Northrop Grumman Q3 2021 Earnings Call Transcript

Participants

Corporate Executives

• Todd Ernst, Vice President of Investor Relations
• Kathy Warden, Chairman, Chief Executive Officer & President
• David Keffer, Corporate Vice President & Chief Financial Officer

Analysts

• Robert Stallard, Vertical Research Partners
• Myles Walton, UBS Investment Bank
• Douglas Harned, Sanford C. Bernstein & Co.
• Sheila Kahyaoglu, Jefferies Financial Group Inc.
• Ronald Epstein, BofA Securities
• Kristine Liwag, Morgan Stanley
• Noah Poponak, The Goldman Sachs Group, Inc.
• David Strauss, Barclays Bank
• George Shapiro, Shapiro Research
• Cai von Rumohr, Cowen & Company
• Seth Seifman, JPMorgan Chase & Co.

Presentation

[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. If at any time during the call you require assistance, please press star 0 and an operator will be happy to assist you. I'd now like to turn the call over to your host, Mr. Todd Ernst, Treasurer and Vice President Investor Relations. Mr. Ernst, please proceed.

[Todd Ernst, Vice President of Investor Relations at Northrop Grumman]

Thanks, Catherine. And good morning, everyone. Welcome to Northrop Grumman's Third Quarter 2021 conference call. We will 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. Forward-looking statements involve risks and uncertainties, which are noted in today's press release and our SEC filings. These risks and uncertainties may cause actual Company results to differ materially. Today's call will include non-GAAP financial measures that are reconciled to our GAAP results in our earnings release. On the call, today, are Kathy Warden, our Chairman, CEO, and President, and Dave Keffer our CFO. At this time, I would like to turn the call over to Kathy. Kathy.

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

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-19 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 have further eliminated the value of Northrop Grumman products and services. On today's call, we will provide insights into these developments and their effects on our business to date, as well as discuss our third-quarter performance results and provide our updated outlook for this year and an initial look at 2022.

I'd like to thank our employees and our extended Northrop Grumman team, including our suppliers, for their relentless focus on delivering for our customers and our shareholders. I am proud of how our team has demonstrated remarkable resiliency and adaptability during these dynamic time. 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 third 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. And our transaction adjusted free cash generation continues to be strong, increasing 15% year-to-date. We ended the quarter with just over $4 billion 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. In addition to having viewing -- 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-19. During the third quarter, 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 or federal contractors, to be fully vaccinated by early December. We have shared the details to this mandate with our U.S. workforce and we are working to help them meet the requirements. We also increased our hiring plans for the fourth quarter to help mitigate the potential impact of any increased attrition.

Based on the team's strong third 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 billion. Dave will provide more details on the quarter, our updated guide, as well as our initial outlook for 2022. Turning to budget updates from Washington, we're seeing strong bipartisan support for national security broadly and Northrop Grumman programs specifically. We're pleased that an agreement was reached on the continuing resolution and debt-ceiling that will fund the government through December third.

We are hopeful that Congress will finalized the fiscal year 2022 appropriations and avoid a protracted continuing resolution. With respect to the FY 22 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. Over the past several weeks, senior customers, members of Congress, and the administration officials has 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 investing, and more rapidly field advanced capabilities. Our Company's portfolio and capabilities are strongly aligned to the find national security priority areas, particularly in advanced weapons, strategic deterrence, 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 for the future. With the emergence of more sophisticated Air Defense Systems, the need for standoff capabilities and speed to target is critical for our customers.

To address this requirement, Northrop Grumman developed our gum ER a high-speed long-range Air-To-Ground Missile. And in the third quarter, after just 28 months in engineering, manufacturing and development, we achieved a critical milestone, clearing the way for production. In September, we received our first 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, known as HAWC.

Northrop Grumman's supplies to scram Jet Propulsion system for HAWC, allowing speeds of greater than Mach 5 argum ER [Phonetic] and HAWC 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 detouring aggression.

