諾斯洛普·格拉曼 (NOC) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Northrop Grumman's fourth-quarter and year-end 2016 conference call.

Today's call is being recorded.

My name is Robin, 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, Robin.

And welcome to Northrop Grumman's fourth-quarter and year-end 2016 conference call.

Supplemental information, in the form of PowerPoint presentation, is available on 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 our Earnings Release and supplemental PowerPoint presentation.

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

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

Well, thanks, Steve.

Hello, everyone, and thanks for joining us.

I want to start today by congratulating the entire Northrop Grumman team on 2016's achievements.

We again demonstrated strong performance across the Company, and continued to create value for our shareholders, customers and for our employees.

It was an outstanding year for Northrop Grumman.

As we strengthen the foundation for long-term profitable growth, it's really encouraging to see that our team remains focused on sustainable performance.

In 2016, all three of our sectors posted higher sales, while growing or maintaining strong operating income and generating solid cash flow.

2016 sales rose 4%, and we achieved a strong 12% segment operating margin rate, and 13% total operating margin rate.

Earnings per share for the year increased 17%, to $12.19, driven both by performance and a lower average share count.

Cash generation was also strong.

Cash from operations totaled $2.8 billion, and after investing in our businesses, free cash flow was approximately $1.9 billion.

During the year, we returned $2.2 billion to our shareholders through share repurchases and dividends.

This includes repurchasing 7.3 million shares for $1.5 billion, which helped reduce our weighted average diluted share count by approximately 6%.

At year end, $2.7 billion remained on our share repurchase authorization.

We increased our dividend by 12.5%, our 13th consecutive increase, and we paid $640 million in dividends to our shareholders.

And our total shareholder return for 2016 was more than 25%.

Our capital deployment strategy continues to call for investing in the business, managing the balance sheet, and returning cash to shareholders through share repurchases and dividends.

Investing in the business is our first priority.

2016 investments included capital expenditures of $920 million.

Our capital spending reflects increased programmatic requirements, and supports our continued focus on cost reduction, affordability, and investments to support our long-term growth strategy.

We also continued to focus on research and development, with over $700 million of internal R&D in 2016, in addition to the R&D investments made by our customers.

We're confident these investments help position us to continue creating value for our shareholders and for our customers.

We expect our higher levels of capital investment to continue for a couple more years, as we expand our workforce, ramp up on large new programs, complete expenditures related to our Centers of Excellence, and pursue attractive new business opportunities.

We also expect strong cash generation to support our capital deployment strategy.

We continue to focus on managing the balance sheet and returning cash to shareholders.

During the fourth quarter, we took advantage of favorable interest rates and issued $750 million of new low-cost debt: a portion of which was used to retire high coupon debt.

The remaining $550 million reduces interest rate refinancing risk on future maturities, and it provides ongoing balance sheet flexibility.

While investing for profitable growth is our highest priority for capital deployment, we also intend to continue repurchasing our shares, and paying a competitive dividend.

Looking ahead, we began 2017 well positioned to grow sales and generate strong cash flows.

Year-end total backlog was $45.3 billion, 26% higher than last year.

Strong book-to-bill performance at Aerospace Systems and Mission Systems drove that increase.

We had several large-restricted awards, along with awards for F-35, Triton, and the UK AWACS program, all of which supported our 2016 backlog growth.

We continue to have a rich opportunity set.

We were one of four companies awarded a concept development contract for the MQ-25A Stingray unmanned aerial refueling vehicle.

Our work on UCAS provides a strong foundation to compete for this carrier-based program.

The RFP for the JointSTARS recapitalization program was released before the end of last year.

We're teamed with GD and L3 to develop an offering that replaces our E-8 JointSTARS with a militarized, business-class aircraft.

During the Pre-EMD Phase, we successfully completed the program design review and had two successful demonstrations.

The Milestone B Decision is expected in late FY17.

We believe we're well qualified to efficiently transition the current capability with minimal impacts to operations, given our expertise in Battle Management, Command and Control and ISR, and our experience with legacy platforms such as the E-8 JointSTARS and the E-2 Hawkeye.

I with would also note that Mission Systems is competing for the radar component of the JointSTARS recapitalization.

The T-X RFP was also released at the end of December, so we now have the final terms of that solicitation to evaluate.

We're presently assessing the terms presented by that RFP to determine whether we see an appropriate business opportunity for us to submit a bid.

We're excited about the growing list of domestic and international opportunities across our businesses.

This includes the Ground Based Strategic Deterrent program, Triton for Australia, SABR Radar for the US Air Force and several international customers, significant restricted opportunities, and additional international programs being pursued by Mission Systems and Technology Services in Australia and in the Middle East.

