Northrop Grumman Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
October 27, 2021

Key Takeaways

  • Delivered another quarter of strong results with a segment operating margin rate of 11.9%, Q3 EPS of $6.63 (+13% YoY), 15% year-to-date free cash flow growth, and a cash balance of over $4 billion.
  • Organic sales growth of 8% year-to-date slowed in Q3 due to fewer working days, higher employee leave, a tighter labor market, and certain supply-chain challenges stemming from COVID-19.
  • Raised full-year 2021 guidance by increasing segment operating margin and EPS outlook and narrowing revenue guidance to approximately $36 billion.
  • Benefiting from strong bipartisan support in Washington, with FY 2022 defense appropriations expected to exceed the President’s request and fund critical national security priorities.
  • Achieved key program milestones—including AARGM-ER production clearance, successful hypersonic Hawk test, B-21 and GBSD production ramps—adding over $1 billion in incremental revenue in 2021 and $500 million in 2022.
AI Generated. May Contain Errors.
Earnings Conference Call
Northrop Grumman Q3 2021
00:00 / 00:00

There are 14 speakers on the call.

Operator

Good day, ladies and gentlemen, and welcome to Northrop Grumman's Third Quarter 2021 Conference Call. Today's call is being recorded. My name is Catherine, and I will be your operator today. At this time, all participants are in a listen only mode. I would now like to turn the call over to your host, Mr.

Operator

Todd Ernst, Treasurer and Vice President, Investor Relations, Mr. Ernst, please proceed.

Speaker 1

Thanks, Catherine, and good morning, everyone. Welcome to Northrop Grumman's 3rd quarter 2021 conference call. We'll refer to a PowerPoint presentation that is posted on the IR webpage. Before we start, matters discussed on today's call, including 2021 guidance 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.

Speaker 1

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 GAAP results in our earnings release. On the call today are Kathy Warden, our Chairman, CEO and President and Dave Kepfer, our CFO. At this time, I'd like to turn the call over to Kathy.

Speaker 1

Kathy?

Speaker 2

Thank you, Todd. Good morning, everyone, and thank you for joining us. We delivered another quarter of strong results in an increasingly complex environment. In the last quarter, we've seen developments in the global fight against COVID-nineteen and macroeconomic changes such as the tightening labor market, supply chain challenges and growing inflation. But we've also seen evolving threats to our national security, which has further eliminated the value of Northrop Grumman products and services.

Speaker 2

On today's call, we will provide insights into these developments and their effects on our business to date, as well as discuss our Q3 performance results and provide our updated outlook for this year and an additional look at 2022. I'd like to thank our employees and our extended Northrop Grumman team, including our And adaptability during these dynamic times. Our company continues to deliver strong operating performance. As we announced earlier today, we had a segment operating margin rate of 11.9% in the 3rd quarter and year to date an exceptional segment operating margin rate of 12%. In addition, earnings per share in the quarter were $6.63 an increase of 13% compared to last year.

Speaker 2

And our transaction adjusted free cash generation continues to be strong, increasing 15% year to date. We ended the quarter with just over $4,000,000,000 in cash, providing significant flexibility in support of our capital deployment initiative. With respect to the top line, our year to date organic growth was 8%. This robust growth reflects the alignment and strength of our broad portfolio to our customers' priorities and future needs. As expected, our organic growth rate slowed in the quarter from the rapid pace that we saw in the first half of the year.

Speaker 2

In addition to having fewer working days in the second half of the year, which we discussed on each of our last two calls, we are also Seeing an impact on our sales from the broader economic environment due to COVID-nineteen. During the Q3, This included employee leave taking at a higher level than planned, a tighter labor market and certain supply chain challenges. We continue to focus on the safety and well-being of our employees, customers and partners as we work to mitigate the impact of these factors. As you know, the President recently issued an executive order, generally requiring employees of federal contractors to be fully vaccinated by early December. We have shared the details of this mandate with our U.

Speaker 2

S. Workforce and we are working to help them meet the requirements. We also increased our hiring plans for the 4th quarter to help mitigate the potential impacts of any increased attrition. Based on the team's strong 3rd quarter performance and in consideration of macroeconomic factors as we see them today, We are increasing our guidance for segment OM and EPS for the year and narrowing our sales guidance to approximately 36,000,000,000 Dave will provide more details on the quarter, our updated guide as well as that initial outlook for 2022. Turning to budget updates from Washington.

Speaker 2

We're seeing strong bipartisan support for national security broadly and Northrop Grumman programs specifically. We are pleased that an agreement was reached on the continuing resolution in debt ceiling that will fund the government through December 3rd. We are hopeful that Congress will finalize the fiscal year 2022 appropriations and avoid a protracted continuing resolution. With respect to the FY 2022 defense budget overall, We see bipartisan support for increased defense spending, including adding funding above the President's budget request. We are hopeful that this additional funding will be supported in final appropriations.

Speaker 2

Over the past several weeks, Senior customers, members of Congress and administration officials have made increasingly public comments about strategic competition in the national security environment and the need to counter and deter evolving threats. One clear and consistent message has been the need to invest in and more rapidly field advanced capabilities. Our company's portfolio and capabilities are strongly aligned to the 5 national security priority areas, particularly in advanced weapons, strategic deterrents, mission systems and space. And we're using digital technologies to develop and deploy capabilities faster and more efficiently than ever before across our entire portfolio. I'll share a few highlights to demonstrate how our performance today continues to position us With the emergence of more sophisticated air defense systems, the need for standoff capabilities and speed to target is Critical for our customers.

