Northrop Grumman Corp (NOC) — Q4 2019 Earnings Call Transcript

Thank you, Regina and good morning everyone. Welcome to Northrop Grumman's fourth quarter and full year 2019 conference call. We will refer to conference slides that are posted on our IR website this morning. Before we start, matters discussed on today's call including 2019 guidance and beyond reflect the company's judgment based on information available at the time of this call. They constitute forward-looking statements pursuant to Safe Harbor provisions of Federal Securities Laws. Forward-looking statements involve risks and uncertainties, which are noted in today's 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 and supplemental PowerPoint presentation. Our GAAP results reflect the mark-to-market method of accounting for our pension and other post-retirement benefits. For consistency and comparability of our results in 2020 guidance, our references to adjusted net earnings and adjusted earnings per share on today's call will refer to earnings and EPS adjusted for mark-to-market impact. These are non-GAAP measures. Our earnings release contained a reconciliation of these non-GAAP operating figures to our GAAP results. On today's call 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. Good morning, everyone. Thanks for joining us today. We had a strong fourth quarter and a good finish to the year. I want to thank the Northrop Grumman team for their continued focus on performance, innovation, and agility. It's the dedication of our employees to these priorities that enables us to meet the commitments we make to our shareholders and our customers. Turning to our results, we met our guidance for segment operating margin and exceeded our adjusted EPS and cash guidance. Our new business capture drove a 21% backlog increase in 2019, providing a strong foundation for future growth. 2019 sales grew 12% to $33.8 billion, benefiting from a full year of Innovation Systems, as well as continued growth at Aerospace Systems and Mission Systems. Full-year sales reflect double-digit growth on the F-35 program and growth in restricted activities at all four sectors. Restricted work accounted for more than a quarter of 2019 sales, a double-digit increase over 2018. Our segment margin rate for the year increased to 11.6%. Strong program performance and cost synergies more than offset margin pressure from early phase development work. Adjusted earnings per share also exceeded guidance at $21.21 for the year. Turning to cash, I want to congratulate the team on a very strong year. Fourth quarter cash from operations totaled $2.5 billion, and free cash flow was approximately $2 billion. For the full year, cash from operations increased to $4.3 billion and free cash flow was more than $3 billion, exceeding the top of our guidance range. Strong cash enabled effective capital deployment. We invested $1.3 billion in our businesses through capital expenditures, strengthened our balance sheet by retiring $500 million of debt and returned $1.6 billion to shareholders through dividends and share repurchases. We increased our quarterly dividend by 10% last May and reduced our weighted average share count by approximately 3%. Business capture was a key highlight of 2019 performance. Net awards totaled more than $45 billion or 1.3 times sales, and we delivered double-digit backlog growth at all four sectors. At the macro level, defense spending continues to be a national priority. The fiscal year 2020 investment accounts are up 3% to $251 billion. This increase shows the emphasis being placed on modernization, as called for in the national defense strategy. The development of capabilities to counter peer adversaries continues to be a priority. Our customers are increasingly focused on rapidly evolving multi-domain peer threats in areas like space, hypersonics, and missile defense. Our growing share of restricted work demonstrates that our customers are turning to Northrop Grumman for these capabilities. In 2019, restricted awards totaled nearly $11 billion, with approximately $7 billion for restricted space. In addition to restricted awards, we received several multi-billion-dollar awards for large legacy franchise programs like F-35 and E2D. We also received awards to transition development programs like Triton, GATOR, IBCS, and Kirkum to work full-rate production. We are also pursuing and winning the early phase development work that is the seed for the next generation of franchise programs. On January 1st of this year, we began operating in a new sector structure to further align our unique capabilities in space, missile, counter hypersonics, cyber, and stealth. It's the next logical step after the acquisition of Orbital ATK to enable the capture of revenue synergy and drive profitable growth. In the new structure, we're bringing together and integrating the relevant capabilities to solve many of the nation's toughest problems. We also introduced our new defining profitable brand, to reinforce the value we're providing through performance, agility, and innovation. Discovery and innovation are at the heart of what we do. We show our customers what is possible, and then deliver through performance