And while we were pleased to see growing support for long needed increases in defend spending, we also recognize and support our customer's need to reduce cost and get the most value for every taxpayer dollar spent.

We've made substantial internal investments to drive affordability and support our growing workforce.

We believe the best approach to achieving affordability is innovation during the design phase to create inherently more affordable systems, combined with a constant focus to drive down the cost of doing business on both the industry and government efforts associated with defense programs.

Our 2017 guidance calls for another year of strong operating performance as our contract mix continues to shift to a greater percentage of development work.

We've said for some time that we would welcome this increase in development work, as it provides the foundation for profitable growth and expanding operating income and margin rates over the long term as development transitions to production.

For 2017, we expect sales of approximately $25 billion with diluted earnings per share of $11.30 to $11.60 and free cash flow of $1.8 billion to $2 billion after capital expenditures of approximately $900 million.

In summary, 2016 was an outstanding year for the Company and for our shareholders.

Going forward, our priorities remain the same; drive strong, sustainable performance; generate strong cash flow; and effectively deploy that cash.

And we will continue to optimize our portfolio to ensure our alignment with global security priorities.

We're committed to build on our solid track record and we look forward to continued value creation for our shareholders, customers, and our employees.

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

Ken?

Thanks, Wes.

And good afternoon, everyone.

I'll add my thanks to our team for their outstanding efforts this year.

Today I'll provide a little more detail on our 2016 results and our 2017 outlook.

We're very pleased with our 2016 sales of $24.5 billion and our strong operating income and cash generation driven by all three sectors.

Turning to the sectors, Aerospace System sales were up 20% for the quarter, and 9% for the year.

Manned Aircraft was the primary driver of sales growth, as we ramped up on restricted work as well as higher volume on the E-2D and F-35 programs.

Aerospace Systems 2016 operating margin rate was 11.4%.

This reflected 40 basis points for a gain from the sale of a property in the fourth quarter, which we had contemplated in our guidance.

For 2017, we expect AS revenue in the low- to mid-$11 billion range.

Due to growth on restricted programs, and Triton, which together more than offset declines in non-restricted space and the NATO AGS program.

We expect F-35 volume will be comparable to 2016.

Just a reminder that the F-35 will continue to be on units-of-delivery accounting in 2017, before adoption of the new revenue recognition standard in 2018.

We expect the AS operating margin rate to be approximately 11%, driven by the changing contract mix to more development contracts.

2017 AS margin-rate guidance also reflects a B-21 booking rate approach, that we believe is appropriate for the early stages of this incentive based development contract.

As a reminder, we will review our booking rate over time, as we work to retire risk and realize incentive fee milestones.

In 2017, cost-type development work is growing at a faster rate than higher margin production work.

This growing mix differential will persist until the F-35 and other production programs, including international, ramp up in 2018.

Moving to Mission Systems, sales rose 9% in the quarter, and 2% for the year.

2016 operating margin rate was unchanged from the prior year at 13.2%.

For 2017, we expect MS revenue in the low $11 billion range with a mid- to high-12% operating margin rate.

Primary revenue growth drivers include continued ramp-up on F-35, partially offset by a decline on E/A-18G.

Looking at Technology Services, 2016 sales were comparable to the prior year at $4.8 billion.

2016 operating margin rate of 10.6% was also comparable to the prior year.

For 2017, we expect Technology Services sales will be in the mid-$4 billion range, with an operating margin rate of approximately 10%.

Lower revenue in 2017 is largely due to an expected decline of approximately $250 million on the KC-10 program.

As we roll all that up, we expect 2017 segment operating margin rate in the mid-11% range, reflecting, as I've mentioned previously, a portfolio of changing business mix with more development work.

We expect our total operating margin rate will be in the mid-12% range.

That's after unallocated corporate expense of about $200 million, and net FAS/CAS pension adjustment of $475 million.

Moving on to pension, 2017 net FAS/CAS adjustment is based on a 4.19% discount rate, 8% long-term rate of return on plan assets, and 2016 net plan asset returns of about 7.7% after expenses, including PBGC premiums.

The [34 basis point] (corrected by company after the call) decline in our discount rate reflects the higher yield on Treasuries at year end.

However, this was more than offset by the credit spread contraction between Treasuries and corporates.

2017 FAS is estimated at $485 million, and CAS at $960 million.

Keep in mind that estimated CAS won't be finalized until the completion of our annual demographic study in the third quarter.

For 2018 and 2019, we currently expect CAS expense of approximately $1 billion.

For 2018 and 2019 FAS, we currently expect $400 million and $350 million respectively.

And for your modeling purposes, holding all other assumptions constant, a 25 basis point change in the discount rate changes FAS expense by approximately $70 million and a 100 basis point change in plan asset returns versus our expected 8%, changes FAS expense by approximately $50 million.