Speaker 2

To address this requirement, Northrop Grumman developed AARGM ER, a high speed, long range, air to ground missile. And in the Q3, after just 28 months in engineering, manufacturing and development, we achieved a critical milestone, Clearing the way for production. In September, we received our 1st low rate initial production award for the program. Also during the quarter, we along with our industry partner Raytheon successfully tested the hypersonic air breathing weapon concept known as Hawk. Northrop Grumman supplies the scramjet propulsion system for Hawk, allowing speeds of greater than Mach 5.

Speaker 2

ARGUM ER and Hawk are just two examples of how we're providing the higher speed and longer range weapons needed to be relevant in today's threat environment. Another key area where we are supporting our customers is in the need and urgency to enhance our country's strategic deterrence capability, especially in light of recent disclosures of investments other nations are making in modernizing their strategic capabilities. The triad is the foundation of the security strategy for the U. S. And its allies and it's been an effective deterrent for decades, preserving peace and deterring aggression.

Speaker 2

As highlighted by recent customer and administration comments, Modernizing the Triad remains a high priority. Northrop Grumman is the prime on 2 of the 3 legs of the Triad with the bomber and strategic missile We're a significant supplier for submarines as well. For the bomber, the B-twenty one program continues to advance. As Air Force Secretary, Frank Kendall recently noted, there are now 5 units in various stages of production We continue to make solid progress on the EMD portion of the ground based strategic deterrent program. We completed key milestones earlier this year and we are tracking toward our first flight as planned.

Speaker 2

The GBSD program has ramped significantly this year, And we now expect that it will add just over $1,000,000,000 in incremental revenue to our 2021 results and another approximately $500,000,000 of incremental revenue in 2022. For both B-twenty 1 and GBSD, we have applied digital transformation concepts as a key enabler to reduce risk, increase productivity, shorten cycle time and improve the system's ability to adapt to changing threats. In today's rapidly changing threat environment, our Mission Systems portfolio, including in communications and artificial intelligence, is making a critical contribution in the advancement of technology and capability needed to allow legacy platforms to be more capable And survivable and therefore more relevant toward addressing the increasingly sophisticated threats. To this end, during the Q3, our next generation electronic warfare system, which will equip domestic F-sixteen, had its first test flight on a testbed aircraft at the Northern Lightning exercise. This system in conjunction with our SABR radar demonstrated full interoperability in a simulated contested electromagnetic spectrum environment.

Speaker 2

With the radio frequency spectrum becoming increasingly contested, this critical set of electronic warfare capabilities will allow the platform to remain survivable. We anticipate an EMD contract for next generation electronic warfare in 2022 with an overall lifetime opportunity of up to $3,000,000,000 And in missile defense, emerging threats from hypersonic missiles are creating new challenges for customers. We are helping to provide differentiated solutions to these challenges by applying our advanced technology and domain expertise. Earlier this year, we were awarded a contract to deliver a prototype satellite as part of the MDA's hypersonic and ballistic tracking space Sensor HBTSS program. This program is designed to detect and track hypersonic vehicles, which have a very different flight profile and signature The ballistic missile required new sensing capabilities in order to detect and track them.

Speaker 2

In September, we conducted a And consistent with increased demand in this area, we received $1,200,000,000 in restricted space awards in the 3rd quarter. I've touched on several major contributions that we've made this quarter to National Security, all of which highlight our strong performance, technology leadership And broad portfolio. I also want to share examples of our collaboration with partners to accelerate innovation and create discriminating technologies. As I've noted before, we are actively engaging and partnering with early stage technology and non traditional defense companies. In the quarter, we closed an investment in OrbitFab, a space logistics company whose goal is to put gas stations in space.

Speaker 2

Their vision fits well with our on orbit satellite refueling and space logistics capabilities. We also continue to work with Deepwave Digital, an innovative company we invested in at the end of last year. Deepwave Digital provides a hardware and software solution enabling very efficient AI enhanced software defined radios for deep learning applications at the edge, which we believe will enhance our efforts in both autonomy and Jet C2. These partnerships as well as other venture investments support our strategy to create solutions at speed for our customers' toughest national security challenges. Now, I'll turn the call over to Dave, who will provide more detail on our Q3 results, our updated 2021 guidance and our 2022 outlook.

Speaker 2

Dave?

Speaker 3

Okay. Thanks, Kathy, and good morning, everyone. I'll begin my comments with 3rd quarter highlights on Slide 3. We continued to generate strong operating results, delivering another quarter of solid organic sales growth, higher segment operating margin rate and outstanding earnings per share and transaction adjusted free cash flow. We continued to return cash to shareholders through our buyback program and quarterly dividend, returning over $800,000,000 in the quarter.

Speaker 3

Slide 4 provides a bridge between Q3 2020 and Q3 2021 sales. Excluding sales from the IT Services divestiture, our organic growth was 3%. This rate was below our first half growth due in part to the broader labor market and supply chain trends that Kathy outlined. Next, I'll review our earnings per share results on Slide 5. Compared to the Q3 of 2020, our EPS increased 13% to $6.63 Strong segment operational performance contributed about $0.14 of growth and lower corporate unallocated added another $0.55 This included a $60,000,000 benefit from insurance settlements related to shareholder litigation involving the former Orbital ATK business Prior to our acquisition, corporate unallocated expense also decreased due to a change in deferred state income taxes as well as lower intangible asset amortization and PP and E step up depreciation.

