Northrop Grumman Corporation (NOC) Q4 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Northrop Grumman Fourth Quarter and Year End Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Steve Movius, Vice President of Investor Relations. You may proceed.

Thanks, Frances, and welcome to Northrop Grumman's fourth quarter and year end 2012 conference call. We provided supplemental information in the form of a PowerPoint presentation that you can access at www.northropgrumman.com. Before we start, please understand that matters discussed on today's calls 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. On the call today are our Chairman, CEO and President, Wes Bush; and our CFO, Jim Palmer. At this time, I'd like to turn the call over to Wes.

Thanks, Steve. Good morning, everyone, and thanks for joining us. We had a very strong finish to the year with outstanding fourth quarter and full year results. We met or exceeded guidance for every metric, and I want to congratulate our employees on a job well done. Fourth quarter earnings per share increased 2% to $2.14; and for the full year, earnings per share rose 5% to $7.81. On a pension-adjusted basis EPS increased 11% in the fourth quarter to $2.06, and 15% for the year to $7.47. Our financial results demonstrate the positive impact of superior program performance driven by cost reductions, affordability initiatives, innovation and portfolio shaping across our 4 businesses. The strength of our sector's operating performance, coupled with continued share repurchases, more than offset lower sales, higher pension expense and higher effective tax rates. Cash generation was also strong. For the year, before the impact of pension prefunding, we generated cash from operations of $2.8 billion and free cash flow of $2.5 billion. On a reported basis, free cash flow of $2.3 billion represents a free cash flow yield of 14.3% and net income conversion of 117%. We deployed that cash by repurchasing 20.9 million shares of our common stock for $1.3 billion, reducing weighted average shares outstanding by 10%. We also paid dividends of $535 million and made a $300 million discretionary pension contribution. Through share repurchases and dividends, we returned more than $1.8 billion in cash to our shareholders or approximately 80% of 2012 reported free cash flow. We captured new awards of $26.5 billion during the year for a book-to-bill of 1.05. Total backlog increased 3% to $40.8 billion and funded backlog increased more than 10% to $25.7 billion. I'm very proud of the performance improvement accomplished by our team. Achieving these improvements has required tough but necessary actions. To put our improvement into perspective, since the end of 2009, sales from our continuing operations have declined about 9% due in part to portfolio shaping. During that same period, our focus on performance has generated a 20% increase in absolute segment operating income, and a 300 basis points expansion in segment operating margin rate or more than a 30% improvement. As a result of this improvement, in combination with effective cash deployment, EPS from continuing operations have grown by a compound annual growth rate of 20%. While superior program performance and portfolio shaping drove much of the improvement, we've also significantly reduced our cost structure. Over the last 4 years, we've reduced our headcount by approximately 17%, and we've reduced our facilities footprint by approximately 12%. As we improved operating income and margin rate, we maintained robust free cash flow and free cash flow conversion. We also monetized assets to create value for shareholders. Over just the past 3 years, we've generated free cash flow of $7 billion, including the $1.4 billion contribution from the HII spinoff. More than 90% of that cash has been distributed to our shareholders, $4.8 billion to repurchase shares and another $1.6 billion for dividends. In addition, we increased the dividend in each of these 3 years. Looking ahead, I can't recall a time of greater uncertainty regarding customer funding levels or government fiscal policy. We continue to operate under a 6-month continuing resolution that expires on March 27, and there is the potential for sequestration on March 1. In addition, other issues such as the debt ceiling raise the possibility of a potential government shutdown. Our nation needs a balanced strategic approached to our fiscal challenges. Blind, indiscriminate budget-cutting is not the answer, but that is exactly what sequestration would entail. We urge Congress to work to avoid the destructive economic impacts, particularly in terms of government and private employment, and the impacts to our national security that would result from a sequester, a prolonged restricted continuing resolution or a government shutdown. Our 2013 financial guidance is based on the assumption that the current 6-month continuing resolution would be immediately followed by appropriations, which, even if in the form of a full year CR, will provide program spending levels that are consistent with those set forth in the President's fiscal year 2013 budget and that support and fund the company's programs. Guidance for 2013 also assumes there is no disruption or shutdown of government operations resulting from a federal government debt ceiling breach or lack of immediate appropriations following the current CR, that sequestration is not triggered and any budgetary approach agreed by Congress to address longer-term spending does not result in significant reductions to our customers' FY '13 budget levels. While we don't have control over these issues and can't predict their ultimate resolution, I believe the work we've done over the last several years on performance, as well as our strong balance sheet, leaves us well prepared for a likely defense spending downturn. For 2013, we expect sales of approximately $24 billion, earnings per share of $6.85 to $7.15, cash from operations of $2.1 billion to $2.4 billion, and free cash flow of $1.7 billion to $2.0 billion. Our top line guidance contemplates a $500 million impact for lower volume on space programs, Joint STARS and the F/A-18; $300 million for the impact of troop drawdowns in overseas contingency operations; $200 million resulting from the current CR impacts; and approximately $100 million each for the ICBM program restructure and portfolio shaping, principally the deemphasis of base and range operations in our Technical Services business and the Park Air Norway divestiture in Information Systems. Beyond that, we expect low single-digit growth for our core capabilities in cyber and unmanned systems. We also expect higher international revenue. In 2012, international revenue, both direct and FMS, totaled approximately 8%. In 2013 with the ramp-up of NATO AGS and other international bookings, we expect international sales to increase to more than 10% of our revenue, and we see continuing opportunities around the globe that our portfolio should allow us to address. In conclusion, our 2012 results demonstrate strong performance in a challenging environment. In order to continue creating shareholder value, we must remain absolutely focused on our key priorities: driving performance, effectively deploying our cash and optimizing our portfolio for the future. Our record these past few years demonstrates we can do this successfully, and I'm delighted to be working with our company's talented team to create long term sustained value. So now I'll turn the call over to Jim for a more detailed discussion of results and guidance. Jim?

