諾斯洛普·格拉曼 (NOC) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter earnings conference call.

My name is Ann and I will be your coordinator for today's call.

As a reminder, this conference is being recorded for replay purposes.

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

(Operator Instructions) We will be facilitating a question-and-answer session following the presentation.

I would now like to turn the presentation over to Mr.

Steve Movius, Vice President of Investor Relations.

Please proceed, sir.

Thank you, Ann, and welcome to Northrop Grumman's third quarter 2011 conference call.

We provided supplemental information in the form of a Power Point 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.

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

During today's call, we will discuss third quarter 2011 results, our 2011 guidance for continuing operations and 2012 pension trends.

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

Please go to Slide 3.

At this time I would like to turn the call over to Wes.

Good morning, everyone, and thanks for joining us.

Overall we are very pleased with our third quarter results.

We continue to demonstrate that we can generate shareholder value and EPS growth in a challenging environment by focusing on portfolio alignment, performance and effective cash deployment.

Our strong operational performance, combined with our ongoing share repurchases generated a 23% increase in EPS from continuing operations.

We are particularly pleased with the results from the sectors.

All 4 businesses generated strong operating income, higher margin rates and healthy book-to-bill ratios.

During the quarter, we repurchased 12.7 million shares, bringing total year-to-date repurchases to 28.4 million shares.

At the end of the third quarter, $2.4 billion remained on our share repurchase authorization.

Third-quarter free cash flow from continuing operations totaled $839 million.

This year through the end of the third quarter we have returned approximately $2 billion to shareholders through share repurchases and dividends.

New awards were also strong this quarter, totaling $7.8 billion for a book-to-bill ratio of nearly 120%.

As of September 30, total backlog was approximately $42 billion.

Based on the strength of this quarter's results, we are raising our guidance for EPS from continuing operations.

We now expect 2011 EPS from continuing operations of $6.95 to $7.05, which at the midpoint of the range represents year-over-year EPS growth of 20% before one-time items such as last year's tax benefit and the impact of our 2010 debt tender.

As we discussed before, we continue to make portfolio-shaping decisions and deemphasize certain business lines.

This includes decisions to exit non-core and underperforming businesses that don't provide attractive financial returns.

Recent examples are the sale of the County of San Diego outsourcing contract and our decision to exit the domestic postal automation business.

These portfolio shaping actions have contributed to a year-over-year sales decline, but have had a very positive impact on our Company's performance.

Excluding portfolio-shaping actions, full 2011 sales would be 2% to 3% lower than last year due to the market environment.

Our business continues to be impacted by budget uncertainty.

Due to the 6-month continuing resolution process in fiscal year 2011, the potential for an extended continuing resolution in fiscal year 2012 and the possibility of further budget reductions, our customers continue to be cautious in releasing funds for their activities.

While there is uncertainty regarding future budget levels we believe there is clarity regarding the threat environment and our customer's need for affordability.

With the draw-down of in-theater operations over the next few years, we believe the nation will focus on developing affordable solutions to address broader, emerging, and more capable threats.

In that environment we expect our relatively low exposure to the OCO budget, which is about 3% of our sales, will benefit us, as will our ongoing effort to cost-competitively position our Company.

We continue to focus on positioning the Company to perform in a more constrained environment.

It's more important than ever that we continue to aggressively address our cost structure, our operational execution and of course our productivity.

Over the long term we believe C4ISR, unmanned, cyber and logistics will continue to be priority investment areas for our customers.

This is where a substantial amount of our portfolio is focused, and I thought it would be help to touch on each area before discussing the sector highlights.

Let me begin with our broad unmanned capability which in addition to fixed wing and rotary vehicles, also spans sensors and processing.

In total, unmanned currently represents about 10% of total sales and it is growing.

Global Hawk continues to achieve important milestones and improved affordability.

International interest in Global Hawk from our allies continues to grow and we see this capability as an important part of future commerce with our allies.

Our BAMS derivative Global Hawk is also progressing well and the X47B, our unmanned demonstrator for the Navy, recently completed a successful demonstration of ship-based softwareing systems that will play a key role in its ultimate operation from the deck of an aircraft carrier.

We expect continued strong demand for C4ISR capabilities as the global threat profile continues to expand.

Our nation and our allies are increasingly dependent on C4ISR to understand and address these threats.

And our extensive sensor technology and our processing capabilities are well-positioned to support information gathering efforts.

In cyber security, we are working with defense and intelligence communities to address the rapid proliferation of threats.

We are also successfully migrating tools and solutions developed for the .mil domain into the .gov domain.

And this represents a significant growth area for our cyber work.

And in logistics we continue to address the need to maintain and modernize aging equipment upon which our customers will depend as the number of new start programs diminishes.

Turning to the sectors, in addition to progress on unmanned programs, during the quarter aerospace was awarded a $795 million contract to continue production of E-2D Advanced Hawkeye's under LRIP Lot 3 and to procure long-lead materials for Lot 4 aircraft.

We were also awarded a contract modification for an additional Lot 2 aircraft.

In electronic systems, our GATOR program has made tremendous progress in terms of the system design and development.

GATOR is the first AESA based multi-mission radar for the Marine Corps.

