U.S. Markets closed

Edited Transcript of NOC earnings conference call or presentation 24-Apr-19 4:00pm GMT

Q1 2019 Northrop Grumman Corp Earnings Call

LOS ANGELES Apr 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Northrop Grumman Corp earnings conference call or presentation Wednesday, April 24, 2019 at 4:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Kathy J. Warden

Northrop Grumman Corporation - CEO, President & Director

* Kenneth L. Bedingfield

Northrop Grumman Corporation - Corporate VP & CFO

* Stephen C. Movius

Northrop Grumman Corporation - Treasurer & Corporate VP of IR

================================================================================

Conference Call Participants

================================================================================

* Cai von Rumohr

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Carter Copeland

Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense

* David Egon Strauss

Barclays Bank PLC, Research Division - Research Analyst

* George D. Shapiro

Shapiro Research - CEO and Managing Partner

* Hunter Kent Keay

Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense

* Jonathan Phaff Raviv

Citigroup Inc, Research Division - VP

* Myles Alexander Walton

UBS Investment Bank, Research Division - Research Analyst

* Peter J. Arment

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Rajeev Lalwani

Morgan Stanley, Research Division - Executive Director

* Robert Alan Stallard

Vertical Research Partners, LLC - Partner

* Robert Michael Spingarn

Crédit Suisse AG, Research Division - Aerospace and Defense Analyst

* Ronald Jay Epstein

BofA Merrill Lynch, Research Division - Industry Analyst

* Seth Michael Seifman

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

* Sheila Karin Kahyaoglu

Jefferies LLC, Research Division - Equity Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, ladies and gentlemen, and welcome to Northrop Grumman's First Quarter 2019 Conference Call. Today's call is being recorded. My name is Shelby, and I will be your operator today. (Operator Instructions)

I would now like to turn the call over to your host, Mr. Steve Movius, Treasurer and Vice President, Investor Relations. Mr. Movius, please proceed.

--------------------------------------------------------------------------------

Stephen C. Movius, Northrop Grumman Corporation - Treasurer & Corporate VP of IR [2]

--------------------------------------------------------------------------------

Thanks, Shelby, and welcome to Northrop Grumman's First Quarter 2019 Conference Call.

Before we start, please understand that matters discussed on today's call constitute forward-looking statements pursuant to safe harbor provisions of federal securities laws. Forward-looking statements involve risks and uncertainties, which are noted in today's press release and our SEC filings. These risks and uncertainties may cause actual company results to differ materially.

Matters discussed on today's call will also include non-GAAP financial measures that are reconciled in our earnings release and supplemental PowerPoint presentation. I'd also note a couple of additions to the earnings release. Schedule 4 provides backlog trend information by sector, and Schedule 5 provides supplemental per share information to help the quarter-over-quarter comparison of pension and purchased intangible impacts.

On the call today are Kathy Warden, our CEO and President; and Ken Bedingfield, our CFO. At this time, I'd like to turn the call over to Kathy.

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [3]

--------------------------------------------------------------------------------

Thank you, Steve, and hello, everyone. Thanks for joining us today. First quarter results represent a good start to the year as the Northrop Grumman team continues to deliver excellent outcomes for our customers and our shareholders. I want to thank our employees for their relentless focus on performance, agility and profitable growth.

Top line growth, strong segment performance as well as continued effective capital deployment drove a 6% increase in first quarter earnings per share. As a result of first quarter performance and our full year expectation, we are affirming sales guidance of approximately $34 billion and raising our 2019 EPS guidance.

First quarter sales grew 22%, reflecting the addition of Innovation Systems and 7% top line growth at Aerospace Systems. Strong performance at all 4 sectors generated a 27% increase in segment operating income and a 50 basis point increase in our segment margin rates. The strong margin rates at all 4 sectors also reflect the cost synergies we are achieving through the Orbital ATK integration, which is benefiting all the sectors. The realignment of the TS business areas continues to improve their cost structure and competitiveness as reflected in this quarter's margin rate and our TS guidance increase for the full year.

As is our typical quarterly pattern, we were a user of cash in the first quarter. We continue to expect 2019 free cash flow of $2.6 billion to $3 billion. Regarding capital deployment, our strategy continues to call for value creation through thoughtful allocation across our priorities of investing in our business, managing the balance sheet and distributing cash to shareholders through our competitive dividend and share repurchases.

Looking ahead, we're on a solid growth trajectory supported by first quarter net awards of $12.3 billion or about 1.5x book-to-bill ratio. Total backlog increased 7% to $57.3 billion, reflecting 16% growth at Mission Systems and 6% increase at Aerospace Systems. Total backlog is up 35% when compared to March 31, 2018. That comparison reflects an increase of more than 30% at Mission Systems and 11% at Aerospace Systems.

At Aerospace Systems, Q1 net awards totaled $5.4 billion. In Space, we received a $3.2 billion restricted award. In Manned Aircraft, we finalized a $740 million contract for the U.S. Navy and Kuwaiti F/A-18s, and we were awarded $535 million for the F-35. And shortly after the end of the quarter, we signed a multibillion-dollar production contract for 24 U.S. Navy E-2D Advanced Hawkeyes. The new multi-year contract includes an option for Japan's purchase of 9 additional E-2Ds. Japan has also approved the additional E-2Ds in their long-term budget, and we expect that we will be under contract by the end of 2019.

