The operator introduces the Northrop Grumman Fourth Quarter and Year-End 2023 Conference Call and turns it over to Todd Ernst, Vice President of Investor Relations. Ernst mentions that the call will refer to a presentation on their IR website and that the matters discussed, including guidance and outlooks, are forward-looking statements. He also notes that the call will include non-GAAP financial measures and introduces Kathy Warden, Chair, CEO, and President, and Dave Keffer, CFO. Warden thanks the team for their hard work and dedication and highlights their important mission. She also mentions the company's talented workforce and their role in delivering advanced technologies for global security.

Northrop Grumman's strategies have positioned them well in the growing market, resulting in a 7% increase in revenue in 2023. Their book-to-bill ratio is in line with their exceptional four-year average and they have achieved a new record backlog of $84 billion. The company generated strong free cash flow and exceeded sales and EPS guidance, despite a charge for the B-21 program. They remain confident in their ability to deliver on their forward outlook. The company's strategy focuses on technology differentiation, performance, and value delivery for customers and shareholders. They have invested over $2.9 billion in R&D and CapEx and returned over $2.6 billion to shareholders through dividends and share repurchases. The company has made progress across their portfolio, further bolstering their confidence in their future.

The company announced the successful use of their GEM 63XL solid rocket boosters on ULA's Vulcan launch vehicle, providing a growth opportunity for their propulsion business. They also expect growth in their weapons systems business due to increased demand and their role as both a supplier and prime contractor. Demand remains strong in their Mission Systems business, driven by their advanced technology solutions for customers.

The company is making progress on the EMD phase of the Sentinel program, but a Nunn-McCurdy Breach has triggered a review of the program's costs. The cost growth is mainly due to estimates for the command and launch facility build-out. The company and its team are working to reduce costs for the program in the future. The B-21 program has entered its flight test phase and the company has been awarded the first LRIP lot. However, the company and its suppliers have faced cost pressure due to global economic conditions, which were not accounted for in the original bidding for the production lots in 2015.

During the fourth quarter of 2023, the company reviewed their estimated profitability on the LRIP phase of the program and determined that the first five LRIP lots will likely result in a loss. This is due to changes in funding assumptions and higher manufacturing costs. However, the company is still confident in their free cash flow growth and remains focused on delivering value to shareholders. The global national security spending is increasing, and the company's differentiated portfolio and alignment to customer priorities make them well-positioned in the market. The company is also hopeful for continued support for defense spending and is monitoring progress on supplemental funding.

The company's allies increasing their defense spending will lead to additional growth, and the company has the right portfolio and team to deliver on their long-term outlook. Organic sales have been growing at a rate of over 5% annually and are expected to continue growing at a rate of 4-5% in 2024. The company also expects to see growth in segment operating margin dollars and EPS in 2024. They have implemented strategies to expand margins and expect free cash flow to grow at a double-digit rate over the coming years. The company plans to invest in their business strategy and provide strong capital returns to shareholders through share repurchases.

In 2023, the company had a strong performance with record backlog and a book-to-bill ratio over one. Sales were up 6% in the fourth quarter and 7% for the full year, exceeding guidance. All segments saw sales growth, with Aeronautics returning to growth earlier than expected. The growth was driven by higher volume on restricted programs and new programs, as well as increased workforce and backlog conversion.

The company's space business saw double-digit growth in sales, with a significant portion coming from the Sentinel and NGI programs. However, there was a charge for the B-21 program that affected segment margins and resulted in a reduction in Q4 sales. This also led to a decrease in EPS guidance, with a significant impact from the B-21 charge and a decrease in pension income. The company had a strong quarter for cash performance, generating $1.6 billion in free cash flow. For the full year, operating cash flow was $3.9 billion and free cash flow was $2.1 billion, representing a 30% increase compared to the previous year. Pension results were strong, with asset returns exceeding long-term assumptions.

The FAS discount rate declined, resulting in a mark-to-market pension expense of $422 million. The company expects CAS recoveries to increase, but at a slightly lower rate than previously projected. Non-operating FAS pension income is expected to be higher in the coming years. The company's funded status is strong and minimal cash pension contributions are expected in the next few years. In 2024, the company expects strong sales in aeronautics and defense systems, with a slight decrease in margin rate due to higher B-21 sales. DS sales are expected to increase, while Mission System sales are projected to have mid-single digit growth and strong margins.