Speaker 3

Pension costs contributed $0.17 of growth, driven by higher non service FAS income. Our Marketable securities performance represented a headwind of $0.17 compared to the Q3 of 2020, which benefited from particularly strong equity markets. Lastly, we experienced a slightly higher federal tax rate in the period due to lower benefits from foreign derived intangible income. Turning to sector results on Slide 6. We saw some broad based COVID related impact, the most significant of which were in our aeronautics sector.

Speaker 3

Aeronautics sales declined 6% for the quarter. Year to date, its sales are down 1%. As we've described in recent quarters, Several programs in our AS portfolio are plateauing or entering a phase of this lifecycle where you would not expect to see growth. This quarter, we experienced slightly lower volume across the portfolio, including restricted efforts, F-thirty five, V2DMS and Global Hawk Programs. We expect this overall trend to continue at AS in 2022, which we'll discuss in more detail momentarily.

Speaker 3

At Defense Systems, sales decreased by 24% in the quarter and 22% year to date. On an organic basis, sales were down roughly 2% in the quarter in year to date periods, driven by the completion of our activities on the Lake City Small caliber ammunition contract last year. Lake City represented a sales headwind of roughly $75,000,000 in the quarter and $335,000,000 year to date. This was partially offset by higher volume on several mission readiness programs. Mission Systems sales were down 5% in the quarter and up 4% year to date.

Speaker 3

Organically, MS sales increased 1% in Q3 and year to date they are up a robust 9%. As we've noted previously, the timing of material volume at MS has been weighted more toward the first half of twenty twenty one than the second. Organic sales growth in the Q3 and year to date periods was broad based across programs such as GATOR, J. Crew and various restricted efforts. And finally, base systems continues to deliver outstanding sales growth, increasing 22% in the 3rd quarter and 28% year to date.

Speaker 3

Sales in both business areas were higher in the quarter year to date periods, reflecting continued ramp up on GBSD and NGI as well as higher volume unrestricted programs in Artemis. Turning to segment operating income and margin rate on Slide 7, we delivered another quarter of excellent performance with segment operating margin rate at 11.9%. Aeronautics' 3rd quarter operating income decreased 10% due to lower sales volume and a $42,000,000 unfavorable EAC adjustment on the F-thirty five program. The adjustment was driven by labor related production inefficiencies, reflecting COVID related impacts on the program. The AS operating margin rate decreased to 9.7% in Q3 as a result of this adjustment, with year to date operating margin slightly ahead of last year at 10.1%.

Speaker 3

Defense Systems operating income decreased by 19% in the quarter and 16% year to date, largely due to the impact of the IT Services divestiture. Operating margin rate increased to 12.4% in the quarter and 12% year to date, largely driven by improved performance and contract mix in Battle Management and Missile Systems, partially offset by lower net favorable EAC adjustments. At Mission Systems, Operating income was relatively flat in the quarter and up 10% year to date. 3rd quarter operating margin rate improved to 15.3% and year to date was 15.5%, reflecting strong program performance and changes in business mix as a result of the IT Services divestiture. Space Systems operating income rose 29% in the quarter and 36% year to date driven by higher sales volume.

Speaker 3

Operating margin rate was also higher at 10.7% in the quarter and 10.9% year to date, driven by higher net favorable EAC adjustments. Moving to sector guidance on Slide 8. Note that this outlook assumes a relatively consistent level of impact in Q4 with what we've been experiencing so far this year from the effects of COVID on the workforce and supply chain, and it does not include any potential financial impacts on the company related to the vaccine mandate. We have updated our 2021 sales estimates for each segment based on our year to date results and current expectations for Q4. For operating margin rate, we Before we get to our consolidated guidance, I'd also like to take a moment to discuss some of the factors to consider in comparing our Q4 revenue to last year on Slide 9.

Speaker 3

In Q4 of 2020, the IT Services business contributed almost $600,000,000 of sales and the equipment sale at AS Generated over $400,000,000 Q4 of 2021 also has 4 fewer working days than the same period in 2020, representing a headwind of about 6%. Adjusting for these three items, our Q4 2021 sales would grow at 3% to 4% based on our latest full year guidance. Moving to Slide 10. Based on what we now see, we expect sales of approximately $36,000,000,000 We're raising our 2021 outlook for segment and total operating margin and for EPS. Our segment operating margin rate guidance is 10 basis points higher at 11.7% to 11.9%, reflecting our continued strong performance.

Speaker 3

Our net FASCAS pension adjustment has increased $60,000,000 for the full year as a result of the annual demographic update we performed in Q3. Other corporate unallocated costs are $70,000,000 below our previous guidance, now at approximately $120,000,000 for the year. As I mentioned, our corporate unallocated costs benefited from a $60,000,000 insurance settlement in Q3 as well as additional benefits from state taxes. These updates translate into an increase of 50 basis points in our operating margin rate to a range of 16% to 16.2% in our updated guidance. Remember that the gain from the IT Services divestiture in Q1 contributed approximately 5 percentage points of overall operating margin benefit

Speaker 4

for the full year.

