in our ESG journey, and we look forward to sharing more in our upcoming sustainability anti CFT reports.

So with that I'll turn it over to Dave to provide more detail on our sector results and guidance and then I have a few additional comments before we move onto Q&A.

Great. Thanks, Cathy and good morning, everyone.

'twenty one was another strong year of performance for the company.

Before going through the details of our results and guidance I'd like to note a few items to keep in mind when comparing Q4 to the same period last year.

As we previewed in prior quarters, the divested it services business the equipment sale.

And for more working days in Q4 2020 represented over $1 6 billion of sales when compared to Q4 2021.

With that said sales per working day in 2021 were at their highest level in Q4.

Moving to sector results, we continued to see certain COVID-19 related effects on our labor and supply chain in Q4, and these effects were most significant in our aeronautics sector.

Q4 decline in sales was partially driven by fewer working days in the 2020 equipment sale.

So included the $93 million unfavorable EAC adjustments on F 35.

Turning to defense systems.

Sales declined in Q4, and 2021, primarily due to the it services divestiture organic sales were down 9% in Q4 and 4% for the full year driven by the completion of our contract with the Lake City ammunition plant, which generated almost $400 million of sales in 2020.

Mission systems organic sales were down 3% in the fourth quarter, primarily due to the reduction in working days.

Up 6% for the full year.

2021 sales were driven by increased volume on Gator GBS D Sabre J crew and restricted programs among others.

And lastly space systems, Q4, and full year organic sales rose by 6% and 24% respectively.

Continued to ramp significantly on franchise programs.

Including a $1 $1 billion increase on GBS D in 2021.

Growth was also driven by restricted space programs as well as in Gi and Artemis.

Moving to segment operating income and margin rate.

Operating margin decreased to eight 4% in the quarter.

Nine 7% for the full year due to the unfavorable EAC adjustments on F 35.

In our other three sectors segment operating margin rates met or exceeded the high end of our prior 2021 guidance ranges.

Vince systems operating margin rate increased 90 basis points to 12, 1% in the quarter and.

And 80 basis points to 12% for the full year.

Higher operating margin rate was largely due to improved performance as well as recent contracts completions.

Mission Systems' operating income grew in both periods.

As a result of higher EAC adjustments and business mix changes operating margin to 15, 9% in the fourth quarter and 15, 6% for the full year.

Space systems operating margin rate was nine 6% in the quarter and 10, 6% for the full year.

Favorable EAC adjustments from strong performance in commercial space programs helped offset mix pressures for the year.

Keep in mind that space along with Tsunamis.

Benefited from the pension related overhead benefits that we recognized in the first quarter of 2021.

At the total company level segment operating margin rate in the fourth quarter was the same as Q4 2020, even with the F 35 charge in 2021.

And it increased 40 basis points for the full year to 11, 8%.

Turning to EPS, our transaction adjusted EPS declined 9% from Q4, 2020, Q4, 2021, primarily due to lower sales volume from the factors I described earlier.

For the full year EPS, we exceeded the high end of the EPS guidance range, we provided in October <unk>.

Transaction adjusted EPS grew 8% in 2021 due to strong segment performance and lower corporate unallocated costs.

Lower corporate unallocated was driven by two items, we've discussed in prior quarters.

$60 million benefit from an insurance settlement related to the former orbital ATK business.

And lower state taxes.

Regarding our pension plan asset performance was strong again in 2021 at nearly 11%.

The third year in a row of double digit asset returns.

Our discount rate increased 30 basis points to 298%.

These factors resulted in a mark to market benefit of roughly $2 $4 billion in 2021.

In addition, our net pension funding status has improved by over $3 billion.

And on a <unk> basis is now over 93% funded.

We continue to project minimal cash pension contributions over the next several years.

Also summarized our pension cost estimates for the years 2022 through 2024.

Because recoveries are projected to continue declining over the planning period.

This causes an EPS headwind, particularly in 2022, it makes our rates more competitive products more affordable.

