Q2 2019 Earnings Call
My name is an Italian and I will be your operator today at this time all participants are any listen only mode.
If at any time during the call you require assistance. Please press star zero and an operator will be happy to assist you.
I would now like to turn the call over to your host Mr., Steve Movius, Treasurer, and Vice President Investor Relations.
Mr. Movius. Please proceed.
Thanks to tell you and welcome to Northrop Grumman's second quarter 2019 conference call.
Before we start please understand that matters discussed on today's call constitute forward looking statements pursuant to the safe Harbor provisions of Federal Securities laws.
Forward looking statements involve risks and uncertainties, which are noted in today's earnings release, and our SEC filings.
These risks and uncertainties that may cause actual company results to differ materially.
Matters discussed on today's call will also include non-GAAP financial measures that are reconciled in our earnings release and supplemental presentation.
On the call today are Kathy warden, our CEO and president and Ken Bedingfield, our CFO at this time I'd like to turn the call over to Kathy.
Thank you, Steve Hello, everyone and welcome to today's call.
We had an excellent second quarter results across the board, including business capture backlog rose sales earnings and cash.
Based on our strong performance and our outlook for the remainder of the year, we are increasing 2019 guidance.
I want to thank the Northrop Grumman team I'm, particularly proud of our ability to deliver innovative quality products and services, which enable global security and human advancement.
Starting with Spain, as we celebrate the fiftyth anniversary of our nation's Apollo 11 lunar landing, we're proud of our strong legacy in supporting each of our nations manned space flight to date.
Looking forward, we're poised to continue supporting manned spaceflight for Nasa's Artemus program, which is expected to return humans to the moon by 2024.
In addition, this quarter innovation system, it's past its one year anniversary of our four sector and I'm delighted with the progress we're making.
Cost and operational synergies are on track and our margin rates across the company are benefiting from the synergies realized since the acquisition.
We're also realizing revenue synergies sooner than we expected.
A good indicator of our success in capturing revenue synergies is our growing share of restricted work.
We booked $843 million in restricted space awards during the second quarter, and four and a half billion in the first quarter.
At the company level restricted work across multiple domains continues to grow as a percent of total revenue.
This demonstrates our strong alignment to the national defense strategy, and our ability to leverage our entire portfolio to create innovative solutions for our customers.
We booked an award to 13 and a half billion in the second quarter and 25.8 billion year to date.
Now in other words are approximately 1.6 times sale and our total backlog is up 18% to $63 billion.
The large multi year awards, we're capturing across the company are the building blocks for sustainable long term profitable growth.
Year to date Aerospace systems is booked net awards of approximately 13 billion and total backlog has increased 20% since year end.
In the second quarter, we booked $3.6 billion for the two D.
Approximately 3.3 billion was booked in Asia for the U.S. Navy snacks, 24, advanced Hawkeyes and associated deliverable with the balance awarded at mission systems.
In addition to U.S. Navy aircraft the multi year includes an option for the nine additional key to these for Japan.
In the second quarter, we delivered the first of four Etwo D. Currently under contract for Japan.
And we anticipate being under contract for the additional nine by the end of this year.
On the F 35 program, we booked awards over 4 billion in the quarter across our four sectors.
At Aerospace systems, we finalized a 4.9 billion dollar agreement for production last 12 through 14 center fuselage units.
And booked an award of approximately 3 billion net of previous incremental funding.
Mission systems added $1 billion of award for additional F 35 radar Cnine under production.
And I asked and TS together were awarded approximately 100 million for their scope on the program.
Moving to innovation system.
Year to date net awards totaled approximately $3 billion.
In addition to our prime role supporting U.S. government hypersonic weapons systems development efforts, we're also supporting Lockheed Martin and Raytheon programs.
In the second quarter, Lockheed Martin awarded US $265 million for the intermediate range conventional prostrate program and I asked is working with Raytheon on the hypersonic air breathing weapon concept, we're Hawk program.
Shortly after the end of the quarter States, Norway awarded I ask the 250 million dollar contract for its Arctic satellite broadband mission to provide critical ground infrastructure and to design manufacture and integrate two satellites.
This activity increases utilization of our hot production line, enhancing affordability and production efficiency across our customer base.
In addition, aerospace systems, it's developing payloads for that space, Norway satellite, which will be posted on the IR spot.
This is another example of revenue synergy in the space domain and it highlights our industry leading into and capability.
Now moving to mission systems.
We signed a 1 billion dollar contract to begin full rate production on our dealer program after achieving initial operating capability in the first quarter.
Gator is our first ground based gallium nitride or again radar to be operationally fielded.
It combined cycle legacy systems into a single solution, improving mission performance and reducing customer costs.
Peter provides real time 360 degree situational awareness against a broad array of threats and we see this system, having strong opportunity for international sales.
