諾斯洛普·格拉曼 (NOC) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Northrop Grumman's second quarter 2014 conference call.

My name is Jasmine 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, Jasmine.

And welcome to Northrop Grumman's second 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 an updated Company overview that provides supplemental information on Northrop Grumman.

You can access our updated Company overview and our 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.

Thanks, Steve.

Good afternoon, everyone, and thanks for joining us.

Our second quarter results reflect our team's focus on delivering top performance for our customers and our shareholders.

As a Company, we continue to focus on superior program execution, affordability and innovation.

I'm proud of our team's performance and their dedication to serving our customers.

This strong sustained operating performance, combined with favorable pension trends and share repurchases, contributed to higher second quarter earnings per share.

We're very pleased with the results at the halfway point of the year.

Based on year-to-date performance, we are raising guidance for segment operating margin, total operating margin, and earnings per share.

Our year-to-date segment OM rate is 12.6%, slightly higher than last year's results.

For 2014, we now expect a low 12% segment operating margin rate and a low 13% total operating margin rate.

We're increasing our EPS guidance to a new range of $9.15 to $9.35.

Second quarter and year-to-date sales are consistent with 2014 sales guidance, which is unchanged at $23.5 billion to $23.8 billion.

We continue to see growth in our international business partially offsetting the impact of domestic budget pressures.

We expect this trend to continue in the second half of the year.

Cash from operations totaled $572 million for the quarter, and we ended the quarter with a cash balance of approximately $3.5 billion.

We continue to expect healthy cash flow this year, and our guidance for cash from operations and free cash flow is unchanged.

Turning to cash deployment, during the quarter, we repurchased 6.1 million shares for $741 million.

Year-to-date, we've repurchased 10.9 million shares for $1.3 billion, and our weighted average diluted share count has been reduced by 9% year-over-year.

And we've now passed halfway mark toward our goal of retiring 60 million shares by the end of 2015, market conditions permitting.

Over the last five quarters, we've repurchased 31.7 million shares toward that goal.

In May, we increased our quarterly dividend 15%, to $0.70 per share, again demonstrating the importance of a competitive dividend payout ratio as part of our cash deployment strategy.

In addition to returning cash to shareholders, we've also announced plans to increase investments, primarily in our longer cycle, more capital intensive Aerospace Systems and Electronics Systems sectors.

We're investing in our Aircraft Integration Center of Excellence in St.

Augustine, Florida and increasing investments in our Manned Aircraft Design Center of Excellence in Melbourne, Florida.

And we are increasing Electronic Systems' capital expenditures by $50 million this year.

These AS and ES investments are examples of our ongoing effort to improve our strategic alignment with our customers' need for increasingly innovative and affordable products, services and solutions.

In addition to capital expenditures, we are investing in new business opportunities and investing in our ongoing programs to reduce costs, improve affordability, and enhance competitiveness.

We and our F-35 partners are investing in a blueprint for affordability initiative aimed at significantly reducing aircraft costs.

This type of investment strategy represents a win-win opportunity for industry and our customers.

Industry is incentivized to reduce costs and improve affordability.

As we demonstrate cost reductions, we will recover our investments and have an opportunity to earn a return on that investment.

Our backlog at the end of the quarter was $35.6 billion, which includes new awards of $5.3 billion.

I would note that this does not include the $3.6 billion E-2D multiyear award that we received after the close of the quarter.

Through the first six months of the year, we've captured new awards of $10.2 billion, including $665 million for the F-35, $552 million for our work on Virginia class submarines, $460 million for the F/A-18, and $299 million for the B-2.

New awards for the first six months of the year represented 86% of sales.

Electronic Systems and Information Systems had book-to-bill rates close to or more than 1 times sales.

Aerospace Systems' book-to-bill for the first six months of the year was impacted by the timing of the E-2D award.

Looking ahead, we continue to have a robust opportunity set across the Company, including significant international opportunities for platforms like Global Hawk, Triton, F-35 and E-2D, and in domains like C4ISR, cyber, and logistics and modernization.

We're pleased that our programs continue to be well supported as Congressional budget negotiations progress.

While we are encouraged by the tone of FY15 budget negotiations, we remain cautious regarding the longer term vector of US defense spending, given the likelihood of another continuing resolution at the start of FY15 and a potential sequestration in FY16, if Congress does not act to avoid that outcome.

Despite these continuing uncertainties, we are confident that the actions we've taken to reduce costs, drive innovation, and enhance program execution have positioned Northrop Grumman to compete and succeed over the long term.

In closing, we're very pleased with our performance in the first half of 2014, performance that enabled us to raise our full year guidance.

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

Jim?

Thanks, Wes, and good afternoon, ladies and gentlemen.

As Wes said, another solid quarter.

Our team continues to execute very well, and I want to add my sincere appreciation for their efforts.