Our Cas prepayment credit is approximately $1 7 billion as of January one of this year.

Now turning to cash we generated nearly $3 6 billion of operating cash flow and $3 1 billion.

Transaction adjusted free cash flow in 2021.

Line with our expectations.

In the fourth quarter, we made our final federal and state tax payments associated with the ITC services divestiture of almost $200 million.

We also made our first payment of roughly $200 million.

Deferred payroll taxes from the cares Act legislation.

The remaining payment of the same amount will occur this December .

Looking ahead to 2022, our sector guidance as shown on slide nine this outlook assumes that appropriations bills are passed by the end of Q1.

It assumes a relatively consistent level of impact from the effects of COVID-19 that we experienced in 2021.

In Aeronautics we.

We expect sales in the mid to high $10 billion range as we noted last quarter.

<unk> headwinds in our <unk> portfolio as well as lower sales on Jay stores.

<unk> in our restricted business.

Sales on F 35 are expected to be slightly higher in 2021 due to the EAC adjustments, we booked in Q4.

We expect an EBITDA margin rate of approximately 10%, which is up 30 basis points year over year.

Operating margin rate is expected to remain very strong in the high 11% range.

Mission systems sales are projected to be in the mid $10 billion range up from $10 $1 billion of organic sales in 2021, reflecting continued strength in demand for our products.

Operating margin rate is expected in the low 15% range.

Space systems is expected to remain our fastest growing business.

And to become our largest segment in 2022.

Sales are projected in the mid $11 billion range up from up about $1 billion from 2021 with a margin rate in the low 10% range.

Turning to slide 10.

Total revenue guidance is $36 2 billion to $36 6 billion.

Representing a range of 2% to 3% organic growth consistent with the rate we estimated in October 2021.

This growth is enabled by our strong backlog, which stands at over 76 billion.

And covers more than two years of annual sales.

The 2021 book to Bill of <unk>, Nymex was lower than our prior expectation due to the S. F 35 award shift to 2022.

More importantly, our three year trailing average book to Bill is approximately one to two it remains the foundation of our current and future growth.

That's COVID-19 related headwinds that we experienced late in 2021 continue into early 2022.

We anticipate the first quarter 2022 sales will be less than 25% of the full year.

We have increased the segment operating margin rate outlook that we provided in October as we now expect a rate roughly consistent with 2021 in the range of 11, 7% to 11, 9%.

This projection reflects our continued disciplined approach to cost management and our efforts to offset mix headwinds with strong program performance.

Altogether, we expect transaction adjusted earnings per share to be between $24 50.

And $25 10.

Based on approximately 155 million weighted shares outstanding.

As shown on slide 11. This includes roughly $2 of year to year EPS headwinds from lower net pension benefits driven by the reduction in Cas recoveries and higher corporate unallocated expense due to the onetime benefits in 2021.

Earnings volume from sales growth strong operating margin performance and a lower share count will help to offset those non operational items.

We project 2022 transaction adjusted free cash flow of $2 5 billion to $2 8 billion.

Assuming the R&D tax amortization law is deferred or repealed we continue.

To project about $1 billion of higher cash taxes should current tax law will remain in effect.

As I mentioned, our cash tax outlook includes the final payroll tax payment from the cares act of approximately $200 million.

Capex is expected to remain roughly consistent with 2021 on an absolute dollar basis and slightly lower as a percentage of sales.

Slide 12 provides our longer term outlook on cash.

The midpoint of our 2022 transaction adjusted free cash flow guidance is $2 $65 billion and includes roughly $375 million of lower recoveries in 2021.

From there, we expect a double digit free cash flow CAGR through 2024, driven by operational performance lower Capex and the absence of the payroll tax headwind.

Our base case again assumes deferral of the R&D tax for all periods.

Speaking of taxes, we're projecting an effective tax rate of approximately 17% going forward roughly consistent with 2021, excluding the divestiture or mark to market pension effects.

Also we anticipate the resolution of an appeals process for certain open years of legacy OE Teekay tax filings in 2022.