frameworks and cultures that balance agility and affordability with quality and safety. We're investing in innovative concepts and technologies that align with the priorities of our customers. I'm pleased with the progress we are making. And I'll share four examples of demonstrations we completed in the fourth quarter, each of which offers innovation to support our customer's vision for future operations. First, as we work closely with the Department on the joint all-domain command and control effort, we are leveraging our experience with the Army's IBCS. We recently conducted a successful test using air- and ground-based sensors against multiple fast-moving airborne targets. We are using agile development methods to integrate sensors and the sectors to rapidly and more precisely address new complex threats. Second, we participated in the first advanced battle management systems demonstration using feeds from multiple domains to find, track, and destroy cruise missiles. Here we integrated the communication suite necessary to connect the F-22 and the F-35 platform enabling this integrated battle management solution. A third example is our development and integration of a world record 150-kilowatt class high-energy laser weapon system on board the USS Portland. The laser system is undergoing final verification testing before deploying later this year, at which time the Navy will gain experience with directed energy systems in support of future fleet operations. And lastly, we successfully flight tested a rapid prototype conventionally configured hypersonic ground-launched ballistic missile in response to an urgent capability request from the DoD. The launch vehicle met a highly aggressive eight-month design, integration, and launch schedule achieving flawless flight results. These accomplishments are the result of our investments to address our customers' emerging requirements with the capability they require. These investments are solid 2019 financial results and successful business capture provided a strong foundation for continued growth and sustained performance. Our 2020 guidance called for sales to grow to between $35.3 billion and $35.8 billion with a segment operating margin rate of 11.3% to 11.5%. We expect 2020 adjusted EPS will range between $22.75 and $23.15. After capital spending of approximately $1.35 billion, we expect free cash flow of $3.15 billion to $3.45 billion. 2020 guidance contemplates that we are selected for the next phase of the GBSD program in accordance with the Air Force's current acquisition timeline, which calls for an award in August. We submitted our proposal in December, and we are in active discussions with the Air Force as they work through this selection process. We are continuing to perform well on the technology maturation and risk reduction phase of the contract. Together with our nationwide team, we are investing in technologies and facilities necessary to be ready for day one of EMD. We anticipate the EMD phase of this multi-billion-dollar decade-long recapitalization of the nation's ICBM capability will be accretive to 2020 sales and slightly dilutive to the operating margin rate, as well as free cash flow due to higher capital expenditures. Ken will review the detailed guidance for the sectors, but I wanted to provide some context around 2020 sector performance. First, sector guidance under the new structure is consistent with the trends we've been talking about in our businesses. We expect space systems will be our fastest growing sector. Beyond 2020, in addition to GBSD, we have large opportunities in Space 3 architecture, hypersonics, intermediate range ballistic missiles, and national safe launch. In civil space, we're well aligned for NASA's Artemis program. For Aeronautics Systems, we have resident technology and integration expertise in critical domains like stealth and autonomy to support growth over the long-term. On an apples-to-apples basis, the businesses comprising aeronautics grew backlog 24% in 2019, which provides a solid foundation for sustained growth. For Mission Systems, competitive opportunities in airborne and ground-based radar systems create an opportunity for enhanced growth. In addition, Mission Systems' advanced capabilities and domain expertise are key competitive differentiators that we leverage across the entire company as we pursue new business. Mission Systems is expected to continue to have attractive top-line growth coupled with strong margin rates. And for Defense Systems, over the long-term, key growth drivers include high-speed weaponry programs like AARGM-ER and our C2 and cross-domain C2 programs. We expect stable to growing revenue from legacy technology services businesses, as they focus on the defense and intelligence market continue to generate results. So, in summary, we have strong performance in 2019 and we expect continued top-line growth and sustained performance in 2020 and beyond. We also expect continued strong cash generation that will support our capital deployment strategy and create value for our shareholders and customers. I'll turn the call over to Ken now for a more detailed discussion of our financial results, guidance, and trends.

