諾斯洛普·格拉曼 (NOC) 2011 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Northrop Grumman second-quarter earnings conference call.

My name is Crystal and I will be your operator for today.

At this time all participants are in a listen-only mode.

(Operator Instructions).

As a reminder, today's conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today Paul Gregory, Vice President of Investor Relations.

Please proceed, sir.

Thank you very much.

Good morning everyone and welcome to Northrop Grumman second-quarter 2011 conference call.

We provided supplemental information in the form of up a PowerPoint presentation that you can access at www.northropgrumman.com.

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 detailed in today's press release and our SEC filings, and include a new risk factor related to the resolution of the issues regarding the US government debt ceiling.

These risk factors may cause actual company results to differ materially.

During today's call, we'll discuss second-quarter 2011 results and our financial guidance for 2011 continuing operations.

On the call today are our CEO, Wes Bush, and our CFO, Jim Palmer.

With that, let's go to Slide Three.

And at this time, I'd like to turn the call over to Wes.

All right.

Thanks, Paul.

Good morning everyone.

Thanks for joining us.

Our second-quarter results demonstrate that our strategy of driving shareholder value through performance, portfolio optimization, and effective cash deployment, continues to generate EPS growth.

Despite a challenging top line environment, we had exceptional margin rate performance for the quarter.

After adjusting last year second-quarter results for the $0.98 per share tax benefit, our earnings per share from continuing operations increased 24% to a $1.81 from $1.46.

The primary EPS growth drivers were continued performance improvement in our businesses, higher pension income, and a lower share count.

Our businesses generated a 12% segment operating rate.

Total operating margin rate increased to 12.8%, primarily reflecting performance improvements and higher pension income.

In May, we executed a $1 billion accelerated share repurchase, which immediately reduced our outstanding share count by 15.6 million shares.

And, along with the dividend increase, we also announced in May, demonstrates our continued commitment to creating shareholder value through returning cash to our shareholders.

We now expect our 2011 EPS from continuing operations to range between $6.75 and $6.90.

The increase in 2011 EPS guidance contemplates our strong year-to-date results and performance improvement for both segment operating margin and total operating margin rates.

The new range represents double-digit, year-over-year EPS growth after adjusting for one-time items in 2010, such as the tax benefit and the impact of our debt tender.

Cash performance for the quarter and year-to-date continues to support our guidance.

Through six-months, cash from continuing operations before discretionary pension contributions totaled $490 million, 21% higher than last year.

As we have stated on previous calls, we expect cash generation to be weighted for the second half of the year, which has been our historical pattern.

Turning to sales, three primary factors impacted the quarter.

Budget uncertainties impacting our customers, the announced force reductions in Iraq and Afghanistan, and our own portfolio shaping decisions that were anticipated in our guidance.

So let me briefly discuss all three of these.

First, overall budget pressures and the decline in government and defense outlays.

The six-month continuing resolution, as well as continued uncertainties surrounding the debt ceiling and future defense budgets, cost our customers to move more slowly and spend more conservatively.

We did not see the recovery in spending that one might have expected with the end of the continuing resolution and the passage of the fiscal year 2011 budget.

In this environment new awards are moving to the right and it's also taking a bit longer to get continuing business under contract.

In addition to budget pressures, we are beginning to see the impact of the announced troop draw downs in Iraq and Afghanistan, primarily in electronic systems for IDIQ contracts, such as the vehicular intercommunication systems that are used by the Army.

And finally, sales do reflect our strategic portfolio shaping which includes the previously announced decision the reduction in our Nevada test site joint venture participation, which we announced earlier this year, as well as the sale of our San Diego County outsourcing contract back in May.

While these two actions reduce second quarter sales by approximately a $160 million, they also supported this quarters performance improvement and segment margin rate expansion.

So, based on year-to-date results and our outlook for the rest of the year, we now expect 2011 sales of approximately $27 billion.

Looking forward, we continue to believe that we are well aligned with our customers investment priorities in unmanned systems, cyber security, C4ISR, and logistics.

We believe that these areas will be continue to be well supported in future budgets, as they are critical to the most pressing national security missions.

We expect that once the current state of budget disarray is resolved and future projects are clarified, our customers' spending behavior should begin to normalize.

However, the environment continues to be very dynamic and it may take some time before there is more clarity in DOD's strategy and it's program level planning.

Now, turning to our operations, last Friday we were awarded a $795 million E-2D contract that includes LRIP 3, a plus up on LRIP 2, and long-lead funding for LRIP 4.

The contract also provides an option for LRIP 4 production, which we expect will be awarded sometime next year.

This is a significant milestone for Northrup and for the Navy, as it increases the number of aircraft purchased across multiple production lots and it results in overall per aircraft cost reductions through economies of scale.

Based on this contract, we expect to recover sales on this program in the first half of the year.