Thanks, Wes, and good morning, ladies and gentlemen. I also want to add my congratulations to our team on the outstanding work this year. 2012 results were simply excellent. Our dedicated team again rose to the challenge and performed very well in a tough environment. We continue to make the difficult decisions to reduce cost, improve affordability that are helpful in translating to our record results. Let me give you a few numbers to put our performance into perspective. Segment operating margin rate of 13.5% for the quarter and a record 12.6% for the year. Pension-adjusted operating margin rate of 11.9% for the year, also a record. I'm particularly pleased by the cash our operations generated this year. Wes noted that our free cash flow was $2.3 billion. That means that free cash flow per share was more than $9. Of that amount, we distributed about $7.30 per share through share repurchases and dividends or 80% of free cash flow. Based on our average 2012 share price of $63.63, our cash yield was 14.3%. And in 2012, our shares appreciated 15.5%. As you can see from the guidance, we expect another strong year of cash generation, and we expect to continue our balanced cash deployment strategy that returns a substantial amount of cash to our shareholders. Turning to results for the sectors. Aerospace Systems finished the year on a high note with a 7% increase in fourth quarter sales and slightly higher sales for the year. AS margin rates for the quarter were outstanding at 13.8% and margin rate of 12.2% for the year matched last year's strong performance. AS did book a couple of positive performance adjustments in the quarter in its space programs, neither of which was more than $20 million. For 2013, we expect AS sales of approximately $9.7 billion, with a margin rate of low to mid-11%. The sales trend reflects lower volumes for space programs, Joint STARS and the F-18, which is more than offset by higher volume unmanned programs due to the ramp-up of NATO AGS and Fire Scout. Electronic Systems also had outstanding results. While fourth quarter and full year sales experienced a mid-single-digit decline, operating margin rate increased 28% for the quarter and 11% for the year. Margin rate was outstanding at 18.5% for the quarter and 17.1% for the year, records for both periods. ES fourth quarter net performance adjustments were about $50 million higher than last year, reflecting solid operational performance, as well as a lower level of negative adjustments for contractual issues. The fourth quarter of 2011 also included some costs from reductions in force. For 2012, ES operating income includes an increase of approximately $160 million in net positive performance adjustments. The increase is driven by 2 factors. First, last year's negative adjustments included about $50 million in our domestic postal automation business that obviously didn't occur this year. And secondly, in 2012, we had a higher level of favorable adjustments, particularly for combat avionics, as well as several programs, completed deliveries, negotiated contract modifications or successfully mitigated risk. For 2013, we expect ES revenues will be roughly comparable to 2012 levels at approximately $6.9 billion. This does contemplate lower volume for some space programs, some continued impact from force reductions in our overseas contingency operations, partially offset by higher international sales. We do expect continued strong margins, but obviously, some of the 2012 performance improvement is likely not sustainable. We expect ES operating margin rates of low to mid-14% for 2013, and while not at the record levels of 2012, they are still very healthy and indicative of outstanding execution at Electronic Systems. Turning to Information Systems, fourth quarter sales declined by 2%, principally due to the divestiture of Park Air Norway in the second quarter of this year. Park Air contributed $30 million in sales in last year's fourth quarter. For 2012, IS sales declined by 7%. For the year, the divestiture of Park Air Norway and the County of San Diego IT outsourcing contract reduced sales by $100 million, and the JTRS termination accounted for about another $80 million of the variance. After these items, IS sales decline was about 5% and reflects force reductions in overseas contingency operations and a wind down in completion of a variety of programs. IS operating income reflects lower volume and improved performance. Fourth quarter margin rates do reflect the impact of some costs related to affordability initiatives. But for the year, margin rate expanded 60 basis points to 10.3%, outstanding performance, particularly in light of the lower volume in a challenging market environment. For 2013, we expect IS sales of approximately $6.7 billion. I want to point out that about $125 million of that variance to 2012 sales reflects some portfolio shaping activities, as well as the transfer of intercompany efforts to our corporate shared services organization. That transfer, which is about $100 million of the $125 million, does not impact overall company P&L -- as you know, intercompany sales are eliminated -- but will impact the year-over-year comparison for IS. Excluding these items, we expect a decline of about 8 -- 7% due to lower volume for in-theater programs like BACN, Command Post Platform and C-RAM, to name a few, the wind down or completion on a variety of other programs and the expected impacts of the current CR. Moving to Technical Services. Fourth quarter and 2000 sales -- 2012 sales declined 7% and 5%, respectively. Trends in both periods reflect our portfolio shaping actions to reduce base and range operations volume, to lower KC-10 volume and the ICBM program restructuring. Operating income for the fourth quarter is consistent with the change in volume. And for the year, the higher income and margin rate are due to improved performance on the KC-10 program. For 2013, we expect TS sales of approximately $2.7 billion, which contemplates the impact of the current continuing resolution, some force reductions in the ICBM program restructuring and then a little bit of portfolio shaping as well. We expect a mid to high-8% range in margin rate for TS in 2013. And I know many of you know this, but I would point out that our IS and TS businesses are our shortest-cycle businesses and most vulnerable to the uncertainty of the current budget environment. As I said, our segment operating margin rate for 2012 was 12.6%. You will see when we file our 10-K that we had net favorable performance adjustments of $985 million for this year. That includes an increase of about $150 million in favorable adjustments and about $100 million decrease in unfavorable adjustments. Much of the increase in the net favorable adjustments occurred at ES, and I don't expect that to reoccur this year. So on a consolidated basis, we expect segment margin rate in the low to 11% (sic) [low to mid-11%] range. Turning to pension costs for 2013, the assumptions that underlie our 2013 net FAS/CAS pension adjustment of $120 million include a discount rate of 4.12% versus last year's 5.03%. A long term expected rate of return of 8% versus 8.25% last year and reflect 2012 investment returns of slightly more than 12%. We expect 2013 FAS of approximately $380 million, which is about equal to the 2012 amounts, and we expect our CAS cost of approximately $500 million. That CAS amount could move up or down by about $30 million depending upon the outcome of our annual demographic study which we expect to complete in the third quarter of 2013. So after pension cost and corporate unallocated expenses, we would expect our total operating margin rate will range between high-10s and low-11% for 2013. We also expect a tax rate of about 33%. That includes the positive impact of the extension of the 2012 and 2013 R&D credit, which we estimate at about $27 million or about $0.10 or $0.11 for 2013. The 2012 credit, about $15 million, will be recorded in the first quarter of this year. Earnings from continuing operations are expected to range from $6.85 to $7.15 per share, which assumes a weighted average share count reduction of approximately 7%, reflecting continued share repurchases in 2013. Cash from operations of $2.1 billion to $2.4 billion and free cash flow of $1.7 billion to $2.0 billion before the after-tax impact of discretionary pension contributions. We did make progress in 2013 in reducing the seasonality of our cash flow. But I still expect cash flow to be weighted towards the second half of the year. We do plan, at this point, a $500 million discretionary contribution in 2013 over and above our required contributions which are less than $100 million for this year. Beyond 2013, we would expect CAS harmonization will begin to increase CAS pension recoveries in 2014 and '15. And over that same period, our annual pension contributions -- required pension contributions, should be about a little bit less than $100 million, which is principally for our nonqualified plans and some of our foreign plans. In summary, continued strong operating performance, strong cash flows for our businesses in 2013. So Steve, I think with that, we're ready for some Q&A.