It replaces 5 different legacy radar systems and it's a model for affordability, not only in acquisition costs but in savings realized in training and sustainability of a single system.

With several requirements for other new development ground-based radars being considered by the DOD, the rapidly maturing GATOR system provides a highly capable and affordable alternative.

And in the third quarter ES was awarded a contract to deliver advanced threat warning sensors as the latest upgrade to our Department of Navy Large Aircraft Infrared Counter Measure System, also known as LAIRCM.

In information systems, we recently won 2 key healthcare IT awards.

IS received the Centers For Medicare and Medicaid task order to develop a system to identify high risk claims, in order to detect and prevent fraud waste and abuse.

And we won the Department of Health and Human Services' Electronic Data Processing Systems award.

EDPS will track and aggregate Medicare data to support risk and pricing models.

Both of these awards are aligned with our focus on the higher-end, high engineering content part of the healthcare IT market.

And our BACN system continues its mission-critical in-theater performance.

We've received follow-on awards to extend service, continue operations and maintenance and provide essential payload elements for interoperability testing.

And a number of go-forward alternatives for additional variance are also being considered.

Technical services received an award modernize the unmanned Hunter MQ-5B system to a digital configuration and provide interoperability engineering services for our Army customer.

In conclusion, it was a very strong quarter.

Superior operating execution and effective cash deployment more than offset top line pressure.

We continue to demonstrate that we can create value in an environment of constrained top line growth by focusing on our key priorities.

Performance and execution that supports our customer's need for affordability.

Aligning our portfolio with priority areas of customer investment that provide attractive rates of return.

And effectively deploying our cash.

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

Thanks, Wes.

And good morning, ladies and gentlemen.

Let me start by offering my perspective on our quarterly results which I would characterize as a good strong operating and cash flow result, in a challenging environment that continues to put pressure on the top line.

The strong operating performance that I just referred to, together with improved net FAS/CAS pension adjustments, a lower effective tax rate and ongoing share repurchases, combine to generate a 23% increase in earnings per share from continuing operations.

On a pension-adjusted basis, earnings per share from continuing operations increased 8%.

Once again operational improvements have offset lower sales with segment operating margin increasing for both the quarter and year-to-date.

All of our businesses executed well.

Operating margin rates expanded in all 4 sectors and all 4 sectors generated book-to-bill ratios greater than 1.

Quarterly segment operating margin rate expanded 110 basis points to 11.8%.

And total operating margin rate expanded 230 basis points to 12.5%.

I would also note that on a pension adjusted basis, our operating margin rate expanded 80 basis points for both the quarter and on a year-to-date basis.

As a result, pension-adjusted operating margin rate was 11% for the quarter and 10.9% year-to-date.

Given the focus most of you have had on the top line, I thought it was appropriate to spend a few minutes on some of the drivers of our year-over-year sales decline.

There are 3 principal drivers causing the lower year-over-year sales.

First are the strategic decisions to deemphasize non-core underperforming businesses that Wes referred to.

Second is the transition to a units-of-delivery method on the F-35.

And third are the external budget pressures.

Much of the decline in the expected full-year year-over-year revenues is driven by our actions to deemphasize or sell non-core and underperforming businesses.

This includes the reduced participation in the Nevada National Security Site joint venture, which accounts for $580 million of reduced revenues on a year-over-year basis.

As well as about $250 million net results from deemphasizing several other businesses and contracts.

These include the base operations -- some base operations support and technical services.

The sale of the San Diego outsourcing contract and information services.

And our decision to exit the domestic postal automation business and electronic systems.

I want to reiterate what Wes said.

It is important to recognize that these portfolio-shaping action have contributed to the performance improvement we generated both in the third quarter and on a year-to-date basis.

Secondly, with the anticipated move away from the cost-type contracting environment for the F-35 program, we are transitioning to a units-of-delivery revenue recognition model with LRIP 5, which will reduce 2011 revenues by about $225 million.

The third factor reducing sales is attributed to the customers' spending challenges and budget pressures, as well as in-theater draw-downs.

The current [CR] and the impact on the current budget reduction discussions continue to constrain customer spending.

Our prior guidance contemplated some improvement in the funding environment in the second half of the year, which would have offset some of the portfolio shaping and F-35 impacts that I just discussed.

But with the impact of the ongoing deficit discussions and the current continuing resolution for fiscal 2012 I would now expect our fourth quarter revenues to be roughly comparable to this quarter.

Let me spend a few minutes and walk through the third-quarter results for each of the sectors.

In aerospace systems, third quarter sales declined 5% due to reduced funding for the weather satellite programs and the James Webb Space Telescope program, as well as lower volume on several other space programs.

Lower revenue on the F-35 program reflects the revenue recognition transitioning to a units-of-delivery revenue method from a cost-incurred method, beginning with LRIP 5.

Rather than recognizing sales as costs are incurred, sales will now be recognized as units are delivered.

This is essentially a timing difference which reduced AS sales by about $50 million in the third quarter.

The impact of this timing difference will increase over the next few quarters before it begins to reverse in the second half of 2012.

Despite lower sales, AS third-quarter operating income was comparable to last year.