As highlighted by recent customer and administration comments, modernizing the Tri-Ed remains a high priority. Northrop Grumman is the prime on likes of the Tri-Ed with the bomber and strategic missiles, and we are a significant supplier for submarines as well. For the bomber, the B-21 program continues to advance. As air force secretary Frank Kendall recently noted, there are now 5 units in various stages of production. And the systems are in his word, making good progress to real fielded capability. For strategic missiles, 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. The GBSD program has ramped significantly this year, and we now expect that it will add just over 1billion in incremental revenue to our 2021 results, and another approximately 500 million of incremental revenue in 2022. For both the 21 and GBSD, we have applied digital transformation concepts as a key enabler to reduce risk, increased productivity, shorten cycle time, and improve the system's ability to adapt to changing threat. 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 platform to be more capable, and survivable, and therefore more relevant towards addressing the increasingly sophisticated threats.

To this end during the third quarter, our next-generation electronic warfare system, which will equip domestics, had its first test flight on a testbed aircraft at the Northern lightning exercise. This system in conjunction with our Saber radar, demonstrated full interoperability in a stimulated contested electromagnetic spectrum environment. With the radio frequency spectrum becoming increasingly contested. That's critical set of electronic warfare capabilities will allow the platform to remain survivable. We anticipate EMD contract for next-generation electronic warfare in 2022 with an overall lifetime opportunity of up to $3 billion. And in missile defense, emerging threats from hypersonic missiles are creating new challenges for customers. We're 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 prototypes satellite as part of the MDA's hypersonic and ballistic tracking space sensor program.

This program is designed to detect and track hypersonic vehicles, which have a very different flight profile and signature than ballistic missiles. They required new sensing capabilities in order to detect and track them. In September, we conducted a successful HV TSS critical design review and are progressing towards a 2023 launch. In a Space domain, Northrop Grumman is working with our customers on advanced capabilities to address a range of new and evolving threats. Many of these programs are classified and consistent with increased demand in this area, we received $1.2 billion in restricted space awards in the third 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 to our collaboration with partners to accelerate innovation in 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 orbit fab, a space logistics Company whose goal is to put gas stations in space. 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 jets C2. These partnerships, as well as other venture investments, support our strategy to create solutions at speed for our customer's toughest national security challenges.

Now, I will turn the call over to Dave, who will provide more detail on our Third Quarter results, our updated 2021 guidance, and our 2022 outlook. Dave?

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

Okay. Thanks, Kathy, and good morning, everyone. I'll begin my comments with Third 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 million in the quarter. Slide 4 provides a bridge between third quarter 2020, and third quarter 2021 sales. Excluding sales from the IT services divestiture, our organic growth was three percent. 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 will review our earnings per share results on Slide 5 compared to the Third Quarter 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 million benefit from insurance settlements related to shareholder litigation involving the former Orbital ATK business prior to our acquisition. Corporate on allocated expense also decreased due to a change in deferred state income taxes, as well as lower intangible asset amortization and PP&E step-up depreciation. 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 third quarter 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 six, we saw some broad-based COVID -related impact. The most significant of which were in our Aeronautics sector. Aeronautics sales declined 6% for the quarter. Year-to-date it's sales are down 1%. As we've described in recent quarters, several programs in our AS portfolio are plateaus, or entering a phase of their life cycle where you would not expect to see growth. This quarter, we experienced slightly lower volume across the portfolio, including restricted efforts. F-35, B2B, DMS, and Global Hawk programs. We expect this overall trend to continue at AS in 2022, which we'll discuss in more detail momentarily. 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 and 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 million in the quarter and $335 million 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. Organically, MS sales increased 1% in Q3, and year-to-date, they're up a robust 9%. As we've noted previously, the timing of material volume at MS has been weighted more towards the first half of 2021 than the second. Organic sales growth in the third quarter and year-to-date periods was broad-based across programs such as Gator, J Crew, and various restricted efforts.

Finally, based systems continues to deliver outstanding sales growth, increasing 22% in the third quarter and 28% year-to-date. Sales in both business areas were higher in the quarter and year-to-date periods, reflecting continued ramp-up on GBSD and NGI, as well as higher volume unrestricted programs and 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 Third Quarter operating income decreased 10% due to lower sales volume and a $42 million unfavorable EAC adjustment on the F-35 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%. 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 percent year-to-date, largely driven by improved performance in 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, third quarter operating margin rate improved to 15.3% in 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.

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're increasing our guidance at defense and Space, and the margin rates at AS and MS remain unchanged.

