諾斯洛普·格拉曼 (NOC) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Northrop Grumman's third quarter 2013 conference call.

My name is Francis and I will be your operator today.

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

(Operator Instructions)

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

Mr. Movius, please proceed.

Thanks, Francis.

And welcome to Northrop Grumman's third quarter 2013 conference call.

Before we start, please understand that matters discussed on today's call constitute forward-looking statements pursuant to Safe Harbor provisions of federal security 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.

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

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

Thanks, Steve.

Good afternoon, everyone.

Thanks for joining us today.

Once again our results were strong and reflect the hard work and dedication of the entire Northrop Grumman team.

I want to start our call today by acknowledging our employees' unwavering dedication in maintaining top performance in support of our critical global security missions, especially in challenging times.

As a company we are always mindful that our products and services are of critical importance to our nation and to our allies.

Today's budget issues are creating real challenges for both our industry and our government customers, compounding our nation's difficulty in addressing the modern global threat environment.

I'm very proud of the hard work by our employees and by our government partners who remain focused and committed to the mission we serve.

As we've said in prior quarters our strategy is focused on performance, effective cash deployment, and a portfolio aligned with our customers' priority investment areas.

All three elements continue to be major value drivers for our shareholders, customers, and employees.

We are focused on delivering affordable and innovative products and services for our customers and solid financial returns for our shareholders.

While declining defense budgets continue to pressure our topline and backlog, the substantial reductions we've made to our cost structure, including headcount reductions, facility consolidations, and numerous other affordability actions continue to support strong earnings and cash flow performance, and you can see this in our third quarter results.

Despite a 3% sales decline, third quarter EPS grew 18%.

Performance and effective cash deployment were primary drivers of the improvement.

Third quarter results included a 90 basis point improvement in our segment operating margin rate, the result of strong operating income and margin rates at all 4 of our businesses.

As expected our shorter cycle businesses, Information Systems and Technical Services, continued to experience more substantial topline declines as a result of the budget environment.

Despite lower sales, both sectors continue to deliver solid operating income and strong operating margin rates.

Our cash performance is also strong and we continue to return cash to shareholders.

During the quarter, cash from operations totaled $950 million and free cash flow totaled $860 million.

Year-to-date, before discretionary pension contributions, we have generated $1.6 billion in cash from operations and free cash flow of $1.5 billion.

During the quarter we used $753 million to repurchase 8.1 million shares of our stock, and year-to-date we've repurchased 20.6 million shares for $1.7 billion.

Including more than $400 million in dividends paid year-to-date we've returned more than $2 billion in cash to shareholders this year, substantially more than our year-to-date free cash flow.

In addition to deploying cash through share repurchases and dividends we are increasing capital investments to ensure long-term competitiveness, affordability, and innovation.

Third quarter capital expenditures increased, principally due to investments for the construction of our two new manned military aircraft centers of excellence in Florida.

Capital spending will also increase in the fourth quarter and into 2014 as our investment in these centers of excellence ramps up.

We ended the quarter with a total backlog of $37.5 billion, which reflects new awards of $5.9 billion, a 97% book-to-bill ratio.

Through the end of the third quarter we've captured $16.2 billion in new awards, for a book-to-bill of 88%.

These include significant awards for the F-35, Advanced EHF satellites, the B2, the E-2D Advanced Hawkeye and Global Hawk.

And during the quarter our SABR radar won the competition to upgrade US and Taiwanese F-16 with the next generation AESA radar.

This program is a key strategic win for us and will provide F-16s unprecedented operational capability and greater reliability.

Based on our year-to-date results we are increasing guidance for 2013 sales, earnings per share, and cash flow.

We now expect sales of approximately $24.4 billion and we expect EPS to range between $8 and $8.15.

Cash from operations is now expected to range between $2.3 billion and $2.6 billion with free cash flow of $1.9 billion to $2.2 billion.

Guidance for both those metrics -- those cash metrics is before discretionary pension contributions.

As we said last quarter we will provide 2014 guidance on our year-end conference call.

But we wanted to give you some idea of how we are thinking about 2014.

As you're aware after beginning fiscal year 2014 with a partial government shutdown, we now have a continuing resolution through January 15.

And the debt ceiling has been raised through February 7. We don't know whether we will have a formal 2014 budget, or like last year, it's possible that we may be operating under a continuing resolution for some extended period of time.