Thanks, Kathy, and good morning, everyone. I also want to congratulate the team on strong performance this year. I'll spend a few minutes on 2019 results and discuss our 2020 guidance in more detail. We will be providing guidance in our new sector structure with some broad year-over-year trend information. Our first quarter earnings release in April will include a schedule that recasts prior period results for comparison. Referring to slides five and six in our PowerPoint deck, I'll turn to sector results. Aerospace System sales rose 10% for the quarter and 6% for the year, largely due to higher levels of restricted activity. In addition, sales were higher in both periods for all three business areas. Restricted activities, F-35 production increases, and higher E-2D volume were the growth drivers at manned aircraft. Next-gen OPIR activities were a growth driver at space; autonomous systems reflected higher volume across several programs, including Global Hawk and Triton. Aerospace Systems operating income increased by 9% in the quarter and 2% for the full year. Fourth-quarter operating margin rate was comparable to last year. The 2019 operating margin rate of 10.3% reflects lower net favorable EAC adjustments related to several programs nearing completion. Turning to innovation systems, fourth-quarter sales rose 9% and full-year sales increased 10% on a pro-forma basis. Sales were higher at all three business areas for both periods. In space, this was driven by higher volume for national security satellite systems. At flight systems, fourth-quarter growth reflects higher volume on propulsion systems, and full-year results reflect increased volume on aerostructures and launch vehicles. Higher volume on tactical missiles and subsystems, including GMLRS and our new AARGM-ER program, drove higher defense sales in both periods. Fourth-quarter operating income increased 20% due to improved performance at flight systems and space systems. For the full year, operating income totaled $671 million or an 11% margin rate, which exceeded our guidance. Turning to mission systems, fourth-quarter and full-year sales rose 6% and 5%, respectively. Like Aerospace Systems and Innovation Systems, all three business areas within mission systems had higher sales in both periods. At advanced capabilities, higher volume for restricted activities and marine systems drove growth in both periods. The fourth quarter also benefited from higher volume on Poland's IBCS as that program ramped up. Growth in cyber and ISR was driven by higher volume for space and restricted programs. In sensors and processing, fourth-quarter growth reflects higher volume for airborne radar programs. For the full year, sensors and processing sales growth is being driven by higher volume for airborne radars and new restricted programs. Mission systems' fourth-quarter operating income rose 13%, and the operating margin rate increased in 90 basis points to 14%. For the full year, operating income rose 8%, and operating margin rate increased 40 basis points to 13.4%, exceeding our guidance. Mission systems' margin rate reflects improved performance on advanced capabilities and sensors and processing programs, as well as a $20 million gain on the sale of property. Technology services fourth-quarter and full-year 2019 sales were 4% lower as expected. Fourth-quarter 2018 sales included an approximately $30 million favorable EAC adjustment for completion of an IT outsourcing contract. The 2019 year-over-year revenue comparison was negatively impacted by this adjustment and completion of the GRDC and KC10 programs, partially offset by growth in other programs. Technology services' fourth-quarter operating income declined 8%, and the operating margin rate was 10.4%. Again, the quarter-over-quarter comparison reflects the favorable Q4 2018 impacted by items related to the closeout of the state IT outsourcing contract. For 2019, operating income increased 3% and operating margin rates increased 80 basis points to 11.1%, exceeding our high 10% guidance. At the total company level, 2019 segment operating income increased 13% to $3.9 billion, and the segment operating margin rate was 11.6% versus our mid-11% guidance. Total operating income was approximately $4 billion with an operating margin rate of 11.7%. This was largely due to unallocated corporate expense, which came in lower than we expected due to an $89 million benefit for the resolution of a cost claim accounting matter, which was not contemplated in our guidance. A couple of comments on our mark-to-market adjustment: our discount rate declined 92 basis points to 3.39%, which drove a $4 billion increase in our pension liability. We also changed our assumptions to reflect updated Society of Actuaries’ mortality data, as well as an updated evaluation of our plan population. This increased our pension liability by $800 million. These increases were partially offset by plan asset returns that exceeded assumptions, increasing assets by approximately $3 billion. So that's how we get to the $1.8 billion pretax expense. Our cash prepayment credit is approximately $1.6 billion as of January 1st of this year. Turning to cash, as is our typical pattern, we had a strong fourth quarter. For the year, cash from operations was approximately $4.3 billion, and after capital expenditures of about $1.25 billion, our free cash flow grew 18% to more than $3 billion, exceeding our guidance. Now, looking ahead to 2020, I'll mention that our new sector and reporting structure is laid out on Slide 11 of the PowerPoint deck. I'll refer you to a discussion of sector guidance on slide 12. At Aerospace Systems, we expect solid mid-single-digit sales growth to the mid to high $11 billion range with a low to mid 10% margin rate, stable versus 2019. About half of the 2020 sales growth is expected from restricted programs in manned aircraft. We also expect mid-single-digit growth on the F-35 program. For defense systems, we expect sales to be comparable to 2019 in the mid-$7 billion range, as Lake City transition offsets growth in other areas of the business. We expect an operating margin rate in the mid-10% range up slightly from 2019. At the new mission system sector, we expect solid mid-single-digit sales growth to the high $9 billion range with a low 14% margin rate. Sales growth is supported by F-35 activities and production ramps and GATOR, Kirkum, SABR as well as restricted development work. The 2020 margin rate expectation at mission systems is down slightly due to the $20 million gain on the property sale in 2019 and the changing mix that reflects a growing percentage of development work. At Space Systems, we expect low double-digit sales growth to the low $8 billion range with a low to mid 10% margin rate. This represents continued strong margin rate performance. I would note that Space System sales and margin rate guidance contemplate more early-phase development work, including GBSD, which is expected to be accretive to sales but slightly dilutive to the margin rate of the existing portfolio. Our sector guidance rolls up to 2020 sales of $35.3 billion to $35.8 billion. And I would note that under the new structure, we expect inter-segment eliminations to decline to about $1.8 billion. I would point out that first quarter 2020 sales are expected to be a bit less than 25% of full-year sales, as Mission Systems and Space Systems revenue is weighted towards the second half of the year. We expect a segment operating margin rate of 11.3% to 11.5%. We expect 2020's total operating margin rate will range between 10.8% and 11%, reflecting $390 million for the operating portion of the net FAS/CAS pension benefit and unallocated corporate expense of approximately $565 million, which includes $315 million non-cash and tangible asset amortization and PP&E step-up depreciation and $250 million of other estimated unallocated items. Moving to pension, slide 13 provides our 2020 pension assumptions. These assumptions exclude any 2020 mark-to-market impact. Slide 14 summarizes our pension estimates for years 2020 through 2022, and slide 15 summarizes sensitivities to changes to our 2020 assumptions. Our guidance systems include $500 million of interest expense, de minimis interest income, and an effective tax rate of approximately 16.5%. I'll remind you that our 2019 reported effective tax rate reflected the mark-to-market expense. So, please don't use that as a baseline as you think about our 2020 effective tax rate. Based on all that, we expect adjusted earnings per share will increase to a range of $22.75 to $23.15, or about 8% growth at the midpoint. EPS growth reflects higher sales and higher segment operating income, as well as pension benefit, partially offset by higher corporate unallocated expense and a higher tax rate. I'd also note EPS guidance is based on 168 million weighted average shares outstanding, a reduction from 2019 of about 1% for 2020. After capital expenditures of approximately $1.35 billion, we expect free cash flow will range between $3.15 billion and $3.45 billion, or about 9% growth at the midpoint. Capital expenditures include the required early capital investment for GBSD. We expect the cash flows will continue to be heavily weighted to the second half of the year. I'll also mention that our cash continues to be driven significantly by operations with net pension defined as CAS less funding, expected to be about 11% at the midpoint of implied 2020 cash from operations. Our capital deployment strategy continues to call for investing in our businesses, strengthening the balance sheet, and returning cash to shareholders through share repurchases and a competitive dividend. In addition, we do have $1 billion of debt maturing this fall, which we are currently planning to retire. In summary, we expect to continue strong value creation through a combination of growth, performance, and robust cash generation, as well as thoughtful capital allocation. I think we're ready for Q&A. Todd?