At Innovation Systems, the Navy awarded us a sole-source $323 million EMD contract for AARGM-ER, an extended range version of our current missile. AARGM-ER will initially be fielded on F/A-18 Super Hornets and Growlers. It will also be the first supersonic long-range missile to be integrated on to the F-35, and it is expected to be the strike weapon of choice for both the Navy and the Air Force.

The President's FY 2020 budget includes a request for the Air Force variant of AARGM-ER and it's called the Stand in Attack Weapon. AARGM-ER is an early example of revenue synergy. Innovation Systems leads the effort with 2 of our other sectors contributing to the program. This draws from the full breadth of our technologies and capabilities for delivering high-speed missile systems and demonstrates our ability to work seamlessly across the company to provide needed capabilities to our customers. We expect follow-on production after EMD will be in the multibillion-dollar range.

We are currently performing on a number of other high-speed and hypersonic missile programs at the prime contractor and subcontractor levels, which are contributing to IS backlog and sales growth.

Turning to Mission Systems. Net awards totaled $5 billion in the quarter. In airborne radar, MS was awarded a contract to equip 5 U.K. Wedgetail airborne early warning and control platforms with our MESA radar. The U.K. joins a number of other international customers in selecting the MESA radar for this capability. In command and control, MS received a $633 million FMS award to supply our IBCS Battle Management System for Phase 1 of Poland's next-generation air and missile defense. This award aligns Poland with the U.S. Army in utilizing IBCS's "any sensor, any shooter" capability for next-generation air and missile defense.

We continue to invest in expanding IBCS's addressable market. For example, during the quarter, we and MBDA funded the successful demonstration of IBCS's functionality with a non-U. S. missile system by integrating MBDA's CAMM family of missiles. We did so quickly and at a fraction of traditional missile defense system cost.

MS was also awarded $117 million to develop the next-generation radar threat warning sensor to protect Navy Rotary aircraft. This sensor counters a new-generation of highly-mobile antiaircraft weapon, and has the potential for international sales. During the quarter, our G/ATOR program achieved initial operating capability, and is now transitioning into service. We are currently negotiating a full rate production contract with the Marine Corps, which we expect will be finalized in the near future.

And at TS, we were awarded $52 million for KC-30 sustainment in Australia and $44 million for a Battlefield Airborne Communications Node. Company-wide, these awards position us for accelerating growth and will be executed over the coming years.

Across the sectors, on F-35, we are nearing completion of negotiations for center fuselage units, radars, CNI, DAS, aerostructures, and other equipment for the lots covering the next several hundred aircraft. We continue to aggressively drive affordability on this program, while maintaining strong program performance.

Now I'd like to spend a few minutes on a major area of opportunity for us, space. With the addition of Innovation Systems, our space portfolio is in excess of $7 billion in annual revenue. Our capabilities address end-to-end mission needs, including launch, satellites, payloads, ground systems and command-and-control. We are designing and manufacturing systems vital to our national security and continually pushing the boundaries of science and exploration. We are taking commercial applications in technology and creating cost-effective and reliable solutions for our government partners using agile processes.

We established a resiliency and rapid prototyping space business unit to augment and sharpen our focus on emerging customer opportunities in the new space war-fighting domain. A notable outcome from this unit is the R3D2, an experimental satellite for DARPA, which launched from a commercial launch pad in New Zealand in late March. R3D2 demonstrated a new type of deployable antenna for small aircraft. This landmark program went from concept to orbit in 20 months. This successful demonstration will lend support to developing additional smaller, faster-to-launch and lower cost capabilities that can optimize the new commercial market for small inexpensive launch vehicles by both the DoD and commercial users. We're extremely proud of this effort and I want to congratulate the entire team on its success.

I also want to recognize the Innovation Systems team for last week's successful on-schedule and on-budget Antares rocket launch of our Cygnus spacecraft. Cygnus delivered 7,600 pounds of scientific equipment and supplies to the International Space Station. This is our 11th launch under the first commercial resupply contract, and we look forward to continued successful missions under our follow-on contract.

The President's FY 2020 budget includes increased investments in space, missile defense, nuclear deterrence, artificial intelligence and hypersonics. There is strong bipartisan support for these increased investments to support the National Security Strategy, the National Defense Strategy as well as the framework outlined in the Missile Defense Review. I'm confident that we have the advanced technologies, products and services necessary to support our nation's most critical security missions, which are well-funded in this President's budget.

As CEO, I'm focused on sharpening our operational efficiency and agility so that we capture and successfully execute the programs that our portfolio enables. I'm very pleased at how the team is responding. Our ability to engage with and quickly address our customers' rapidly evolving needs with affordable and innovative solutions is critical to achieving our growth potential, creating value for our shareholders and supporting global security and human advancement with our customers.

So now I'll turn the call over to Ken for a more detailed discussion of our financial results and guidance. Ken?

--------------------------------------------------------------------------------

Kenneth L. Bedingfield, Northrop Grumman Corporation - Corporate VP & CFO [4]

--------------------------------------------------------------------------------

Thanks, Kathy, and good afternoon, everyone. I also want to thank our team for solid first quarter results. I'd note that our presentation includes an EPS bridge from first quarter 2018 to first quarter 2019, a bridge to our updated 2019 EPS guidance as well as a slide highlighting backlog trends. As you can see from the bridge on Slide 6, approximately $0.15 to $0.25 of the EPS increase is driven by a strong first quarter operational performance and full year expectations with the remaining $0.15 primarily reflecting lower expected interest expense.