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 fourth-quarter revenue to last year on Slide 9. In Q4 of 2020, the IT services business contributed almost $600 million of sales and the equipment sale at AS generated over $400 million. Q4 of 2021 also has 4 fewer working days than the same period in 2020, representing a headwind of about 6%. Adjusting for these 3 items, our Q4 2021 sales would grow at 3% to percent based on our latest full-year guidance. Moving to slide 10. Based on what we now see, we expect sales of approximately $36 billion.

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. Our net FAS/CAS, pension adjustment has increased $60 million for the full year. As a result of the annual demographic update we performed in Q3. Other corporate unallocated costs are $70 million below our previous guidance. Now at approximately $120 million for the year. As I mentioned, our corporate unallocated costs benefited from a $60 million 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 for the full year. We continue to project the 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 we'll cover on Slide 11. Segment performance is contributing about $0.15 of the increase, with the benefits to corporate on allocated 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. Before we move to 2022, I wanted to give you an update on our cash performance. Year-to-date, we have generated over $2.1 billion of transaction adjusted free cash flow up 15 percent compared to 2020. And we ended the quarter with over $4 billion in cash on the balance sheet. Keep in mind that we have a roughly $200 million 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 fourth quarter. Our healthy cash position has enabled us to repurchase over $2.7 billion of stocks so far this year, on track with our full-year target of $3 billion or more. 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 b reach 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. We've talked in recent quarters about the headwinds in our hail portfolio. We're also projecting lower sales on Jay stars, F/A-18, as well as our restricted portfolio. Looking further to the future, it's an exciting decade for defense aerospace. Rapidly evolving threats are sparing a new wave of all-time this 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. 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 plan 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. 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. First is lower CAS pension recoveries. As you can see on Slide 13, our CAS recoveries are currently expected to be lower by $350 million 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. In addition, as we've noted in the past, current tax law would require companies to amortize costs, so we're 5 years starting in 2022, which would increase our cash taxes by around $1 billion next year in smaller amounts in subsequent years. There continues to be uncertainty in the tax environment with potential new legislation that could change the R&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&D and capital spending continues to be our priority. 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. 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 will turn the call back over to you, Kathy.

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

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 third 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. 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.

Questions and Answers

[Operator]

Ladies and gentlemen, if you wish to ask a question, please press star, followed by one on your touchtone telephone. Again, press star one to ask a question. If your question has been answered, or if you wish to exit the question queue. Press the pound key to exit the queue, and to be respectful of time, please limit yourself to one question and one follow-up question. Please press star 0 at any time for operator assistance. And your first question comes from Robert Stallard with Vertical Research.

[Robert Stallard, Analyst at Vertical Research Partners]

Good morning.

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

Good morning. Rob.

[Robert Stallard, Analyst at Vertical Research Partners]

Kathy or Dave, just on the 2022 expectations for AS, your decline that you're expecting -- I was wondering if you could give a little bit more detail on the puts and takes, consciously 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.

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

Sure, Robert, 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 life cycle of a lot of our key programs in A.S at this point. There is 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. We have mentioned that the Global Hawk portfolio is projected to decline next year as black 20's and 30's continue in their retirement process. F-18 is projecting a decline for our portion of that program. Jay stars is another -- I would highlight there. And so across the board, these are fairly consistent drivers, F-35, 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 '22 outlook. So hopefully that gives you a sense of some of the key drivers, as I mentioned, it's not anyone's specific program.

[Robert Stallard, Analyst at Vertical Research Partners]

And just a quick follow up Dave -- sorry.

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

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.

[Robert Stallard, Analyst at Vertical Research Partners]

Just a follow-up. Do you think 2022 is likely the trough for these issues as some of these other less mature programs start to grow in 23 beyond?

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

Obviously, we'll provide more insight on 2023 as we get to a similar point in 2022, and throughout the year, we will talk more about specific programs within that portfolio. I think for some, the trends will continue, for others they won't and we will defer to later date to give you more specifics as we look at the 23 outlook and beyond.

[Robert Stallard, Analyst at Vertical Research Partners]

Okay, thank you very much.

[Operator]

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

[Myles Walton, Analyst at UBS Investment Bank]

Thanks. Good morning. I was hoping

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

Good morning.

[Myles Walton, Analyst at UBS Investment Bank]

You could touch a bit on the cash commentary for 22 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 billion-dollar headwind? Are you taking cash taxes or headwind? Regardless, and then a similar question related to the double-digit growth through 2024.