In addition, another round of sequestration is scheduled to be triggered in January.

These next couple of months are an important time for our Congress to address the budget uncertainties that have been created by the sequester and the breakdown of the appropriations process.

As the senior leadership of the DoD has said many times, the current environment is not supportive of planning and managing the institutions in our government that ensure our national security.

The inability of Congress to agree on a budget poses real problems for the long-term.

And the sequester is clearly impacting national security already.

But it's also having impacts on other elements of our society, such as reducing the research and development that underpins our future economy, and negatively impacting education at all levels in our country.

We need to return to a functional appropriations process in managing our country's affairs, and ending the sequester should be a first step in that direction.

As we look ahead, considering the budget environment, we would expect lower sales in 2014.

We expect our businesses to continue to perform well and generate strong margin rates.

We also expect strong cash flows to continue.

Our goal is to convert 100% of earnings into free cash flow.

This is before any discretionary pension contributions, and we've been successful at achieving that over the last few years.

The degree of topline decline will largely depend on budgeting decisions.

As we saw this year, our shorter cycle businesses have been more impacted by the budget turmoil.

We would expect this to be the case next year as well.

Conversely we would expect our longer cycle businesses to be less impacted.

Obviously, today's budget environment creates uncertainty.

But by focusing on the things we can control - performance, and capital deployment - we expect to deliver solid 2014 results.

This outlook assumes that our operations do not experience any significant disruptions as a result of major program cancellations or restructurings.

While the budget environment continues to be dynamic, we are positioning Northrop Grumman for the long term.

That means continuing to invest in a portfolio that is aligned with the enduring priority areas of investment for global security - unmanned, C4ISR, cyber and logistics and modernization, along with manned military aircraft.

It also means achieving and sustaining a high level of financial and program performance and effectively deploying our substantial cash resources to create value.

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

Jim?

Thanks, Wes and good afternoon ladies and gentlemen.

My comments will focus on third quarter and year-to-date results and our updated 2013 guidance.

As Wes said, just another solid quarter.

Our team has proactively responded to the challenging budget environment to ensure that we continue to execute very well.

I want to add my sincere appreciation for our team and their dedication and focus, particularly during the last several weeks.

Major drivers, as Wes said, for the quarter were performance and share repurchases.

We also benefited from a lower tax rate this quarter due to the benefits associated with our 2012 federal tax return and the R&D tax credit extension.

And we had an improvement in our net has FAS/CAS pension adjustment that reflects an update for actual demographic experience as of the beginning of the year.

The tax benefit added $0.07 and the pension benefit added $0.08 to third quarter earnings per share.

So before the tax and pension benefits EPS would have been $1.99 or about 9% higher than last year's third quarter.

Higher corporate unallocated expenses, as well as interest expense, along with lower other income, were partial offsets to the tax and pension benefits.

Turning to the sectors, Aerospace Systems had sales decline of 4%, primarily due to lower volume on the F-35 and Global Hawk programs.

Excluding Global Hawk, our unmanned systems portfolio continues to experience revenue growth.

While the Global Hawk program is mature, we continue to ramp up on other unmanned programs, including NATO AGS and Triton to name just a couple.

Space revenue also increased due to higher volume for AEHF and the James Webb Space Telescope programs.

Those increases were partially offset by lower volume for our restricted space programs.

AS operating income increased 15% and operating margin rate was substantially higher at 13.3%.

During the quarter AS had a $44 million increase in net favorable adjustments, primarily for space and manned military aircraft programs, which more than offset the impact of lower sales.

Based on year-to-date results we continue to expect AS sales of about $9.9 billion in 2013 with a margin rate of approximately 12%.

For Electronic Systems, we saw sales rise 4% in the quarter.

Higher sales for the quarter included growth in international and combat avionics programs, partially offset by declines in navigation and maritime systems programs.

Operating income declined 2% and operating margin rate declined to 15.4%.

Operating income reflects a lower level of net favorable adjustments than in the prior year period, which more than offset the higher sales.

Based on year-to-date performance we continue to expect ES 2013 sales to increase to at least $7.1 billion with an operating margin rate in the high 16% range.

Revenue guidance includes continued growth in International and space volume and margin rate guidance anticipates performance generally consistent with our year-to-date results.

