諾斯洛普·格拉曼 (NOC) 2014 Q4 法說會逐字稿

Good day ladies and gentlemen and welcome to Northrop Grumman's fourth-quarter and year-end 2014 conference call.

Today's call is being recorded.

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

(Operator Instructions)

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

Mr. Movius, please proceed.

Thanks Katelyn, and welcome to Northrop Grumman's fourth-quarter and year-end 2014 conference call.

We provided supplemental information in the form of a power point presentation that you can access at our website.

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 the supplemental power point presentation.

I would also like to note that in 2015, our earnings releases will be in the fourth week of the month following the quarter end, due to reporting conventions.

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

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

Thanks, Steve.

Hello everyone, and thanks for joining us.

Before I begin my formal remarks today, I want to note that this is Jim Palmer's last conference call as Northrop Grumman's CFO.

On behalf of the board, our leadership team and all of our employees, I want to thank Jim for his many contributions since joining Northrop Grumman in 2007.

Jim has been an incredible partner in formulating our strategy, executing major strategic actions and driving the performance transformation that's created so much value for our shareholders, our customers and our employees.

Jim has also ensured that we have the financial resources and flexibility to take advantage of our opportunities and honor our commitments, which has been particularly important during the challenging budget environment over the last few years.

But perhaps most importantly, Jim has been a steadfast advocate of ensuring we think about the long-term strength of our Company and our industry, as he has a deep conviction about the importance of what we do.

I want to personally thank Jim for his leadership, his dedication and the energy and integrity he applies to everything he does.

After we file our 2014 10-K, Ken Bedingfield will become Northrop Grumman's CFO, and Jim and Ken are working to ensure we have a seamless transition over the next few months.

For those of you haven't met Ken, prior to joining Northrop Grumman he spent 17 years at KPMG, where he had roles of increasing responsibility, and just prior to joining our team, Ken was the national client leader of KPMG's US aerospace and defense audit practice.

Here at Northrop Grumman, Ken led financial reporting and compliance as our Corporate Controller and Chief Accounting Officer.

He also served as the Chief Financial Officer of Aerospace Systems, our largest sector.

Most recently, Ken has served as Vice President, Finance, with all of our sector CFOs reporting to him.

In these roles, Ken has also been a leader in executing our strategy of performance, portfolio alignment and cash deployment.

And as CFO he will play a more prominent role executing this same strategy going forward.

So, congratulations to both Jim and Ken.

Now, I'd like to discuss our 2014 financial results and our 2015 guidance.

2014 was another year of outstanding performance, and I want to congratulate the entire Northrop Grumman team on a job well done.

Our focus on performance, cash generation and effective cash deployment produced strong results and shareholder value creation.

We ended the year with sales of nearly $24 billion.

While customer funding constraints continue to pressure our shorter cycle businesses, our longer cycle businesses were stable.

And international sales growth helped to partially offset domestic funding challenges.

In 2014 International sales increased 20% to approximately $3 billion, or 13% of 2014 revenue.

International sales grew at all four of our sectors.

2014 earnings-per-share increased 17% to $9.75, and on a pension adjusted basis earnings-per-share grew more than 13%.

Our businesses continued to perform well, growing segment operating income and expanding segment operating margin rate by 40 basis points to 12.9%.

We ended the year with a total backlog of $38.2 billion, a 3% increase over year end 2013 total backlog.

2014 new awards totaled $25 billion.

We are starting to capture major opportunities in our international businesses, and at year end these awards represented 14% of backlog.

We expect international revenue to grow to approximately 15% of sales in 2015, as our footprint continues to expand and demand grows for our unmanned and manned aircraft, electronics, cyber, sustainment and other offerings.

In addition to the Republic of Korea's contract for four Global Hawks, Japan has type selected Global Hawk to fulfill its high altitude ISR mission and has also type selected our E-2D advanced Hawkeye for its future advanced early warning and battle management mission.

And shortly after the end of the year, Saudi Arabia awarded one of our joint ventures, reported in Technical Services, a $900 million contract for the Ministry of National Guard Training Support.

In addition, Information Systems was competitively awarded a seven-year IDIQ contract by the UK Government to develop and deliver cyber security solutions in support of data security and information assurance.

Cash generation and capital deployment are key elements of our strategy.

In 2014 our operations generated $2.6 billion, and after capital spending, free cash flow totaled more than $2 billion.

We returned $3.2 billion to our shareholders, or nearly 160% of free cash flow.

We repurchased 21.4 million shares for approximately $2.7 billion, which reduced our weighted average share count by 9%.

And through the end of 2014 we have repurchased 42.2 million shares, or approximately 70% toward our goal of retiring 60 million shares by the end of 2015, market conditions permitting.