Speaker 3

We continue to project a 2021 effective federal tax rate in the high 17% range, excluding the effects of the divestiture, which is consistent with our prior guidance. Lastly, we're raising our EPS guidance, which I'll cover on Slide 11. Segment performance is contributing about $0.15 of the increase with the benefits to corporate unallocated and pension contributing the remainder. In total, this represents an $0.80 improvement in our transaction adjusted EPS guidance. With this latest increase, Our 2021 EPS guidance is up by about $2 since our initial guidance in the beginning of the year.

Speaker 3

Before we move to 2022, I wanted to give you an update on our cash performance. Year to date, we've generated over $2,100,000,000 of Transaction adjusted free cash flow, up 15% compared to 2020, and we ended the quarter with over $4,000,000,000 in cash on the balance sheet. Keep in mind that we have a roughly $200,000,000 payroll tax payment in Q4 from the CARES Act legislation, with the second similar payment in 2022. Additionally, we expect to pay the balance of our transaction related tax from the IT Services divestiture in the 4th quarter. Our healthy cash position has enabled us to repurchase over $2,700,000,000 of stock so far this year, on track with our full year target of $3,000,000,000 or more.

Speaker 3

As we look ahead to 2022 on Slide 12, our outlook is based On the same set of assumptions that we described for 2021 guidance regarding the COVID environment and vaccine mandate, It also assumes that the continuing resolution does not extend beyond 2021. And like our 2021 guidance, It assumes that we do not experience a breach of the debt ceiling. We expect space to be our fastest growing segment again in 2022, driven by GBSD, NGI and several restricted efforts as they continue to ramp. Mission Systems and Defense Systems should also produce organic growth. Regarding Aeronautics Systems, after several years of strong growth, Our latest 2021 sales guidance calls for a mid single digit decline and we see that trend continuing in 2022.

Speaker 3

We've talked in recent quarters about the headwinds in our Haile portfolio. We're also projecting lower sales on JSTAR's F-eighteen as well as our restricted portfolio. Looking further to the future, it's an exciting decade for Defense Aerospace. Rapidly evolving threats are spurring a new wave of autonomous vehicle and 6th generation fighter development. So the opportunity set in AS remains solid, and we will continue to invest in the cutting edge technologies that allow our customers to stay ahead of the threat environment.

Speaker 3

Altogether, we currently expect 2022 sales at the company level to reflect continued organic growth. Looking at segment margin, we expect the strong results we've demonstrated in 2021 to continue in 2022 With excellent program performance offsetting a portion of the 20 to 30 basis point benefit we generated from pension related overhead rate changes in Q1 of 2021. While we project higher sales and strong segment operating margin, we expect Transaction adjusted earnings per share to be down next year as a result of several non operational headwinds, Lower CAS pension recoveries and higher corporate unallocated expenses are currently projected to create an EPS headwind next year of more than $2 For FAS pension, our outlook for 2022 will depend on our updated actuarial assumptions, including discount rates and planned asset returns, which we will determine at the end of the year. Earnings per share driven from sales growth, strong operating margin performance And lower share count will help to offset these non operational items. Next, I'd like to spend a moment discussing cash.

Speaker 3

We expect relatively stable cash flow at the program level in 2022, but there are a few temporal items that should be factored into the year over year comparison of overall free cash flow. 1st is lower CAS pension recoveries. As you can see on Slide 13, our CAS recoveries are currently expected to be lower by $350,000,000 next year. The second is cash taxes. Excluding the impact of the IT Services transaction, we expect cash taxes to be modestly higher next year.

Speaker 3

In addition, as we've noted in the past, Current tax law would require companies to amortize R and D costs over 5 years starting in 2022, which would increase our cash by around $1,000,000,000 next year and smaller amounts in subsequent years. There continues to be uncertainty in the tax environment with potential new legislation that could change the R and D amortization provision and other provisions. We will provide updates on each of these items on our January call. Taking all of these cash flow factors into consideration, we would expect to decline in 2022 transaction adjusted free cash flow, followed by a double digit growth CAGR through 2024, driven by strong operational performance. Regarding capital deployment, investing in the business through disciplined R and D and capital spending continues to be our priority.

Speaker 3

We expect CapEx to be roughly flat next year in absolute dollar terms. We believe these investments allow us to stay at the forefront of technology as we invest in our business. And as we've said, we continue to expect to return the majority of our 2022 free cash flow to shareholders through dividends and share repurchases. With that, I'll turn the call back over to you, Kathy.

Speaker 2

Thanks, Dave. In summary, we have delivered excellent year to date results and operating performance, And we are pleased to be increasing our full year EPS guidance for the 3rd consecutive quarter. We are actively engaged with our supply chain and our employees as we work to mitigate broader COVID related risks and continue to keep our programs on track. As shown by the many milestones in the quarter, We have highly relevant capabilities and programs that align well to national security requirements and our customer funding priorities. So as we look forward, 2022 is expected to deliver another year of organic sales growth and excellent performance, paving the way for longer term margin expansion and free cash flow growth.

Speaker 2

We remain focused on protecting the safety and well-being of our employees, delivering the capabilities our customers need to protect national security and sustain our planet and delivering value to our shareholders. So with that, Catherine, if you would please open the phone line for questions.