Operating margin rate expanded 60 basis points to 11.8% due to improved program performance and somewhat lower amortization of purchased intangibles, which were partially offset by a negative performance adjustment on a space program.

Based on year-to-date results we now expect AS sales of $10.6 billion, with an operating margin rate in the mid to high 11% range.

AS ended the quarter with a total backlog of $18.1 billion which reflects new awards of [$27] billion, the largest being the E-2D award that Wes mentioned.

Book-to-bill for the quarter was about 105% in aerospace.

Turning to electronic systems, where sales increased 2% due to higher volume for ISR targeting systems and enabled marine systems.

Operating income at ES increased more than 12% and operating margin rate expanded to 15.4%.

Higher operating income and margin rate for the quarter resulted from performance improvements across various programs, including the achievement and a cost incentive for a space program and improved performance on an international radar program.

These program performance improvements were partially offset by a $25 million loss provision for a dispute on the flat sequencing system domestic postal automation program, which as Wes mentioned, we are exiting.

Based on year-to-date results, we expect ES sales of approximately $7.4 billion with an operating margin rate in the low 14% range.

ES total backlog at the end of the third quarter was $9.9 billion and reflects new awards of $2.3 billion during the quarter with a book-to-bill ratio of about 120%.

Information systems had a sales decline of about 8% for the quarter.

Primarily due to lower volume for defense and civil systems.

Sales were also impacted by our program completions and the sale of the County of San Diego outsourcing contract, which had quarterly sales of $32 million in last year's third quarter.

IS also continues to be impacted by the fiscal 2011 continuing resolutions and budget disruptions which reduce funding for existing programs.

As our shortest-cycle business, budget reductions impact IS sooner than in some of the other areas.

Despite more sales, IS operating income for the quarter was relatively stable and operating margin rate expanded 70 basis points.

The improvement is due to better performance in civil systems, including the benefit of the sale and of the County of San Diego contract.

Based on year-to-date results, I now see IS sales of about $8 billion with an operating margin rate in the low 9% range.

IS ended the quarter with a total backlog of $10.5 billion reflecting new awards at $2.6 billion and a book-to-bill of just over 130%.

Moving to technical services.

Third quarter sales declined 22%, primarily due to the reduced participation in the Nevada National Security Site joint venture which last year represented sales of $163 million.

Operating income in technical services was comparable to last year and operating margin rate increased 170 basis points, principally due to the change in the joint venture participation.

Based on year-to-date results, we expect TS sales of about $2.6 billion, with the operating margin rate of about 8% for the year.

Technical services ended the quarter with a total backlog of $3.5 billion, including new awards of $861 million and a book-to-bill ratio of about 125%.

For the Company, based on the strength of year-to-date results we now expect a segment operating margin rate in the low 11% range and a total operating margin rate in the high 11% range.

The increase in total operating margin rate reflects operational improvements we achieved to date and assumption of about $200 million for unallocated corporate expenses and some potential risk items.

Turning to cash, through 9 months, cash provided by continuing operations before discretionary pension contributions is approximately $1.4 billion and free cash flow before discretionary pension contributions is about $1 billion.

Based on our year-to-date results we are on track for our cash guidance for the year.

As Wes mentioned we have increased our guidance for 2011 earnings per share from continuing operations to a range of $6.95 to $7.05 on a per-share basis.

And as Slide 4 indicates, our increased earnings per share guidance reflects an additional $0.10 to $0.15 for improved operating performance and $0.10 for lower diluted share count.

I now see a reduction in weighted average shares outstanding for the year as slightly more than 6%.

I know many of you are focused on pension trends for 2012 so I wanted to provide an update in this area.

Assuming our current discount rate and expected long-term rate of return on plan assets of 8.5% that as well as a host of other assumptions on mortality, wage increases, et cetera.

2012 net FAS/CAS pension adjustment will be comparable to this year's income of about approximately $400 million.

Year-to-date through last Friday, estimated plan asset returns are slightly more than 5%.

And as we have discussed last quarter, every 100-basis-point difference from our 8.5% expected long-term rate of return represents approximately $35 million of FAS expense.

And for the discount rate, every 25-basis-point variance is about $65 million of FAS expense.

Obviously we don't know exactly where interest rates will end the year.

But if I were setting the discount rate today, my cursory look would suggest a decrease in the range of 25 to maybe 50 basis points from our current rate of 5.75%.

We continue to be very focused on managing the business for superior execution and strong cash generation, while effectively deploying cash to create shareholder value.

Included, obviously, is investing in our business, distributing cash to shareholders in the form of share repurchases and dividends and managing the balance sheet.

I would like to reiterate that year-to-date we distributed approximately $2 billion to shareholders through share repurchases and dividends.

At the end of the quarter we had $2.4 billion remaining on our share repurchase authorization.

On the balance sheet side, we will continue to monitor our pension plan investment performance and cash-flow forecast to gauge whether or not we should make another discretionary pension contribution either later this year or maybe even early next year.

In conclusion, we are pleased with this quarter's results, especially the performance of our businesses, and we remain focused on generating value through portfolio optimization, performance, and effective cash deployment.

Steve, with that overview, I think we are ready for some Q&A.

Thanks Jim.