During the fourth quarter, our Board approved a new $3 billion authorization to support share repurchases, including the completion of the 60 million share reduction.

At the end of 2014, a total of $3.4 billion remained on our share repurchase authorizations.

We paid shareholders $563 million in dividends in 2014, and increased our dividend by 15% last May.

Over the last five years, our annual dividend per share has grown 60%.

While we returned substantial amounts of cash to our shareholders in 2014, we also continued to invest in our businesses.

Capital spending increased more than 50% to $561 million, and research and development investments increased more than 12% to $569 million.

Our strategy of focusing on performance, portfolio and cash is working.

We've created a portfolio centered on our key capability of unmanned and manned aircraft, C4ISR, cyber, logistics and modernization.

Our strategy has resulted in a high-performing portfolio that's well aligned with the current and emerging technologies and capabilities that we believe will be of highest priority for future global security.

Simultaneously, we have improved our affordability through both cost reductions and innovation.

Both efforts are necessary to truly achieve affordability for our customers.

As we look ahead, Congress passed an FY15 appropriations bill that provides a degree of certainty for our customers, but it also represents the seventh year of continuously declining budgets.

In addition, the debt ceiling limit still needs to be addressed, and a potential sequestration could be triggered for FY16.

All of these factors will continue to influence our customers' spending decisions during the coming months.

Turning to guidance for 2015, we expect sales of $23.4 billion to $23.8 billion, with earnings-per-share of $9.20 to $9.50, cash from operations of $2.4 billion to $2.7 billion, and free cash flow of $1.7 billion to $2 billion.

Jim will provide more detail on our guidance, but we expect continued pressure on our shorter cycle businesses, which will be partially offset by growing international sales.

In conclusion, our 2014 results represent another year of strong performance.

In 2015 our priorities are unchanged.

Drive strong, sustainable performance, generate cash and effectively deploy that cash, and, continue to optimize our portfolio to ensure our alignment with global security priorities.

We have a solid track record that demonstrates that we can do this successfully, and we look forward to continued, long-term, sustainable value creation.

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

Jim?

Good afternoon, ladies and gentlemen.

I want to add my congratulations to our team on their continued outstanding performance.

And Wes, I want to personally thank you for your kind comments.

I truly appreciate them.

I've thoroughly enjoyed being part of a Company of outstanding people who are fulfilling missions of the highest importance to our nation and our allies.

I'm really proud to have been part of a team that's accomplished so much.

Today, I'll briefly review 2014 results and then discuss 2015 guidance.

Beginning with performance, 2014 segment operating margin rate improved 40 basis points to 12.9%.

About 20 basis points of that improvement resulted from the $75 million in settlements at Aerospace Systems that we recorded in the third quarter.

Excluding the settlements from both consolidated sales and segment operating income, our 2014 segment operating margin rate would have been 12.7%, versus 12.5% in 2013.

The year-over-year improvement reflects better operating margin performance in three of our four sectors.

Aerospace Systems was the largest contributor to this year's margin rate improvement, with part of the improvement being the previously mentioned settlements.

So, adjusting AS sales and operating income for the settlements, would give them a 12.5% operating margin rate for the year, still, a 40 basis point increase over 2013 due to improved performance.

Information Systems and Technical Services continued their strong performance with margin rate improvements of 20 and 10 basis points, respectively.

Electronic Systems, while down versus 2013, posted a very strong 16.5% margin rate.

Total operating margin rate for 2014 was 13.3%, 60 basis points higher than last year, principally due to more favorable net FAS/CAS pension adjustment and higher segment operating income.

These positive trends were partially offset by $50 million increase to a more normal level of unallocated corporate expenses.

You'll recall that our 2013 unallocated expenses were unusually low, due to lower provisions for disallowed costs and litigation matters, as well as favorable settlement of overhead claims.

On a pension adjusted basis, our operating margin rate increased to 12.2%, a new record for the Company.

You also saw in our press release that in the fourth quarter we recognized a full year 2014 R&D tax credit of $38 million, due to the extension of tax benefits at year-end.

Turning to cash, 2014 was another good year.

Both in absolute dollars and on a per-share basis.

Free cash flow totaled $2 billion, and we returned more than $3.2 billion, or $15 per share, to our shareholders.

And 2014 total shareholder return was 31.4%.

So, it was another very good year, both in terms of performance and value creation for our shareholders.

Now, let's spend a couple of minutes and discuss our 2015 guidance, beginning with sector sales and OM rates.

For 2015, we expect AS sales to range between $9.8 billion and $10 billion, with a margin rate in the high 11% range.

Sales guidance reflects lower volume for manned aircraft and space programs, partially offset by growth in unmanned programs.

