Q3 2022 Northrop Grumman Corp Earnings Call

October 27, 2022

Good day, ladies and gentlemen, and welcome to the Northrop Grumman third quarter 2022 Conference call. Today's call is being recorded my name is Michelle and I will be your operator today.

At this time all participants are in a listen only mode I would like to turn the call over to your host Mr. Todd Ernst Treasurer, and Vice President Investor Relations. Mr. Ernst. Please proceed thanks.

Before we start matters discussed on today's call, including guidance and outlooks for 2022 and beyond reflect the company's judgment based on information available at the time of this call may 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.

On the call today are Kathy Warden, our chair CEO , and President and Dave Keffer, Our CFO at this time I'd like to turn the call over to Kathy Kathy. Thanks, Todd Good morning, everyone. Thank you for joining us.

The Northrop Grumman team delivered another quarter of solid performance our top line returned to growth with continued strong execution.

For our products remains robust with a book to bill ratio of near one, including a number of key awards in our restricted and missile defense portfolios.

And we remain on track to deliver strong results for the year with growth expected to accelerate as we look toward next year.

Taking a step back for a moment from the quarter I'd like to start with an update on the global security environment.

Earlier this month the Biden administration released its full version of the National Security strategy, which is used as a guide for policy and budget decisions with.

Strategy spotlights, the dynamic and challenging threat landscape around the world and stresses the importance of working with allies, maintaining a strong industrial base and continuing to invest in advanced technology.

It also reinforces the triad is a top priority.

So it's clear that Northrop grumman's portfolio continues to be extremely well aligned with the requirements outlined in the national security strategy.

As reflected in the administration's fiscal year 2023 budget request, which showed alignment with these priorities and strong support for many of our key program.

Throughout this summer congressional committees marked up the administration's defense budget request generally increasing the proposed level of funding with the intent of strengthening the country's defense posture and addressing the impacts of inflation.

Based on these additions we believe that the ultimate fiscal year 'twenty three base defense budget will be higher than the President's budget request and as you know we started off this fiscal year in another continuing resolution, which currently extends to mid December and this is factored into our guidance.

We are confident in our program funding positions and hopeful that the annual budget will be passed by year end.

In the Asia Pacific region, we've seen similar interests and air and missile defense as well as maritime ISR advanced radar and other mission system.

All of this points to a strong demand environment for Northrop Grumman.

And we're doing our part by investing in solutions and capacity to address many of our customers' most pressing needs.

This year, we expect to invest over $2 5 billion in Capex and research and development.

And as a result, we are winning new business and bolstering our backlog for long term growth.

Our backlog has increased year to date in each of our four segments and is up nearly 5% overall.

Given that we now expect that our full year 2022 book to Bill ratio will be over one a significant improvement from where we started the year.

This increase is attributed not only to the robust defense budget environment, but also a strong competitive win rate.

That said, we recognize that our industry and many others are experiencing macroeconomic volatility that we haven't seen in decades.

Inflation remains at 40 year highs lead times have been extended in certain areas of our supply chain and the labor market shows signs of easing, but it remains tight for critical skill.

Our team is tackling these challenges keeping our focus on our people and performance and driving efficiencies across the business.

In the labor market, we've driven improvements in hiring and retention over the past several months, which Dave will describe in more detail.

This was instrumental in our return to growth in the third quarter and it's worth noting that this favorable trend has continued into the fourth quarter as well.

This supports our full year 2022 guidance and our outlook for accelerated sales in 2023.

In the supply chain, we continue to experience disruption and delayed deliveries in certain areas of our business, which we have there has been a headwind to growth.

It's the risk that we're closely monitoring and we're working with our suppliers to mitigate but we do anticipate that supply chain challenges will continue in 2023 and this is now reflected into our 2023 outlook.

Elevated inflation levels in both labor and supply chain has persisted more than expected as we came into this year.

To address this we are implementing operational efficiencies and working with many of our customers on program funding and other contract actions to support the health of the defense industrial base.

We believe this balanced approach is the best solution to allow continued investment in the capabilities that support our customers' missions.

With that said, we see it as a temporal challenges and remain committed to driving our segment margin rates higher over time.

Turning now to the execution of our long term strategy one of the key elements of our strategy is a relentless focus on performance.

That's why I was particularly pleased to receive the 2022 stemming Cup for operational excellence on behalf of Northrop Grumman earlier this week.

The award recognizes our achievements in leadership and creating a culture of operational excellence and continuous improvement across the company.

Our customers recognize this commitment.

Have entrusted us to deliver some of the most technologically advanced next generation systems and solutions.

The B 21, greater is one such example, and were excited to unveil the aircrafts to the public on December 2nd.

The B 21 outstanding performance can be directly tied to our company's investment in digital tools and facilities and the incredible U S Air Force and Northrop Grumman team, who are developing the sixth generation platform.

The program continues to progress through testing in preparation for first flight in 2023.

Last month, we announced the data sharing agreement on B 21, enhancing data access and collaboration across the programs, including the launch of a shared environment for the B 21 digital twin.

This data sharing agreement enhances our partnership with the Air Force and further demonstrates our digital maturity on the program.

Our mission systems solutions are another area of our portfolio, where innovation is critical to success.

Where the fast pace of threats of new technologies is driving the need for platforms and sensors to be able to connect with one another share data and be part of a broader family of systems.

In this growing market, we are building on our strong position in sensors secure communications and networking to compete for and win new opportunities.

For example, last month, we were selected to be a member of the Air Force's Abms digital infrastructure consortium.

We continued to strengthen our position in this area with a $1 $3 billion ground based midcourse defense weapons system Award in the third quarter.

And turning to our weapons business I am pleased to share that we've now delivered more than 100000 precision guidance kits to the U S Army.

This program is one of several hypersonic opportunities within our portfolio.

So now I'll turn it over to Dave who will provide more color on our Q3 results and touch on our expectations for 2023, Dave.

Thanks, Kathy and good morning, everyone. As you heard from Kathy we delivered solid results across all key metrics in Q3.

We're reaching an inflection point in our sales growth driven by the strength in the demand environment, our new business performance and our success in hiring and retaining employees.

We had another strong quarter for bookings with roughly $8 7 billion in awards.

Tribute to our year to date book to Bill ratio of 114, and an increase in our full year book to Bill expectations.

Our Q3 top line results of roughly $9 billion were up sequentially from Q2 and up about 3% compared with the third quarter of 2021.

This acceleration has been driven by our positive hiring trends.

We added nearly 1000 net new employees in Q2, and we added an additional 2700 plus people in Q3.

With continued positive hiring and retention results, we've improved our labor driven sales visibility. So the supply base is now the key to achieving our full year sales outlook.

We're seeing temporal challenges in the supply chain as our most others, including longer lead times and higher costs in some areas.

Our suppliers are a critical element of the defense industrial base and we are closely monitoring small businesses, who are the most vulnerable to the challenges of this macroeconomic environment, particularly inflation.

We're encouraged by recent comments from Congress on this topic.

And we're actively working with our customers to help mitigate inflationary effects on our contracts.

<unk> those being felt by our suppliers.

Our program execution remains solid in the quarter with segment margins of 11, 2%, reflecting lower net EAC adjustments due in part to the inflationary pressures that we've noted.

As costs have remained elevated.

We've captured our latest estimates of inflation and opportunities to mitigate it.

Ics et.

Is that a downward effect on our margins in Q3, but year to date. Our segment margins are 11, 7% and we continue to expect the full year rate to be in the range of 11, 7% to 11, 9%.

Turning to earnings per share are diluted EPS in the quarter were $5 89.

The year over year earnings decline was driven by non operational factors, including lower net pension income and <unk>.

Favorable returns in our marketable securities.

And then insurance settlement for $60 million that was recognized in the third quarter of 2021.

Together these items represented roughly 85.

Of year over year EPS headwinds.

As I pointed out our businesses continue to execute very well in a complex environment.

In terms of cash we generated outstanding operational cash flows in the third quarter of over $1 3 billion.

And we expect Q4 to be even better.

This is consistent with our historical pattern of collections and disbursements.

In the quarter, we made our third test tax payment associated with the R&D amortization law of approximately $220 million and we continue to expect roughly $1 billion in cash tax payments related to R&D for the full year.

Through the end of Q3, we completed over $1 billion in share.

Purchases and we're on track for an additional $500 million in the fourth quarter.

Now moving to 2022 guidance, we have not changed our sales earnings or cash outlooks. So.

The foundation for our strong financial performance starts with the continued demand we're seeing for our products.

We are increasing our expectation for book to Bill again, this quarter to greater than one times, which is a significant improvement from our original expectation.

<unk> team has done an outstanding job of serving as a trusted partner to our customers and winning new business.

We're maintaining our original guidance for the top line.

And based on year to date results. We continue to expect our full year sales to be around the low end of the range consistent with the trends we described last quarter.

Our full year outlook implies Q4 sales of roughly $9 6 billion.

Which represents excellent sequential and year over year growth as.

As we've noted throughout the year, we anticipate that Q4 will include a strong volume of material receipts across each of our four segments.

We're also maintaining our guidance for the bottom line, including segment Om rate and earnings per share.

