諾斯洛普·格拉曼 (NOC) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the Northrop Grumman's First Quarter 2014 conference call.

My name is Glen, and I will be your operator today.

(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, Glen.

Welcome to Northrop Grumman's First Quarter 2014 conference call.

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

Forward-looking statements involve risks and uncertainties, which are detailed in today's press release and our SEC filings.

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

Matters discussed on today's call may also include non-GAAP financial measures that are reconciled in today's Earnings Release.

We will be posting updated Company and sector overviews that provide supplemental information on Northrop Grumman and our four sectors.

You can access our updated Company overview and the sector overviews on the Investor Relations page at www.northropgrumman.com.

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.

Thank you, Steve.

Good afternoon, everyone, and thanks for joining us.

Our team is off to a good start for the year with a solid first-quarter set of results.

We continue to focus on superior program execution, affordability, and innovation in our drive to achieve strong, sustainable results.

We are proud of our team's performance and the continued focus on delivering value for our customers.

First-quarter earnings per share increased 30% to $2.63.

Excluding this quarter's tax benefit for the partial resolution of the IRS examination of tax years 2007-2009, earnings per share grew 18%.

Strong operating performance, favorable pension trends, and a reduction in share count were the primary drivers of this quarter's results.

We're also pleased to see the increase in awards relative to the first quarter of last year.

First quarter sales were consistent with our guidance for the year.

We continue to see lower volume for programs associated with in-theater troop withdrawals, program ramp downs, and program transitions.

Growth in our international business is partially offsetting these impacts.

We expect these trends to continue, with declines in domestic programs being partially offset by higher volume for international programs, which represented 14% of our year-end backlog.

First-quarter segment operating margin rate increased to 12.9%, primarily due to strong program performance.

Total operating margin rate was 14.4%, reflecting operational strength and favorable pension trends.

During the quarter, we repurchased 4.8 million shares for $564 million.

Share repurchases reduced weighted average shares outstanding by approximately 9%.

As of March 31, we had repurchased 25.6 million shares or more than 40% toward our goal of retiring 60 million shares by the end of 2015, market conditions permitting.

Cash from operations was a use of approximately $400 million, principally due to higher working capital, and we ended the quarter with cash of approximately $3.9 billion on the balance sheet.

As you know, the first quarter is typically our lowest in terms of cash generation.

Jim will provide more detail on cash later in the call, but I would note that we continue to expect healthy cash flow for the year.

And we are maintaining our full-year guidance for cash from operations and free cash flow.

Backlog at the end of the quarter was $36.2 billion, which includes new awards of $4.9 billion.

We had solid award trends in three of our sectors.

Electronic Systems had a book to bill of 111%.

Information Systems had book to bill of 92% principally due to awards in cyber solutions.

Technical Services also had solid awards this quarter.

Aerospace Systems, with a book to bill of 60%, was impacted by timing of awards.

As our longest cycle business, awards here tend to be larger and less frequent.

Although our customers continue to cope with declining budgets and the threat of sequestration returning in 2016, most of our programs were well supported in the President's FY15 budget.

And over the long term, we see a significant set of opportunities aligned with our core capabilities both domestically and internationally.

In unmanned we were pleased that the President's budget proposal specified Global Hawk as our nation's high altitude, long endurance ISR platform for the future.

The program is currently on contract for long lead advanced procurement for three Global Hawks in lot 11, and the President's budget calls for funding of future upgrade and sustainment efforts.

Our team worked very hard to improve Global Hawk's affordability.

And this program is a good example of effectively combining innovation and affordability to produce a good outcome for our customer.

In recognition of our performance and cost-effectiveness, the Air Force awarded the Global Hawk team the Roche Sustainment Excellence award for the second year in a row.

Last month, Korea signed a letter of offer and acceptance for the acquisition of Global Hawk Block 30s, an important first step toward finalizing the contract.

The Royal Australian Air Force also announced its interest in acquiring Triton for its future maritime high altitude surveillance.

And several other countries have expressed interest in both Global Hawk and Triton.

We see international sales of our HALE platforms as a robust, long-term opportunity.

Regarding the UCAS-D platform, we continue to demonstrate its utilization in the carrier environment.

The National Aeronautic Association recently honored our X-47B demonstrator team with aviation's highest honor, the Collier Trophy, for developing the first unmanned autonomous air system to operate from an aircraft carrier.

Our UCAS-D experience provides a strong foundation for our future efforts in unmanned systems.

On the manned military side, we and the Navy are working towards a multiyear agreement for the E-2D Advanced Hawkeye, which continues to be very well supported in the budget.

The F-35 also continues to be a priority program, and we expect it will be an additional source of international growth.

And while we can't say much about the long-range strike opportunity, it is a high-priority effort for the Air Force and an important opportunity for Northrop Grumman.

Our space programs are well supported in the budget.

The FY15 budget provides for incremental funding for SBIRS GEO-5 and 6, and SBIRS RDT&E funding is consistent with prior expectations.

