Good day, ladies and gentlemen, and welcome to the Northrop Grumman’s Third Quarter 2020 Conference Call. Today’s call is being recorded. My name is Natalia, and I’ll be your operator today. At this time, all participants are in a listen-only mode. [Operator Instructions] I would now like to turn the call over to your host, Mr. Todd Ernst, Treasurer and Vice President, Investor Relations. Mr. Ernst, please proceed.

Thank you, Natalia. Good morning, everyone, and welcome to Northrop Grumman’s third quarter 2020 conference call. This morning, we’ll refer to a PowerPoint presentation that is posted on our website. Before we start, matters discussed on today’s call, including 2020 guidance and remarks regarding 2021 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 financial 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’d like to turn the call over to Kathy. Kathy?

Thank you, Todd. Good morning everyone, and thank you for joining us today. We hope you and your families are well. As you all know, we continue to operate in the midst of a global pandemic. Our focus remains on the safety and wellbeing of our people, delivering on our customer commitments and supporting our suppliers and communities. As the pandemic continue, we are operating under protocols that we instituted earlier in the year to help preserve the wellbeing of our employees. And these are helping us to meet our commitments to customers and deliver strong operating results, while also continuing to strengthen our foundation for the future. In addition to COVID-19, we have experienced locally devastating natural disasters at summer. I especially want to recognize our Northrop Grumman employees in Lake Charles, Louisiana, who have persevered through two hurricanes in the last two months. Despite experiencing personal loss, they have returned to work and continue to support the U.S. Air Force through sustainment of JSTARS aircraft. Their resiliency embodies the spirit of Northrop Grumman employees everywhere. Also, before I discuss this quarter’s results, I want to take this opportunity to thank Janis Pamiljans, who is retiring as President of Aeronautics System. In his more than 34 years with Northrop Grumman, he has made significant contributions to the business, through his leadership and unwavering commitment to our employees and customers. And I want to congratulate Tom Jones, who will succeed Janis on January 1. Tom currently leads Airborne Sensors & Networks in Mission Systems. This business delivers large scale, mission critical C4ISR system and complex hardware and software products for airborne platforms, including many in aeronautics. Tom is a seasoned executive with 30 years of aerospace and defense experience, and we’re fortunate he will be leading our Aeronautics business as…

Thanks, Kathy and good morning everyone. I’d also like to thank our employees for their strong performance in this quarter. My comments begin with the third quarter highlights on Slide 3. We delivered excellent bookings, sales, operating income, EPS and cash. And we’re pleased to be increasing our 2020 guidance for sales, EPS, and free cash flow with the assumptions that Kathy articulated. Slide 4 provides a bridge between third quarter 2020 and third quarter 2019 earnings per share. Higher sales and segment operating income drove $0.51 of the increase. Net pension contributed $0.40. These positives were partially offset by a higher corporate unallocated, which was primarily driven by a $50 million increase in state taxes, as well as higher net interest expense, federal income taxes and other items. I would also note that COVID-19 related expenses are reflected in our current results. I’ll begin a review of sector results on Slide 5. Aeronautics sales rose 5% for the quarter and 4% year-to-date. Sales in Autonomous Systems and Manned Aircraft were higher in both periods, for the quarter and year-to-date restricted activities and the E-2D contributed to sales growth and for the quarter F-35 volume was also higher. Defense System sales decreased 4% in Q3 and year-to-date sales are comparable to last year. Third quarter trends included lower volume for Mission Readiness as the Hunter UAV sustainment program nears completion. And in Battle Management & Missile Systems, third quarter sales reflect lower volume at Lake City and on an international weapons program as both of those activities neared completion. Declines in these areas were partially offset by higher volume on GMLRS and AARGM. Year-to-date results reflect similar program trends. Mission Systems sales were up 10% in the third quarter and 6% year-to-date. All four MS business areas contributed to this…

Natalia, please remind everyone how to get in the queue and ask questions.

[Operator Instructions] Your first question comes from the line of Robert Stallard with Vertical Research.

Thank you so much. Good morning.

Good morning.

And thanks for all the detail there on the 2021. But Kathy, just on another topic, on GBSD, I was wondering if you could comment about how confident you are about this program staying on track because there has been some commentary, it could be at risk or the change of administration and a tougher budget environment. And in relation to that, as the program progresses, do you think 2021 will be this trough year for space margins? Thank you.