In the interest of providing everyone an opportunity to ask a question, we ask that you limit yourself to 1 question and 1 brief follow on.

Now Ann, we are ready to take our first question.

(Operator Instructions) Howard Rubel with Jefferies.

Wes, you have been pretty good in anticipating a bunch of these changes and while you talk about some of your businesses having some growth opportunity, how would you characterize really the potential to show revenue growth over the next couple of years?

Well, it's certainly going to be a more challenging environment.

And so -- and let me give you a little bit of a flavor staring into 2012 as best we can.

And again, we're not providing 2012 guidance on this call so this is more in the category of flavoring.

I would say beyond that we are just going to have to continue to see how the budget environment shapes up as we go forward.

But I would characterize it this way.

Based on what we know today about 2012 budgets, the budgets appear to be heading towards I would say sort of a flat outcome relative to 2011.

And in terms of translating that into us, we would expect slightly reduced sales in a flattish environment due to the continuing impacts of some of the decisions we have made and these are proactive decisions we've taken on.

One, the set of portfolio shaping actions that we have been talking about now for sometime.

As well as what Jim mentioned, the change in our approach to accounting on F-35 moving over to units-of-delivery.

So, when we put those 2 things together.

That represents in the range of $450 million to $500 million of downward pressure on our top line for next year.

But I have to add, there can be additional changes in the budget environment.

Whether it's a result of sequestration or other budget outcomes.

And even though technically those things are targeted to cause changes that would commence out in the 2013 timeframe, we know from observing our customer behaviors over the course of this year, that those changes would likely translate into customer actions in 2012.

So even though I would characterize the 2012 budget environment as being from what we can tell right now, rather flattish, it all depends on what happens over these coming months with a lot of the budget debate that's going on.

I am encouraged just to balance that out a little bit, very encouraged by the strong statements that we are seeing from the national leadership both the Secretary of Defense and others in the administration, as well as a number of critical congressional members who are calling for the preservation of a robust national security spending profile.

So that's on the encouraging side of the equation.

But realistically we, like most others in our industry, are preparing for a range of outcomes to make sure that we stay competitive and that we are positioned to create value irrespective of which way we see this go.

There are meaningful opportunities out there, and as I went through the perspective on our portfolio, unmanned, cyber, C4ISR and logistics, in all of those areas, we see priorities for customer investment.

The question is going to be how much capacity do they have to apply towards those priorities.

I see that and you also seem to indicate that there is a number of international opportunities that are possible.

Are any of these really close at hand?

Or is this -- I mean as you sort of see it, your 2012 -- I don't want to talk too much about 2012 either and get you there, but if you sort of look at it, you don't have a lot of holes to fill for '12.

There is more a potential for opportunity.

Is that the way to think about it?

There is always a balance between the negative budget pressure as well against some of the opportunities.

International is an interesting area.

I've learned a long time ago never try and project the timing on international awards.

There are so many variables involved there.

But there are some very substantial international opportunities on the horizon.

The unmanned interest in our unmanned capabilities just continues to grow.

And it will take a little bit of time for all of the policy decisions to be sorted out and the exact decisions on who can buy what.

But I see that as a very meaningful set of opportunities for us.

And just more broadly in the C4ISR profile I also see some very meaningful opportunities for us around the globe in that arena as well.

So, yes, international will be an important part of our perspective as we think about managing our portfolio going forward.

Projecting the timing is a little difficult.

Thanks, Wes.

George Shapiro with Access 342.

Question I had, Wes, is one general one and one follow-up.

If the sales next year will be down a little bit, the book-to-bill is all being well above 1 would imply that the duration of that what's being booked now is somewhat longer and that would be the reconciliation of those 2 comments?

Well we will have to see how that actually plays out.

What I indicated was some pressure on our top line for next year.

In terms of the ongoing effects of the portfolio decisions as well as the accounting change on F-35.

I want to be careful I'm not giving guidance for next year.

We will think about doing that as we have our call at the end of the fourth quarter.

But your observation is a good one George.

Book-to-bill was strong this quarter.

I think our backlog is holding up nicely and a lot of that is longer term work.

But it depends on which of the sectors in the Company that we are talking about.

AS is usually the longer term cycle on the awards where as IS and certainly TS are much shorter and ES is somewhere in the middle.

Okay.

And then just one for Jim.

In the aerospace sector you mentioned there was an unfavorable performance adjustment for a space program if you could just quantify that a little bit.

And then in electronics you gave the number for the flat sequencing system, but you also said there was some positive adjustments.

So, kind of what was the overall net-net effect in the electronics area?

In aerospace, the adjustment on the space program was about $18 million negative.

An adjustment to change our booking assumption related to future on-orbit fees.

And then in electronics, yes there are $25 million adjustment on for the dispute around the postal -- domestic postal program.

But that was partially offset by positive adjustments, more than fully offset actually by $17 million of the cost performance achievement on the SBIRS program as well as a $14 million international radar performance improvement.

Net-net, ES had positive performance adjustments, including those 3 items as well as some smaller items as well.

Okay.

Thanks a lot.

Doug Harned with Sanford Bernstein.

I'm interested in information systems.

And you had a very good -- you've had a very good backlog there now this quarter.

