諾斯洛普·格拉曼 (NOC) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Northrop Grumman's Second Quarter 2017 Conference Call.

Today's call is being recorded.

My name is Kara, and I'll 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, Kara, and welcome to Northrop Grumman's Second Quarter 2017 Conference Call.

Before we start, please understand that matters discussed on today's call constitute forward-looking statements pursuant to safe harbor provisions of federal securities laws.

Forward-looking statements involve risks and uncertainties, which are detailed in today's earnings 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.

I would also note that we have posted an updated company overview to our Investor Relations homepage.

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.

Thanks, Steve.

Hello, everyone, and thanks for joining us.

Our businesses continue to deliver solid results.

Our entire team remains focused on strengthening our foundation for profitable growth over the long term, and I want to express my appreciation to our team for their great work.

We're pleased with our results at the midpoint of the year.

Second quarter sales totaled $6.4 billion, a 6% increase over last year's second quarter.

Aerospace Systems continues to be the primary growth driver as we ramp up on Manned Aircraft activities.

Based on our year-to-date sales and our outlook for the remainder of the year, we're increasing our sales guidance to the low $25 billion range versus our prior guidance of approximately $25 billion.

Segment operating income also rose in the quarter, and our businesses combined to generate an 11.8% segment margin rate.

Our year-to-date segment operating margin rate was 11.7%, and we continue to expect a mid-11% segment operating margin rate for the full year.

Ken will provide additional sector-level guidance later in the call.

Total operating margin rate was 13.4% for the quarter, and we continue to demonstrate that we can grow operating income through a combination of sales growth and performance as we continue to succeed in bringing on new development work.

Second quarter earnings per share rose 11%, reflecting higher sales, higher operating income and a lower share count.

Based on the strength of our second quarter and year-to-date results, we're raising our full year 2017 earnings per share guidance to a range of $12.10 to $12.40.

Cash provided by operating activities totaled $507 million in the quarter, and after capital spending of $217 million, free cash flow for the quarter was $290 million.

Capital spending during the quarter reflects our investment in support of long-term profitable growth and affordability for our customers.

We continue to expect free cash flow for the year will total between $1.8 billion and $2 billion.

Our capital deployment strategy calls for investing in the business, managing the balance sheet and returning cash to shareholders.

We expect to distribute a healthy percentage of our free cash flow to shareholders after capital expenditures of approximately $900 million.

During the quarter, we repurchased approximately 550,000 shares, bringing year-to-date repurchases to about 1.5 million shares.

Year-to-date, we spent approximately $370 million on share repurchases.

We also raised our quarterly dividend 11% to $1 per share, our 14th consecutive annual increase.

Year-to-date, we've distributed approximately $700 million to our shareholders through share repurchase and dividends.

We had a number of operational and capture highlights during the quarter.

The U.S. Air Force announced the selection of SABR for its F-16 radar upgrades.

In addition to the international F-16 upgrades currently in production, we are now in the engineering, manufacturing and development phase of the U.S. Air National Guard F-16 upgrade program, which we expect will be followed by an upgrade of 72 AESA radars.

SABR extends the operational viability and reliability of the F-16 and provides pilots with fifth-generation fighter radar capabilities to counter and defeat increasingly sophisticated threats.

We foresee a robust growth opportunity for SABR going forward.

We also delivered the first low rate initial production G/ATOR system to the Marine Corps after the program successfully completed its system acceptance test procedure ahead of schedule.

This was the last of the program's required milestones in the production test phase.

Five additional systems will be delivered to the Marines under our current contract.

Our MQ-8C Fire Scout Autonomous Helicopter successfully completed its first flight from a littoral combat ship, proving its capability to fly from multiple ship classes.

On May 30, our Advanced Battle Management and Launch Control system, an integral part of the Ground-Based Midcourse Defense system, successfully supported an important intercept of an intercontinental ballistic missile target.

We're a strategic partner on this program that provides our nation's defense against long-range ballistic missiles.

We were awarded a $169 million contract to build and support a new satellite communication system for Australia, which will enable deployed Australian forces to connect to strategic information networks.

The technology is aimed at assisting with a range of Australia Defense Force operations, including border protection, humanitarian and disaster relief missions.

And lastly, after the close of the quarter, we received a follow-on competitive award to provide logistics product support for 4 Battlefield Airborne Communications Node, or BACN, aircraft, as well as subsystems and support equipment, in support of overseas contingency operations.

Looking ahead, we're competing for several important near-term opportunities, including the Ground-Based Strategic Deterrent and the Joint STARS recapitalization program.

On GBSD, we expect 2 technology maturation and risk reduction contracts will be awarded before the Air Force begins full-scale development on the nation's next-generation ICBM system.

