Northrop Grumman Corp (NOC) — Q3 2019 Earnings Call Transcript

Thank you, Erica. Welcome to Northrop Grumman's third quarter 2019 conference call. Before we start, matters discussed on today's call including 2019 guidance and any outlook or expectations for 2020 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 earnings release and our SEC filings. These risks and uncertainties may also cause actual Company results to differ materially. Matters discussed on today's call include non-GAAP financial measures that are reconciled in our earnings release. Additional information can be found in the supplemental presentation posted on our Investor Relations website. On the call today are Kathy Warden, our Chairman, CEO and President, and Ken Bedingfield, our CFO. At this time, I'd like to turn the call over to Kathy. Kathy?

Thank you, Todd. We're pleased to have you aboard as our Vice President of Investor Relations and I also want to thank Steve Movius for his many years of service in that role. Good afternoon, everyone and welcome to our third quarter 2019 earnings call. I want to thank the entire Northrop Grumman team for another solid quarter. We delivered strong business capture and backlog growth, higher sales at all four sectors, strong earnings and healthy cash flow. Year-to-date results supported a substantial increase in our EPS guidance, as well as an increase to the lower end of our free cash flow guidance, and we are on track to achieve the other major elements of guidance. Before discussing the quarter in more detail, I want to touch on the realignment we announced in September. Beginning in January, we will have four operating sectors that more closely align with our customers' priority investment areas. Our new sectors are Aeronautics Systems, Defense Systems, Mission Systems and Space Systems. These changes will enable our teams to quickly identify and deliver solutions for rapidly evolving national security challenges. The realignment is also aimed at driving continued strong execution, sustained profitable growth and operational efficiency. Under the new structure, Aerospace Systems becomes Aeronautics Systems and continues under the leadership of Janis Pamiljans. In addition to the long-duration franchise manned and unmanned programs, the sector will also include the aerostructures work currently being performed at Innovation Systems. A new sector, Defense Systems, brings together Technology Services, the defense businesses of Innovation Systems and select capabilities for Mission Systems. In addition to being our global sustainment and modernization business, Defense Systems includes tactical missiles, munitions and our Integrated Air and Missile Defense program. Defense Systems will focus on products and services that address evolving threats and quick-turn requirements for a wide variety of national security, military, civil and international customers. Chris Jones, the President of Technology Services has announced his intention to retire. I want to thank Chris for his many contributions to Northrop Grumman particularly for leading the effort to position Technology Services for the future. We wish him the best. Mary Petryszyn, who currently heads Land and Avionics C4ISR within Mission Systems will lead the new sector. Mission Systems remains largely intact, but with a sharpened focus on growing its leadership position in open, cyber-secure, software-defined systems for defense and intelligence applications. Mark Caylor will continue to lead Mission Systems. The fourth and final sector, Space Systems, brings together our significant space and launch capabilities from across the company into one organization. Space Systems will be a robust platform to accelerate the development of innovative and affordable offerings for our national security, military, civil, commercial and international customers. We expect Space Systems will be the fastest growing sector in our new structure. Blake Larson, currently the President of Innovation Systems, will lead Space Systems. This realignment is the next logical step to maximize the powerful revenue synergy opportunity we envision from our combination with Orbital ATK. It also further enables strong execution and our organization's agility. Turning to financial highlights for the quarter. Sales rose 5% to approximately $8.5 billion and included sales growth at all four sectors. Our year-to-date segment operating margin rate of 11.5% is tracking to our guidance of approximately 11.5% for the year reflecting solid operational results. Cash from operations increased $327 million to $1.1 billion in the third quarter and free cash flow increased to $882 million. Year-to-date, operations have generated $1.8 billion of cash. After capital expenditures of approximately $800 million, year-to-date free cash flow increased to approximately $1 billion. New awards remained robust and demonstrate our strong competitive position in the critical national security domain. In the third quarter, we booked more than $10 billion in new award or 1.2 times sales. Book-to-bill was above 1 times at Innovation Systems, Mission Systems, and Technology Services. At Aerospace Systems, year-to-date, book-to-bill is 1.6 times sales and backlog is up 28%. During the third quarter, Japan