Let's turn to the sectors. Aerospace Systems sales rose 7%, reflecting higher volume in all 3 business areas. Operating income increased 12% and margin rate increased 50 basis points to 10.9%. Manned Aircraft and Autonomous Systems programs were the primary drivers of higher sales and operating income as well as margin rate expansion. Restricted, F-35 and E-2D programs drove higher Manned Aircraft volume. Higher autonomous sales reflect higher volume across several programs, including Triton as that program moves towards full rate production. We continue to expect AS sales to increase to the high $13 billion range with a mid- to high 10% operating margin rate. No change to prior guidance.

At Innovation Systems, based on pro forma sales comparisons, first quarter sales rose 10% due to higher volume in all 3 business areas as we see the benefits of revenue synergy begin to kick in. In space, higher volume on national security satellite systems drove the increase. Defense systems had higher volume in tactical missiles, including the AARGM program, as well as higher volume for precision munitions and armaments.

And at Flight Systems, higher sales reflect increased volume on launch vehicles, principally Ground-based Midcourse Defense as well as higher volume on aerospace structures. IS operating income was $167 million and operating margin rate was strong at 11.6%. First quarter margin rate reflects favorable outcomes on certain commercial contract negotiations. We had expected these items later in the year, and we're pleased they concluded in the first quarter. We continue to expect IS sales to increase to the high $5 billion range, with margin rate in the mid-10% range. No change to prior guidance.

Turning to Mission Systems. First quarter sales were comparable to last year's first quarter. Operating income increased 3% and operating margin rate expanded 40 basis points to 13.3%. First quarter MS sales reflect a headwind of approximately $100 million from JRDC and a restricted space program. The headwinds from these 2 programs are now largely behind us. The first quarter was also a low point for material receipts.

As double-digit backlog growth from year-end 2018 suggests, we are just beginning to accelerate on a long-term growth trajectory at Mission Systems. This positions MS well for the remainder of 2019 and in 2020 as volume ramps on airborne and space restricted programs, F-35 and IBCS for Poland, just to name a few. We continue to expect MS revenue to grow to the low to mid-$12 billion range with a margin rate of approximately 13%. No change to prior guidance.

Technology Services sales and operating profit declined in the quarter, reflecting completion of the VITA IT outsourcing program, the KC-10 sustainment program and JRDC. The headwind from these 3 programs was about $125 million in the first quarter. Looking ahead, we expect TS sales will stabilize as these headwinds diminish, and we continue to expect TS sales in a low $4 billion range. Based on strong first quarter performance, we are raising guidance for TS operating margin rate to approximately 10% versus prior guidance of mid- to high 9%. As we roll all that up, we continue to expect 2019 sales of approximately $34 billion with a low to mid-11% segment operating margin rate, no change to prior guidance.

Guidance for total operating margin rate is also unchanged at mid- to high 10%. We are reducing our interest expense guidance to approximately $560 million from our previous guidance of approximately $590 million, largely reflecting a revision in our capitalized interest estimate. We are increasing our mark-to-market earnings per share guidance to a range of $18.90 to $19.30 based on approximately 170 million weighted average shares outstanding.

Turning to cash, first quarter cash flow was impacted by an ERP system conversion to a single instance of SAP covering the majority of our businesses. My congratulations to the team for achieving this significant operational efficiency milestone. Although successfully completed, the conversion delayed billings and cash receipts of approximately $350 million. We expect full recovery of billings and cash collections in the second quarter.

First quarter cash use also increased due to the addition of Innovation Systems, which drove $250 million of cash use in the quarter. This seasonal pattern mirrors the rest of the company. We continue to expect strong cash flow in 2019 with no change to full year guidance of $3.8 billion to $4.2 billion cash from operations, and $2.6 billion to $3 billion of free cash flow after capital expenditures of approximately $1.2 billion. We continue to plan share repurchases of approximately $750 million this year, assuming current market conditions, and as previously discussed, we intend to retire about $500 million in debt in the third quarter.

In summary, we expect to continue strong value creation through a combination of continued growth, strong program and financial performance and robust cash generation, reflecting our growing business, normalization of CapEx and capture of working capital opportunities.

I think we're ready for Q&A. Steve?

--------------------------------------------------------------------------------

Stephen C. Movius, Northrop Grumman Corporation - Treasurer & Corporate VP of IR [5]

--------------------------------------------------------------------------------

Thanks, Ken. (Operator Instructions) Shelby, please open the line for Q&A.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Your first question comes from Rob Spingarn of Credit Suisse.

--------------------------------------------------------------------------------

Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [2]

--------------------------------------------------------------------------------

So Kathy or Ken, I guess the elephant in the room here is the sales growth primarily at TS, but in MS, too. So I wanted to ask about the recoveries for both of those. It sounds like from the bookings in your comments just before that maybe MS starts growing here in the second quarter, but I wanted to check on that, see if that's correct. And then, with TS and given that the book-to-bill was below one there, can you really see growth in 2020 as I think you said last time? And how do you think about that sector strategically? Would you say that the first quarter was below your expectations?