Moving to Information Systems, third quarter sales declined 9%.

Transfer of intercompany efforts to our enterprise shared services organization and portfolio shaping activities accounted for $17 million of the decline.

So excluding those transfer and portfolio shaping activities, sales declined, if you want to call it organically, about 8% due to lower volume across a broad number of programs.

IS continues to be impacted by lower funding levels, contract completions and in-theater force reductions.

And, I think as many of you know, of all of our four businesses, IS has been the most impacted by sequestration.

Although operating income declined slightly for the quarter, margin rate expanded by 40 basis points due to improved performance.

We continue to expect IS sales of about $6.6 billion for the year and a mid 9% margin rate consistent with year-to-date results.

Finally, on Technical Services, third quarter sales declined by 5% with lower volume in integrated logistics and modernization programs, along with some lower volume in the ICBM program as the principal drivers of the revenue decline.

Operating income, though increased 8% and operating margin rate improved 110 basis points to 9.4%, reflecting improved performance across several programs and a higher level of net favorable adjustments than in the prior period.

For 2013, we expect Technical Services sales of $2.8 billion versus our prior estimate of $2.7 billion.

And we are increasing our expected operating margin rate to approximately 9% from a mid to high 8% range previously.

So, on a consolidated basis, third quarter segment operating margin rate improved 90 basis points to 12.5%, which includes or reflects a $22 million increase in net favorable adjustments on -- in the quarter.

That improvement largely came from Aerospace Systems, and to some extent from Technical Services, which was partially offset by lower net favorable adjustments in Electronic Systems.

So based on year-to-date results we now see a 2013 segment margin rate in the low to mid 12% range.

Third quarter total operating income increased 7% due to the 5% increase in segment operating income and a $27 million improvement in our net FAS/CAS pension adjustment.

That improvement, the net FAS/CAS improvement, represents nine months of increase in our CAS recoveries based on updated demographic experience as of the beginning of the year.

Prior CAS estimates were based on estimated demographic data.

For the year, we now expect our net FAS/CAS pension adjustment will be about $160 million.

Based on the updated segment operating margin and pension estimates, we now see 2013 total operating margin rate in the low to mid 12% range.

And then third quarter interest expense increased $17 million, basically due to the additional $2 billion of debt we raised in the second quarter.

Turning to taxes, third quarter tax rate declined to 31% from 34% last year.

With the lower rate including an additional $16 million benefit associated with our 2012 federal tax return, as well as the $6 million of R&D benefit in the quarter, resulting from the restoration of the R&D credit under the American Taxpayer Relief Act.

So we now see a 32% tax rate for the year.

Cash before discretionary pension contributions, on a year-to-date basis, totaled $1.6 billion.

Free cash flow before discretionary pension contributions was $1.5 billion reflecting a year-to-date free cash flow conversion of 100%.

So based on those year-to-date results we are increasing guidance for cash from operations to $2.3 billion to $2.6 billion and for free cash flow to $1.9 billion to $2.2 billion.

I would also note that our updated EPS guidance assumes that share repurchases will reduce our weighted average shares outstanding for the year to approximately 234 million shares or a decrease of about 8% from last year's weighted average shares outstanding.

And that's versus our prior guidance of 7%.

On a year-to-date basis we repurchased 20.6 million shares.

As you know in May, we announced a goal of retiring 25% of our common stock or 60 million shares by the end of 2015, market conditions permitting.

During the second and third quarters we repurchased slightly more than 14 million shares, or nearly 25% of that 60 million share repurchase goal.

So lastly let me take a few moments and provide some comments related to potential 2014 pension costs.

I'm going to use September 30 as a baseline.

And as of September 30, our year-to-date investment returns are approximately 4%.

And based on the 10-year treasury rate, we could see an increase of approximately 80 basis points in the discount rate, which would give us a discount rate of about 4.92%.

So if we were able to set our 2014 FAS expense using 4% year to date investment returns and a 4.92% discount rate, our estimate of 2014 FAS expense would be about $315 million.

So holding all other assumptions constant, every 25 basis points change, in this assumed 4.92% discount rate results in about a $60 million change in 2014 FAS expense.

The impact of that higher discount rate and the 4% investment returns likely would improve our funded status in all the plans to over 90% from the 83% we had at the end of last year.