Regina, please open the line for Q&A.

Okay, thanks very much. Good morning. So, I just wanted to ask maybe one question Ken about working capital. Like very strong performance in the quarter and whether you expect working capital to grow in 2020. It looks like it was maybe even down a hair in 2019. And whether you think you can keep it flat or not. And then secondly, you mentioned the $1.6 billion CAS credit, and it looked like over the next three years that pretty much gets eaten up. And so, should we assume in the out years beyond your forecast that CAS contributions are roughly in line?

Sure. Thanks, Seth. I'll start with the working capital question and then head to pension. I would say from a working capital perspective, we did have better than expected performance in 2019. We've been really focused on working capital and trying to maximize the benefit there. And we did see that that performance exceeded our expectations in 2019. So, we're pleased about that. As we look at our ability to generate cash in 2020. We're certainly looking at the growth of the company, the strong margin profile, delivering the ability to convert that margin into cash as the primary driver of the cash flow growth. But certainly, managing working capital as efficiently as possible will be a part of that as well. So, I think that, from a working capital perspective, it's something where it's not going to be a headwind. We don't necessarily expect the continued tailwind that we had in 2019. But as we look at 2020, I think that strong growth and converting our margins into cash are probably the biggest driver of cash. And again, strong performance by the team in 2019 and we look forward to maximizing again in 2020. From a pension perspective, you're correct, Seth. The current assumptions on pension would result in the prepayment credit getting burned down in 2022. That would therefore result in CAS and funding being pretty similar as we look beyond 2022. And I would just comment that, as we look at the pension assumptions, we've laid out for 2021 and 2022. We've got a scenario where generally the cash - net pension cash, CAS less funding is relatively in a box, I would say. There's not a lot worse it can get. You'll notice that in 2022 CAS is about 150-160 greater than funding. That would say that as we look at our performance, it is kind of in a box. And on the opportunity side, if we can outperform or other assumptions change, then we have the ability to drive down that 22 funding that is required under the current assumptions.

Operator, please clear the line with Ron. It's been static.

Thank you very much. Kathy, you mentioned restricted - the restricted portfolio is about a quarter of the business and it grew double-digits in 2019 so you're clearly taking share. How long do you think that's sustainable? And what are parts of the business that are maybe underperforming your expectations and do they expect to pick up?

Thanks, Sheila. I did mention restricted being our key growth area, both in our sales in 2019, as well as the awards that we received with $11 billion awards and $7 billion of that coming in restricted states. So, we clearly still see space being a growth driver for us into the future. And we also had noted in our third quarter call that we had received $1.3 billion in awards in hypersonics, and we continue to see that as a growth area for the business as well. Additionally, I mentioned in my comments today, a demonstration that we conducted in the fourth quarter in hypersonic missiles as well. So, those are a couple of the areas that I would notice as key growth drivers going forward in our restricted portfolio. As I look across the business, we clearly have headwinds as we exit the Lake City contract. This year, we have noted about $300 million of headwinds in 2020. We basically now have exited the small caliber business. And so that's a headwind that will largely be behind us as we get past 2020. As we look at Aerospace, Mission Systems, and Space, we see strong growth expected in each of those sectors. Aeronautics is aiming for mid to high-single-digit space to low-double-digits, while defense systems are facing the Lake City headwinds, expecting a stable growth profile, but really not looking at any part of the portfolio as underperforming with those headwinds, with the exception of small caliber.

Great, thank you.

Yes. Good morning, Kathy and Ken. Kathy, just kind of going back to the legacy innovation systems segment. I know it's now obviously space, but we've been tracking the kind of the synergy number that you had laid out previously. And then also the revenue synergy, I think was something that originally wasn't a number that got quoted, but maybe just talk about some of the opportunities you're seeing there and how that's progressing? Thanks.

We'll do. Thanks, Peter. So, in cost synergy, I noted in my comments that we exceeded our cost synergy target in 2019. That helped us to generate a higher than expected segment operating margin rate. So that area of commitment is certainly one, where we feel we did what we said we were going to do and even had some opportunity to outperform in driving costs out of the business. And that not only generates near-term margin but it also helps us to position the business more competitively to win in the future, which gets to the part of your question around revenue synergy. We have been realizing the revenue synergy ahead of the estimates we had in by plan for the Orbital ATK business. We see that continuing as we look into the future. I had noted previously that space and missiles are the two areas where we are seeing the greatest synergy, and I gave a few examples in each including AARGM-ER which I talked about again today and the opportunity that we see there not just domestically but also internationally. We still see those two areas - space and missile seeing the ones that will be the key drivers of revenue synergy over the plan.

Thanks very much. Good morning.

Good morning, Rob.

Ken, quick question for you on capital deployment. You commented that you intend to pay off a billion dollars of debt later this year. I certainly could walk us through the thinking on that, because obviously, with interest rates being very low, you've already got a strong balance sheet. Would it not make sense to keep the debt, refinance the debt, and perhaps return more cash to shareholders?