Northrop Grumman has played a critical role on the U.S. Air Force's intercontinental ballistic missile system since its inception.

As a trusted partner and technical integrator, we've mastered the complexities of its flight, launch and command and control systems.

We look forward to providing an affordable and technically robust system design that combines our legacy ICBM expertise, core capabilities across multiple domains and demonstrated ability to deliver secure, resilient integrated systems.

On the Joint STARS recapitalization, we believe our team has the unique experience and capability to execute a low-risk plan for a seamless transition from the legacy platform, on which we are the prime, to a new system based on a smaller, more efficient and more capable platform.

Our offering includes the rightsized high-altitude aircraft and a highly capable Battle Management Command and Control and communication system.

We're also competing separately for the AESA radar portion of the program.

We believe that we're well positioned for both competitions.

I would mention that in addition to these competitions, we also have the opportunity to address a growing set of restricted programs.

As we look ahead, adequate and reliable defense funding will be critical to executing our country's national security missions and maintaining our military superiority.

As we address a variety of national security issues, the readiness of our forces, the aging of our strategic deterrent, the increased vulnerability of our space assets, to name just a few, we're encouraged that Congress avoided a year-long continuing resolution and passed the FY 2017 budget, which together with OCO funds, provided needed increases in defense spending.

Both the Senate and the House are working on the FY 2018 appropriations, and the House Appropriations Committee has completed its markup of a defense bill.

We encourage our government leaders to work together to avoid the negative impacts of a long-term continuing resolution in fiscal year 2018 as well as avoiding a triggering of sequestration under the Budget Control Act.

We continue to expect a modest upward trend in national security spending for the foreseeable future.

Industry must play its part in supporting national security by investing in capacity and capability and focusing on affordability for our customers to ensure we're delivering value for our customers and the taxpayer.

This is our focus at Northrop Grumman, and we believe this will create value for our shareholders, customers and our employees.

In summary, we're pleased with our results and our outlook at the midpoint of the year.

Again, thanks to our team for their continued focus on performance and execution, which supports our strategy to drive profitable growth over the long term.

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, everybody.

I'd like to add my thanks to our team for a good first half of the year.

As compared to last year, 2017 second quarter results included higher sales, higher segment operating income, solid margin rates and higher net FAS/CAS pension adjustment.

Segment operating income includes the benefit of the Cost Claim.

These improvements were partially offset by increases in our unallocated corporate expenses and our effective tax rate.

These results, along with our lower share count, combined to drive an 11% increase in second quarter EPS.

Moving on to sector results and guidance, Aerospace Systems sales were up 14% for the quarter and 13% year-to-date.

Manned Aircraft was the primary growth driver for both periods as we ramp up on restricted activities and had higher volume for the E-2D program.

We also had higher volume in Autonomous Systems and Space.

In Autonomous Systems, the ramp up on Triton and other programs continues to more than offset lower NATO AGS volume as that program moves towards completion.

Space was also higher as additional restricted activities are now beginning to offset declining sales in non-restricted programs like advanced EHF.

Based on year-to-date AS sales of approximately $5.9 billion, we are increasing our sales guidance for AS full year sales to a range of $11.5 billion to $11.7 billion, largely due to our growing development work.

Operating income at Aerospace Systems is up for both the quarter and year-to-date, with operating margin rates of 10.6% and 10.7%, respectively.

The trend versus last year reflects higher development volume for Manned Aircraft.

We expect this trend to continue for the rest of the year.

For 2017, given our increased sales outlook, we now expect AS operating margin rate will be in the high 10% range versus our prior guidance of approximately 11%.

Moving to Mission Systems, sales rose approximately 3% for both the quarter and year-to-date.

Higher sales volume for both periods reflects increased sales for combat avionics, as we ramp up on F-35 and SABR, as well as higher volume for communications programs.

Operating margin rate was 13.4% in the quarter and 13.2% year-to-date.

Operating margin benefited from the Cost Claim, partially offset by a provision for cost reduction initiatives.

Cost claim adjustments are not unusual.

In last year's second quarter, our unallocated corporate expenses benefited from the finalization of prior year incurred Cost Claim.

Thus, while some benefit to segment operating income, net of the cost reduction provision, the net impact of this quarter's Cost Claim is only a modest increase to total operating income.

For 2017, we now expect MS revenue will range between $11.1 billion and $11.3 billion versus our prior guidance of low $11 billion.

Based on year-to-date results, we are increasing our expectation for MS margin rate.

We now expect MS operating margin rate will be approximately 13%, an increase to our prior guidance of mid- to high 12%.

At Technology Services, second quarter sales declined 3%, and year-to-date sales were down 2%, due to the completion of several programs as well as lower volume on the KC-10 program.