We also have several large pending rewards including F-35 and the latest multi-year for the F/A-18.

Now I'd like to spend a few minutes discussing some of our unmanned programs.

Starting with Global Hawk.

The program is making very good progress.

We have used the block 30 IOT&E results as a basis for incorporating a number of improvements.

Of the 9 primary issues identified in that report, 5 have already been corrected, and the program is on track to correct the remainder over the next several months.

The Department of Defense has recertified the program and deemed it critical to national the defence.

The DOD also recommended reducing the number of block 30 attrition aircraft and using those savings to fund support areas, such as sustainment, spares, and ground station and communications, to enable the extensive operational use of these systems.

In addition, the Global Hawk affordability initiative that Northrop Grumman is driving with the Air Force is making progress in ensuring these systems continue to bring value to our customer.

To quote some recent remarks by a senior Air Force official --Global Hawks are getting the job done today for the war fighter in the field and will continue to be a key contributor in our intelligence, surveillance and reconnaissance capabilities.-- We believe the program is postured for success and should be ready for a full rate production decision.

Fire Scout also has made tremendous operational advancements in recent months, despite some early reports that questioned its ability to support the goal of 300 flight hours per month in Afghanistan.

Well, we are happy to report that in June 2011, during its very first full month of operational flying, Fire Scout provided 307 hours of support to ground troops and it's on track to meet or exceed 300 hours for July.

We also continue to make solid process on key development program such as Navy UCAS, LEMV, and BAMS.

And aerospace systems in intensely focused on the successful pursuit of new business opportunities, including Uclass and the long-range strike program.

Aerospace systems is performing well and despite its sales for the first six months of 2011 being down about 4% from last year, we see a stronger second half for the sector and believe that sales will end the year at about the same level as last year.

Jim will cover the sector outlooks in a bit more detail in his comments.

During the quarter, electronic systems, directional infrared countermeasures systems, or DIRCM, achieved more than 1 million operational hours in service while demonstrating operational availability of more than 99%.

ES continues to be a technology leader in non-kinetic products and systems such as those required for advanced electronic warfare.

We expect this to be an increasing important national security capability.

Information system sales have been impacted by the prevailing budget uncertainty, but they continue to have a robust set of new business opportunities including the Gmb development and sustainment program, the CANES program, and numerous cyber related opportunities.

During this quarter, we also sold the San Diego County IT contract.

This decision is consistent with our strategy of exiting lines of business that do not meet our standards of performance.

And I might add, this decision was made in collaboration with our customer.

Technical services had a solid quarter.

Their results included higher logistics and modernization sales, consistent with our strategy for the sector.

Also during our quarter, technical services received one of three awards for the $300 million headquarters US Air Force Civil Engineer Support Agency, IDIQ contract and it will compete for task orders to support DOD civil engineering missions world wide.

In closing, I'd like to reiterate that we continue to position the Company for an increasingly competitive and challenging environment, in which deficit reduction is becoming a higher priority for our national leadership.

Our challenge is to continue to anticipate the needs of our customers, provide affordable innovative solutions, and aggressively address our cost structure, operational execution, and our productivity.

As we demonstrated this quarter, we can create value in an environment of constrained top line growth by focusing on our key priorities; performance driven by strong execution; optimizing our portfolio; and effectively deploying our cash.

So now, I'd like to turn the call over to Jim for a more detailed discussion of results and our guidance.

Jim?

Thanks, Wes.

And, good morning ladies and gentlemen.

I will begin my comments by providing a little bit more detail on our second-quarter results.

As I look at the quarter, the highlights were segment operating margin rate expansion, which largely offset the impact of lower sales, higher total operating income as well as margin rate, and a 24% increase in underlying earnings per share.

We are experiencing some headwind on the top line, and as I analyzed the results for the quarter across our businesses, it looks to me about half of the variance of last year include things that we anticipated in our guidance for this year.

Nevada joint venture participation reduction and imposters structure in our examples of those types of items.

The remainder of the variance I would attribute to second quarter budget pressures issues at which largely impacted electronic systems and information systems.

These a budget pressure issues include the lingering impact of the six-month continuing resolution as well as announced troop draw down, delay towards and the overall budget be as well as customer conservatism that Wes talked about in his comment period --.

Movie to guidance in slide four, we now anticipate about a 2% reduction or $500 million in 2011 sales due to the budget pressures and the troop draw down.

Clearly we were operating in the highly that's environment and our full-year sales will reflect the evolving budget process in the second half of the year.

I want to go into a little bit more detail on a sector by sector basis.

I will start with the aerospace systems.

The second quarter sales reflect the delayed awards for the F-35 and the E-2D programs which lowered sales by about $150 million, as well as the imposed restructuring which represents an additional $50 million impact in the second quarter.

Before these three items, AS sales were within 2% of last year.