Thanks, Jim. [Operator Instructions] Frances, we are ready to begin the Q&A.

[Operator Instructions] Our first question will come from the line of Jason Gursky.

I wonder if you might just give us a bit of an update on the long term margin targets and whether you've seen any change here as we move into the new year.

Yes, we set those targets a number of years ago by looking at the performance of our peers over a long period of time, and we used them to incentivize our organization to improve and drive performance. It's worked really well. I tend to think of those not necessarily as targets, if you will, but more of a benchmark on what our businesses ought to generate over a long period of time. We continue to strive to do better than those "targets" or benchmarks. We have done better than that. We've been very successful in using them as a motivation for our team to do better, and I continue to believe that they are applicable, as I said, over a long period of time looking at the performance that we and our peers have generated during that period of time. I find that they tend to be supported by many of our major peers as well. So all in all, I think they have served us well. They continue to be that benchmark that we refer to and using to strive to do much better. As I said, we continue to incent our team to drive performance, and it really has been beneficial in doing that. So I'm comfortable with them as they are.

Okay, that's great. And then the follow-up question is just a book-to-bill outlook as we move into 2013 and how that kind of translates into revenue streams as we move out.

Jason, this is Wes. I think we all recognize that this year, with the continuing resolution that we have in place, much less some of the uncertainties that we see as potentials on the horizon, that book-to-bill is going to be under pressure and getting to a 1.0 book-to-bill would be a tremendous outcome. We don't guide on book-to-bill or awards each year, but I would say anything close to 1 for 2013 would be a great outcome.

Your next question is from the line of Doug Harned from Sanford Bernstein. Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division: I'm interested, Wes, you've talked about some of the success you've had in cost reductions, square footage, headcount over the past couple of years. And when you sit today and look at the opportunity going forward for the next year and say the following year, does it look as like the opportunities are as large today as you saw in the past?