For Advanced EHF, the FY15 procurement plan continues the incrementally-funded block buy of satellites #5 and #6.

Information Systems, the incumbent on the Navy's CANES development contract, is competing for the follow-on production work, which is expected to be awarded later this year.

The Army's CIRCM program, the next generation counter measure system, slated to protect rotary wing aircraft, is an important competitive opportunity for our Electronic Systems team.

ES successfully completed acceptance testing on the first CIRCM suite of equipment two months ahead of schedule.

ES will now compete for the EMD phase, which is expected to be awarded next year.

CIRCM has the potential to be a multi-billion dollar opportunity over the life of the program.

ES is also competing for 3DELRR, the Air Force's next generation long-range radar system.

This competition is expected to be decided this year and would also likely have potential for future international sales.

So while the US budget environment continues to be challenging, particularly for our short-cycle businesses, we have a good long-term set of opportunities that includes the potential for continued growth in international sales.

Based on first-quarter results and our financial outlook for the remainder of the year, we are increasing our earnings per share guidance to a range of $8.90 to $9.15 from our prior range of $8.70 to $9.00.

We continue to expect sales of $23.5 billion to $23.8 billion, and we are maintaining our outlook of $2.3 billion to $2.6 billion in cash from operations and $1.7 billion to $2 billion for free cash flow.

Now I'll turn the call over to Jim for a more detailed discussion of our results and our guidance.

Jim?

Thanks, Wes.

Good afternoon, ladies and gentlemen.

As Wes said, just another solid quarter.

Our team continues to execute in a demanding environment, and I also want to express my sincere appreciation to them for their continuing dedication.

My comments will focus on sector results and our cash outlook for the year.

Starting with the sectors, Aerospace, sales declined by $65 million or 3%.

The volume decline was largely in space programs and unmanned systems, with the unmanned volume decline primarily due to lower production activities on Global Hawk and Fire Scout.

These declines were partially offset by higher volume on the NATO AGS program.

Operating income increased by 20% due to strong performance and a $48 million increase in net favorable adjustments.

The higher level of adjustments was across several contracts, none of which were material on an individual basis.

For the year, we continue to expect sales to range between $9.7 billion and $9.9 billion.

And we expect AS will have a margin rate in the high 11% range versus our prior guidance of mid to high 11%.

Turning to Electronic Systems.

First quarter sales declined by 4% due to timing of deliveries for various combat avionics programs, as well as lower deliveries of navigation and maritime systems.

Declines in these areas were partially offset by double-digit growth in international activities.

Operating income declined 9%, and operating margin rate declined by 90 basis points.

You might recall that last year's first quarter benefited from the reversal of a $26 million non-programmatic risk reserve, while this year ES had favorable adjustments of $57 million, which were $23 million lower than last year.

So for the year, we continue to expect sales of $6.8 billion to $7 billion, with an operating margin rate in the low- to mid-15% range.

At Information Systems, first-quarter sales declined by 6% or about $100 million.

IS experienced lower funding across a broad number of programs, including a decline of about $40 million due to in-theater troop draw downs.

The decline in IS first-quarter operating income was in line with that lower revenue, and operating margin rate was comparable to last year's first quarter.

For the year, we continue to expect sales at IS to range between $6.1 billion and $6.2 billion.

And we now expect an IS margin rate in the high 9% range versus our prior guidance of mid-9%.

Moving to Technical Services.

First quarter sales declined 3%.

Lower revenues reflect volume declines for the Hunter and ICBM programs, partially offset by higher volume for the KC10 program.

During the quarter, we completed the acquisition of Qantas Defense Systems.

TS operating income and operating margin rate increased due to the improved performance.

For the year, we continue to expect sales of approximately $2.7 billion, with a high 8% margin rate.

On a consolidated basis, first-quarter segment operating margin rate improved to 12.9%, 60 basis points, and included a $23 million increase in net favorable adjustments.

The remaining performance improvements reflect the higher booking rates across our portfolio that resulted in part from EAC adjustments in prior quarters.

As a result of this quarter's strong performance, we are increasing our full-year guidance for segment operating margin rate to approximately 12%.

And we now expect a total operating margin rate of approximately 13%.

I would also note that we had a lower tax rate this quarter.

This quarter's 26.3% effective tax rate reflects a $51 million benefit related to the partial resolution of the IRS examination of our 2007-2009 tax returns.

This quarter's benefit from the partial resolution of that IRS exam is higher than what we had assumed in our initial 2014 guidance.

And as a result, we now expect an effective tax rate of about 31.5% for the year.

Last year's first-quarter effective tax rate included a $20 million benefit related to the reinstatement of the research tax credits.

On the other hand, our 2014 guidance does not include the potential renewal of the R&D tax credits at this point.

Our lower effective tax rate, combined with this quarter's strong segment operating income, are the primary drivers of the increase in our 2014 EPS guidance.

Turning to cash from operations, we used $402 million in the quarter.