Operating income was up slightly for both the quarter and year-to-date.

Based on year-to-date performance, we now expect TS sales will range between $4.5 billion and $4.7 billion with a mid-10% margin rate, a modest increase to our prior guidance of mid-$4 billion sales with a margin rate of approximately 10%.

Total segment operating income increased 3% for both the quarter and year-to-date, and we continue to expect a mid-11% segment operating margin rate for the year.

No change to prior guidance.

Total operating margin rate for the quarter was 13.4% and 13.3% year-to-date.

Both periods reflect higher net FAS/CAS pension adjustment, partially offset by increased unallocated corporate expenses.

For the full year, we continue to expect a net FAS/CAS adjustment of $500 million.

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

In addition, we continue to work on CAS affordability items, particularly to the extent they also reduce required funding over the next few years.

Our corporate unallocated costs are typically weighted toward the second half of the year.

We continue to expect 2017 unallocated corporate expenses of approximately $200 million with a total operating margin rate in the mid- to high 12% range versus our prior guidance of mid-12%.

We continue to expect an effective tax rate of about 27.5% and a weighted average share count of approximately 175 million.

Just a few comments on our cash results and our expectations for the full year.

For the quarter, cash from operations generated $507 million, and we spent $217 million on capital expenditures.

Free cash flow for the quarter was $290 million.

Year-to-date cash trends reflect working capital growth in support of higher sales.

We expect working capital to decline in the second half of the year, consistent with our typical pattern.

We continue to expect cash flows will be weighted heavily toward the end of the year with free cash flow in the range of $1.8 billion to $2 billion after capital expenditures of approximately $900 million.

No change to prior guidance.

So in summary, it was a solid first half, and we look forward to continued strong performance from our team for the remainder of the year.

With that, I'll turn it over to Steve to start Q&A.

Thanks, Ken.

(Operator Instructions) Kara?

(Operator Instructions) Your first question comes from the line of David Strauss with UBS.

Yes.

My question is, so if I take a look at your guidance, it looks like you're guiding for sequentially flat Q3, Q4 with Q2.

Typically, you, from a seasonal basis, you ramp up in the back half of the year.

What is different about this year that we wouldn't see some sequential growth in the back half of the year?

I would say if I look at history, we are historically relatively flat in the second half of the year.

We're also seeing a tougher compare in the second half if you -- as you look at 2016, as we were really starting to grow the business in the second half of 2016 as well.

I would say that in terms of the guide itself, we may see some additional volume at Mission Systems, essentially the legacy ES business, on some of their units-of-delivery sales.

But largely, I don't see this as inconsistent with our historical pattern and relatively consistent.

And David, the one thing I would add, too, on that is, and I mentioned this briefly in my remarks, as we look at the kind of September, October time frame for the year, there is some uncertainty out there right now on the whole budgetary environment.

And I think many in our customer community are of a mind that we are likely to have a continuing resolution at the end of the year.

And so we've seen a variety of customer behaviors in the -- what will be our fourth quarter, and that would be the first quarter of the new fiscal year.

We've seen a variety of customer behaviors over the last number of years as we've dealt with this budget uncertainty.

So until we get a little bit better resolution on that, we factor some of that into our thinking as well.

I appreciate that.

A quick follow-up, probably for Ken.

The 10-Q, it looks like you went through and ran the rev rec on 2016, and it looks like it was a positive for revenue but a negative for EBIT.

Can you just comment a little bit on that, Ken?

Sure.

Thanks, David.

I would say we did disclose in the Q the impact, the expected impact, upon adoption on the 2016 P&L.

You did see that there was higher revenue of about $200 million.

That largely relates to the change from units-of-delivery to cost-to-cost as we pulled some costs forward and -- on some of the growing units-of-delivery programs.

That would tend to increase operating margin in 2016.

We did have a couple other contracts that had some impact as we looked at 2016.

That resulted in a lower margin in 2016 of about $70 million.

And I'll just give you an example.

In one case, we had changed the performance obligations of a particular contract, and it pushed back some profit prior to 2016.

We also had another situation where a change in performance obligations resulted in some margin moving out into the future from 2016.

So it's just one of the vagaries of the adoption of the rev rec standard.

I wouldn't take 2016 and assume that when we ultimately adopt in 2018 that it's going to be similar.

That was relatively unique impacts of those 2 particular programs at that point in time.

We will certainly keep you updated and be able to provide full information on our year-end call.

But definitely don't read that situation into our ultimate adoption in 2018.

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

Wes, I was wondering if you could just spend a few minutes kind of updating us all on your supply chain strategy.

Affordability is, obviously, key for DoD at this point.