Doug, it really depends on the business space that we see on the horizon, and all of that sort of depends on some of these budgetary decisions that get made. To the extent that the there are more severe budgetary outcomes than the Presidents FY '13 budget would suggest, then yes, there's a -- it will go with that. We will need to scale -- continue to scale the operations and continue to address whatever comes our way. I think we've shown we know how to do that. It's not something we'd rather do in terms of dealing with a more severely depressed budget than the Pentagon is already trying to manage its way through, but we do certainly have the capacity and know how to get that done. If things were pretty much on track for the budget, just from my perspective, there's always room for more, and we're going to continue to push and drive efficiency in our corporation. I'm not going to set any public targets on how much more we can get there, but I think I would just say that the market should be informed by the work that we've been doing, that we are determined at ensuring that we can be very, very competitive from a cost structure perspective, and that goes to every aspect of cost. And that we can be putting forward the most affordable concepts and approaches for our customers who are dealing in a much more tightly constrained environment. So it really is a responsibility that we see to support our customers to be most cost efficient as possible. Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division: And then on the continuing resolution, certainly with the CR in place, that limits the availability of funds for new starts, for transitions from development into production often. When you look across your portfolio, where are the areas or the major programs that you're most concerned about in terms of being able to ramp up or make the transitions?

Doug, it touches every one of our sectors in some way. In the large sort of hardware-oriented parts of our business, we have a whole variety of programs that are undergoing that transition. Whether it's unmanned systems like BAMS, even things that are at the very early stages of development, where you want to go out and do long lead that are associated with production. Those -- it would be too long a list to go through. I mean, they're all touched in some way. And then clearly, the shorter-cycle businesses, both Information Systems and Technical Services, deal with this at a much higher rate because the nature of a short-cycle business is you've got to start the new programs more frequently. And when you're constrained in your ability to do that, it really hamstrings the customer community and us from doing that in the most efficient way. Ultimately, what you end up seeing happen in those types of business, our current programs, our services approach get strung out. And while that can be good in some respects, ultimately that's usually not the best answer for the customer either. So I hate to give you too general of an answer to that question, but the detailed answer would be incredibly detailed, and that we see this environment with those types of very tight restrictions really touching all the components of the business. And I think that's why you're hearing -- well, it's one of many reasons why you're hearing the department be so vocal about the CR approach and how constraining it is, and they're attempting to be very clear with the Hill that resolving these restrictions as we come to the end of March and the current CR expires is a necessity for them to be able to really operate the department in a more efficient manner. If we're talking about saving money for the government, efficiency matters, and so that's a critical message.

Your next question is from the line of Carter Copeland from Barclays.

Just, Wes, I know this is a hard topic to address and in terms of contingency planning if we actually do trigger the sequester. I mean, obviously, you have a set of contingency plans that you'll work off of. I wondered if you might kind of take us through what's the sequence of internal events if something like that is triggered. What's the sort of play-by-play of the implementation of one of those plans?

The work that we've been doing to get ready for the variety of scenarios is both broad and deep. And I guess I should start just by saying that I'm clear about this, I'm not going to speculate on what scenario might lie in front of us, whether it's sequestration or problems associated with the CR that I was referencing in relation to Doug's question. There's clearly a lot of uncertainty on how this whole situation's going to get addressed and the fact that we're seeing now... [Audio Gap] scenarios you think will come into play. But the other think that I think is really important to point out here and sometimes gets lost a little bit in some of this dialogue is, our primary obligation is to successfully execute on the portfolio of contracts that we've taken on. And so the planning work that we're doing is trying to be mindful of what might happen, but also have its primary objective, do no harm. To make sure that we really can and do continue to execute really, really well. When we think about all of these different scenarios, I think to the question you're asking, we have to think about it in terms of contractual, potential contractual actions that our customers would take and traditionally that's what would trigger any particular sequence of events on our side, whether it's delay in terms of slowing a contract down or in a more ugly situation, termination for convenience on the part of the customer. Naturally, as a part of our process, we have gone through our full set of contracts, and we understand what the issues and approaches would be associated with those variety of potential customer actions, and they all vary by scenario, and we're certainly prepared to address those if we have to. In general, as I was remarking earlier to Doug's comment, it adds cost. It adds cost to the department to have to go through and do those things in a period of time when the nation's trying to minimize outlays, the idea of adding cost is not a really good idea. And what's interesting to me is, I don't see folks on the Hill adding up the numbers that go with all of those additional costs that will get created by that massive inefficiency that would result. The other part of the planning process that's also very important is the people part of this. And this isn't just about contracts, contracts turn into work that real people perform, and these are individuals whose skills are precious resources in our country. These are the skills that enable the companies and the Defense Industrial Base to provide the technological superiority upon which our nation's strategy, our national security strategy relies. And so part of our challenge, as we think our way through this, is being ready to address how we most diligently and carefully manage that precious resource of capability that we're going to need to make sure that we preserve our ability to continue to support the nation as we go through this challenge. And I would say that, in my mind, is the most challenging part of this. We're talking about extraordinarily good people who have lots of opportunities and making sure that they see our industry as a great place to continue their careers despite these budgetary pressures. That's something we're all working hard on because we know that ultimately that determines the success of our ability to support the mission that we're here to serve.

Your next question is from the line of Cai Von Rumohr from Cowen and Company.

So F-35, I think on the Q3 call you mentioned... [Technical Difficulty]

And that question is from Cai Von Rumohr from Cowen and Company.

So I think on the third quarter call you mentioned the F-35 was going to be, I think, higher volume in the second half. Could you give us some sense in terms of where was the F-35 volume last year? Where should it be in 2013? How is your performance and kind of what's the opportunity for improved profitability at some point?

