Northrop Grumman Corporation (NOC) Earnings Call Transcript & Summary

It's smaller for you guys than it is for relatively than Lockheed or Raytheon. So...

International, in aggregate, is about 15% of our work, slightly under 15%. And that really is across a large number of countries and customers. So agreed. There's no one particular opportunity there that will be a big impediment for us, but it's certainly something we'll keep an eye on.

Got it. So as you look at this year, maybe remind us of the key growth drivers. And then you kind of laid out your expectation for the numbers by sector. But maybe as you talk about the growth drivers and the drags, maybe the areas that if you're lucky, things could be a little bit better than you projected in the areas where maybe there's a little bit more challenged to get to your guide?

Sure. I think I'll stop short of handicapping the guide, in particular, and providing thoughts on where there's more upside than downside, but I can give you some color that will hopefully be helpful there. In aggregate, our organic revenue growth guide is in the 3% -- 3% to 4% based on our guidance. And that obviously adjusts for the divestiture of the IT services work and also removes the onetime equipment sale that we had to a restricted customer in Q4 of 2020. So 3% to 4% in aggregate. Obviously, there are portions of the business growing faster and slower than that rate. GBSD and its $800 million to $900 million that you mentioned earlier of 2021 growth from 2020 is a good example of where we're seeing additional growth. In the space portfolio, in all, with its mid-teens implied growth, certainly driving a lot of healthy growth across the company. The restricted portfolio and some of the key wins we had in 2019 and 2020 are other examples of where we're seeing pockets of Space growth. I think if you look inside the divisions within Space, you'd see growth in each of them in 2021 and coming off of a very strong 2020. So really healthy profile of backlog and new opportunities, new starts across each of the pieces of our base portfolio. Across the other 3 divisions, I'd highlight our Mission Systems business. We talked about this on the call. Again, in addition to 3DELRR and some of the kind of headline new start opportunities, there are really a healthy number of kind of mid-single digits growing programs across the Mission Systems portfolio that aggregate to its mid-single digits growth rate expectation in its guidance. Again, not any one single pocket growing much more rapidly than others. But, in aggregate, really well-positioned work across the sensors and radars and electronics components across the Mission Systems business. Defense Systems has pieces of growth. We talked about the IBCS full rate production opportunity in Defense Systems. There are some recent wins on the sustainment and modernization services portfolio in Defense Systems. We talked about the CBP-3 win in 2020. That's an example there. But those are offset by the Lake City program ending in October of 2020. That will be a little over 1% drag on the overall company's growth and, obviously, a much larger drag on Defense Systems itself in 2021. And there are a couple of other smaller programs that ended earlier in 2020 that, again, are going to anniversary this year and work their way out of the growth comps for DS. But DS is one where we see nice long-term growth opportunity once we get through this current churn in its business mix. And then AS, we talked about the slowing growth in a few elements of its portfolio earlier. Another headwind example there is in the commercial Aerostructures business, which is one of the few parts of our market that have been very directly affected by COVID. And so we, again, expect that part of the business to be down in 2021. But, in aggregate, the rest of the AS portfolio will offset that to the tune of a pretty flat guide from 2020 to 2021. In terms of where you see more opportunity for upside or downside, much of that is determined in any year for a portfolio like ours by the longer cycle versus shorter cycle portions of our business and the mix that we see of where we are in the life cycle of various programs. And at this point, I think that's fairly evenly distributed across our 4 sectors as they're constituted today. So I wouldn't say we have dramatically more or less upside or downside opportunity in any one of the 4.

Got it. So over the same period, the question everybody always asks that's not always answered, which of the sectors are the programs with the greatest opportunity for margin expansion and which might still have more challenge?

Sure. As we look at the next few years, the margin opportunity, I would say, is a bit different in each of the 4 sectors. Our Mission Systems sector, at its nearly 15% margin, over the last couple of years is clearly a high-performing profit margin portion of the business already, and we'll look to sustain those margins given the differentiation they provide to their customers, the uniqueness of a lot of the technology that they deliver. In our Defense Systems business, the margins have come up over time and the mix continues to improve in that business, which has pushed its margins above 11%, which is well above where they have been in recent years, if you were to do an apples-to-apples comparison based on today's mix of business in that Defense Systems portfolio. And so I'd say we have modest opportunity for continued really strong performance and potential progress there. Our Aeronautics and Space businesses, again, slightly different types of work than we would see in Defense Systems and Mission Systems. On the Space side, we've talked about the pressures on margin from the growing cost-plus development portion of that portfolio. And so I think that's one you should expect to be flatter as we look to -- in margin rate, as we look to offset that mix with really strong performance in the rest of its portfolio, and that's what we've been able to deliver in 2020 and now are projecting in '21 and it's relatively constant 10% or so margin rate guide. And in the aeronautics portfolio, a lot of its margin rate will be determined by the mix of business, both in the restricted and unrestricted portions of that portfolio, where we are in the life cycle of some of its key programs. That's another where I'd say that over the next several years, given the changing mix that we see in aeronautics, there's an opportunity for us to build upon its current margin rate, particularly given that 2020's margin rate was suppressed a bit by the equipment sale that we had in Aeronautics Systems. So again, slightly different perspectives on each of the 4. In aggregate, margin rate is certainly something we're keenly focused on. Margin dollar expansion is really the key focus for the company to be able to continue to create earnings growth, free cash flow growth and dollars to continue to invest in the business and return to our shareholders.

