Richard Safran: Kathy, Dave, Todd, I think we probably all agree the stock right now seems to reflect the idea that defense is going to be a bill payer as we move to a period of deficit reduction. And I realize this question puts you a little bit on the spot forecasting government spending. But I wanted to know if you’d expand on your optimistic opening remarks. Talk about your macro outlook relative to what seems to be being priced into your stock? And if you think modernization might be sacrificed as part of the budget negotiations?
Kathy Warden: Yes. So we look at the stock price over a longer time horizon than weeks, and we’ve consistently outperformed the industry on a relative TSR basis over the long term. But as you indicate, — we’ve seen some pullback in the last several weeks across the sector and even more so with Northrop Grumman. I am a little surprised at the level of relative pullback we’ve seen given our strong continued results, our growth outlook and the relative portfolio positioning that we have in the U.S. and internationally. And to answer the second part of your question directly, I do not see the U.S. or our allies pulling back on funding their national defense strategy that is well aligned with the Northrop Grumman portfolio. So I’d sum it up by saying, with a strong backlog, growing global demand for our products, differentiated technology and the ability to attract and retain top talent, we’re really well positioned to continue executing on the strategy that we have that is expected to deliver differentiated growth and a potential to generate greater than 20% free cash flow growth for at least the next several years, and we believe beyond.
So I think investors are going to like that. And we’ve been in periods like this before following sequestration, where there was noise in the system related to the government’s commitment to national security. But following that, it was one of the best periods of relative TSR growth at our company, and really, our industry has produced in a while. So I see this as a temporal speed bump in our past and yet our strategy remains strong to deliver value.
Richard Safran: Just as a quick follow-up on inflation. The comments on the B-21 that you’ve been making, is there a general trend here is when your contracts you’re signing right now with the government, are they generally accounting for inflationary effects or are you not finding that?
Kathy Warden: So our customers are engaging in conversations with industry to understand to motivate our investment in future capability and capacity, that is what they really want. And I think many of them now understand that shifting too much risk to industry doesn’t support that investment, nor does it deliver the capability they need in a timely fashion. So with that, I expect we’re going to see less the price development going forward. And they are specifically to inflation, the industry broadly is pushing back on accepting long-term fixed price contracts right now. And they’re asking for reopeners for inflation. We expect that to continue. And as our suppliers ask us for that, we, of course, are passing that on to the government. And really, that’s just common sense. So I believe it will become the norm.
Operator: Our next question comes from Douglas Harned with Bernstein.
Douglas Harned: Last year, you had a decline in Aeronautics that we understood pretty well because you’ve got quite a few legacy programs that were ramping down, like JSTARS Global Hawk. When you look at this year, with your fairly flat guidance for Aeronautics, how do you look at the pluses and minuses when we look at B-21 growth but you still got some legacy programs that are declining. How do you see those offsetting each other?
Kathy Warden: So Doug, this year is really a continuation of those same trends flowing through the top line. The programs that have been declining. We’ve seen the majority of those declines, but they do still flow into the ’23, ’22 compare. So it is things like Joint STARS and Global Hawk. F-35 being a big revenue contributor in AS is relatively flat. So that ties directly into the narrative about their revenues being flat. And then B-21 is an increase, but it’s not a significant increase yet because we’re just moving from EMD into LRIP and these 2 combined are not a significant increase in the program as of yet.
Douglas Harned: Well, and then on a slightly different topic. When you look at rocket motors, and this is an important area for you. And I’m trying to picture what the growth trajectory looks like. And also just in a sense of your market share, you’ve got 1 competitor that is a mature player. There are new entrants coming into the space. How do you see the long-term evolution of your market share and how you’re positioned in that area?