Your margins have been strong.

When you look out, this is an area at shorter cycle.

I think there are a lot of concerns about the federal IT budget environment.

And there appear to be a lot of competitors trying to move after new starts.

What are you seeing when you look forward, both in terms of the competitive environment, and in just the general margin and earnings trajectory that one might reasonably expect?

Well Doug, let me give you a little bit of a flavor on the environment.

If we look at the top line trajectory in IS over the course of this year it's pretty much inline with what we are seeing across the market.

Interestingly if you dive into it a little bit, we have 3 major components of IS.

We have intel business, the defense business and a civil business.

Intel and civil are essentially flat over the course of the year taking into account as Jim mentioned in his remarks, the sale of the County of San Diego contract.

The decline that we have seen has been primarily in defense.

And when you analyze what's happening there, it is essentially pretty much across the board a very broad array of program activities where we are seeing lower funding levels driven by the customer's behavior as they are dealing with the complexities of their budget environment and all of the challenges that those customers are dealing with.

I think it's important to understand where we are seeing the effect and how that effect is manifesting.

This is a market where there are a lot of competitors.

When IS goes to market it goes to market oftentimes against 4 or 5 competitors.

So, there is a lot of competition.

It is a market with a lot of variation as well in terms of how the products and services are offered.

We tend to position towards the higher engineering content side of that marketplace.

And we have got some good competitors out there.

But, we continue to see it as an attractive market.

There is a continuing need on the side of the government both the DOD and the intelligence community and the civil community to modernize the systems when it comes to cyber security.

To better protect the systems.

And over time to actually put the government in a position of saving money by having more modernized and efficient IT systems.

So, it's a meaningful market but certainly a lot of competition.

Are you seeing margin pressure when you look forward with this higher level of competition?

We've given a view that I think we continue to see as the right view that a margin rate of around 9% in that business is sustainable.

And I haven't seen anything that would cause us to change that outlook.

Doug, if I might, I would add that I look at our information services business I'd characterize it as 2 broad categories, maybe 30%, 35%, 40% in that kind of range is service.

The balance, let's call it 60% is much more in software development and integration, hardware integration, kind of product if you will, product development.

Yes.

Clearly, I think we are seeing greater pressure on the services side potentially.

It's always been characterized by a significant number of competitors and so that's the nature of the business, basically.

Okay, well that's helpful.

Thank you.

Myles Walton.

First one is just more of a clarification Jim.

Reconciling the discount rate 25 basis point to 50 basis points kind of would be where you snap the line today.

And I guess I was just trying to reconcile that with 100 basis point drop in the AA Corporate and kind of what some of the other industrial companies are looking for, more in the 75 basis point to 100 point basis point area.

Any thoughts there?

Myles, we -- our discount rate is developed based on a AA bond portfolio exactly matched to the maturities of our pension liabilities.

And so when we have done that in the past, that kind of and using that model at today's point, that gives us a roughly 25 basis points to 50 basis points of reduction in discount rate.

At this point, it's almost meaningless as you know we set the rate at the end of the year.

But snapping the line as of 9/30 we were looking at about 25 basis point to 50 basis point decline.

Okay, fair enough.

And the real question was on the F-35 Lockheed is talking about the expenditure before contract essentially on the lot 5.

And I know for you guys lots 4 I think price point, I'm not sure, you have finalized that.

Can you give us an update where you are on both lot 4 and lot 5 in terms of definitizing your pricing and also if there is any read-through implications for you building off of contract or pre-producing before contract is offered?

Let me take the last piece first.

On LRIP 5, we have at this point I'd characterize as a $50 million exposure if the program were to be terminated for some reason at this point in time.

So it's something that we are mindful of and thoughtful of, I think that we will continue to monitor this as we go through time.

But it's a really important program as you know for our customers.

And we just have to come through the negotiations around the contract at the prime level and then we will get our negotiations I think in shortly after that completed as well.

On LRIP 4 we continue to have conversations.

We, I think are pretty well close.

We don't have a final deal as yet.

But continue to work towards the deal.

Okay.

Now Myles, this is Wes.

Let me add on LRIP 5, it is really important that this contract get funded.

In terms of keeping these -- the overall production process on track to enable industry in the end of broad supply chain that supports industry to enable us to continue to work on affordability.

So, there is a direct connection between affordability and getting this thing funded.

And I know that everyone is working hard on that.

We are working to support the process as best we can.

But that is a key factor to keep in mind relative to this program.

Getting LRIP 5 funded is a critical next step.

Is there any type of -- I don't want to say drop dead date but, I mean is this just it gets more painful the further on you go and there is no real drop dead date though?

I think everyone has to think through where we all stand on this.

The position that I would say broadly industry is taking is we always work with our customer.

Our customer's under great duress right now.

And we are working hard with our customer.

But we are not in the business of financing these programs.

So there comes a limit in everyone's capacity to deal with that.

So, it's something that I would say that there is strong alignment on across industry and we were working as hard as we can to be supportive of the program but we recognize that we've got to get this thing funded.

Okay.

Thanks.

Joseph Nadol with JPMorgan.

Nice margin performance again this quarter.

And I wanted to dig into that a little bit from a high level just looking at the segment margins.