Mission systems is also supplying the upgraded integrated avionics suite for the Black Hawk program, which entered over at the April .
An initial 25 kids were ordered under this already and the army plans to upgrade 760 Black Hawk with this avionics suite.
And lastly, the army awarded US an LTAC for agile software development of the next incremental build at the Vcs capability.
This competitive win signifies our customers confidence in our ability and commitment to accelerate delivery of critical New war fighting capabilities.
Mission systems year to date net awards totaled approximately $8 billion and backlog is up 14% from year end.
The common thread running through our successful efforts on Kedar Black Hawk as well as IBCM is our modular multi mission open architecture approach to next generation defense electronics.
We are reaping the benefit of substantial technology investments, we've made to support development of solution that gives the customer advanced performance and greater affordability as well as the ability to rapidly address future threats.
Turning to technology services.
Global services of $223 million for an international training program.
70 million dollar task order to support the joint Chiefs of staff and a 15.9 million dollar contract to provide enterprise defense cyber operations for the Marine Corps.
In global logistics and modernization, we secured a $162 million Army award for Sustainment of the Hunter unmanned aircraft system.
And on EA, Pat our electronic attack on upgrade program, the Air force exercise of $44 million option.
Our business capture has been outstanding year to date, and we expect strong bookings to continue.
We have a robust opportunity set across the corporation with large potential award in restricted stays national security space launch TBSI and product line expansion in airborne radar and electronic warfare.
In may on the National Security Space launch program innovation system successfully conducted a full scale static fire test of the first stage of our do Omega rocket.
This milestone keeps Omega on track to performance first launched in 2021 and be an operational launches of National security payloads in 2020 two meeting the congressional mandate and view Us Air Force requirements.
And as you know the final RFP for GTSP was released last week.
Northrop Grumman has been a trusted systems engineering partner for every new I. Cbms system over the last 60 years, we look forward to offering a highly capable technically mature and affordable solution that addresses the evolving threats and facilitate our nation's critical nuclear deterrence mission.
Turning to PNM at the midpoint of the year sales are up 20%.
As we indicated last quarter mission systems sales growth is accelerating and the topline is stabilizing and technology services.
Looking ahead, we continue to expect sales of approximately 34 billion for 2019.
In addition to solid topline results are sectors generated a 26% increase in second quarter segment operating income and a 70 basis point increase in our segment margin rate driven by strong performance and cost synergies.
Year to date, our segment our win rate is up 60 basis points and we are raising our guidance for the year to approximately 11% from low to mid 11%.
EPS rose, 12% on the quarter and we now expect full year earnings per share to range between $19.30 and $19.55.
Cash generation was also a highlight this quarter.
Our businesses generated $1.6 billion and after capital expenditures of 252 million free cash flow totaled approximately $1.4 billion.
For the year, we continue to expect 2019 free cash flow of $2.6 billion to $3 billion.
And beyond this year, we expect to continue generating strong cash as we grow the business.
We continue to execute a balanced cash deployment strategy.
In addition to capital expenditures, we increased our quarterly dividend by 10%. We continued repurchasing shares toward our 2019 target and we will retire 500 million in debt in August .
Now turning to the U.S. budget, we're pleased to report that Congress and the administration have reached an agreement on fiscal year 2020, and 2020 , one that should prevent harmful budget cuts and disruption.
Predictable funding enable our customers to increase.
Investment in critical technologies needed to stay ahead of rapidly advancing global threat.
We believe our nation's leaders understand the threats, we face and will act to provide the necessary resources to modernize key capabilities.
Northrop Grumman continues to invest in advanced capabilities to enable long term value creation.
Our new franchise programs and leading technology demonstrate the success of our investments and an approach that combines innovation with affordability.
We believe that our portfolio and cost structure, our competitive differentiators.
That is evidenced by our business capture success, we'll continue creating value for our customers and shareholders.
Now I'll turn the call over to Ken for a more detailed discussion of our financial results and guidance Ken.
Thanks, Kathy and good afternoon, everyone.
I also want to thank the team for a strong second quarter.
I'd note that our presentation includes EPS bridge from second quarter 2018 to second quarter 2019.
And the bridge to our updated 2019 EPS guidance.
As you can see from the bridge on slide six.
The majority of the bps increase is driven by strong year to date operational performance and full year expectations.
With the remaining 10 cents, primarily reflecting a lower expected unallocated corporate expense.
Let's turn to the sectors.
Aerospace systems rose, 2% in the quarter, reflecting higher F 35 volume and manned aircraft.
And increased civil space activity in space systems.
I'll start on the sales were comparable to the prior periods I will note second quarter sales were also unfavorably impacted by the timing of supplier costs.
Operating income operating income rose slightly and is operating margin rate was comparable to last years second quarter.