Given the 2022 sales volume will be around the low end of the range, we expect EPS to be near the low end of its range also.

Within our earnings outlook, we're accounting for continued year to date pressure on our marketable securities portfolio.

Set by an anticipated federal tax rate benefit in Q4.

Our marketable securities are down nearly $100 million in 2022, which represents about 50 of earnings per share pressure.

The income tax line, we have lowered our effective rate expectation from 17% to 15, 5%, reflecting progress in resolving matters related to historical filings and one of our businesses.

We currently expect those matters to be concluded in Q4.

Resulting in about 50 cents of EPS benefit that offset the marketable securities pressure.

It's also possible that the tax item could be resolved in Q1, which would shift the benefit from 2022 into 2023.

Moving to cash flows while we remain optimistic that Congress will repeal or defer the R&D amortization law, we have focused our free cash flow guidance. This year on the current tax loss scenario, which is unchanged from last quarter.

If the law is deferred or repealed in Q4, we would expect a one time spike in state taxes recognized in corporate unallocated expense as well as the cash refunds in 2023.

Operationally, we're very pleased with the progress we made in cash flows in Q3.

Bolstering our confidence in the full year outlook.

Next I'd like to take a few moments to describe the outlook for our pension plans.

Most importantly, our current funded status remains strong and roughly unchanged year to date.

And the cash flow implications of Kaz changes over the next several years provide a modest benefit.

The GAAP income statement effects. All described today are noncash in nature.

Year to date, our plans have experienced double digit negative returns and discount rates have risen nearly 250 basis points.

This combination of results will affect our GAAP earnings in future years, So I'd like to take a moment to discuss what our 2023 net pension income would look like under various scenarios.

In January we provided a sensitivity table in our earnings call deck related to changes in discount rates and asset returns on our non service pension income.

Based on the high level of volatility of the pension funds have experienced so far this year I wanted to provide a grid of potential outcome, but also incorporates Fas service expense and cash costs, which can be found on slide nine of our presentation today.

Self calibrate you to this slide we've highlighted the 2023 pension estimates provided in January which were based on expected 2022 asset returns of seven 5% in a year end discount rate of roughly 3%.

Given the year to date asset returns and discount rates at the end of Q3, we would expect significantly lower net <unk> pension income in 2023.

Currently in the range of over $900 million less than our previous projections.

As I have described this lower net <unk> pension income is noncash in nature overtime higher Cas recoveries would lead to modestly higher cash flow related to our pension.

I also wanted to provide additional insights on our high level financial outlook for 2023.

Note that this is predicated on our current expectations regarding the macro environment.

As Kathy said, we expect strong demand to continue into 2023.

In terms of hiring and retention trends.

Now shared a few times, we've seen improvements since the beginning of 2022 and we anticipate that this will remain consistent next year.

In the supply chain, where the environment has remained challenging with various delays and disruptions. We projected those challenges will continue throughout 2023 and.

And with regard to inflation, which has been more persistent in 'twenty two than originally expected.

Our projections incorporate gradual easing based on the latest industry labor and material indices.

As Cathie described we continue to expect our sales growth to accelerate next year building on the momentum we've driven in 2022 in total we expect sales growth in the 4% to 5% range based on our low $36 billion expectation for 2022 that would put us in the high $37 billion range.

2023.

Within our segments, we continue to expect space to remain our fastest growing business.

With sales growing by another $1 billion over 2022.

We expect strong strong sales growth in EMS in the mid single digit range and we anticipate sales at <unk> to be flattish compared with their latest 2022 levels.

We also expect to generate solid segment margin rates as I've described net EAC improvements are likely to be later than usual until inflation begins to normalize. So we would expect our segment Om rate, which would otherwise have been projected in the high 11% range next year to be between the mid 11% in the high 11%.

With regard to earnings pension income will be a noncash headwind as quantified on slide nine, but excluding pension we expect our earnings per share to grow faster than sales in 2023, driven by continued strong execution and a lower share count.

We expect our tax rate to return to its more normal level of around 17% next year.

And we continue to generate excellent cash flows with our prior three year cash outlook intact and another year of free cash flow growth expected in 2025.

We anticipate modest increases to our prior capex projections based on the strength of this years, new business wins and backlog growth offset by corresponding improvements in operating cash flows.

We're very proud of the performance we've delivered this year and a continued challenging environment.

And we're pleased with our projected growth acceleration in the second half of 2022 and in 2023.

With our multiyear cash flow outlook intact, we're looking forward to continuing to create value for our customers and shareholders.

That we are ready for your questions.

Thank you to ask a question you May press star one on your telephone.

So if you please limit yourself to one question and one follow up question. Please standby, while we compile the Q&A roster.

Our first question comes from the line of Doug Harter with Bernstein. Your line is open. Please go ahead.

Good morning, Thank you.

Hi.

You talked about supply chain here and that's obviously an issue sort of across the board is it is it possible to look at the constraints you had from the supply chain and give us a sense.

Of what.

The quarter and the year might have looked like.

As you not had those constraints.

We're just trying to figure out.

What sort of normal would be and how much is being held back.

Good morning, and thanks for the question supply chain, certainly is central to not only the remainder of this year, but next so let me try to characterize not particularly in numerical terms, but.

More or less quantitative terms, what we have been seeing.

It is in particular areas of the supply chain. So it is not widespread but it's in areas that are important.

Yes components to our development program in particular, where we have seen delays then result in impact to those development effort and so its the timing of sales not necessarily a deferment of sales. If you will and this year I would point to our 2020.

To original guidance, which was our expectation with either minimal or no supply chain disruption because when we put that plan together late last year, we were not anticipating the level of supply chain disruption, nor the duration of supply chain disruption that we've experienced.

Throughout the year, we pointed to now to the low end of our sales guidance and I would say the best way to think quantitatively about the impact we would have expected to be on the high end of that guidance had we not experienced these supply chain disruption now I do want to point out and we said it in the call that.

We expect these challenges to persist into 2023, so when I talk about timing, we do not expect all of what we experienced in 2022 to recover by the end of 2023, we expect it.

<unk> to be a bit sticky for the next year, we do expect them to resolve in the 18 to 24 months timeframe.

And as you go into 2023.

You said in the outlook.

This is expected to be up by about a $1 billion.

That.

Got it.

So.

Can you help us understand what the drivers are in those two two units that lead to somewhat different results. Obviously, you have huge backlogs in space, but just trying to understand that.

As to the trajectory.

Sure Doug I'm happy to shed some light on that in both cases those trends are consistent with what we've communicated previously and the drivers are therefore, consistent as well starting in Aaas.

We project.

Table 2023, given the anticipated growth in programs, including B 21, but then offset by.

Modest declines in programs like the.

Legacy programs in the <unk> portfolio joint stars et cetera.

The modest decline in F 18 likely over the next couple of years. So again continuation of trends, we've been talking about for a while and we continue to anticipate.

Growth recovery in 2024 for that business in space the expansion and the growth opportunity is broad based across multiple orbits.

Across multiple mission areas.

For missile tracking to ISR growth in our support of launch capabilities.

It's really an outstanding.

<unk>.

Performance for US recently on the growth side you see.

Growing market, but growth also in our market share.

Of course, GBS D as a contributor to that growth, but by no means the only one each.

Each of our divisions and that business is growing at a nice clip. So we're really pleased to be able to continue that outlook in 'twenty three.

Great. Thank you.

Thank you and one moment for our next question.

Yes.

And our next question comes from the line of Ronald Epstein with Bank of America. Your line is open. Please go ahead.

Yes, good morning.

Maybe just.

Question on capital deployment.

Going to be generating a lot of cash right you pointed that out.

What's your plan to do with that into next year is there is it just share buybacks or is there some selected M&A or how are you thinking about that.

So our plans for capital deployment are still aligned with what we've been saying all year, our balanced approach to capital deployment is still investing in supporting the growth of the business that we've experienced which as we said has been even more robust than we anticipated coming into this year not just because demand is higher but we have been.

Quite successful and competitive win so we will continue to invest to be able to deliver that business successfully and generic resulting in earnings and cash flows from it. We also look at our dividend is a significant part of our capital deployment strategy, we have been consistently raising the dividend this year and other.

10% increase and so we will see.

<unk> into next year about the dividend as a mechanism for returning capital to shareholders.

<unk> the share repurchase, which I know with the core part of your question and this year. We are on track for $1 billion of share repurchase we plan to complete that would you expect that to be slightly higher next year as we.

We look at our plans for capital deployment.

I'll share those with you in more specificity on what our guidance is for share count in January .

But safe to say we are still.

<unk> set of returning 100% of our free cash flow to shareholders and those three elements are the major waves and I told you that in 2023.

Got it and then one follow on if I can on the supply chain stuff, that's been impacting the whole industry.

Are you seeing.

Doing anything to help resolve it.

Some of the issues it seems like youre running into everybody's running into.

And is doing anything to help to help the industry.

Yes, they are and I applaud the work that <unk> is doing I think today and we would agree that we need to continue to do more particularly for medium and small businesses, who find themselves lower and the supply chain and even in circumstances, where primes may have cost plus contracts.

They often how fixed prices that we need to adjust and so the government working with the primes to address that impact on small businesses I outlined in my comments earlier on this call is going to be important for the health of the defense industrial base and <unk>.