The cash use was principally driven by changes in trade working capital, largely influenced by the timing of cash receipts including the burn down of international advances.

As you know, the first quarter is typically our lowest quarter for cash generation, and we are seeing the same trend this year.

But there are a couple items that also drove the higher-working capital.

You'll notice on the balance sheet that advanced payments declined by more than $200 million from year end.

And as I mentioned earlier, the majority of that decline resulted from the burn down of international advances.

Also, you may recall that we had a very strong cash generation at the end of last year, some of which was a pull-forward of payments for Aerospace programs that we would have expected in the first quarter of this year.

Free cash flow for the quarter was a use of $462 million with capital spending in the quarter of $60 million, up from $40 million last year.

We do continue to expect capital spending of approximately $600 million for the year.

Capital spending to support the establishment of our Centers of Excellence will be ramping up in the second quarter.

And as many of you know our capital spending is typically weighted towards the second half of the year, which will also be the case this year.

As Wes indicated, we are comfortable with our 2014 cash outlook from cash from operations and free cash flow.

One final item before I turn the call over to Steve for questions and answers.

And that is, sometime later this year, the Society of Actuaries is expected to finalize new guidance for mortality assumptions.

For financial reporting purposes, these new assumptions are likely to be in effect at year end 2014 for the measurement of our projected benefit obligations.

If that is the case, the new assumptions would then impact 2015 FAS pension expense.

The mortality assumptions used to determine our future CAS expenses would also need to be revised.

The new assumptions, when fully implemented, will likely result in increased liabilities; increased annual FAS and CAS pension expense; and potentially, increased funding requirements depending upon the funded status of the affected plans.

This applies in all cases, holding all other assumptions constant and with no change to applicable funding regulations.

In our case, even if the new mortality assumptions were to be immediately required for funding purposes, through 2016 we would not expect a substantial increase in required plan contributions given our plan's funded status, our prior contributions, and of course holding all other assumptions constant.

Steve, with that, I think we're ready for Q&A.

Thanks, Jim.

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

And with that, Glen, we are ready to begin the Q&A session.

(Operator Instructions)

Your first question comes from the line of Myles Walton with Deutsche Bank.

Please proceed.

Hey, guys, it's actually Amit Mehrotra here for Myles.

Good afternoon.

How are you?

Good, thanks.

Had a quick question on share repurchase.

You're executing well to your plan to retire 25% of the shares by the end of next year, but it would be helpful to get your thoughts on you how you're thinking about share repurchase beyond that.

Should we expect a shift in strategy maybe from cash allocation away from share repurchase, more to M&A?

Can you just offer some thoughts on that, and where does acquisitions also rank when you look out beyond 2015, as well?

So we're in April of 2014, and our plan, as we've announced, really carries us through 2015, so I really wouldn't want to today speculate on what might be going on in our environment and how we might be thinking about things at the end of 2015.

All I would say is if you kind of look back over the last number of years and look at how we've been approaching cash deployment, our priorities remain the same.

We like investing in our business.

We want to make sure we're doing a good job of managing our balance sheet, and of course we want to make sure that we're doing a good job of returning cash to shareholders.

I would say we're a fairly predictable crowd in that regard.

Okay.

And just a quick follow up with respect to the backlog, could you just offer any color on where you see that shaping up by the end of the year and maybe provide some of the major awards out there that we can expect in the coming quarters?

We don't guide on awards for the year.

As I noted in my remarks, we clearly had I think a respectable quarter in terms of awards.

And as I think about the set of opportunities that are in front of us, predicting the exact timing quarter to quarter is always a little bit of a challenge, given how things are tending to move around a little bit with the RFP dates and the rest.

But we see ourselves well positioned as I said in my opening remarks across each of our sectors for a number of important opportunities that are both in the remainder of this year and into next year.

Many of those are competitive opportunities that I mentioned.

But it's also an important perspective to understand about our Company that much of our sales in the year are derived from our current backlog.

In fact, we expect that about 80% of our revenues this year flow directly from our backlog in the Company.

Okay.

All right.

Thanks, guys, good quarter.

And your next question comes from the line of Noah Poponak with Goldman Sachs.

Please proceed.

Hi, good afternoon everyone.

Hi, Noah.

I just wanted to follow up on some of the color you gave in the segments.

In Aerospace where you cited lower unmanned, can you quantify how much that came down, and can you say when the total unmanned revenue contribution bottoms?

I know some things are moving higher, some are moving lower.

And then in IS, when you're citing in-theater reductions, can you quantify what that total contribution is to the segment at this point and how it progresses from here?

Yes, Noah.

As we said, IS sales for example were down roughly $100 million.

The in-theater stuff is less than half of that.

So again, in IS you get --

In terms of the change.

Pardon?

In terms of how much it changed?

Yes.

Okay.

And then in terms of unmanned, basically unmanned is largely flattish on a year-over-year basis, some spaces, a little bit greater declines on the -- as I mentioned, the two programs, Global Hawk and Fire Scout and then growth in NATO AGS.