In terms of our outlook for the year, we view the impacts from F-35 and E-2D as timing issues.

The finalization of these contracts and higher volume in several other programs should allow us to recover sales during the third and fourth quarters.

So, as Wes said, we continue to expect relatively stable sales for aerospace systems in 2011.

Aerospace second quarter operating income was roughly comparable to last year and has improved program performance across several programs drove the margin rate in aerospace to --12.8%, compared to 11.8% last year.

Margin rate expansion largely offset the impact of lower sales in the quarter.

And based on the strength of year-to-date operating income, we now expect aerospace operating margin rates to be in the mid 11% range for the year.

On the electronic systems side, the sales declined by nearly 10% due to lower deliveries under IDIQ contracts for [lorumcrum] and vehicular intercommunications Systems, or VIS, driven by the announced draw down of troops in Iraq and Afghanistan.

Lower deliveries for these two programs reduced sales by about $130 million in the quarter.

So, as I look at sales for ES for the year, we now expect them to range between $7.3 billion and $7.4 billion for the year.

Despite the lower sales, however, operating income increased 8% and margin rate expanded to 15.9% outstanding margin rate.

The quarters improvement reflects some positive adjustments on programs nearing completion in the land south protection systems and targeting system areas, as well as improved performance in intelligence, surveillance and reconnaissance programs.

A number of these performance improvements are nonrecurring, so this quarter strong margin rate is likely not sustainable.

However, based on the first half results, we are raising the expected margin rate for ES to the mid to high 13% range from approximately 13% previously.

In information systems, sales declined by 4% for the quarter, primarily due to lower volume on several programs in the defense systems part of the business.

Operating margin for the quarter was 9.3%, compared with 9.7% last year.

We might remember that last year included a $18 million benefit related to a subcontractor risk retirement on the New York City wireless program.

So, if we exclude that benefit from last year's operating margin rate, the rate would have been 8.8%.

This quarter's results included a small pickup from the sales of the San Diego County IT outsourcing contract, but even excluding that pickup, the underlying IS margin rate improved on a quarter-over-quarter basis.

Similarly to ES, budget pressures are impacting the IS top line and now we expect sales of about $8.2 billion for the year.

Additionally, a part of this decline is also due to the sale of the San Diego IT contract that we talked about previously.

We continue to expect an operating margin rate of about 9% for the IS business for the year.

Moving on to technical services, second quarter sales reflect our reduced participation in the Nevada national security site joint venture, which represented sales of about $150 million in last year's second quarter.

The change in the joint venture participation more than offset the higher sales for the logistics and services part of the business.

Their operating income was comparable to last year and operating margin rate increased 130 basis points principally due to the change in the joint venture participation.

So we continue to expect sales of approximately $2.5 billion for TS for the year, which largely again reflects that reduced participation in the joint venture, and as well contemplates the phase out of some business lines that aren't meeting our return expectations.

And we continue to expect the margin rate in TS to improve to about 8% for the year.

So, based on the strength of the year-to-date results we are increasing our estimate to about approximately 11% from the mid 10% range and we now expect a total operating margin rate in the mid 11% range for the year.

The increase in total operating margin rate contemplates the higher segment operating margin rate and increase in the net pension adjustment from about $355 million to about $400 million of income, and an assumption of about $200 million for an unallocated corporate expense and potential risk items.

The increase in our expected pension income is due to the finalization of our plan demographic analysis that we complete based on the population at the beginning of the year.

Turning to cash, through six months, cash provided by continuing operations before discretionary pension contributions improved by 21%.

As expected, cash from continuing operations was low, but for the quarter, and we continue to expect cash to be heavily weighted towards the second half of the year, as has been our historical practice.

As we mentioned last quarter, we did have some substantial cash outflows this quarter, including a $500 million discretionary pension contribution, as well as tax payments totaling about another $500 million.

I think I should also provide a quick update on our share repurchase program.

As Wes mentioned in his comments, we executed a $1 billion ASR program in early May, which immediately reduced our shares outstanding by 15.6 million shares.

I would note until the ASR is completed under the terms of the contract, we are restricted from purchasing shares in the open market.

As Wes mentioned, we increased our guidance for 2011 EPS from continuing operations to $6.75 to $6.90.

The guidance reflects an additional $0.10 for higher pension income, another $0.07 for a lower assumed diluted share count, and net a net pension and share count improvements against the impact of lower sales at $500 million reduction in guidance for the year, results in about a 3% to 4% improvement from our previous guidance.

So, the balance of the increase was driven by operating performance improvement in the sectors are about $0.20 of the improvement is due to that operating performance.

Finally, I should note that our guidance assumes that the national debt ceiling issue is successfully resolved in a timely manner.

So, in conclusion, second quarter results demonstrate that we remain focused on generating shareholder value through performance, portfolio optimization, and effective cash deployment.

That concludes my formal remarks.