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [3]

--------------------------------------------------------------------------------

So Rob, thanks for the question, and I'll start and then ask Ken to provide more details on the financials. And let me start with the second part of your question first in terms of the positioning at Technology Services. From a portfolio shaping perspective and the program launches that we've experienced, which we've been talking about for a while, first, Wes was indicating those and then more recently, me, we certainly saw that those were quite impactful this quarter. A tough Q1 compare to 2018 as we had multiple programs that have rolled off over the last year, including, but not limited to, KC-10, JRDC and VITA, which we've talked about quite a bit. So what we have been doing with that business is really repositioning it for growth. And you are seeing the impact of some of those changes that we made late last year, including the consolidation into 2 segments. This is positioning the business better for competitiveness in the marketplace and also margin rate performance and they delivered that this quarter. So we're going to continue throughout this year to see a better profile from TS as those programs roll off, several of them in this first quarter and look toward a return to growth for TS late this year. In terms of Mission Systems, you hit the nail on the head. We've seen strong backlog improvement at MS, 30% year-over-year for MS and they are positioned for accelerating growth. They too had 2 program headwinds that end in the first quarter of this year, and then, largely, those headwinds are behind us, and I expect MS to return to a healthy growth rate in the second quarter. Ken, anything you'd like to add?

--------------------------------------------------------------------------------

Kenneth L. Bedingfield, Northrop Grumman Corporation - Corporate VP & CFO [4]

--------------------------------------------------------------------------------

I would just say that from a details perspective, TS, we were certainly hoping for a bit of a different outcome in the first quarter. We did certainly understand that there was the headwinds that existed in that, represented about 11% headwind for the quarter. So if you think of, without those note items, TS would have been down about 4% and we were hoping for less than that. So we'll certainly continue to work hard there to generate the awards that will position them for 2020 and beyond. And at MS, I think I would just say, I would reiterate strong backlog whether you look at from last year's first quarter or even from year end, backlog was up 16%. We did have some timing of material receipts that I mentioned, which have some impact. And I think we feel awfully darn good about how MS is positioned right now.

--------------------------------------------------------------------------------

Operator [5]

--------------------------------------------------------------------------------

Your next question comes from Jon Raviv of Citi.

--------------------------------------------------------------------------------

Jonathan Phaff Raviv, Citigroup Inc, Research Division - VP [6]

--------------------------------------------------------------------------------

Is the implied -- when you talk about growth going forward, would you say the implied kind of exit growth rate this year is sustainable? And at least something to accelerate in 2020? And to what extent really can you do that? And then, really, amidst that growth acceleration, how to think about -- how should we think about margins from the mid- to high 10% this year, since margin is usually mix-driven? Do you see a path to accelerating growth, while also expanding margins?

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [7]

--------------------------------------------------------------------------------

So thanks, Jon. At the macro level, I certainly see the opportunity for accelerated growth and we've pointed to backlog a couple of times, but let me also talk about other things that we've done in the business because I think it's important context. We talked earlier in the year about having added an element of our incentive compensation to focus on segment operating margin growth with the full impact that our team will be incentivized to capture profitable sales.

We're also winning programs that represent revenue synergy from the IS acquisition. I've talked to AARGM-ER this time. In the last call, I talked about some of the opportunities in space. And we've started to make some structural changes that better position us for capturing growth. I talked about the TS consolidation and earlier in this call, I mentioned the creation of a space resiliency and rapid prototyping unit. All of these activities in combination are positioning us to continue with growth and accelerate it over the coming year. So absolutely seeing that as possible. And expansion of margins also, you saw in the results of this quarter, some margin expansion.

We are taking the cost synergies that are created through the integration of Orbital ATK, and those are benefiting all sectors, and you're seeing that in the results, not just solid program performance, which also continues, but the addition of these overhead reductions that are benefiting the sectors.

--------------------------------------------------------------------------------

Kenneth L. Bedingfield, Northrop Grumman Corporation - Corporate VP & CFO [8]

--------------------------------------------------------------------------------

And I think what I would add to that, Kathy, is if I think about the acceleration or the implied exit growth part of the question, I would say we do feel pretty confident about that. And I guess there are a couple drivers there. One, would be we are a long-cycle business and it takes some time for budgets to turn into outlays, and then outlays to turn into our sales. And we certainly try to be careful and thoughtful in terms of how we generate those sales, such that we are as efficient as possible and don't perturbate production lines for short-term growth. And then I would also say that where we are aligned within how the budget is positioning going forward today and dealing with the threats that are identified in the National Security Strategy, National Defense Strategy, Missile Defense Review, we feel good about our capabilities and technology alignment to the mission needs that our customer will face.

So I would say we do feel good about the long-term growth that we've talked about 2019, 2020 and beyond. And then on the margin expansion, I would say that a couple of things. I think we have the opportunity for margin expansion. There are a few things that we need to think about in that regard. Number one, we've been, I think, effectively managing our cost structure and that continues. That's a benefit. We also have strong growing production programs. I mentioned Triton getting ready to move into full rate production. That's a benefit. And then we also have a growing set of international opportunities, which should generate nice margin. Going the other way, we have some margin rate pressure in terms of continued growth in development programs, both in national security space and hypersonics, as Kathy mentioned. So that could put a little bit of pressure on the margins. And if there were a big win like a GBSD, as we've talked about before, that could have some impact as well. But we do certainly feel confident about maintaining strong margin rate and having a nice set of growing margin dollars, consistent with what we see on the top line.

--------------------------------------------------------------------------------

Operator [9]

--------------------------------------------------------------------------------

Your next question comes from George Shapiro of Shapiro Research.