Operator

And your first question comes from Robert Stallard with Vertical Research.

Speaker 5

Good morning.

Speaker 2

Good morning, Rob.

Speaker 5

Kathy or Dave, just on the 2022 Expectations for AS, your decline that you're expecting there, I was wondering if you could give a little bit more detail of the puts and takes. I'm conscious you can't talk that much about classified, but If you could give some sort of scale of the moving parts, that would be very helpful. Thank you.

Speaker 3

Sure, Rob. It's Dave. I can touch on that a bit further. As we mentioned, We're projecting a mid single digit growth decline this year in AS and that's about the same trend That we anticipate next year in light of where we are in the lifecycle of a lot of our key programs in AS At this point, there's no single factor or even 2 or 3 factors that contribute the lion's share of that Decline, but rather a fairly consistent trend in the trajectory across a lot of our key programs in the sector. You mentioned we can't say much about our restricted portfolio, certainly agreed on that front.

Speaker 3

We have mentioned that The Global Hawk portfolio is projected to decline next year as Black 20s 30s continue in their Retirement process, F-eighteen is projecting a decline for our portion of that program. JSTARS is another I would highlight there. And so across the board, these are fairly consistent drivers. F-thirty five, we've talked about some of the COVID impacts there in Q3, and it's kind of pattern going forward in the AS Portion of the program is relatively flat to modestly declining as we look at the 'twenty two outlook. So hopefully that gives you a sense Of some of the key drivers, as I mentioned, it's not any one specific program.

Speaker 5

And just a quick follow-up, Dave. Sorry.

Speaker 2

Just Quickly, Rob, the only thing I would add is that our AS sector has been and we expect may continue to be the most Impacted by the COVID related challenges that we spoke about.

Speaker 5

Yes. And just a follow-up. Do you think 2022 is likely to be the trough for these issues, as some of these other less mature programs start to grow in 2023 and beyond.

Speaker 3

Obviously, we'll provide more insight on 2023 as we get to a similar point in 2022. Throughout the year, we'll talk more about specific programs within that portfolio. I think for some, the trends will continue, for others they won't And we'll defer to a later date to give you more specifics as we look at the 2023 outlook and beyond.

Speaker 5

Okay. Thank you very much.

Operator

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

Speaker 4

Thanks. Good morning. I was hoping you could Touch a bit on the cash commentary for 2022 and just so we can all get to the same base level you're thinking about, Dave. Is that When you talk about the cash taxes being a headwind, is that assuming the amortization rule sticks around and you have that $1,000,000,000 headwind or are you thinking cash taxes are a headwind regardless? And then a similar question as it relates to the double digit growth through 2024?

Speaker 4

Sure. So

Speaker 3

the kind of high level view we gave you on 2022 through 2024 Assumes that the amortization of those R and D costs does not go into effect, Though the trend line would be similar, it would be lowest in 2022 with an increase in 2023 2024. But let's talk about it assuming that guidance does not go into effect. What I think you can expect from us in 2022 is to continue to drive A similar volume of working capital improvements to what we've done this year. We've certainly had a good track record over the last couple of years of working capital Efficiency across our business and that will help to provide that steady level of program driven cash that we talked about on the call. We also talked about pretty steady CapEx next year, slightly lower as a percentage of sales with the sales growth, But a fairly consistent volume on a dollar basis.

Speaker 3

And so that means the kind of non operating items are What we expect to provide the year over year reduction, dollars 350,000,000 less CAS pension recovery is what we project today. I think of that more as a purification of our free cash flow stream. That day was going to come For a while and so we're reaching that point now where we've reached a sustainably lower level of CAS reimbursement. On the cash tax side, we project that those would be modestly higher without the R and D amortization Provision or other changes in the rate or other key provisions legislatively. Of course, legislation could then change that further If we don't have a removal or deferral of the R and D tax item, for example.

Speaker 3

So More to come on all of those fronts on the January call, but hopefully that gives you a sense for it today. As we think about 2023 2024, We do expect continued decline in capital expenditures as a percentage of sales. We will also benefit from not having the payroll tax deferral in 'twenty three and 'twenty four as we have in 'twenty one and 'twenty two. And at the program level, we expect continued working capital efficiencies On some of our key programs in 2023 2024, which is what gives us the confidence in that increase in those years.

Speaker 4

Okay. And just one quick clarification, the prior CAS outlook had slightly modest growth in CAS recoveries in 2023. That trend line still holds?

Speaker 3

At this point, yes. I think you'll see much less significant changes In 'twenty three and 'twenty four, again, based on what we see today and based on the actuarial environment today. So from 2021 to 2022, as well as 2020 to 2021, we've had significant reductions in CAS recovery. We no longer expect significant movement really in Either direction in those out years.

Speaker 6

Okay. Thank you.

Operator

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

Speaker 7

Good morning. Thank you. I wanted to go back to Aeronautics. And When you described the lower aeronautics revenues in 2022, you referred to opportunities long term to reverse that. Those were things like the 6th GenFighter, new autonomous systems.

Speaker 7

But I think of those as being fairly long term and fairly uncertain. If you look at that revenue trajectory, the B-twenty one, we should certainly see strong growth come about from that. Do you see that as sufficient To reverse this trend and when might that grow to a point that we would see that?