Sure. Let me walk through that. As we look at 2020 and our capital deployment plans, we continue to think about it in the same way we have historically, and that is invest in the business, which we're doing in 2020, including what we expect to invest in GBSD, as Kathy talked about. Certainly, paying a competitive dividend. And then also managing the balance sheet and share repurchase. We've got an amount of repurchase that we're planning for 2020 and with that, behind us, we've got the cash to pay off the debt. As we look forward, there's more debt that's coming due and we'll certainly evaluate whether or not we continue to delever by paying off debt, or if we just delever through growing our EBITDA. I wouldn't necessarily assume that because we're paying off the 2020 debt that means that we're going to continue to pay off more debt; we've got optionality and obviously, we'll continue to evaluate what the best use of cash is, as we look at all those options for capital deployment. But we're in a good position with our strong cash flow being able to deploy all of those avenues of capital deployment.

Thanks, good morning.

Good morning, David.

I want to ask about CapEx. It sounds like GBSD is adding a bit to that this year, maybe 50 basis points as a percent of sales. I think you previously talked about CapEx stepping down in 2021 to like 2.5% of sales. How does GBSD kind of impact that, Ken? Thanks.

Sure, let me start on that one. From a CapEx perspective, we were at 3.7% of revenue in 2019. We had talked about the profile that we were expecting, as we were looking forward into 2020 and 2021. For 2020, we have updated our outlook to include GBSD that's for CapEx as well as revenue, certainly at the high end of the guidance. That was not included in the numbers that we talked about last fall. So, the GBSD is now included; we're looking at CapEx of about $1.35 billion for 2020 and probably $1.35 billion for 2021. Then continuing to decrease the percentage of sales beyond that. I'd also note that, as we look at 2020, we do have the CapEx in for GBSD and only maybe $250 million or so of sales given the award, expected to come in August.

Hi, good morning.

Good morning.

Kathy, this one's I thought I'd ask you about open architecture, which I think you've discussed in the past. What I was wondering if you might walk through how you're positioning Northrop to benefit from these increased emphases on that design paradigm. And, do you think you can leverage that to drive market share gains at Mission Systems over the long-term?

Thanks for the question. I'm glad that you picked up on that, Rob, because we have been talking about it for a while, particularly as we discussed what we have done on IBCS as a program, but I've also talked about that being more of an architecture. We are now beginning to demonstrate that to the Department of Defense as we participated in demos in the fourth quarter, at least two of them. The one I noted around IBCS, for joint all domain command and control, as well as the one that we did to connect F-22 and F-35 in communications to enable the battle command system. So, as we think about what the future holds, the ability to have an architecture that rapidly integrates both sensors and the sectors, and allows the department to tie these systems that have been built in more of a stovepipe fashion to communicate and to share information will be critical to their vision for future operations. We are able to rapidly do this because we have been working on these open architectures for a number of years. We have ready-to-go solutions that enable this demonstration of capability.

Good morning, everyone. Just thinking about GBSD being a major change, I think, from the 3Q outlook in the fall. I think you talked about mid-single-digit sales and flat margin. Your GBSD is less than 1% of sales but second largest now down in 2020. Can you just sort of put all those pieces together for us and add a little more color as to what's going on with 2020 versus what you said in the fall and then really with the opportunity to accelerate on simply GBSD going forward? Thank you.

Sure, Jon. Let me start on that one. I would say that as we look at 2020, based on the guidance that we've laid out, you call it 4.5% to 6% or so growth given the range. Again, that does include GBSD, proceeding as expected in the August timeframe. From a margin perspective, I would say that as we think about it, in the new sector structure, again aeronautics would be relatively comparable to 2019. Space Systems would be down a little bit, some of that is GBSD and some of that is just other mix changes as it continues to win new business and take on additional development work. And as we talked about, a low double-digit growth rate there at Space Systems. In MS, we did have the property gain in 2019. So, we see that as having a little bit of an impact on margins at MS. We mentioned that would result in a little bit of margin reduction into 2020 on a comparative basis. At the new Defense Systems, we are projecting that margin will be slightly up as that business performs well. So, we always incentivize the team to perform and to outperform our peers and we look forward to a 2020 where the team will hopefully continue to step up to the challenge as I've seen them do and drive the best margin outcome that we can get to.

And Jon, I believe the second part of your question was around the possibility of acceleration of award on GBSD. So, let me just comment briefly on that. As you know, the Air Force has made it clear that GBSD needs to be in fielding in 2029 and that the time to do so is short. It's essential that we get started on the critical requirement. So, we've been investing in the people and facilities that we need to ensure that our team is ready to start upon award and that we could support for an accelerated award schedule if they are able to do so.