And then finally, at this point we would expect 2014 CAS expense to increase to about $625 million, partly or largely due to the benefits of CAS harmonization.

Now I know I should point out that, and remind you all, that our assumptions can change.

And are likely to change between these estimates and year-end.

So we're going to have to really see where we end up at the end of the year in terms of discount rates and investment returns.

And I also should point out that under these same set of assumptions, our required cash contributions for 2014 would remain under $100 million.

So Steve, I think with that we're ready to take some Q&A.

Great.

Thanks, Jim.

As a reminder, each participant should limit themselves to a single one part question.

Francis, we're ready to begin the Q&A session.

Thank you.

(Operator Instructions)

Noah Poponak, Goldman Sachs.

Good afternoon, everybody.

Wes, I wondered if we could just maybe try to discuss what you were talking about with the 2014 top line a little further.

I know you gave us some color directionally there, but with somewhat limited quantification.

Maybe if you just assume sequestration holds relatively close to its current form, how would you expect the pace of decline in 2014 to look?

And is it possible that -- you mentioned the shorter cycle versus the longer cycle dynamics, which you saw pretty clearly or you're seeing pretty clearly in 2013.

Is it reasonable to expect actually all of the operating segments to look reasonably similar in terms of the rate of change in 2014 versus 2013?

Noah, I think inherent in your question is the reality of a lot of moving parts here.

Clearly, it's too early to tell which way the budget outcome will be.

You suggested a thought process around a continuing sequester.

And clearly, as we make our plans for our cost structure and our overall approach, that's heavy in our minds and we want to be prepared for just about any outcome that might ensue here.

But one thing I would point out that I think it's important for everyone to understand as we think about 2014 -- and Noah, your point, the difference between the short cycle and the long cycle businesses -- in each year, the definition of the short-cycle business is that they are going to be more attuned to what actually happens in the amounts that the customer community can go out and obligate within the year.

Whereas for the longer-cycle businesses, their sales in any particular year are more heavily dominated by what was obligated in prior years.

So there's sort of a delay effect and even actually a filtering effect, if you will, that goes into the calculus for the sales on an annual basis in the longer-cycle businesses.

And that inherently provides a little less volatility in what we see in the longer-cycle businesses in any particular year-over-year comparison.

But the shorter cycle businesses, as I mentioned, are more directly attuned to what's actually getting obligated year by year.

So in the situation that you described, where we do have part two of the sequester next year, where there's something on the order of another $20 billion that gets addressed towards the DoD accounts, we would expect that to show up more quickly in the short-cycle businesses.

I think that's about as much color as I can give you on it.

Until we see some more particulars and details, it's hard to get out in front of that and I wouldn't think it wise to try to.

Okay.

Thanks.

Yes.

Carter Copeland, Barclays.

Good morning, guys, and good quarter.

Thanks.

I wanted to ask a question, Wes, about something you guys have talked about on prior calls, and just overall competitiveness.

And I want you to, if you can, address a couple of elements of that, whether it's the impact of pension or IRAD or your overhead rates, and how you think about your cost structure.

Obviously the F-16 win was a big strategic win you called out, but there's been some other big competitions that haven't gone your way this year in Jammer and AMDR and some of these others.

And as you look out at how Northrop Grumman competes vis-a-vis its peers as we go into next year, with obviously a pension benefit, you've been pretty aggressive on the cost structure.

How do you think about competitiveness as we look into next year and you try to grow in your growth areas?

Carter, I can give you two dimensions of that.

Competitiveness obviously has a strong component of cost structure and the broader affordability actions that we've been taking for some time and I'll come back and touch on that.

But competitiveness also has a strong component around innovation and our ability to continuously put forward new ideas and be competitive on the basis of good thinking, and that requires investment.

And so let me touch the innovation part of it first.

As a Company we've been working hard to ensure that we can maintain our investments in technology across the board.

We are a technology-driven company and it is just an absolute strategic imperative for us to make sure that we are both maintaining our own internal investment, and that we are doing a good job of capturing the available opportunities for customer investment in advanced technology within our Company.

So that's a strong part of not only our culture but our operating discipline and our ongoing operating rhythm within the enterprise.

You heard in my remarks a few comments about our capital investments and how we're going to continue to make sure that we are investing for the long term in our infrastructure so that we are able to be innovative and able to support the type of research and development that we know we need to do to stay at the top of the pack in that regard.