Cai, from memory, the F-35 this year was around $1 billion in terms of revenue and about $1 billion would be the expectation for next year as well. You know we don't comment on profitability by individual programs, so I'm really not going to go there. We are working hard to be a teammate with our friends at Lockheed and support the program. We're doing well in our pieces of the work, and I would characterize our margins at this point as basically as I would expect given the stage of the program.

So the follow-up would be if we look at aerospace, you kind of have lower margins projected and some mature stuff coming off. When do we have some of these newer programs like the F-35 reach the point where they should start maturing so that those margins in aerospace could start to improve?

On the F-35, I don't really see a step-up in terms of volume until about 2016 given that the current plan for quantities.

Okay. But I mean, the question was volume. As you mature the program, and you made the point about where you are in the stage of the program, usually the margins get a bit better. So when do we reach the point when more of that volume starts to become mature?

If we want to talk about aerospace in total, we still have a very good strong mix of new development-type programs. And I don't think that changes much over that couple of year period of time going forward. So the good news is, continued growth on new opportunities will be important as that portfolio transitions over time.

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

I wanted to talk a little bit about ES. Jim, you had mentioned about the net favorable adjustments this year and that they were the majority of the total. If I back those out, and I don't know exactly what the total favorable adjustments are, but it would still seem to imply a margin well into the high-14s on the baseline, and your guidance seems to imply kind of 50 basis points below that. So I'm wondering why is it declining kind of even x the adjustments in 2013 versus 2012?

I thought you were going to ask me why they were above our long term rate of return or something.

No, the basis points are, that's not a new question.

Oh, okay. I think that the guys, the team at ES is just doing a fabulous job over the last few years. They really have driven up the margins. We've worked really hard to reduce the negative adjustments that part of that business has been plagued by over looking back 3 or 4 years or so. And at low to mid-14s, I think they're going to just have a great year.

So there's not really a change in the mix or development to production or anything else that's going to drive it?

I don't think so. We do have -- did have in 2012 a number of programs or contracts reached the end of their production or life. And as well, did get a benefit from the cost-reduction activities that we undertook at ES and at the company in '11 and in '12 had a big impact or favorable impact on their contracts. And as you know, you give those up as you go forward with new contracts. All of that are factors into that overall margin rate expectation for ES for 2013. Having said that, you bet we're going to push to get us the very best performance that we can out of that part of the business and every other part of the business.

Jim, I would just add that similar to your earlier remarks around aerospace, ES has been very successful these last couple of years in capturing some new development work as well. And as you all know that the margin rates during the development cycle are generally less, and I think we'll see some of that too.

And we have some new development activities, possibilities.

Exactly, on the horizon here.

And your next question will come from the line of Rob Stallard from Royal Bank of Canada.

Just a quick one, Jim, actually. I was looking at goodwill on the balance sheet. You've got $2.4 billion. I was wondering if you did your annual impairment review, what the results of that where, how much cushion you might have from the latest reassessment of that goodwill?

You bet, we did our annual impairment test. And just like last year, the most sensitive piece of our businesses is IS, and we do have a cushion. It's not real large, if you want to call it that or look at it from that perspective, but we're comfortable with where we are at the end of the year and as we go forward, we'll do the test again based on new information when we have it.

I mean, I'm sure you wouldn't be able to get into specific details, but can you give us an idea of maybe how much that cushion might have reduced versus last year?

It's down a little bit from last year, and frankly, the cushion is a combination of a whole bunch of different factors. Obviously, interest rates play into the discount rate on the use of discount cash flows that has an impact on terminal value, has an impact on pension liability. All those are factors in the overall calculation, but it does start with the expected cash flows from the business. And our guys at IS, although revenues were down, we still expect that they'll have reasonably healthy margins given our guidance for 2013, and again, comfortable with where we are.

And just a quick one for you, Wes. I was wondering if you can maybe comment on the competitive environment that you are seeing in services and your ability to preserve margins going forward.

I think a lot of that goes back to the point I was making earlier around affordability. Clearly, as the department's budgets are under increasing pressure, our customer community needs our industrial base to drive additional efficiencies into the way that we do business, which we've been busily doing now for several years, and they need good ideas. They need the innovation that can come out of our industry to suggest alternative approaches to getting things done. So I think, just thinking about it very broadly, the competitive environment is going to be very healthy. I think everyone's working on cost and everyone's working on innovation. And hopefully, we're all going to be able to not only be competitive with each other, but be supportive of our customers in this more difficult period of time. It is going to be a challenging competitive environment. I don't want to sound dismissive of that at all. Those of us who had been through defense downturns in the past have that experience under our belt and understand very clearly what that means. But that's part of the reason we've been doing the work we've been doing to get ready for this.

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

The first question is more of a clarification, Jim, I think in the slides it implies what the share -- diluted share count benefit is to EPS with 6% drawdown. I don't have the period end share count, so I don't know exactly, but is the share repurchase number on a dollar basis about...

It's 7% on a weighted average shares this year to next year.

Yes, is the dollar repurchase assumed to be about the same?

Yes, roughly the same. Obviously, for planning purposes, we've assumed that it's generally proportionate throughout the year, which equates to about a little bit more actually. It's price dependent, obviously.

Yes. That kind of brings me to the question, so -- to your earlier comments on your pension plan, you're in a much better funding position than probably anyone else or definitely better than anyone else out there and probably 85% or so funded.