Industry are doing our part certainly looking at those investments and managing some of our cash into the supply chain in ways that we have not historically done for the benefit of keeping those businesses healthy and we've been doing that now for the last several years really since the pandemic began and I expect we will continue to do that.

There are impacts, though to large business as well and so we're.

Are all of them together as you point out.

We have.

Work ahead of us.

I am encouraged by Congress as comments that they expect that the <unk>.

<unk> thousand three budget will start to address some of these challenges and I'm hopeful that as the administration to through 2020 for budget together. They will continue on the path to identifying funding that would allow us to keep the defense industrial base is healthy.

Got it thank you.

Yeah.

Thank you and one moment for our next question.

Okay.

And our next question is going to come from the line of Myles Walton with Wolfe Research. Your line is open. Please go ahead.

Thanks, so much.

David or Cathy I am not sure, which the fourth quarter recovery I think you pointed out was going to come from receipt or timing of material receipts and I'm. Just curious does that put you more at risk from supplier performance and your own internal performance as you go into the fourth quarter.

Is that the way to think about it.

Myles its Dave I'm happy to address that one.

I think the way we look at it as.

The really strong head count.

Growth that we've had over the last quarter in particular, but the last six months broadly, adding approximately 4% through our overall employee counts or over 3500 employees really shores up the labor visibility for labor driven sales for.

For 2022 and sets us off on a good track for 'twenty three.

And to your point that means the supply base and its performance are key to the fourth quarter with that said we've had a year now of these.

More challenge supply chain conditions.

<unk>.

Become accustomed to where there are constraints in where there are not.

I give a lot of credit to our supply chain folks and our program teams, who are managing and mitigating those challenges every day. We think we've got the captured in our outlook for Q4, the pressures to date have pushed us towards the low end of the sales range for the full year and we think thats.

Procreate caution as a result of the supply chain conditions, but feel that we have.

Did it well in that range as we think about Q4 and the full year now.

Okay, and maybe just a follow up within the space.

Negative EAC is there.

Is it is there any program driven.

Drivers to those negative indices or is it purely cost and inflation dropping through across the portfolio.

If there was not any one single.

Program EAC.

See that drove a material change this quarter in the <unk>.

Base business or any other.

Across our portfolio I think youre right to point to the broader market conditions.

Costs are escalating at a level not expected a year or two ago.

We're mitigating that very well across our business.

But in fact, our latest expectations are factored into the EAC is on our programs and that did have a dampening effect, particularly in spaces margins in Q3, okay.

Okay. Thank you.

Thank you and one moment for our next question.

And our next question comes from the line of Kristina Kristina <unk> Blue.

With Morgan Stanley . Your line is open. Please go ahead.

Hey, good morning, Dave.

Hi, Christine.

One of your peers has recently announced significant new share repurchase authorizations using debt.

Considering the multi year visibility in the cash flow to strengthen the balance sheet and the upward pressure on defense budgets would you consider levering up and increased buyback similar to what the company did a decade ago.

Well Christine.

<unk> rolled it out as we sit here today, but I'm also not announcing any plans we.

Currently our executing our strategy, which is as I said, a few minutes ago for our balanced capital deployment strategy and we think that is the right thing for our company Our foundation and fundamentals are incredibly strong with the growth in our backlog the ability to grow the business top line, we want to ensure.

Or that we're investing appropriately in that it's the best thing for our shareholders in the long term, we believe as well as our customers who need this capability and capacity that we're delivering.

So that remains our top priority.

And we as I have said are committed to return 100% of our free cash flow this year.

To our shareholders and we'll do that in the balance of.

Dividends and share repurchase, but as you know we have <unk> in the past and we have looked at share repurchase and we'll continue to do that on a regular basis and keep your price of any change in our plan.

Thanks, Kevin.

Okay, and if I could do a follow up you mentioned that you expect supply chain issues to persist into 2023 can you provide more color on what's embedded in your 2023 revenue outlook of $4 to 5% where are the risks.

Opportunities to that.

Yes.

So in the earlier in the call we outlined three major elements that we are monitoring closely the first just our own labor and we have talked about that throughout this year as being a bit of a headwind for us in the first half of the year, we were not adding head count and retaining head count at the level, we needed to fuel our grew.

And that started to turn the corner in the summer than you've seen in the third quarter really robust results of net head count growth as Dave outlined with nearly 3000 adds we are.

In this environment that we're experiencing currently not necessarily nearly 3000 adds in a quarter, but this hiring and retention environment as what persistence of 2023.

There could be some opportunity there as you all know certain firms are reducing their head counts or at least they're hiring. So we are as I noted <unk> seen that in certain areas. The labor market is starting to soften, but we aren't counting on that.

Being a significant tailwind to us next year, we're looking at that continuing about like we see it today in supply chain. As we noted we do expect the disruption that we now see in the supply chain to have lingering effects into 2023, and we've done our best to capture those and what we have now reflected as are updated.

Guidance, but if they were to get worse, we certainly would have some downside risk I don't expect them to get significantly better. So unlike labor I would say that one is more of a risk and then in the third area of inflation.

Our time to the indices as we look forward. We certainly has now captured the inflationary pressures that some of what we indicated was the downside on segment operating margin rates that we saw in the third quarter of this year and.

Your guess is as good as mine as to when does inflation really start to modulate So where do you see me and the thesis our best way to get our arms around that I don't see that as a big opportunity or risk I think that we probably have.

Pretty well, but we're monitoring it as I said so.

That was a lot of contacts, but I think it's important because we did put a 2023 outlook in front of you even at this early stage, which we often do but I will say this is the more volatile time, then we often experience.

Going into the following year.

Great. Thank you for that context on the color.

Sure.

Thank you and we'll move on to our next question.

Okay.

And our next question comes from the line of Rob Stallard with vertical Research partners. Your line is open. Please go ahead.

Thanks, so much good morning.

Good morning.

Dave I'm going to start with you.

On the 2023 margin guidance are you expecting any major changes in the segments versus where they are likely to end up at the end of this year.

Thanks for the question, Rob, we do not anticipate meaningful movements in the segments as we look at 'twenty three let's talk in aggregate first and then I'll give you some color on the segments.

As you'll recall our segment Om rate was in the 12% range in the first half of this year.

We talked on the call today about the fact that that will fluctuate a bit from quarter to quarter. We worked through some of the temporary challenges that we and most other industries phase III days around inflation and supply chain and such.

I noted some of that in the Q3 result.

Year to date, we're in that guidance range that we've provided for the full year as we talk about next year, we noted mid to high 11%.

Our current expectation think of that is in the range of 20 basis points lower next year than than we're seeing this year and at a business level.

What I'd highlight is in a few of the areas, where we had unique upside in the first half of the year, that's where we would expect that to normalize and create.

Some of the lower margin profile next year I'd note as head of <unk>.

Land sale in the second quarter.

You can think of that as 2030 basis points of margin rate pressure on a year over year comp basis.

In space, we think.

The volume of new <unk>.

And work they've continued to add in the.

Pressure that's put on their margin this year.

Again, a good reflector of what you'd be likely to see next year in space.

Mission systems and defense continues to perform well on the margin rate side, and we don't anticipate meaningful movement. There EMS did have some strong upside in the first half. So we will look to see what they can continue to deliver in 'twenty three again, no meaningful movements across the border just adjust for some of those comparability items.

In 2003 to get a segment level view.

Very helpful. And then just a quick follow up for Kathy on the B 21, we're looking forward to the rollout in December but I was wondering how the numbers on the <unk> program are progressing.

We're making good progress, but given it's a fixed price program with inflation and how are the margins on this program going.

Yes. Thanks for the question. We are also very excited about the rollout on December 2nd, but we are keeping our focus on the performance of the program. So while it's important for us to celebrate milestones as they come. It's also a long term program as you suggest and so we are working their program as we all are all to each quarter.

Order reflects what we know about the current environment and our projections going forward and as we outlined earlier. This year. We spent a good bit of time actually talking through the B 21, and how we were keeping our assumptions updated that continues to hold true and so theres nothing to report.

To you in any material change on our outlook for the profitability on that program.

That's great. Thank you very much.

You.

Thank you and one moment for our next question.

Yes.

Yeah.

Okay.

Our next question comes from the line of Sheila <unk> with Jefferies. Your line is open. Please go ahead.

Hi, Good morning Happy day, Thank you.

And you talked about flattish defense sales next.

Next year can you give us some of the puts and takes in that business with supply chain does that continue to linger and what's going on on the services side, and maybe incremental opportunities with programs such as Ibs and missiles.

How you think about Europe , playing into that as well.

Thanks, Sheila certainly at the disruption that we're talking about it does hit short cycle businesses, a little more than long cycle and so there is a bit of that in defense, but really it's more about the portfolio shifts that we are making one is the growth that we're seeing in munitions.

Im, particularly that demands, which we expect to grow even more with the conflict in Ukraine, but we also CIBC us as a centerpiece of that growth both domestically and internationally I noted in my comments that we have gotten significantly more increase the crop.

Increased interest in demand coming out of Europe on <unk>.