Terrific. Thank you very much. So, could you update us on your strategy and hypersonic? I think at one point you talked about focusing predominantly on propulsion. Are you also going for a major push in the systems integration role and then maybe update us on the outlook for counter hypersonics? Thanks.

Yes. So, in hypersonics, we do have a dual path strategy, the first being to support all of the primes in propulsion. We've talked openly about the relationship that we have with both Lockheed and Raytheon in that regard. We also are a system integrator. The demonstration that I mentioned in my comments earlier in the call was an example of where we were the integrator for that demonstrator. So, we do see ourselves following both paths. We want to be a good provider to the primes in propulsion, and that means making investments that support multiple technology paths. But at the same time, we do have the capability to prime efforts and be an integrator for certain types of systems. I also will talk briefly about counter hypersonics and there we see our expertise in space and the capabilities that we have in space being a key enabler to the future counter hypersonic mission sets. We've looked at the space business that we are assembling and view ourselves as both a capable prime and payload provider in that space. So again, a similar strategy that we can be both a merchant supplier to other primes with payloads of importance in that space but also the ability to integrate systems and provide end-to-end capability ourselves.

Thank you. Good morning. If I go back a few years and look at autonomous systems, my understanding was that a big advantage that Northrop Grumman had was on its common operating systems that they could be applied to multiple programs, say in many different classes of UAVs. But today, it appears that the dominant autonomous programs are still really built off of Hale Systems, Global Hawk variants, Triton. So, is there a broader platform for growth in autonomous systems that we're yet to see? Because either they're in early stage development or restricted, or should we think of this as still likely to grow off of these large Hale Systems in the future?

So, Doug, we certainly do see growth opportunity in Hale systems. I would also point to examples that we're working in the medium altitude space programs like Fire Scout. We also have areas of new technology developments that will allow us to scale the system down even further. But I would suggest that the high altitude that you hear a speak about in the context of surveillance is the best coverage that can be provided. It's quite economical for these high-altitude systems, at least in the surveillance mission to fly in high range. It all depends on the mission requirements, and that's what drives the system design. But we do have system architectures that allow us to scale as the mission requires.

Good morning. Hopefully, this connection is a little better.

That is better, Ron.

Yeah. Great. Cool. Thanks. So, Kathy, just a big picture question for you. You've been in the rollout for a little over a year. When you think about where Northrop Grumman is now? Is it where you wanted to be? If it's not, what are some of the challenges you see for you over the next couple of years?

Well, thanks for the question, Ron. I appreciate the opportunity to talk about both my macro assessment and outlook. I am pleased with where we are. One of my priorities when I stepped into the role was to orient the team toward several high-growth campaigns and align our investments there. We have aligned the organization to execute that strategy. As I look to the evidence of success, I point to the backlog growth that we saw in 2019. I would also say that being ahead on our revenue synergy projections came from a lot of hard work from the team on a successful Orbital ATK integration, but also very rapidly integrating them into our strategy for these mission campaigns and the growth that we see there. I've also focused the team on performance and agility. We continue to perform well in our program even as we take on a number of new development efforts and scale production, which are difficult challenges that come with the opportunity of long-term, sustained growth as well as strong operating margins. I'm pleased with what the team is doing there because we're laying the foundation not only for our near-term future but for our long-term future. We realize the cost synergy from a successful Orbital ATK integration. While that's generating some short-term margin enhancement, the opportunity is that we're more competitive over the long term with better rates. Overall, I feel that we've over the last year enhanced our competitiveness. The demonstrations that I talked about were put together very rapidly as a result of making smart technology investments, understanding the missions that would be needed by our customers under the national defense strategy, and quickly aligning our portfolio to bring forward solutions that meet those needs. Overall, I feel good about where we are. I think we're deploying our capital in a way that not only invests in the business but returns a lot of the cash we're generating to shareholders and positions us well for future optionality.

Thanks. Good morning, I had two questions that relate to margins. The first one is on R&D; it looks like it was a couple hundred million dollars or 25%. Just curious what that looks like for 2020 in which business absorbs that. And then on EACs, it looks particularly low, but the margins actually were pretty in line, despite that low EAC contribution. So, I'm curious, did you change the booking rates underlying on a systematic basis similar to kind of what you did in 2015 to reduce some of the volatility? Thanks.