We continue to expect I guess sales for the year and the high $13 billion range with a mid to high 10% operating margin rate no change to prior guidance.
And innovation systems based on pro forma sales comparisons second quarter sales rose, 8% due to higher volume at flight systems and defense systems.
Flight systems had increased volume on military aerospace structures and launch vehicles.
Defense systems at higher volume and tactical missiles, including the Arden program.
I guess operating income was 169 million with a strong operating margin rate of 11.3%.
I asked you year to date margin rate reflects several favorable adjustments and risk.
Yes.
The largest of the businesses grew above the sector growth rate.
Increased volume on infrared countermeasures airborne radar and restricted programs drove the sensors and processing growth.
And higher volume unrestricted programs drove growth at advanced capabilities.
At cyber and is are we had increased volume on space programs.
With previously discussed program completion headwinds behind us.
Mission systems growth rate has accelerated as we ramp up on a number of programs such as F 35, Gator curriculum and I Vcs to name just a few.
We continue to expect SMS revenue to grow in the low to mid $12 billion range. This year.
With a margin rate of approximately 13%.
No change to prior guidance.
And technology services I'm pleased to report sales were comparable to the prior year period.
TS operating profit increased 19%.
And operating margin rate increased to 170 basis points to 10.8%.
Looking ahead previously discussed program completion headwinds moderate in the second half.
And we expect Ts sales will continue to stabilize.
We continue to expect Ts sales in the low $4 billion range.
No change to prior guidance.
And based on strong first half performance, we are again raising guidance for Ts operating margin rates.
We now expect a low 10% range versus prior guidance of approximately 10%.
As we roll all that up.
We continue to expect 2019 sales of approximately $34 billion.
And based on strong year to date performance and sector guidance increases.
We are increasing guidance for total segment operating margin rate to approximately 11.5%.
Below segment OEM, we now expect unallocated corporate expense of $225 million versus prior guidance of $250 million.
Higher segment OEM.
Along with a lower unallocated corporate expense.
Moves our full year guidance for the total operating margin rate to the high 10% range.
Through the first half of the year, our effective tax rate is 16.4%.
Versus 17, and a half at this time last year.
Our year to date effective tax rate reflects a higher level of research credits than we currently anticipate for the second half of the year.
So no change to our guidance for 2019 effective tax rate.
As a result of improved performance, we are increasing our mark to market adjusted earnings per share guidance to a range of 1930 to $19.05. This continues to be based on approximately 170 million weighted average shares outstanding.
Turning to cash it was a very strong quarter.
Second quarter cash from operations reflects improved trade working capital and higher earnings.
Improved to trade working capital includes the recovery of first quarter delayed billings that resulted from our ERP conversion to a single instance of S&P covering the majority of our businesses.
For the year no change to prior guidance of 3.8 to 4.2 billion cash from operations and $2.6 billion to $3 billion of free cash flow.
After capital expenditures of about $1.2 billion.
We continue to planned share repurchases of approximately $750 million this year.
Subject to market conditions.
And as previously discussed we intend to retire about 500 million of debt in the third quarter.
Beyond this year.
We expect growing cash flows as a result of growing earnings some improvements in working capital and are well funded pension plans as a result, we expect to have increasing capacity for value creating capital deployment.
In summary, it was a strong quarter a good first half and we expect strong results for the remainder of the year.
I think we're ready for Q in a Steve.
Thanks, Ken.
I would ask each participant to limit themselves to a single question.
Italian would you. Please open the line for acuity.
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Your first question is from the line of Myles Walton with DBS.
Thanks, Good morning.
Good morning.
Yes, I was I was wondering on the on the bookings front, obviously extremely strong in the first half and particularly here in the second quarter.
I think in the 10-Q you filed it also shows a slower burn of that backlog.
About 40% over the next 12 months as opposed to the 50% over the next 12 months for the last several quarters now couple of years can you talk about.
How indicative that growth in backlog is about your acceleration of growth given that.
Kind of reduced burn rate if that's accurate.
Yes, let me start on that one miles and I would just say that.
You know we are.
I'm really happy to see the awards in the backlog that we have been able to get.
In the first half of the year and as Kathy mentioned, we do expect to see continued strong awards in the second half of the year.
I would just point out that a number of the awards, we've been booking like the B 21.
Etwo D, which is a five year multi year contract.
F 35 lots.
12 to 14 many of these programs are going to support multiple years of revenue.
And so given the in particular, the the awards booked in the first.
Part of the year first half of this year.
The biggest ones being Etwo D as well as F 35, and then some restricted space activity, we expect those awards too.
Result in sales for a multi year period and give us really good visibility into strong sales growth for a number of years to come.
And so given those.
The impact of those large multi year awards, we do see that.
Those will result in our backlog turning into sales at about 40% in the next 12 months versus our previous.