CAS is significantly less sensitive to changes in discount rate and plan asset returns.

In aggregate, on a GAAP basis, the year-end funded status of our plans was slightly below last year at 80%.

Our funded status reflects the impact of discount rate assumptions, a discretionary pension contribution in 2015, and actual plan asset returns.

Our qualified plans also remain well funded at 84%.

Our required contributions remain minimal for the next few years, less than $100 million in 2017 and 2018, and increasing to about $400 million in 2019.

Again, based on our current assumptions.

Beyond 2019, we continue to expect required funding will be lower than CAS recoveries.

Turning to tax, we expect a tax rate of approximately 29.5% in 2017.

Our guidance includes an estimated first-quarter tax benefit for ASU 2016-09, the accounting change for excess tax benefits on employee share based payments.

Our 2017 earnings per share guidance of $11.30 to $11.60 assumes weighted average diluted shares of approximately 175 million, a share count reduction of about 3%.

Just a few comments on our cash results and our expectations for 2017.

With nearly $1.9 billion in free cash flow, we delivered strong cash results in 2016 while investing for the future with $920 million in CapEx.

And we expect 2017 free cash flow will range between $1.8 billion to $2 billion.

We also expect our cash generation will be heavily weighted toward the second half of the year, as is our typical pattern.

Also, during the fourth quarter we did repatriate about $472 million from certain foreign subsidiaries, so now we have more flexibility in using that cash.

We ended the year with a cash balance of $2.5 billion, nearly all of it in the US.

Year-end cash balance includes $550 million remaining from the November debt offering of $750 million, 3.2%, 10 year notes after the redemption of the high coupon debt.

So in summary, we had an outstanding year and we look forward to continued strong performance from our team in 2017.

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

Thanks, Ken.

(Caller Instructions)

Robin?

(Operator Instructions)

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

Hey, good morning, gentlemen.

Hi, Carter.

Hey, Carter.

Just a question on the Aerospace growth in the quarter, just to clarify the disclosure.

Were the increases in manned E-2 and F-35 contributors in that order?

And, if we were to think about the lead times you've referenced before on the F-35, relative to Lockheed, they're talking about a 40% increase in deliveries next year.

Is that the kind of order of magnitude of increase you saw in the quarter on that program?

Just trying to figure out -- it's a lot of revenue delta, almost $500 million in the quarter.

How should we think about that splitting between those pieces?

Thank you.

Sure, Carter.

I'll just comment I guess that in terms of the magnitude of revenue growth in the fourth quarter at AS, restricted was clearly the largest driver of the growth, and with E-2 and F-35 following it from a military aircraft perspective.

And certainly nice contribution from Autonomous Systems with Triton and Global Hawk as well.

Specifically on F-35, I would he say that -- I'll just remind you that our accounting model is different from Lockheed's, so I would not necessarily look at their change and project it to what you see for us.

We are looking at from an AS perspective, as well as MS, remaining on a units-of-delivery basis for one more year.

We're working our way through, for the most part, production on lots that were relatively consistent in terms of number of units and the units of delivery increases.

As we see increases in the quantities for nine and 10, and going forward, would on a units-of-delivery basis, flow through in 2018.

Although, by that point we'll be on to the new rev rec standard.

We'll be on to cost-to-cost with Lockheed.

And, I think that's when you'll really see us start to ramp from an F-35 perspective.

Yes.

I'm really just looking at the units that they're calling out.

They had said 66 deliveries, versus 46 or 47, I think.

So, if you're on units-of-delivery, that would imply that the F-35, given the lead times you've previously referenced, would have been greater than the growth rate you saw in the segment.

I was just trying to clarify if that still made sense from a units-of-delivery standpoint.

Yes, just keep in mind, our units are when we deliver it to them versus their unit when they deliver it to the Air Force.

So, we're well ahead of them in terms of the units-of-delivery.

I don't have the exact numbers in front of me in terms of what units were delivered this year versus last year.

There was a slight uptick, but I'll remind you that we've been driving the price down, as well as we've been moving through lot by lot negotiations.

Certainly happy to have you follow up with Steve on any more details.

Great.

Thanks.

Your next question comes from the line of Peter Arment, from Baird.

Yes.

Good afternoon, Wes, Ken, Steve.

I guess my question's really around the budgets and kind of overall, a lot of focus on the readiness of the new administration but a lot of people don't always tag Northrop Grumman as kind of being the readiness play.

Just maybe give your high level thoughts on just if there's any impact to you or how you're viewing that.

So, just in terms of the broader budget view, clearly readiness is a heck of a problem right now.

The silliness of the sequester, the Budget Control Act, however you want to reference it, has gone on way too long.

It clearly needs to get fixed.

It's impacting both readiness and the ability of the nation to recapitalize our military force structure.

