That is opportunity. That would be upside to a flattish look next year. Although, as I also indicated, we are expecting some modest improvement in margin rate next year. What then we look at is the mix, and that has been a factor for both base and mission systems over the last couple of years, particularly notable for mission systems this year. We don’t see a significant mix shift going into next year. It is a very gradual mix shift. And so that — those two pieces of the business will still feel some margin rate pressure until they can shift to more production in the portfolio. As you note, our Defense Systems business has the most both top line and margin upsize that could come as the result of growing international demand as well as what we see domestically, particularly through the supplemental.
Those are uncertain at the moment. So we do factor those in our plan, but that could be a source of upsize. But then, of course, we are managing risks across the entire portfolio. And so when we put all of that together, we’re looking at some modest rate improvement into next year and really striving to do better. But at this point in the year, we are very comfortable with what we’ve laid out as a set of expectations.
Operator: Our next question comes from Ken Herbert with RBC Capital Markets. You may proceed.
Kenneth Herbert: Kathy, maybe I just wanted to follow up on the strong bookings this year. Can you call out or maybe help quantify how much of that could have been or is international? And as we think about sort of this growing set of international opportunities, maybe not so much in ’24, but how much international growth could you see next year and into ’25? And I guess, more importantly, how could that impact margins as I think about maybe international being slightly accretive to margins?
Kathy Warden: Yes, Ken. So you’re pulling on all the right threads. Our bookings are up for the international portfolio this year. And as we look into our future plans, we expect that, that trend will continue. It takes a little while to then materialize that into sales in a meaningful way. So we see a gradual shift in terms of the percentage of our overall sales that will come from international. We’ve talked about achieving a double-digit growth rate. I would expect that not necessarily in 2024, but into 2025 because of the time it takes to ramp sales on these awards. And so you could also expect that any upward margin opportunity would also be more material starting in that 2025 time frame than 2024, but we are actively working those opportunities now so that they do materialize in that time frame.
Kenneth Herbert: That’s helpful. And is there any way to think about just with, obviously, a lot of what we hear in the geopolitical environment, are you seeing that yet translate into sort of bid opportunities when you think about international? I’m just trying to get a sense as to with all of the — all of sort of this growing expectation, how much you’re actually seeing that yet transpire or actually materialize in terms of real opportunity you’re going after?
Kathy Warden: We are seeing it in signals of demand. So I mentioned on our last call that we have over 10 countries that have expected — expressed interest in our IBCS product line. Today, I noted another dozen or so that have expressed interest in AARGM. As we look forward, we do expect that, that demand signal for many of those countries will translate into contracts it takes time. And that’s why I was talking about seeing 2024 is a time frame where we’ll be working to translate those demand signals into contracts, but 2025 being more the time frame we expect them to materialize. And I’d say the same is true with the domestic marketplace as we look to replenish U.S. stockpiles or to work through the supplemental budget that I would expect to be more material for us in 2025, but we’re working now to ensure that we’re qualified to be a supplier on either second source or new missile programs.
Operator: Our next question comes from Scott Deuschle with Deutsche Bank. You may proceed.
Scott Deuschle: Kathy, in the emergency supplemental request from the White House, there was $2.6 billion included for classified Air Force procurement programs. Do you have any sense for whether that could potentially help support your programs in the event that there’s an extended CR here? Or is that just entirely a black box as we might otherwise expect?
Kathy Warden: Yes, there’s really nothing I can comment on with regard to that, Scott. I will simply say we do continue to work with the Air Force on ensuring that we have the resources necessary to make B-21 program successful.
Scott Deuschle: Okay. Fair enough. And then Dave, the updated margin guide on MS implies something like a 15.9% margin in the fourth quarter. Just curious if you could talk a little bit about the drivers there. Obviously, you’ve done above 16% before so I assume something like what we’ve seen historically. But just curious for any commentary on drivers.
David Keffer: Sure. A couple of thoughts there. One, you saw a similar trend last year in our MS business with its strongest margin performance in the fourth quarter of the year, driven by the mix of business that we tend to see spike in the fourth quarter with more predominance of mature fixed price programs in that fourth quarter sales mix. We anticipate a similar trend this year. With that said, need to continue to perform and execute well and with efficiency across that MS portfolio to deliver on that result. In aggregate, the 23% margin guidance change for MS is really driven by mix. A lot of the growth in MS this year has been in critical work in the restricted portfolio that tends to be at this phase in its life cycle cost-type work.
There is opportunity for that work to shift back towards more fixed price over time. But the fact that most of the growth in MS this year has been driven by growth in cost-type contracts has been a pressure on its margin rate. With that said, it along with the rest of our businesses drove margin dollar growth year-over-year in Q3, and we anticipate the same trend in Q4.
Operator: Our next question comes from Gavin Parsons with UBS. You may proceed.
Gavin Parsons: Dave, I was hoping you could go into just a little bit more detail on the Section 174 change and what the offset is given it would seem like that has to be pretty sizable, especially if you get some recapture from 2022?
David Keffer: Sure. Happy to go into that. I think the important takeaway here is that our cash tax forecast is, in the aggregate, largely unchanged, and that remains a tailwind for our free cash flow outlook over these next several years. To your point, 174-driven taxes have come down a bit in that outlook. That’s largely due to lower-than-projected cost applicable to the 174 guidelines, not a change in our interpretation of the latest guidelines. To be clear there, we will continue to assess any future guidance that comes out on 174 and continue to apply our best interpretation of that guidance to our own costs and the appropriate and applicable cost there. With that said, the issue that others in the industry have discussed around the difference between cost type and fixed price R&D-related expenditures is less impactful for us than it appears to be for some of our peers, particularly given the reduction in our 2022 174-driven costs.
So less of an impact based on our interpretation than for others. So with all of that said, there are some puts and takes across a business of our scale with as many open tax years as we have, and we disclose all this in some clarity in our 10-Qs every quarter. There is a balance of upside and downside items that are largely driving an unchanged cash tax forecast.
Gavin Parsons: Got it. That’s helpful. Kathy, you mentioned stickier inflation. Any update on discussions with customers for relief on that front?
Kathy Warden: Discussions continue, and I think we’re making good progress in having awareness of the issue. And with Congress setting a precedent last year of having some funds available, I’m hopeful that once again this year, we will see funds appropriated that give the departments the flexibility, both in language and dollars to address these issues.
Operator: Our next question comes from Seth Seifman with JPMorgan. You may proceed.