Hosing, we're proud of our 2021 performance and we're focused on continuing to execute well in our business and financial strategy in 2022.

That I will turn the call back over to you Cathy.

In summary, we have strong franchise programs that are well aligned to budget priorities.

We're focused on capturing and investing in new growth opportunities, while also executing to drive earnings and cash flow growth we.

We delivered a solid set of results in 2021, and we are well positioned to continue growing and performing in 2022 and beyond.

Our top priority for cash deployment remain shareholder return, including a competitive dividend and share repurchases with that in mind. Our board of directors recently approved an increase in our share repurchase authorization of $2 billion and based on our outlook today, we plan on returning at least one 5 billion.

To shareholders via share repurchase in 2022.

Before turning to your questions I'd like to thank the Northrop Grumman team for delivering solid operational results with dedication and perseverance, we have extraordinary talent and this includes our leadership team.

As we announced in November Blake Larson is retiring after a 40 year career with Northrop Grumman and its heritage companies.

Blake has helped to position our space business for incredible growth.

And as important our focus on performance and quality.

We are grateful for his contributions to our company and our country.

And I'd also like to welcome Tom Wilson to my leadership team as he succeeds Blake <unk>.

Tom brings strong experience in the space market. He was part of the space team and I'm confident in his ability to lead this business.

So with that we'll go ahead and open the call up for questions Natalya back to you.

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.

Please limit your questions to one question and one follow up if your question has been answered or if you wish to ask the questions queue press the pound key to exit the queue.

Press Star zero at anytime for operator assistance.

Yes.

Your first question is from the line of Kristine <unk> with Morgan Stanley .

Thanks.

Kathy can you elaborate more on the labor and supply chain issues experienced in the quarter at Aeronautics.

Are these the same issues flagged last year.

How long do you expect these issues to persist.

Employee safety is our first priority, we encourage people to be out of work if they're experiencing any symptoms and we also isolate people who have been in close contact and so as a result absenteeism has been higher than these searches and it has an impact, particularly in our high rate high volume production line.

Talked specifically about the impact to that program.

The rest of the business, it's not that we are experiencing the same conditions, but we're able to mitigate.

Better and you'll see less of a pronounced impact in any one period, but certainly we would have expected to see a stronger fourth quarter topline had we not experienced those two searches.

Confirmation that we plan to exit depleted uranium ammo.

<unk> parts of the portfolio that we no longer wanted to support directly.

Your next question is from the line of Seth <unk> with Jpmorgan.

Okay, Thanks, very much and good morning.

I Wonder if you could talk a little bit about.

Where aeronautics goes from here and.

How much the headwinds that are coming in 2020 to persist into the out years and then.

At the risk of asking about a classified program when we think further out towards the middle of the decade and beyond.

Every place that you are a prime contractor gets up to kind of the expected full rates of production.

In very rough and <unk>.

Qualitative terms.

<unk>.

What that means in terms of the aeronautics topline several years down the line.

Thanks, Seth So I'll start and then Steve to provide a little more color and specificity.

See our aeronautics sector.

Having.

Headwinds this year that will dissipate going into 2023. So we don't expect the same level of decline as we move into next year.

And then that trend reversing in the 2024 time frame and I won't point to any particular program, but it is at that point in time that we expect.

Some.

The trajectory for top line, but we also see their margin rate progressively improving over that period as well. So that gives you the macro view, Dave anything you'd like to add to that.

I think you covered it well Kathy.

22 outlook is consistent both in.

The mid single digit decline in the sources of that decline with what we talked about in recent calls.

As you pointed out we expect 'twenty three to be more stable.

Growth opportunities beyond that.

Thing I'd point out is we're very focused on managing the business well in the meantime cost management.

Managing our capital expenditures and so.

We're focused on execution and delivery every day in that business and looking to optimize that outlook.

Okay great.

One this morning, thanks very much thanks Beth.

Your next question is from the line of Sheila <unk> with Jefferies.

Hey, good morning, everyone and thank you.