--------------------------------------------------------------------------------

George D. Shapiro, Shapiro Research - CEO and Managing Partner [10]

--------------------------------------------------------------------------------

Could you tell us how much F-35 revenues grew in the quarter? And then also, will this be one of the best quarters of the year? Because with your high end of your guide at $19.30, $5.06 is obviously more than 25% of the year. Or are you just providing conservative guidance?

--------------------------------------------------------------------------------

Kenneth L. Bedingfield, Northrop Grumman Corporation - Corporate VP & CFO [11]

--------------------------------------------------------------------------------

On the first question, George, I don't remember the precise F-35 sales growth number for the quarter. But I will say that it's -- I believe our largest program in the range of 9% to 10% of sales. We do see F-35 growth at all 4 of the sectors. AS, with the center fuselage, MS, radar, CNI and other equipment and then IS with aerostructures and TS for sustainment. And for the year, I think we see that growing across the company at a rate of high single-digit growth. And then with respect to your question on EPS, I would say that, look, we continue to try to burn down risks as we work through the year and realize opportunities such that we can find ways to look at where we can ultimately get to on EPS. In terms of first quarter, I would say that we had solid operational results in terms of margin rate. And we look at that as giving us the opportunity to perform a bit better in our range, segment margin and total margin range than we previously talked about. And then we had the reduction in the interest expense. So Q1 is a solid quarter, a good EPS number. We'll continue again to try to find those risks to burn down. And I guess the only other thing I'd remind you of is that Q4 does tend to be a heavier quarter for corporate unallocated, and so that could drive a little bit more cost into fourth quarter than we normally see in the first 3. So I would say that's the way to think about it, George.

--------------------------------------------------------------------------------

Operator [12]

--------------------------------------------------------------------------------

Your next question comes from Carter Copeland of Melius Research.

--------------------------------------------------------------------------------

Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [13]

--------------------------------------------------------------------------------

This -- Kathy, this maybe somewhat of a too nuanced of a question, but I'm somewhat intrigued about the insertion of the word agility into your prepared remarks and the press release. I went back and looked at that in terms of general performance statement over the last couple of years and that's not a word that comes up. And so it sort of strikes me as that particular point of emphasis, and I wondered if you might elaborate a little bit on what that means for all the simultaneous efforts you've outlined in the previous answer to the question.

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [14]

--------------------------------------------------------------------------------

Yes. Thank you. I would like to talk about agility in a couple of contexts. First, our ability to rapidly identify new solutions to help our customers, and you've heard me talk about that and how important it is to the profitable growth in our company and also realizing the revenue synergy with the acquisition of Orbital ATK. And I'm quite pleased to see the team responding in the way that they are to very rapidly pull together components of our portfolio and meet customer needs. I also talk about agility in the speed at which we are able to work with our customers today. I gave the example of R3D2 and the fact that we were able to get something from concept on orbit in space in 20 months. So when we think about the way we deliver, we're also implying agility to our operations. And this helps us to be more competitive in the marketplace, but it also aligns to what our customers are talking about in a need to address the threat at the speed of relevance. So as the threat is advancing, speed of capability to mission is absolutely essential. And Northrop Grumman is well positioned to do that, with the components of our portfolio and with our operations. We're just continuing to streamline those operations so that we can move even more quickly.

--------------------------------------------------------------------------------

Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [15]

--------------------------------------------------------------------------------

How do you benchmark that?

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [16]

--------------------------------------------------------------------------------

The way I benchmark it is against the performance expectations that our customer has. So if a customer believes it should take a certain amount of time to get a capability fielded, if we can beat that, we're going to have a competitive differentiation. I benchmark it internally in terms of our own processes in looking at the cost at which we deliver those services, but also the speed at which we deliver those services.

--------------------------------------------------------------------------------

Operator [17]

--------------------------------------------------------------------------------

Your next question comes from David Strauss with Barclays.

--------------------------------------------------------------------------------

David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [18]

--------------------------------------------------------------------------------

The 25% to 30% of the portfolio that's restricted, could you talk about the -- how that grew in the first quarter?

--------------------------------------------------------------------------------

Kenneth L. Bedingfield, Northrop Grumman Corporation - Corporate VP & CFO [19]

--------------------------------------------------------------------------------

I'm not sure I've got that number off the top of my head, David, in terms of first quarter growth. What I will say is that a few things: one, we do believe that the restricted portfolio is particularly well aligned to our customers' needs in terms of what they are focused on today and those threats. And we do expect that for 2019 and for sort of the long run, we believe that the restricted portfolio will likely grow faster than the unrestricted portfolio. And I would say we expect that at the macro customer level as well as at the Northrop Grumman level.

And it's -- can't say a lot about it, but it is a strong portfolio that will likely turn into continued opportunities both from a customer relationship perspective as well as the potential to accelerate what happens in those programs to future phases, be it EMD to production or whatever it may be. And so we feel really good about the portfolio. And maybe just to point out a couple of things for Q1 and Steve can certainly follow up later on with the number, but we did talk about growth at Innovation Systems and National Security Space, most of which would be restricted and certainly growth at Aerospace Systems where we talked about restricted and then also comments at Mission Systems with respect to a few areas where they will see restricted growth in the next 3 quarters of the year and into 2020.

--------------------------------------------------------------------------------

David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [20]

--------------------------------------------------------------------------------

Okay. And then you highlighted the backlog growth at Mission Systems. Kathy, I think you've previously talked about mid-single-digit top line growth in 2020. Would you expect MS to lead that growth among the 3 businesses -- or 4, sorry, business segments?