Myles, let me take those questions at least, to start. From an R&D perspective, the biggest impact, the additional R&D was the full-year of NGIS. You remember we closed that acquisition in June of 2018. We only had a little more than six months of their R&D. Certainly, it is a strong investor in technology and R&D to drive that future growth. So that's the biggest impact. I would say this is a company that's always invested in R&D. Certainly, as we look at our growth here and our ability to grow over the long-term, I think the fact that we continue to invest in R&D through the downturn is one of the strengths that drives us today, and we will continue to do that. So, I'm not going to put a number on it for 2020, but continued strong investment in technology that will drive the growth that Kathy's been talking about is certainly where we're thinking about it. From your question on the EAC perspectives, I would just say that, look, a lot of the EAC adjustments are about timing. As we think about 2019, and strong margin performance, some of that did come out of some of the more mature programs, where we have a bit of a stronger baseline margin rate rather than seeing it come through adjusted or EAC adjustments. That’s really how we think about the business: what the programs can deliver and how the programs can perform rather than an EAC adjustment. As we look at 2020 and the programs and the sectors, we see continued strong performance, and that's how we generate that segment margin rate that we talked about in our guidance.

And Myles, as we look at net EAC adjustments in recent years, we had a high watermark in 2018, with over $0.5 billion of net favorable adjustments; this year at $480 million, still very strong. I look at our program performance, and just one indicator of that is our net EAC adjustments and feel that we've been doing quite well over the last couple of years.

Thank you. Good morning, everybody.

Good morning.

Kathy, could you talk about E-2 for a minute? Just give us an update on where you are in terms of total program size and margins. And then can you talk about growth in the program as you portion it out between domestic and international opportunities through both new potential customers and upgrades? Thank you.

Absolutely. As we look at the program, both domestically and internationally, we see growth. We are delivering more E-2Ds to the Navy; we also have the Japan orders that we booked in 2019, which will be deliveries over the next several years. I'll ask Ken to give you some more of the specifics on the financials, both revenue and margin rate expectations.

Hunter, I would just say that as we look at our awards and backlog in 2019, E-2D contributed over $5 billion of awards as we look at both the Navy as well as Japan orders. It's a solid contributor to revenue as well, around $1.5 billion in sales and strong margins. So really a solid program for us and one that we see as contributing nicely to our growth at Aeronautics in 2020 as well.

Hey, good morning, everyone.

Good morning.

So a lot of things below the top line matter; profits and returns on capital matter, obviously. But when we speak to investors, there's still just a lot of focus on the top line, because there seems to be a differentiation in the programs you've won and what you've put in the backlog. And so, we hear two camps: one is, yes, they have the programs, but it's very diversified and there are always moving pieces, so they're just going to grow the top line 5% forever. And the second camp is, no, you have to be patient and all of the large new wins start to ramp 2021 and beyond, and the growth rates are going to accelerate significantly. So can you speak to which of those it is, and does 5% for 2020 meet the criteria of outpacing your end market or does that definition that you’ve provided in the past mean something much faster?

As we think about outpacing the end market, the investment accounts in the 2020 budgets are up 3%, and we're projecting 5% growth. So, in the near-term, you could suggest that is outgrowing. But as you and I both know, it takes a while for backlog in these long cycle businesses to manifest in sales. That goes to the premise that it takes a while for the awards that we've booked in 2019 to come into sales over a multiyear period and therefore, is derisking growth in those out years and creating the opportunity for acceleration of growth. To answer your question more explicitly: in our portfolio, we have opportunities like GBSD, which, if awarded to us, creates a sizable ramp over the next several years. We also have talked about space and see space being one of the fastest-growing elements of the budget. But those awards are not yet manifesting themselves in sales. We have other rewards that we anticipate this year that create opportunities for outpaced growth. There is indeed opportunity for us to continue to outgrow the budget growth over the long-term, which requires us to continue to win business and execute successfully.

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

Very good. Thank you, everyone, for joining us on today's call. I want to conclude by just reiterating my thanks to the team for an outstanding 2019. We're positioned well as we start the year-end 2020. With the backlog growth that we've experienced, strong performance, and our commitment to continued thoughtful capital deployment that allows us to grow this business for the long term for our shareholders. Thank you all for being with us today. We look forward to talking to you after our first quarter.