Average at about 50%.
But it does not give us any pause as to.
Any guidance, we've given risk with respect to 19.
Sales or with any indication we've given you about where we think we can be on 2020 sales and I'll just remind you talked about.
A mid single digit range on 2020, but given our awards activity and the opportunities we see in front of US. We think we've got opportunity to be in the higher end of that range for 2020. So we think it's a it's really a good news story and supports again this what we've been talking about.
The level of.
Visibility we have into.
Some long range sales growth for this business.
Thats great color. Thanks again.
Your next question is from the line of Brian Epstein with Bank of America.
Hey, good morning, guys.
Hi, good afternoon actually.
Quick question, it's my understanding that the RFP came out for bid through the next phase of GBSD.
Can you share any thoughts on what you guys are thinking about it.
How you feel about it.
Yes, Thanks Ron.
As we look at the RFP, which should come out one day a week ago.
We are really.
We're seeing what we expected to see.
And we are positioned to be able to support the U.S. Air force requirements.
Viewed us as a strong opportunity for our company as I noted in my own remarks, Weve been supporting me I Cbm system for over 60 years. So we have the knowledge and the expertise needed to put together a strong offer for the US Air Force and we look forward to doing that.
There is a 150 day response period, so we'll be submitting a proposal late this year and still expect an award in.
The mid to late part of 2020 .
Great. Thank you very much.
Your next question is from the line of Peter Arment with Baird.
Hi, guys good afternoon Catherine.
Kathy you mentioned the word.
The revenue synergies that Youre, starting to book, obviously, a lot less unrestricted so.
You can't really talk about it but I just.
Wanted to talk about how that flows through to growth do we expect to start to see that layer in kind of the way Ken described the burn rate on the backlog or is it something that happens fast or maybe just some color there. Thank you.
Yes, we had talked about revenue synergy really not starting to kick in in earnest to 2020 and I've mentioned.
In last quarter's call as well as this one that we are seeing those revenue synergies sooner than we expected.
Our on efforts that are restricted and developmental largely and therefore, you see a fairly slow.
Ramp of that revenue in 19, you'll see it more materially happening in the 20 and 21 timeframe as we've talked about previously as you noted it is.
In restricted space and today I shared the Big Norway Award because its something thats on classified that we can talk about that demonstrates how in that case innovation systems and aerospace systems are working together with is providing the boss and the integrated ground and then building the payloads for the satellites and so we're going to continue to see those kinds of opportunities that are pulling end to end capabilities from across our various sectors together in multiple mission areas, but certainly we're seeing more of that in the space than any other domain.
Appreciate the color. Thank you.
Your next question is from the line of Doug Harned with Bernstein.
Thank you.
Good innovation systems, you had you had what we would consider to be very good margin performance in the quarter at the same time, you reported that the percentage of cost type work had gone up to 29% from 26.
So when you look first can you talk about what's been driving the good performance. Good margin performance that add innovation systems and then as you look forward and think about how you.
Take parts of that business and link it to other aerospace into mission systems to capture revenue synergies. How do you ensure that you can continue.
To improve margin there.
So Doug let me start and then I'm going to ask Ken to provide some color on some activities in the first half of the year, which won't be recurring that did have a positive impact on the margin, but more broadly. The good margin performance were seen at innovation system is due in part to their strong performance and also in part to the cost synergies that we're realizing across the company and the more that we're able to utilize the facility footprint.
The infrastructure that we have across the whole idea and all the sectors are benefiting from that so its not just the cost that were taking out that I referred to as cost synergy, but also starting to realize some of the operational synergy that's having a positive impact on margins as well in terms of our outlook for IHOP. We expect that strong performance to continue but as I noted there were a couple of events in the first half that increased their operating margins and Ken I'll ask you to Usher shed some light on that.
Yes, I would just add that.
You May remember Doug in the first quarter, we talked about.
The.
Contribution of some commercial negotiations that we had planned to occur in 2018, which which occurred earlier than we expected driving the Q1.
Margin up and then in Q2, largely we had some.
Positive adjustments on some of our contracts that.
That drove some additional margin rate and obviously as we look at the second half of the year, we'll work hard to manage risk and realize opportunities to try to continue to drive.
Upside to margin rate.
But we've had a real successful first half the year, so far and.
Still need to fill it and for the full year.
In terms of the question specifically about the 26 versus the 29% I would just remind you that the.
The previous year period, only included about three plus weeks of activity.
So probably.
Not a material change in terms of the revenue then versus revenue now.
But certainly.
We can perform on cost type contracts and drive favorably is easy adjustments there as well.
Okay, great very good thank you.
Thanks, Doug.
Your next question is from the line of Seth Seifman with Jpmorgan.
Hi, Thanks, Thanks, very much and good afternoon.