So from a broad competitiveness perspective, innovation is a big part of it.

Affordability is another big part of it, and just our overall cost structure is something that we've been aggressively addressing over the last number of years.

And it comes in just about every flavor that you can imagine of the cost structure, and you listed several of them.

In terms of the headcount part of this and our overhead structure, we have been going at that very aggressively.

Through the end of September our headcount is down about 19% from our peak of just a few years ago.

So that doesn't just happen.

That's the result of the entire organization realigning itself to a much tighter cost structure; much tighter management structure, across the enterprise and a much more efficient way of operating.

We've made similar large reductions in our footprint.

And when we look across the board at all the components of our overheads and the direct costs that go into our contracts we've been very aggressively addressing those.

Jim has talked a little bit in the past about pension and the actions that we've taken to make sure that our pension plan is well-funded.

And some of the benefits that provides us - so that's also another component to it.

So competitiveness is a multi-dimensional beast.

It's one that we take very seriously.

We do look at every single contract loss as well as every contract win.

And go after a set of lessons learned from that to make sure that we're doing the very best that we can on all fronts.

And the other thing I would mention with respect to some of the recent contract announcements, I think some of the things that you've seen us do -- AMDR is a good example of it -- where we are pressing the boundaries of areas where we have historically not had much of a footprint, and attempting to see if we can go into some of those areas.

We're going to be successful at some and not successful at others.

But we're going to keep doing that, because I think we have a lot of opportunity to leverage the incredible technological capacity of this enterprise to continue to support our customers in new and different ways.

So that's kind of a long-winded answer to your question, Carter, but I think it's important to have that framework as we think about the future of our enterprise.

That's great color, Wes.

Thank you.

Thank you.

Ron Epstein, Bank of America Merrill Lynch.

Good morning.

This is actually Elizabeth on for Ron.

I just actually had a question regarding your backlog.

Yesterday, Lockheed reported that their aeronautics backlog was up and yours is down.

So I was wondering if that has to do with how you are recognizing LRIP 6 and 7 of the F-35?

Or what's driving that decline?

Well, we're certainly more than just F-35 in our overall backlog.

And if you look particularly, though, at F-35, we did book LRIP 6 and 7 back in the second quarter, not in the third quarter.

And so there's a timing differential that goes with any particular program within the overall backlog.

But year to date our backlog across the board is, I think, performing very competitively, and certainly continues to be an area of strong focus for us.

Okay.

Thank you.

Thank you.

Jason Gursky, Citi.

Good afternoon.

It's Jon Raviv on for Jason.

Thanks for taking the question.

Just a question, in talking about cash flow, operating and free cash flow building blocks for next year, sounds like pension could provide a tailwind, certainly from a required perspective, but also from a discretionary contribution perspective.

Can you talk about that?

And then also you mentioned that CapEx might be up.

So could you just size those different moving pieces as we move from this year to next year on that cash flow line?

Thanks.

Jon, we will give our 2014 guidance in January when, in accordance with our normal plan, when we report release fourth quarter results.

I do agree that not having required contributions in 2014 -- or not expecting to have required 2014 contribution -- is a benefit.

But let's wait until January when we give all of our guidance for 2014.

Myles Walton, Deutsche Bank.

Thanks.

Good afternoon, guys.

The question I had was more of a top-level question, maybe for you, Wes; or Jim from your insights and history.

You're bringing down -- and not just you, but the industry is bringing down its workforce at a pretty healthy pace and it's a painful process, but you're bringing it down well in advance of the revenue declines that are showing up.

And is there any quality of service metrics that you're using from the customer that you're still keeping up with the quality of service that they're asking for?

So that there's no dropping of the ball here?

Obviously it's a hard process to manage on the way down and sometimes you cut too much before you realize it.

I'm just curious how you're measuring that as you go.

Myles, that's a very insightful question.

And let me give you a little bit of color on a few dimensions to it.

We constantly are monitoring the view of our customers in terms of our performance in a number of different dimensions.

We're fortunate to work in our industry where we get an enormous amount of feedback from our customers, whether it's award fee scores, or the CPARS that we get, or the regular interaction that we have because our team is working with our customers arm in arm every day.

We receive enormous amount of input, and we also receive that on the quality side as well.