Speaker 3

Sure. Doug, obviously, that's one that we can't get into much detail on. And so, I guess, refer you to the overall trends that programs tend to see as they're in these phases of the life cycle that we've described on B-twenty one and maybe more importantly that our customer has described on that program, Certainly, it has been a contributor to our growth in the restricted AS portfolio over the last several years as we've Described, but the go forward trajectory and the pace and timing of that growth is something we can't say much more about. So we've Giving you a sense for the 'twenty two outlook there and where the program stands in its lifecycle and that's about what we're able to say at this phase. Okay.

Speaker 7

Well, if I switch to F-thirty 5 and perhaps go outside of aeronautics, I think of the kinds of things that you're doing on F-thirty 5 is right at the heart of Tech Refresh 3, systems upgrades. Now that has with it, I'd say some good news that there should be a lot of, I would expect growth there. But there have also been quite a few challenges that have been highlighted around Tech Refresh 3. Can you talk about both the growth opportunity that you have on F-thirty five there as well as how you're dealing with some of the challenges that have come up?

Speaker 2

Sure, Doug. This is Kathy. I'll take that. So as you noted, there is opportunity, particularly in our Mission Systems sector as we look at the I'll refresh on the F-thirty 5 and the mission systems that we provide to the aircraft. There have been some delays that have It's been noted this year.

Speaker 2

They have had some minimal impacts just on the timing of our work and the funding to support our work, But we have not experienced performance issues as a result of those delays. It's just shifted some sales out of this year into next. And in terms of our overall outlook for our Mission Systems work, we do see that and we've been consistent in saying this as Upside opportunity, while the production volume is flat and price pressure is driving overall production sales volume down slightly across the board. The other area you didn't ask about, but sustainment And you can see an opportunity as well and we see that both in all three sectors that predominantly led through our Defense Systems business for the aircraft, the airframe and our Mission Systems business with sustainment contracts for the Mission Systems.

Speaker 7

Okay, very good. Thank you.

Operator

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

Speaker 8

Good morning, guys. Thank you for the time. Kathy, maybe to follow-up on an earlier question, just thinking about the 2022 revenue framework, you noted Aeronautics is down, but GBSD is growing $500,000,000 which is less than what we thought. What are any other major headwinds? And if we roll it up, is it I think about 3% to 4% revenue growth for 2022.

Speaker 8

And maybe as a follow-up to that, you gave some space color. Maybe if you could just talk about how you think about the rest of the portfolio outside GBSD?

Speaker 2

Yes. Thanks for the question, Sheila. So to unpack the space growth, both this year and the trend that we expect to continue into next year, GBSD has contributed roughly 50%, a little bit over 50% to the sales growth in space in 2021, and we expect that to continue into 2022. To your point about $500,000,000 of growth next calendar year being less You might have anticipated, you might be looking at budget data, which showed an incremental $1,000,000,000 in each of the 2 years. But I'll remind you that a quarter of that 2022 government year is in 2021.

Speaker 2

So we've seen a more significant ramp over course of the 12 months in 2021 than we anticipate in our calendar year 2022. So it's not a change in Profile, it's nothing different. It's just how that falls into our calendar year. With regard to your broader question on how that translates to our outlook for the company overall. I think it is safe at this Based on what we know today to suggest that low single digit growth in 2022 is A reasonable expectation.

Speaker 2

At this point in the year, we see some COVID impacts That we've referenced, we saw them in 3Q. We're anticipating those to stay at that same level in Q4, but it is difficult to Project what that impact may be in early 2022. But what I will say is we see those more as Speed bumps than we do derailers. Our fundamentals are intact. We have strong backlog, Strong pipeline and great portfolio alignment to budget priorities.

Speaker 2

So we still see the path to growth that we've been talking about. We just have some of these COVID, as I call them, speed bumps that we're working our way through. Hopefully that helps.

Speaker 8

Sure. Thank you so much.

Operator

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

Speaker 9

Hey, good morning. Maybe just following up on the whole series of questions, Kathy, because I think this is a question that's on a lot of people's minds. And obviously, I'm not asking you for guidance. Clearly, that would be kind of out of the game. But how do we think about kind of medium term growth, Right.

Speaker 9

So when the speed bumps are behind us and we're kind of in production on B-twenty 1, GBSD is kind of humming along, whatever else is coming along. So if we step out over the next couple of years, how do we think about medium term growth?

Speaker 2

Well, as I said, we see a path to continuing to grow this business and it's based not only on the strength of the backlog we have with programs, as You were referencing like B21 and GBSD, but it's also a pipeline that includes continued new awards. And I highlighted a few of those today of programs that are moving into a phase where they will see production awards in the next couple of years. So we still see a path to growth over the medium term, and it's just a matter of how quickly that growth comes In the next several quarters as a result of some slowdowns that we've seen. And I should say, Ron, and I appreciate the opportunity to address that we've seen fairly minimal supply chain impact Because we have a relatively high NG labor content on our jobs versus external supplier content. We've talked a bit about the leave taking that we saw being higher in the Q3, but that too is finite because as people take leave, of course, they're burning down their leave And when I look over a longer term period, it trends like labor market, Issues that may drive labor rates up or inflation, we have in the industry one of the highest levels of cost plus work.