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

Sure. So, the kind of high level view we gave you on 22 through 24 assumes that the amortization of those R&D costs does not go into effect. Though the trend line would be similar, it would be lowest in 22 with an increase in 23 and 24. But let's talk about it, assuming that guidance does not go into effect. What I think you can expect from us in '22 is to continue to drive a similar volume of working capital improvements to what we've done this year, which 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. That means the kind of non-operating items or what we expect to provide the year-over-year reduction, $350 million less cash 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 the sustainably lower level of cash reimbursement. On the cash tax side, we'd projected those would be modestly higher without the R&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 for all of the R&D tax item, for example. So more to come on, all of those fronts on the January call.

[Myles Walton, Analyst at UBS Investment Bank]

Okay.

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

But hopefully that gives you a sense for it today. As we think about '23 and '24, we do expect continued decline in capital expenditures as a percent of sales. We will also benefit from not having the payroll tax to payroll in '23 and '24 as we have in '21 and '22, and at the program level, we expect continued working capital efficiencies on some of our key programs in '23 and '24, which is what gives us the confidence in that increase in those years.

[Myles Walton, Analyst at UBS Investment Bank]

Okay, and just one quick clarification. The prior CAS outlook had slightly moderate growth in CAS recoveries in '23, that trend line still holds?

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

At this point, yes. I think --

[Myles Walton, Analyst at UBS Investment Bank]

Okay.

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

You'll see much less significant changes in 23 and 24, again, based on what we see today and based on the actuarial environment today. From 21 to 22, as well as 20 to 21, we've had significant reductions in cash recovery. We no longer expect significant movement really in either direction in those out-years.

[Myles Walton, Analyst at UBS Investment Bank]

Okay. Thank you.

[Operator]

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

[Douglas Harned, Analyst at Sanford C. Bernstein & Co.]

Good morning. Thank you. I want 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 sixth-gen fighter, new autonomous systems. But I think of those as being fairly long term and fairly uncertain. If you look at that revenue trajectory, the B-21, we should certainly see a 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?

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

Sure, Doug, obviously that's one that we can't get into much detail on, and so I guess, I'll refer you to the overall trends that programs tend to see as they're in these phases of the lifecycle that we've described on B-21 and maybe more importantly that our customer has described on that program. Certainly it has been a contributor to our growth as 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 given you a sense for the 22 outlook there and where the program stands in its life cycle and that's about what we're able to say at this phase.

[Douglas Harned, Analyst at Sanford C. Bernstein & Co.]

Okay. If I switched to F-35 and perhaps go outside of Aeronautics, I think of the kinds of things that you're doing on the F-35 is right at the heart of tech refresh 3 systems upgrades. Now that has with it, I'd say some good news as there should be a lot of -- I would expect growth there. But, they 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-35 there, as well as how you're dealing with some of the challenges that have come up?

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

Sure, Doug, this is Kathy, I'll take that. So as you noted, there is opportunity, particularly in our Mission Systems sectors. We've look at the tech refresh on the F-35 and the Mission Systems that we provide to the aircraft. There has been some delays that has been noted this year. They have had some minimal impacts just on the timing of our work in 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 think 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, sustainment continues to be an opportunity as well. And we see that 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.

[Douglas Harned, Analyst at Sanford C. Bernstein & Co.]

Very good. Thank you.

[Operator]

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

[Sheila Kahyaoglu, Analyst at Jefferies Financial Group]

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 million, which was less than what we thought. What are any other major headwinds. And if we roll it up, is it fair to think about 3% to 4% revenue growth for 2022? 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?

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

Yes, thanks for the question, Sheila. So to unpack the space growth for this year and the trends 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 trend to continue into 2022. To your point about 500 million of growth next calendar year being less than you might have anticipated, you might be looking at budget data which showed an incremental billion in each of the two years. But I'll remind you that a quarter at ' 22 government year is in 2021. So, we've seen a more significant ramp over the 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 fall 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 point based on what we know today, to suggest that low-single-digit growth in 2022 is a reasonable expectation. 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 maybe in early 2022, but what I will say is, we see those more as speed bumps than we do speed rumpers. Our fundamentals are intact, we have strong backlog, strong pipeline, and great portfolio alignment to budget priorities, 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.