exercised an option for nine additional E-2D Advanced Hawkeyes for approximately $1.4 billion. This is in addition to the $3.3 billion multi-year award we booked last quarter. I would also note that France has indicated they're interested in purchasing three E-2Ds. At Innovation Systems, we booked the initial $300 million of $1.1 billion Missile Defense Agency competitive award to supply new targets and countermeasures used to test the Ballistic Missile Defense System. Our offering provides a new solution to the complex threat scenarios our customers face. I also note that IS has been awarded approximately $1.3 billion for hypersonic and counter-hypersonic activities, as both the prime and subcontractor. At Mission Systems, we were awarded a 13-year IDIQ contract to produce and sustain next-generation navigation systems for the US Air Force and international customers. The Sole Source Award has a potential value of $1.4 billion. Mission Systems also booked a six-year $375 million order to provide surveillance radars for the Navy's Triton Aircraft, and a $200 million IDIQ Award for our layer front systems and related support. And at Technology Services, in addition to winning two large recompete, TS won a competitive restricted award valued in the hundreds of millions of dollars. We're particularly pleased with this award as it demonstrates the sector's ability to win new restricted work and expand our national security services portfolio. A good indicator of our company's portfolio alignment to the national defense strategy is our growing share of restricted work. Year-to-date, restricted awards totaled $8.5 billion. At the company level, restricted work across multiple domains continues to grow as a percent of total revenue. As of September 30th, total restricted backlog has grown 22% since year-end, and new awards of approximately $36 billion or 1.4 times year-to-date sales. Looking ahead, we have large opportunities across our portfolio in all four sectors and program execution remains solid. Turning to Aerospace Systems. F-35 production continues to ramp up. Year-to-date, AS has delivered 100 center fuselage units and we are on pace to deliver a total of 134 units in 2019, 13 more than last year. As we celebrate the 30th anniversary of our B-2 Spirit, the world's first stealth bomber, we continue to perform well on the B-21 radar, our nation's next-generation stealth bomber. Last month the then acting Secretary of the Air Force, Matt Donovan noted that the development program is on schedule and production will occur in Palmdale, California. At Mission Systems, our IBCS Systems successfully intercepted a cruise missile at an extended range with Sentinel and Patriot System. The flight test demonstrated the value of IBCS to detect, track and engage low-flying threats at a distance well beyond the range limitation of the current Patriot System. In August, Innovation Systems submitted our proposal for the National Security Space Launch down-select, which is currently planned for the third quarter of 2020. Our OmegA vehicle is on track to meet the customer's requirement for a first launch in 2021 and operational launches of national security payloads in 2022. On GBSD, we have assembled an exceptional nationwide industry team, that is ready to meet the Air Force's technical and schedule requirements. We are successfully executing on the TMMR phase of the program and we look forward to submitting our proposal for the next phase of the competition. The Air Force has been clear that our nation urgently needs to modernize the ICBM System, and that it is critical that this acquisition remains on schedule. Turning to the US defense budget. We're now working under a continuing resolution that expires on November 21st. More often than not, we begin each fiscal year under a CR and we don't expect this to cause a significant disruption to our fourth quarter activities or our outlook for next year as long as there is not a prolonged CR. Our customers need predictable funding that is not constrained by continuing resolution limits. This enables investment in the critical technologies we need to stay ahead of rapidly advancing global threats. We believe our nation's leaders will provide the necessary resources to modernize key capabilities and therefore we are hopeful that the government will act quickly to finalize appropriations. In closing, based on a solid quarter, strong year-to-date performance and our outlook for the remainder of the year, we are again increasing 2019 earnings per share guidance. We now expect mark-to-market EPS will range between $20.10 and $20.35. We are maintaining our sales guidance of approximately $34 billion, and we are updating our free cash flow guidance by raising the bottom end of the range by $100 million. We now expect free cash flow of $2.7 billion to $3 billion for the year. Regarding the 2020 outlook, we will provide detailed guidance in January. We expect mid-single-digit sales growth in 2020, which now includes the impact of the Lake City contract winding down in the latter part of the year. We also expect segment margin rates consistent with 2019 and strong and growing free cash flow. So now, I'll turn the call over to Ken for a more detailed discussion of our financial results and guidance.