At Aerospace systems, I guess in the first quarter, we saw a step up.
And.
Yes in sales to about 3.5 billion and what you've done in the first half and the guidance sort of implies that we're going to stay at about that that level through the end of the year.
When do we see the next leg up and in aerospace revenue and then.
Yes, Kathy on the fourth quarter call I think you talked and a little bit more detail about the three pieces.
Manned unmanned and space and so maybe if you could talk qualitatively about the outlook now that you've got a few more of these awards under your belt for the next up for the next couple of years for each of those.
Mhm.
I'm going to ask Ken to start with giving you the outlook for the remainder of the year and then I'll talk to our overall view of the three segments.
Yes. This is just a couple of comments I guess I would make for.
Yes.
Yes, I would say that.
You know as I referenced in my remarks, we did have that some timing of some supplier cost that.
I moved to the right a little bit from Q2 into the second half of the year.
We did have a relatively tough compare for EPS growth, which had grown 11%.
Q2 of 18.
On top of 11% Q2 before that so yes, it's been a solidly growing business and.
We continue to be comfortable that it continues to grow as we look forward.
We're comfortable with our full year guidance for EPS and.
You know feel feel good about where we are and where that business is going to be going in the next few years and all that comment I'll, let Cathy comment more specifically on kind of the divisions within I guess.
Yes, so we've been seeing growth across the three segments, Oh asked manned unmanned and space in each quarter that vary a bit this quarter manned space were up offsetting some slight declines in unmanned just largely timing of deliveries in that business as we look forward and over the long term, we see space as likely the fastest growing segment of the aerospace.
And that we see budget increases in that area. It's a key area, where we're identifying and executing revenue synergies across the entire portfolio. So I do see that being one of our fastest growing segment in the company over time.
I would say that man continues to benefit from a number of key franchise programs like he two d. The additional awards. They are with the U.S. Navy, but also it will be fueled by the international growth.
We noted Japan and then of course, we continue with up 35 to see some decent growth in that segment as well, but unmanned two will have a nice growth outlook as we take Triton to early operating capability. Later this year, we'll be ramping up production on that program over time and we also as you know how strong international demand there with units going to Australia, and some interest in Germany as well, so I really see nice opportunity across all three elements of the aerospace portfolio.
Great. Thank you very much.
Your next question is from the line of Robert Stallard with vertical research.
Thanks, so much good afternoon.
Good afternoon.
Ken you mentioned that next year, you should have some more flexibility for value added capital deployment.
I was wondering what your priorities might be in that area and where the pre funding the pension might have moved up the agenda that.
Sure Rob I'll I'll comment on that I would say that.
You know as we look at the value creating.
Capital deployment opportunities.
Probably not going to lay out the specifics for what 2020 might look like until we actually give guidance.
For 2020.
But I would probably reference you to our.
You know consistent.
Allocation over the past number of years in particular I would note that.
We've been.
Repurchaser of our shares for many years dating back to 2003, we certainly expect that to continue we've talked about what our capex profile looks like.
[noise] certainly continuing to invest in technology through R&D investment and things like that.
In terms of pension pre funding.
I haven't seen that really rise too high on my radar screen at this point I would say that we've had pretty solid.
Pension returns year to date and that should help us from a required funding perspective, and I think if if you think back to our previous discussion we didnt have a whole lot of funding required for the next couple of years on pension so not necessarily high on my radar screen my previous commentary on the debt payoff in August of this year.
We do expect that.
After we pay that off and then we look forward at our growing EBITDA and cash flows we have the opportunity to get back to our preferred triple B plus credit rating at that point, so lots of optionality on kind of.
Managing the balance sheet, I would say from that perspective and.
I will just lots of.
Lots of opportunity as we see again, a growing set of cash flows to think about what the most value creating capital deployment us.
That's great. Thank you.
Your next question comes from the line of Robert Spingarn with Credit Suisse.
Good afternoon.
Yes so.
Hey, there can just on that growing set of cash flows you know you talked earlier about the strength of the multi year awards.
And that 2020 revenues could be at the high end of expectation, so, it's becoming clear that double digit.
Growth for free cash flow per share as possible. So I wanted to I know you don't want to get too far ahead of yourself, but how do you feel about the.
15% to 20% growth implied in the consensus free cash flow for 2020 of $20 per share.
Great. Thanks for the question.
As I mentioned previously we're not ready to give guidance for 2020 at this point, but.
I think we've been clear and I'll continue to be clear that this is a business that will be a strong generator of cash as we look forward.
And let me just let me just walk through a few of the drivers of that for 2020 and beyond.
First as as you mentioned, we expect to continue to see solid growth.
And thats for multiple years, given our portfolio alignment.
To what our customers needs and the.
Changing threats.