So it is actually something that we've built into our operating rhythm within the Company, our operating review process, and look at it across every single one of our businesses every month in our entire enterprise.

And we have it built into our incentive system as well.

So it is an area where that feedback mechanism is absolutely critical.

And we're trying to make sure that we are not just looking in the rear-view mirror and looking at that feedback.

We're working to ensure that the real-time nature of that is impacting our planning in each of these areas.

When I think about the human part of this equation on a go-forward basis across our enterprise, it clearly is important that we find the right balance in staffing levels; but it's also incredibly important that we manage what we have in terms of the overall intellectual capacity of the enterprise.

Across the industry and at least the civilian side of the government enterprise, we do have a shifting demographic.

And that means we have a large number of folks who are well within the timeframe of a ten-year retirement cycle.

And it poses some real challenges for all of us across our enterprise to make sure that we're doing the right thing and bringing the newer members of our organization up to speed very quickly.

It also means that we're out recruiting aggressively.

An interesting thing about our industry right now is that, while we are bringing the headcount down, because of that transitioning demographic we are out recruiting aggressively.

In fact, within our Company -- I mentioned to you that we brought our headcount down about 19% since our peak of just a few years ago -- we're going to hire on the order of 4,000 to 5,000 people at Northrop Grumman this year.

And it's something that a lot of people don't expect -- that, that's actually what's going on.

So we're bringing in a lot of folks.

We are bringing in a lot of bright folks.

We're bringing in, quite honestly, in some areas, some new innovative thinking that's actually making us better in a lot of dimensions, so there is a strong positive upside to this.

But there's also a strong part of managing that transition to make sure that we can, with very high confidence, continue to deliver all of the things not only that we've signed up to, but that we're out pursuing as we go forward into the future.

So the people side of the equation, not only in our Company, but across our industry, and across more broadly the defense enterprise, is a big part of the equation here over the coming years that's going to require a lot of very focused management attention to make sure we get it right.

That's good color.

And just a clarification, Wes -- it is really a workforce reduction.

It's not an outsourcing make buy decision that's causing that accelerated decline in the labor force, is it?

No.

No.

It's not a make buy.

In fact, I will tell you there have been some areas where we have had to bring things in-house because of some weakness in the supply chain.

Okay.

And that's not generally something that we like to do, but we will do it where we need to, to make sure that we're going to be able to deliver our products and services.

So we have over the past, now, three years, really ramped up our monitoring engagement with our supply chain so we can stay out ahead of those kinds of issues.

Okay.

Thanks again.

Thank you.

Sam Pearlstein, Wells Fargo.

Good afternoon.

Wes, you talked about some of the uncertain environment with regards to the Budget and Continuing Resolution.

And I'm just wondering -- can you talk about how you think about that with respect to the capital deployment and the plan to shrink share count by 25%?

Because in a quarter where there probably was a lot more uncertainty, it seems like you had really stepped up the buyback activity relative to previous quarters.

So should we expect to see more clarity before you really step up more?

Should it continue at this kind of pace?

Can you just talk about that?

Sam, we think about that a lot.

All the time.

And I would just give sort of a couple basic principles.

First is, we take a long-term view when it comes to capital deployment, in particular share repurchase.

We take a long-term view of the value that we see in our enterprise and how we see the various forces out there impacting that long-term value perspective.

We're clearly an enterprise that's generating a lot of cash, and we also look at -- so this would be the second principle -- we look at the alternatives for the use of that cash and how we help generate that long-term value through the uses of the cash.

So it's not as if we just set the throttle on one speed and just stay throttled up whatever happens.

We constantly are assessing those parameters as well as our environment, and making our decisions on that basis.

Okay.

Thank you.

Thanks, Sam.

Doug Harned, Sanford Bernstein.

Thank you.

On Electronics Systems, over time your backlog has come down a little bit.

You're now below $9 billion for the first time in quite some time.

The revenues have held up reasonably well.

Could you talk about how you see the top line going forward?

I'd say both the contribution from US and from international.

Is this something, should we expect more of a top line decline here?

Or can this turn around?

Doug, this is Jim.

I think our guys at ES have been doing a fabulous job, frankly.

And backlog is -- with the large international content that our ES sector has, backlog is always influenced by the timing of those major international awards.

Probably that's the impact that you're seeing more than anything else, I believe, in Electronic Systems.