Thanks, Kathy, and good afternoon, everyone. I also want to thank the team for another solid quarter. We had excellent awards, strong book-to-bill, and higher sales at all four sectors. Year-to-date awards support our outlook for continued top-line growth. And as Kathy said, we are tracking to our segment margin rate guidance. Turning to the sectors. Aerospace Systems sales rose 5%. Higher manned aircraft reflects volume increases on the E-2D and F-35 programs. Space sales also increased reflecting growing activity on next-gen OPIR programs. Autonomous Systems sales were also higher due to volume increases in multiple areas, including Global Hawk. AS third quarter operating income declined to $324 million and operating margin rate was 9.4%. This was driven by lower net favorable EAC adjustments. AS had fewer favorable adjustments this quarter primarily due to timing. We also had negative performance adjustments on two activities. The B-2 Defensive Management System Modernization program is experiencing schedule delays. Although the upgrade has taken longer than planned, installation of DMS has been completed on the first test aircraft and aircraft checkout is underway. AS has now completed most milestones on the program and is well along toward completion. We also experienced production delays for certain commercial space components. We have introduced new leadership and processes in this business in order to successfully complete these contracts. In both cases, we believe our current EACs have captured the cost to complete the required work. Excluding these two adjustments, AS third quarter margin rate would have been in the mid-10% range. We continue to expect AS sales for the year in the high $13 billion range. We are maintaining operating margin rate guidance of mid-to-high 10% with a bias toward the lower end of the range. At Innovation Systems, third quarter sales rose 12% in its first full quarter comparison. In Space, we had higher volume on national security satellite systems. Defense Systems had higher volume on precision munitions, armaments and tactical missiles, including the AARGM-ER program. Flight Systems had increased volume on military and commercial aerospace structures. IS operating income increased 2%, reflecting higher sales. Operating margin rate for the quarter was solid at 10.4%. The prior year period benefited from favorable indirect performance and the recovery of an insurance claim. Year-to-date, operating margin rate is 11.1%. For the year, we continue to expect IS sales of approximately $6 billion with a high 10% operating margin rate. No change to prior guidance. Turning to Mission Systems. Third quarter sales grew 4% and operating income was comparable to last year. Advanced capabilities had higher volume on marine programs. Cyber and ISR had higher volume on space and restricted programs. Sensors and Processing had increased activity on airborne radar and electronic warfare programs, including F-35 and radars. Based on year-to-date results, we continue to expect MS revenue to grow to the low-to-mid $12 billion range. And we are raising margin rate guidance to the low 13% range. At Technology Services, sales rose 3% and operating income rose 23% with an operating margin rate of 12.7%. As we discussed last quarter, program headwinds are moderating and we are now seeing the underlying sales growth in both TS businesses. Operating income benefited from a focus on cost reduction, as well as a favorable adjustment on a sustainment program. We continue to expect TS sales in the low $4 billion range, no change to prior guidance. And based on strong year-to-date performance, we are raising guidance for TS operating margin rate. We now expect a high 10% range versus prior guidance of low 10%. As we roll all that up, we continue to expect 2019 sales of approximately $34 billion with a total segment operating margin rate of approximately 11.5%. Below segment OM, we continue to expect unallocated corporate expense of $225 million. Unallocated corporate expense is typically higher in the fourth quarter and our guidance contemplates an estimate for state deferred taxes and year-end accruals. We are increasing our guidance for total operating margin rate to approximately 11%, largely due to updated cash pension estimates as we completed our annual demographic study. The presentation materials we posted this morning include updated estimates for CAS, net FAS/CAS pension adjustment and required funding for 2019 through 2021. Our 2019 estimates do not include the mark-to-market adjustment we will be recording in the fourth quarter. 2020 and 2021 estimates are based on year-to-date trends and assume a discount rate of 3.31%, 12% planned asset return in 2019 and 8% planned asset returns thereafter. Through September 30, our actual returns were about 14%. I'd also note that our CAS prepayment credit approximates $2 billion. The demographic study increased 2019 CAS and net FAS/CAS adjustment by $60 million. For 2020 and 2021, our updated assumptions increased net FAS/CAS adjustments by $140 million and $80 million respectively. And over the three-year period, our required funding is about $100 million lower. Moving to taxes. Our effective tax rate for the quarter was 11.6%. Based on year-to-date results and our updated fourth quarter analysis, we now expect the tax rate in the low 16% range for the year. Wrapping all that up and considering year-to-date results, we are increasing our mark-to-market adjusted earnings per share guidance to a range of $20.10 to $20.35. This continues to be based on approximately $170 million weighted average shares outstanding. Free cash flow increased $352 million in the quarter. Year-to-date, we've generated more than $1 billion in free cash flow. Based on year-to-date results and our fourth quarter outlook, we are raising the bottom end of the free cash flow range by $100 million. We now expect $2.7 billion to $3 billion for the year. We continue to expect capital expenditures of approximately $1.2 billion, as well as share repurchases of approximately $750 million. And as planned, we retired $500 million of debt in the third quarter. Beyond this year, we expect growing cash flows driven by higher sales and earnings, some improvements in working capital and modest required pension funding. Regarding capital expenditures, we continue to invest in growth opportunities as robust backlog growth continues. We are still targeting capex at about 2.5% of sales in 2021. In summary, we had a solid third quarter and we expect strong results for the remainder of the year. I think we're ready for Q&A. Todd?