It seems that Jim, a couple of the revenue points -- points that you've pointed out in terms of revenue pressure also are probably helping lift your margins and of course you have good performance as well I'm sure.

But deemphasizing the non core businesses, those are certainly lower margins.

And then the budget pressure the new start revenue that is not coming in presumably would have been lower margin revenue.

So, is there is a way to quantify maybe of the 90 BPS improvement year-on-year for the quarter or the 110 year-to-date, how much of that is maybe the -- due to those issues?

And then really what I'm looking at is going forward, you think about your segment margins next year, do you think these levels are sustainable or do you think that the mix might provide a little bit of pressure if it normalizes?

Well, as Wes said and I want to reiterate, we are not providing guidance for 2012 at this point.

But at the same time, we have commented a number of times that our long-term margin rate objectives for each of the 4 segments we believe are representative of where those businesses ought to be performing over a long period of time.

Feel comfortable about that, even in today's environment.

As far as trying to quantify how much of this year's margin performance improvement is mix or other factors, it's very, very difficult to do.

Clearly the organization has had a increase focus over the last couple of years, frankly, on strong execution.

As you know, we have been very mindful of being prudent about the types of contracts we take.

Getting contract structures properly structured to reflect the risk inherent in the type of work that we are performing.

And ultimately making sure that we have a management team that is strong and focused on delivering both the product as well as the margins that were negotiated in the contracts.

I don't think I can really break it down into the elements that you are looking for.

It's a tough question.

I know.

Just as a follow-up on your pension comments, Jim, what is in terms of the flat FAS/CAS what is your assumption for each of the components for FAS and for CAS and I'm specifically trying to define your CAS expectations?

Actually, I don't have that number with me, but as I recall the CAS cost accounting number doesn't move much on a year-over-year basis from '11 to '12.

I would have to get back to you on other numbers -- in actual numbers.

As I recall there is not much improvement or change in cost accounting pension expense from '11 to '12.

Okay.

Thank you.

Carter Copeland of Barclays Capital.

Just I want to go back to one of your growth areas and that you talk about in cyber and General Clapper was commenting a week or 2 ago about the pressure that we may see on IC budgets and the intelligence community participating in the budget cuts and deficit reduction.

I wanted to know -- I mean, it's part of your business I know it's tough to talk about.

But, as you think about that growth avenue in the context of that sort of commentary, have your expectations there changed at all?

What are you seeing there?

How are you thinking about that?

Is there information in there that we should take notice of?

Another way we characterize it just fairly broadly is kind of in 2 pieces.

One intel and then more broadly.

On intel clearly every part of the federal government is going to have to participate in the efforts to work on the budget deficits.

And I think Mr.

Clapper's statements were reflective of that.

That said, within each of the budget areas there are going to be priorities and we continue to see cyber as a priority, a very high priority because of the just effort growing recognition of the threat and the ever growing magnitude of the threat.

So, within intel we continue to see cyber as a priority.

But the second prospective is the broader perspective which is, cyber for many years had been something that had been largely focused in the intel and defense communities as the primary concerns around what the threats might be capable of doing with respect to challenging the nation's capabilities.

That is no longer the case.

Clearly intel and defense continue to be very, very concerned and very focused on cyber.

But that concern is now expanded across the government.

And even beyond government.

And as I think I mentioned in my opening remarks, as we see the concerns migrate from if you will, the .mill domain into the .gov domain the need for cyber security and cyber protection is continuing to expand.

So, we think this is an important part of our overall portfolio and we do see it as high on the priority list in just about any scenario going forward.

So, what is it -- so if the IC budget needs to contract but cyber doesn't, what is it that has to lose?

It seems like a zero sum gain to me.

Clearly there will be other aspects of it and I really wouldn't want to go into the other elements of the intelligence community budget.

But it will be a portfolio balancing process that the intelligence community has to go through just as the DOD is going through.

Great.

Thanks.

Understood.

Cai vonRumohr with Cowen and Company.

So, just 2 follow-ups in terms of risk issues.

Have you completed your contract with Boeing on the F-18 and secondly, given that you took a loss on a postal contract in this quarter, are we going to have to see any more losses to get out of this business?

Let me take the last one first.

Obviously if we thought there were any more losses that we had to take we would have booked them in the quarter.

Obviously every quarter addressed the situation so it's dumping changes that will be reflected in that quarter's results.

Cai, based on what we know we got it.

But, as the environment changes we will address it.

On the F-18 multi year contract we continue to have negotiations or conversations with our -- with Boeing around that contract again making progress but I wouldn't characterize it as signed, sealed and delivered at this point.

And lastly, do you have any other contracts.

You've mentioned F-35 and F-18.

Any other contracts where you are a subcontractor where you are kind of working without a finalized contract?

I mean obviously not a $10 million job but any other large ones of substance?

I don't think so.

The key I think what you are really trying to get at is where you don't have funding.

So for example, just because we don't have a contract on F-18, we have funding and are being paid in accordance with normal practices for costs being incurred.

So I don't -- other than that -- the comments around the F-35 lot 5, I can't think of any substantial dollars or contracts where -- that we really have at risk associated with work that we have already performed.

Terrific.