My comments today will focus on our quarter and year-to-date sector results, and I'll provide a little bit more color on our EPS guidance for the year.

The increase in our EPS guidance essentially reflects our strong second quarter performance and our current expectation for a 9% reduction in weighted average diluted shares outstanding for the year.

Turning to the sectors, Aerospace Systems' second quarter sales declined $111 million, or 4%.

On a year-to-date basis, sales are down 3%.

Lower volume for both periods reflects declines in unmanned systems and space programs, with lower Global Hawk production activity and lower development activity on Fire Scout being the two biggest drivers of the trend.

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

I would note that we continue to see unmanned as a long-term growth driver for our Company, particularly as international opportunities emerge.

Current unmanned revenue trends reflect the normal pattern we would expect as mature production activities ramp down, like on the Air Force Global Hawk program, and transition to and ramp up on development programs like NATO AGS and Triton.

AS second quarter operating income and margin rate declined, due to lower volume and quarter-over-quarter differences in risk retirements and performance improvements.

But on a year-to-date basis, AS operating income rose slightly and operating margin rate was very healthy, at a 12.5% rate.

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

And based on the strength of year-to-date results, we now expect an operating margin rate of approximately 12% versus our prior guidance of high 11%.

Electronic Systems second quarter sales declined slightly and are 3% lower year-to-date.

Both second quarter and year-to-date results reflect fewer deliveries of navigation and maritime systems, as well as fewer deliveries of infrared counter measure products.

Year-to-date results also were impacted by the timing of combat avionics deliveries.

During both the second quarter and year-to-date, declines in domestic programs were partially offset by higher international sales, which have increased 12% year-to-date.

ES operating income declined 10% for both periods, due to lower sales and quarter-over-quarter differences in risk retirements and performance improvements.

You will also recall that during the first half of 2013, ES had a benefit from a $26 million non-programmatic reserve reversal.

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

Our current guidance reflects second half ES margins in excess of 14%.

Information Systems second quarter sales declined 8% and year-to-date sales are 7% lower.

As you know, Information Systems is our shortest cycle business and has the greatest in-theater exposure of our four sectors.

Lower government funding levels continue to impact a broad range of programs in both periods, and in-theater troop draw downs reduced sales by $43 million in the quarter and by $86 million on a year-to-date basis.

Despite top line pressures, IS increased operating income and margin rate in both the second quarter and on a year-to-date basis.

Second quarter income rose nearly 9%, and margin rate expanded by 150 basis points, to 9.8%.

Year-to-date operating income rose 1% and operating margin rate expanded 70 basis points, with trends for both periods reflecting improved performance.

For the year, we continue to expect IS sales of $6.1 billion to $6.2 billion, with an operating margin rate in the high 9% range.

Moving to Technical Services, second quarter sales improved, due to higher international sales, principally due to the Qantas Defence Services acquisition, which more than offset lower ICBM volume.

On a year-to-date basis, sales are comparable to last year and also include higher international sales offset by lower volume across several other programs, including ICBM and Hunter.

For the year, we continue to expect sales of approximately $2.7 billion, and we're increasing our guidance for operating margin rate to approximately 9%.

On a consolidated basis, segment operating margin rate was 12.3% in the quarter and 12.6% on a year-to-date basis.

Our year-to-date 12.6% segment operating margin rate reflects improved performance, partially offset by lower net favorable adjustments.

As a result of year-to-date performance, we now expect a segment operating margin rate in the low 12% range, slightly higher than our prior guidance of approximately 12%, and with the higher segment operating margin rate, we now expect a total operating margin rate in the low 13% range versus the prior guidance of approximately 13%.

We continue to expect a tax rate of about 31.5%, and I would point out that this does not include the potential renewal of the R&D tax credits.

I would also note that we now expect a 9% decline in our weighted average diluted share count for the year, versus the prior guidance of about an 8% reduction.

Turning to cash from operations.

We generated $572 million in the quarter and $170 million on a year-to-date basis.

Free cash flow for the second quarter was $456 million, with our year-to-date cash performance reflecting higher trade working capital than we had in 2013.

Consistent with our historical pattern, we do expect strong cash flows in the second half of the year.

On a year-to-date basis, capital spending increased by about $90 million, and we continue to expect capital spending of about $600 million for the year.

Capital spending to support the establishment of our Centers of Excellence has begun ramping up and will continue to increase as we go through the second half of the year.

Given our historically strong second half cash flows, as well as the expectation for the ramp-up in second half capital expenditures, we remain comfortable with the outlook for our 2014 cash from operations and free cash flow guidance.

A final item before I turn the call over to Steve.

Last quarter, I mentioned the Society of Actuaries was expected to issue new proposed guidance for mortality assumptions.

Those proposed changes have been issued.

They are receiving a great deal of comment and discussion.

And so the logical question is, what does it mean?