Erica, we're ready for questions.

Afternoon, Kathy, Ken, Todd welcome.

Yes, thanks.

Kathy, thanks for all the details on the realignment. Could you maybe give us just your thoughts on, sometimes when you do a realignment, you do shine a bright light on something that doesn't fit. Is this going to result in any portfolio shaping and just any updated thoughts on that? Thanks.

Yes, thanks for the question. And you're absolutely right, as we did this realignment, we've looked in-depth at what we had in the portfolio to ensure that we were getting things aligned in a way that would create the most value for the company going forward. And I'm really pleased with the structure we're putting in place; it seizes the opportunity that we knew we had in space to bring the portfolio together in the new Space sector. I'm also excited about the creation of the Defense Systems sector, as it brings together some of our munitions and integrated air and missile defense capabilities in a tighter way along with our sustainment strategies, which deal with customers' very quick-turn requirements. So, this has really been about the forward look in our company and seizing those opportunities that exist. And as we did shine a light on the whole of the portfolio, there wasn't anything that didn't fit within the structure that we created. But, of course, I continue to look at that on a regular basis and as we execute the strategies that we defined in this newer realignment, we'll continue to assess just that question.

Hi, good afternoon, everyone. This is Kristine dialing in for Ron today. And yes. I just wanted to follow up on the B-2 Defensive Management System Modernization effort. Are the operating issues you're facing there related to the re-baselining of the program, and then also, should we expect lower margins in this program to continue to your B-2 contracts going forward or is this issue kind of a one-time thing?

So, Kristine, I'll start and then hand it over to Ken to talk about the financial implications of what we saw on B-2 this quarter. We are managing thousands of contracts across the company and delivering very strong performance. And sometimes contracts are re-baselined as we did report earlier in the year, the B-2 program. What we saw this quarter was an adjustment there that Ken outlined in his comments related to the performance on that program. We feel very good about where we are in completing major milestones on our way to finalizing and executing the B-2 program. It is complex to update a system of that type, but we now have our arms around those challenges. So, I'll turn it over to Ken to talk a little bit more about the financial implications.