But before we begin Q&A, I just wanted to mention that today is Paul Gregory's last conference call before he assumes a new role at Northrop Grumman here at the end of the month.

I know many of you have enjoyed working with Paul and I want to personally acknowledge his strong contributions to our IR activities over the last two plus years.

Steve Movius, who is currently the CFO of our Information Systems Sector, will take over Paul's duties as VP of IR here at the end of the month.

So, obviously, I wish both of you, Paul and Steve, the very best in your new roles.

At this point, I think we are ready for some Q&A.

Thank you, Jim, for those kind comments.

And with that, I think we are ready to move on to Questions-and-Answers.

(Operator Instructions).

Myles Walton, Deutsche Bank.

Thanks.

Good morning.

Jim, can you size the EAC adjustments in there, was it about $40 million?

I think that's a little high.

The way I look at it is, I call it a range of $30 million, $31 million.

Without that, margin rates are probably about mid-teens for the quarter.

Okay.

And the back half of the year is assumed rates of 13, just more mix than anything else?

Yes, I'd say so.

Okay.

And Wes, I have a little question for you.

The incentives that you've put in place for the last couple of years have really been focused on the margin, the efficiency, the cash conversion, and all of those things are essentially playing out.

The 1 thing that's been lacking for purpose probably has been any type of incentives toward sales growth.

I'm curious.

Sales are coming in light and we are explaining that with CR and the down draft in operations.

But do you think that you should put a carrot out there for sales growth in the future?

And would that help the situation at all?

Or we just in the realm of moving with whatever the budget growth is?

I appreciate the question because I think it's important to be able to convey how we think about sales in the Company.

At the beginning of last year, we stood back and thought a little bit about some of the challenges we had experienced over a number of years, and really getting the level of performance out of the Company that we need.

Specifically, around margin rate performance.

And, some of that went to looking carefully at our portfolio and really understanding what was performing and what was not performing.

In doing so, we needed to make some decisions, and we talked about it last year.

We talked about it this year at the beginning of the year, but actually we are going to push ourselves down.

Because we wanted to focus on higher-quality sales in the organization.

We also wanted to focus on sort-of mechanics of how we were putting those sales through the system in terms of how well we are negotiating our contracts, and of course, how well we are executing.

So, those have been underlying perspectives that have made us sharpen our pencil a bit on which things we are really going to pursue.

And also, really focus on how we are executing and negotiating on those.

We have not forgotten the importance of sales in our business.

I don't want anyone to think that is the case.

In fact, our long-term incentives that are permeated throughout the organization, RONA, really does require growth for us to be able to capture those long-term incentive returns.

So, I would tweak your earlier statement a little bit that our sales incentives is more embedded in our long-term than it is in our annual.

But, we did that for a purpose because we wanted to make sure that as we are capturing sales they are generating long-term benefits to our Company.

That it's not just to move the needle on the sales line that might eventually come back and bite us.

So, the focus in the Company is on growth.

That is important to us and that goes to the way we've been shaping our portfolio.

When I talk about portfolio optimization and our focus on unmanned and cyber and C4ISR and logistics, those are the areas that over the long-term, and as I said it's going take a little bit of time for our customers to get all this sorted out.

But, over the longer term, we see those as the areas where our customers are going to make their priority investments.

And we think are going to serve the Company well.

So, there's a little bit of a reshaping that's been underway that has, as you pointed out, impacted the top line in a number of respects.

But, we think it's a little bit of the medicine that we needed to get us in the right place for the long-term.

I would point out, just back to your question on incentives, that our annual incentive plan does include awards.

So, those awards are, of course, the seeds, the germination for the sales that we gain overtime.

But, as you know, there are good sales and bad sales.

We need to be very, very careful that we are not just given our credit for overruns on cost contracts, or sales that really are not generating the level of returns that we need to be generating in our business.

I like incentivizing awards.

I think that's the right place for us to be.

And I like the sales perspective to be more of a long-term perspective, because it forces us to think about the long-term actions that we are undertaking when we go after a certain bid.

Jim, anything you would like to add on that?

Since you and I were intimately involved in that process, I totally agree.

I would also just point out that as you all know, in our business, most of our sales are coming out of our backlog.

Incentivizing sales is really reaping the benefit out of the backlog.

Incentives around new business capture is really capturing activities that occur in the current year.

That's why we moved to awards versus sales.

That's helpful.

I am more curious, and I think that those strategies worked.

I am more curious if and when the pendulum could swing too far.

But, I will stick to 1 question.

Thank you Miles.

Howard Rubel, Jefferies.

Paul, I don't know, it's going to be hard to start all over again, but nice job.

Thanks Howard.

Just to go back a little bit in terms of business opportunities, Wes, this is a larger question also as opposed to the quarter and there are 2 parts to it.

One is, how do you convince your customer that he is not in the business of making your life more difficult?