Over the last several months. So those are growth drivers, but those are offset by retirements of legacy platforms that we sustained out of the defense systems sector, and we've been talking about those as headwinds to us for a while but as those programs are retired.

<unk> platform Sustainment.

It impacts are being felt in DFS, so that would be programs like joint stars and global Hawk.

Great. Thank you.

Thank you and one moment for our next question.

And our next question comes from the line of George Shapiro with Shapiro Research. Your line is open. Please go ahead.

Thank you.

Dave in terms of your margin guidance next year, how much lower are you expecting eac's to be because this year, they're running so far like 150.

$1 million lower than last year, and yet you're getting help them, yes, but the margin looks like it's going to turn out to be similar to where it was last year.

Sure George as you know, we don't have a specific dollar for dollar.

Expectation of many Acs.

On any one program or in fact in aggregate going into a typical year, what we do get a sense for is.

Trends in aggregate volume.

In 2021 for example, we had a unique trend associated with the benefit in our rates from the pension benefit.

2022, we've had a couple of.

Upside items as you mentioned in Aaas, but broadly speaking the pressures that we've noted from the macro environment. This year.

What I would characterize 2003 as is more of a continuation of some of those macro pressures as Kathy outlined nicely earlier in the supply chain in the inflationary environment and so we would anticipate.

What I would characterize as a continuation of the lower net EAC trend in 'twenty three based on what we know today, but I wouldnt put too fine of a point on the dollar amount today, we'll give you more insights on on that as we get into the January guidance call.

Yes, I'm just looking at the fact that this year segment margin likely be similar to last years and yet EAC are running already at $150 million below where they were last year, so maybe there'll be down $200 million for the year and.

So you got to have a pretty sizable maybe a bigger drop next year I mean, otherwise why wouldn't the margin be similar to the high 11% like Youre seeing this year.

So thats high 11% margin rate.

It was predicated on a certain volume of both program performance and net EAC benefits.

We're projecting a wider range currently in the mid elevens to the high elevens, because it's tough to project as Kathy noted earlier with too much specificity given the macro environment. We're in today. Our program performance continues to be exceptional, but we think today.

Appropriate outlook is about 20 basis points lower margin rate next year with with continuation of kind of the second half trends. We're seeing this year in <unk> I think that's about as specific as we can be at this point in the process George.

Okay, and then one quick one how much contribution will GBS and.

<unk> beat to the billion dollar growth that you're talking about in space in 'twenty three.

We project GBS D to be a little less than half of that growth NCI will also be a contributor. But then there are a number of other programs. The wins, we've talked about this year space development Agency a continued growth in the gem 63 portfolio with the Amazon <unk>.

And there there are a number of drivers of growth across our space portfolio, both national security civilian and otherwise.

Okay. Thanks very much.

Yes.

Thank you and one moment for our next question.

And our next question comes from the line of Jeff Eisman with.

J P. Morgan Your line is open. Please go ahead.

Thanks, very much and good morning, everyone.

Kathy and Dave.

I know you were just in the early stages of 2023 so.

Sorry to bring up 2024, but you guys have talked about cash flow target for that year and also our segment margin and I think in that 12% range.

We're still on target for.

Reaching those goals.

Sure I can touch on that as we noted today, we continue to reaffirm our multiyear cash flow outlook for 'twenty three that's intact for 24 as well and as we noted on the call today, we expect another growth year in 2025 will be more specific in quantifying that on our January call.

When we will do our typical update of the multiyear quantified free cash flow outlook.

Continued strength in the expected returns from the business, we will update the specific numbers there based on section 174 legislation status in January on the margin rate side. As we noted we were operating at that 12% level in the first half of this year businesses continued to execute well.

And mitigate.

Broader macroeconomic challenges.

We're anticipating about that 20 basis points of.

A decline based on what we currently see in 2023, we do anticipate longer term recovery.

At this stage of the game to project, whether that recovery back to the high elevens in the 12% level occurs as soon as 2024 or whether its subsequent to that a lot of that will depend on the pace of recovery in these macroeconomic factors, but again critically the the.

Sales growth expansion, we see next year, the acceleration of the 4% to 5% range multi year free cash flow guidance remaining intact. I think is indicative of the kind of economic value we are delivering even in this environment.

Great.

Thanks, Dave and just as a as a quick follow up with the supply chain challenges lingering into 2023 and.

Probably lessening through the year should we expect a similar distribution of sales throughout the year and 'twenty three that.

That we've seen in 'twenty two in terms of the percentage per quarter.

It's <unk>.

Mature for me to give you a percentage by quarter at this phase we're doing our best to give you our latest insights into the full year outlook. Some of that quarterly profile ends up being determined by the timing of material receipts on large programs at across the business base. So it gives us a few more months to give you a quarterly profile.

We'll certainly do so we'll give you more insights on that in January as we typically do.

Okay fair enough. Thank you.

Thank you and one moment for our next question.

Our next question comes from the line of Ken Herbert with RBC Capital markets. Your line is open. Please go ahead.

Yes, hi, good morning, Kathy and Dave.

Yes.

Good morning.

Kathy relative to our day relative to the initial expectations in the year you have seen stronger bookings that you've called out as we've gone through the year and I'm. Just wondering if you can parse that out a little bit.

I know you called out share gains, but how much of that has been share gains versus maybe an acceleration or timing around contracts and how much should we sort of read through we think about maybe an expanded opportunity set for you heading into 'twenty three based on some of the stronger bookings this year.

Yes.

Thanks for the question.

When we look at the portfolio. It has been broad based in terms of the improvement that we've seen in our expectations for book to Bill All four segments now projecting over one and it has been most pronounced in space, where we've called out some specific opportunities that we're competitive so to your point taking share that.

We were able to secure.

We may not have anticipated winning as many of those as we started the year as we ultimately have we.

We feel that we are in a good position with backlog in each of the businesses going into 2023 supporting the accelerated growth that we've laid out.

Our outlook for next year.

We don't expect that our book to Bill next year will be as robust as it was this year because we do have quite a bit of backlog that we will be carrying into the year and the opportunity set is not as strong in 2023, but we do see then that picking up again in 'twenty four and 'twenty five.

I would tell you we tend not to look at awards on a single year basis.

Calculate book to Bill only on a single year, we look at it on a running basis in our system strong as in aggregate over the last three years, we expect that to continue well into the future.

Well thats helpful. But as you think about the strength of the comment you just made on strength in the 'twenty four would that be more on the space side within space or maybe more on the launch missiles side or any color on that would be helpful.

First space, we've seen broad based.

Opportunities across both launch missiles as well as our space segment, and we expect that to continue there are multiple programs that will be selected for next phase.

And be awarded in that timeframe in both elements of our space business.

Great Alright, thank you very much.

Thank you.

Thank you and one moment for our next question.

And our next question comes from the line of Scott <unk> with Credit Suisse. Your line is open. Please go ahead.

Hey, good morning, Thank you for taking my question.

Good morning, anything you can say about the equipment sales that impacted Q3 free cash flow is that similar in nature to the large equipment sales at <unk> booked a while back.

It is actually cash flow associated with that equipment sale booked a while back. So it is the timing of payments driving a particular cash received this quarter, but it is fully associated with the equipment sale you noted from the past.

Okay got it and then Kathy on MDI.

Is it reasonable to think that you might be able to offer some cost savings to your customer there.

If theres product commonality between the interceptor and the GBS D booster and would you potentially designed for commonality.

They are in order to drive that cost benefits the customer. Thank you.

Well, it's an excellent question and because we are in an active competition I won't speak too much about our approach, but what I would say is that we constantly look for ways to deliver more value to the customer based on a broad.

Out of capabilities, both in the case of interceptors as well as our missile defense portfolio. So I've noted has been growing and we expect it to continue to grow taking a full mission understanding of the threat environment as it evolves and bringing it back into our product development strategy is key across the entire portfolio.

<unk> will also benefit from that level of expertise that we have.

With the threat the solution elements and submission.

Makes sense. Thank you. Thank you.

Thank you and one moment for our next question.

And our next question comes from the line of David Strauss with Barclays. Your line is open. Please go ahead.

Thanks, Good morning.

Good morning.

Kathy.

F 35 cuts across a number of your businesses I think you've talked about it being 10% of sales in total can you can you.

Give us an idea of what you've got baked in for F. 35 in total in 2023 from <unk>.

I assume it's declining a bit with that is rolling off and so on but can you can you give us an idea of what's baked in for F. 35 in 'twenty, three and whether as you look beyond 'twenty three F 35, stabilizes or maybe even begins to grow again.

Well, Dave it actually when we look across the entirety of the company F. 35 is pretty flat going into 2023. So we have a lot of moving parts as you indicated in aerospace we have volume that is fairly consistent in our case, because remember we build a couple of years about <unk>.

Months ahead of Lockheed Martin and so we're maxing out at our limitation of capacity for building center fuselages, and so that project out flattish into 2023 as Dave noted earlier, but in our mission systems side of the business, while we have that.

<unk> is being replaced with new product insertion. We're also working on new product insertion in the other elements of the portfolio. So we have some development work going on in block four that continues to grow and production there too is fairly stable.

If we look out over the time period and Sustainment as well so.