Thanks, Kathy and Kristine, I appreciate the question. Let me just say that, as I mentioned in my comments, we do believe that our EAC reflects the cost that we think will be required to complete the program. And as we look at our portfolio and I'll just go back to Kathy's comments, a portfolio of many different programs and contracts across not just the Aerospace sector, but across the company. We don't expect this program as it will book essentially a lower margin from now until completion to have any material impact on our overall segment margin rate at either AS or in total for the company, again, given the very diverse portfolio that we manage on a day-to-day basis.

Good morning. Thanks. Ken, could you discuss the repayment of some of the debt? Looking ahead to the next few years, there are several debt obligations coming due. Can you share your strategy for handling that?

Sure, Seth. I would say as we look forward, we do have debt coming due. We also have a growing EBITDA as we look at growing the business, growing the top-line and maintaining strong margins, and that growing EBITDA gives us some naturally deleveraging there. So, as we look at that, I would say, we've got some optionality on what to do and depending on the value-creating opportunities that we see in front of us will very much shape what we do in terms of that debt repayment strategy, and we'll continue to evaluate what are the most value-creating uses of our capital and that will really shape it.

Thank you. Good afternoon, Kathy and Ken. Kathy, you made some preliminary comments on 2020. Can you talk about your comments regarding margin mix and having it consistent or margins being consistent, can you talk about mix within the portfolio, how you see it transitioning from mature to development programs, if you could give some color?

So, we'll be giving detailed guidance in January in our new structural alignment, but my comments did apply to the company as a whole seeing our segment operating margin rate stay consistent with 2019 guidance. And as we look at what's happening within our segment operating margin rate, we are taking on additional development work and there is some downward pressure on margin rates as a result, but we're also having very good cost management, which is offsetting our rates and allowing us to keep both competitive rates to win new business, but also healthy segment operating margin rate, and we expect that trend to continue into 2020. So, it's like a duck on water. While we're remaining consistent, there is a lot happening beneath to keep the margin rates consistent even as we take on additional development work.

Okay, thank you.

Thanks, good afternoon, everyone. Regarding the mid-single-digit sales growth guidance, Ken, you hinted at the possibility of something higher during the last call, mentioning Lake City. Can you clarify if Lake City was the only change compared to what was previously discussed and how that affects our outlook for 2020 and 2021? Thanks.

Certainly. As we assess our sales growth for 2020, Lake City has significantly influenced our outlook compared to what we had previously shared. We estimate that Lake City will contribute approximately 1% to our anticipated sales for 2020. Furthermore, as we look ahead, we expect mid-single-digit sales growth, strong margins, and an increase in cash flow following Lake City. We are optimistic about leveraging our existing portfolio to drive this growth and convert it into cash margins.

Hi, good afternoon. Ken, a question for you just coming back to the couple of comments you made on cash. I appreciate the color on easing capex and improving working capital. Can you maybe take it a step further and give us an idea of what conversion looks like over the next few years and maybe in 2021 and in particular given your comments there on capex levels?

Sure, Rajeev. Let me first comment on the importance of being cautious when considering conversion due to several factors. Mainly, there's the impact of pensions and the amortization of PI, among other aspects. I want to focus on how we are viewing cash as we look ahead to 2020 and beyond. We will provide detailed guidance in January and explain everything in depth. I want to emphasize that we are confident this business will generate significant cash moving forward. Let me outline some of the factors contributing to that expectation. We anticipate solid sales growth for several years, driven by our portfolio's alignment with customer needs. This is evidenced by the strong backlog we have been building and expect to continue generating in Q4 and 2020. As I mentioned, we also expect to maintain strong margins and convert those margins into cash.

Thank you, good afternoon. I wanted to understand the growth trajectory in the Autonomous Systems area. When looking at the components of this, we see F-35 and some restricted space growth, but regarding autonomous systems, you mentioned Global Hawk. However, it seems that the focus is heavily on Hail Systems, which appear to be somewhat sporadic, particularly with Global Hawk, NATO AGS, and Triton. Can you discuss how we should view this as a long-term trajectory for autonomous platforms?