To answer your question directly, we do benefit from the budgets on readiness.

While that may not be the way a lot of folks think about us, we do a lot of that type of work across the Company, and so we're supporting our customers in a very broad way on a readiness side.

But, I think it's important to continue to emphasize the need to deal both with the readiness side and with the recapitalization side.

We have such an aging infrastructure, from a national security perspective, that we have to get on with it.

And I'm just delighted to see, with the new administration, and in particular, General Mattis, and others who are taking a strong lead and communicating the imperatives from a national security perspective, a strong support for getting this done, as well as the support we're seeing for it on the hill.

Appreciate the color.

Thank you.

Your next question comes from the line of Seth Seifman, with JPMorgan.

Thanks very much.

Good morning everyone.

Hi, Seth.

Hi.

Ken, I wonder if you could talk a little bit more about some of the margin drivers in the guidance.

I guess if you look at Aerospace, and you highlighted some of the mix headwinds there, but if you take out the gain that you had in the fourth quarter, it looks like you could be keeping Aerospace margins fairly flat next year and you guys actually usually have a little room for upside.

And so potentially even a bit higher with those headwinds.

Whereas, in Technology Services I would have thought maybe with exiting a lower margin contract maybe some opportunity to stay flatter or be up.

And then it looks like Mission Systems is where there actually is a little bit of headwind on an underlying basis.

Maybe if you could just talk qualitatively about those.

Sure.

Maybe I'll take your question, Seth, sector by sector and I'll just start at AS.

From a margin perspective I really think that as we look at AS, the item that's impacting our margin guidance for 2017 really is about the additional development work that we're taking on.

It's really about the changing mix that we're seeing, and as I mentioned in my prepared remarks, we expect that that will have an impact on AS until some of the more mature production programs start to ramp.

And we expect that -- we expect to see that in 2018 and beyond.

If you want to think of F-35.

And then, including international F-35 opportunity, and other international opportunities including Global Hawk and other autonomous systems.

So AS, I would really characterize as being, again, driven by the mix change with the additional development content.

From an MS perspective, I think we've seen strong performance out of that team.

I think we're guiding a strong margin rate for MS for 2017.

They've also got some mix changes.

We've been seeing additional volume out of their restricted space business, in particular.

So that will have some impact on MS. But we've seen strong performance out of that sector in 2016.

And then from a TS perspective, we do see that TS will have some lower volume out of the KC-10 program, which was not a great margin contributor for us.

But, we are working with TS in terms of reshaping that portfolio a bit, and getting it where we want it to be from a 2017 and beyond perspective.

We see that having a little bit of impact on margins in 2017, but we look to work with that sector for continued strong performance.

And I'll say industry-leading performance from that business against its peers.

Seth, it's Wes.

I would just add, and Ken did a great job of walking you through kind of the puts and takes in the individual sectors.

Just from a broad view, just as we do each year at the beginning of the year, we think hard about the balance of risks and opportunities, and the challenge to our team, is to manage those risks down and to realize the opportunities.

We'll see how we do as we get into this year.

I've been pleased with the approach that our team has used over the last number of years to effectively drive on that balance of risks and opportunities.

So it's kind of where we are again this year.

Thank you very much.

Thank you, Seth.

Your next question comes from the line of Noah Poponak, Goldman Sachs.

Hey, good afternoon everyone.

Hi, Noah.

Hey, Noah.

So, I guess my question is, how does a relatively large defense contractor grow revenue 12% organically in a quarter where total DoD investment is flat to slightly down?

And then, how does that same Company that's exiting at a year at 12% step down to 2% when it's a pretty long cycle business, and the comparisons are reasonable in that next year?

Noah, I think as you know it all comes down to programmatics and our business in a very real sense is -- when we're talking about top line, I think is best viewed through that lens.

It's programmatics, and it's portfolio.

And if you look at the combination of AS and MS, together, those two sectors are enjoying nice growth.

And I think we'll continue to he see that as we get into the course of this year.

As we talked about last year, on a couple of our calls, we're going through a rebalancing of the portfolio in Technology Services.

And that rebalancing puts some downward pressure on their growth for this year, and you have to put that in the overall math of the whole Company.

So that's really the flavor I would give in that -- from the perspective of the top line, is that it's the way the parts come together against the programmatics and the portfolio work that we're doing.

And, again, all of that is aligned around the idea of ensuring that we've got the right portfolio for the longer term, that we're going to be best matched to the needs of our customers.

We think we've got that calibrated about right, about where we want it to be.

Wes, I'll just add, that if you look quarter-over-quarter, Q4 of 2016 to Q4 of 2015 you will see a 12% increase, but I would just caution you and remind you, that fourth quarter of 2015 was our low point in terms of quarterly sales last year.