And when you net all those down, it's nominal.

Is the unmanned business growing once you're out of 2014?

I believe so.

Yes, I think if you look back at the remarks I made about the set of opportunities that we have in front of us, clearly getting Triton into production is I would say the biggest lever, the biggest step, and we're going through the test program today, and that's doing well.

But the international side of unmanned is also quite intriguing.

I mentioned earlier about the step forward in Korea with the LOA and the growing interest that we're seeing around the globe in our high altitude, long endurance programs, what we call our HALE programs, both Global Hawk and Triton based platforms.

We see a lot of opportunity in unmanned in front of us.

Okay.

And sorry, just so I'm clear on IS with the in-theater revenue, what is the absolute dollar number?

Not the rate of change, but just how much it still is on an absolute dollar basis.

Across the Company, we're looking at about $800 million as I recall, Steve, is that right?

$300 million reduction.

$300 million from last year.

Year-over-year, but $800 million for the year.

Yes, across the Company.

How much of that is in IS?

Two-thirds, three-quarters, something like that.

The reduction is probably 40% at IS.

Yes.

Okay.

Thank you.

Thank you.

And your next question comes from the line of Cai von Rumohr with Cowen & Company.

Please proceed.

Thanks so much.

Yes, good results again.

I think you said you expect your foreign business to go from roughly 10% to 13% of the total.

I mean, it's a little tough to tell exactly what that is with rounding.

It looks like that implies a gain of about 25%.

And you've mentioned several times the opportunities, HALE, F-35.

Can you give us some color, where should we see that going next year, and where do you see this in, like, three to four years as a percent, maybe give a range.

Cai, it's always difficult to time the exact point when all these international opportunities occur.

For me, what's positive is the increasing interest across a number of countries in our high altitude, long endurance platforms.

So again, I'm not going to call exactly when that will occur.

Getting Korea done will be an important first step.

I believe that is important not only because of the opportunity, but it serves to facilitate the next move behind it.

So again, we're working really hard on Korea.

We have a letter of offer and acceptance, and the next step is to get that under contract.

That's what our team is working on.

And Cai, I would just add, in addition obviously to the newer story for us in international being our unmanned opportunities as well as potentially some manned opportunities with platforms like E2D, we continue to have a robust international business and set of opportunities through our Electronic Systems organization.

And in fact, all four of our sectors are focused on a set of international opportunities.

Jim's point about the predictability of timing is a very important one in international business.

But we are very focused on this and are working it broadly across the entire enterprise today.

Right.

And while I realize it's always difficult to pinpoint the timing, it certainly looks like F-35 clearly is going to be a plus there.

HALE clearly will be a plus.

If you look out three to four years, so that we're not timing it exactly, I mean, could this be 20% to 25% of your sales or any rough range you could give us?

It, again, is kind of hard to say.

So much of what we do on export also depends on the nature of export control restrictions.

And I'm delighted with what I see happening today with the administration, working hard to move things ahead.

There's extensive commitment in DoD to step out and help drive policy changes that will enable the US to better support its allies around the globe.

But there are a lot of factors in the mix here that make it difficult to put a number or even a range of numbers on at this point.

But the vectors seem to be aligning in a very positive direction.

Okay.

Terrific.

Thank you very much.

Thank you, Cai.

And your next question comes from the line of Jason Gursky with Citi.

Please proceed.

Good afternoon, everyone.

Hi, Jason.

Hi, Jason.

Big picture question, kind of follows on the heels of the spirit of Cai's questions, as well, in trying to get a sense of timing.

And as you suggest, the exact timing is always difficult.

But in looking at the FY15 budget and the program decisions that were made within that, and putting OCO aside, and the in-theater revenue streams that you've had, and looking at your base domestic business, do you have a sense of the FY15 budgets implemented, when you might see a trough in your domestic revenue streams?

Cai's looking at the long-term trajectory of international, and I'm curious, given what you've seen in FY15 budget, when do you think the domestic budget, OCO aside, might stabilize?

The way I would characterize that is, first and foremost, obviously, we're all delighted to be operating right now under a real appropriations.

This is a big step forward from where we had been in terms of predictability and the ability to plan.

And with the Bipartisan Budget Act that came together at the end of last year, it does, and I think this was part of your question as well, it does offer a better outlook in terms of predictability and stability for 2015 as well.

So I think the real question is what happens after that, and there are a range of possibilities.

There the sequester budget is a real possibility.

I think the President rightfully put forward to the Congress in the longer term outlook a very strong message about what's really needed to support the security of our nation, and the budget profile that came forward in the plan that the President submitted is above the sequester level.

How all that will work out through the politics over the next couple years, I think it would be foolish to speculate on that at this point.

I do think it's rational to expect that the US budgets will eventually stabilize, and clearly investments in security are going to need to start growing again.

But at what rate, and exactly when I wouldn't want to be in a spot of trying to predict that right now.