Actually, 83%. You'll see in the K.

83%, all right. So if I look at your cash balance, that continues to grow. You're returning over 80% or 80% of the free cash flow generated in 2012. But again, the cash balance continues to grow. You're in a net cash or close to net cash or 0 net debt position. At what point do you actually take some of the cash balances and return those or at least increase more than 100% free cash flow return to shareholders? Or is there M&A out there on the horizon that you'd like to retain it for?

Well, actually, if you think about the comments that we just went through pro rata a little bit more than last year, dividends and our free cash flow guidance for 2013, you're at 100% if not maybe more than 100% just with that.

Yes, Myles, I'll just add. We continue to see share repurchase as a very important part of our overall balanced cash deployment strategy. We think that has been serving our shareholders well, and it has been a good use of our cash. We do think about our business over the longer cycle and that's the perspective that we have in mind when we're thinking about our approach in share repurchase in particular. So it continues to be a very attractive mechanism for cash deployment for us.

Okay. So the cash balance though question, you would still expect it to be not coming down anytime soon in terms of this being the level that you'd be comfortable maintaining on the balance sheet?

I'm sorry?

It seems like...

If I have, let me try to answer. $1.7 billion to $2 billion on free cash flow, and let's call that midpoint of $1.8 billion or something like that. $500 million for dividends, round numbers. If I have a similar amount of share repurchases to last year's, that's $1.8 billion, midpoint of that free cash flow. Got CapEx. That free cash flow is out of that. But then if I spend any money at all on things like funding the pension plan or other opportunities, and clearly, as we tried to outline, we're in an uncertain environment, so we do want some financial flexibility to be able to deal with that. I think I'm, on one hand, I'm continuing to do what we've set out to do and have done over the last few years with deploying cash to invest in the business, to manage our pension plans and return excess cash to shareholders and provide us with financial flexibility to deal with this uncertain fiscal environment that we're in at this point in time.

Your next question is from the line of David Strauss from UBS.

Your level of EACs that you've assumed in your 2013 guidance is what?

Less than last year.

Okay. Any -- obviously, last year was close to $1 billion was pretty high. Any sort of range?

No. I really think about it as those overall margin rate as opposed to what kind of level of adjustments do I need to have to get there.

Okay. Jim, on the cash flow from ops walk, can you give us some help on working capital, cash taxes, what's baked into that number relative to 2012?

Yes. As you all know, the hardest bit in this business on cash flow projection is working capital. So right now, the guidance anticipates a use of working capital anywhere from, let's call it, $50 million to $250 million for the year. Cash taxes and tax expense roughly about the same, maybe $50 million greater on cash taxes. And then the other variable in that whole range of EBITDA to free cash flow is, first of all, stock compensation, about $100 million and then CapEx of around $400 million for the year.

Great. And then last one, if I'm looking at it correctly, you still have a decent chunk of what would be considered relatively high cost debt outstanding given today's rate environment. What's the plan, if anything, to address that? I know other companies have gone after that pretty aggressively.

We tendered for all of that or much of that in 2010. We actually tendered for $1.9 billion at the time and were able to pry out about $800 million. We continue to look at it, continue to look at who holds it and the likelihood that they might be receptive to tenders. And at this point, we haven't been able to convince ourselves that something like that makes sense given who the holders are of that -- largely of that high-coupon debt.

Your next question is from the line of George Shapiro from Shapiro Research.

I wanted to ask, you were surprising to me in the sense that you had substantially up margins where a couple of your major competitors had down margins in the quarter. But yet, you're still guiding to significantly lower margin in '13 and even though you've always been conservative in the past, I'm just wondering, is it all just EACs reflecting in '13 or the core programs are that much tougher? Can you just go through that a little bit more?

Well, I would say that we have an increasingly tougher environment. At the same time, we're working very hard to make sure that on all the new contracts we get reasonable terms and conditions, that our cost estimates fairly reflect what we think our cost are to do the work. As I did mention earlier, we have taken -- we tried to get out ahead of what we saw as a decline starting in 2011. We did take a number of actions to reduce, as Wes said, our footprint and our headcount. We did get a benefit in 2012 on our backlog for those activities. And our backlog normally runs about 1.5 years. If you get all the benefit on 1.5 years, you get a year's worth in '12, you don't have a whole lot left, do you? So it's a combination of just what we see in the marketplace in terms of the environment and the actions we've taken that have resulted in favorable performance adjustments. As I said, we have also worked very hard to reduce the quantity and the quantum of any of our problem programs and been, I think, pretty successful with that. So it's really just that look at the entire portfolio of programs and where we stand that lead to our judgment around those margin rates for 2013, which I think are really strong operating performance, particularly in light of our benchmarks for the types of businesses we're in, which, as I said, largely are confirmed by many of our peers, both in their guidance for this year, as well as their performance. So all in all, I think we're doing a pretty good job.

You definitely are. And just a follow-up for either you or Wes. So Wes, you clearly have done a great job in taking out cost before ahead of revenues. Can you continue to do that if sequestration goes into place, which is going to be somewhat more abrupt? I mean, how do you actually plan to be able to do that or continue that?