In manned aircraft, we expect lower volume for the F/A-18 and Joint STARS, which will be partially offset by ramp up's in E-2D and F-35.

In space, we expect lower volume for the Advanced EHF and for the James Webb space telescope.

And then turning to unmanned, we expect double-digit growth in our high-altitude long endurance business, which includes programs such as Global Hawk, Triton and NATO AGS, to partially offset declines in other businesses.

For Electronic Systems, we expect 2015 revenue of $6.7 billion to $6.9 billion, and our sales guidance includes some lingering impacts from in-theater force reductions that partially offset by expected growth in international sales.

We expect ES operating margin rate in the low to mid 15% range, although lower than 2014, still very healthy and indicative of continued, strong performance.

We expect Information Systems sales in the range of $5.9 billion to $6.1 billion, or a low- to mid-single digit decline, compared to a 6% decline in 2014.

So this is a moderation in the rate of decline.

The sales decrease primarily reflects reduced volume in command and control, ISR and similar programs, due to program completions and transitions, as well as continued in-theater force reductions.

Higher volume on F-35 and growth within our international portfolio, should partially offset those impacts.

Our outlook for IS continues to reflect the pressure on the shorter cycle businesses, due to lower funding levels and budget uncertainty.

As Wes said, the budget process is a little bit better at this point, but our customers are still facing the potential sequestration in FY16.

And we expect that situation will continue to influence customer behavior in our shorter cycle businesses, particularly as we approach the end of the government's fiscal year.

But despite the topline pressures and continued investment in our international business opportunities, we expect IS to maintain a mid- to high-9% operating margin rate in 2015.

Moving to Technical Services, our expectation for 2015 sales is $2.7 billion to $2.8 billion, with a margin rate of approximately 9%.

The sales outlook for TS reflects lower revenue for ICBM, Hunter and Combined Tactical Training Range programs, with growth in international programs expected to offset some of the decline in these other programs.

So on a consolidated basis, we expect 2015 segment operating rate will be about 12%, and we expect our total operating margin rate will be in the mid-12% range.

Turning to pension, on the third quarter call I had discussed the potential impact of variables such as the updated mortality assumptions and lower discount rates on our expectations for the 2015 net FAS/CAS pension adjustment.

And at that time we estimated that our 2015 net FAS/CAS adjustment would be income of about $150 million.

Now that we have final data, we're increasing our 2015 net FAS/CAS pension adjustment to income of $290 million, or an increase of $20 million from 2014 levels.

This reflects 2015 CAS expense of approximately $675 million and FAS expense of $385 million.

Our 2015 estimates reflect adoption of updated mortality assumptions, actual 2014 plan asset returns of about 9.75%, net of expenses, an 8% long-term rate of return on plan assets and a discount rate of 4.12% versus last year's discount rate of 4.99% at the end of the year.

When we file our 10-K, you'll see that our projected pension obligations have increased by approximately $4.5 billion to $30.5 billion, with the increase being largely the result of the decrease in the year- end discount rate, and then to a somewhat lesser extent due to the updated mortality assumptions.

On a longer-term basis for 2016 and 2017, we currently expect CAS expense of approximately $765 million and $840 million respectively, while FAS expense is currently expected to be $315 million and $240 million for 2016 and 2017 respectively.

And for your modeling purposes, a 25 basis point change in the discount rate, results in a net $65 million change in 2016 FAS expense.

Likewise, a 100 basis point change in plan asset returns, versus the assumed rate of 8%, results in a $50 million change in 2016 FAS expense.

In the aggregate, on a GAAP basis, the funded status of our plans was 82% at the end of 2014, reflecting the impact of the lower discount rate and the updated mortality assumptions.

Our qualified plans are 86% funded, and our required contributions remain minimal, about $75 million in 2015 and for the next several years.

I would note however, that we are continually evaluating whether to make additional voluntary plan contributions based on their potential economic benefit.

Turning to taxes, we expect a tax rate of approximately 32.5% in 2015, which does not include an R&D tax credit extension or the potential benefit of possible resolution of IRS exam issues for the tax years 2007 through 2011.

Our 2015 earnings-per-share guidance of $9.20 to $9.50 contemplates an 8% reduction in weighted average shares outstanding, to approximately 195 million shares.

We expect cash from operations before discretionary pension contributions will range between $2.4 billion and $2.7 billion, and free cash flow before discretionary pension contributions is expected to range between $1.7 billion and $2 billion.

Our free cash flow guidance anticipates capital spending of about $700 million in 2015.

We spent slightly less in 2014 than our planned capital expenditures of $600 million, and frankly I would expect that that under spent amount will be made up in 2015, along with some other increases.

Regarding cash trends in 2015 versus 2014, we do expect an increase of about $300 million in CAS collections in 2015.