So we'll have to stay tuned.

I think there's a lot of work to be done to get the budgeting process in the right place to support national security, as we work our way through 2015 and really take on the challenges associated with that range of possibilities in 2016 and beyond.

And I know a lot of folks have tired of the discussion around the sequester, but I think we should all be realistic and understand that there's still an important set of policy decisions and budgetary decisions that are out there in front of us that we're going to be taking on as we go through this year and next year.

Fair enough.

Thank you.

Thanks, Jason.

Your next question comes from the line of Doug Harned with Sanford Bernstein.

Please proceed.

Hello.

Thank you.

Hey, Doug.

I'm interested in how two things might affect your F-35 margins.

The first one is volume, and as F-35 quantities are down in the President's budget, particularly for the C model, and then sequestration in 2016 would lead to some further reductions, I'm interested in how -- knowing that you do have volume considerations and pricing, that could affect your margins.

And then second, over the past year the program office has made a point to try and look beneath the prime into costs in the subcontractor community.

And I'm just interested, the volume question and then the change in the way the program office is looking at the program, does this impact you at all in terms of what your margin expectations are?

You know, Doug, the volume is a very important contributor, probably the most important contributor to our ability to drive down the learning curve.

So volume is really important.

We've been coming down a very healthy learning curve already.

But as you point out, volume is critically important to being able to continue driving down that learning curve.

Let me maybe talk about the perspective on the program office side of it.

The way I would frame this is, Lockheed is I think doing a very good job as the prime on this program.

This is a team, and so we have a big part to play as do other companies in making the program successful.

And so, naturally the program office is very interested in what the major teammates are doing and how that's going.

So I don't see anything unnatural in the process that has been under way.

I think it's sort of a natural step here, particularly as we are together very focused on, to Jim's point, how we deal with the volume challenges that are out there in the near term and maintain an appropriate path forward on driving down the curve and driving the affordability that we know is so important for this program, both domestically and internationally.

So I would characterize it more as the framework of the team environment, with Lockheed out in front as the prime and doing the things that are very, very appropriate for the prime to be doing.

But I continue to see a very good team environment on F-35 and I think that's part of what is contributing to enhancing the success of the program that we're having now.

So I'm positive about the way we see F-35 operating today.

So given the performance improvements that you and others in the program have made, if you balance that off against some of these other pressures such as volume, would you say as you look forward you're more or less optimistic on your ability to get a good margin progression going forward?

Well, typically as we move forward in a program and move into the production phases, that's where industry has an expectation of making margin, in production.

And we've all made substantial investments in this program and continue to make investments in the program, and that is sort of the natural cycle.

So I don't have any different expectation than what experience would tell us should be the outcome.

Okay.

Very good.

Thank you.

Thanks, Doug.

Your next question comes from the line of Sam Pearlstein with Wells Fargo.

Please proceed.

Sam, how are you.

Good, how are you?

Good.

Was wondering if you could talk a little about more about Aerospace Systems and you put out the $48 million worth of adjustments.

Can you just talk about is there any particular program that's a bigger percentage of that?

And what was contemplated in the earlier guidance that might have just been later in the year, versus something that was new performance.

You hit on an important point, and that is timing.

Many times our EAC adjustments are tied to specific events as they occur.

We did have some of those events occur in the quarter that affected the timing of adjustments.

As our guidance would indicate, the 13.4% for the quarter is not where we would expect aerospace to land for the full year.

So there are clearly some of those items affecting the first quarter.

As I said in my prepared comments, none of the adjustments on an individual contract basis were material.

I think that's a pretty good summary of what happened in the quarter, just good, strong underlying operating performance and then some events that were tied to various timing aspects of that, managing the programs.

Okay.

And if I can follow up something unrelated.

Is May typically when you look at your annual dividend?

And I know that you've typically been very payout focused but I'm just wondering is there anything about the capital deployment strategy that would change the way you look at that, and the type of decisions you might make?

Sam, it's Wes.

Yes, May is typically when we look at that.

That is a Board level decision.

I would not want to get out in front of that level of decision.

I would simply say what I said earlier.

Our approach to capital deployment, and our priorities in capital deployment have not changed.

Thank you.

Thanks, Sam.

Your next question comes from the line of Robert Stallard with Royal Bank of Canada.

Please proceed.

Good afternoon.

There's been some talk recently about the recent green book that came out, and what the DoD is projecting for outlays this year.

I was wondering if you've looked at this and how it might tally with your revenue forecast for the year, particularly on shorter cycle areas.

We've, of course, looked at it.

We did not see anything in the green book that altered our outlook for 2014.

I think I mentioned earlier that over 80% of our 2014 revenues tend to flow from our backlog, and when you look at what's in the green book, clearly there's a lot of work done to pull that together.

The green book forecasts really do not represent contractual ceilings and outlays, which are typically quite a bit lower than budget authority.

The budget authority does represent kind of what the limit is, so you need to be looking at the BA aspects of things.