Because you have seen changes in contract terms that are unfortunate across a number of places.

And second is, what sort of other opportunities, could you be a little more specific in terms of things you think about as the second half unfolds?

Let me touch that first question first.

Our customers buying behavior has, quite frankly, out of the necessity in terms of what they are dealing with, been shifting a little bit.

A lot more focus on affordability, than perhaps the value a question, I would say sometimes.

And we are looking at new competition, we are seeing a few more were cost is getting weighted more highly than performance.

And so, that's something that we are focused on, making sure that our business capture efforts are highly focused around affordability, and frankly our continuing program activities are focused on affordability.

I mentioned in my earlier remarks, the work that we have been doing on Global Hawk on affordability jointly with the Air Force.

And I have just been absolutely delighted to see how that's been embraced both by Air Force and the folks at OSD, in terms of working with us on this.

They've recognized that it's not just about the contract coming forward turning the cost numbers down.

It's about how we actually acquire some of these things.

That has been just a tremendous positive working approach to driving affordability on that program.

We really use that as a blueprint and spread it across the Company to address just about every major acquisition activity that we have underway.

To really go back and press on requirements, press on the way that things are getting bought and quite frankly press on the way we are executing to see if we can't turn those knobs on affordability even further.

So that we can help the customer deal with just this intense pressure that they are having to cope with.

The other part of the change in buying behavior, if you will, has been, as you mentioned, the terms and conditions part of it.

And that one, we're just having to take on 1 by 1.

Just about every case, where there's a shift to go from name it, cost plus to FPI, or FPI to FFP, we have to have the tough conversations about how you balance that out.

Obviously, we can take on risk if we are compensated for, and that becomes the discussion.

I would say those are sometimes a little bit more difficult discussions than we've had in the past but that's where it is.

Not every case does the customer decide, at the end of the day, wants to shift its contract form when faced with the bill for doing that.

So, we simply have to be very clear with them early on.

I think they have to be clear with us early on about what they are trying to achieve so that we can navigate to a more common place.

Your question relating to the outlook and the second half of the year, let me cut that into a couple of pieces.

Both a AS, our aerospace systems business, and technical services businesses, we believe will continue on the track for the annual guidance that we gave at the beginning of the year.

And Jim went through that in a little bit of detail.

And so, in AS in particular, if I focus on that.

As you know we have a very nice portfolio programs.

There were few of those programs relative to last year, the first half of this year, weren't moving quite as quickly, either because of delayed awards, or just a slower progress in how the customer was metering us on our activities.

We have a pretty good transparency on the profile of that for the second half of the year.

And, as I mentioned in my remarks, and Jim did in his, we see a net net coming out of the year at AS at about the same as we were last year in total revenue.

And, that is just the accumulation program by program of what we are doing on production primarily in each of those areas.

There's a little bit of development activity that makes up some of that difference as well, but it is fairly widely spread across the program base in AS.

The other 2 sectors, IS and TS, as Jim indicated in his remarks, in both of those sectors, we have taken our guidance down a little bit for the year, primarily reflecting the slowness that we have seen in the way the government is procuring things.

And, IS in particular, is a much faster turnaround business so it's contracts get rotated on a much more frequent basis, shorter-term contracting activities.

So, they have been the most, I would say, impacted by that level of the shift in that buying behavior.

I don't think we are alone in that.

If you look at how others are reporting this quarter and their similar businesses, we are all seeing about the same thing going on.

I don't see any negative differential there.

ES is also impacted by that.

As you know, ES has a number of IDIQ vehicles, as well as other vehicles that are shorter duration.

So, they've experienced that.

And, then ES also has had a little more exposure particularly to the Army.

And, I think as you are familiar, as we've gotten into this announced draw down, I think the Army has slowed down on buying some of the higher rate items that it had been buying in the past.

For example, our vehicular intercommunications systems and a little bit we've seem it as well with our laser range finder business.

Those are the factors that drive it for.

But, as we look at that profile and think about where we come out for the year, we have shifted our guidance a little bit to $27 billion.

That's what seems to make sense for us.

Thank you very much Wes and Jim.

Doug Harned; Sanford Bernstein.

I would like to follow on that a little bit more.

When you talk about the effect of the continuing resolution and the challenges we saw in the budget earlier in the year, we seem to be at a point now where the customer, and I would say that in a combined sense, DOD and Congress, in a way has certain objectives for spending in defense.

Yet, they are not really getting there.

There's a gap because of the budget delays.

Is it possible for you to quantify the size of this impact, and if you think that as we roll forward in the year things get normalized, are you going to see a lot of that flow back?

You might actually see a surge in backlogs or revenues?

Or is this something that we just may never close?

in other words, we'll just muddle along and stay at these lower numbers?

This is Jim.

We have a chart in our posted material that reconciles the change in guidance.