On an after-tax basis, that is about a $200 million of increased cash flow.

However, there are two other major factors that will reduce 2015 cash flow when compared to 2014.

First, 2014 had three unusual items that at this point are not expected to repeat in 2015.

They are the $75 million of settlements, the IRS partial resolution of tax years 2007 through 2009, and the R&D tax credit extension.

Together those three items represent approximately $125 million reduction in this year's 2015 after-tax cash flow, when compared to 2014.

Finally, in 2015 our bi-weekly payroll cycle results in 27 pay periods rather than a normal 26, and another $125 million reduction in cash flow versus 2014.

Our guidance reflects another year of strong operating performance and strong cash generation supportive of continued investment in our business and distribution of cash to our shareholders.

So that concludes my comments on 2014 performance and our 2015 guidance.

But before we begin Q&A, I'd like to spend a few minutes and introduce Ken Bedingfield, our CFO elect and add just a few thoughts.

Obviously Ken and I have worked closely together in his role as Corporate Controller and as the operating CFO at Aerospace Systems.

After seeing him in those roles, I'm confident that Ken has the skills and qualifications to lead our financial organization.

He has earned the trust and confidence of our management team, and I'm pleased to be succeeded I such an outstanding individual.

So, Ken, over to you.

Thanks, Jim and good afternoon, everybody.

I'd like to add my thanks to the team for another job well done.

Over the last several months, I've had the opportunity to meet a number of you and I look forward to meeting more in the coming months.

Wes, Jim and I share similar philosophies, particularly on sustainable performance and cash deployment.

We have worked closely together over the last several years, and I'm looking forward to assuming the CFO role after we file our 10-K, which should be next week.

I'd like to thank Jim for his leadership and guidance, he's been a great mentor and I'm confident that our continued transition over the next few months will be seamless.

I look forward to speaking with you again on our first-quarter conference call.

Let me turn it back to Steve.

Thanks, Ken.

As we open up the call for Q&A, I would ask each participant to limit themselves to a single question.

With that, Katelyn, we are ready for questions.

(Operator Instructions) Cai, Cowen and Company.

Yes, thank you very much, and Jim, congratulations on a job very well done.

Thank you, Cai.

Wes, you mentioned your R&D was up 12% last year.

Where do you see it going in 2015?

And if you could give us a little bit of color in terms of by divisions, where you're spending it and what the net impact on your earnings might be?

Thanks.

Thanks, Cai, it's a really important question about how we're thinking about R&D.

We don't guide with specific numbers for each year on what they are; we do report them at the end of each year.

But I will just say that as we think about our role in the broader global security community, our role is to bring technology forward and to bring the types of solutions that are based on technological superiority that enables our nation and those of our allies to get their jobs done.

So, technology has always been a core part of what we do, and through this downturn cycle we've held our R& D as a percentage of sales up through the cycle, and I see us continuing to emphasize this and grow it over time.

And this goes across all of our businesses, by the way.

As you might imagine some of our businesses are a little bit more technologically intensive than others and so it's not exactly the same percentage in each of the areas, but every single one of them has a strong, technological underpinning.

And that span of technology encompasses not only the things that we're working on in terms of near-term developments to bring into products, but also the very early stage technologies, things that aren't going to pay off for our Company or for our customers for many, many years.

We see that as just an absolutely integral and critical part of our R&D strategy.

Not every one of those investments turns out that we can turn it into something, but we believe that's a key part of being in the technology space.

We're going to try some things that don't always work out and some of them work out astoundingly well.

So we are going to continue that on our path forward.

And I've mentioned several times in past calls about half of our population, about half of our 65,000 folks, are degreed to scientists, engineers, mathematicians, or technologists of some kind.

So, there's just an amazing amount of creative capacity in this organization.

And our ability to get good returns on our technology investments is really because of the hard work and dedication and creativity of our great team.

Joe, JPMorgan.

Thanks.

Good afternoon.

Congratulations to Jim and Ken, both.

Thanks.

My question is, just as we look at the margin guidance for Aerospace and for Electronic Systems, and you guys have done a pretty good job over the last several years of guiding lower and beating.

Just trying to get some context here on whether -- how much upside there might be if you're able to maintain -- to what degree might be able to maintain the margins you've been running at the last couple of years?

So maybe the question would be, how much of the margin degradation is due to mix and how much of the expected margin degradation is due to lower cumulative adjustments?

Joe, this is Jim.

We don't really plan for cumulative adjustments.

We plan for margin rate associated with each of our businesses looking at the backlog and the margins inherent in the backlog, as well as where we think the business will perform.

When I think about our Electronic Systems business, 16.5% margins this year and guidance for next year still is very good performance relative to the industry peers.