So when you take all of those elements across the entirety of our portfolio F. 35 is pretty flat going into 2023, and we expect to be relatively flat going into 2024, maybe a little bit of upside to that.

Alright, perfect Thats very helpful.

And then on the on the back on the margin guide for for next year.

Would you characterize the drop I guess.

<unk> I think we were all thinking kind of flattish next year, and then maybe improving a bit in 'twenty four.

Would you characterize.

The lower guide.

Is that is that more mix related you know maybe the.

Your lower margin programs are accelerating faster than you would expected or is this inflation related or some combination of both.

I would say, it's a combination of all of those factors, but leaning more towards the macro factors. This is.

A unique environment that we're all operating in these days and we're.

Eyes wide open to the continuation of a lot of those pressures in 2023.

And Thats why we think it's not a huge impact but call it 20 basis points compared to.

The high levels, we've been operating at in 2022.

I think importantly, as you get down to the earnings per share line, excluding the noncash pension element of it we anticipate EPS growth faster than even the 4% to 5% accelerated sales growth. So we're managing through these these times I think particularly well when you think about.

The pace of EPS acceleration as well.

We're going to have to leave it there, okay and one more.

Alright, I will leave it there I'll turn it over to Kathy for closing remarks.

Before concluding today's call I, just like to take a moment to thank our entire team for another strong quarter in what we have appropriately characterized as challenging macroeconomic times the business fundamentals for Northrop Grumman remain incredibly strong and that's due to the work of this entire team, but I want to especially thank one of our team members Mary Patricia who will be.

Retiring from Northrop Grumman in January she has provided 10 years of outstanding service to our company. Most recently as the defense systems front and we wish her the very best.

October 17th I'm sure you all noted that Roche and rotor became our new President of defense system. She is an experienced executive in our company I'm very confident in her ability to take the business to the next level and I look forward to introducing her to many of you. So.

Thank you for joining our call today I expect to see many of you in the coming months, but for those I don't see let me wish you a healthy and happy holiday season, and we look forward to talking to you in January .

Ladies and gentlemen. This concludes today's conference call. Thank you for participating have a great day.

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Good day, ladies and gentlemen, welcome to the Northrop Grumman third quarter 2022 Conference call. Today's call is being recorded my name is Michelle and I will be your operator today.

At this time all participants are in a listen only mode I would like to turn the call over to your host Mr. Todd Ernst Treasurer, and Vice President Investor Relations. Mr. <unk>. Please proceed.

Thanks, Michele good morning, everyone and welcome to Northrop Grumman's third quarter 2022 conference call. We refer to a Powerpoint presentation that is posted on our IR web page. This morning before we start matters discussed on today's call, including guidance and outlooks for 2022 and beyond reflect the company's judgment based on information available at the time of this call.

They constitute forward looking statements pursuant to safe Harbor provisions of 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.

On the call today are Kathy Warden, our chair CEO , and President and Dave Keffer, Our CFO at this time I would like to turn the call over to Kathy Kathy. Thanks, Todd. Good morning, everyone. Thank you for joining us the Northrop Grumman team delivered another quarter of solid performance. Our top line returned to growth with continued strong execution.

Demand for our products remains robust with a book to bill ratio of near one including a number of key awards in a restricted in missile defense portfolios.

And we remain on track to deliver strong results for the year with growth expected to accelerate as we look toward next year.

Taking a step back for a moment from the quarter I'd like to start with an update on the global security environment.

Earlier this month the Biden administration released its full version of the National Security strategy, which is used as a guide for policy and budget decisions.

The strategy spotlights, the dynamic and challenging threat landscape around the world and stresses the importance of working with allies, maintaining a strong industrial base and continuing to invest in advanced technology.

It also reinforces the triad as a top priority.

So it's clear that Northrop grumman's portfolio continues to be extremely well aligned with the requirements outlined in the national security strategy.

This is reflected in the administration's fiscal year 2023 budget request, which showed alignment with these priorities and strong support for many of our key program.

Based on these additions we believe that the ultimate fiscal year 'twenty three based defense budget will be higher than the President's budget request and as you know we started off this fiscal year in another continuing resolution, which currently extends to mid December and this is factored into our guidance.

We are confident in our program funding position and hopeful that the annual budget will be passed by year end.

Meanwhile, global commitments to invest in defense and National Security capability continue in Europe , we've seen increased demand for our integrated air and missile defense solutions and precision weapons and advanced ammunition in the Asia Pacific region, we've seen similar interests and air and missile defense as well as <unk>.

<unk> ISR advanced radar and other mission system.

All of this points to a strong demand environment for Northrop Grumman.

And we're doing our part by investing in solutions and capacity to address many of our customers' most pressing needs.

This year, we expect to invest over $2 5 billion in Capex and research and development.

And as a result, we are winning new business and bolstering our backlog for long term growth.

Our backlog has increased year to date in each of our four segments and is up nearly 5% overall.

Given that we now expect that our full year 2022 book to Bill ratio will be over one a significant improvement from where we started the year.

This increase is attributed not only to the robust defense budget environment, but also a strong competitive win rates.

That said, we recognize that our industry and many others are experiencing macroeconomic volatility that we haven't seen in decades inflation.

Inflation remains at 40 year high lead times have been extended in certain areas of our supply chain and the labor market shows signs of easing, but it remains tight for critical skill.

Our team is tackling these challenges keeping our focus on our people and performance and driving efficiencies across the business.

In the labor market, we've driven improvements in hiring and retention over the past several months, which Dave will describe in more detail.

This was instrumental in our return to growth in the third quarter and it's worth noting that this favorable trend has continued into the fourth quarter as well.

This supports our full year 2022 guidance and our outlook for accelerated sales in 2023.

In the supply chain, we continue to experience disruption and delayed deliveries in certain areas of our business, which we have they have been a headwind to growth.

If the risk that we're closely monitoring and we're working with our suppliers to mitigate but we do anticipate that supply chain challenges will continue in 2023 and this is now reflected into our 2023 outlook.

Elevated inflation levels in both labor and supply chain has persisted more than expected as we came into this year.

To address this we are implementing operational efficiencies and working with many of our customers on program funding and other contract actions to support the health of the defense industrial base.

We believe this balanced approach is the best solution to allow continued investment in the capabilities that support our customers' missions.

With that said, we see this as temporal challenges and remain committed to driving our segment margin rates higher over time.

Turning now to the execution of our long term strategy one of the key elements of our strategy is a relentless focus on performance.

That's why I was particularly pleased to receive the 2022 stemming Cup for operational excellence on behalf of Northrop Grumman earlier this week.

The award recognizes our achievements in leadership and creating a culture of operational excellence and continuous improvement across the company.

Our customers recognize this commitment.

Have entrusted us to deliver some of the most technologically advanced next generation systems and solutions.

The B 21, greater is one such example, and were excited to unveil the aircrafts to the public on December 2nd.

The B 21 is outstanding performance can be directly tied to our company's investment in digital tools and facilities and the incredible U S Air Force and Northrop Grumman team, who are developing the sixth generation platform.

The program continues to progress through testing in preparation for first flight in 2023.

Last month, we announced the data sharing agreement on B 21, enhancing data access and collaboration across the program, including the launch of a shared environment for the B 21 digital twin.

This data sharing agreement enhances our partnership with the Air Force and further demonstrates our digital maturity on the program.

Our mission systems solutions are another area of our portfolio, where innovation is critical to success.

Where the fast pace of threats of new technologies is driving the need for platforms and sensors to be able to connect with one another share data and be part of a broader family of systems.

In this growing market, we are building on our strong position in sensors secure communications and networking to compete for and win new opportunities.

For example, last month, we were selected to be a member of the Air Force's Abms digital infrastructure consortium.

We're also seeing interest from global customers, including the Australian Defense Force, where we recently demonstrated a product solution with robust situ functionality to lake sensors and effectors across domains.

Another significant area of focus for the U S and our allies is the modernization of missile defense solutions to address current and future missile threats.

We continue to strengthen our position in this area with a $1 3 billion ground based midcourse defense weapons system awards in the third quarter.

This award builds on our missile defense portfolio and helps our customers defend against intermediate and Intercontinental missile attacks.

And turning to our weapons business I am pleased to share that we've now delivered more than 100000 precision guidance kits to the U S Army.

These projectiles provide enhanced precision artillery units and come embedded with built in safety features we have.

Exceeded requirements on both accuracy and reliability with these upgrades.

And one last area that I'll highlight is hypersonic.

We continue to win new competitive business.

Last month, the Air Force selected our Raytheon and Northrop Grumman team to develop the hypersonic attack cruise missile also known as <unk>.

How can builds on our scramjet propulsion technology and ushers in a new era of faster more survivable weapons.

This program is one of several hypersonic opportunities within our portfolio.

We're approaching this market as both a prime and sub bringing our expertise in high speed propulsion, survivable navigation and targeting capabilities and systems integration multiple solution.

These are just a few examples of markets, where we continue to grow our business by delivering the products and solutions that our customers want and need while also building long term value for our shareholders.

So now I'll turn it over to Dave who will provide more color on our Q3 results and touch on our expectations for 2023 safe.