Yes, Doug. So, as I think about the opportunity for unmanned systems, we've clearly seen some adoption for unmanned in applications like intelligence, surveillance and reconnaissance. As we look into the future, we believe unmanned systems will be utilized for more missions and we also see the opportunity for more international sales of unmanned systems as export regulations are considered and perhaps addressed to allow more of its capability to get into the hands of our allied nations. So, when we think about UAS under a long-term trajectory, we see a continued evolution of these platforms into additional missions, we see them continuing to evolve in terms of their technical capabilities and these are the areas that we are investing in as a company. Today, there's everything from remotely piloted to truly autonomous systems, and as you know, we tend to operate on the high end of that sector and we believe more missions will continue to evolve to that higher end capability as well.

Thanks, good afternoon. Kathy, I know that in the 10-Q, you mentioned the FTC disclosure regarding the rates of competition for GBSD. I'm curious about how your discussions with the customer may indicate their view on this as a potential barrier to receiving bids, which I believe is set for mid-December.

Yes, thanks, Myles. So, we did indeed receive an inquiry from the FTC, and I want to note that we've been working with the FTC and the Department of Defense to ensure our compliance with the FTC decision in order that governs our ability to enter into the transaction of acquiring Orbital ATK and we're going to continue to do so. This is just a more formal inquiry that we are responding to as part of this latest request and that's why we disclosed it in the Q. With regard to the GBSD competition, we haven't seen any changes regarding the RFP process since the final RFP was released this summer. As you know, we have established a nationwide team and it's ready to go in meeting the Air Force's technical and schedule requirements for the competition. So, we're looking forward to supporting and submitting our proposal in December, and we've had no indications that there will be any change to the acquisition strategy at this point, and both the Department and the Air Force has made statements as recently as this week about their support for the program.

Good afternoon, team. Kathy, I wanted to ask about the overall program performance. This seems to be only the second quarter in a decade where there were multiple negative performance mentions, with the last one occurring just over a year ago. I'm concerned there might be a trend, especially with the realignment and the changes you are managing. As you navigate this situation, could you share your level of confidence that no additional issues will emerge? I would appreciate any insights you can provide on the program's performance.

Yes, thanks, Carter. As I look at our program performance, it continues to be very strong. I'm particularly proud with some of the large development efforts that we've undertaken, as well as our ramp on major production programs that we are delivering on those very well, and you've seen some public statements by our customers about how pleased they are with our performance on some of those, so I won't rehash them here. But every year, we do have a small number of programs that require negative EAC adjustments based on performance out of the thousands of contracts that we're managing and sometimes the timing of those adjustments causes a particular segment's operating margin rate to fall below our expectations in that quarter. You're referring to that this quarter with AS and a little over a year ago with Mission Systems. But as you've seen over time, our performance management has remained strong and we're yielding good margins as a result of these circumstances being few and far between and fairly isolated. So, that was the case that you saw in AS this quarter. I'll also note, we had positive EAC adjustments that delivered to both expected segment operating margins and that happened in TS this quarter and is driving the increase in segment operating margin guidance at both MS and TS for the year. So, performance overall is still very strong in our company, and as a result, we're continuing to hold our guidance for the year on operating margin performance. Carter, if I could just add, I would say that in terms of the items that we called out this quarter, we were really trying to indicate what was the trend between last year's third quarter and this year's third quarter and help you understand the movement there as opposed to trying to identify the two items as having a longer impact on our performance. So, really it was a comment with respect to just the trend between Q3 '18 and Q3 '19.

Hi, good afternoon. I wanted to discuss TS, especially since we won't have visibility on it in the future. It appears that it is experiencing acceleration with high single-digit growth in the US government sector and double-digit growth internationally. With the headwinds easing in Q4, is it possible that this business, despite its previous form, could achieve mid-to-high single-digit sales growth next year if we consider its current state? I believe this might be somewhat unclear, so I'm interested in your thoughts.