Frankly we've had at Electronic Systems, a group of mature production programs that are nearing completion, being replaced by younger development programs and or younger production programs, so we're going through a little bit of a shift from some mature programs to some less mature programs, but that's kind of the normal cycle.

At Aerospace, again $75 million benefit that's in margins in Aerospace this year, will not -- at least, I see no reason why it's going to be repeated next year, so that's a big part of the change in margins in Aerospace.

But again, high 11% margins is really good performance.

We've had a little change over the last couple of years in our fixed price business mix change, but it's not been that significant, probably up a couple percentage points on a year-over-year basis.

So we'll continue to have significant development activities in each of our businesses, which actually is the lifeblood of our future.

Jim, I'll just add to that, because Joe had a good comment about mix.

And I think that's a really important perspective, just to reiterate something that we've all said a number of times over the past couple of years.

As we go forward, we do expect, or we know, a number of good development activities, and I'm okay with our margin rates coming down a little bit based on our successful capture of new development activities.

I'm not okay with margin rates coming down if there are performance issues.

We went through in era as a Company where we had a series of performance issues, and we've worked hard to get past that.

So, our focus is, go out, get those really good development opportunities that should create great value for our shareholders over time.

If we need to have a little bit lower margin rate because of that mix shift over time, that's fine, but we're going to keep performing and that's really going to be the focus across the enterprise, is that whatever we go out and capture we're going to execute well.

Howard, Jefferies.

Thank you very much.

Mr. Palmer, you have set a high bar.

He has, hasn't he?

Well, it has been -- not only that, it's actually been a pleasure to work with him.

Thank you, Howard.

I really appreciate the comment.

You spend $700 million in capital, which is large, relative to normal standards.

Could you elaborate a little bit on where it's going and how fast you think you might be able to see some pay off from it, Wes?

Yes, then I'll ask Jim, too, to give a little bit more color on it.

But it goes back actually back, Howard, to what we were just talking about, as we have looked at our future, we have made some decisions to structurally get aligned a bit better, and we announced a little bit of time ago our focus on moving into centers of excellence.

That requires a bit of capital to actually get those stood up and operating the right way.

As we get those facilities in place we look forward to having a number of all of you from the investment community come and take a look at these new centers.

So, that's a part of it.

Other parts of it go fundamentally to supporting the program opportunities that we've captured, or that we see on the horizon.

We're investing in the Company because we see a good opportunity for return here.

Jim is there any more detail on that --

I'll just echo your comments, centers of excellence and program opportunities are really the drivers in the capital investment.

Frankly, last year we said that the capital expenditures were going to be high for a few years and we're basically implementing what we said we were going to do.

I'll just point out as well, when we talk about centers of excellence sometimes that just sounds like Company consolidation and yes perhaps at the 50,000-foot level that's what it is.

But ultimately it's a key part of our strategy to drive both affordability and innovation in the organization.

We're finding that as we do a better job of integrating some of the activities that have been geographically separated, that we're getting a lot of very positive energy that is going, not only into the programs that are being executed, but also the development of new opportunities.

So, that's a big part of it on the innovation side.

And of course on the affordability side, consolidating our footprint has been a process that's been underway now for several years and that is already paying off, of course, and we expect to see good returns on that as we go forward.

So, overall my point is the capital investment has a lot of different strands that run through it: affordability, innovation and supporting our programs across the board.

We're delighted to be able to have those kinds of opportunities to invest where we see those returns.

Doug, Sanford Bernstein.

Thank you.

Hello, Doug.

Hello, Jim.

Really, it's been just great working with you, so, I want to wish you all the best, going forward.

It's been a great, great several years here.

That's a mutual feeling shared.

Yes so anyway, good luck.

On the short cycle businesses, Information Systems and Tech Services, when you look at the backlogs, you're looking at 10% decline in Information Systems backlog and even more in tech services, yet your guidance for revenues is down a little in each.

I'm assuming you got KC-10 and ICBM support in Tech Services, but it was surprising to me to see your revenue expectations hold up reasonably well considering what appears to be a lot of pressure on backlog here.

Well, Doug, you hit on a couple of the items.

Clearly, right after the end of the year we booked a $900 million award in the Technical Services piece of the business.

It was touch and go whether that would be before the end of the year, or in the first quarter of 2015 and basically we didn't rush the deal.

We made sure that we got a deal that made sense and so it flopped over into 2015, so be it.

Frankly, when we look at the other shorter cycle business, Information Systems, it's interesting that only about a little over half of the revenues actually come out of funded backlog for the year.

That is a shorter cycle business, a big part of the business moves from unfunded backlog to funded backlog as we go through the year.

Or said differently the customer tends to fund us in a number of months of increments rather than a full annual year basis.