Basically, 2 items, let's just call it CR plays or budget pressures.

The bigger item, $300 million, and then draw downs.

Our assumption, frankly, is that as we go into the 2012 budget year we're going to will end up in another CR.

There is just a slowness, or molasses in the system if you want to characterize it that way, because of the real uncertainty of what budgets are going to be.

It's just taken longer to get stuff done.

It will be helpful once we ultimately get beyond the debt ceiling conversations, get into a 2012 budget, whatever it is, certainty is better than uncertainty.

We are seeing this hesitancy to act in some cases, because of the need or potential need, perceived need, to maybe save a few dollars just in case the budget is less than I'd anticipated.

It seems, as you've said, to have a stronger effect on the shorter cycle businesses particularly information systems.

It struck me when you look at the margins that you've been able to deliver in the first 2 quarters there, which have been quite good, yet your guidance is only for 9% for the year.

Is that conservatism related to these issues or do you expect something in the business unit itself to change over time?

I really don't expect anything to change in the business unit in the next 6 months or so.

But, I think it's also fair to say that the level of uncertainty that we are faced with given those 2, what's going to happen with the budget, when are we going to get the debt ceiling issues resolved.

All of those uncertainties are clearly greater than what we dealt with over the last couple of years at this point in time.

So, I don't know if that's conservatism or whatever, but yes.

I understand.

Thank you.

That's helpful.

This is Wes.

I want to just add, I do see in our interaction with our customer community, a desire to get to the other side of this thing so that they have a better clarity around what their budgets are going to be and they can get on with things.

But, until we get to that place, I think we are going to see them continue out of necessity to hold back just a little bit, to be able to sort through what this is all going to mean.

As you know, with the arrival of our new Secretary of Defense Panetta, and with the intersection of this budget challenge, the Pentagon is going to this mini QDR, they are calling it, to try and sort through how they really think about the military strategy and intersect that with their best understanding, as they can, of the budget realities.

And, I do think that there is some just sort of hold back in the system, just waiting to see how that all sorts out.

You can hardly blame them.

That's a very rational response to the situation.

But, I do see, once we get through this, and I think it's going to take some time.

As Jim pointed out, we are probably going to see another continuing resolution this year.

I hope it is not as long this year, but it's likely, given the challenge that everyone is facing up on the Hill.

I think it's going to take a bit of time.

If you detect us being a little bit conservative, it's because we are seeing the dynamics of the Hill community and the customer community with respect to what they are facing over the near term.

I do believe we're going to get to a point of more clarity around the budget here in the not-too-distant future, which will enable the Pentagon to sort through its strategy.

And we feel strongly that when we come through that, the places where we focused are going to be the places where priorities are being placed on investment.

But, if we are talking about the next few quarters here, I think we just need to recognize that this uncertainty can translate into where we are.

Okay, thank you.

Cai von Rumohr, Cowen and Company.

You are moving your headquarters to the East Coast.

Presumably, that will give you some cost savings.

Could you tell us how much?

And could you tell us, in light of this more difficult environment, are you considering more dramatic headcount reductions like Lockheed did and more portfolio shaping moves in response to the current environment?

And if so, can you give us any color on how you think about that issue?

I would just say that we are aggressively working the cost equation in our Company on every dimension.

We obviously, and I've mentioned this on some of our prior calls, we are taking our corporate office size down about 25%, just in terms of the headcount, just quantify it a little bit, as we are making the move.

We are, and we have already, made a number of reductions in headcount, primarily indirect headcount, across all of our sectors in the business.

And we got out, I think, a little bit in front of that, to make sure that we were doing the right things from an affordability equation over the last 2 years.

But we are continuing to press on affordability very comprehensively.

Some of that goes to our cost structure, both organizational structure and our imbedded costs.

Some of that goes to the way we are managing our supply chain.

And a lot of that goes to how we construct the offerings that are we are putting forth to our customer community.

We are a very innovative Company, and I would say historically we have used that innovation to discriminate ourselves in terms of capability.

We are going to continue to do that.

And one thing we're not going to do as we're cutting costs, we are not going to take the heart out of our investments for the future.

But we are looking to redirect some of that innovation more towards affordability, not just capability.

I think that will help our positioning over time.

And I think it will help our customers as we bring forward ideas that will help deliver much of this capability for lower cost.

So, sometimes that's a difficult thing to get your head around because you become accustomed to a certain way of doing business.

But comprehensively across the board, in our businesses we are executing our business that way.

I mentioned earlier Global Hawk.

I think that's a good model.

It's not a perfect model because it's not exactly the same set of issues as we see in other areas.

But I think in terms of a model for how to work with a customer to really go after cost, it is a good lesson learned that we are applying broadly in the Company.

And to the second part of the question of portfolio shaping.

Has that getting any increasing interest on your part?