And also as evidenced by our strong backlog.
We continue to expect to generate strong margins and convert those margins and the cash.
We invested ahead of the curve and we continue to expect our Capex will moderate in future years.
Pension plans are well funded to Rob's question previously.
Some of the best funded plans and industry in industry to be Frank.
And as we look forward, we continue to think that working capital should moderate a bit starting in 2020 and with more opportunity in the out years, so with kind of that framework I think you're hitting on the right issues or the right.
[noise] thoughts and I wouldn't argue with your thesis or assumptions on on solid free cash flow growth.
Okay. Thank you.
Your next question based on the line of Sheila Kahyaoglu with Jefferies.
Hi, Thank you good afternoon Kathleen Ken.
And just on the missiles market, it's been a big focus lately, maybe can you talk about orbital ABT, what it's brought incrementally in terms of technology and exposure and how do you think about the opportunities going forward and maybe your market share today.
Thanks.
So as we look at the missile space. There is clearly an opportunity for us to continue to be key suppliers to Raytheon and Joaquin, which we've been doing more traditional cruise missile space and as I noted on today's call. We continue with that partnering in lot hypersonic weapons based as well and then there are some select instances and I went into some of those in our prior discussions Arkon are is a good example, where we are the prime provider for the missile.
We can provide that full integration and delivery capability, but we also have clearly the specialization and propulsion for other prime missile system and so when we think about the business we really do.
Focus ourselves on continuing to evolve the technology in not only the propulsion system, but our ability to provide guidance and the other elements of that system. The composite structures that we can offer to others. We're in select instances.
Provide through our own prime offering.
We see that area growing or IOP.
As we see it growing for the other primes as well and so we think that theres plenty of market opportunity for the three of us in that arena.
Thanks.
Your next question is from the line of David Strauss with Barclays.
Thanks, Good afternoon.
Kathy could you.
Could you address your competitive win rate within Ts and whether you still think that Ts as a whole can return to growth.
In 2020 and.
Could you also could you also address your positioning within no pam's competition the fence off that's going on there. Thanks.
Sure, let me start with technology services.
Our win rate there in the first half of the year has been very solid, particularly on Recompetes, where we've been able to defend the business that we have.
And as you know at the beginning of the year, we laid out a trajectory for that business.
The actions that we've taken have stopped stabilize the top line and you also see that we're increasing the margin rate in that business because the team is executing to that plan quite well.
As our guidance indicates I expect that that sector is going to be flattish for the remainder of the year and we still expect that this sector will return to growth in 2020 .
It's largely driven by still having some headwinds from programs that have exited the global services part of the portfolio. While we are growing the global Sustainment and modernization part of the test business.
And I just want to also note that Ts is providing us affordable lifecycle support and modernization for systems and platform that we build as well and so they are an integral part of many of the program that we have and they offer an affordable options for that services component of the program execution for the bid.
So now turning to the second part of your question around L. town. We are in an active competition. There we did submit a bid and we feel confident that we have an offer that is competitive and is based on the mature Gan technology. So we'll wait to see what the army. Thanks, but we certainly are pleased to be able to participate in that competition and bring forward. What we think is a good offer.
Data tell you next question. Your next question is from the line of Jon Raviv with Citi.
Thank you good afternoon, everyone.
Chassis I know investments a very important part of the thesis the differentiator for North Europe , you know one of your near peers would say has engaged in some M&A where investment is also a part of their thesis too so any thoughts of perspectives on size and scale in light of some of those M&A moves and the importance of size and scale and being competitive going forward in the in the defense market.
We're certainly assessing the implications.
Consolidation.
Our market, but let me share how we think about our.
<unk>.
I see that we have a strong portfolio, especially now with the addition of innovation.
And the portfolio is well aligned to our customer's highest priority investment areas.
As you noted we have been investing to support value creation.
We've been investing in technology I gave one example today of a multiyear investment stream we've had.
And Oh in mission systems electronics, and some of the programs that we're now winning in mission systems as a result of those investments.
We of course have been investing in the facilities and equipment. We need many of you have seen the expansion that weve done at Palmdale and across our other aerospace centers of excellence or for the last several years.
And we have a competitive cost structure as witnessed by some of our recent wins and the fighting of our cost advantages in the.
So when I look at where we are today, we have that portfolio and a strong basis just support business capture we also have a strong and improving balance sheet, that's going to continue to allow us this investment optionality into the future.
And we've demonstrated the ability to compete and win at our current scale.
So I see often that the quality of investment choices is even more important than the pure size of the investment itself.
And looking at where we are with a focused strategy well aligned investments to that strategy I feel good about where we're positioned.
Thank you.
Your next question is from the line of George Shapiro with Shapiro research.
Yes, good good afternoon.