Okay. Thanks, Cathy and good morning, everyone. As you heard from Kathy we delivered solid results across all key metrics in Q3, we're reaching an inflection point in our sales growth driven by the strength in the demand environment, our new business performance and our success in hiring and retaining employees.

We had another strong quarter for bookings with roughly $8 7 billion in awards.

<unk> contributed to our year to date book to Bill ratio of 114, and an increase in our full year book to Bill expectations.

Our Q3 top line results of roughly $9 billion were up sequentially from Q2 and up about 3% compared with the third quarter of 2021. This.

This acceleration has been driven by our positive hiring trends.

We added nearly 1000 net new employees in Q2, and we added an additional 2700 plus people in Q3.

With continued positive hiring and retention results, we've improved our labor driven sales visibility. So the supply base is now the key to achieving our full year sales outlook.

We're seeing temporal challenges in the supply chain as our most others, including longer lead times and higher costs in some areas.

We're encouraged by recent comments from Congress on this topic and we're actively working with our customers to help mitigate inflationary effects on our contracts, including those being felt by our suppliers.

Our program execution remains solid in the quarter with segment margins of 11, 2%, reflecting lower net EAC adjustments due in part to the inflationary pressures that we've noticed.

As costs have remained elevated.

We've captured our latest estimates of inflation and opportunities to mitigate it.

Is that a downward effect on our margins in Q3, but year to date. Our segment margins are 11, 7% and we continue to expect the full year rate to be in the range of 11, 7% to 11, 9%.

Turning to earnings per share are diluted EPS in the quarter were $5 89.

The year over year earnings decline was driven by non operational factors, including lower net pension income unfavorable returns on our marketable securities and.

And an insurance settlement for $60 million that was recognized in the third quarter of 2021.

Together these items represented roughly 85 of.

Year over year, EPS headwinds, but as I pointed out our businesses continue to execute very well in a complex environment.

In terms of cash we generated outstanding operational cash flows in the third quarter of over $1 3 billion and we expect Q4 to be even better this.

This is consistent with our historical pattern of collections and disbursements.

In the quarter, we made our third cash tax payment associated with the R&D amortization law of approximately $220 million and we continue to expect roughly $1 billion in cash tax payments related to R&D for the full year.

Through the end of Q3, we completed over $1 billion in share repurchases and we're on track for an additional $500 million in the fourth quarter.

Now moving to 2022 guidance, we have not changed our sales earnings or cash outlooks.

The foundation for our strong financial performance starts with the continued demand we're seeing for our products.

We are increasing our expectation for book to Bill again, this quarter to greater than one times, which is a significant improvement from our original expectation.

Our team has done an outstanding job of serving as a trusted partner to our customers and winning new business.

We are maintaining our original guidance for the top line.

And based on year to date results. We continue to expect our full year sales to be around the low end of the range consistent with the trends we described last quarter.

Our full year outlook implies Q4 sales of roughly $9 6 billion.

Which represents excellent sequential and year over year growth as.

As we've noted throughout the year, we anticipate that Q4 will include a strong volume of material receipts across each of our four segments.

We're also maintaining our guidance for the bottom line, including segment Om rate and earnings per share.

Given the 2022 sales volume will be around the low end of the range, we expect EPS to be near the low end of its range also.

Within our earnings outlook, we're accounting for continued year to date pressure on our marketable securities portfolio.

Brian anticipated federal tax rate benefit in Q4.

Our marketable securities are down nearly $100 million in 2022, which represents about <unk> 50 of earnings per share pressure.

The income tax line, we have lowered our effective rate expectation from 17% to 15, 5%, reflecting progress in resolving matters related to historical filings in one of our businesses.

We currently expect those matters to be concluded in Q4.

Resulting in about 50 cents of EPS benefit that offset the marketable securities pressure.

It is also possible that the tax item could be resolved in Q1, which would shift the benefit from 2022 into 2023.

Moving to cash flows while we remain optimistic that Congress will repeal or defer the R&D amortization law.

We're focused our free cash flow guidance. This year on the current tax loss scenario, which is unchanged from last quarter.

If the law is deferred or repealed in Q4, we would expect a one time spike in state taxes recognized in corporate unallocated expense as well as the cash refunds in 2023.

Operationally, we're very pleased with the progress we made in cash flows in Q3 bolstering our confidence in the full year outlook.

Next I'd like to take a few moments to describe the outlook for our pension plans.

Most importantly, our current funded status remains strong and roughly unchanged year to date.

And the cash flow implications of cost changes over the next several years provide a modest benefit.

The GAAP income statement effects. All described today are noncash in nature.

Year to date, our plans have experienced double digit negative returns and discount rates have risen nearly 250 basis points.

This combination of results will affect our GAAP earnings in future years, So I'd like to take a moment to discuss what our 2023 net pension income would look like under various scenarios.

In January we provided a sensitivity table in our earnings call deck related to changes in discount rates and asset returns on our non service pension income.

Based on the high level of volatility of the pension funds have experienced so far this year I wanted to provide a grid of potential outcomes that also incorporates Fas service expense and cash costs, which can be found on slide nine of our presentation today.

Given the year to date asset returns and discount rates at the end of Q3, we would expect significantly lower net <unk> pension income in 2023 <unk>.

Currently in the range of over $900 million less than our previous projections.

As I have described this lower net <unk> pension income is noncash in nature over time higher Cas recoveries would lead to modestly higher cash flow related to our pension.

I also wanted to provide additional insights on our high level financial outlook for 2023.

Note that this is predicated on our current expectations regarding the macro environment.

He said, we expect strong demand to continue into 2023.

In terms of hiring and retention trends.

Now shared a few times, we've seen improvements since the beginning of 2022 and we anticipate that this will remain consistent next year.

In the supply chain, where the environment has remained challenging with various delays and disruptions we projected those challenges will continue throughout 2023.

And with regard to inflation, which has been more persistent in 'twenty two than originally expected.

Our projections incorporate gradual easing based on the latest industry labor and material indices.

For 2023.

Within our segments, we continue to expect space to remain our fastest growing business.

With sales growing by another $1 billion over 2022.

We expect strong strong sales growth in EMS in the mid single digit range and we anticipate sales of smbs to be flattish compared with their latest 2022 levels.

We also expect to generate solid segment margin rates as I've described.

EIC improvements are likely to be lighter than usual until inflation begins to normalize. So we'd expect our segment Om rate, which would otherwise have been projected in the high 11% range next year to be between the mid 11% in the high 11%.

We expect our tax rate to return to its more normal level of around 17% next year.

And we continue to generate excellent cash flows with our prior three year cash outlook intact and another year of free cash flow growth expected in 2025.

We anticipate modest increases to our prior capex projections based on the strength of this years, new business wins and backlog growth offset by corresponding improvements in operating cash flows.

We're very proud of the performance we've delivered this year and a continued challenging environment.

And we're pleased with our projected growth acceleration in the second half of 2022 and in 2023.

With our multiyear cash flow outlook intact, we're looking forward to continuing to create value for our customers and shareholders.

We're ready for your questions.

Thank you to ask a question you May press star one on your telephone.

Ask that you please limit yourself to one question and one follow up question. Please standby, while we compile the Q&A roster.

Yes.

Our first question comes from the line of Doug Harter with Bernstein. Your line is open. Please go ahead.

Good morning, Thank you.

You talked about supply chain here and that's obviously an issue sort of across the board is it possible to look at the constraints you had from the supply chain and give us a sense.

Of what.

The quarter and the year might have looked like had you not had those constraints.

We're just trying to figure out.

What sort of normal would be and how much is being held back.

Good morning, and thanks for the question supply chain, certainly is central to not only the remainder of this year, but next so let me try to characterize not particularly in numerical terms, but.

More or less quantitative terms, what we have been seeing.

It is in particular areas of the supply chain. So it is not widespread medicine areas that are important.

We expect these challenges to persist into 2023, so when I talk about timing, we do not expect all of what we experienced in 2022 to recover by the end of 2023, we expect these issues to be a bit sticky for the next year, we do expect them to resolve in the <unk>.

24 months timeframe.

And as you go into 2023.

You said in the outlook that the space is expected to be up by about a $1 billion.

<unk>.

There are no Alex so.

Can you help us understand what the drivers are in those two two units that lead to somewhat different results. Obviously, you have huge backlogs in the space, but just trying to understand.

Those two trajectories.

Sure Doug I'm happy to shed some light on that in both cases those trends are consistent with what we've.

Indicated previously and the drivers are therefore, consistent as well.

Starting in Aaas.

We project a stable 2023, given the anticipated growth in <unk>.

Programs, including B 21, but then offset by modest declines in programs like the.

Legacy programs in the <unk> portfolio joint stars et cetera.

A modest decline in F 18 likely over the next couple of years. So again continuation of trends, we've been talking about for a while and we continue to anticipate.

Our growth recovery in 2024 for that business in space the expansion and the growth opportunity is broad based across multiple orbits.

Cross multiple mission areas.

For missile tracking to ISR growth in our support of launch capabilities.

It's really an outstanding.

<unk>.

Performance for US recently on the growth side you see.

Growing market, but growth also in our market share.

Of course, GBS D as a contributor to that growth, but by no means the only one each.

Each of our divisions and that business is growing at a nice clip. So we're really pleased to be able to continue that outlook in 'twenty three.