[Sheila Kahyaoglu, Analyst at Jefferies Financial Group]

Sure. thank you so much.

[Operator]

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

[Ronald Epstein, Analyst at BofA Securities]

Good morning. Maybe just following up on a whole series of questions, Kathy. I because I think this is a question that's on a lot of people's mind. And obviously I'm not asking for guidance clearly, would be kind of out of the game, but how do we think about kind of medium-term growth, right? So when the speed bumps are behind us. And we're kind of in production on B-21, 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?

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

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 you were referencing like B-21 and GBSD. But it's also a pipeline that includes continued new award and I highlighted a few of those today of programs that are roofing into phase where they will see production award in the next couple of years. 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 impacts because we have a relatively high 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 third quarter, but they up to is finite because as people take leave of course they're burning down their leave balances. And, when I look over a longer-term period at trends like labor market issues that may drive labor rates up or inflation, we have in the industry at one of the highest levels of cost plus work. So those costs get passed on and shared with our customer. Now I do want to emphasize that we in no way, it want to pass those costs onto our customers, so we are working to 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 in 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 grow.

[Ronald Epstein, Analyst at BofA Securities]

Great. Thank you.

[Operator]

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

[Kristine Liwag, Analyst at Morgan Stanley]

Hey, good morning guys.

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

Good morning.

[Kristine Liwag, Analyst at Morgan Stanley]

Kathy just following up on 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?

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

So, we are implementing the vaccine requirements across our U.S. workforce as the mandate requires us to do. We are certainly early in our stage of collecting data about our employee status and 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 impact. But as I mentioned, we are proactively increasing our hiring now in anticipation that we may have some loss of workers. 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, they're just too difficult to really quantify for you at this time.

[Kristine Liwag, Analyst at Morgan Stanley]

Great. And the specifics on the supply chain challenges with Aeronautics?

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

For us, they've been relatively minimal as we have seen our own increases in leave taken, we've seen the same thing in our suppliers and that was primarily driven by 2 things in the third quarter. We estimate one was the delta variant. We saw increased case counts and therefore people out of the workforce while they either recovered from COVID or we're staying out based on close contact and we understood those supplier similar phenomenon. Then the other was that people had not been taking leave at the same rate, but as things started to open up, people actually took some well needed and deserved vacation. So, those are the two primary drivers that we saw and our suppliers saw the same which slowed down deliveries a bit. But as I noted, we see those as being temporal in that leave taking is somewhat limited at that point in time.

[Kristine Liwag, Analyst at Morgan Stanley]

Thank you.

[Operator]

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

[Noah Poponak, Analyst at The Goldman Sachs Group]

Hi, can you hear me?

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

Yes. Good morning.

[Noah Poponak, Analyst at The Goldman Sachs Group]

Hi. Good morning, everybody. Dave, in the cash flow projection that you talked about on I will tell you

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

Noah, we lost you. Are you there?

[Operator]

Can we get to the next question. I will go right back to Noah.

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

Sure.

[Operator]

We have David. Oh Noah, your line is open. Are you there?

[Noah Poponak, Analyst at The Goldman Sachs Group]

Hi, sorry. Yeah, I was just wondering David, if you could speak to what you're assuming directionally from margins in that projection on a total Company basis. Thank you.

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

Sure. We're really pleased to have been able to increase our 2021 segment operating margin rate guidance for the 2nd time now to another ten-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 first quarter of the year. And we anticipate being able to offset a portion of that reduction as we look to 2022. I don't think it's requires a specific assumption for '23 and '24 margin rate to get to the general trend that we're providing for those years. We'll 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 '23 and 4, 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 are what really drives that.

[Noah Poponak, Analyst at The Goldman Sachs Group]

Okay, thank you.

[Operator]

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

[David Strauss, Analyst at Barclays Bank]

Thanks for taking the question, Loraine [Phonetic]. Just Dave to follow up on that so I'm Clear. Your guiding segment margin overall lower versus I guess whatever that call it, 118 midpoint for 2021, you're guiding it lower in '22 and then in terms of free cash flow on an absolute basis is '23 and '24 free cash flow higher than 2021 transaction adjusted free cash flow just on an absolute basis?