We've been doing a lot of portfolio shaping.

You might remember we divested task.

You might remember that we spun out ship building.

You might remember that we decided to exit the state and local IT business out sourcing business over time.

And we sold the EOS business.

And earlier this year, we announced reshaping of our technical services portfolio.

So, you might, can tell, we kind of like portfolio shaping.

There's a lot we've been doing.

We think it can create a lot value.

And I think any healthy company is always carefully examining its portfolio to make sure that we are really focused on the right things for the future.

I'm not going to try to get out front and any predictions on other things we might be doing.

I would just point to our behavior over the past couple of years and characterize that as indicative of the way we think about value creation.

Cai, I would add that as we think about portfolio potentials, we tend to look at how well is the business performing, how well is the market performing, and how well our we positioned in the market to help us make decisions about whether or not that piece of the business is something that is really going to fit with our business on a go forward basis.

Thank you very much.

Thanks, Cai.

Heidi Wood; Morgan Stanley.

Nice quarter.

Paul, in addition to congratulations on your new horizons.

Wes, congratulations on adding a new title of Chairman of the Board, as well as CEO now.

That was nice to see.

Thank you Heidi.

I am going to gear my questions away from the domestic environment, which you can't influence.

And I would to, Wes, have you talk about the initiatives of expanding into Northrop's growth overseas.

I happened to see you in a UAE defense article, so it's clearing you've got focus there.

Can you tell us about what you are doing there?

Yes, absolutely.

And let me characterize the international environment broadly, as well, so that there's a good perspective on this.

There are a number of areas around the globe that are cutting back defense spending.

And we have to be mindful of that when we think about our strategies and how we are positioning.

There are other areas around the globe that not only are investing in defense but are reshaping their priorities.

And as we look at some of that reshaping that is going on, we are seeing a move into some of the areas where we do have, I would say, more discriminating capabilities.

As I mentioned on some of our prior calls, one of the key factors in this for us is export ability.

And I have welcomed, as have others in our industry, really welcomed the work that this administration is doing to stand back and take I think a more sensible approach to thinking about how we manage defense exports in our country.

That has enabled us and others in our industry to start having a little more expansive discussions with some of our allied partners around the globe on the potential for exporting some of our more modern capabilities.

I just point to Unmanned as an example of that.

As we have been thinking about the needs of our partners, and what's interesting to me about this is if you go over into the theater of operations are partners are using these systems all the time, side by side with us.

So, recognizing that reality as we are thinking about export I think it's very important.

But if I think about Unmanned for just a moment, we are seeing a growing interest in Global Hawk around the globe, and Fire Scout is another area of substantial interest.

Those areas of interest are both, I would characterize it, in the Middle East, and through out our partners, our allies in Asia and the Pacific Rim.

That's an example.

We are continuing to focus our international business through electronic systems and IS and a little bit through TS as well.

But I would say, perhaps an interesting change to reflect on is, what we are seeing in aerospace systems, primarily with Unmanned but also the manned systems, the E-2D program, and of course we are big players on F/A-18 and joint strike fighter.

So, this will be a little bit lumpy around the globe just because the customers are all different around the globe.

Every country has its own set of priorities.

But I would say compared to where we were just a few years ago, we are seeing a lot more forward looking opportunity at aerospace systems than we have been seeing.

Good, thank you.

And just as a follow-up, Wes, can you talk about M&A in your assessment as whether you're seeing some attractive properties that might get dislodged and available for sale given the budget outlook?

I would say most of what we have seen come onto the market of late has an extraordinary high multiple attached to it.

But we do look.

We're going to be very disciplined about how we approach this.

It's important for us to look and be engaged in assessing what is out there on the market so if there are opportunities to create value we will be addressing those opportunities.

But I think you will see us being disciplined.

Okay, good.

Thanks very much.

Robert Stallard, Royal Bank of Canada.

Thanks, good afternoon.

Good luck to Paul in his new role.

Jim, I thought I would tackle you on the OCO side of things.

I noticed you had a little bit of a knock in the quarter from the troop draw down.

I was wondering if you could size that you think your exposure might be to military operations to date and whether you see any other business lines that could have pressures going forward from here?

In terms of OCO exposure, actually we are not that large.

The electronic systems, in addition to OCO does have some, as we said, sales to the Army itself in the regular budget.

We have some exposure there, if you want to characterize it that way.

I think what we've seen is more on the OCO side at this point, but as we have said in the past, it is relatively nominal.

Probably, that draw down we are seeing in our guidance is much of our OCO type activities.

So, what is done in 2011 and how much more do think there is left to go?

Our guidance for the year is in the $200 million draw down period

Okay.

Thanks Robert.

Jason Gursky; Citi.

Just two quick follow-up questions to things that have been asked earlier.

You did go out of the way this time to quantify what you are describing as Army, or OCO, related things in the ops temp.