So in holding all other assumptions constant and no change in applicable regulations, the new mortality assumptions, when fully implemented, will likely result in increased liabilities, increased annual FAS and CAS pension expense and potentially increase funding requirements, dependent up the funded status of a Company's pension plans.

The timing of the ultimately agreed upon mortality guidance and adoption requirements are uncertain, but regardless of these timing issues, we expect to update our mortality assumptions.

Our preliminary review of our own mortality experience would suggest an increase in liabilities in the 4% to 6% range.

For planning purposes, we are currently assuming that the new mortality assumptions will be in effect at year-end 2014 for the measurement of the projected benefit obligations; and if that's the case, the new assumptions would then impact 2015 FAS pension expense.

Holding the discount rate constant and expected rate of return and all the other assumptions, we would expect mortality rates to increase FAS expense by approximately $50 million for every 1% increase in our liabilities and CAS cost would increase by about $40 million for every 1% increase in the liabilities.

We don't expect the adoption of the new mortality tables to impact our 2015 or 2016 required contributions, given our plan's funded status and our prior contributions and, of course, holding all other assumptions constant.

In addition to the potential impacts of the revised mortality tables, we also need to keep in mind that Congress is currently considering a new Highway and Transportation Funding Act which, at this point, includes extending the previous MAP-21 provisions that smooth pension funding requirements.

An extension of the MAP-21 discount rates that would result in, for example, a 100 basis point increase in our CAS harmonization discount rate, would likely offset much of the near-term impact of the mortality changes.

At this point, we would not expect the MAP-21 extension to have an impact on our funding requirements for either 2015 or 2016, and we do anticipate that the resolution of these potential changes would occur this year.

Just to remind everyone of our other FAS sensitivities.

A 25 basis point change in the discount rate changes FAS expense by about a net $60 million, and a 100 basis points change in our expected rate of return on plan assets would change FAS expense by about $45 million.

And finally, I would note that we expect to finalize our 2014 plan demographics in the third quarter, which may impact our 2014 FAS -- or CAS cost.

So to summarize, we now have potentially four major variables that can impact FAS and CAS cost.

The discount rate, the plan returns, new mortality assumptions, and possibly a MAP-21 extension.

So a lot of moving parts.

Obviously, we're following them very closely.

And we'll provide updates to our pension assumptions and estimates as all of these elements become better known.

So Steve, I think with that, we're ready for questions.

Thanks, Jim.

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

Jasmine will open the line at this time.

Jasmine?

(Operator Instructions)

And your first question comes from the line of Carter Copeland with Barclays.

Please proceed.

Good morning, gentlemen.

Or good afternoon, I should say, and good quarter.

Thanks, Carter.

Wes, I wanted to ask a big picture question for you, because it's getting to be that time of year where everybody gets engaged in their strategic planning process.

And when you look at where we are this year and where we've been in the past couple years, you were obviously doing some planning with considerable amounts of uncertainty.

And I realize that, per your comments, there's still a good bit of uncertainty about what may happen in 2016 and where the 2015 budget may come out.

But when you sit down and you start crafting that long range plan, how is that different this year relative to perhaps some of the scenario analysis and stuff you've done in the prior years, and how much more emphasis are you putting on revenue growth and benchmarking on things like that as opposed to what you saw in the planning process of the prior years?

Carter, I guess I would just provide kind of a broad view of how we see the overall environment.

Clearly, the deal that was reached at the end of last year that looked out for two years, that was very helpful.

It provided a little bit more stability compared, certainly, to where we had been in the prior year.

But the reality is our customers, of necessity, plan over a much longer cycle than two years.

And I would say that they are still struggling to plan effectively, given that we have a law on the books that says the sequester returns at the beginning of 2016.

Now, you'll note, as everyone else did, that when the President put forward his budget recommendations, he was pretty clear that to support national security, we could not be operating at a level that was dictated by the sequester.

So there are kind of two benchmarks out there right now.

One is the President's budget and the other is the sequester.

And it does create some fairly substantial uncertainty in the planning arena, particularly from the customer optics, as they're trying to profile out these multi-year programs and investment cycles, and quite frankly, as they are struggling to deal with everything that's going on around the globe, given the budget pressures that we have in place today.

So I would say that there remains a fair amount of uncertainty out there.

Clearly, the events around the globe, I think, are highlighting the importance of strong national security capability.

And hopefully, as we move along through this year and get into next year, we'll have a Congress that can tackle some of those challenges and come to grips again with how to really go forward on a budget perspective.

In the more near-term, as we're thinking about next year, I'm glad to see the committee's appearing to make some progress as we're going through the appropriations cycle.

But I think it's increasingly clear that we're going to be in a CR as we migrate into FY15.

Hopefully that CR doesn't last a long time, but it's hard to predict exactly how that's going to go.

So there's even a little bit of consternation in the near term on this process.

I know there have been a number of folks out trying to make a call on which year will be the trough.

Just given that range of uncertainties that I've just described, I think it's a little bit too early to call that.