Great. Thank you.

Thank you and one moment for our next question.

Yes.

And our next question comes from the line of Ronald Epstein with Bank of America. Your line is open. Please go ahead.

Yes, good morning.

Maybe just.

A question on capital deployment.

Going to be generating a lot of cash right you pointed that out.

What's your plan to do with that into next year is there is it just share buybacks or is there some selected M&A or how are you thinking about that.

Yes.

In competitive win so we will continue to invest to be able to deliver that business successfully and generic resulting in earnings and cash flows from it. We also look at our dividend is a significant part of our capital deployment strategy, we have been consistently raising the dividend this year another 10% increase.

And so we will think.

Favorably into next year about the dividends of the mechanism for returning capital to shareholders.

Remaining piece to share repurchase, which I know with the core part of your question and this year. We are on track for $1 billion of share repurchase we plan to complete that would you expect that to be slightly higher next year.

We look at our plans for capital deployment.

We'll share those with you in more specificity on what our guidance is for share count in January .

But safe to say we are still.

<unk> set of returning 100% of our free cash flow to shareholders and those three elements are the major waves and I told you that in 2023.

Got it and then one follow on if I can on the supply chain stuff, that's been impacting the whole industry.

Are you seeing gear doing anything to help resolve it because some of the issues. It seems like youre running into everybody's running into.

And is doing anything to help to help the industry.

Certainly looking at those investments.

Managing some of our cash into the supply chain in ways that we have not historically done for the benefit of keeping those businesses healthy and we've been doing that now for the last several years really since the pandemic began and I expect we will continue to do that there are impacts, though to large business as well and so we are all of them.

There are as you point out.

We have.

Work ahead of us.

I am encouraged by Congress as comments that they expect that the <unk>.

Got it thank you.

Yes.

Thank you and one moment for our next question.

Okay.

Yes.

Okay.

And our next question is going to come from the line of Myles Walton with Wolfe Research. Your line is open. Please go ahead.

Thanks, so much.

David or Cathy I am not sure, which the fourth quarter recovery I think you pointed out what is going to come from receipt or timing of material receipts and I'm. Just curious does that put you more at risk from supplier performance and your own internal performance as you go into the fourth quarter.

Is that the way to think about it.

Well since Dave I'm happy to address that one.

I think the way we look at it as.

The really strong head count.

For 2022 and sets us off on a good track for 'twenty three.

And to your point that means the supply base and its performance are key to the fourth quarter with that said we've had a year now of these.

More challenging supply chain conditions.

<unk>.

Become accustomed to where there are constraints in where there are not in.

I give a lot of credit to our supply chain folks and our program teams, who are managing and mitigating those challenges every day, we think we've got that captured in our outlook for Q4, the pressures to date have pushed us towards the low end of the sales range for the full year and we think thats.

Procreate caution as a result of the supply chain conditions, but feel that we have.

Rounded it well in that range as we think about Q4 and the full year now.

And maybe just a follow up within the space.

<unk> there is it is there any program driven.

Drivers to those needing to bdcs or is it purely cost and inflation dropping through across the portfolio.

If there was not any one single.

Program.

See that drove a material change this quarter in the space business or any other.

Across our portfolio I think youre right to point to the broader market conditions.

Costs are escalating at a level not expected a year or two ago.

We're mitigating that very well across our business.

But in fact, our latest expectations are factored into the EAC is on our programs and that did have a dampening effect, particularly in spaces margins in Q3, okay.

Okay. Thank you.

Thank you and one moment for our next question.

And our next question comes from the line of Cristina Cristina <unk>.

With Morgan Stanley . Your line is open. Please go ahead.

Hey, good morning, Kathy Dave.

Hi, Christine.

One of your peers has recently announced significant new share repurchase authorizations using debt.

Considering the multi year visibility in the cash flow to strengthen the balance sheet and the upward pressure on defense budgets.

You consider levering up and increased buyback similar to what the company did a decade ago.

Well Christine.

Roll it out as we sit here today, but I'm also not announcing any plantains.

Currently our executing our strategy, which is as I said, a few minutes ago for our balanced capital deployment strategy and we think that it's the right thing for our company our foundation and fundamentals are incredibly strong with the growth in our backlog the ability to grow the business top line, we want to ensure.

Sure that we're investing appropriately in that it's the best thing for our shareholders in the long term, we believe as well as our customers who need this capability and capacity that we're delivering.

So that remains our top priority and we as I have said are committed to return 100% of our free cash flow this year and thus to our shareholders and we'll do that in a balance of dividends and share repurchase but as you know we have <unk> in the past and we have looked at share repurchase.

And we'll continue to do that on a regular basis and keep you apprised of any changes in our plan.

Thanks, Kevin.

And if I could do a follow up you mentioned that you expect supply chain issues to persist into 2023 can you provide more color on what's embedded in your 2023 revenue outlook of 4% to 5% where are the risks.

Opportunities to that.

Yeah.

So in the earlier in the call we outlined three major elements that we are monitoring closely. The first is our own labor and we have talked about that throughout this year as being a bit of a headwind for us in the first half of the year, we were not adding headcounts and retaining head count at the level, we needed to fuel our growth.

And that started to turn the corner in the summer than you've seen in the third quarter really robust results of net head count growth as Dave outlined with nearly 3000 ads.

We are expecting that this environment that we're experiencing currently not necessarily nearly 3000 adds in a quarter, but this hiring and retention environment as what persistence of 2023.

There could be some opportunity there as you all know certain firms are you seeing there head counts or at least they're hiring. So we are as I noted <unk> seen that in certain areas. The labor market is starting to soften, but we are counting on that.

Being a significant tailwind to us next year, we're looking at a continuing about like we see it today in supply chain. As we noted we do expect the disruption that we now see in the supply chain to have lingering effects into 2023, and we've done our best to capture those and what we have now reflected as are updated.

Sure the inflationary pressures that some of what we indicated was the downside on segment.

Operating margin rates that we saw in the third quarter of this year and your.

Your guess is as good as mine as to when does inflation really start to modulate So where do you see me and the thesis of our best way to get our arms around that I don't see that as a big opportunity or risk I think that when we probably have pretty well, but we're monitoring it as I said.

So that was a lot of contacts but I think it's important because we did put a 2023 outlook in front of you even at this early stage, which we often do but I will say this is the more volatile time, then we often experience.

Going into the following year.

Great. Thank you for that context on the color.

Thank you and we'll move on to our next question.

Okay.

And our next question comes from the line of Rob Stallard with vertical Research partners. Your line is open. Please go ahead.

Thanks, so much good morning.

Good morning.

Dave I'm going to start with you.

On the 2023 margin guidance are you expecting any major changes in the segments versus where they are likely to end up at the end of this year.

Thanks for the question, Rob, we do not anticipate meaningful movements in the segments as we look at 'twenty three let's talk in aggregate first and then I'll give you some color on the segments.

As you'll recall our segment Om rate was in the 12% range in the first half of this year.

And noted some of that in the Q3 result.

Year to date, we're in that guidance range that we've provided for the full year as we talk about next year, we noted mid to high 11%.

Our current expectation think of that is in the range of 20 basis points lower next year than than we're seeing this year and at a business level.

What I'd highlight is in a few of the areas, where we had unique upside in the first half of the year, that's where we would expect that to normalize and create.

Some of the lower margin profile next year.

<unk> had a land sale in the second quarter.

So you can think of that as 2030 basis points of margin rate pressure on a year over year comp basis.

In space, we think.

The volume of new <unk>.

And work they've continued to add in the.

Pressure that's put on their margin this year.

Again, a good reflector of what you'd be likely to see next year in space.

Missile systems and defense continue to perform well on the margin rate side, and we don't anticipate meaningful movement. There <unk> did have some strong upside in the first half. So we will look to see what they can continue to deliver in 'twenty three again, no meaningful movements across the border just adjust for some of those comparability items.

In 'twenty three to get a segment level view.

Very helpful. And then just a quick follow up for Kathy on the B 21, we're looking forward to the rollout in December but I was wondering how the numbers on the <unk>.

Program are progressing.

We're making good progress, but given it's a fixed price program with inflation how are the margins on this program going.

Yes. Thanks for the question. We are also very excited about the rollout on December 2nd that we are keeping our focus on the performance of the program. So while it's important for us to celebrate milestones as they come. It's also a long term program as you suggest and so we are working their program as we all are all to each.

To you in any material change on our outlook for the profitability on that program.

That's great. Thank you very much.

You.

Thank you and one moment for our next question.

Yeah.

Our next question comes from the line of Sheila <unk> with Jefferies. Your line is open. Please go ahead.

Hi, Good morning Happy day. Thank you good morning.

You talked about flattish defense sales next.

How you think about Europe , playing into that as well.

Thanks, Sheila certainly if the disruption that we're talking about it does hit short cycle businesses, a little more than long cycle and so there is a bit of that in defense, but really it's more about the portfolio shifts.

We are making one is the growth that we're seeing in munitions.

Vicarly that demands, which we expect to grow even more with the conflicts in Ukraine, but we also CIBC asked as a centerpiece of that growth both domestically and internationally I noted in my comments that we have gotten significantly more increased.