And I know you've done quite a few things over the last several years, particularly with your centers for excellence.

But I was wondering if you've had any further thoughts on the overall strategy and whether there's a greater inclination towards further vertical integration for yourselves and others in the defense world.

I appreciate the thoughts.

Well, thanks, Jason.

Yes, it's clearly a really important part of our enterprise.

If you just look at the mix of things that we do, I think this year, we'll probably acquire slightly in excess of $10 billion worth of our content from parties outside of our company.

And we're proud of our supply chain.

We've worked hard over a number of years to drive on quality and to make sure that we're driving on performance in our supply chain the same way that we're driving on performance within our company.

And at the end of the day, those are kind of the biggest levers when it comes to making sure that we are getting the outcomes that we need in our programs for our customers.

And I've seen great reaction across our supply chain to step up where we've identified some issues in that regard and also to invest ahead with us.

As we are investing in our company robustly because of the opportunities that we see and the focus that we have on ensuring we're going to be there for our customers around the globe, our supply chain has stepped up with us as well.

You mentioned a really important aspect of our engagement with our supply chain, and that's affordability.

And I want to be clear about our approach on this because I know there are some different perspectives out there in the industry on that equation.

From our perspective, affordability is all about getting better designs that are inherently lower cost.

It's not about squeezing the death out of our teammates, trying to get them into a place where they might be even potentially unviable for the long term.

We don't do business that way.

We are focused on helping our teammates get to a place where the products they're providing us are inherently more affordable because we're addressing cost.

And I think that's a really important perspective, because that's the only thing that's really sustainable over the long term.

If you're just squeezing for the sake of a near-term deal, you're really not going to help yourself for the long term.

So that's been our focus, to drive on affordability.

The other aspect of it is, and I mentioned this briefly with respect to investment, is we really like being engaged with the most innovative members of our supply chain, those who are bringing their ideas forward, who are pushing us as well in thinking about how we can do things differently.

And because we so much appreciate that innovation and the fact that our supply chain members do invest along with us, we always work hard to keep that appropriate balance on how much we do inside versus how much we do outside.

And it really is a set of business decisions each time.

If we can do something more effectively, that is more affordably with more innovation outside, that's our first choice.

And it makes all the sense in the world to manage an enterprise that way.

Because we do participate at the very high end of the technological spectrum in the work that we do, there's just inevitably a fair amount of our effort that is internally focused and derives from the internal investments that we make in the capacity and capabilities of our extraordinary team at Northrop Grumman.

But even there, over time, we attempt to take a lot of that and place it in the hands of able suppliers that we trust to not only perform on it but to continue to invest in it as we go forward.

So we do not have in place an overt strategy to drive more vertical integration.

That's not the way we think about it.

We think about it element by element to make sure we're making good business decisions and decisions that will ensure the viability and capability and capacity for serving our customers for the long term.

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

Can I ask about your mix of business, and in particular, your cost-plus development mix of business?

This year, I think, if I've got the numbers right, you have about 58% of your total sales are in the cost-plus category.

That's up, obviously, 7 or 8 points from where it was a couple of years ago.

Is this the peak year for that mix?

I know you won't start to give '18 guidance yet, but clearly, one of the concerns of the market is around margins and compression of margins.

Do you feel comfortable that this is the peak year for a cost-plus development mix, though?

So Myles, let me start on that one and I'll hand it over to Ken.

Let me just say, I know you'll hate this kind of answer, it all depends.

We are out there aggressively pursuing some businesses, some new business opportunities that are development in nature that we believe represent good, positive, value-creating opportunities for our company.

And to the extent that we are successful in capturing more new development work, that mix will continue to go up a bit.

And as I have said in the past, I'm delighted to see that happening.

We've been quite successful for a while in capturing new development work.

And you're exactly right.

That does put some pressure on margin rates.

The test that we continue to apply to ourselves is can we grow both the top and the bottom line?

And if we're doing the right things, taking on that development work that positions us well as it transitions into production, and we're growing our net income as we do it, that's really the way we're thinking about goodness here.

Margin rates are important.

We continue to use them in our incentive plan because we like that measure as a measure of goodness.

We had a very strong, strong focus on that as we were in a downturn environment, because that's a really important time to make sure you're completely optimizing yourself around those metrics.

But you'll notice that in our incentive plan, we've also added net income growth because as we're looking to ensure that we're building the right foundation for long-term profitable growth, we want to make sure that we're thinking about this equation in -- through that lens.

So again, I apologize for having to tell you it depends, but it depends on how successful we are in capturing some of the new things that are in front of us.

But Ken, would you want to add a little bit more to that?

Yes.

Myles, let me see if I can maybe add a little bit more to that.