And given we are a long cycle business, I would just think about it with a little more of a longer term view in terms of where we've been, and where we're going, and certainly reflecting Wes' comments, as we look forward.

That makes sense and is helpful.

The TS headwinds make sense.

The segment is about half the size of the other two, and even if I go to the mid-4%s, you're pointing to, it looks like the average of even AS and MS isn't far from the implied growth rate of the total.

But that's okay.

Can you remind us the -- can you size the headwind from the KC-10 loss that you referred to in TS?

Yes, I think the -- rough order of magnitude, we see that as being about a $250 million revenue headwind for 2017.

Okay.

Great.

Thank you.

Thanks, Noah.

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

Thanks.

Good afternoon.

Good afternoon, Myles.

Wes, your opening remarks, you commented on some of the opportunities that were in the trade space, one of which was the T-X, obviously.

So, the final RFP has come out.

It sounded like you're reviewing it as if you hadn't determined that it was a good business to be bidding into, and yet you've obviously clean-sheeted your own design.

You've spent hard earned cash and effort to develop these prototypes.

What is it that's holding you back from thinking you definitely would bid it?

So, Myles, let me be clear.

We've not reached a conclusion on that.

My statements were more a reflection of the discipline that we have in our Company, of really looking at each of these opportunities through the cold, hard lens of what's the RFP really tell you, and what would the business case look like.

So, while it's interesting that we have made some investments along the lines of supporting this program, investments, which by the way tend to have broader applicability, we need to be thoughtful, as we are on every single one of these RFP activities.

We need to be very thoughtful about, okay what's it mean going forward.

And that's really the business case we look at.

You've seen us make a variety of decisions over the years, once we see the actual terms.

And it's that discipline that, I think, keeps us in the right place, so that we don't walk ourselves into a decision to do something just because we've being doing it.

They all have to be good business opportunities for us.

So my remarks were intended to simply reflect that that's where we are in that process, having just recently -- we've gotten the final terms of the RFP.

But, there was no change in the final versus the prior to -- in terms of your thinking, this is just the due course of evaluating if it was a good business or not.

That's our process.

Okay.

Thanks.

Thank you, Myles.

Your next question comes from the line of Finbar Sheehy, from Bernstein Research.

Good morning.

Good morning, Finbar.

I wonder if you could take us back to TS for a moment.

I know you've talked about restructuring that portfolio, and even before that, revenues have been down in the last three years, backlog's been declining.

Margins have been doing pretty well.

Are you at a point where you have a sense for what the bottom in revenues is, the base from which you're going to be building after restructuring?

And when that might happen?

And what the starting point for margins would be?

And then as you grow it do you expect to be able to grow margins at the same time?

Or would the growth be at lower margin business at first, in the sense of just because they're starting as new activities?

Sure, sure.

Appreciate the question.

And let me just, maybe clarify.

I hate to think of what we're working on, from a portfolio perspective at TS, with the word restructuring.

So, I would say more so about aligning the portfolio with where we see our capabilities and the customer needs.

As I think about TS, the revenue has been declining.

Yes, I would agree with that.

But it's been in a declining budgetary environment.

We see it continue to decline in 2017, as contemplated in our guidance.

But largely driven by, again, the activities, realigning the portfolio, as well as the impact of the KC-10 revenues coming out.

But also, the impact of some decisions that we've made, about not pursuing some business that's lower margin and not differentiated.

And, I think you're seeing that through the higher margin rate that that business delivers as compared to its peers.

My thought on the portfolio realignment is, we get that through the system largely in 2017, and my expectation is that 2017 -- and I'm not going to provide sales guidance beyond then, but 2017 would likely be where we'd see the impact, and we ought to see a different trajectory as we move forward from there.

We're ready for the next question, Robin.

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

Goods afternoon.

Good afternoon, Sam.

Just thinking back to the AS margin, I know there was the gain this quarter, but just thinking about a little bit of a decline in 2017.

I'm just trying to think about, as some of that restricted work continues beyond 2017, you mentioned some of the ramp-up of the other programs, that F-35 converts over to the percentage of completion.

So I'm just trying to think about the trajectory of AS margins, do you see that staying flat?

Going down?

Going up beyond 2017?

Sam, I wouldn't want to provide any guidance beyond 2017.

What I would probably reference you to is, if you think about the comments we made in our prepared remarks, again, we see that our 2017 margin rate is largely impacted by the mix, with that mix being more heavily weighted to development and I think to Wes' point, we look forward to some of that development work transitioning into production, and starting to generate the additional margins and additional operating income out of those.

But I couldn't comment for you on any specifics on numbers beyond 2017.

Sam, let me just add -- it's Wes.

Let me just add.