And so we tend to see that kind of cycle move through there, as well as just being a shorter cycle business, so new awards have a more of an immediate impact on revenues in the current year.

So it's a combination of all of those kinds of things and frankly, some expectations for our international opportunities as well, that went into our revenue guidance for both of those businesses.

I would just add a little bit in the science of backlog conversion to revenues in the following year is an interesting area of study.

We all know that in our long cycle business it often takes a while for that backlog to convert to sales, and that's what we mean by long cycle.

And obviously in shorter cycle we know that there's a lot more volatility in that conversion, and I think if you think about these vectors of backlog and revenue, it's probably easier to conclude that the direction of the vectors is more often aligned than it is to conclude that the magnitude of the vectors is aligned and correlated.

If you look back just over the last few years, in IS we have seen some years of notable declines in backlog where the revenues in the following year were directionally the same, it was down, but the magnitude was a lot different, and that goes back to what Jim was saying.

It's due to the nature of these short cycle businesses that sometimes we're seeing more revenue from the awards that are captured in the year of performance.

So when we do our look forward and give our guidance, we really do look at the whole pipeline.

It's not just a backwards look at the backlog, it is a perspective that encompasses what we see in front of us in the current year and how we see that translating into revenue.

So of course our 2015 guidance does contemplate what that current backlog position looks like, but I would say more importantly it contemplates what we see from a pipeline perspective and a position perspective.

Carter, Barclays.

Good morning.

I guess I should say good afternoon.

And again, let me add to the congratulations, Jim, on all of your successes.

Thank you, Carter.

I want to go back to one of the earlier questions on research and development and at least from a high-level or directional, I know you don't disclose the number, Wes, as you said, but several of your peers so far this quarter, and this year, have talked about greater amounts of internal research and development impacting their margin outlooks.

And I wondered if you might speak at least directionally, is that something that's influencing your P& L this year?

Or potentially in future years, or should we see a relatively stable amount of that investment?

It's not a big factor this year, clearly, it varies from year to year depending on the mix of fixed price cost plus and you can play the math through on that.

But I don't see it as a differentially big issue this year relative to prior years.

I don't want to put a stake in the sand on future years.

Obviously we need strategic flexibility to decide how we manage that based on the environment.

But as I said earlier it's going to continue to be really, really important to us; it's the lifeblood of our enterprise.

We're going to make sure we're managing it the right way.

Jim, do have any other to add to that?

I would just add, Wes, and, Carter we manage all cost, not just one element of cost.

And so, to the extent that we choose to spend more money on R&D, or IRAD, essentially we're trying to find other ways that we can reduce other costs so we keep our total cost structure in line with what Wes anticipated when we bid the various contracts.

So it's always a little bit of push and pull between, how much for this or how much of that, but in choosing to spend more on IRAD, or Research and Development, we are cautiously working to reduce other costs to give us the flexibility to absorb that increased IRAD investment within our total cost structure.

And that's such an important point.

If you look at how we've done that over the last few years, if you think about it, and Jim and Steve will correct me if I get these numbers slightly wrong, but over the last five years our topline's down around 13%, but our headcount's down around 20%, 21%, our footprint is down around 10%.

So we've gone after a whole set of cost structure issues that have enabled us to maintain our R&D investment.

And as we said earlier, we've done it because that's what we do.

That's the essence of our enterprise to be able to bring technologically -based solutions to our customer community.

And I certainly anticipate we'll be doing that on a go forward basis.

Noah, Goldman Sachs.

Good afternoon.

Jim, congratulations.

That was a fairly impressive run you put up there.

It sounded like you might of been tearing up a little in your prepared remarks, actually.

Actually have a pretty bad cough and I had a cough drop in my mouth.

It's good that you had a planned excuse lined up.

I was tearing up though, Noah.

So a little bit bigger picture question.

If I look at the past, many years, call it 20 years of the Company, it's grown double digits organically, very few times and it's a mature, steady business so that makes sense.

Looking forward, if you're able to secure some of the larger wins you're going after, and if the defense budget can actually grow a little for you, should it be in our collective scenario analysis that we could actually move into one of those periods where between now and the end of the decade you can actually put up one or two years where you actually grow double digits?

I'm not asking you to commit to that obviously, but is that kind of the order of magnitude type of math we're dealing with given the size of some of the stuff you're going after?

Noah, I would say that there are some factors that drive that probably well beyond our control.

Clearly the global security environment is the most prominent driver of how that works out.

And we all know we're dealing with a world around us today that so much volatility in that regard that any one thing in that basket of volatility could push our nation and our allies into a very different place of security spending.

So, trying to predict that and get out ahead of that is difficult, but we want to make sure we're always ready in the event that we're called upon to respond to that sort of outcome that we're ready to do it.

So that's one aspect of it.