George, I've remarked on this just a little bit earlier that in the event of sequestration or other budgetary actions, our first challenge is going to be addressing whatever contractual changes come along. But ultimately, we have to scale cost structure with that, and that's what our planning has been focused on, to enable us to do that in a smart way so that we're not doing something that undermines our ability to perform for the long term. But we worked our way through those scenarios and are certainly ready to take on the variety of scenarios. Ultimately though, in any of those outcomes, first and foremost, we're going to have to deal with the contractual matters.

Your next question comes from the line of Yair Reiner from Oppenheimer. Yair Reiner - Oppenheimer & Co. Inc., Research Division: A question about free cash flows after discretionary pension. They've been fairly volatile here over the last couple of years. $1.9 billion a couple of years ago and now just $2.3 billion in 2012, and I guess the guidance for 2013 implies somewhere between $1.2 billion and $1.5 billion. Now I understand that a lot of these discretionary pension payments are going to come back to you later on, but can you just help us understand what we should think about as a long term sustainable free cash flow after pension?

I've said a number of times publicly that I think even in this environment, that we're going to have relatively strong free cash flows as we look forward. I really don't see -- we've had strong cash flows. I continue to expect that we will have those relatively strong cash flows, free cash flows on a go-forward basis. I don't know what else to tell you there.

And we look at the voluntary pension amounts sort of on a year-by-year basis depending on what's going on in the marketplace and the economic benefit that we see by making those contributions. So that is something that we do look at and make decisions based on the environment. And a look to the longer term as well.

Your next question is from the line of Joe Nadol from JPMorgan. Joseph B. Nadol - JP Morgan Chase & Co, Research Division: Your backlog went up, both funded and overall, this past year and you have revenue guidance that's down without sequestration, and I was wondering if you could comment on whether that's just a profile of the backlog, the tail got bigger or if there's something else in your planning? And also, you had a good quarter from a sales standpoint, I might add, the best one you've had in a while.

Joe, backlog is a function of obviously contracts and the genuine performance of contracts. A contributor to our backlog this year is the NATO AGS contract. It extends over 5 years or so. So when you get a contract like that, it adds to your overall backlog numbers as well as the period of performance that goes with that. So that's principally the factor that you're seeing that's contributing to growth in backlog dollars, and you perform those contracts, as I said, over about a 5-year period of time. Joseph B. Nadol - JP Morgan Chase & Co, Research Division: So it's just AGS?

NATO AGS.

And Joe, in my earlier commentary, I sort of went through the components of the -- of about roughly $1 billion differential in sales. So I don't know if you caught that commentary, but it might be helpful in addressing your question as well. Joseph B. Nadol - JP Morgan Chase & Co, Research Division: Okay. And the next one, the second one is just we're all focused right here on the sequestration and the CR and everything. Wes, when you look out a little further or not even that much further. You have this Jammer, this Next Gen Jammer competition. Could you comment on that and your teaming arrangement there with Exelis and what led you down that path? And then really, any other competitive situations that you see over the next year to 2 for the company that you consider important?

There's a whole variety of activities that we're pursuing, and I like your perspective on it, that we all do need to keep looking down the road because the nation's going to continue to need a Defense Industrial Base, and we're going to continue to need that technological superiority that the industrial base provides. Next Generation Jammer is an exciting opportunity. We've been working on that now for some time. Our teaming with Exelis was driven by a view of how do we bring the very best offering to our customer. And we saw in the team at Exelis some great capability that when combined with ours, we believe is a compelling offer. So that relationship is going well, and I'm looking forward to continuing it. There are whole series of opportunities of that nature and some even larger scale as we look on the horizon. Clearly, both the Air Force and the Navy, and I would add to that, the intelligence community really need to position their capabilities to align with the nation's evolving national security strategy. This pivot to Asia-Pacific has brought implications on the types of capabilities that are going to be needed, that range from aircraft, unmanned and manned. They range to sensor systems, the C4ISR domain. And also, cyber continues to be just a heck of a challenge for our country, and we think it's going to continue to be a challenge. So across that array of sort of broad mission areas, there are whole array of specific programmatic targets, both '13 and '14, that we are investing in and continuing to push hard on. One point I would make in response to your question, that even while we're seeing a perhaps tougher environment around the top lines, we're committed to continuing to invest for the future here. We think that -- we feel very strongly that it's going to be imperative that the Defense Industrial Base continue to bring innovation to the nation's capabilities and investing now is going to be important for our ability to serve for the long term. Joseph B. Nadol - JP Morgan Chase & Co, Research Division: Wes, are you seeing the procurement groups at your classified customers having the same sort of freezing up, same sort of issues that the broader customer set is going through right now? Or have there been more provisions for -- to enable them to operate more smoothly through this whole situation?

Joe, there's only so much I can say about that, but I will say that they too are subject to the legislation around the CR and potentially, if we were to get to the sequester, those issues as well. So they're having to address that in a very prudent manner and address it from a planning perspective as well. So these budgetary effects sometimes just get a stamp on it associated with the Department of Defense, but they hit everybody. And I think it's important to understand that from a broad policymaking perspective, that this really does span across government, all the functions of government.