One of the things that I wanted to be clear about in my introductory remarks, is, we see quite a nice array of new opportunities in front us, and we are pursuing quite a few of those.

We're making a lot of decisions in the Company around how we will pursue those and which ones we're pursuing.

Nevertheless, our hope is that we're going to be successful on a number of them.

And in doing so, we'd be bringing some more development content in.

So, this question of mix over time is one that is somewhat dependent on our success in what we capture and when we capture it.

And as I've said a number of times, I'll be delighted to be successful with good business cases, capturing a little bit more development mix in this period of time when our nation's working to get the recapitalization initiatives under way.

And if that means I've got a little bit more pressure on margin rate for some period of time, I think that's the right thing to do for the long term of the enterprise.

And, that's how we're thinking about this decision space in front of us.

As Ken said, we aren't providing some guidance out into 2018, in part because we'll have to see where we're successful on some of these new development initiatives, and also the rate at which our customers are able to support financially the ramp-ups on production.

So those are sort of the variables that are out there that I think go to the question that you're asking.

Okay.

That's very helpful.

Thank you.

Thank you, Sam.

Your next question comes from the line of George Shapiro, with Shapiro Research.

Yes, I want to pursue a couple of things.

One, Wes, if I look at your earnings guidance that you provided this time last year, it was $9.90 to $10.20, and we all know you did $12.19 for the year.

Now, maybe about half of that was due to tax benefits and stuff that won't recur, but a good part of the rest was due to lower shares and operations.

So my question is, what's different this year that we shouldn't assume at least some steady improvement in the EPS, especially since you look at the Aerospace backlog; it's up 50%.

So, I would think that, per Noah's question, that you'd have faster growth in Aerospace sales than what you're providing.

Yes, George, I do appreciate that question.

And I appreciate you kind of recounting the success that we had last year in really driving on performance and the outcomes of our approach to capital deployment.

And I would just say, that we are a Company that really does take a careful look in assessing both -- I mentioned this a little bit earlier -- assessing both the risks and the opportunities that we see at the start of each year, as we look into the year.

And, that's the way we think about our financial equation.

And, it's also the way that we structure the framework for the team, and the work that the team has in front of them across this rather large portfolio of programs that we have, to really drive on performance.

So how we come out depends on how well we do on executing.

And we have a view of it today, that we think is the right balance and that's the basis of our guidance, the right balance between those risks and opportunities.

But we sure are going to be working hard as we go through the year to realize opportunities and manage those risks.

So we'll have to see how we come out this year.

I've been really pleased, as I said in my remarks, with how the team performed in 2016 and to be honest with a number of years prior to 2016.

I think there's a growing execution discipline within the organization.

But, we have to actually see the outcomes.

So that's kind of the framework that we're using, and I think is the right place for us to be at this point in the year.

Ken, is there anything you would add to that?

I think that was great, Wes.

Let me add to it.

George, you commented on a couple things, one of which is tax.

And I agree that tax was a significant contributor to the increased EPS in 2016 versus our initial guide.

You referenced shares as well.

I actually think from a share count perspective, we came awfully darn close to what our guide was.

So, I don't see shares as being -- share count as being a significant contributor.

But I will remind you, as well, that corporate unallocated is an area where we had some success in 2016 in reducing our corporate unallocated expenses that included some one-off type items including settlements, including some state tax refunds that the benefit of those we saw in 2016, and not clear that they would recur as we look at 2017 and forward.

Let me follow up.

How about, Wes, on the sales guide for Aerospace, I mean, you gave for the first time year-over-year backlog up 50% in Aerospace.

Is there a way to look at the duration as to how fast that actually rolls into revenues?

Because on the surface it would seem that the Aerospace sales guide would be low.

Well, George, I would say we were really pleased with the captures in Aerospace last year.

It demonstrated what we've been working to do to really position ourselves, from both an innovation and good ideas perspective with our customers, as well as from an affordability perspective.

And I would say our success in capture last year had as much or more to do with affordability as it did with the inherent technology and capabilities of our offerings.

So, I was just really pleased to see those outcomes.

With respect to this translation of backlog into annual sales, again, there's this wide variability across the programs.

We're seeing in Aerospace, and actually it's rippling into some other areas, a little bit more of a longer-cycle view on some of these awards.

I can't give you the exact translation factor but I would just say we're going to have to be thoughtful and mindful of how to think about awards translation into annual sales.

And that's gone into the way that we're thinking about our guidance.

Okay.

Thanks very much.

Thank you, George.

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

Hey, good afternoon everyone.

Good afternoon, Jason.

Hey, Jason.

Hey, Wes.

I was wondering if you wouldn't mind just commenting on recompetes that you face, maybe particularly in the services-related businesses.