And I would say that if you look at 2016, it was a couple of points, maybe 3 points higher in terms of mix than 2015.

And if you look at 2017, probably a couple of points higher from 2016.

Could be the peak.

I think to Wes's point, we've got a number of opportunities in front of us for growth, some of that being fixed-price production and some of that being cost-type development work.

I would also point out that not all cost-type work is the same.

Certainly, in general, fixed-price margins are greater than cost type.

But as we take on new programs, there are obviously a number of risks and opportunities that are identified.

And the goal there is to burn down the risks and harvest the opportunities and make sure that we were able to drive the margin rate up.

So more mature cost-type programs, where we've been successful in that regard, can be strong generators of margin.

We do have some cost-type programs that are still in the process of getting through some of those risks and capturing some of those opportunities, and we'll work diligently to try to maximize every dollar of margin out of those.

But I think it's a nice place to be, where we've got a growing set of opportunities in front of us for both production and development.

And ultimately, we will see our mix come back to more historical norms.

I'm just not sure I could predict if this is for sure the year for you.

Okay.

And I also thought the rev rec adoption would also help that to some extent in '18, but thanks for the answer.

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

I wanted to ask about Mission Systems.

If I exclude the Cost Claim in the quarter, the margins looked a little weak to us.

Can you talk about what's going on there?

You referred to the cost reduction effort in Advanced Capabilities, but what's happening there?

And how should we think about the mix of that business going forward and what kind of a normal margin would be?

Let me start on that one, Doug, and I would say that we certainly had the Cost Claim noted that it was partially offset by some provisions for cost reductions, as we always look to make sure that we are able to run our businesses as efficiently as possible.

I don't see, necessarily, any major mix changes at MS. I would say that we have seen in the last 18 months or so a bit more in terms of some cost-type work at MS, but I don't see a major change necessarily this quarter.

We've talked about some additional space-restricted opportunities there that we're performing on and a couple of others.

But I don't think there's anything particularly huge from a mix perspective.

I would say that as we look at that business, we'll work hard to have a strong second half of the year.

And we continue to think of that business as one that compares to its peers.

And we've talked about kind of the 12% range as a benchmark for that business.

And we continue to incentivize the team to perform better, and they have.

And we'll certainly work hard to continue to do that in the second half.

And I'd maybe just add, this is a business that's our highest performer in terms of margin rate.

We see a very strong performance trajectory there.

And I feel good about seeing that continue.

So I don't have any concerns at all on that.

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

Yes, just to quickly follow up on Doug's question.

If you could tell us, Ken, what the cost reduction provision was there so we could net that out and get a better picture of what the underlying margin actually was in Mission Systems?

Yes, George.

I don't think I want to get down into that level of detail.

Obviously, the Cost Claim impact at MS, we discussed, was in the range of $30 million, and this was a partial offset to that.

And to be honest, I don't have the number in front of me.

But we look at MS as performing well.

And certainly, we'll continue to focus and make sure we maximize that as we look forward.

So let me ask another one then.

Can you give us what the overall classified growth was in the quarter?

You had mentioned how that was a big contributor.

I don't think I'd be able to go there, George.

I would just say certainly a big contributor, certainly a big contributor at Aerospace, but also a contributor as we look at the MS business as well.

Yes, and George, just along those lines, as we go forward and we see our customers become, very appropriately, become a bit more sensitized to the security environment and the nature of the threat profile that we're addressing, we do see the possibility, and I would say -- I'd reframe it a little bit more strongly, the likelihood that an increasing fraction of our business may become restricted.

And as you might imagine, there are some sensitivities to how much information, even when it comes to percentage types of information, that we can discuss along those lines.

But we do see our customers increasingly thinking about how they classify their programs.

Let me ask an easier one that you probably can answer then.

The F-35 growth in the quarter and what kind of growth are you expecting for the year.

Regarding the F-35, George, I would say I don't have the quarter numbers in front of me.

But from a full year perspective, we're looking at AS being relatively flat from an F-35 perspective.

Last year, it had some EMD volume still in it, and we don't see that this year, and the units are largely starting to ramp in '17.

And I'll remind you that the -- certainly, the price per unit has been coming down nicely as well.

But at Mission Systems, we are looking at an F-35 increase in probably the $0.25 billion range, and that's across all 3 of its F-35 contracts, the radar, the DAS and the CNI.

So nice growth at MS, and we see that trend continuing at both sectors.

And to Myles' point, probably something that will be impacted by the rev rec standard as we look at 2018 and beyond.

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

Wes, I wonder if you could talk a little bit about the IBCS program.

And I know it's not necessarily the biggest earnings driver at the company, but it's one that got singled out a little bit in the Authorization Act and in some of the articles about the development of Patriot and the ability to sell it to foreign customers.