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [21]

--------------------------------------------------------------------------------

As we look to the remainder of this year, MS will be a strong contributor to the growth in the company.

--------------------------------------------------------------------------------

Operator [22]

--------------------------------------------------------------------------------

Your next question comes from Sheila Kahyaoglu with Jefferies.

--------------------------------------------------------------------------------

Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [23]

--------------------------------------------------------------------------------

Just on that, I guess on MS, you were awarded IBCS for Poland in the quarter. How do we think about the ability to leverage some of these programs to both grow the international business and just when we could think about other franchise opportunities?

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [24]

--------------------------------------------------------------------------------

Yes. I see good opportunity, particularly in the Mission Systems portfolio and I noted a few of them today. You mentioned IBCS Poland and I talked about also the work we did with MBDA to demonstrate the ability to integrate an international missile with our missile defense system. I also see exportability for G/ATOR. We talked about a new sensor that we're developing that has international applicability in MS as well. So across the board, we have had a strong export business in Mission Systems and I see that potential continuing to grow. And we also have global operations in, particularly, Europe and Australia, that are continuing to grow across the portfolio, but particularly with opportunity in Mission Systems as well.

--------------------------------------------------------------------------------

Operator [25]

--------------------------------------------------------------------------------

Your next question comes from Seth Seifman of JPMorgan.

--------------------------------------------------------------------------------

Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [26]

--------------------------------------------------------------------------------

So Ken, I wonder if you could tell us, I mean, historically, you guys were a pretty good performer on working capital. I know things kind of move around quarter-to-quarter, so this quarter is an anomaly. But now that we've got Innovation Systems in there, what's, let's say, at a year-end -- any year-end period, what's the appropriate level of working capital for the business? I don't know if you can size it as a percentage of sales or anyway that you're comfortable.

--------------------------------------------------------------------------------

Kenneth L. Bedingfield, Northrop Grumman Corporation - Corporate VP & CFO [27]

--------------------------------------------------------------------------------

Sure. Yes, as I mentioned in our prepared remarks, we do think that there are working capital opportunities in front of us. As we look at 2019, we probably see more opportunity from a working capital perspective quite frankly in 2020. I think as we grow the business in '19, we see the ability to either grow working capital at a similar rate or potentially slightly less, but we do see some opportunity to liquidate some working capital in 2020. And I would say that NGIS had a little different working capital structure than we did. Some of that is structural, say, NASA, CRS, those payment terms are going to be what they're going to be. There's opportunity to burn some down on some other programs. And then, we'll just continue to diligently work day to day to make sure that we get the right payment terms for the type of work that we're performing and the contracts that we're signing and just continue to stay focused on that. And then, also we need to continue to work with our customer and make sure that the -- their payment terms are appropriate again for the type of contract and the type of work. And we would like to see opportunity on that side as we continue to work with them for, again, appropriate industry-wide payment terms.

--------------------------------------------------------------------------------

Operator [28]

--------------------------------------------------------------------------------

Your next question comes from Hunter Keay of Wolfe Research.

--------------------------------------------------------------------------------

Hunter Kent Keay, Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense [29]

--------------------------------------------------------------------------------

I think you talk about this $1 billion submarine subsystems award. Is that really the Columbia class? I'm sorry. And can you remind me of your total exposure -- company exposure to shipbuilding, and how you expect that to trend over the next few years?

--------------------------------------------------------------------------------

Kenneth L. Bedingfield, Northrop Grumman Corporation - Corporate VP & CFO [30]

--------------------------------------------------------------------------------

Sure. I wouldn't be able to comment on specifically the class of submarine, but what I would say is that we did reach an agreement in the quarter for about $1.3 billion. Some of that had been previously recorded as long lead to provide a number of units for propulsion and turbine generators in support of U.S. Navy submarine production. And we do expect that to be delivered over a number of years. In terms of the overall exposure to shipbuilding, I would probably frame that in the range of mid- to high single digits in terms of sales, maybe more like mid-single digits.

--------------------------------------------------------------------------------

Hunter Kent Keay, Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense [31]

--------------------------------------------------------------------------------

And you expect that to stay roughly there over the next, say, 5 to 10 years?

--------------------------------------------------------------------------------

Kenneth L. Bedingfield, Northrop Grumman Corporation - Corporate VP & CFO [32]

--------------------------------------------------------------------------------

I don't expect -- based on what we do in that area, we don't tend to see a lot of volatility. I think there's an opportunity for growth as you think about the Columbia class, as you asked about. There are some other areas we would provide capability for surface ships, electronic equipment and things like that on surface ships as well as some seaborne radar capability and maybe some opportunity for growth, but probably not one of the fastest growing areas in the company.

--------------------------------------------------------------------------------

Operator [33]

--------------------------------------------------------------------------------

Your next question comes from Robert Stallard of Vertical Research.

--------------------------------------------------------------------------------

Robert Alan Stallard, Vertical Research Partners, LLC - Partner [34]

--------------------------------------------------------------------------------

Ken, a quick question for you in cash. Is there any way you can fix this seasonality you see in this cash? Make it a little bit level loaded throughout the year?