So we're thinking about this, as we have continuously throughout this process, with a longer term perspective, making sure that we're doing the right things that continue to position us well for the longer term, working hard on our cost structure, making sure that we're performing well, and making the right investments to ensure that we're going to be able to support our customers' needs as we go through the inevitable cycles in our industry.

Jim, do you have anything you'd like to add to that?

Since we have probably a good portion of the Northrop team listening, and they all know that we're doing multiple scenario planning for our plan, I just want to reinforce your comments and the level of uncertainty that, as you look at a multi-year planning process, that range of uncertainty over the years dramatically escalates.

And so, yes, Carter, we are continuing to do multiple scenario planning, even in today's environment.

I think it's just a healthy thing for any enterprise to do, as well, because it allows you to be prepared for a variety of outcomes and to test your decisions and your assumptions against a variety of outcomes.

Thanks, guys.

Thank you, Carter.

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

Please proceed.

Good afternoon, guys.

Actually, Jon Raviv on here for Jason.

Sorry to disappoint.

Hello, Jon.

Quick question about IS and the in-theater exposure.

I was wondering if you could size that for us in terms of what you're still exposed to there, from a revenue perspective and also which programs that might be.

And given the fact that troops are on their way out over the next couple years, how much more downside is there, and then at what point and what opportunities do you see there for some longer term growth?

We're going to turn to our Information Systems expert, Mr. Movius, and ask him to answer that question.

Sure, be happy to.

The in-theater for the Company, which is a combination of our efforts in-theater, as well as those contracts funded with OCO funds, was about $1.1 billion last year.

We expect it to be about $900 million this year.

And IS does have the biggest piece of that.

Of the $200 million decline, the bulk of that is coming out of Information Systems.

We have four programs that -- program areas -- that make up like two-thirds of that sales volume, and IS holds at least a couple of them.

So the BACN program, which, quite frankly, will have legs even after the in-theater effort is over.

The C-RAM effort, which will probably drop off more materially as the in-theater efforts wind down.

And then our Electronic Systems has a product area in IRCM, as well as the laser business, which again will drop off somewhat, but has long-term viability in the marketplace.

So the $900 million, is it going to decline into the future?

Yes.

But a significant portion of that will continue into future year periods.

Thanks.

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

Please proceed.

Yes.

Thank you.

Hello, Doug.

Hello.

I was interested in unmanned.

Because now when you look forward, and if you're looking at some of the opportunities out there, I'd love to hear how you're seeing them now.

That includes Navy, UCLASS, variants of the Global Hawk platform.

But what I'm interested in is, as you see the unmanned aircraft industry mature, do you see certain segments where you're best positioned to compete, perhaps others that may not suit you as well?

How do you look at this market going forward today?

Doug, we're very excited about the opportunities in the future on unmanned.

It's still a capability, really an industry in its infancy, in many respects.

The great success that unmanned has enjoyed in the past decade, I think is testament to the potential.

But we're really just at the very beginnings of that.

Global Hawk clearly kind of set the stage for where things can go, from our perspective.

The ability to really see a large area and see it perceptively to deploy a variety of different sensor capabilities and to become an integral part of the operational doctrine of how things get prosecuted, I think really helped set the stage.

And then building on that with the Triton program for the Navy, the Triton program moving along very well.

We've had some really good recent progress, completing the initial flight test program, and we're looking forward to getting into LRIP as we get into next year.

And then on top of that, the success we've enjoyed with the UCAS-D program and landing an unmanned aircraft on the deck of an aircraft carrier.

All of those things I continue to see as real stage setters for where this can go, and go not just domestically, but internationally, as we've talked about on some of our calls and at the conferences in the past.

We're seeing a growing demand by our allies around the globe for this class of capability.

And we're looking forward to supporting that, particularly given the support for that outcome that we're seeing from the United States government, with DoD policy focusing substantially on making sure that our allies can have this class of capability and use it in a way that's highly integrated with US operational doctrine.

So there's a good path forward here.

The exact timing of when particular opportunities roll out is a little bit hard to predict, especially if we're talking about international, because it's always a little bit of uncertainty in all the steps you've got to get through on the international side.

But clearly, with Global Hawk and Triton, we're seeing great interest in those capabilities in Korea, Japan, Australia and other countries.

We've got the NATO AGS program underway in NATO today, and that's moving ahead very nicely.

You mentioned the UCLASS program.

There is a draft RFP that's been released for comment.

That's a program where there continues to quite a bit of discussion in both the Navy and at the OSD level about the mission and its requirements.

So a little early to call how that one's going to go quite yet.

But I think it's just another indicator that this is an area, an arena with a lot of dynamics and a lot of opportunities.

We tend to position ourselves more on the higher end of the capability.

And I think that serves us well, in terms of being able to look ahead to what our customers are going to need and invest in the near term to make sure those capabilities are going to be present for them.