And the last question will come from the line of Howard Rubel from Jefferies. Howard A. Rubel - Jefferies & Company, Inc., Research Division: Kind of 2 parts. Wes, the interesting thing about all that's gone on is the authorization bill protected Global Hawk in a big way and actually underscored how important it was. Can you address sort of some of the other positives that came out of that and how do you sort of square that walk with what Congress' will there with, in fact, this meat-axe approach to solving a problem that doesn't?

Yes, it's hard to square that, Howard, I appreciate your question. It's clear to us that when Congress, and then particularly those in Congress who are charged with addressing specific matters associated with the functioning of our government, when they're given the latitude to dig in and really address a particular issue, they're able to do that strategically, and they're able to make great decisions. When there is this broad umbrella approach to trying to deal with the bigger challenges without dealing with the strategy, you get to these other approaches that really don't make sense from a strategic perspective. On Block 30, I would just say that we continue to be pleased with the performance in-theater of those systems. They're in very high demand by the combatant commanders, and we were just delighted to see the Authorization Act support the continuation of Block 30. We continue to work with the Air Force to provide more affordable approaches to sustaining that program because we think that will be something that's going to be important to the country's ability to conduct its surveillance mission for a long time. So I would just say, it's sort of a contrast between the processes, when the Congressional processes that have been developed over many years to work on and deal with the authorization and appropriations for specific components of government are allowed to do their jobs, I think we get to very good rational outcomes. When there's this broad across-the-board meat-axe approach, we get to really bad outcomes. Howard A. Rubel - Jefferies & Company, Inc., Research Division: And then just last, just a follow-up. I mean, the numbers would say, you don't have very many red programs or anything close to them, but I'm sure there's always you're not happy with. How would you evaluate maybe the bottom 10% of your performers at the moment? What are you trying to do to change that?

Yes, we've been doing a lot of work on that over the past few years. Jim alluded earlier to the fact that it wasn't that long ago, 4 or so years ago that we had a serious list of red programs that we kept talking to you all about, it seemed like every quarter. So the focus on performance in our company is not just about margin rates. It goes to performance for our customers as well. It starts with quality. It starts with the quality of our processes and the quality of how we approach getting the work done, and I'm not just talking about quality coming out the end of the production line. It's the quality of engineering, it's the qualitative of contracting, it's all of those aspects. So we're not perfect. I wouldn't want anybody to hear that we think we are somehow reaching a point of perfection in any way. We have still a lot of work to do as any honest organization would tell you. But we have substantially reduced the number of programs in our portfolio that are demonstrating those performance variations, in part because I think we've made good progress on our risk management methodologies. And for those programs that are in sort of the bottom 10%, I would characterize them as those where the risk that we've identified and been working to manage still find a way to manifest in some way, but we're able to get on it more quickly and more aggressively, and we've become a lot better about utilizing the resources of the entire corporation to go after them when those problems pop up. So still work to do, still, I think, to some extent inevitable in the technologically complex environment in which we operate, but a lot better place than we were a few years ago.

This concludes the Q&A session. I would like to turn it over to Jim for a couple of brief comments on some information that's always of interest to you all, and then turn it over the Wes for final comments.

I'm kind of disappointed. I didn't get my normal FAS/CAS pension question. Let me try to answer what I would have anticipated to be your questions. So we talked about our FAS and CAS guidance for 2013, and if I look forward to, let's say 2015, 2 years out, I would expect based on no change in our assumptions that our FAS cost would decline about $130 million and that CAS cost would increase about $300 million or the net FAS/CAS change being about $430 million. 2014 is probably halfway in between the 2013 numbers and the 2014 numbers. Spent some time this morning talking about the current environment, the possibility that we're faced with at least an uncertain defense budget and likely a declining defense budget. So clearly, in that environment, the emphasis on affordability is so important. So growth in CAS cost isn't necessarily good as it does add to the affordability challenge that we all face in light of that environment. So we are working really hard to reduce both FAS and our CAS cost. And if we find ourselves in a rising interest rate environment, as you know from our past conversations, that rising interest rate has a near-term impact on our FAS cost, and we would look at that today at being every 25 basis points is in a range of $85 million to $90 million. However, because of MAP-21, a rising interest rate environment over the near-term likely doesn't have nearly the impact on FAS as it does on CAS and on funding. So ultimately, besides rising interest rates over a long term, the important levers for reducing or controlling your FAS cost or CAS cost rather, CAS cost as well as funding are first of all, investment performance. Our 10-year compound annual rate of return is just under 10%. And then you have to manage the provisions of your plans. We have capped entrants to the pension plan back in 2008, as I recall. So any new employees do not have the same pension benefits as the past. And then last year, we announced another change for our pension plans that essentially capped growth in compensation cost, all of which are aimed at reducing that CAS cost on a go-forward basis. So we've been working really hard. I know you all are interested in those trends around FAS and CAS, so I wanted to give you that flavor as you work your models, but this is going to be an important item as we go forward. So Wes, with that I think we're ready to close.

Thanks, Jim and Steve. Let me just wrap up with a couple of thank yous. First, thank you to our employees for their incredible focus on performance and serving our customers. Our 2012 outcomes are due to the hard work of our team, and we all sincerely appreciate that. And secondly, thanks to all of you for your continuing interest in our company. We appreciate you being with us on the call today. Thanks, everyone.

And ladies and gentlemen, this concludes your presentation. You may now disconnect.