Kathy Thanks for the Aeronautics color I was wondering if maybe we could transition does space and if you could bridge us on the growth for space. It seemed like GBS D with maybe more additive in 2021 than prior expectations. So how do we think about that growth cadence and how do we think about the balance of growth across the other.

The space portfolio.

So in GBS see Hudson, a significant component of our growth in the last two years and we expect that to start to level out, but GBS cedar continues to be a growth element in space for the foreseeable future.

But with that said Youre right to point out that there was significant growth in the rest of the space portfolio as well balancing about 50 50 with GBS seeing contributing last year and we expect that same trend to continue this year with a $1 billion or so of sales growth that we're projecting in space.

And that really is broad based growth, it's coming from all areas of the business of propulsion satellites as well as component is coming from both restricted and classified work as well as the unclassified work and it's coming from a variety of customers.

For sealed air force as well as NASA as I highlighted today. So we really are seeing base growth to be quite balanced.

Even in 2023 or 2022, but even more so as we look forward to 2023, and we expect it to continue to be one of if not the fastest growing sector for the foreseeable future.

Great. Thank you.

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

Yes, good morning.

Yes, I was wondering if you could speak to if you've seen some of the <unk>.

Harold help portfolio assets, maybe some of the legacy stuff.

To fade away are there opportunities to replace that.

Whats out there in that world because it's hard to believe that.

Asset classes, just going to go away. So if you could speak to.

Are there opportunities for Northrop Grumman to replace those assets in the future.

Winds, where the plant how we more of Triton and the production pause and then the global Hawk Hot phasing out but the reality is autonomous systems are still an important part of both the U S Air Force and U S Navy strategies going forward as well as an important asset in the portfolio for our international customers. So we see that mark.

It is continuing to evolve with some specificity to your question I mentioned earlier in this call that the U S. Air Force Secretary Kendall has recently been more specific about launching some new effort in unmanned systems within the Air Force and we do see those as <unk>.

Opportunities that we will pursue so they're starting to be some more meat on the bones as to what those specific opportunities will be but we do see the market is continuing to be attractive.

Great. Thank you.

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

Thank you good morning.

You gave guidance today for cash free cash flow in 2022 23 2024.

And.

23, and 'twenty four.

Yes.

Hey, Doug, it's Dave I'm happy to dig into that I appreciate the question.

You will find today's outlook is consistent again with what we had projected at a higher level on our October call I think it's important to provide some context when we talk about our free cash flow outlook over these next few years Ortez pension reimbursements were over $800 million.

Just two years ago in 2020.

Along with much improved funded status on the <unk>.

<unk> side and that's the primary driver of the change over the last couple of years, but what that does for US is create a great foundation for us in 'twenty two to build off of and grow more rapidly over the next few years and that supports that 10 plus percent CAGR. We've been talking about so 21 free cash flow was around $3 1 billion and as we talked about <unk>.

<unk> is down almost $400 million in 'twenty two from 'twenty one.

The working capital assumption over the next year is roughly unchanged.

Similar in 'twenty, three before creating more opportunity in 'twenty four and beyond we.

We talked a bit about the payroll tax deferral that ends with a payment in late 'twenty. Two so that two creates a tailwind as we enter two three and four.

And the other is around lower capex, as we get into particularly 'twenty four and beyond so.

So of course, the corollary there as that puts us in a nice position to be able to return a healthy volume of cash to our shareholders and we've noted on this call and others.

It remains our top priority for cash deployment over the next couple of years with a 1 billion and a half as our repo target in 2022 for example, so well.

Wouldn't read too carefully into a specific sales or margin target in these out years related to cash will get more into that guidance as we get closer to those years, certainly will look to continue to grow the company and deliver strong performance along the way.

Okay.

Go ahead seconds or heart of what you are asking is what is our outlook and while we're not going to provide specific numbers as Dave said I'll.