Once you win one of those major programs you have a revenue stream that likely lasts for a number of years.

Typically those programs have an S-curve associated with them, where you start off smaller and build over time, and then decline as you get near completion.

So we haven't given guidance for 2014 yet, so I think the comments that Wes had at the beginning of the call around the longer-cycle businesses likely having a better balance, if you will, as we go into 2014, are how I would frame it at this point.

And if I can, just on when you're looking at the long versus short cycle -- on the IS side, when you look at that, you call it more of an 8% reduction right now.

How much of that has been due to in-theater force reduction?

How big a portion of that would you tie to this?

Across our portfolio -- and largely IS and TS have the biggest exposure to the in-theater -- we've been estimating that in the aggregate for the year would be about $300 million.

I would say probably about half to two-thirds of that is from the IS sector.

And some in ES as well.

Yes.

But it's largely there.

And some in TS too?

Some in TS.

A little bit in TS.

Yes.

But it's really IS and ES.

And as we go forward into 2014, obviously with the draw down sort of winding down, we would expect that over the course of 2014 we would pretty much see the tail of it.

Yes.

Okay.

Great.

Thank you.

Thanks, Doug.

Joe Nadol, JPMorgan.

Thanks.

Good afternoon.

Wes, I wanted to engage you actually on a similar topic -- the short cycle, long cycle thing -- but really focusing in on IS.

You've had a little bit of a pop in the backlog here this past quarter.

You led us to believe that next year it's going to be weaker than the other sectors, and I can see that, given the longer backlog trajectory, year on year, I guess.

But do you think that's the last year, next year, where we say that?

And maybe the lines cross going up beyond that?

I'm not asking for guidance, obviously, but just in terms of profile, do you think maybe next year's the last year?

And then, just within IS you've talked about the different pieces in the past and how you're pretty comfortable with how you're positioned.

Maybe just give a little update as to where we saw some of the backlog strength and how you're thinking about the various pieces from here?

Sure.

If I had a crystal ball, I'd feel a lot better about the outlook here; and I know there's a lot of concern and consternation about what happens with some of the shorter-cycle businesses.

But I guess the way I would frame it is, it's one of those effects that has the shortest time constant from a physics perspective.

When things are going down in a top line environment, they're going to go down the fastest; and when things start turning, they'll go up more quickly, because of the inherent built-up demand, pent-up demand that gets sprung loose once things turn around a little bit, and the fact that they are short cycle.

So, is 2014 a bottom for the short-cycle businesses across our industry?

I don't know.

It all depends on what happens with things like sequester and the broader budget decisions that are in front of us.

So, hard for me to call that one.

All I can say is, it will react faster to whatever the change in the budget environment turns out to be.

With respect to your question on the components of IS.

Across the board, the businesses have been doing reasonably well.

There are parts of that business -- so we talk about short cycle and long cycle -- within IS there are shorter, shorter cycles and slightly longer shorter cycles.

I would say a lot of the work that we do on the defense side probably has a little bit of a longer of the shorter cycle in IS, and it's probably been a little bit stronger through some of what we've been seeing here.

And some of the work that we do on the intel side as well has that characteristic.

Steve has described in the past the delineation between the different parts of the businesses, where on the order of about 40% is what you put into that maybe shorter, shorter cycle piece.

And so it has different characteristics.

More driven, though, by the nature of the work being done than it does by the nature of who the customer is.

Because all of our customers have some degree of longer-term contracting versus shorter-term contracting.

Okay.

Thank you.

Cai von Rumohr, Cowen and Company.

Thanks so much.

Actually, two questions.

The first one is -- 2014, while we have a lot of visibility issues, presumably you have some visibility of your foreign business.

That's longer lead time.

Can you give us a rough sense of what percent will foreign be of your sales this year?

Is it still 7% or 8%?

And what sort of relative growth rate would you expect?

Give us a range for next year.

Cai, we had said that for 2013 we expect our international revenues to be in the 10% range.

It was about 8% in 2012.

So for 2013 we're looking at in the 10% range for the international revenues.

Again, I think it's a growth area for us.

I'm not going to give you a number for 2014 since we haven't given guidance for 2014; but it does feel like it's going to be increased as well again as we look to next year.

Cai, the color I would give on that is, as we've talked about our opportunities on international, you can see that some of them are a little bit longer in the development wave than others.