Thanks, Rob. Every new administration has conducted an analysis of the triad and we expect that to happen again if after the election or working with the new administration. But I’ll also note that each have reaffirmed. It has a critical role to play in our national security. Since 1994, the DoD has had a formal Nuclear Posture Review process. And in that they evaluate the nation’s strategic deterrent posture and have validated all three legs of the triad as being critically important. And I’ll note that the two most recent Nuclear Posture Reviews, one which was in 2010, was conducted by the Obama-Biden administration. And of course the one in 2018 was conducted by the Trump-Pence administration. But again, both confirmed the need for the triad to include GBSD and the B-21. And historically, if we look back, when defense spending declined and conventional military forces come under budget pressure, the U.S. and the allies have relied even more heavily upon nuclear deterrence to ensure global stability. So we think that this triad is going to be viewed as even more important from a budgetary priority perspective if those conditions exist. So we’re confident that a new administration would recognize that value and continue to support the modernization efforts that are well underway for both GBSD and B-21.

Your next question from the line of…

Natalia, just before we move on, you had a second part to the question, Rob. So let me address that quickly. You asked about space margins and weather 2021 would be the trough given the mixed pressure that we will have from the GBSD program. I’ll remind you that we’re expecting nearly $1 billion of incremental growth from GBSD next year, but we also expect significant growth going from 2021 into 2022, so that mixed pressure will persist. But as Dave noted in his commentary, we are working to offset that pressure at the company level with strong costs reduction and program performance. And Natalia, now we’re ready for the next question. Thank you.

Your next question is from the line of Carter Copeland with Melius Research.

Hey, good morning, everyone.

Good morning, Carter.

Kathy, I wonder if you could talk about what you expect in terms of backlog growth opportunities in 2021, given that 2019 and 2020 were so strong with some big lumpy awards. Do you think you can still grow backlog next year? Or is that going to be tougher, given the compares? Thanks.

We certainly see the opportunity to continue to grow backlogs next year. We have a number of opportunities that we’re pursuing across all sectors. I’ll point to a few next in jammer and Mission Systems, as well as the 3DELRR replacement called SpeedDealer. Also in Mission Systems, we have NGI, the Next Generation Interceptor, which would be in Space. So these are just a few examples of large potential awards, new starts that we could look to, to bolster our book-to-bill next year. But certainly we expect that book-to-bill won’t be as robust as this year, just given the singular effect of the GBSD award and the strong backlog that we have across our sectors. And just to provide a little bit of color on that, we don’t tend to look at awards and book-to-bill on a quarterly basis, we look at on a longer term and we are well above a year of sales in backlog in Space, aerospace – Aeronautics and Mission Systems. Defense Systems tends to run as the short cycle business more with a backlog about equal to sales, but that’s typical. So we see strong backlog in all of our sectors and the opportunity to continue to build backlog at the company level.

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

Good morning. I was interested in trying to get a sense for where services are headed. You’ve had some very good top line growth in product sales, but services have really been flat at best. And perhaps you could talk about why that is. And do you expect to see the services revenues grow from here? And do you expect F-35 sustainment to be a significant part of that?

Thanks, Doug. So let me start with the last part of the question first, and then I’ll talk more generally about services. We do the F-35 sustainment growth as a contributor to our overall services business, but I’ll also note that some of that F-35 sustainment growth runs through our Aeronautics business and our Mission Systems business. When we’re talking about spares and repairs, those gets done by the businesses that produce the products themselves, not necessarily through our Defense Systems business, where our aircraft modernizations, that team is involved in the sustainment of program for the F-35. So we see sustainment spread across the company and we see that growth contribute to all three of the sectors that I noted. In terms of services growth within Defense Systems, we have seen that business be relatively flat. And we’ve talked about some of the headwinds there that have been running off over the last couple of years based on strategic decisions we’ve made about business to not pursue and that certainly slowed even into our 2021 results. But we’ve also seen some nice new program wins in that business, we talked about our large restricted program earlier in the year. We had a significant award in our services – IT services business in the third quarter. So we are seeing growth, it’s just offset by those headwinds that we’ve been talking about. And as you know, we’ve been executing on that strategic repositioning for our services business in TS and now CS for several years.