Thank you very much.

Rob Spingarn with Credit Suisse.

Regarding the bookings and this goes back to George's question and Wes I think you did acknowledge that the very strong quarter here, of course.

But the earlier quarters were a little lighter.

What are you thinking for December?

Was this driven by the year-end for the federal budget?

We generally don't guide on awards and so I wouldn't want to get into the habit of doing that.

Third quarter is oftentimes a stronger awards quarter.

Particularly in IS.

Yes, particularly in IS where we have a little bit more of the short-term stuff.

However, I would say that this year has not been a typical year by any stretch of the imagination with the effects of the continuing resolutions both last year at the 2011 CR and the prospect of a longer CR here in 2012.

So I wouldn't try and use my average year comparisons for this year because things have been quite a bit influx.

So, we will see how we do in the fourth quarter.

We are working that aggressively.

Working it hard of course to make sure that our backlog continues to be a healthy position for the Company.

But when I look at how we are doing competitively which is kind of how it comes out ultimately, I'm pleased with how we were doing competitively.

I think we are doing quite a good job in capturing the work that we are going after when I look at it in a broad sense across the Company.

And if we can continue to do that I think we will do just fine.

And then just on a cash return to shareholder basis, you have been very good about buying back stock and using your portfolio shaping opportunities to do that and a long history there.

Are you thinking at all about shifting the stock repurchase alignment against the dividend and perhaps favoring the dividend going forward?

There seems to be a trend there.

Rob, we continue to, as I said, with a $2.4 billion remaining authorization for share repurchases.

We like the balanced approach that we have had over the frankly since we started share repurchases in 2003 and I just would point out that since 2003 through the end of the third quarter, cash return to shareholders in the form of share repurchases and dividends is, in round numbers, 100% of free cash flow on an aggregate basis through that period of time.

I don't see much change in continuing to emphasize that both share repurchases and dividends.

We obviously view dividends as very important and as a long-term commitment to our shareholders.

So we look at both the competitive payout ratios as well as using other cash to be able to purchase this stock when prices are -- we find attractive.

But would you see any value perhaps in having a higher dividend yield given what some of your peers have done in order to send that message on your long-term confidence?

You know, you mentioned yield.

I am not a yield focus guy.

I can get yield up by having the stock loss decline.

I am a payout focused guy.

As a Company think about it in that term.

And we think that we have competitive payout ratios.

Thank you.

Heidi Wood with Morgan Stanley.

Wes, I want to turn back to this F-35 issue and explore it just a little bit more.

And I'm just-- admit I'm a little confused about your statements about being encouraged by strong statements from leaders.

Because we have Shay Assad on record talking about being willing to break glass in the industry.

And going through this should-cost review.

Should we take this to mean that this should-cost review is going to be confined to the F-35?

I guess I'm just a little worried that this is the canary in the coal mine.

Well Heidi, my commentary with respect to strong statements by leaders was with respect to the robustness of national security spending.

And the view that Secretary of Defense and as I think I mentioned others of the administration as well as some senior leaders on Capitol Hill have been very public in expressing over these last number of weeks that it's imperative that even though we've got to all work hard in deficit reduction, we have to protect the national security.

I see that as very, very encouraging.

� With respect to the implementation of the variety of initiatives under way in the pentagon, I do think that the should-cost methodology is a broad methodology that is intended to be applied in a variety of different circumstances.

I wouldn't know how to project what the full breadth of that application might be.

But it's something that I do think we will see in an increasing amount.

It remains to be seen what that translates into for contract outcomes.

Obviously the government, the department needs a set of methodologies to make its determination of value and cost on contracts.

But there is always somebody else at the table and that's industry.

Industry also has to make its determination for what we are willing to do.

Of how far we are willing to go in terms of the risk side of the equation.

And what reasonable profitability opportunity needs to be on those contracts.

So it's not 1 sided.

It's 2 sided.

And we have to be able to work our way together through this.

So, I would say there is probably a little bit more tension in the system right now around how all this is going to work.

And what the real outcomes are going to be.

But we are going to have to plow through it.

All right.

And then a follow-up.

You and I have had discussions about how you are shaping Northrop Grumman in keeping with what you see ahead.

You have been obviously divesting in a thoughtful and disciplined way.

Should we expect to see as we look ahead a pick up in M&A activity?

It will always for us come down to value creation.

And I will say in watching some of the recent M&A activity, it's been a little hard for me to figure out how with the multiples getting paid you actually generate a lot of value.

So, when we are looking at really high multiple, transaction multiples out there it's probably not the first place we go for value creation but we do look.

We are engaged.

We have not closed down our M&A department.

It's an important part of the long-term vitality of any organization to be engaged in bringing in capabilities.

I have said a number of times and I am still of the same mind that I don't see any big gaping holes in our portfolio today.

So there is not a strategic urgency that we are feeling around.

We have to go buy this capability or we have to go buy that capability.

But we were thinking about it in a broad way.

Thinking about the future of the industry and where the industry may shape out here in a different environment.

And I think you should expect us to be thoughtful but disciplined as we get into this process.

And if not then we will see more focus on share repo and dividends as usual?

We have had a long track record of doing that.

All right.

Thank you very much.