Increased interest in demand coming out of Europe on <unk>.

<unk> platform Sustainment.

[noise] impacts are being felt in DFS, so that would be program like joint stars and global Hawk.

Great. Thank you.

Thank you and one moment for our next question.

Our next question comes from the line of George Shapiro with Shapiro Research. Your line is open. Please go ahead.

Thank you.

Right.

Dave in terms of your margin guidance next year, how much lower are you expecting eac's to be because this year, they're running so far like 150.

Million lower than last year, and yet you're getting help them, yes, but the margin looks like it's going to turn out to be similar to where it was last year.

Sure George.

We don't have a specific dollar for dollar.

The expectation of net EAC is on any one program or in fact in aggregate going into a typical year, what we do get a sense for is.

Trends in aggregate volume.

In 2021 for example, we had a unique trend associated with the benefit in our rates from the pension benefit.

In 2022, we've had a couple of.

Upside items as you mentioned in Aaas, but broadly speaking the pressures that we've noted from the macro environment. This year.

What I would characterize as a continuation of the lower net EAC trend in 'twenty three based on what we know today, but I wouldnt put too fine of a point on the dollar amount today.

Give you more insights on on that as we get into the January guidance call.

Yes, Im just looking at the fact that this year segment margin will likely be similar to last years and yet EAC, they're running already a $150 million below where they were last year, so maybe there'll be down $200 million for the year and so.

You got to have a pretty sizable maybe a bigger drop next year I mean, otherwise why wouldn't the margin be similar to the high 11% like Youre seeing this year.

So that's high 11% margin rate.

It is predicated on a certain volume of both program performance and net EAC benefits.

We are projecting a wider range currently in the mid 11 to the high elevens, because it's tough to project as Kathy noted earlier with too much specificity given the macro environment. We're in today.

Program performance continues to be exceptional, but we think today.

Okay, and then one quick one how much contribution will GBS.

<unk> b to the billion dollar growth that you're talking about in space and 23.

Pension there there are a number of drivers of growth across our space portfolio, both national security civilian and otherwise.

Okay. Thanks very much.

Yes.

Thank you and one moment for our next question.

And our next question comes from the line of <unk> with J.

J P. Morgan Your line is open. Please go ahead.

Thanks, very much and good morning, everyone.

Kathy and Dave.

I know you were just in the early stages of 2023 so.

Sorry to bring up 2024, but you guys have talked about cash flow target for that year and also our segment margin I think in that 12% range.

We're still on target for.

Of reaching those goals.

And we will do our typical update of the multiyear quantified our free cash flow outlook and so continued strength in the expected returns from the business. We will update the specific numbers there based on section 174 legislation status in January .

On the margin rate side as we noted we were operating at that 12% level in the first half of this year businesses continued to execute well and mitigate.

Broader macroeconomic challenges we are.

Anticipating about 20 basis points of.

Decline based on what we currently see in 2023, we do anticipate longer term recovery is tough at this stage of the game to project, whether that recovery back to the high elevens in the 12% level occurs as soon as 2024 or whether its subsequent to that a lot of that will depend on the pace of recovery in these macroeconomic.

<unk>, but again critically the the sales growth expansion, we see next year, the acceleration of the 4% to 5% range multi year free cash flow guidance remaining intact. I think is indicative of the kind of economic value we are delivering even in this environment.

Great. Thanks, Dave and just as a quick follow up with the supply chain challenges lingering into 2023.

Probably lessening through the year should we expect a similar distribution of sales throughout the year and 'twenty three that.

That we've seen in 'twenty two in terms of the percentage per quarter.

Yeah.

It's premature for me to give you a percentage by quarter at this phase we're doing our best to give you our latest insights into the full year outlook. Some of the quarterly profile ends up being determined by the timing of material receipts on.

Large programs at across the business base. So it gives us a few more months to give you a quarterly profile will.

Certainly do so we'll give you more insights on that in January as we typically do.

Fair enough. Thank you.

Thank you and one moment for our next question.

Our next question comes from the line of Ken Herbert with RBC Capital markets. Your line is open. Please go ahead.

Yes, hi, good morning, Kathy and Dave.

Good morning.

Kathy relative to or day relative to the initial expectations in the year, you've seen stronger bookings that you've called out as we've gone through the year and I'm. Just wondering if you can parse that out a little bit.

I know you called out share gains, but how much of that has been share gains versus maybe an acceleration or timing around contracts and how much should we sort of read through where think about maybe an expanded opportunity set for you heading into 'twenty three based on some of the stronger bookings this year.

Thanks for the question.

When we look at the portfolio. It has been broad based in terms of the improvement that we've seen in our expectations for book to Bill All four segments now are projecting over one and it has been most pronounced in space, where we've called out some specific opportunities that we're competitive so to your point taking share that.

We were able to secure.

We may not have anticipated winning as many of those as we started the year as we ultimately have we.

We feel it.

We are in a good position with backlog in each of the businesses going into 2023 supporting the accelerated growth that we've laid out in our outlook for next year.

We don't expect that our book to Bill next year will be as robust as it was this year, because we do have quite a bit of backlog.

We will be carrying into the year and the opportunity set is not as strong in 2023, but we do see then that picking up again in 'twenty four 'twenty five so I would tell you we tend not to look at awards on a single year basis.

Calculate book to Bill only on a single year, we look at it on a running basis in our system strong as in aggregate over the last three years, we expect that to continue well into the future.

That's helpful. But as you think about the strength of the comment you just made on strength in the 'twenty four would that be more on the space side within space or maybe more on the launch missiles side or any color on that would be helpful.

First space, we've seen broad based opportunities across both launch missiles as well as our space segment and we expect that to continue there are multiple programs that will be selected for next phase.

And be awarded in that timeframe in both elements of our space business.

Great Alright, thank you very much.

Thank you.

Thank you and one moment for our next question.

And our next question comes from the line of Scott <unk> with Credit Suisse. Your line is open. Please go ahead.

Hey, good morning, Thank you for taking my question.

Good morning, anything you can say about the equipment sales that impacted Q3 free cash flow is that similar in nature to the large equipment sales at <unk> booked a while back.

Okay got it and then Kathy on N G I.

Is it reasonable to think that you might be able to offer some cost savings to your customer there.

If theres product commonality between the interceptor and the GBS D booster.

Would you potentially designed for commonality there.

They are in order to drive that cost benefits the customer. Thank you.

Or is as well as our missile defense portfolio. So as noted has been growing and we expect it to continue to grow taking a full mission understanding of the threat environment as it evolves and bringing it back into our product development strategy is key across the entire portfolio that NCI will also benefit from that level of expertise that we.

We have.

With the threat the solution elements and submission.

Makes sense. Thank you.

Thank you.

Thank you and one moment for our next question.

And our next question comes from the line of David Strauss with Barclays. Your line is open. Please go ahead.

Thanks, Good morning.

Good morning.

Kathy.

35 cuts across a number of your businesses I think you've talked about it being 10% of sales in total can you can you.

Give us an idea of what you've got baked in for F. 35 in total in 2023 from a.

Uh-huh well.

Well, David actually when we look across the entirety of the company F. 35 is pretty flat going into 2023. So we have a lot of moving parts as you indicated in aerospace we have volume that is fairly consistent in our case because remember we build a couple of years about 18 months ahead.

<unk> of Lockheed Martin and so we're maxing out at our limitation of capacity for building center fuselages, and so that project out.

Laddish into 2023, as Dave noted earlier, but in our mission systems side of the business, while we have that.

Which is being replaced with new product insertion. We're also working on new product insertion in the other elements of the portfolio. So we have some development work going on in block four that continues to grow and production there too is fairly stable.

Look out over the time period and Sustainment is growing so when you take all of those elements across the entirety of our portfolio F. 35 is pretty flat going into 2023, and we expect to be relatively flat going into 2024, maybe a little bit of upside to that.

Alright, perfect Thats very helpful.

And then on the on the back on the margin guide for for next year.

Would you characterize the drop I guess before I think we were all thinking kind of flattish next year, and then maybe improving a bit in 'twenty four.

Would you characterize.

The lower guide.

Is that is that more mix related you know maybe the your lower margin programs are accelerating faster than you would have expected or is this inflation related or some combination of both.

I would say, it's a combination of all of those factors, but leaning more towards the macro factors. This is.

A unique environment that we're all operating in these days.

As wide open to the continuation of a lot of those pressures in 2023.

And Thats why we think it's not a huge impact but call it 20 basis points compared to.

The high levels, we've been operating at in 2022.

I think importantly, as you get down to the earnings per share line, excluding the noncash pension element of it we anticipate EPS growth faster than even the 4% to 5% accelerated sales growth. So.

We're managing through these.

I think particularly well when you think about the.

The pace of EPS acceleration as well.

Alright, we're going to have to leave it there okay one more.

<unk>.

Alright, I will leave it there I'll turn it over to Kathy for closing remarks, thanks Todd.

Tiring from Northrop Grumman in January she has provided 10 years of outstanding service to our company. Most recently as the defense systems front and we wish her the very best.

Ladies and gentlemen. This concludes today's conference call. Thank you for participating have a great day.

Q3 2022 Northrop Grumman Corp Earnings Call

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