Your next question is from the line of Jon Raviv with Citigroup.

Thank you, and good morning. Kathy, in your prepared remarks – excuse me, you talked about how there’s uncertainty, but Northrop has strengthening foundation for growth. What about the foundation for strengthening growth? And I ask in the context of really what is the prospect for growth rate to accelerate after 2021, as new programs ramp up, you overcome some headwinds like Lake City. I know in July we talked about Aero unremarkable in 2021 and 2022, but just thinking about growth ahead in sustaining that number as you point to maybe, call it, 3% to 5% in 2021.

Yes. Thanks, Jon. Well, as you note, our outlook for 2021 represents another solid year of growth. Growth beyond 2021 will be somewhat dependent on the top line defense budget outlook, but also on our portfolio’s ability to offer the solutions for U.S. governments and our allies field are necessary for their most pressing threats. And our recent success in capturing new work indicates that we do have a strong alignment to those high priority items, but the combination of the budget and portfolio are certainly what will drive our outlook for 2022 and beyond. We’ve seen strong bipartisan support for our key, like B-21, GBSD, F-35 and these two will be the key to continuing to see growth beyond 2021. But given the threat environment, we expect that support to continue for those large programs. And we have a really nice visibility as a result of being on the early end of programs like B-21 and GBSD, which go for many years as you know and have a growth profile in that period. I will acknowledge that flattening budget could lead to fewer new starts, but we feel well positioned and that our backlog has been building over the last couple of years very nicely. And as I noted earlier, in response to your question, we see the potential to continue building that backlog at least into next year.

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

Thanks. Good morning.

Good morning, David

Kathy and Dave, I want to ask on free cash flow, or I guess first of all on pension, how you’re thinking about that and maybe the potential of the front-end load, some of the pension contributions you’re thinking about in the out years, given the cash balance you’re going to have here. And then thinking about the cash profile from here, it looks like despite everything this year that working capital based on your guidance for the full year, it looks like working capital is going to be fairly neutral. Does that benefit you from here? And then last part of it, your CapEx profile, do you still see that stepping down pretty meaningfully in 2022? Thank you.

Sure. Thanks, David. I’m happy to dig into each of those pieces as we look at cash flows in the years 2021 and beyond. I think you’re right that we’ve generated a healthy cash balance at this point with $5 billion at the end of Q3 that certainly enabled us to pay down the $1 billion of debt that we talked about earlier in October. We do continue to plan for a gradual de-leveraging of the balance sheet. So that’s one element of our capital deployment strategy. Investing in the business is certainly – continues to be the hallmark of our capital deployment strategy. On the CapEx side that you asked about, our outlook there is unchanged, $1.35 billion this year and next with a gradual decline in terms of a percentage of sales thereafter. We don’t see anything that would cause us to change that outlook at this point. Returning cash to shareholders remains a priority as well. And as Kathy talked about earlier, we do anticipate restarting our share repurchase program in 2021, and continuing to maintain a competitive dividend. On the pension side, it is something that we look at in terms of the timing of pension contributions that are anticipated to pick up a bit in 2022. As we noted earlier, those are not incorporated into our free cash flow guidance for this year or next, but the opportunity to make voluntary early pension contributions remains a possibility in either of those years. So the bottom line is our intent is not to sit on the current high levels of cash that we have generated over the last couple of years for longer than we believe it’s necessary. And you should expect a nice balanced approach to capital deployment over the next couple of years to…

Your next question is from the line of Seth Seifman with JPMorgan.

Thanks very much, and good morning. I wonder, Kathy, maybe if you could talk a little bit more about the autonomous portfolio and kind of the mechanics and timeframe of – starting to get growth to pick up there. And in particular maybe the Skyborg award and how you guys think about that, given that it’s kind of a different type of program in terms of being a low cost solution and kind of the more high-end stuff that Northrop has been focused on traditionally?