--------------------------------------------------------------------------------

Kenneth L. Bedingfield, Northrop Grumman Corporation - Corporate VP & CFO [35]

--------------------------------------------------------------------------------

We're working on it, Rob, I would say. There are some, I would call them, structural timing of certain payments and receipts that we see that make that a little bit of a challenge. There are just certain outflows that occur early in the year. And we've always tended to have a strong fourth quarter, and we're always working hard to pull more cash from next year into this year. That means you've got to do it all over again. But we're looking at strategies. I don't see us ever getting to a point where we're level, but we can certainly be significantly better than we were this year. We had a couple of notable challenges, as I mentioned, this year. And we can do better, but I wouldn't expect us to be kind of ratable across the year.

--------------------------------------------------------------------------------

Operator [36]

--------------------------------------------------------------------------------

Your next question comes from Ron Epstein of Bank of America Merrill Lynch.

--------------------------------------------------------------------------------

Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [37]

--------------------------------------------------------------------------------

Kathy, as we think about the next couple of quarters, can you give us a little, maybe, inside baseball on what programs we should be keeping an eye on? I mean, so what are the shorter-term opportunities that could, as outsiders, we should be keeping an eye on that you guys could potentially win?

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [38]

--------------------------------------------------------------------------------

So Ron, as is usually the case, a good bit of the work we continue to pursue and even what we talked about winning in this first quarter is restricted. So while I can't point to specific opportunities, we are seeing growth in hypersonics, and the programs that we have already won will continue to have opportunities for increased scope. We have National Security Space, which is a number of restricted programs, some of which we booked in this first quarter and we referenced in today's call, others that are pending a little later in the year. We also have opportunities that are more public. Clearly, the launch services agreement that we are under today in working with the Air Force to compete for the down-select to be 1 of 2 launch services providers for national security launches. And then, we have GBSD, which we are competing for and we expect the RFP on later this year that will be awarded next year, are just a handful of areas that I would suggest that you monitor with us.

--------------------------------------------------------------------------------

Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [39]

--------------------------------------------------------------------------------

Okay. Great. And then, maybe a follow-on, related. When you think about the budget request from the administration and kind of maybe where we are through the process, the Armed Services Committee, House Armed Services Committee coming back with the response, how do you feel about that budget relative to how you're positioned?

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [40]

--------------------------------------------------------------------------------

I feel very positive about our alignment to the budget even after we look at the Congressional mark process that is going to ensue. We have strong alignment to the threat and being able to address areas that are certainly of note. We've talked about a number of them today, hypersonics, artificial intelligence, the continual progression of sensors that can detect advanced threats, which impact both our Mission Systems business, our continuing growth in the weapons and high-speed missiles area. I talked about AARGM-ER today, and I see a strong alignment to the capability that will be needed in the future. And both the Navy and the Air Force have expressed interest in that missile as a missile of choice. So as I look at how those programs are supported in this budget, I see very strong alignment around the areas that we've been investing in and positioning our portfolio to fulfill and the budget. And the budget is very much based on the National Defense Strategy. And that strategy is enduring and expected to continue to be the view of both parties that we need to align to that strategy and ensure that we're dealing with the threats of particularly China and Russia.

--------------------------------------------------------------------------------

Operator [41]

--------------------------------------------------------------------------------

Your next question comes from Rajeev Lalwani of Morgan Stanley.

--------------------------------------------------------------------------------

Rajeev Lalwani, Morgan Stanley, Research Division - Executive Director [42]

--------------------------------------------------------------------------------

Two quick ones, if I may. One, just with your latest on GBSD and how you're feeling about it as time has evolved and you've digested IS and then unrelated to that, but coming back to something you said earlier on the missile defense side, can you talk about Patriot and your involvement in the sense-off and the potential opportunity on the radar, if that's a potential here on the domestic side?

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [43]

--------------------------------------------------------------------------------

Sure. I'll actually start with the latter. And as you might have guessed, there isn't a lot that I'm going to say about an active competition, other than the fact that we are participating in the sense-off. And so we're looking forward to offering a competitive solution that meets the requirements. Shifting to GBSD, we have been working with the government, as you know, on the risk-reduction contract, TMMR, that is going well. We have received drafts of the RFP for the next phase of GBSD, and so we're, in earnest, working our proposal. There's nothing in the draft RFPs that have been a surprise to us. And we continue to work to put in place a very competitive offering for the Air Force, and expect that proposal to go in later this year, and as I noted in the earlier comments, be awarded next year.

--------------------------------------------------------------------------------

Operator [44]

--------------------------------------------------------------------------------

Your next question comes from Peter Arment of Baird.

--------------------------------------------------------------------------------

Peter J. Arment, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [45]

--------------------------------------------------------------------------------

Kathy, maybe you could just give us a couple of comments on metrics, if you can, on the innovation systems integration process. Where are you today? And are you on track for kind of the goals that you set up when the deal was achieved?

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [46]

--------------------------------------------------------------------------------

Yes. The integration continues to progress exceptionally well. I'm proud of how that team is performing. We had that cost synergy target to reach $150 million run rate by the end of 2019, going into 2020. We are on track to achieve that. And as I said, some of the performance improvement that we've seen across the sectors, even in this first quarter, are a result of those cost synergies starting to be reflected in the sectors. We also are starting to see revenue synergy realized. And when we first laid out the business case behind the deal, we did not anticipate seeing revenue synergy quite this quickly. So both in space and missiles, we've been pleased at how quickly those have progressed. And then we also, when we laid out the deal with all of you, talked about operational synergies. And these are areas like facilities overlap that we have within the portfolio that we have an opportunity now to rationalize with the addition of Orbital ATK. And we are making good headway on those operational synergies as well. Again, even faster than I had anticipated we've been able to identify some opportunities and realized those this year. So all in all, I feel very positive about the performance of the business as well as the integration process that we're executing.