So Rob, certainly, this year we have worked to reposition TS to be more competitive, that's been some good cost management, it's then rebuilding a stronger pipeline, and I'm really proud of what the team has done there and you see in the third quarter, a return to growth year-over-year and a strong operating margin. I believe that can persist and as we said, we do expect this to be a growing segment of our business in 2020. I would not go as far to say high single-digits, I would see it more in the low-to mid-single-digits, it is on a bit of a ramp and we still have some VITA burning off through the remainder of this year. So, that would be my macro outlook, and I'll hand it to Ken for any other comments he wants to make.

Yes, to provide some context for TS this quarter, we experienced a 3% growth quarter-over-quarter. You may be referencing the increased sales to the US government compared to inter-segment sales, and we've been working at TS to take the lead on certain international programs, particularly International Hail, which were previously under AS. What you are noticing is that they are now leading some of those programs, which include FMS and some projects through the US government. Overall, we are pleased with the 3% growth this quarter and anticipate continued growth in the TS sector in 2020 as part of our Defense Systems. However, we do not expect to see the growth in the high single-digit range that you mentioned; some of that relates to shifts within our segments and the prime work.

Hi, good afternoon, everyone. Ken, referring to the segment margins for 2020, you've mentioned the potential for modest margin expansion over time, considering you've streamlined a lot in recent years and may have reached a limit in that area. In 2020, you'll be comparing against this quarter's issues, which hopefully won't recur, and having Lake City out should aid the margin comparison. Mission Systems is your largest earnings contributor and highest margin segment, and I believe it may experience the fastest growth next year. I'd love to hear your insights on this since it seems to be growing slower than expected. It appears there are some opportunities for margin improvement next year. Am I underestimating the amount of development or classified work still in the pipeline, or should we anticipate flat margins as a baseline with some potential for upside?

As we evaluate the margins for 2020, I want to first mention that our full-year projections for 2019 are still aligned with our expectations based on segment margins. Each sector remains consistent apart from TS, which we anticipate will see an increase. Regarding AS, their forecast for 2019 aligns with current figures, and we don't perceive any significant impact on the portfolio from a Lake City standpoint. Looking ahead, we'll provide guidance in January. In 2020, our focus will be on enhancing portfolio performance and increasing margin rates as we have in the past. We do have some early-phase development work, particularly in IS, which includes projects in the restricted space and national security sectors. This development will contribute to our growth. I believe the Space sector will be the fastest growing in 2020. We will share more details and guidance during the January call.

Thank you. I want to follow up on the margin question from 2020, looking at the bigger picture. Ken, you mentioned that IS classification is contributing to some of the pressure. Can you point out other areas of the business that are experiencing similar development pressure? Also, is there anything different about the development work you are doing today compared to a few years ago that might be increasing upfront risk, such as contract structures? Thank you.

So, as we look at it, I don't see anything different honestly, Jon, with respect to what we're doing today. I mean, simply when we start in the early phase of a long development program, we're identifying the risks and therefore we're tending to book a lower rate as we try to burn down those risks over time. So, no change in how that's worked over the years. I think the biggest change being that we're seeing more opportunities for early development growth. And those are opportunities that we're more than willing to take on, and those will lead to those next-generation production programs that will provide that additional opportunity for margin expansion down the road. So, I don't see any change. I mean, as I think about some of the restricted programs, they may not be multi-year awards, but many of them are multi-year in periods of performance. And so we're just managing risk over that long-term period of performance and again trying to create those opportunities as we look forward.

Thank you very much. Maybe going back to Myles's question, the FTC investigation. Do you expect it to have any impact on when the GBSD decision might be made and roughly when might that be? And have you had any pressure or kind of suggestion from the customer that maybe you might consider the national team proposal that Boeing has made?

So, Cai, we do not currently expect any change to the Air Force acquisition strategy as a result of this inquiry. They do plan to award next August, so there is some time. Our proposal is due in December, and so obviously we will continue to monitor that, but right now, we do not see any impact. And in terms of the question about any pressure, we are not receiving any pressure to engage in a national team, because I would point out that we do have a, what we're calling nationwide team that includes many large and small companies across the country, who are bringing strong capability that will support our GBSD bid.