Sam Pearlstein with Wells Fargo.

Just on the use of cash, Jim, you had mentioned thinking about a discretionary pension payment either the fourth quarter of this year or into next year.

Just how do you weigh that just because obviously with the pressures you are going to see from the FAS side going into next year?

How do you weigh that relative to buybacks or dividends?

As I mentioned, we will look at both investment performance in the plan and then our cash flow expected results for the year as well as into next year.

As you know, our history in the pension plan has been to generate a nice returns in excess of our long term rate of return of 8.5%.

And so pension contributions in which you get a tax deduction and then generate those kind of returns that we've had in a historical basis is a very, very good use of cash.

Cash on cash returns on a historical basis in excess of 12%.

So, balance both wanting to make sure that our plan is very well funded.

Returning cash to shareholders as I mentioned.

So it's really a balancing activity around the effective use or deployment of our cash.

All right.

And then just in general, it sounds like what you have been saying is that the areas that impacted you in the second quarter in terms of a slow recovery from the end of the continuing resolution that the customer behavior really has not changed over the course of the third quarter?

Or is it actually gotten a bit little worse in terms of the time it takes for them to give you task orders, et cetera?

I would characterize it as a overall about the same.

In some areas it's a little bit better.

In some areas there is as I mentioned in my comments, we thought that there may have been some additional funding on certain programs that would have allowed us to offset some of the other declines that we were -- we had anticipated for example the F-35 change in revenue recognition model.

So on an overall basis I would characterize it as about the same.

Okay.

And just I'm sorry, one last question is for Wes or either of you.

Is are there any key orders or bigger orders that we should be thinking about?

I know like an LRIP 4 F-35 stands out when those comes in, but is there anything else that we should be thinking about that is big over the next say 6 months or so?

There is a whole variety of things that are out there.

No one in particular is make or break.

But I have mentioned a few of them already.

Maybe if I give you a little bit of flavor across some of the businesses.

In AS, unmanned continues to be an important area for us both domestically and increasingly international.

The UAE, the airborne surveillance program is important NAS.

And over the longer term UCLASS is a program that we were certainly putting a lot of attention and focus on.

But that's a little bit longer term.

In ES, I would point out the Kirkland program, that's the Army IRCM program that's upcoming.

The Air Force is working on upgrades to F-16.

I think that's going to be an important part of it and the Navy pursuing new class of radar that they call it Air and Missile Defense radar, AMDR That's an important set of future opportunities there.

In IS CANES on the Navy side is coming in the not too distant future I believe.

And I have already talked a lot about the cyber work and the different dimensions of that.

Ground combat vehicle where we are partnered with BAE systems is another very important program.

We will see how that matures and what the timing for that might eventually turn out to be.

And technical services has a whole variety of both sustainment and upgrade activities that it is out competing for in the not too distant future.

So, the whole Company is actively engaged in opportunities.

And pursuing them aggressively.

Okay, thank you.

David Strauss with UBS.

Wes, you described your exposure to OCO at around 3%.

Does that reflect the $200 million impact you have already seen this year?

Or is that prior to that?

And the 3% or so you do have left, how do you expect that to kind of come down here with obviously with what's going on in Iraq and the draw down in Afghanistan.

Well, it's the overall 3% is kind of 2 different pieces.

One piece of it is BACN.

BACN was an important component of the OCO business and how BACN transitions over time, does it find its was into the base budget or not we will have to see.

It's been very, very successful in-theater and there has been a growing view of its longer term importance.

So, hard to tell how that piece of it goes.

The other pieces of it are lots of different programs.

We talked on the second quarter about Viz was an important piece of it there was a huge push over the course of last year on Viz to get it deployed in-theater on all kinds of different vehicles.

And so this year's sales have come down substantially on Viz.

But the remainder of that is just a whole variety of programs that are providing individual pieces.

[Layercome] has also benefited from some of the OCO funding.

So, it's a little bit hard to tell with the planning in Afghanistan exactly which pieces of it come out at what time.

But again it's fairly distributed set of elements across our portfolio.

Okay.

As a follow-up based on your guidance, you're calling for a lower Q4 in terms of earnings, I think this might have to do with higher -- partially to do with higher corporate expense.

Jim, maybe if you can just give some color around that and maybe talk longer term the outlook for corporate?

It seems to keep coming in lower than what you are guiding to.

Well, David I know in the fourth quarter that we have taken some actions already in the fourth quarter.

Some head count reduction actions.

And so that will be somewhat of a drag in the fourth quarter.

And there are a couple of things in the corporate unallocated that at least have a potential to occur in the fourth quarter so all of those have been considered or factored into our thinking around the fourth quarter results.

And that concludes our Q&A.

Wes, any final comment?

I guess just to summarize, I would say our strong third quarter results demonstrate that our continuing focus on performance, portfolio optimization and cash deployment to benefit our shareholders is creating value for our Company and positioning us well for what is going to be a more challenging environment.

So thanks again everyone for joining us today and for your continuing interest in our Company.

Ladies and gentlemen, we thank you for your participation in today's conference.

Ladies and gentlemen we thank you for your participation in today's conference.

This concludes the presentation.

And you may now disconnect.

Have a good day.