I was wondering can see your Ken if you could go through some of the programs that are in unfunded backlog for aerospace since that was a big part of the jump in backlog. This this quarter.
Hi.
George to be honest with you on that one I don't have that data in front of me so I'd have to get a.
Steve to follow to you with the specifics on that.
After the call today.
[noise].
Okay. Another question you wanted to go through.
Oh, yes, the EEI sees in aerospace we're down you know were 54 versus 95 last year can you talk through.
What might have been negative in the quarter or why it was down by as much as it was.
Yes, I'd be happy to go through that George.
I don't think there were really negative us up any significant consequence in this years second quarter.
You may remember that last year's second quarter, we did have.
And actually pick up you see positive adjustments of about 69 million on a couple of restricted programs. So really if you look at it I mean, it was more positives in last year's second quarter and if you think about this year's second quarter with a similar margin rates.
That would tell you that the the underlying baseline EA see rates that were booking at is stronger.
Then it was four.
For last year's second quarter. So we feel good about where we are I'm always careful to.
Put too much credence into the AC adjustments because there's always.
Timing and fluctuations and ups and downs and I think the most important thing is we continue to perform.
We have not seen that.
An uptick in negative adjustments and ER.
You know continue to deliver consistent strong performance at each of the sectors.
Okay. Thanks.
Your next question is from the line of Brent Ti, even want whiny with Morgan Stanley .
Hi, Cathy I kind of.
Hey, <unk>.
[laughter] just a an F 35 question Lucky, it's been pretty vocal about getting the price town and it seems like there.
Successfully giving so given that it's one of your biggest programs how is that.
Filtering down to you on the revenue and or margin side.
As a follow up.
Can you highlight any contracts that are maybe rolling over over the next 612 18 months that could create a little bit of a noise. If you will as we start looking at growth rates moving higher.
Sure as usual I'll start on that one and then Kathy can add any color, but from an F 35 perspective.
I would just say that we're performing well we've been you know delivering quality product.
On time or ahead of schedule.
We do have [noise].
Four contracts across a number of sectors actually have more than more than four contracts now with is and Ts starting to see some of the logistics activity and Sustainment. So it's a significant program for us and we have been.
Really working hard to support.
Our customer Lockheed Martin as well as the U.S. government to deliver.
To that target that has been established from a price per unit perspective and.
And clearly our cost as a part of the cost reduction that that our customers are seeing so we feel really good about where we are on that program and.
We've seen a really solid operational performance and.
You know, we're we're pleased with where that that program is at this point.
And then was there is I think really your second question was related to any return.
In the second half of the year is that right.
Yes, or just simply contracts that are that are rolling off.
Yes, you got the right idea.
Right. So we have the remaining headwinds from the Virginia outsourcing contract that is still in tier three in the third quarter and then we have in our innovation system sector a contract for Lake City ammunition plant that is expected to be awarded.
In September of this year.
That would be about 10% of the revenue and innovation system.
And it does not currently have economic value. So there would not be a profit impact, but we are positioning to compete for that contract.
We are expecting to hear in the next couple of months.
I would just add to that the.
The.
Ammunition contract the Kathee talked about.
As a bit of a longer phase and then most contracts so probably start it would start to transition and.
Kind of mid to late 2020, although we've put together a competitive bid and we've got a lot of confidence that will.
See that.
Production continued to be a part of our business and on Zita I would just say that it's had a more significant impact in the first half of the year and we see it really only about $75 million of headwind as we look at the the second half for Ts So not a significant.
Set of.
And contracts that could sort of move against us.
Thank you.
Your next question is from the line of Hunter Keay with Wolfe Research.
Thank you.
Good afternoon.
I've got a follow up on GBSD.
Can you help us frame for the long term opportunity for that program and including some of the Sustainment work and then also please tell me I'm I'm being too nitpicky, but Kathy why did you include the phrase.
Technically mature when you're talking about the offering in your prepared remarks and nature of the question is basically now you've got a chance to review the RFP is less of a science project. If you will is there anything in there that would suggest that.
The customers looking for proven technology as opposed to more sort of ambitious development work as they think about.
The award thanks.
So to frame out the opportunity for you. It's clearly starts with the development of the modernized <unk> PBM system, and then moves into production phases over a number of years actually.
Produce the capability and then would move to Sustainment, but that Sustainment scope is not part of the RFP for the offering that's really that's about the development and.
Production phase of the contract and transmission system statement.
My freezing on technically mature is because we've been executing a tech maturation and risk reduction program for the last several years on GBS d. and through that process, we have been able to retire.
And really mature our offering and so we do feel that at this point in time, what we're able to offer.
Wrong some of that risk that we would have identified at the early stage of our design concept out of our offering.
Thanks.
Your next question is from the line of peak good bit scheme with Alembic global.
Yes, good afternoon.