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

Sure. Let me address both of those, David. On the segment OM rate, you're right to think about the 2 factors we've described in '22 compared with our increased guidance for 2021. We'll look to offset a portion of the 20 to the 30 basis points reduction that we would see from the absence of those rate benefits in '22, 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 23 and 24 free cash flow, we've got a lot of moving pieces yet to be determined on the tech side, as we mentioned, things can continue to move as they often do on the pension side. Based on what we know today, I think what's best to say today as we anticipate that healthy growth outlook in 23 and 24, as we get to January and provide more specifics on the 22 level of free cash flow and know more than we could note today, in terms of tax legislation and such. We'll provide a bit further detail on the 23 and 24 growth rate in comparison to where we are today also.

[David Strauss, Analyst at Barclays Bank]

All right, thank you.

[Operator]

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

[George Shapiro, Analyst at Shapiro Research]

Yes Dave, I wanted clarification when you say AS declined at a rate similar to 21, is that -- because organically it's more like down 2% with equipment sale is taken out of it or are you talking the 5% that you just see?

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

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

[George Shapiro, Analyst at Shapiro Research]

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

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

Sure. The $350 million number is pretty consistent with what we've been projecting in recent months and in the July and 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. Then the other factor is in 2021, that CAS number came up by about $60 million, as we noted on the call today. The compare from 2021 to 2022 got $60 million tougher, but the 22 level has been pretty stable for us since that new legislation came out in the spring.

[George Shapiro, Analyst at Shapiro Research]

Okay. Thanks very much.

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

You bet.

[Operator]

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

[Cai von Rumohr, Analyst at Cowen & Company]

Yes, thank you so much for taking the call. So by the middle of '22 we'll know about the R&D tax credit. And as you look at '23, '24, you're saying, hey, we don't have the payroll tax repayment. We have lower CapEx. We have better ops and we have less downside in terms of cash. So your 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?

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

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 by, we increased the dividend again this year and we have committed to at least $3 billion 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.

[Cai von Rumohr, Analyst at Cowen & Company]

But actually Lockheed is implying that their net debt will go up, if you consider all of their number. So they're basically saying they're looking at net debt because EBITDA is going up, that basically increasing the net debt somewhat because of the strength of their balance sheet. Is that something you would consider or is it basically just the cash flow that's available?

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

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 mean, Kathy's point is the important one around the priority for us over the next couple of years will remain first 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 will 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. 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.

[Todd Ernst, Vice President of Investor Relations at Northrop Grumman]

And Catherine --

[Cai von Rumohr, Analyst at Cowen & Company]

Good answer. Thanks so much.

[Todd Ernst, Vice President of Investor Relations at Northrop Grumman]

If we have more question.

[Operator]

Alright, your last question will come from Seth Seifman with JPMorgan.

[Seth Seifman, Analyst at JPMorgan Chase & Co.]

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 stabilize and given the decline we've seen year-to-date in the Defense Systems backlog, what gives you confidence on the growth outlook there?

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

So, Seth, we see our book-to-bill being close to 1 again this year have been significant awards that we anticipate in the Fourth Quarter. And our backlog has grown over 90% since the end of 2017, so to your point is there -- we don't expect that kind of accelerated growth in our backlog it currently sits at over two times sales, so it's quite strong, and we feel supports the continued growth of the business for several years to come.

[Seth Seifman, Analyst at JPMorgan Chase & Co.]

Great. And then on defense?

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

Sure. What is the specific question on Defense. Seth, I'm sorry?

[Seth Seifman, Analyst at JPMorgan Chase & Co.]

Just that the 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 what gives you confidence in the Defense Systems business growing next year?

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

That business also has some key awards in fourth quarter of this year that would position for its growth next year. We also in defense see 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 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 add, Dave?

[David Keffer, Corporate Vice President & Chief Financial Officer at Northrop Grumman]

Yeah, of course, the year-over-year backlog comparisons in DS 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 important in this particular year.

[Seth Seifman, Analyst at JPMorgan Chase & Co.]

Great. Thank you very much.

[Todd Ernst, Vice President of Investor Relations at Northrop Grumman]

I will leave it there, Kathy?

[Kathy Warden, Chairman, Chief Executive Officer & President at Northrop Grumman]

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

[Operator]

[Operator Closing Remarks]