So the short answer to your question of whether or not we saw anything in the green book that changed our outlook, the answer is no.

Obviously, the green book came out after we gave our forecast for the year, outlook for the year, we haven't changed our sales guidance.

I see.

Unrelated follow-up.

The acquisition you made in Australia this quarter, I was wondering if you could give us some of the background there or what this adds to the portfolio, and whether we can expect further bolt-ons going forward.

Rob, we look routinely across the board at opportunities such as this.

We've not been a very major acquirer for quite a few years, and I think that reflects the discipline that we have in looking at potential opportunities.

This looked like a very nice fit and I think it's going to be a very nice fit for us.

It dovetails with the work that we're doing in our technical services organization, both domestically and internationally.

Australia is a very important ally of the United States, clearly a very important market for Northrop Grumman and so the fit from a portfolio perspective and a geographic perspective and a market perspective we found to be very attractive.

Great.

Thanks very much.

Thank you.

Your next question comes from the line of Howard Rubel with Jeffries.

Please proceed.

Thank you very much.

Good afternoon, Howard.

Hi, Howard.

Gentlemen, it's a pleasure.

I'm going to kind of go in a different direction.

There was an expression, I think Willie Sutton, they said wherever Willie Sutton was he's going to rob a bank, or where the money is, go rob a bank.

You guys are banging your head to some degree against the wall with some of the difficulties that exist either in foreign sales or in DoD.

And not to say that's not your expertise, but then there's these guys in Silicon Valley that are trying to spend billions of dollars solving problems that you've solved many times over, Wes.

And so why aren't you approaching some of those companies, or doing something to take advantage of all that money that's sloshing around, solving problems you've addressed before?

Howard, I do appreciate your question, because it's a good kind of sanity check sometimes to look at all the things going on in the world around us and try and test what makes sense.

One of the things that I think we've learned, I would say in our Company, and I think generally across our industry is that we are quite good at what we're good at, and we tend to want to stay focused on that.

And periodically we do look at what other companies are doing and market access that they may provide to see if there are reasonable partnership opportunities, and we explore those from time to time.

We've had I would say across our industry some notable successes in that regard, as well as some abysmal failures in that regard.

So I think it's just prudent to be very careful and thoughtful about how you go about doing those things.

But we are a very technologically oriented enterprise.

I've mentioned a number of times of our 60,000 employees more than 30,000 are degreed scientists, engineers, mathematicians.

This is a very, very capable enterprise when it comes to advancing the state-of-the-art on technology.

We have both an interest in partnering where we see that it makes sense.

But also we have, and we take this very, very seriously, an obligation to our customer community to very carefully protect the technologies that are utilized from a national security perspective.

So we're careful and diligent about balancing that out.

So should I take that to mean that some of these things that are percolating in the commercial -- I mean, I get it.

How should I say it?

It's hard to sell into a market that's got different requirements than what you're selling into now.

Yes.

To your point on testing your comfort zone, though, these rewards might be fairly lucrative, and they change the valuation of the enterprise.

And they -- as you know, when you were at TRW, periodically there were great successes but also there were --

There were.

There also some oops.

Yes.

And I think we've all learned from both of those sides of the experience curve and recognize that there are value-creating opportunities periodically.

You simply need to select your partners carefully.

You need to have a very clear view of what the real channels to market are, and you need to be ready and willing to turn things off if it's not panning out.

And that guides a lot of our thinking and how we approach these things.

So I'm just trying to draw you into an answer that is that some of these things have some appeal, or we tested them and no thank you very much, we're very comfortable in our space.

I would say that part of being a good partner is to protect the privacy of your partnerships, and so we're very careful about anything that we would say about that too broadly.

But the one thing that we do say when we get out on campus to young folks that are thinking about their options, and there's an incredible competition for talent in the technical space these days, if you really want to work at the leading edge of technology and advance it, our industry is the place to be.

Thanks, Wes.

Thank you, Howard.

Your next question comes from the line of Joe Nadol with JPMorgan.

Please proceed.

Thanks.

Good afternoon.

Hi, Joe.

Hi.

So Wes, I have a question for you that's been kind of brewing for -- since the last quarterly call, which is on your CapEx plans, because you guys have been pretty tight-fisted I think in a good way in terms of your spending in all kinds of ways, including CapEx.

The last couple years you've talked about Aerospace Centers of Excellence is really kind of the key driver of the plan going forward.

I was wondering if you could maybe take a couple minutes and give a little bit more on what you're doing and why you're doing it.

Is it about more about productivity or business capture?

Is it programs that you already have or ones that you're chasing, just a little more on the investment.

Yes, Joe, thanks, I appreciate the question.

Aerospace Systems is certainly a big part of our enterprise, and as you've heard us talk today about the set of opportunities that we see in the future, from our perspective that set of opportunities is adequately robust to merit investment, to make sure that we're doing the right things to be able to pursue those opportunities, as well as to execute on those that we've already captured.