--------------------------------------------------------------------------------

Operator [47]

--------------------------------------------------------------------------------

Your next question comes from Myles Walton of UBS.

--------------------------------------------------------------------------------

Myles Alexander Walton, UBS Investment Bank, Research Division - Research Analyst [48]

--------------------------------------------------------------------------------

Kathy, always look at the changes of incentive metrics when new leaders come in and you mentioned one of those with the insertion of segment operating margin growth. And I guess there was a little bit of de-emphasis on the weighting of margin rates, and I think Ken touched on that. But the other incentive you added was RONA. And I'm curious, the last time this was in the mix was prior to the spin-off of shipbuilding and was probably a pretty good indication of how the company was thinking about relative asset returns. So I'm curious when you included this new metric, what exactly are you trying to motivate and incent with the addition of this particular one?

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [49]

--------------------------------------------------------------------------------

So let me start, and then I'll have Ken add a little bit of color on the measure itself. And what we are looking to do is incentivize the top team, and I should note that this metric has been in place for most of our leadership as part of our incentive plan. We added it for the top leadership team as a component of the long-term incentive. And we are working to drive performance in the elements of the business that leadership can control in terms of both returns, but also managing the asset to the business. And we focused more on the operating assets of the business so that we aren't penalizing the team for areas like goodwill and the issues that come with making an acquisition as we just did, and I'll let Ken detail that a little bit for you. But really, it is getting the team focused on the operations of the business. I also added another element of our non-financial goals on operational efficiency. And that is meant to streamline our processes, speed decision-making so that we are able to operate more efficiently and effectively inside the corporation. And that goes back to the comments I was making in response to Carter's questions about agility.

--------------------------------------------------------------------------------

Kenneth L. Bedingfield, Northrop Grumman Corporation - Corporate VP & CFO [50]

--------------------------------------------------------------------------------

Yes. Just a couple of comments I would add there, Myles. We essentially focus our incentives around growth from a profitable growth perspective, not just growth for growth's sake, which is why we like the segment margin dollars as a growth metric. We also have cash generation as a significant measure in both our annual and long-term plan. And then with respect to your question on sort of RONA in the old days, I think what you may be remembering in the old days was an economic value-add metric. We actually have had RONA for some period of time. And then 2 years ago, we moved from RONA to what we call operating RONA. And think of operating RONA as essentially a return on working capital. And we didn't want to try to dilute the -- our ability to create value through managing the balance sheet by including things in there like goodwill and intangible assets and those things that are more challenging for the team to manage, obviously, on a day by day basis. So we essentially created a metric that is return to working capital, and we call that operating RONA.

--------------------------------------------------------------------------------

Stephen C. Movius, Northrop Grumman Corporation - Treasurer & Corporate VP of IR [51]

--------------------------------------------------------------------------------

So we have time for one more question.

--------------------------------------------------------------------------------

Operator [52]

--------------------------------------------------------------------------------

Your next question comes from Cai von Rumohr of Cowen and Company.

--------------------------------------------------------------------------------

Cai von Rumohr, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [53]

--------------------------------------------------------------------------------

So Kathy, on the fourth quarter call, you talked about B-21 being flattish this year and yet it looks like it was up in the first quarter. Has anything changed there? And secondly, you -- revenue growth is a key issue. What sort of backlog growth should we see in the remainder of the year to tell us this is going to happen in the future?

--------------------------------------------------------------------------------

Kenneth L. Bedingfield, Northrop Grumman Corporation - Corporate VP & CFO [54]

--------------------------------------------------------------------------------

Let me start on that, Cai, and then Kathy can add some commentary. I would say that looking at Q1, we did see some higher volume on restricted programs within Manned Aircraft, and I wouldn't want to comment beyond that as to what that might be. In terms of the B-21 program, I would say that's been one of our fastest-growing programs for the last few years, and we continue to think that the profile we talked about for the full year 2019 is appropriate. In terms of awards, I would say that Kathy mentioned a multibillion-dollar, multi-year award on E-2D that we got in April. We're certainly expecting another significant award as we look forward on working with Lockheed on F-35 and that would be across a number of sectors. And then Kathy mentioned an option for 9 aircrafts on E-2D for Japan. We do think that is likely to come later in the year. And then also, we did highlight a significant restricted award in the quarter, and we're looking at some continued restricted awards in the balance of the year. So I think there is a really solid story here, not just the first quarter, but as we look forward into 2019. And I'll just remind you that we are a long-cycle business. And in particular, multi-year awards will turn themselves into sales over longer period of times. But we're gaining confidence in our ability to continue to grow as we look forward.

--------------------------------------------------------------------------------

Stephen C. Movius, Northrop Grumman Corporation - Treasurer & Corporate VP of IR [55]

--------------------------------------------------------------------------------

At this time, I'd like to turn the call over to Kathy for final comments.

--------------------------------------------------------------------------------

Kathy J. Warden, Northrop Grumman Corporation - CEO, President & Director [56]

--------------------------------------------------------------------------------

Thanks, Steve. I'll end the call, again, by thanking the Northrop Grumman team for their outstanding performance and commitment to deliver growth and provide long-term value for our customers and shareholders. And I want to thank everyone for joining us on today's call.

That concludes the call. I'll speak to you in July.

--------------------------------------------------------------------------------

Operator [57]

--------------------------------------------------------------------------------

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