Speaker 2

So those costs get passed on and shared with our customer. Now I do want to emphasize that we in no way want to pass those costs on to our customers. So we are working And minimize those impacts for their benefit, but our shareholders, they're not carrying that exposure. So I feel really good about the portfolio that we have and our ability To weather any of these short term impacts or what we expect to be short term impacts and still be on a path to growth.

Speaker 9

Great. Thank you.

Operator

Your next question comes from the line of Kristine Liwag with Morgan Stanley.

Speaker 2

Hey, good morning, guys. Good morning.

Operator

Kathy, just following up on

Speaker 2

that supply chain challenge, Can you provide more specifics in terms of what you're seeing? Why they're more prevalent in aeronautics versus the other segments? And also right on labor, if the vaccine mandate, does come into effect December 8, how are you thinking about the potential impact? So we are implementing the vaccine requirements across our U. S.

Speaker 2

Workforce as the mandate It requires us to do. We are certainly early in our stage of collecting data about our employee And I have a good sense that a vast majority of our employees are vaccinated or in the process of being vaccinated. And with other employees, we are working through their options to meet that requirement by December 8. It's really too early to predict what those impacts might be until we have a better sense of not just the pure quantum of employees who may not meet their requirement, but where they work and what they do in our company and therefore how we would mitigate those impacts. But as I mentioned, we are proactively increasing our hiring now in anticipation that we may have some loss of workers.

Speaker 2

And we are ensuring that we have training and skill building programs in place. So as we bring those new employees into the workplace, they can get productive and efficient as quickly as possible. So actively working to mitigate impacts, but they're just Too difficult to really quantify for you at this time. Great. And the specifics on the supply chain challenges with aeronautics?

Speaker 2

For us, it's been relatively minimal as we have seen our own increases in leave taking. We've seen the same thing in our And that was primarily driven by 2 things in the Q3. We estimate 1 with the Delta variant, We saw increased case counts and therefore people out of the workforce while they either recovered from COVID or were Staying out based on close contact and we understand that our suppliers saw similar phenomena. And then the other was that people had not been taking leave at the same rate. But as Things started to open up.

Speaker 2

People actually took some well needed and deserved vacation. So those are the 2 primary drivers that we saw and our suppliers saw the same, which Slow down deliveries a bit, but as I noted, we see those as being temporal, in that leave taking is somewhat limited At this point in time. Thank you.

Operator

Your next question comes from the line of Noah Poponak with Goldman Sachs. And Noah, your line is open.

Speaker 10

Hi, can you hear me?

Speaker 2

Yes. Good morning.

Speaker 10

Hi, good morning, everybody. Dave, in the cash flow projection that you talked about on a multiyear

Speaker 1

No, we lost you.

Speaker 3

Noah, are you there?

Operator

Can we go to the next question? We'll go right back to Noah.

Speaker 11

Sure.

Operator

Okay. We have David oh, no, your line is open. Are you there?

Speaker 10

Hi, sorry. Yes. I was just wondering, Dave, if you could speak to what you're assuming directionally for margins in that projection on a total company basis? Thank you.

Speaker 3

Sure. So we're really pleased to have been able to increase our 2021 Segment operating margin rate guidance for the second time now to Another 10 basis point increase this year. As we noted in 2022, we won't have the 20 to 30 basis point Benefit that we have this year from the pension driven overhead rate benefits that we experienced in our EACs in the Q1 of the year. And we anticipate being able to offset a portion of that reduction as we look 2020 2, I don't think it requires a specific assumption for 2023 and 2024 margin rate to get The general trend that we're providing for those years will be more specific about margin rate outlook as we get closer to those years. But I think a relatively stable margin rate would get you to the trends that we've talked about in 2023 and 24 with A healthy double digit CAGR as it relates to free cash flow from the 22 base up to that 24 level, again, no payroll tax deferral, a bit of efficiency on the capital expenditure side and some program driven opportunities Or what really drive that.

Speaker 4

Okay. Thank you.

Operator

Your next Question comes from the line of David Strauss with Barclays.

Speaker 6

Thanks for taking the question. Good morning. So just Dave, to follow-up on that, so I'm clear. So you're guiding segment margin overall lower versus, I guess whatever that, call it 11.8% midpoint for 2021, you're guiding it lower in 2022. And then In terms of free cash flow on an absolute basis, is 23 20 24 Free cash flow higher than 2021 transaction adjusted free cash flow just on an absolute basis?

Speaker 6

Sure.

Speaker 3

Let me address both of those, David. On the segment OM rate, you're right to think about the Two factors we've described in 2022 compared with our increased guidance for 2021, we'll look to offset a portion of the 20 to 30 basis point reduction that we would see from the absence of those rate benefits In 'twenty two, we'll look to offset a portion of that 20 to 30 basis points through continued strong operating performance, but not all of the 20 to 30 basis Points on the OM rate side. And look, in terms of the 2023 and 2024 free cash flow, we've got a lot of moving pieces yet to be determined on the Tax side, as we mentioned, things can continue to move as they often do on the pension side. So based on what we know today, I think what's best to say today is we anticipate that healthy growth outlook in 2023 and As we get to January and provide more specifics on the 2022 level of free cash flow and no more than we could note Today in terms of tax legislation and such, we'll provide a bit further detail on the 2023 and 2024 growth rate in comparison to where we are today also.

Speaker 6

All right. Thank you.

Operator

Your next question comes from the line of George Shapiro with Shapiro Research.