And talk about whether, when these contracts get recompeted, either when you're the incumbent or you're challenging to get in on some new business that's not yours, whether the funding levels have begun to stabilize in those recompetes?

Or whether we're continuing to see funding levels decline?

And then, secondarily to that, just the competitive environment around those recompetes, whether things have changed in any significant way over the last 12 or 18 months.

Thanks.

Thanks for the question.

Let me kind of give a flavor of it, and Ken can I think perhaps give a little more color or details to it.

But your question actually, particularly because you directed it toward Technology Services, goes to a lot of what we're thinking our way through on this portfolio reshaping.

In the areas where we see a good, sustainable differentiated business for the long term, we're happy to engage in the recompetes if they're well funded, if we see that the customer commitment to them to be something that merits the natural investment you put into a recompete.

There have been a few over the last couple years, and there's likely to be some on a go-forward basis, where we see a recompete really as a transition opportunity for us to help the customer transition to another party.

I've said this before and we're serious about it.

We will never leave a customer in the lurch.

If they have invested in us a responsibility to get something done, we're going to get it done.

And, if it means doing it for a bit longer than we might have otherwise liked, we'll keep doing it until they're ready to make a transition.

But the recompetes tend to offer those opportunities for those transitions.

And we look very carefully at each one of them, both in terms of, as you mentioned, the funding and the funding stability that goes into it, as wells as what we read to be the customer's view of its need for a differentiated capability.

So that's kind of the flavor of how we think about it.

Ken, would you want to offer some more color on that?

Yes, that's great.

Thanks, Wes.

Jason, I would just say that as we look at our recompete exposure for 2017, we don't see it as material to our results, one way or the other, successful or unsuccessful on those recompetes.

And actually, the largest recompete opportunity that we see is at Mission Systems, and that would be what you might be familiar with as the JRDC program.

And we've been the prime on that for a number of years.

There are some other recompetes at MS and a few at TS.

I would tell you that again, we don't see it as being significant in terms of our financial results for 2017.

Great.

Thanks.

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

Yes, thank you, very much.

Impressive cash flow guidance for 2017, given the very heavy level of CapEx.

Can you give us some more color on how you can get there, given that high level of CapEx?

And then looking forward, you'd indicated that we're going to have some more high level CapEx looking forward.

About how long do we stay at this elevated level?

And can you sustain the cash flow over this period?

I'll start, Cai, first of all, thanks for your comment and question.

From a cash flow perspective, as we look at 2017 we do see it as being a strong year of cash generation.

We're going to generate significant cash from operations.

We are going to spend about $900 million on capital expenditures as we look to continue to invest in the business, investing in profitable growth, investing in affordability and competitiveness, all of which Wes mentioned.

I'll maybe mention that, from a cash perspective, we have built a little bit of working capital over the last few years.

I think as an industry you've seen that as a theme or a trend.

We look at, as we're growing the business, actually the ability to manage working capital to a relatively flat outcome for 2017.

Again, while we're growing the top line, so we see some ability to manage that perspective, the working capital.

We'll also just mention that we do have the CAS recoveries that we're seeing, that are generally equal to or greater than the CapEx we're expending in the year.

So, there's kind of a nice mix there of the recoveries on the pension and investing in the business for future growth.

And, Cai, to answer your question about the outlook on this, I mentioned in my remarks that we see these elevated levels for another couple years.

And, I'll also go back to what I said in response to an earlier question, if it turns out that we are successful on a number of other new programs, depending on the magnitude of those programs, and the related investments, we would enjoy that success and it could have some implications on CapEx, even beyond the couple years.

We're just going to have to wait and see how all that works out.

Thank you.

Thanks, Cai.

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

Good morning.

Or good afternoon, I should say.

Hi, Rob.

Hey, Rob.

Hey, guys.

I wanted to talk about this concept of -- I see this dichotomy forming over contract type at DoD between low cost and best value.

And I just noted, Wes, in your comments earlier on the T-X RFP, and on the withdrawal of one of the teams yesterday, if that isn't starting to turn into a bit of a low cost shoot-out, and if that might be -- sounds like that just might be less appealing especially as you go here and you're working through some other contracts that will eventually allow your aerospace margins to rise as we get into production.

Is that something that you see?

And if that's the case, how do we think about JSTARS in that -- from that framework?

Is that a best value or a low cost type of opportunity?

Yes, Rob, it's a really good question, and I think an important one in the environment that we're in.

And so let me give a framework that I see right now.

And I think our customers are actually being thoughtful in how they're approaching this.

There are some things that our customer's going to want to buy, where, there isn't that much differentiation in the type of outcome of the product.

And in those cases, it appears they're making, what seems like a reasonably good decision to really focus on the cost, and to drive for the lowest cost answer they can get.

And, in some instances that might be interesting to us.