There is a whole range of unmanned capability out there, everything from what you might think of as remote controlled airplanes, some people call those unmanned systems, all the way to the high end of robotically flown aircraft, which is really where our focus has been.

And quite frankly, I think there will be some good opportunities across that spectrum of unmanned capability, as we look into the future.

But we will tend to be focused more on the higher end of the capability.

And do you see it as a steady source of growth in revenue, or is this something where we may have to wait a few years to really see it move?

I think there are clearly some near term things that are moving ahead, in terms of driving some growth.

I mentioned Triton going into LRIP.

That's an important part of the process for us.

I mentioned the international ones.

So I think it's -- it won't be every single quarter that we've got some great news.

But if I think of it on an annual basis over the next few years, I am continuing to be optimistic about the vector for this.

And clearly, over the longer term, if you take a decadal look, I think this will be transformative.

Okay.

Well, thank you.

Thanks, Doug.

Your next question comes from the line of Yair Reiner with Oppenheimer.

Please proceed.

Great.

Thank you.

So book-to-bill looks like it would have come in close to 1, had the E-2D contract signed in the second quarter.

How are things looking for the back half of the year?

So book-to-bill, if E-2D had been in earlier, would have been closer to 1.5.

And I think E-2D is just another reminder that the long cycle businesses that we have, such as AS and ES, tend to get their awards in lumps.

And so we have to think about that over the longer period of time.

As well as international.

And Jim's right, and international, as well, comes in lumps.

So we don't guide on awards or book-to-bill for the year, so I won't give a projection for the second half.

I would just say we're pleased with how things are going.

Great.

And then if I could just rephrase or try an earlier question again about the budget trajectory.

I guess if we look at even the lower budget that's out there, the sequestered budget, looks like 2015 is a bottom.

Obviously, there's a disconnect between when there's budget authority and when there's an outlay.

But it seems like there's things that are a little bit different about this cycle.

There's a little bit of noise from OCO and so forth.

Is there reason to think that your DoD revenues are going to be substantially different than what we see in the budget authority?

Always hard to tell.

Again, you made the point in the difference between budget authority and outlay.

Ultimately, what this comes down to is the customer's confidence in taking a longer term view that if they start meaningful program activities, they're going to be able to get them done.

The last thing they want to do is get something started and have a calamity on the budget side that creates great inefficiency.

So there are tough decisions that our customers are going to need to make over the next couple of years, as best they can, given the haziness of the crystal ball right now.

And we'll see where that goes.

I continue to see our portfolio as very well aligned with the strategic directions that our customers are moving and will need to move, given what's going on around the globe, whether it's unmanned, the work we do on a variety of manned aircraft systems, the work that we do in C4ISR and cyber, as well as work we do in logistics and modernization.

I'm really pleased with how the portfolio is aligned for the longer term.

But this business of trying to call a trough, I think, is time misspent right now.

Okay.

Thank you.

And your next question comes from the line of Howard Rubel with Jefferies.

Please proceed.

Thank you very much.

Hello, Howard.

Good afternoon.

You've talked about changing your investment profile.

Frankly, it's a portion of capital that you expect to have reasonable returns on going forward.

Could you elaborate on some of the decisions that went into building these new facilities?

And are there multiple solutions to having these facilities available to you, and how does it improve your competitiveness, Wes?

Thanks, Howard.

Any time you make a decision to invest in a new facility, you kind of have to test it against a variety of potential outcomes.

And Jim talked a little bit earlier about the scenario work that we do, and that's an important part of it.

The facilities that I mentioned in my remarks, the ones in Florida, in particular, are locations where we not only have a great legacy of doing really good work, they're also increasingly centers where we're able to pull our teams together and really focus the benefit of having co-located teams to come up with new ideas and propel the current programs that we have underway.

So I would say that none of the facilities that I've mentioned so far are speculative facilities on some future opportunity.

These are activities and facilities and capabilities that will both benefit our ongoing business, as well as position us incredibly well for some of the things that we see on the horizon.

There is a natural benefit, and we've seen this time and again across the Company, a natural benefit of pulling together these sets of capabilities with people who can bring a wide variety of disciplines to address some of these increasingly complex problems.

And if I look at, for example, what we're doing in Melbourne today and the Manned Aircraft Design Center of Excellence that we're establishing there, we've had a long-term just tremendous set of capabilities in Melbourne, but we've had other capabilities that we've had scattered around the country.

And this gives us an opportunity to pull some of those things together, get the people together in a more focused manner to drive some different outcomes for us.

And I'm excited about what we already have going on there and what it will represent as we get that activity completed.

So just to follow up, not only does this sort of position you for some business, future business opportunities, it also may -- and I don't want to use the word lower costs -- but maybe improve productivity or enhance some other -- that's sort of where you're --

Yes, yes.

Absolutely.