Kathy Warden: So we stay focused on investing in the future capability needed and more so lately in the capacity needed. And in many ways, the reason we are being asked take on more share of the market is because we’ve been investing in this business and are able to take on that additional business because we have outfitted our manufacturing facilities to support the growth. As with the government is asking, we have been responsive. And so as a result, we are winning more business in that area. But we expect to be able to compete even as other new entrants come into the space because we do have a long heritage of expertise that contributes to our solid rocket motor business. And that’s for all size, as I talked today and highlighted some of the larger solid rocket boosters that we build in support of SLS and GEM 63 for Kuiper.
But that’s true in businesses like , where we are taking on more of the needed capacity because we’ve been investing in our manufacturing capacity there as well.
Operator: And our next question comes from Seth Seifman with JPMorgan.
Seth Seifman: I wonder if you could talk a little bit about the profitability in the space business. The margin guidance came down there, margin rate guidance came down there a couple of times during the year. And it’s kind of perceived to be kind of a 10% business, I think, is what we’ve talked about in the past and looking to a second year in the mid-9s here in 2023. So what’s changed there over the past year?
David Keffer: Seth, it’s Dave. So I think you pointed out accurately that we’re now projecting a margin rate for space in the mid-10s going forward. There were a lot of puts and takes in that margin rate upward and downward throughout 2022. Obviously, it’s a rapidly evolving business, a tremendous amount of backlog growth and new program activity added into that portfolio over the last couple of years. So we’re really pleased with the volume we’re adding both at the top line and the bottom line in that process. Obviously, a lot of new cost type work being added to that portfolio and that mix growing, but also work that will evolve toward fixed price over the next couple of years and some new fixed price programs in that mix as well.
So in aggregate, we think the mid-9s is the right way to look at 2023. In the coming years, we do see the opportunity for margin rate expansion. But I think the most important takeaway for the space business is that the volume of top and bottom line growth that we’ve been delivering over the last couple of years and now are projecting over the next few is really adding a lot of value there.
Seth Seifman: Okay. Okay. Great. And then just as a follow-up, Dave. So the working capital performance was quite good in ’22. I think the way that measuring here. Working capital actually came down a bit despite the growth and despite the tough operating environment, only 6% of sales, which is below some of your peers. What’s the opportunity from here? Or is there kind of a normalization at some point where actually for a growing business, the normal level of working capital is higher?
David Keffer: So let’s talk about that for a few minutes. There is not a substantial change in working capital projected in the 3-year free cash flow guide that we gave today. There is more capital intensity in 2023 and 2024 that we’ve signaled throughout this year, given just how much more new business we were awarded this year and the additional capital investments that we need to make to support capacity and capability there. We’ve talked about things like the Amazon Kuiper Award and and other areas of the business that Kathy just noted, we’re making investments upfront for these long-term franchise programs. So that is a headwind to free cash flow. But we’re pleased to be able to offset that and deliver free cash flow guidance for ’23 that’s in line with our prior expectations.
That’s supported by the growth of the business, both top and bottom line. The R&D tax numbers will come down steadily over the next 5 years. And then gradually, over the next several years, we’ll see improvements in the CAS pension cost reimbursement based on current projections. So not much change in working capital, but there are some other moving pieces in the mix. I think importantly, when we look at the underlying fundamentals of growth and margin rate, as we talked about in our scripted remarks, we do anticipate growth through this 3-year outlook that we’ve provided at the top line, and we are modeling small but gradual improvement in the margin rate as well. So that’s a healthy underlying condition for free cash flow. And while we’re at it, as we think about this outlook for free cash flow, the foundation is set for strong free cash flow beyond this 3-year period.
The second half of this decade will have more programs moving to production, fewer of these upfront investments required to do so. The foundation we’ve laid over the last several years of capital investment is going to pay off in the second half of this decade on many of those programs. And so that’s a healthy environment for continued growth in free cash flow as well as the continuation of the R&D tax amortization rolling off as a headwind. So when you look at the second half of the decade, I think your expectation should be more of the same strong growth in free cash flow that we’ve been talking about in the first half.
Operator: And our next question comes from Myles Walton with Wolfe Research.