You pointed to some of the comments that I made we expect continued top line growth in this business beyond 2022, and we expect the earnings expansion and so those are factored in both to our 2023 and 2020 for expectations for cash and you can draw some conclusions that we see an accelerated.

<unk> profile going from 23 into 'twenty four.

On earnings.

That would be a fair assumption to make as well based on what we've outlined for you.

And then just as a follow up with one piece of this if I go back a few years.

Missiles was one of the hottest areas in the budget.

And I know we've had this discussion around it really Northrop Grumman and working to become a third missile supplier.

But over that time period.

We've seen essentially missile budgets turnover and legacy certainly a lot of the large legacy programs.

Demand is considerably less.

<unk> got some important programs now in missiles development programs, but how do you see that market is this still the same kind of opportunity you were looking at a few years ago.

You know Doug when we were looking at this a few years ago I would say our expectations.

We're balanced between space and missile.

And what we've seen is spaces outperformed our expectation missiles has been more in line to date with expectation, maybe not as much opportunity as well.

We project out into the out years that faces more than offsetting that and we've always gotten a return on investment I will say that we continue to be a strong merchant supplier in the missile space. So as that market continues to grow and expand and we do expect it will particularly in hyperscale.

We are partnered with the larger weapons providers to provide them important components that both weapons system and so.

By no means believes that our return on investment is not maturing in the weapons space. It's just maturing work quickly.

More significantly in Spain.

Okay, great. Thank you.

Your next question is from the line of Robert Stallard with vertical research.

Thanks, so much good morning.

Good morning.

I'd like to follow up on Doug's question really on that slide 12, and you've got that some protected.

Projected large pickup in free cash flow in 2024, and I'm wondering if you could maybe qualitatively Tivoli walk through what some of the moving parts are the leading to that particularly strong growth in a couple of years' time.

Sure happy to I mentioned that the.

The 10 plus percent CAGR over the next couple of years really shows up particularly strongly in that 2024.

Timeline and that's for a couple of the reasons that we've described and I'll go into a bit more detail on those one is around our expectation of lower capex in 2024, we've talked about that coming down gradually as a percentage of sales and we start to see that in R 22, and three guidance.

As we get to 'twenty four we expect that to continue to come down on a dollar basis and a percentage of sales as we see.

The level of demand for cabin beginning to.

The decline a bit further in 'twenty four.

Working capital side, we have a quite a few programs obviously none of them.

Of too much significance in the overall.

Sales or balance sheet of the company, but when we aggregate all that we see more opportunity for working capital.

Efficiency drives in the 24 timeline.

Than we do in 'twenty, two 'twenty three given the timing of some particular performance based payments and milestones and incentives. So we're excited about the opportunity as we look at 'twenty four and beyond for.

For free cash improvement and of course for the.

The flexibility that that provides us on the deployment side as well I mentioned, the other factor earlier, which is more.

Just the timing of the payroll tax deferral that we had the benefit in.

In 2020 that we're now paying half of in 'twenty, one and 'twenty two so that's the only kind of unique items.

Add to that mix.

Hope that helps okay. Yes, that's helpful. So it doesn't sound like anything really on the operation side.

Massively accelerating in 2004, it sort of nonoperating items.

I think thats, a good way to characterize it I think cathy covered well our expectations for growth and performance over the next couple of years and these.

Cash flow timing issues are layered on to the outlook, yes, Okay. And then just a quick follow up on the cash you.

Yes. Thanks for the follow up question on that I should note is.

Approximately 20% lower per year after 2022, not exactly given some of the.

Resolving 60 174 through deferral of repeal in the meantime, there continues to be good broad broad bipartisan support for doing so it's really just a matter of finding the right legislative vehicle and of course that has proven challenging so far so that's why we wanted to give you.

A sense for that.

Volume on today's call.

Your next question is from the line of Noah <unk> with Goldman Sachs.

Hi, good morning, everybody.

Morning.

The profit margins in space have come down as you layered in a significant amount of new revenue.

As the growth rate sort of transitions there how should we think about.

How much recover you could see in the profitability in that business.

So no one is.