Got it. And so -- I mean, at some point, ex '21, you kind of laid out the relative growth of your business areas. If you look out 3 or 4 years, is there any way you can say, okay, this area looks like it's going to be the fastest grower. Will it still be Space that will be #1 over, say, the 3- or 4-year period or maybe that maybe not, but...

Sure. Of course, it's tough today to gauge where anything will be 3 or 4 years into the future. But certainly, elements of the Space portfolio like GBSD should be larger 3 or 4 years from now than they are today. Some of the other restricted programs we've won recently, we would also expect to be larger in 3 or 4 years than they are today. And there is ample opportunity for additional new starts and growth opportunity in Space over the next few years. When we think about our growth over a multiyear period in any particular piece of the business, it's really the combination of the strength of its backlog and the way that backlog will run off over time as well as opportunities for new starts and market share gains. And I would say Space has a good combination of both of those elements with a great backlog and additional opportunities to take share and grow in a rapidly growing portion of the market. So I think that's the one I'd call out. Certainly, Mission Systems has a healthy volume of new business opportunity ahead of it. None of our businesses are without ample competition and really strong competition, but we feel good about our offerings there and our positioning in Mission Systems. We talked about some of the near-term headwinds in Defense Systems. And our aeronautics business is really more concentrated on a number of particularly key programs in that area. So the revenue growth profile over time is more dependent on where we are in the life cycle of any given program there. But I'd certainly call your attention, first and foremost, to the continued growth of the space market.

Very helpful. So it's been 2.5 years since you bought Orbital. Obviously, it looked like a great strategic fit, great financial fit. Maybe what are the biggest benefits you felt you got from that? And some of those were kind of obvious. But maybe talk to the other side, it was a pretty diverse business. Are there any capabilities that are maybe not as good a fit?

Sure. I would say very few in aggregate. And one that represented perhaps a weaker fit in the Northrop Grumman portfolio was the small ammunition business. And, of course, that is now -- has now left the portfolio through the Lake City loss. The rest of the portfolio, and essentially what remains of the Orbital ATK portfolio, we see as a very strong fit. On the propulsion side, in the missile business, examples like AARGM-ER, which really brought together both the best of the legacy Northrop business and the legacy OATK business. And then, of course, really across the Space portfolio with its combination of small sat capabilities combined with the larger, more exquisite capabilities in the legacy Northrop portfolio that -- the way that we can now address really every segment of the space market, both in the DoD and intelligence agency market, restricted market as well as elements that we continue to support in the commercial market through OATK. It's just a really nice harmony that we found between the 2 businesses in Space as well as in our Defense Systems portfolio when we talk about the weapons business in particular. We looked at cost synergies and talked kind of quantitatively about cost synergy at the time. Certainly, we met and exceeded those targets. But certainly, the revenue opportunity, the kind of combined market synergy that we see there is what we were more excited about at the time and what we continue to see really going exceptionally well today.

So what about aerostructures? I mean, you do commercial aerostructures. I've done this long enough, I can remember when Boeing did -- the Northrop did the Boeing 747 fuselage, but that doesn't seem -- aerostructures doesn't seem to be a core target competence, certainly commercial. Is that something that -- and I know that you have some defense business there that might outweigh it. But just comment, if you could, how that fits?

Sure. It's obviously been a tough nearly 12 months now for any commercial aerostructures business given the state of that portion of the market. And so perhaps an unfair time for me to address the commercial aerostructures business at a single point in time. [indiscernible] market one that, over time, will continue to address both commercially and in defense. Certainly, there are key defense missions that, that -- and platforms that, that portion of our business supports today, and we expect to continue to support. As to whether that commercial aerostructures market is one that we look to invest more in over time, exactly how we see the defense versus commercial applications of that aerostructures business, that will continue to evolve as market conditions evolve. But certainly, we feel like that business has been resilient, has continued to do a great job supporting our defense platforms and defense business. The commercial market will recover over time, and we'll continue to look at that just as we look at all elements of the portfolio to make sure they are kind of optimized for Northrop Grumman over time.

Terrific. And so you just sold the IT business to Veritas. And as a result, you've initiated a $2 billion accelerated repo, said you plan a total of $3 billion. $2 billion of debt retirement. Does this mean there's no M&A this year? Or how do you think about M&A in the context of what you're doing?