So, I think it would be helpful it for us all to know if you have the ability to quantify what's remaining, if the OCO went to zero over the next couple of years, what that might mean for you.

And then, secondly, on Cai's question with regard to some of the actions that we've seen at other companies.

Can you describe for us where your head count sits today relative to where it did five years ago?

It's gotten a little bit lost in light of the HII spend.

It would be a good metric for us to all follow to get a sense of how much of cost actions might be left at Northrop at this point?

I think we are going to have to have Paul or Steve get back to you with any of those various details.

And we generally don't do a detailed accounting on headcount because it's a little bit, in many respects, not as meaningful as we shift on some programs from what's internal to what's external.

I'd be reluctant to point to headcount as a measure of the action.

You have to think a little bit more perceptive approach to looking at that.

But, obviously, our headcount is down.

I would caution you, Jason, as you are looking at what other companies are doing.

We could go out tomorrow and announce a big head count reduction, but that just might mean that we shipped it cost somewhere else.

You have to look at the total cost profile for that to be a meaningful discussion.

But to try to put some of this into perspective, we did, two years ago, combine 4 sectors into 2.

Absolutely.

In the process of doing that we reduced our cost about a couple hundred million dollars in each of those combined sectors.

I do agree that headcount is not the right measure.

You can simply outsource activities or subcontract activities.

But headcount is down.

Maybe a better way to ask that question is, if you were to have a pipeline over the next several years, are margin rates sustainable at this point and what do you have under your control to be able to sustain them?

As I've said a couple of times recently, I believe our long-term margin rate guidance that we talked about for each of the four sectors are sustainable over the long term.

That's helpful.

Thank you.

Thank you.

Sam Pearlstein; Wells Fargo.

Good afternoon.

Jim, I just wanted to go back on the comment you made about pensions.

Can you repeat why it is running higher than expected, and what your outlook is for this year?

And then, if you couple how performance looks year-to-date plus this $500 million contribution, how are you thinking about FAS/CAS as we go into next year at this point relative to this year?

Okay, so, at the beginning of the year given those headcount reductions that we just talked about, from combining the sector operations, I had a concern that our demographics that went into our initial estimate of FAS/CAS would be light.

So, I essentially hedged what was our pension income for potential demographic changes.

We have now completed our update to demographics, headcount, age of the population, years of service, all of that kind of stuff.

And, as it turns out, there were some changes in demographics, but there were other impacts that offset it.

So, the estimate for the FAS/CAS pension difference for the year is $400 million.

Previously, I had an estimate of $355 million.

It is essentially finalizing the demographics.

In terms of pension sensitivities, we talked about these in the past, and I need to update them for the impact of the shipbuilding spend.

So, let me just go through those real quick.

For every 25 basis points change in the discount rate, either upwards or downwards, that's about a $65 million impact to the net FAS/CAS difference on a go forward basis.

Likewise, our investment returns, for every 100 basis points difference for long-term rate assumption, which as you guys know is 8.5%, so if we were at 7.5% or at 9.5%, 100 basis points, that's a $35 million impact to net pension costs on a go forward basis.

Frankly at this point, it is way too early to try to call what 2012 is going to be.

As you know, we don't set the discount rate until December 31.

I don't even look at what the discount rate would be today because it's meaningless.

I do look at that sensitivity that we just talked about.

And Sam, I think with that sensitivity, you have a perspective on where this could go for next year.

Thank you.

And can I just ask 1 other question in terms of the buyback activity that you had, and the agreement from May.

And some of that actual buyback would occur and move into the third quarter.

Is there any sort of assumption we should be using about what the ultimate settlement is in Q3?

It really is dependent upon actual purchases over time, compared to the initial purchase price that was established, which was an average cost of $64.17 through June.

You will see this in the queue, when you get the queue, we are at an average cost of $65.02, as I recall.

So, at this point in time, if we just bought the rest of the shares at that $65.02, we owe, on settlement, we would owe about $20 million or about 286,000 shares of stock.

We have the ability, the option, to sell in either cash or in stock and obviously we will make those decisions once the program is completed.

Probably in the third quarter some time period

Okay, thanks.

Thank you Sam.

I think that would wrap up our Q&A, as we have used up our hour here.

I would like to thank everyone for their participation, and, Wes, would you like to close.

Yes, thanks for joining us on the call today.

As we go forward, we are going to continue our strategic focus on making sure that we are driving performance with outstanding execution in our Company.

As we talked about today, shaping our portfolio continues to be an important part of our strategy.

And, of course, our capital deployment strategy, returning cash to shareholders is also critical to our overall approach to driving EPS improvements over time.

Thanks everyone for driving interest in our Company and thanks for joining us today.

Goodbye.

Ladies and gentlemen, that does conclude today's conference.

Thank you very much for your participation.

You may now disconnect and have a great day.