If you turn the clock back quite a few years ago, we are a Company like many in our industry, built through acquisition and that did not necessarily result in the most efficient structure and architecture for how to get things done.

So, as we have worked hard to clarify our strategy to make decisions in our Company about what market spaces we're really going to pursue and invest in versus those that we're not, it's become clear, had become clear over the last couple of years that we needed to re-architect our footprint to better align with that strategy.

And the benefits that we see from these centers of excellence are really several fold, and I think you touched on them in your question.

One is our ability to better align the human capital that really makes these things work into centers of excellence, where the people who are working on similar things are more closely co-located, and we can better share the knowledge, as well as to create new opportunities by having individuals more closely working together on a day-to-day basis.

Secondly, the efficiency of the facility infrastructure itself has the opportunity to be dramatically enhanced with the investments that we're making.

And so we see that as very, very meaningful and important from a competitiveness standpoint as we take on some of these new opportunities over the next few years.

And a third point that I would make as well is, by having these teams working together and really creating centers of excellence, we find that to be an attribute in recruiting, and recruiting is an important part of our Company.

I know sometimes it's a little bit of an odd message for folks who think about our industry right now as perhaps shedding jobs and reducing footprint, but even though we're down about 20% in headcount from our peak, we hired about 5,000 people last year.

And we're going to do about the same this year.

So recruiting is a big part of our thought process as we think about how we architect our infrastructure and our capabilities to enable us to continue to support technological superiority and deliver capabilities for our customers.

So it's sort of a multidimensional answer to your question.

But all the rational pointed in the same direction that now is the time to take this step and invest in our own future.

As we look at your financials the next two or three years, where are we going to see this first?

I guess that's -- is it moving work and more increased efficiency and productivity and higher margins?

Or is it in uptick sales somewhere where maybe we're not expecting it?

I would say it's going to be a combination of improved efficiency to sustain margins and then the potential for higher sales as new program opportunities materialize.

Okay.

I just had one quick one for you, Jim, also.

The EPS guidance went up.

It may be up a little less than one might think since you raised your margin guidance and also had the tax benefit that wasn't fully incorporated.

Were there any offsets, or is this just Q1 conservatism?

Actually, the guidance raise essentially is about half of tax rate and half operations.

When I looked at our raise in guidance, in terms of segment operating margin rate, it's roughly 10 basis points or so.

That's about $0.07, $0.08, $0.09, depending upon where you were, and the tax rate is about another similar amount.

Okay.

Essentially, that's the adjustment to guidance.

Okay.

Thanks, guys.

Thank you, Joe.

Your next question comes from the line of Robert Spingarn with Credit Suisse.

Please proceed.

Good afternoon.

Hello, Rob.

Hi, Rob.

Guys.

Couple different questions here.

First, Jim, a clarification.

On the mortality comment you made earlier in your opening remarks, did you say there was no impact or did you not quantify it?

I can't quite tell.

What I said is this mortality discussion has been ongoing for a while.

We do expect that we should see some updates to mortality assumptions later this year.

If that occurs, it will be in effect for year-end measurement of projected benefit obligations, which then affect 2015 expense.

Next year.

Then we get a range of what that may mean, because obviously all of us are trying to understand what will be the updates to mortality assumptions, whether or not, or how directly they apply to our circumstances.

So frankly, we're going to have to have a little bit more information and a little bit more time to study what it means.

Okay.

I think the expectation, and it may be incorrect was given that one of your peers actually threw a number out there, which is probably subject to change once things are finalized, you're not in a position to do that.

I think we can all speculate what it may mean.

I think in all confidence I can say that over the long term projected benefit obligations will increase, that FAS and CAS expense will likely increase, and dependent upon the funded status of your plans, funding may be impacted, as well.

Exact timing and exact amounts at this point are a little bit of an unknown.

Unknown.

Okay.

Two more.

This one, Wes, is for you.

And it's a little bit of a budget discussion again, and on M&A, but you talked about the differences in fidelity perhaps between budget authority and outlays.

Given that sequestered budget authority in 2016 would seem to be about flattish with Ryan Murray budget authority for 2015, is it fair to say that on the domestic business you have really reached trough or you can at least see it.

And should that invite perhaps earlier M&A activity now that visibility's improved a bit?

I would continue to say that visibility is improved for 2014 and 2015, projecting the political dynamics between now and the appropriations cycle in 2016, not something I would want to be speculating on.

If you just turn the clock back that amount of time instead of looking forward, turn it back that amount of time backwards and try and predict exactly where we would have been today given where we stood then, you would have been wrong.

So I think we're going to have to see how this plays out.

I am concerned about it as I said in my earlier remarks, and as I know our customers are concerned about it.

Any time we're in a place where the President, despite all of the challenge that we all recognize we're facing from a total budgetary authority perspective, the President, in putting forward a budget has to be as clear as I think the clarity was provided in this round, that the current budget at the sequester level just doesn't do it for national security.