What's your feeling on kind of where you guys stand on that program, and how much risk there is around it?

Yes, I appreciate the question, Seth.

IBCS is a program we've been working with the Army for some time.

It addresses a really tough challenging problem for the Army.

And so inherently, as the effort has moved forward, the view of the capability that's required and the way that it needs to be tested and implemented does evolve a little bit.

So we're partnered closely with the Army on this.

I see, today, from the Army, a strong conviction that -- of its importance and the need to continue forward with it.

And over time, there are likely variants of this of interest to our international partners around the globe.

And so we are absolutely committed to this program.

It's getting many of our best and brightest in the company in terms of its focus.

And I believe we're going to see, over the longer term -- it will take a little while to get all this aligned with where the Army and then ultimately the international market will want it to be.

But I see, over the long term, a really nice opportunity here.

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

On Technology Services, kind of the guidance there for mid-10% margins, you're running north of 11% now, implies, obviously, kind of a high single-digit in the back half of the year.

Is there anything unique there?

Or is that conservatism or just timing?

Maybe just a little more color there on how we're thinking about that.

So I would say, Peter, part of this goes to Wes' remarks earlier about the second half of the year in terms of CR and funding and things like that and the impacts that could have on the shorter cycle business as well as customer challenges and behaviors and things like that.

TS has done a really, really nice job of managing the business in the first half of the year and finding ways to generate some additional margins.

And we're -- continuing to look under every rock to see if we can find more in the second half of the year, but this is a business that performs very well relative to its peer group.

And I would say, looking at the second half performance, what we're looking at now is not shabby, but we'll certainly work hard to outdo it.

Your next question comes from the line of Robert Stallard with Vertical Research.

I thought I'd follow up on your comments about SABR, and then some idea of how big this market could be for you over the next few years and how the margins on this might compare to the rest of the division that it's in.

That's a great question.

SABR is specifically, right now, targeted to the F-16.

And as you know, there's a lot of F-16s out there.

So the question, obviously, is how far this goes.

How many of those would be aligned on this type of replacement.

And it's kind of hard to tell.

All I could say is if I were an F-16 pilot and I was offered the opportunity to go up against an adversary in an aircraft with a SABR versus an aircraft that didn't have one, I know which one I'd pick.

So we'll have to see how many of the services that are deploying F-16s are aligned on those types of upgrades versus other alternatives of a different aircraft they might be looking at.

And obviously, there's an affordability side of this.

So it's a little hard to call right now.

I would just say that the adoption that we've seen so far has been great, both domestically, primarily domestically, but the international interest on this is significant.

We have a good partnership with Lockheed Martin on this, where both companies are committed to continuing to make the F-16 a very strong, capable platform for a long time.

And we just have to kind of see where this goes.

It's -- you also asked about the overall profitability.

And like most of these things, volume improves the profitability on that program over time.

And over time, it's certainly our desire that this demonstrates a level of profitability in excess of what MS demonstrates in aggregate.

But we need to see that production volumes move it in that direction over time.

I would just add to that, Wes, that we were excited to be awarded the NORTHCOM JUON.

That will certainly help from a volume perspective.

We're moving out of the EMD phase and moved into production late last year.

So that is an exciting phase of the program as we move into full rate production.

And some of the international customers Wes referenced and the NORTHCOM contract are certainly helpful towards that volume ramp that we're looking for.

And we look to continuing to support Lockheed on future opportunities.

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

So excuse me if you've already answered this, but $54 million was the Cost Claim.

$32 million was at MS. Where was the rest of it?

And in addition to the cost reduction at Advanced Cap, were there any kind of onetime sort of items in the Q2?

Cai, let me see if I can run through that.

$54 million was the Cost Claim, $32 million at MS. The rest of it was at the other sectors and across the corporation.

I think if you saw the 10-Q, there was a reference to some of the impact at TS, not largely material to any other part of the organization, and to be honest, I don't have the numbers in front of me.

In terms of the cost reduction initiatives, that is a, I hate to use the term, but a one-time effect that should be behind us and as we look forward, an opportunity to run that particular business in a more efficient manner and generate stronger margins in that regard.

Was there any other piece of your question I didn't get to?

There wasn't, really.

Cai, you'd asked about were there any other big sort of one-time moving things, and nothing that was material at all.

Got it.

And then just a quick one on foreign sales.

I mean, it's -- you have less growth than some of the others.

But it looks like the environment has improved for a number of your peers.

Are you seeing any pickup in terms of discussion activity or likely sales?

Yes, Cai, the international marketplace is robust right now for us and our peers.

The question always is when does the discussion and the interest translate into sales.