The other aspect of it, I just want to be very clear about because I know many folks listen to these calls, including some of our employees, and we are not an enterprise that's being driven by visions of the topline.

We drive our enterprise by value creation and if we put our heads to it and said by golly we're going to figure out one way or another to get a double digit in the top line, yes we could probably go figure out how to do it and perhaps live to regret it a few years later.

We're going to continue to drive this enterprise on value creation.

So even in the case where there may be extraordinary opportunities in front of us, we're not going to get mesmerized by topline mathematics, we're going to continue to make case-by-case decisions on what makes sense and how we create value.

So, those two things I think are important to have in your mind as you think about our Company.

We're going to be value driven, and we're going to be ready to support our customer community, no matter what they face.

Robert, RBC Capital.

Thanks so much, good morning.

Morning, Rob.

Afternoon there.

Jim, I add my congratulations and thanks for your help with pension over the years.

I don't know who I am going to pass the baton to.

I've often said Jim is able to provide a PhD thesis on pensionology.

I will avoid that topic this time.

Actually a question for you.

You mentioned that if everything goes to plan that your share buyback plan should be concluded this year.

And I was wondering what we could expect after that.

Because you made several comments this morning, this afternoon about more internal investment, so wonder if that alters your capital deployment plan for the longer term?

I would say, Rob, we're first and foremost focused on achieving the objective that we laid out for ourselves when we announced our plan in the middle of 2013, that retirement of the 60 million shares.

So we've got a full year ahead of us, and that's really our focus to make sure that we do that in a way that's thoughtful and a way that creates good value for our shareholders.

Beyond that, I really can't say anything that would provide too much commitment.

But what I can say is, if you look back at what we've been doing for a long time, we're a fairly predictable crowd.

We obviously prefer to put every dollar we can inside the business to generate long-term returns and you're seeing us do a bit of an increase in that regard because we see opportunities against which we can match those investments.

But in aggregate we've been a very healthy returner of cash to shareholders, and we think that strategy has worked well for us.

We, of course, always continue to evaluate that, to make sure that we're making the best decisions on behalf of our shareholders for how we deploy that cash.

But as I said earlier, you can tell how we think by looking at our track record.

Myles, Deutsche Bank.

Good afternoon and Jim, congratulations.

I hope you get to take more time off than the CFO you replaced when you showed up back in 2007.

He was certainly a better CFO than the one he replaced in 2007.

The question I had was on international sales and obviously great growth you're having.

And then just to turn the question around, the domestic sales slide 4% or 5%, is really an opportunity once that bottoms out.

Do we have at this point enough ground truth to say 2015 looks like the bottom for your domestic sales?

Well, Myles, I hate to try and call the bottom of a trough.

And the analogy I keep giving is it's hard to tell if the trough is going to be V-shaped, or if it's one of these troughs that has a long flat center to it.

And if you just look at the math, and I'm sure everybody has done the math, the math of the sequester budget actually on a pure dollar number basis looks a little better than where we are in 2015.

So you could say, gee, even if we have the sequester it might be a little better.

I would caution folks not to be too excited about that.

If we have a sequester what we really have is a horrible, horrible mechanism that goes with the sequester that has this mindless approach to cutting everything equally.

So, how that lands in terms of individual companies, what impact that would have on our customer communities, just even the thinking of the customer community and how they would go about getting things under contract and making decisions, I think the sequester, if not fixed, is a disaster.

So, I'm very focused, as I know our customer community is, and quite honestly I know many thoughtful members in Congress are, as well.

Focused on being clear that this sequester is something that has to get fixed.

So, I'm personally a little bit concerned about this image that somehow, just because a number looks a little better in the sequester budget next year, that that means this year is the trough.

If we don't get this thing fixed, it could be ugly.

And we've got to get it fixed.

Now, as I said on our last earnings call, I am seeing a lot more sanity in the discussion that is underway up on the Hill around these issues and I really applaud what the department is doing in terms of providing clarity to both the Hill and the American people about the necessity of getting this thing fixed.

But it's not fixed yet, and until it is, I think we all need to be a little bit careful in terms of how we think about this.

Rob, Credit Suisse.

Good afternoon.

Hello, Rob.

Congratulations, Jim and Ken.

Wes on what you just said I want a quick question on that and then a follow-up.

But with regard to sequester, and the fact that we've been living with it for a while and the budget has essentially, it's flattened if you will and even if we keep the budget caps we're kind of flattish to slightly up from here.

So is it the behavioral side that you're most concerned about?

Because I wouldn't expect to see sales continue to decline.

And then I have a follow-up on aerospace.

Why don't you throw in the follow-up, as well, so we can get both of them for you?