From an affordability perspective, it is almost always more efficient to have teams co-located in facilities that we optimize the use of those facilities, as opposed to widely distributed, where we have suboptimal utilization of multiple facilities.

So there's a really important affordability and competitiveness perspective that goes into the Center of Excellence architecture.

Jim, did you --

Howard, I just -- our most valuable resource is our people.

Allowing our people to be co-located where they can share experiences across a wide range of programs is invaluable.

There's no way to really quantify the benefit that comes from being able to utilize the resources on a more effective basis across multiple programs, rather than have them dedicated to individual programs, and then just the sharing of experiences and ideas that comes from being next to the person and seeing what they're working on and how they're approaching the problem.

So yes, there's capital that's going into facilitate the sharing of the resources, but it really is, how do we best utilize our people resources?

Just one last perspective on this, Howard.

And I don't want to beat it to death.

But as you know, we are a Company built of acquisitions.

And so there are -- have still over time been sort of the remnants of doing things in different locations that sort of came along through the acquisitions.

In some respect, this is another next natural step of really integrating the Company in a tighter manner, and standing back and looking operationally at how we're getting things done and asking ourselves the question, is that really optimal?

And in some cases, it wasn't.

So we're fixing that.

And we think we're going to get a really good benefit from that.

Maybe just to conclude, getting the money out of Jim, I recognize probably was quite a challenge.

There must be a very --

Howard.

(Laughter)

There has to be a good hurdle here, is what I'm --

Absolutely.

The discipline remains high.

Thank you.

Thanks, Howard.

And your next question comes from the line of Myles Walton with Deutsche Bank.

Please proceed.

Hello, Myles.

Thanks.

Good afternoon, guys.

How are you?

Good.

Wes, I was wondering if we could take a path down the cyber lane.

And I want to ask the question in a way of what are the enablers for you, or any defense company, to succeed in moving away from the national security tier of cyber security and more into the business or even the personal/commercial tier of cyber security.

So more looking at it from the blockages that exist today and the potential for those blockages to be removed in the future that would open up markets for you or companies like you.

Let me give kind of a broad perspective on that.

First and foremost, on the cyber side, our expertise and focus continues to be on the national security side of it.

That's what we have been doing well for many, many years.

And we see an incredible demand for that, both in the US government, as well as in the governments of a number of our allies around the world.

As you know, there is hardly a domain that is as borderless as cyber.

So when it comes to thinking about the needs of both our country and that of our allies, those needs really do span in a very broad way.

So we see that as a very important dimension and are really, I would say, focusing our efforts in that direction.

There are clearly concerns within our country around how this plays in the broader realm, whether we're talking about the critical infrastructure or domains beyond that.

And you mentioned all the way to (Indiscernible).

We are obviously focused on how we can help in that regard.

We have a lot of work that we do with US government organizations, particularly the Department of Homeland Security, that has principal responsibility for the critical infrastructure and the implications of cyber vulnerabilities to the critical infrastructure.

So we're channeling a lot of our energy and capability into making sure we're supporting DHS as effectively as we possibly can.

When it comes to more of the commercial side of this, over time, we, like other companies in our industry, take a look at how we might use some of our technologies to help beyond our core mission area.

In each of those areas, our history is we tend to find the right partners and figure out what makes the most sense.

We are typically not a company on the forefront of a commercial set of markets.

So we test that from time to time, we look at it from time to time, and spend a lot of time talking to others who are in that marketplace to see if there is an avenue by which we can both be helpful and to generate some value.

But I would just reinforce that our Company is primarily focused on the business we're in.

And we see a big opportunity there, and I want to be careful that we don't get too diluted in chasing things that really aren't up our alley.

Makes sense.

And appreciate the color.

Thanks, Wes.

Thank you, Myles.

And your next question comes from the line of Rob Stallard with RBC Capital.

Please proceed.

Thanks very much.

Good afternoon.

Hello, Rob.

Quick question on Information Systems.

Wes, you mentioned this is probably your shortest cycle business.

I was wondering if you could give us an idea of what sort of trends you've been seeing there in terms of bid and proposal activity and those bids actually being turned into awards.

Well, IS is certainly our shortest cycle business.

It took the quickest, if you will, hit when the federal budget pressures came into play.

And we've seen that across the industry for similar businesses.

It continues to be extraordinarily competitive.

Our team in Information Systems is doing an absolutely great job of picking out the competitions that we want to go out and pursue, and being successful on them.

We had a reasonable quarter in terms of awards in IS, so --

actually, reasonable six months.

That's right.

The last six months has been quite good.

So I'm very satisfied with how we're positioned in that area.

It is a business that I see as very important to our Company for the long term, not only in its capabilities in the cyber arena that we were just speaking about with Myles, but also broadly, in C4ISR, in the work that we do in that domain, or all of those domains that are embodied in C4ISR, IS is an absolute leader in our industry.