Kathy I want to get your thoughts on this idea from kind of early on in the administration that was going to look at AK steel country reform that could help with you Avi exports I think it gets to the missile technology could trade regime or some other controlling agreement.
I was wondering if you can see progress on that or is it still the com youre just kind of fell off the table in terms of a major priority for the administration.
Initially I thought that maybe it could be a big opportunity for you guys.
Mhm.
It certainly hasn't fallen off the table, we're still engaged actively with the state department in looking at M. TCR and also specifically looking at certain countries that have requested our unmanned systems capability and I would say that we see.
Much more opening to have that dialogue and request from us to come forward with areas.
That have expressed interest and put some ideas on the table. It is slow to develop those into actual approval for export. So we're still working through a process that requires a lot of stuff for us to get there and we'll look at Mtc are also requires multi national engagements to make a change.
To that policy, so that too we expected and are seeing that that'll take some time.
Okay. So we should be patient on that front.
Okay. Thanks, guys.
We are being patient, but not patient.
We're pushing.
Your next question is from the line of Cai von Rumohr with Cowen and company.
Thank you very much so Kathy you mentioned, you're supporting two of your peers on Hypersonics.
With all yes, you now have capability in propulsion you have capability in guidance are you.
Yes, aspiring to become a bigger prime yourself and if not why not.
And also one of your peers talks about.
Defensive hypersonics as a bigger market is that an area that you're focused on because there you also looked like you had the technology capability.
Yes.
Why don't I start with the second part of your question because in the counterfeit hypersonic part of the market. We are establishing ourselves as the prime we have capabilities in the missile defense regime today and in the space regime that we believe will be highly relevant to counter hypersonics. So that is an area that we are aggressively pursuing in the case of hypersonics.
You know the offensive weapon systems themselves.
As I noted today, we do have prime effort.
We also are supporting both Lockheed and Raytheon and that's an important part of our strategy, we have been and orbital 80 k. prior to joining Northrop Grumman had been a merchant supplier to Raytheon and Lockheed we got into agreements to support them on certain programs and we are very committed to uphold those agreements and continue to support them with our best.
And brain its people and technology.
As we look forward over the long term, we certainly will look at every new opportunity as one that we would make a decision is it right for us to pursue that as a prime or continue to house partnership.
And work through the Prime Oh.
Raytheon, Lockheed and perhaps others that might emerge in the space as well.
Or both and offer capability to everyone here with two thing to pursue the marketplace.
And so those are decisions, we'll take one by one we are certainly not looking to.
To take an aggressive stance in that marketplace, because as I said, it's a growing market and it's one that we feel is big enough for three party to to adequately play and we want to make sure that our technology is getting into the hands for the war fighter and that we're getting the best capabilities in a timely fashion and sometimes it makes sense for us to work with our competitors to do that.
John Thank you very much.
Thats correct.
Yes. Your final question is from the line of Joseph Denardi with Stifel Nicholas.
Hi, good afternoon.
Can you talked about getting your confidence in the cash flow generation of the business and kind of the capital deployment strategy you guys have one of the lowest dividend yields in the industry. Obviously, there are two components to that equation, but can you can you talk about how you think about the dividend well either as a percent of kind of free cash flow or total capital deployed and whether you have a.
More ambitious plans for that going forward. Thank you.
Sure I'd be happy to talk about that thanks.
From a dividend perspective.
I guess I'll start with you know, we simply don't chase yield and can't Chase yield.
That being said, we have seen significant increases in our dividend every year for the last number of years I think it's been six years or so with double digit increases and in fact, two increases I guess it was in 2008 a team.
210% increases for 10 plus percent increases in 2018.
So we've been seeing.
You know a significant increase in.
Our dividend per share and I will say that.
Yes.
You can think of US as you know certainly continue to think about what our future dividend.
Increase would look like.
But again that being said, we don't we don't chase yield and.
It remains an important part of our capital deployment strategy, we've tended to think of it as.
Kind of a range of 30% to 40% of our pension adjusted net earnings.
And we have tended to.
It will be in the middle of the pack to our peers in terms of looking at our at our dividend based on.
That measure and so we think from a yield perspective, we may be a little bit low, but we think from a.
Again looking at it relative to our pension adjusted net earnings that were pretty squarely in the range in terms of.
Making sure that we have a competitive dividend.
Yes, Thanks again for the call over to you for final remarks.
Thanks, Steve I once again want to thank our team for their outstanding performance.
Our business capture a growing backlog are fruitful investments, we continue to provide the opportunity for long term value creation for customers and our shareholders.
I also want to thank all of you for joining us for the call today I hope that you enjoy the remainder of your summer and I look forward to talking to you again in October .
I would tell you that concludes our call.
Thank you ladies and gentlemen. This concludes today's conference call you may now disconnect.