Okay, so on Aerospace, sort of the opposite of Noah 's question, which is, we know that you're going after some very important premier programs here.

And they're significant and I think there's a general feeling that they're additive to the aerospace business?

I apologize for asking another long-term topline question, but I do think it's important.

Could you talk about whether or not that assumption on additive is fair given your core aerospace business, and how that trends over let's say the next four or five years?

Sure let me take on these one at a time.

First on the sequester, the point I think is really important to understand is the sequester mechanism that's embedded in the law requires that the budget cuts that come with it are across the board and apply, on a percentage basis, the same to each of these line items if you will.

And that removes the flexibility of the department to manage the force structure, to manage its operations, to manage all of the things that have to manage in a rational way.

No reasonable person managing a budget, having to take money out of the budget would say we cut everything the same.

That's a disabling approach to managing things, and as a result of that the department would be put into disarray.

Because their mission hasn't changed, no one has said, gee we're going to cut everything the same but let's cut down our focus on ISIS, by the same we cut down our focus on Russia, by the same we cut down our focus on emerging threats, or the same that we cut down our focus on cyber security.

You have to make sure that you're managing how we deploy our capability to address the threat.

So is this mechanism that cuts equally across all programs, projects and activities is absolutely nonsense.

And that will impact behavior.

If you are the recipient of that type of forced guidance -- it is more than guidance, it is the law -- if you are the recipient of that requirement, that you manage things in that manner, yes it would create some behaviors that you otherwise would not exhibit because you're trying to manage to do something that doesn't make any sense.

So as I said earlier, we've got to get it fixed for the sake of the nation, clearly for the sake of not only the Defense Department, I would also say for the sake of all the other components of the discretionary budget that need to be operating in a rational manner.

We need to get back to whatever the number is, we need to get back to a normal appropriations methodology that enables management of our government programs or our government operations.

So that's -- I will get off my soapbox -- but that's my worry, that getting this fixed is not done yet.

With respect to Aerospace, the set of opportunities that we see before us in aggregate, yes would represent an additive outcome to the magnitude of what we do in Aerospace.

And there are many of those opportunities, both domestic and international, that we're addressing in our Aerospace business.

I mentioned in my prepared remarks at the beginning the success that we're beginning to see around the globe with our unmanned systems.

The Global Hawk contract with Korea, the type selection of Global Hawk by Japan, the strong interest in Triton that we're seeing in several countries now, those are very exciting opportunities in front of us.

Jim mentioned E-2D as well, the type selection of E-2D by Japan and the opportunities, the other opportunities we see internationally for E-2D.

So, the international side of this is exciting in Aerospace, and then domestically there are a variety of programs that are on the horizon here that too would be additive.

And yes, there are some things coming down; F/A-18 is coming down a bit, and there are inherent ups and downs in different parts of the AS business.

But when I add those opportunities that we see in front of us to the things we already have that are growing like F-35, I see some, over the next year some real nice opportunity for growing Aerospace business.

Which, by the way I see for some of our other businesses, too.

Katelyn, I think we have time for one more.

Jason, Citi.

Good afternoon, Jim, congratulations, best of luck.

Thanks.

I just had a quick question on the F-35, I was hoping you could, either Wes or Jim, the tail end of a year here, update us on the F-35 program.

And what I'm looking for is, what is your revenue exposure on the program today, either as a percentage of the total, or average selling price of that aircraft or however it is that you view it in dollar terms?

And then talk a little bit about the split amongst all of your businesses, how much of it goes into Aerospace, Electronics Systems, other areas within the company.

And then just kind of lastly, whether the margins that you're recognizing on the F-35 program in each of those segments is above or below segment operating margins and whether that margin will grow to be in line with segment operating margins over time.

Just kind of holistic update on the F-35 would be great.

Sure.

F-35 is one of our largest programs across the Company in aggregate.

It's roughly about 5% of sales.

The mix is heavier towards Aerospace maybe 70% of total.

Electronic Systems and IS are the balance, 30%, is roughly evenly split between ES and IS but maybe a little bit heavier at ES.

Probably up about $150 million in revenue on a total Company basis this year, 2015 versus 2014.

Margin rates, probably a little bit less than each of the sectors overall margin rates.

Younger program, but making progress.

That's how I would look at it and over a long period of time should perform like a mature production program.

This concludes the Q&A portion of the call.

At this point time I'd like to turn it over to Wes for final comments.

I'll just wrap up with a brief summary of what I said at the start of the call.

2014 was another year of solid performance by the Northrop Grumman team and we remain focused on our strategy that is creating long-term value for our shareholders, our customers and our employees.

Thanks everyone for joining us today, and thanks for your continuing interest in our Company.

Ladies and gentlemen this concludes today's conference call.

Thank you for your participation, you may now disconnect.