The space sector has been experiencing strong sales growth, but it is expected to moderate in 2024 with higher margins. The company's guidance for the year includes a 4-5% growth in sales and margins, with a solid year of bookings. They plan to issue new debt to take advantage of favorable rates and to support refinancings and share repurchases. The projected effective tax rate for the year is around 17%.

The company is close to resolving several open audit and appeals processes with the IRS, which could impact book and cash taxes in the next few years. Their forward guidance does not include any potential adjustments to these matters or changes to R&D tax legislation. They expect their 2024 earnings per share to be between $24.45 and $24.85, with a projected 5-year impact from R&D amortization of $2 billion. Free cash flow is expected to be between $2.25 billion and $2.65 billion in 2024, with continued double-digit growth in the coming years. The B-21 charge will affect cash flows through 2026, but the company is confident in their ability to deliver strong free cash flows in 2027 and beyond.

In the closing of the call, Kathy Warden thanks the Northrop Grumman team for their contributions to a successful year. She also mentions the strength of their portfolio and visibility of franchise programs, which allows them to generate strong cash flows. The call is then opened up for Q&A, with the first question about the B-21 program. Kathy explains that they have been working with the customer and have received some relief for inflation, but are still in discussions for future relief. They have updated their assumptions and are focused on executing the program while also looking for opportunities for performance improvement. The next question is about the Sentinel program, to which Kathy briefly expands on in her opening remarks.

Kathy Warden, CEO of Sentinel, discusses the actions being taken to get the program back on track. She mentions that the program is a top priority for the Department of Defense and has been validated by multiple administrations. The cost growth in the military construction and procurement segments has caused a non-operating cost reach, but Warden notes that this would not have triggered a breach in the EMD phase. The latest cost estimates also account for higher inflation since 2020. Despite these challenges, Warden is pleased with the progress made in the last 3 years, including onboarding engineers, maturing the system design, and producing and testing critical hardware.

Kathy Warden, CEO of Northrop Grumman, discusses the company's engagement in risk reduction and detailed planning for the future phase of the B-21 program. She mentions her recent visit to a missile field and the commitment of the Airmen to the mission. Warden emphasizes the importance of this program and the close partnership with the Air Force. A question is raised about the potential for program costs to increase over time, and Warden's team plans to update projections quarterly. David Keffer, a representative from Northrop Grumman, mentions that they have more information now than they did last year and that the majority of suppliers are under contract.

The company has estimated productivity and learning curves for their program based on historical experience and will continue to track economic and inflationary factors. They are performing well and believe their customers will receive great value from the program. The Air Force has reported a potential 2-year delay in IOC and a Nunn-McCurdy breach due to cost growth, not scheduled delays.

The company is working to inform the Air Force of alternative ways to reduce costs and procurement for the program, but the delay in timing does not significantly impact their near-term assumptions on sales and profitability. The free cash flow guidance remains at a 15% CAGR, with the strength of other programs offsetting any pressures from the B-21 program.

The company is confident in its multiyear outlook and expects double-digit growth in the next several years. They had a strong finish to 2023 and are focused on working capital efficiency and driving cash returns. This has resulted in a unchanged free cash flow outlook for 2024 and 2025, with a strong 2026. The main drivers of this outlook are growth in the top line, margin rate improvement, strong margin dollar volume, and stable working capital performance. Other factors such as CAS pension reimbursement and declining cash taxes are also expected to contribute to strong free cash flow growth in the next several years.

Seth Seifman asks two questions about the B-21 program. First, he asks if the $143 million EAC (estimated at completion) loss is the extent of the entire anticipated loss for Lot 1 and how the losses will progress on future lots. Second, he asks about the opportunity to do better than anticipated, as the charge includes lots that will not be under contract or worked on for a while. David Keffer responds that the $143 million EAC adjustment is only for Lot 1, and there will be modest growth on future lots. He also mentions that the current projections indicate a couple hundred million dollars a year in after-tax impact on the cash line from B-21, but the team is working to mitigate this through efficiencies and negotiations with suppliers. They will continue to update the public on this matter.