But yet to see the pushback that initially came from the hill on that to me a very strong signal that we've got a lot of political dynamics still in front of us.

Where it actually lands we're going to have to see.

Is this to some extent because of your exposure to the programs they've already talked about if sequester comes through in 2016?

My commentary is not so much about our particular Company's situation on this.

I'm speaking more broadly about the investment accounts and the O&M accounts that our industry relies on and as its source of domestic revenue.

And related to obviously what it means for structure and the rest of it.

Those are all things that are bound up together, the set of decisions that translate from the total budget levels into what actually gets invested in equipment and maintenance and the rest of it.

There's a lot that goes on in the world between now and 2016.

Okay.

Then just lastly on margins, and this is really for either of you, but you've done a great job, and many in the space have in terms of getting ahead of revenue declines with your costs.

And certainly I think this translates well in the short cycle contracts.

On the long cycle side, where would we be in terms of repricing to the new cost structure in terms of how much turnover have you seen where you've already re-upped contracts or signed new contracts that have pricing that reflects your new cost structure, and how much is left to do?

You know, Rob, you can pretty simply do the math, frankly.

If you look at the run rate of revenues in each of the sectors versus the backlog, and that tells you how much of our --

The turn.

The turn.

Obviously Aerospace is a little longer than the others, and IS is shorter than the long cycle business.

It essentially goes with the comments that we've been making all along about the longer cycle businesses and the shorter cycle businesses.

Yes, but then there's all the contract nuance that's not easily detected from outside.

I was just going to say that is the nature of this business, it is continually repricing contracts every year, when new contracts come up and continuing to manage cost on a day in, day out basis.

That is the business.

So I guess --

Rob, I guess I would -- the thing too I would add is be careful about a static kind of approach to thinking about the cost equation.

Yes, we and others in our industry have made some good progress on managing cost and doing what I would describe as the tough blocking and tackling approach on headcount and infrastructure and that sort of thing.

No one should assume that the game is up on cost management.

That's a constant focus, certainly in our Company, and I think even more broadly than our Company.

And as we look at all of the levers involved in that, whether it's technology or architecture or the other elements of affordability, we all have to continue to be on the cost agenda, if you will.

So, it is not sort of a static model where you can say okay, we've taken cost out now.

All go-forward contracts no longer get any benefit of future cost reduction.

If that were the model, we'd be in trouble.

Fair enough.

Thank you.

Thanks, Rob.

Your next question comes from the line of John Godyn with Morgan Stanley.

Please proceed.

Thank you for taking my questions.

I wanted to follow up on two topics from earlier in the call.

First on international sales and the growth opportunity there, I was hoping that you could just elaborate on how to map that to some of the segments to the extent that Aerospace and Electronic Systems maybe have greater exposure to it than some of the other segments.

And the second topic just a follow-up on the last question that was asked.

I'm curious, with the improvements in cost and productivity, and you've certainly been differentiated in that right, as well as the well positioned pension.

Have you found that to actually lead to any competitive wins or an ability to kind of position yourself as a lower cost provider and turn it into maybe a little bit of a better revenue trend.

Thank you.

So in International, the breakout that I would see if you're trying to map it to sectors, clearly Electronics has our biggest footprint internationally, has done so for many years.

ES has in the range of 20%, 25% of its sales as international and sees continued very meaningful opportunities around the globe, ranging from upgrades to radar systems to new sensor suites on both the airborne side, the ground-based side, and ES is, I think, a very well-positioned and robust international business for our Company.

Aerospace Systems is a little bit more if you will the new story, largely associated with the unmanned system capability, and as well as I mentioned earlier, we do see some manned potential around the globe in terms of our E2D platform and potentially some others.

It is more of an emerging international business, has some footprint today in that regard, but is, I think, rapidly growing.

With respect to Information Systems, clearly the awareness and understanding of the importance of cyber security is growing around the globe, and we have a very important and well-established position here in the US, and we are exploring the options for continuing to grow that.

IS has for some time participated, I would say, at a smaller level, but in a growing way in the C4ISR domain for some international business.

So those are really the pieces.

Tech Services by the way does a fair amount of training and maintenance support around the globe, too.

Those are good opportunities for us that I think we're going to continue to push on and see the opportunity expand.

With respect to your final question on cost, clearly, yes, it's important that we continue to work on the cost structure.

I would put it in the inverse manner.

If we weren't doing it, I'm sure we would be losing.

So hard to you attach individual wins to a particular cost structure, but we know it's vital to the competitiveness of our Business.

Thanks, John

Glen, I think we're out of time.

At this point in time I'd like to turn the session over to Wes for final comment.

Thanks, Steve.

As I said at the start of the call, the first quarter really is a good start to the year for us, and I'm just delighted that we were able to raise our EPS guidance based on the performance that we've seen in the first quarter.

So, thanks everyone for joining us on our call today and thank you for your continuing interest in our Company.

Ladies and gentlemen, that concludes today's conference.

Thank you for your participation.

You may now disconnect and have a great day.