And those capabilities are core to what we do more broadly across the enterprise.

So we're toughing it out, like everyone else in that side of the space.

But I'm very, very pleased with our competitiveness.

The portfolio of capabilities that we have in IS, I think, is strong, in terms of the breadth of its support.

Like all of our businesses, we continue to assess all the pieces of it and we look hard at where those are and how we see them for the long term.

But on a relative basis, I think IS is doing well.

In a down environment, they've performed very well.

They have.

Okay.

Thanks very much.

Thank you, Rob.

Your next question comes from the line of Cai von Rumohr with Cowen and Company.

Please proceed.

Yes.

Thank you very much.

Couple of questions.

With the situation changing in the Mideast, in Iraq and some of the other conflicts we have, does that have any impact, either positive or negative, on your international sales in the near term and as you look forward?

Cai, I think it's just a reminder that there is instability in our world, and that both we and the US and our allies around the globe need to be capable of dealing with those things.

Does that translate into something in the very near term?

I really don't see that.

It's hard to tell.

Might there be some things that pop up as a result of it?

Yes, potentially.

And we do stay in very, very close contact with all of our customer communities around the globe, to make sure that we are as responsive as we possibly can be to their emerging needs and are looking forward for them and bringing ideas to them from a security perspective.

But I would characterize what we're seeing around the globe right now as more of -- as having more of an impact on the longer term thinking about the need for a more capable and robust global security environment.

Okay.

And then switching to Aerospace, your margins were down.

And I guess your EACs were down some $58 million.

It looks, excluding new potentials, like long range strike and UCLASS, looks like your business is switching from development to more production, E-2D, NATO AGS, etc., F-35.

Should we, on an ongoing basis, expect that EACs in that sector might be coming down as you've completed the development, but that as you move into production and as you get more foreign mix that maybe your inherent profitability would improve, so the margins would be stable or maybe moving up, excluding those two new programs I mentioned?

Let's see, Cai.

I would agree with everything that you said.

That could be happening.

And as we get -- as we transition from our -- more of our development activities into production, margins generally are improving.

Adding more international content normally would improve margins, as well.

But there are some major, major new development opportunities ahead of us, as well.

Ultimately, what happens with both the international opportunities and the new domestic development opportunities will influence what the overall aerospace margins are going to be on a longer term basis.

And Cai, I would add, as I've said before, I'm delighted to have the downward pressure on our margin rates that results from taking on new development programs.

Because that means we're being successful and competing for the new opportunities.

So that's the way we're focusing as a team.

We see the substantial opportunities out there, and we intend to compete for them, and hopefully are successful in a significant number of them.

Clearly, you do.

But if we just think about the core business, excluding those two to three programs, is it fair to assume that the profitability should start to -- should improve ex- EACs, as we move forward?

Because you will have more production work and you will have more foreign work.

Cai, I don't think you can ever think about margins ex adjustments.

Adjustments are a normal part of the business.

They occur every quarter in every company, at least in my experience.

Even in production.

Even in production.

There are always risks and opportunities that a program is working to manage and control.

And the nature of estimating cost over a multi-year period, our airplane programs that we receive today take about three years to perform on them.

So there are going to be risks and uncertainties, opportunities associated with every single one of those contracts.

And in some cases, we're going to do better than we thought, and maybe in other cases, not as well.

We are really working hard to make sure that our team understands first, what are the risks and opportunities, so that we can manage them to reduce the risk and harvest the opportunities.

But ultimately, you're always going to have EAC adjustments.

Okay.

Great.

Thank you very much.

Thanks, Cai.

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

Please proceed.

Hello, Sam.

Hello.

Wanted to go back to a comment you made about the buyback during the initial remarks, which is you went from down 8% to down 9%.

And it just seems like looking at where you are at the end of the quarter in the Q, add back a load of options, if it just stayed there, you would get pretty close to 9% for the year.

So I'm just trying to think about how you're thinking about buyback.

Because the second half cash flow is clearly much stronger than it was in the first half.

And why wouldn't the underlying share count be going down more than the 9%, just given where you are year-to-date?

Recognize that we're talking about the weighted average shares outstanding for the entire year.

As you go through the year, every month is worth less to that average for the year.

And compared to last year, we were fairly heavy in our share repurchases in the second half of last year.

So that is a 9% reduction off of last year's average, influenced by the timing of last year's share repurchases.

So at this point our ability to get substantially greater reduction in weighted average shares for this year is relatively small.

Okay.

That's fair.

And if I can just follow up on the E-2D multiyear that was just signed.

When does that -- when does work on that contract start?

And is it the type of thing where you do get a margin degradation -- kind of going back to the question just before -- when you first start, and then you have to work your way back up to a better margin?

Actually, work has started on that multi-year contract and it will -- typically has a traditional U-shaped approach associated with it.

So start off small, and as we get into more of the production and deliver aircraft again, we're recognizing aircraft when -- or recognizing revenue when aircraft are delivered here.