Thanks, Seth, I’d be happy to. So let me start by talking about our current autonomous portfolio and looking at tail in particular, so the combination of our Global Hawk and Triton program. We have talked about some budget pressures there. You may be familiar that for Triton the Navy has discussed the production pause for the next two years. And that is what is currently programmed into the Navy’s 2021 budget request. We are working with the Navy and Congress to see what that production pause actually entails in terms of aircraft for next year. But with Australia, we also see some offsets to that production gap that we would experience otherwise with the Navy pause. We do believe the Navy is committed to the program in the long-term based on all of the statements that they’ve made and so this really is a opportunity for the air vehicle to pause and wait for some government provided sensors that would get integrated into the production vehicles going forward. With regard to Global Hawk, the Air Force is contemplating a reduction in their fleet from largely Block 20s and Block 30s and while they’ve signaled that, that is not formal direction at this point. So we really don’t have more color to add on what those pressures might look like for Global Hawk. But we do anticipate that over the next several years that will become more clear and we will have a stronger projection, and that leads to the question that you asked about Skyborg and other analysis of alternatives that are being considered in this case particularly by the air force. But I would note that all of the services, strategic plans, call for a significant contribution by unmanned systems in particular, aerial unmanned systems including not only…

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

Thank you very much. So Kathy, you mentioned that backlog could grow in 2020 just looking at it doesn’t look like the new opportunities are that huge. Maybe I’m wrong there, but so what would it take to get you, are the existing programs, is there a big increases coming? You’ve already gotten your money on GBSD, but in the other restricted areas what are the key elements that could get you to a higher backlog next year?

So Cai I noted a few programs, but as you I’m sure appreciate across our programs sets, the timing of awards of some large like F-35 we expect to have another production, a lot of awards next year, but there are many smaller efforts as well that will just have their natural annual increment particularly production program that will flow in next year that create a significant base and foundation of award. And I just referred to a few of the new awards, the new business that we would see contributing to an ability to get to a one or greater book-to-bill next year. But certainly there are lots of awards that are anticipated in just normal course of business across all four of our sectors.

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

Hi, good morning, Kathy, Dave and Todd. Just given 10% growth in Mission this quarter and the promotion of Tom Jones to lead Aeronautics, your largest segment from a sub-segment in Mission, how do we think about actual growth drivers of mission growth over the next few years, because outside of GBSD it is your most significant growth contributor in your portfolio?

Yes, Sheila and thank you for recognizing that. Certainly Tom Jones at his leadership at Airborne Sensors & Networks inside Mission Systems has contributed to very strong growth for Mission Systems, it has been of the four businesses inside of Mission Systems, the most significant contributor to growth for a couple of years. But I would also note that all of the businesses in Mission Systems contributed to its growth this year. So we have them pleased to see that it isn’t just one of the divisions driving that growth. Speaking to Tom Jones in particular, I have one of the reasons that I’m very pleased to have him stepping into the role at Aeronautics sector is that, in addition to leading our Airborne Sensors & Networks, he was leading our cross-company campaign for Next Generation Air Dominance, which looks at all next generation aircraft and mission systems that would meet the requirements of the government for their sixth-generation fleet. And so in that role, he was already working very closely between our Aeronautics and our Mission Systems sector on how we bring these capabilities together to accomplish the mission that our customers have laid out, both the air force and the navy for their next generation of aircraft and mission program. So that synergy between those two businesses will only get stronger as we have Tom transition into Aeronautics. I’d also note that the team under Tom in Airborne Sensors & Networks is a very strong team. So I fully expect that the growth that we’ve seen there will continue under their leadership.

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

Hey, good morning guys. Thanks. So, Kathy a bigger picture question for you. The classified programs have become such an important piece of Northrop’s business and I guess for important reasons, right there sort of a black box. How do you want investors to think about it? And kind of as follow-on to that or a addendum to that, with the announcement of NGAD and DoD wanting to do more rapid aircraft programs, prototyping the whole Digital Century Series thing, what kind of opportunity does that present for Northrop, because presumably that’s all in the classified world as well.