Clearly unmanned is an area that we see over the longer term as having a lot of opportunity, whether we're talking about Korea, Australia, or Japan -- many of the countries that have been quite open and vocal about their strong interest in growing their unmanned capabilities.

And it's being supported by the US in that regard.

C4ISR is in another area where we see a lot of opportunities around the globe and those also sometimes take a while to develop.

As Jim referenced earlier, and I think in one of the responses to one of the earlier questions about Electronic Systems, ES continues to have a very strong international business base.

And we continue to see a lot of interest and a lot of demand for pretty much their full product set.

So that is encouraging to us.

And as you know, we have a big footprint on both the Joint Strike Fighter and the F-18.

So all of those areas put together suggest a nice set of international opportunities for us as we look into the future.

Okay.

Then a second question -- I think earlier this year you talked about an objective of taking your share count down 25% by the end of 2015.

As your stock price has moved up so aggressively here, what's the trade-off?

Are you going to back off from that?

Or commit more of your cash flow to that?

How does that all work?

Cai, when we announced the 25% reduction goal, we characterized it as market conditions permitting.

As Wes responded to an earlier question, we do take a long-term view of the Company, its portfolio, how well it's positioned, the revenue and cash flow generating capability of the Company.

And we make decisions on a regular basis about the pace and the quantity at which we buy based on the facts and circumstances at that point in time.

We haven't backed off the 25% goal at this point.

As I mentioned, for the first 2 quarters that the goal has been in place, we've repurchased a little bit over 14 million shares or almost 25% of the goal.

So we, I think, have plenty of flexibility to deal with the overall goal as we look through the next little bit over 2-plus years.

Terrific.

Thank you very much.

Thanks, Cai.

George Shapiro, Shapiro Research.

The question I have is, we keep hearing the long-cycle businesses.

I had thought that by 2014 we would start to see the long-cycle businesses have an impact.

But maybe I guess the backlogs are a little bit longer than I thought.

So do we push that out to 2015 now, where you'd really start to see the long cycle businesses start to match up with what we've seen for some of the shorter-cycle businesses?

George, if you think about the typical life cycle of those long-cycle businesses, you're probably thinking about a 3-year period of performance -- 2 to 3 years, maybe even a little bit longer depending upon the nature of the products.

So really all of this is going to depend on those budgetary decisions that are going to need to be made as Congress deals with the 2014 budgets, and whether or not there are any major changes to individual programs.

All of those will be the major driving factors on the long-cycle business, I believe, more so than anything else.

And George, there's another effect as well that I think is sometimes missed in the process.

When monies are appropriated, they're not instantly obligated.

And so it takes some time, and sometimes that time is measured in more than a year between when it's appropriated and when it gets obligated.

And so we're still seeing things getting obligated that were appropriated 2 years ago.

So that is another part of that delay, or stretch, if you will, that is more inherent in the long-cycle business.

The nature of the business, as you know, George, unless there are unexpected decisions made on program changes or cancellations, the nature of the business with its long cycle gives you time to look through the windshield at what's coming your way and make your cost decisions to manage the Company in anticipation of what you see coming your way.

Again, without unexpected decisions, we have the ability, basically, to manage the business based on what we see coming.

I appreciate that.

And you guys have done a great job in trying to do that.

But I was looking at it from the standpoint of the revenue side, when we start to see the revenues step down from some of these long cycle businesses, like we've already seen from the short cycle.

I wasn't questioning the margin side of it.

Yes, it's hard to predict based on how the flow of obligated amounts is going to go, and what the spend rate is of those obligated amounts over the duration of the program.

So, kind of hard to call that at this point.

Thanks, George.

Frances, at this time I'd like to conclude the session, and I'd like to turn the call over to Wes for final comments.

I just want to wrap up again by thanking all of our employees across the enterprise for their continuing hard work and commitment.

And also, thanking our partners in government for all that they are doing.

Our nation just put our government employees through a pretty tough period over the past month; not something that should have happened, but something that did happen.

And I will tell you from my own observation, that's a team that stood tall, and continued to execute their mission very well.

So, we are all fortunate to be the beneficiaries of their hard work as we go forward.

Thanks, everyone.

Thanks for your continuing interest in our company.

Ladies and gentlemen, this concludes today's conference call.

Thank you for your participation, and you may now disconnect.