I look at that business, we continue to layer in new development work, we talked about a few of those things today, but by foods interceptor.

In Gi program and so it's not just the GBS the phenomena that is causing that mix headwind, but as GBS D transition from a development phase even into the early stages of production, we would expect to see that need the biggest driver.

Yeah.

Tailwind to margin rate and that happens around the middle of the decade in the meantime.

<unk> continues to perform exceptionally well and the margin rates for our base business are very solid in comparison to others. So we're really pleased without performance.

We in all of this development work.

I believe that we can maintain those rates in line with what we have projected for 2022.

See increases towards the middle of the decade.

Great understood.

And then Dave just quickly following up on that.

On the free cash flow math.

If I take.

Each of the years, you've now provided back out the Capex and then back out all the pension inputs you've provided.

Which sort of gets to a clean number relative to the business segments, excluding anything with cash tax or working capital.

That number relative as a ratio of the business segments is pretty low compared to where you've been in the past. So that would indicate that you are specifically assuming.

Our working capital headwind.

Or some other headwind.

Outside of the business segments is that the case or is my math wrong.

Sure happy to get into those details.

Their time, if you'd like to.

Dig further it could be easier with the same numbers in front of US right exactly in aggregate I think the important headline here is we've had great working capital performance over the last couple of years, we project more stable working capital performance over the next couple of years before seeing that opportunity expand again in 2024, and I think that may be.

The summary of what what Youre seeing is after a couple of years of just outstanding working capital performance, especially in 2020, when we have things like the progress payment improvement.

And other tail winds from the kind of.

Street perspective on on cash we are in a more normalized period in 2022, and 2023 before seeing that opportunity expand again in 'twenty four so again happy to follow up.

That gives you a feel for it.

But it is not youre not assuming an actual incremental working capital headwind 'twenty two 'twenty three it's just sort of relatively no change year over year.

Yes, that's correct okay.

Okay. Thanks, so much.

Thank you. Our next question is from the line of Cai von <unk> with Cowen and company.

Yes. Thank you so much so I mean, it's pretty clear that in space. Your mix is shifting towards the GBS and.

You saw a reversal in 'twenty four but you mentioned dissipation in 23 of headwinds.

I read dissipation, meaning that margins can get better in 'twenty three but those dissipation mean, it's just going to go down but not quite at the same level. So I guess the <unk>.

Bottom line is for that.

Looking at the total company 2425, we can see the margins maybe get better, but maybe they are flat to down over the next two years is that a fair assessment.

Yeah.

At the company level.

What we are seeing is continued growth on the topline and margin expansion opportunity but.

Just as we've demonstrated right we've seen 40 basis points of improvement going from 'twenty to 'twenty. One as we look at 2022, we're holding that range constant with where we ended 2021 and that's largely because we have offset these mix pressures as we've brought more development work into the portfolio and so.

We are suggesting is that that would continue to be the case until we move the mix more in the direction of production, but we are having performance improvements and cost efficiencies that are providing tailwind on margin right. So you would expect us to continue to.

Work those levers.

With this current mix.

And we see opportunity for margin, even as we look into 2023.

Thank you very much.

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

Hey, good morning.

Kathy I was wondering if you could comment on the backlog and bookings opportunities in 'twenty two and.

<unk> 35 in Gi I imagine you're a big movers, there, but do you expect the year to end at a higher backlog and then Dave just a clarification on the $1 7 billion of prepaid credit.

Clear that you ever recover that based on the slide of funding and Cas recoveries can you just clarify.

Thanks, Myles I'll start with your question about.

Year 'twenty, two awards and backlog expectation, we do not expect to have book to Bill of one and 2022, we see fewer new competitive opportunities. This year, it's just timing.

And we also see fewer multiyear award with the exception being the.

F 35 award, which has pushed into this year.

We tend not to focus so much on singular year.

Book to bill, but instead, a longer term view because we have so many multiyear awards.