In response to a question about the recent losses on the B-21 and Halo contracts, the operator thanks the speaker and introduces Cai von Rumohr from TD Cowen. Cai asks if the company has changed its bidding strategy due to the increased risk in fixed-price contracts. Kathy Warden, the speaker, acknowledges the need for changes and mentions that they have passed on some contracts and taken a different approach in recent bids. She emphasizes the company's commitment to remaining disciplined and finding growth opportunities.

The company has a strong pipeline of opportunities they are pursuing, with a good risk/reward balance in the industry. They try to project future conditions for their projects, but it can be difficult to do so over a long period of time. The company is currently going through an IRS appeal process and cannot provide a range for the potential cash impact.

David Keffer, in response to a question from Scott Deuschle, explains that a majority of supplier costs have been fully negotiated across the LRIP phase, with negotiations ongoing for the remainder. In regards to the commercial inventory in the space business, there were offsetting effects in 2023, but they are not core to the current or future growth story of the business. Ken Herbert then asks Kathy about the key margin drivers outlined last year.

Kathy Warden, CEO of the company, responds to a question about the cost and productivity efforts, as well as the mix side, and how they will impact the company's performance in 2024 and beyond. She explains that the stabilization of macroeconomics will provide some tailwinds in 2024, while cost and productivity actions will continue to drive improvement in 2025. The mix shift from cost type to fixed price will also contribute to margin expansion in the latter half of the decade. The company's target of $4 billion in free cash flow in 2028 is still on the table, despite the charge absorption in that period. Warden also confirms that the Aerospace business is still expected to achieve a 10% margin, although there may be a gradual decline in the coming years.

David Keffer and Kathy Warden answer a question about the 2023 free cash flow target and reaffirm their $4 billion target for 2028. They attribute this growth to an increase in top line, margin rate expansion, moderate CapEx, and tailwinds from pension and tax. They also discuss the pressure on margin rate due to strong growth in the B-21 program, but note that margin dollars are on track and their guidance for AS remains consistent.

Kathy Warden, CEO of AS, discusses the company's future plans and growth opportunities. She mentions that the company's success will depend less on the absorption of a lower rate on the B-21 program and more on the rate at which new programs are booked in the AS portfolio. She promises to provide more information on this in the next year as they look towards 2025 and beyond. Warden also mentions the strong demand for the international program IBCS, which is expected to contribute to the company's growth in 2023 and 2024. However, it is not a major contributor to overall growth. The program is currently at $400 million in annual sales and is expected to continue growing.

Kathy Warden and David Keffer address a question about the charge for the B-21 and the reasons why it was larger than the previously stated range of $0 to $1.2 billion. They explain that the charge was deemed probable due to changes in funding projections and growth in cost projections. They also mention that a detailed look at the EAC in the fourth quarter provided more accurate data. Keffer adds that the margin decrease of 50 basis points was due to the increased cost projections and negotiations with suppliers.

The AS business exceeded expectations in sales in 2023 and is projected to continue exceeding them in 2024. The company is focused on driving operating margin and return on invested capital, as well as growth in margin dollars and free cash flow. There have been some shifting priorities from the government in the space business, leading to a deceleration in growth. There are both risks and opportunities in the company's execution, with record backlog and the B-21 risk being notable factors. The company is working to address these issues and maintain a balanced risk and opportunities portfolio.

David Keffer and Kathy Warden respond to a question about the national security space portfolio. They mention that the company's guidance accounts for growth and declines in various programs, including space. Due to budget prioritization, there are some shifts in the space portfolio, but the company's guidance takes this into account and shows potential for value creation and improved returns on invested capital. Warden believes the portfolio is balanced and consistent with previous years, with opportunities for growth both domestically and internationally.

The speaker discusses the risks involved in executing their portfolio, particularly due to the pandemic, but expresses confidence in the team's ability to overcome these challenges. They mention the successful performance of the program and the disclosure of a previously discussed risk. The speaker thanks their colleagues and concludes the call.

This summary was generated with AI and may contain some inaccuracies.