Thanks Ron. So one of the most important things for our performance as the company is the program performance and so what I want our investors to know first and foremost about our classified and restricted work, is that we have the same level of governance over those programs that we do any other program, the appropriate people are cleared into the details of those programs, reviewing them regularly, understanding what they need to perform and providing the resources to them to execute successfully. And so that goes to our ability to continue to have a track record of disciplined and focused performance in our restricted portfolio. Even though, we can’t share as much of that detail with our investor community as we could on our unclassified portfolio. In the second part of your question around digital engineering and the important role that our digital enterprise transformation is going to have on all of our programs going forward, I’d actually start by pointing to GBSD where we are using the digital enterprise as the base for executing that program. The work that we have done with the customer already, even under the tech maturation and risk reduction phase of the program was done in a digital environment. We delivered artifacts for review in a fully-digital environment where they were actually looking at things in a model, not documents produced. This is the first time on a program of this size, where that’s been the case. And we’re very pleased to be pioneering the way in partnership with the air force to make that a reality on the GBSD program. But those investments that we’re making for GBSD are being utilized across our entire portfolio. So as we think about Next Generation Air Dominance and the programs that are part of that overall campaign as I’ll call it, they too will benefit from a full digital engineering thread as being required by our customers. And even in areas like space and mission systems, in addition to aeronautics, each new start is looking at implementing not only the design in a digital way, but a full thread that looks at the producibility and the maintainability through the use of models in the digital environment.

Your next question is from the line of Pete Skibitski with Alembic Global.

Yes. Thanks. Good morning. Kathy, just to follow-up on Seth’s earlier question regarding HALE UAVs, I know you touched on Australia, but in general, that was a domestic discussion. Can you talk about UAV export policy? Because I thought maybe there had been some changes made to the MTCR, but I don’t know how radical or not those changes have been, but can you give us your updated view there on regulation, around exports for HALEs and maybe whether or not it goes far enough to help exports just given, I think a lot of market share has been seeded to some competitors out there. Thanks.

No, I think there were changes to the MTCR and they are very encouraging changes, they will open up more international customers to have potential access. Of course, they still go through the same approval process, but now it looks more favorable upon export of this technology, because it isn’t caught up in the missile technology regime as tightly. And so when we look at this process, we are really pleased that Department of State and the Department of Defense in the U.S. has worked together to make this possible. It will take us some time to work with nations that are now eligible for this technology and get through processes of them requesting it and engaging with them, but it is opening the door that had not been opened before. So over a multiyear period, we do expect us to open up more international sales not just for HALE platform which is what we produce today, but for unmanned systems overall, including ones we might develop in the future

And Natalia we have time for one more question.

The last question is from the line of Myles Walton with UBS.

Thanks, good morning and thanks for squeezing me in. Maybe a clarification on the pension cash assumptions at 2021 and 2022. Did only FAS move or did CAS and funding respectively changed? And then on Space, your growth there for 2021, I think this year you grew space more than 10% without GBSD, so why the implied deceleration to virtually no growth in 2021 ex-GBSD. Thanks.

And Myles, I’ll start on the pension question. We still have a lot of assumptions to finalize there and review internally. And so that’s why it doesn’t make sense for us at this phase to get into a line-by-line detailed review of those assumptions before they’re fully baked. And of course we have to see where discount rates end up as well as a full-year asset performance for this year. It’s possible that there will be movement in both the FAS and the CAS lines, but those are as I mentioned, still in the works, the net result that we’re talking through of 150 to 250 would cover both of those. From a cash perspective, I don’t think you should think of this as being a meaningful change to our 2021 or 2022 outlook. But again, we’ll have more details and we’ll be able to update that on the January call.

And I’ll say just very quickly, with strategic space we’ve seen a tremendous amount of growth this year as you pointed to, many of those programs ramped throughout this year and achieved more of a steady state growth into next year. And strategic missiles, as it’s transitioning from GMD to NGI, we’ll see a little bit of flatness until we get through the other side, but all of that is being more than offset by GBSD and some additional growth in strategic space, just not quite as much there in 2021 on a year-over-year compare as we saw in 2020.

So why don’t I go ahead and close today’s call by reiterating our thanks to the Northrop Grumman team for another outstanding quarter of performance. It’s especially impressive in light of the challenging conditions that we’ve all faced this year. We are successfully executing on our strategy with solid results through the first three quarters and we’re well-positioned to have a strong finish to this year and continue that momentum into 2021. So thank you for joining us today. We look forward to speaking to you again in late January when we’ll report our full year results and provide 2021 guidance. That concludes our call.

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