If we think we've got a particular architectural approach or engineering approach that positions an end product in a very low-cost part of the coordinate system, then we might look at that and see what the returns look like.

If it's a situation where it's just low cost because that's what the customer really cares about, and we don't see a whole lot of differentiation across the spectrum, those are probably less interesting opportunities for us.

So if you look at the -- and, I won't go contract by contract in terms of the opportunities that are out there, because we're in a competitive state right now and would not want to say too much about each and every one of them.

But there are others where our customer is transmitting the message in their RFP, and in other ways, that while cost is always critically important, they see a little bit of a trade space between cost and performance and value, and those tend be a little bit more interesting.

So, we look at each and every one of these and do a very detailed diagnostic.

And we look at it in the -- through the lens -- through what I would call a non-advocate lens within our Company, to ensure that we're not kidding ourselves about what the real investment and cost would look like.

And then we call it.

And sometimes it takes a little longer to call it based on the information that we need to get to a high quality decision.

But, we are looking at the way the customer is communicating around its view of the business deal, and what's important to them to make sure that our offerings really line up the right way in a very competitive environment.

Thank you for your thoughts on that.

Thanks, Rob.

Your next question comes from the line of David Strauss, with UBS.

Thanks.

Good afternoon.

Hi, David.

I know you can't say much on your restricted portfolio, get into specifics there, but could you maybe size it for us as a percentage of sales in 2016?

How much it grew, and what's embedded in your guidance for 2017, specifically for restricted growth?

David, I'm not sure that I would be able to necessarily provide guidance on what growth, or what percentage it makes up specifically for 2017, but I will say that as we look at the 2016 restricted activities as a percentage of total sale, it's in the low-20% range of sales.

I will tell you that it is a nicely growing part of our business, very important to us as a Company, and what we do and what we deliver.

But that's probably the extent to which I could get into it for you.

And, David, I would just add, as our customers look at the environment that we're all operating in today, and the need for security, there is a lot of focus on the restricted side.

And I think there's going to continue to be a growing focus on the restricted side.

And I think it makes sense from a national security perspective.

Thank you.

Thanks, David.

Your next question come from the line of Robert Stallard, from Vertical.

Thanks so much.

Good evening.

Hi, Rob.

On the shift in mix, I don't know if you're able to quantify it, but how much is the cost plus portion shifting from 2016 to 2017, based on what you know today?

Rob, thanks for the question.

Not sure that I have that exact number in front of me, but I will tell you that we are seeing a marked increase in terms of our cost plus.

Think of that as largely being a development-type work, versus our fixed-price or production-type work.

And I'm thinking that's probably in the range of a 3% shift from the 2016 actuals to 2017.

And you can pick up that 2016 number in our 10-K when we file it.

We expect to do that early next week.

So probably the best information I can give you at this point.

Robin, I think we'll do one more question.

Okay.

I'll pass on then.

Thanks, Rob.

Your final question comes from -- is a follow-up, from Noah Poponak, from Goldman Sachs.

Thanks.

Hey, Wes, I wanted to ask you, what is the rate of growth in revenue or in EBIT dollars, whichever one is more important to you I guess -- or easier to quantify, that you would need to be reasonably certain you would obtain over some multi-year period in the future, in order to be willing to double your CapEx for a few years?

Noah, I'm not sure I want to actually put that out there.

A lot of the way we look at our competitive profile is sort of embedded in the way I would think about answering that question.

But, let me say one thing, and I've said this before.

We're not about growing revenue.

That's not the thing that motivates our Company.

We're about growing value.

And I think a lot of folks can make bad decisions in the defense industry, in particular, if they're just looking at things through the optic of the top line.

It's really the ability to capture business that translates into bottom-line growth, and most importantly, translates into cash generation so that you can make good decisions on how you use that cash.

And it's, I think, an important parameter to keep in front of all of us as we look at the opportunity space that's in front of us.

We're not driving our investment strategy based on revenue growth.

And, let me just remind you, Noah, that as we think about capital deployment, we're very focused on the strategy and creating value out of the capital deployment that we do.

And I'll just remind you that we very clearly recognize that we're investing in the business, which is our first priority.

It has to be, where that is driving more value than another investment that we could make.

So, I'd just remind you that we try to be very disciplined in terms of our investments and in terms of how we deploy precious capital of the Company.

Wes, at this point in time, any final comments?

Okay.

Thanks, Steve.

I'll just wrap up by repeating what I said a bit earlier.

The strong year that we had in 2016, really has laid a great foundation for us as we move into the new year in 2017.

And I'm just delighted to see the strong focus on performance across our Company.

And it really is that performance, that is enabling us to invest in our future and to return cash to our shareholders.

So, I sincerely appreciate all that our team is doing to enable those outcomes.

With that, 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.