So the revenue recognition is going to be more back-end loaded.

And we're estimating costs for a multiyear contract, five years.

We're likely to start off at a somewhat conservative margin rate, and then as we go you through time and realize the opportunities and minimize the risk, have the opportunity to step up margins.

Okay.

Thanks.

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

Please proceed.

Thank you.

Hello, John.

Hello.

Thank you for taking my question, and congrats to Steve on his expanded responsibilities.

I wanted to talk a little bit about revenue.

It just seems like on a few of these segments, Aerospace, IS, TS, you're tracking high versus the full year guidance.

You didn't revise the revenue guidance in those segments.

And I'm just curious if there's any kind of specific puts and takes that you'd highlight that might be driving a sequential down tick.

The revenue's always influenced by timing of deliveries or on the cost on cost contracts by the timing of cost.

And cost is many times influenced by subcontractor deliveries.

And so those kind of factors, when are deliveries actually going to occur -- we obviously have a schedule, we can predict based on the schedule, but we work hard to try to accelerate to a schedule.

And at times, if we have supply issues or other issues, we may slip the schedule for a few days or a month, weeks, whatever.

When you're talking about multi-billion dollar products, doesn't take too much to affect revenues.

And then just the cost, the cost is, as I said, largely influenced -- again, we have a pretty good sense of our cost, people, people-related cost.

Timing of subcontractor cost can have a significant impact on revenue on a quarter-to-quarter basis.

Got it.

So you wouldn't flag anything in particular driving sequential down?

No.

Not at all.

Got it.

Thanks, guys.

Jasmine, this is Steve.

I think we've got time for one more.

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

Please proceed.

Thanks.

Good afternoon.

Hello, Joe.

Hello.

So Wes, your backlog has been ticking down a little bit still, but the rate of decline seems to have abated quite a bit over the last few quarters.

I was wondering if you felt the same way, if you feel a little bit more -- a little better about the bookings environment more generally?

I know you're not going to give a target.

You already answered that question.

You're not going to start giving bookings guidance.

But maybe just some big picture color.

And then specifically, you have the E-2D that you already have in Q3.

Obviously, there's LRSB, looking into next year.

What are the other big opportunities, domestic and international, as you look over the next 6 to 12 months?

Thanks, Joe.

It's one of those environments where while it's tough, it makes everybody focus a little bit more on competitiveness.

And I have been pleased with the competitiveness of our enterprise.

It's delightful to see that we're being successful on a wide variety of fronts in what we're taking on.

But as I said in my earlier comments, I am a little bit reluctant to get out ahead of what we see going on in the budget cycle, because there are just a lot of uncertainties there yet.

And it's important that we all be as clear as we can about the uncertainties that we see.

We do have a number of great opportunities in front of us.

I spoke a little bit earlier, in response to Doug's question on unmanned, about some of the international opportunities we see there on the unmanned side.

On international, historically Electronic Systems has been our primary business, with about 20% to 25%, depending on the year, of the sales at ES being international.

And ES is doing very well in pursuing its international business.

And I think this year, they'll be some place around 25% on their sales internationally.

So kind of the new story for us on international is on the Aerospace Systems side of things, both unmanned that I spoke about earlier, as well as some opportunities from the manned side, whether we're talking about our part of F-35 or the E-2D international opportunities.

So we're excited about that.

And I also mentioned a little bit earlier, in response to Myles' question on cyber, that cyber also represents some interesting international opportunities for us.

So we do see international as continuing to be a growing part of our business.

This year, we, as we've said before, are up on international relative to where we were last year.

Last year was around 10% of our sales, and we expect to be about 13% this year on international.

Domestically, clearly there are some big and meaningful opportunities out there, one of the most important of which is long range strike.

But in addition to that, at AS we're looking hard at the UCLASS opportunity that I talked about a little bit earlier.

And at ES, there are a number of upcoming decisions, whether it's the 3DELRR program that we may yet hear about this year, or the CIRCM program, which looks to be on track for a decision in the early part of next year.

Those represent great opportunities for us, as well.

So there's a lot that we're out there pursuing.

But to be successful at that, we have to continue to perform on our programs that we have today.

We have to continue to work on our competitiveness.

Some of the investments that I talked about earlier, in response to Howard's question, are focused on that very thing, making sure that we're going to be competitive for the future and can bring forward very affordable offerings for our customers.

So we continue to see a nice profile of opportunities out there.

Thanks.

Thank you, Joe.

This concludes the Q&A portion of the call.

Wes, final comments?

Thanks, Steve.

As I said earlier, the first half of the year has again demonstrated that our team's focus on performance is enabling us to do well for our customers and for our shareholders.

So thanks, everyone, for joining us on the call today, and thanks for your continuing interest in our company.

Ladies and gentlemen, this concludes today's conference.

Thank you for your participation.