Sure. What we're signaling there with the $2 billion ASR, to your point, the $3 billion-or-so that we projected to deploy on share repurchases this year, and then the debt retirement that we've initiated now, is really the fact that we don't anticipate or aspire to keep more cash than we need on our books at any given time. Obviously, it's a priority for us to deploy that in value-creating ways in relatively short order. The business continues to generate healthy volumes of free cash flow each year and that gives us a nice opportunity to deploy cash in different ways over time. We had amassed a healthy volume of cash at the end of 2020. Obviously, the divestiture only added to that. And so we felt that it's prudent to deploy a good portion of that, certainly not all of that cash, in pretty short order here with the announcements that you've described over the last couple of weeks. As we look at M&A, certainly, we will continue to be thoughtful about any companies or businesses -- portions of businesses that can be additive to our portfolio. We look very hard at our offerings and how they address the areas of the market that we see as fastest-growing and kind of the best fit for Northrop Grumman going forward. And to the degree that there are any gaps there, we'll look to augment them through M&A. The fact that we've bought back some shares and retired some debt early is not an indication that we're out of the M&A market by any stretch. It's certainly something that -- with good example being the OATK deal a couple of years ago, when we saw a particularly kind of unique opportunity to double down on our space presence and some of the other elements of the OATK business that we've discussed. We aggressively pursued it, and we're able to make that work. We're paying down some debt in the meantime as well as returning excess cash to shareholders, continues to fortify our balance sheet and reduce our debt burden and other things to both achieve our long-term credit rating goals. We continue to target BBB+, as we've said over time and also return cash to shareholders. If at some point we find an acquisition that's a particularly good fit, certainly, we'll assess the viability of that when and if that opportunity presents itself.

Great. So if we think about cash flow, your strong return on assets of pension. Last year, your discretionary pension contribution, they stabilized your net pension cash requirements through 2023. So as we look at it, it also -- you have the rising net income, easing CapEx, looks like cash flow should be able to continue to grow or as at one point, it looked like it might have to slow. What are the other cash drivers either plus or minus, we should keep in mind? And is it realistic to think that over the next couple of years, cash flow has the potential to continue to uptrend?

Sure. Let's talk about a few of those drivers and, hopefully, I can give you a good sense for it. So I agree with your perspectives that we've projected that our segments will continue to grow and generate strong returns. We've talked about a continued focus on careful working capital management so that we can maintain good cash conversion really from the core operations of the business. And as you mentioned, the CapEx line should begin to decline a bit over time. In 2020 and 2021, we have the cash inflow from the equipment sale that we discussed on the last earnings call. But over the next couple of years, free cash should benefit from CapEx declining outside of that one inflow. As we think then about a couple of the other kind of unique items, one, you mentioned pension. Certainly, we're pleased that the cash contribution requirement projections now show us out through 2025 or so not needing to contribute any more discretionary cash to the pension program. The flip side of that, though, is with outstanding returns over the last couple of years and changes in the interest rate environment and other actuarial assumptions, we have lower cash coming in from the reimbursement for our CAS pension costs. And so that is an offset to the lower contributions that we need to make them. We provided a next 3 years projection there. Obviously, we'll continue to update that over time. And then on the tax side, cash taxes are difficult to project, I would say, over the next few years, particularly given that the new administration is taking a look at the tax code and, in particular, for our industry and a few others like it, potential changes in the way R&D costs are treated over the next couple of years could have an impact on cash taxes. We talked about that on our July earnings call this past year, the potential $1 billion hit that we could take that would then moderate 20% per year for the next 5 years if the current rules around R&D tax deductibility are not changed. So certainly, we're hopeful that those regulations will be changed before they're implemented in 2022, but that's just another moving piece that I'd call your attention to. But in aggregate, to your point, we're very pleased that we continue to generate great cash flow, builds a healthy balance sheet and gives us all sorts of opportunity to deploy it in ways that create value.

Terrific. So we're coming to the end of our session, but maybe one last one. As you look at '21, what do you think some of the bigger risks, some of the bigger opportunities? If we look back 12 months from now and see the earnings were better or worse, what are the things that you think could make them better or worse?

Sure. There's a lot of talk about whether budgets will -- budget growth will moderate over the next couple of years, flatten or where it may go. A lot of those risks to the market are outside of our control and so we don't focus a lot of energy over exactly where budgets and appropriations will go. Certainly, we feel like our opportunities to remain really well aligned with the national defense strategy and the key priorities based on where the threat exists today. And that's what creates the opportunity for us going forward. What creates the healthy pipeline of 2021, new starts and new business opportunities that we see. We're also in a year where we're deploying cash in ways that we anticipate creating good long-term value for the company and our shareholders. So that combination of value-creating cash deployment as well as being in a year where we've got a healthy volume of new opportunity to pursue based on our positioning today, that's what really gets us enthusiastic about the positioning of the business today and the opportunity set ahead of us.

Terrific. Thank you very much. Dave, and Todd, thanks so much for setting this up. Greatly appreciate it.

Thanks, Cai.

Thanks, Cai.

Enjoyed it.

Bye.