And it takes a little bit longer to get over the hurdle on a few of these things, but we're quite excited about what we see internationally.

We're focused around the globe, as you know.

The 3 major areas of focus for us are Asia Pacific, Europe and the Middle East.

I -- just from a longer-term outlook in terms of the growth rates, I continue to see Asia Pacific as having the higher long-term growth rate, just given the geopolitical dynamics of that region, the need to significantly enhance the security capabilities and the focus of the governments that -- from a partnership perspective, our international partners, the focus of those governments that we see underway.

But clearly, Middle East and Europe are going to be quite important as well.

We see the NATO countries seriously re-examining their investments.

And it's also clear that our allies in the Middle East are taking very seriously their security needs.

So I do see this as an important part of the overall global security picture.

We're actively engaged in it.

And it's just -- you have to play these things through on the time line that they actually materialize.

And Cai, maybe just to add to that, I would say we did see a growing international sales number in not only the second quarter but also the first half of the year, both the quarter-to-date and the full year -- or the 6 months to date, up about 4% from an international perspective.

But to Wes' point, we've got a growing domestic business.

We've got a growing international business.

And what moves first will determine how it looks forward.

But we're excited to again have a nice robust and diverse set of opportunities as we look forward.

Your next question comes from the line of Pete Skibitski with Drexel Hamilton.

I wanted to follow up on Seth's earlier question on IBCS, because I've seen some of the news there.

And I also noted, I think there was some news on the AOC 10.2 cancellation and the DOMino cyber-loss.

And so I started to get a little bit worried about the midterm outlook at MS, considering some of that news.

And so I'm kind of wondering, Wes, whether or not the percentage of problem programs at MS is on the rise.

And also, from a sales perspective, the amount of headwind that maybe AOC and DOMino may provide.

Yes, I -- as I mentioned on IBCS, we continue to see a very good long-term outlook on that program.

You mentioned AOC.

AOC was a case where the Air Force request to the Congress for continued funding was not supported.

And so the Air Force is regrouping and figuring out what it wants to do in that regard.

And I think you also mentioned DOMino was another one of the moving parts.

MS has a very broad portfolio.

And as you recall, we put together 2 large sectors to make an even larger sector.

So many of the elements of that portfolio are these medium or smaller programs that are going to have puts and takes over the course of the year.

But when I stand back and look at all of those puts and takes, I see a nice growth trajectory for MS. You could see it in the quarter; it was growing well.

And as we look forward, we continue to see MS as very, very well-positioned and growing nicely.

I don't see any particular shift in the percentage of programs that might fit the label I think you gave of red.

And there's always a mix in the portfolio of things we're having to put more attention on than others.

But I think the sector is being managed exceptionally well.

We have a team that is both very operationally focused as well as strategically focused.

And I'm delighted with the portfolio mix that we have there and the way that it's been integrated into this new sector.

So I feel good about the outlook for MS.

Wes, I'll maybe just add that from a cyber perspective, with respect to the DOMino question, we do view cyber as one of the areas of business that should see some growth, and that's pure cyber business as well as cyber-enabled.

And I think we are uniquely positioned from a cyber-enabled perspective, given our expertise both with platforms and systems and cyber.

And that's certainly somewhere where we see -- we should see some nice growth over the long term.

Absolutely.

No, cyber continues to be a very good, positive, robust business for us.

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

This is Joe on for Rob.

If I could follow up on David's question from earlier on the implied sales targets for the second half of the year, specifically in Aerospace Systems, I know you're limited in what you can say about classified, but B-21 funding went up from the mid kind of $700 million level in fiscal '16 to about $1.4 billion in the fiscal '17 budget.

So we would have expected to see some of that come through in the third and fourth quarter of this year.

So can you just help us think about the timing on the ramp in B-21 sales, given the ramp in funding there?

We really can't say anything about that at all, and just to say that things continue to go well.

Yes.

I won't comment on the B-21 specifically, but if I can just talk about maybe AS at a broad level for a second, I would say that we've seen a nice growth trajectory in AS over last year.

It was at 14% this quarter and 13% year-to-date.

Again, it's a business that, historically, flattens out a little bit in the second half of the year.

And particularly, if you think about development work, that tends to be driven by a large engineering workforce, we do see that we'll have a lower number of workdays in the fourth quarter.

You've got Thanksgiving, you've got Christmas in there, and that does tend to have an impact on the late-year sales.

Not a ton of units-of-delivery work that's driven out of Aerospace, where you tend to see maybe some additional units toward the end of the year.

They do have a couple of units-of-delivery contracts, F-35 and F-18.

But the preponderance of their business is on cost-to-cost.

And so we look at it.

There's the possibility for some upside there, but as we look at it, given the workdays, we think the guide is pretty squarely in the middle of the fairway.