Dave mentioned when we look at the last three years, our average book to Bill was 122. So it established a really strong foundation for us to continue to grow as we look at this year, we still expect to in this year with a four year trailing average of over one one.

So it just gives you a sense that we expect to not only have a strong backlog, but an average book to bill that continues to support the growth that we are.

Outlining into the future.

And then just briefly on the $1 $7 billion as prepayment credit. We show you. The next three years of current projections.

In a multi decade future for our pension plans, both from a Fas and Cas perspective, and so wouldn't indicate that wed expect that to be final are resolved over the next.

Three years in this particular forecast period, we've got many many years.

Ahead of US there are a lot of market movement ahead of us there, but I think the bottom line on the pension side is where we're really.

Enthusiastic about the continued.

Double digit return performance in 2021 and that has put us in a better funded position that we've been at in many years. So.

Really a good news story as of today on the pension side of things.

Alright, thank you.

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

Kathy David Todd Good morning.

I wanted to ask you a quick credit capital deployment question.

<unk>.

In 2021.

You had adjusted.

Adjusted free cash flow of $3 $1 billion, but you paid $4 7 billion in dividends and repurchases.

With respect to the long term care free cash flow guide and expectations to return.

The majority of free cash flow to shareholders I'm trying to get a sense of what majority means and if your actions in 'twenty, one reflect how youre thinking long term about capital deployment.

For example, could you draw down the balance sheet cash a bit further.

Given the recent credit upgrades are you pointing any on retiring any more that just was curious about.

Given your long term cash flow guide, how you might be thinking about capital deployment over the longer term.

Yes, Thanks, Rich and let me just start with this past year, we had the surge.

Cash being returned to shareholders, we talked about at least one $5 billion of share repurchase this year and that is against the <unk>.

2.6 system at that point or so of our guide in free cash flow. So the and of course dividends on top of that which we have committed to continue paying a competitive dividend, which our board will take up again.

Early this year. So that gives you a sense of what we mean by majority.

And as well and we really don't have any major debt tranches coming to we have one in 2023 that we've outlined but we have flexibility on whether to refinance or to pay that at this point based on where our credit ratings.

So that's how we're thinking about capital deployment.

Okay.

Just real quick.

Your contract mix right now roughly 50 50 cost plus fixed price I'm. Just wondering if you can thinking longer term how do you think that might trend. When you start might start thinking about when the portfolio starts leaning towards more fixed price contracts, because that's something that's a 'twenty three or possibly 24 event.

It gets a little higher over the next couple of years never significantly out of balance with that 50 50 ratio and then in 2025 is when we expect it to start to shift in the other direction.

Thanks, very much for all that I appreciate it.

All right we have time for one more question.

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

Hi, Good morning, this is actually touches on contract type.

Jeff asked about the longer term end of decade Aeronautics revenues I wanted to ask about the risk profile and classified aeronautics nearer term as certain programs transition from development to L. Rip and just especially in light of the cost pressures supply chain and so forth.

Thank you.

So as we look at our classified portfolio.

Just as we do on all of our programs we incorporate the low rate initial production lots that were priced into our SD.

The complete process and so we're looking at that on an ongoing basis that risk is not only being monitored that reflected in our financial statements based on expectations as we know them today and so the production experience that we have even early on in test aircraft and that's all in.

Or how do we think about the low rate initial production lot.

Is there a way to talk about how the revenues transition in 'twenty two from cost plus to fixed price or is this all in 'twenty three.

So not a particular program level, but we do talk about that in aggregate and so as I said, our balance even in aeronautics being specific to the sector is about 50 50, and we expect that to continue.

Continue to be the case in 2022.

So I think we are out of time I'm going to go ahead and wrap up thanks again for joining us today.

I wanted to thank our team also for another strong year in 2021 and for positioning us well for 2022 and beyond we had solid performance at our innovation and investments are positioning us to continue delivering the products that our customers want with the urgency that they need so thanks again for your <unk>.

Support we look forward to talking to you in April .

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

Q4 2021 Northrop Grumman Corp Earnings Call

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