Thanks. Kathy, Ken, Todd, good afternoon. How are you?

Good. How are you, Rich?

Well, thanks.

So, an F-35 question with just a few parts to it as usual partly based on your opening remarks. So, the House and Senate fiscal 2021 mark-up has an increase in the F-35 quantities by 12 or 18 aircraft depending on which version you believe impacting I think Lot 14. So to the best you Ken as always, could you tell us what's being assumed in your 2020 guide for F-35 quantities? Now Kathy, you mentioned no disruption to your guide from the CR, but I wanted to know and maybe it's pressing you a little bit here. Is it possible that you could alter your guide depending on what happens in November when the CR expires and we potentially have a budget with possibly higher F-35 quantities, what do you think you likely captured all the all likely scenarios? And then finally, you've had enviable margins on the program, just wanting to know if that continues with the block buy? Thanks.

I’ll begin by addressing some broader questions before handing it over to Ken for specifics on quantity. As I mentioned earlier, we don’t anticipate any impact on our guidance from a short-term continuing resolution. However, if a longer-term resolution were to happen, that would prompt us to reconsider our guidance, which includes F-35 quantities. We have factored in potential changes to the F-35 quantities through the appropriations process, and I believe this has been adequately incorporated into our guidance for 2020, which we recently provided. Additionally, regarding the F-35, we remain committed to improving performance and reducing costs while being a reliable partner to Lockheed Martin. We also see growth opportunities in the program for the coming years, particularly with increased sustainment work, which I have discussed previously. There’s also growth from the Block IV modernization program, as we are developing new sensors including radar, communications, navigation, and identification systems, which will create long-term production opportunities. For lots 14 and beyond, we anticipate some production growth due to the increases in quantities from lots 12 to 14, although these factors aren’t as significant as production quantities. Nonetheless, they present additional opportunities both in the short and long term for the program. Now, I’ll turn it over to Ken for any further insights he may wish to share.

I think you really hit the nail on the head, Kathy. We wouldn't want to discuss the quantities we've projected for our 2020 outlook at this time, Rich, but we are still making progress with the program and are proud of the performance we've achieved across all sectors that are supporting the program and our customers. We have continued to increase quantities, and we will see further ramp-up. Kathy also mentioned what the longer-term outlook looks like, so I believe that sums it up well.

Erica, we have time for one more question.

Yes. You mentioned that Lake City would impact sales by about 1% next year, which suggests that you might have Lake City for half of the year since I expected the total effect to be around 2% of sales. Also, how long will the current B-2 contract last, given that it seemed to have a significant impact in the last quarter? Thanks.

Sure. Thanks, George. On Lake City, you are correct. We do have a transition from ourselves to the new provider of that service and so we will be performing on that program for at least the first half of the year for 2020. And so we will see some volume on that and the 1%, I was referring to was actually the reduction that we see to the previous outlook we had for sales, so about a 1% reduction to our previous outlook relative to Lake City. From a B-2 perspective, George, I would say that I wouldn't want to comment extensively on the period of performance other than to say that, as I mentioned in my remarks, we're well along on program. We're making good progress. We're passing milestones. And I would just point out to your question about the substantial amount of the adjustment, I would just say that in regards to the adjustments at Aerospace Systems this quarter, neither one of them was in excess of $20 million. Again, we largely highlighted those as having an impact on the trend from our Q3 margin rate of 2018 to our Q3 margin rate of 2019. So, just a little color there for you.

Okay. I'd like to turn the call over to Kathy for final remarks.

Thank you, Todd. One correction from my commentary that I want to make sure I convey is the total backlog, not total restricted backlog growth year-to-date is 22%. So again, I want to thank our team for another strong quarter of financial and operating performance. We're executing well, building on our backlog for profitable growth and strategically aligned to our customers' highest priorities. And all of this provides us an exceptional platform for sustained value creation. So, we're focused on delivering a solid finish to 2019 and a strong start to 2020 with our new organization alignment. I look forward to updating you again in January and providing detailed 2020 guidance in that call. Thank you for joining our call today.