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

Sorry about before.

Wes, it's really a risk management question, and it's 2 parts to it.

First, what we've seen recently is that you enter into a number of competitions, and then, for a variety of reasons, you step aside and let somebody else use price as a way to win or something else.

And what I've seen is you be very successful where you are.

Could you talk about that a little bit and how you go through the program selection and how it's integral to your core?

And then just to finish the question, the other part is you've got a balance sheet that you've used very successfully over time to leverage earnings, but now you're at a point where what other tools can you use to enhance earnings growth?

Thanks, Howard.

Two great questions, and glad your connection worked.

Sorry for the earlier issue there.

Let me first take on your first question about how we think about the program selection process.

It's a process that we have continuously refined over the years.

We have a set of areas that we see as those that are most likely to be areas where we can add value to our customers and that the programs will actually be sustained and supported over the longer term.

So we start with that and do a very comprehensive assessment of what it takes to be in a position to really add value in our participation in those programs.

And sometimes early on, that means getting ahead on the investment curve a bit to position ourselves well for that.

We interact extensively with our customers through the development of the request for proposals and give them very candid feedback, both on the capabilities that they're being -- that they're asking to be created as well as the business terms.

And sometimes, the customers are eager to engage on all of those aspects.

And in other cases, and this is not a negative towards the customers, they see the marketplace offering them so many alternatives that they elect to take business terms or pursue business terms that we find unfavorable.

And so there are times when even though we believe we're well-positioned technologically and that the program is likely going to be supported, that we'll decline the bid because we simply don't see the business terms to be aligned with our view on how we create value over the long term.

And we've been selective in that regard.

I believe our customers would tell you that we've been very candid with them around that so that we're not surprising our customers when we make a decision to not pursue something.

If it is something that is a recompete of work that we're doing, we're very thoughtful about making sure our customers are not left hanging in any way.

We don't do that to our customers.

We stick with them until we transition appropriately.

But we work hard to be very transparent with the customer community around the terms that we think will make sense, reasonable sense, for us to pursue versus those that don't.

And we move on.

There's quite a wide space of opportunity that we're addressing, so there's no sense at all that we've just got to bid something for some reason.

And I think I've been clear in the past that we're a company that does not drive itself from a perspective of the top line.

We really think about the value creation and the flow-through of how we're generating net income and how that gets converted into cash and then, ultimately, to your second question, how we use that cash in terms of the strength of our balance sheet.

And you're right, we've taken a variety of approaches over the last number of years in capital deployment.

We've, I think, been good, steady payers of a good dividend.

We've been very focused on share repurchase as an important tool.

But the most important thing that we do for the long term is invest in our business so that we have the opportunity to grow profit and to make sure that we're delivering good value through that profit growth.

And that's really our primary focus, and you can see that in our current capital deployment.

We are at a bit of an elevated level of capital expenditure because we see those opportunities to drive on affordability and to invest for the opportunities in front of us.

We have been, I think, very thoughtful in that regard.

We're going to see a continued elevation of that capital probably for the next couple of years in reflection of that opportunity space.

We also do look at opportunities outside our company.

Over the last few years, there haven't been any significant ones that really met our criteria for deploying capital towards M&A, but it is an area that we continue to look at.

I think it's a responsibility on our part to continue to test those opportunities.

And should we find one that we have strong conviction that we can apply capital in that direction and grow value, then you should expect us to proceed in that direction.

So we look at that full suite of opportunity.

But I would just cap it off again by saying our strong desire is to put our first dollar towards organic growth opportunities, because we see a large number of them.

We've had good success in converting those investments into outcomes.

And I'm just very proud of how the team drives that discipline.

And I will tell you that for, back to your first question, some of the things that we've elected not to bid, those recommendations have actually been coming up from the teams.

That's not something that is just a big corporate decision.

It's reflective of the discipline that's embedded within the operations of the company, and I'm really proud of that.

So thanks, Howard.

Thanks for asking that question.

If I can just add, Wes, to the second part of the question, we talked about the capital and investing in the capacity and the capability.

But I would also just point out, it's beyond the balance sheet but also down to the rate structure, our ability to invest in R&D for the technology and the capabilities.

And we invested in that R&D through the downturn, and we continue to find ways to enable us to invest as much as we can into R&D.

And I think that's a big component of it that is a little bit nuanced from the balance sheet side of things, but really, it goes to how we manage our rates and our total cost management and really getting to managing every dollar of cost that we run through this business.

Yes, absolutely.

So Wes, back over to you for final comments.

Well, let me wrap up by again thanking our team for their focus on performance.

It's certainly serving our company, our customers and our shareholders well.

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

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

Thank you for your participation.