Speaker 11

Yes, Dave. I wanted a clarification. When you say AS declined at a rate similar to 'twenty one, Is that because organically, it's more like down 2% with the equipment sale taken out of it or are you talking the 5% that you just see?

Speaker 3

Right. We're comparing to the actual mid single digit decline in 2021 when we say we're having a Expecting a similar trajectory in 2022. It's a good question. Thanks for the clarification, George.

Speaker 11

Okay. And then, what changed, if anything, or what changed to that the CAS pension dropped so much next year. I know you talked about it coming down, but I hadn't expecting it to come down the magnitude that it is.

Speaker 3

Sure. The $350,000,000 number is pretty consistent with what we've been projecting in recent Months and in the July April earnings calls, there was legislation Regarding pension earlier this year that affected some of the actuarial assumptions used for CAS purposes and reduced that number. And then the other factor is in 2021, the CAS number came up by about $60,000,000 as we noted on the call today. So the compare from 2021 to 2022 got $60,000,000 tougher, but the 'twenty two level has been pretty stable for us since that new

Operator

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

Speaker 12

Yes. Thank you so much for taking the call. So by the middle of 2022, we'll know about the R and D tax credit. And as you look at 2023, 2024, you're saying, A, we don't have the payroll tax repayment. We have lower CapEx.

Speaker 12

We have better ops and we have less downside in terms of cash. So you're basically saying we're going to have considerably better cash flow. And you also have a strong balance sheet, good low net debt to EBITDA ratio. Your major peer basically in a somewhat similar situation although they have CAS going against them has taken a more aggressive stance toward their strategic use of share repurchase and dividend hikes To return value to shareholders, your situation looks actually similar, if not better. Is that something you would consider?

Speaker 2

Cai, it's not just something we would consider. We have been articulating throughout the year that we do see a majority of Our free cash flow being returned to shareholders over this period and it is in part why we increased the dividend again this year And we have committed to at least $3,000,000,000 of share repurchase in 2021. You could expect to see those trends For cash returning to shareholders in the next couple of years as well.

Speaker 12

But actually Lockheed is that their net debt will go up if you consider all of their numbers. So they're basically saying they're looking at net debt because EBITDA has gone up That basically increasing the net debt somewhat because of the strength of their balance sheet. Is that

Speaker 3

Sure, Cai. I think you noted appropriately at the beginning that we'll know more in the next few quarters than we do today about tax legislation and other Factors, we'll know more about the COVID environment, the budget environment. And so all of these are factors that we think about as we Look at our capital allocation plans, I think Kathy's point is the important one around the priority for us The next couple of years will remain 1st and foremost after making critical investments in our businesses, we've said We will continue to do. The next priority is around returning cash to shareholders over these next couple of years. Whether we choose to Change our net debt balance over the next few years or not, we'll in some ways be affected by those broader factors and we'll Update you and others as we know more and get into 2022 on that front.

Speaker 3

This year we achieved our Credit rating targets and feel like we're in a good stable position there. So again, we'll know more And update you all as we do. Good to answer more questions.

Speaker 12

Thanks so much.

Operator

All right. Your last question will come from Seth Seifman with JPMorgan.

Speaker 13

Great. Thanks very much. Thanks for getting me on. I think I got one more here. So I guess as far as backlog, when would you expect backlog to kind of stabilize?

Speaker 13

And Given the decline we've seen year to date in the defense systems backlog, what gives you confidence on the growth outlook there?

Speaker 2

So Seth, we see our book to bill being close to 1 again this year. We have significant awards that we anticipate in the 4th quarter and our backlog has grown over 90% the end of 2017, so to your point, we don't expect that kind of accelerated growth in our backlog. It currently sits at Over 2 times sales, so it's quite strong and we feel support the continued growth of the business For several years to come.

Speaker 13

Great. And then on defense?

Speaker 2

Sure. What is the specific question on defense stats?

Speaker 13

Or just that defense backlog has been down Fairly significantly year to date and calling for growth next year. I know there are some kind of growth programs in that segment, but kind of What gives you confidence in the defense systems business growing next year?

Speaker 2

Yes. So that business also has Some key awards in the Q4 of this year that would position for its growth next year. We also in defense It's our shortest cycle business, so they do tend to run more of a one to one backlog to sales ratio. And the only other thing I would point to there is we have been trailing off Lake City and that of course has impacted no new awards and A tough year over year compare, but as we look forward, that will stabilize in looking at the backlog to sales ratio in that business. Anything you'd add Dave?

Speaker 3

Yes, of course, the year over year backlog comparisons in BS in particular would be affected by the divestiture of the IT Services business To a lesser degree in MS and space, but certainly thinking of more of an organic change in that DS backlog is

Speaker 13

Okay, great. Thank you very much.

Speaker 4

All right.

Speaker 1

Well, we would say Kathy?

Speaker 2

Yes. Well, once again, I want to thank the Northrop Grumman team for delivering another solid quarter. We are actively working to mitigate the COVID related risks That we talked about today and finished this year strong with robust sales growth and other strong EPS performance and solid free cash flow. And our initial 2022 outlook, as we've said, is expected to continue to deliver growth and strong operating performance again next year. We look forward to providing you some details around that guidance in our January call.

Speaker 2

So we wish you all well, and thanks again for joining our call today.

Operator

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

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