Northrop Grumman Corporation (NOC) Q3 2012 Earnings Report, Transcript and Summary

Stephen C. Movius - Chief Financial Officer and Sector Vice President of Finance and Business Operations Wesley G. Bush - Chairman, Chief Executive Officer, President and Member of Corporate Policy Council James F. Palmer - Chief Financial Officer, Corporate Vice President and Member of Corporate Policy Council

Myles A. Walton - Deutsche Bank AG, Research Division Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division Samuel J. Pearlstein - Wells Fargo Securities, LLC, Research Division Noah Poponak - Goldman Sachs Group Inc., Research Division Joseph B. Nadol - JP Morgan Chase & Co, Research Division Robert Stallard - RBC Capital Markets, LLC, Research Division Howard A. Rubel - Jefferies & Company, Inc., Research Division Cai Von Rumohr - Cowen and Company, LLC, Research Division Jason M. Gursky - Citigroup Inc, Research Division Carter Copeland - Barclays Capital, Research Division Robert Spingarn - Crédit Suisse AG, Research Division George Shapiro

Good day, ladies and gentlemen, and welcome to the Northrop Grumman Third Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I'd 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 Third Quarter 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 call constitute forward-looking statements pursuant to safe harbor provisions of federal securities laws. Forward-looking statements involve risks and uncertainties which are detailed in today's press release and our SEC filings. These risk factors may cause actual company results to differ materially. 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.

All right, thanks, Steve. Good morning, everyone. Thanks for joining us on our third quarter conference call. We're very pleased with this quarter's results and the performance of our businesses year-to-date. We continue to drive program performance, aggressively pursue high-quality new business with innovative, affordable solutions, reduce our cost structure and align our portfolio with our customer spending priorities in a dynamic environment. Our intense focus on these actions, combined with effective cash deployment, continues to create value for our shareholders, customers and our employees. These are not new initiatives for us. These are the ongoing efforts and actions that have generated substantial performance improvement over the last few years and that will be increasingly important in today's challenging environment. Third quarter EPS are comparable to last year despite continued top-line pressure. On a pension-adjusted basis, our third quarter earnings per share increased 6%. We achieved this improvement through a combination of operational performance and share repurchases. All 4 of our businesses performed well in the quarter. Our businesses continue to generate strong operating income, margin rates and cash flow. Year-to-date, we've captured more than $20 billion in new business awards for a book-to-bill ratio of more than 100%. And cash generation has also been strong, even after our $300 million discretionary pension contribution, free cash flow totaled $748 million in the third quarter. And year-to-date, we've generated free cash flow of $1.4 billion or nearly 100% of net income. Our robust margin rates and cash conversion demonstrate the quality of our operational performance for the quarter and year-to-date. We're very proud of our employees' outstanding efforts in generating these results. Our strong cash generation continues to support share repurchases. During the quarter we repurchased about 4.4 million shares of our stock for $290 million. And year-to-date, we've repurchased 13.6 million shares for approximately $850 million. In the first 9 months of the year, share repurchases and dividends have totaled more than $1.2 billion or nearly 90% of free cash flow. We continually assess our share repurchase program to ensure that it's creating long-term shareholder value. As you know, ours is a long cycle business, and we take that perspective when considering the value of our enterprise. We consider our long-term value relative to the market's current valuation of our cash flows and earnings. Based on where we are in the cycle, and the prices at which we are purchasing shares, we believe that share repurchases continue to contribute to long-term value creation. The board recently increased our remaining share repurchase authorization to $2 billion, which provides flexibility in a dynamic environment. Turning to guidance, based on the strength of year-to-date results, we expect to end the year with sales of approximately $25 billion. And we now expect 2012 earnings per share of $7.35 to $7.40. On a pension-adjusted basis, this represents EPS growth of approximately 8% over last year. We're also increasing our guidance for cash from operations and free cash flow. Before discretionary pension contributions, we now expect operations to generate $2.5 billion to $2.8 billion, with free cash flow of $2.1 billion to $2.4 billion. Looking ahead to next year, there is substantial uncertainty regarding federal budgets, including whether sequestration will occur, and if so, how it would be implemented. We believe that sequestration would not apply to obligated program funds that are currently in our funded backlog, but there's little doubt that the long-term impact of sequestration would be highly detrimental to national security and our industrial base. The short-term impacts, should sequestration take effect in January, are more difficult to assess given the lack of specific implementation detail. As a result, we're preparing for a wide range of budget outcomes. But under any scenario, we expect that as currently provided for under the Budget Control Act, sequestration would result in lower revenues, profits and cash flows for our company and our industry over the long-term. Now in addition to sequestration and the potential impacts of the other fiscal cliff issues, we're now working under a 6-month continuing resolution. This CR is more challenging than in previous years in that there appear to be virtually no exceptions for new program starts, which includes new tasks on IDIQs and increases in production quantities. There's also limited ability to effectively shift programming -- shift funding between programs as has been done in the past to mitigate execution issues. There's no certainty when we'll have a formal 2013 budget, and it is possible that the CR would need to be extended, which would be an additional source of uncertainty for us and our customer community. So as we think about next year, our outlook is clouded by these challenges. How all these issues are resolved will determine the degree to which our top line is impacted. However, under any reasonable scenario, we would expect lower 2013 sales as a result of the CR restriction on new starts, along with the other constraints our customers are facing. We will be providing our detailed 2013 guidance when we announce our fourth quarter and year-end earnings. In closing, it was a very good quarter, and we expect a strong finish to the year. Obviously, looking ahead to 2013, there is a high degree of uncertainty, as I said. But we believe we are taking the right steps in the current environment by bringing innovative, affordable solutions to support our customers' needs. And we believe we can continue to create value by remaining focused on our key priorities; performance, cash deployment and portfolio. So now, I'll turn the call over to Jim for a more detailed discussion of results and guidance. Jim?

Thanks, Wes. Good morning, ladies and gentlemen. Highlights for the quarter were outstanding cash generation and strong, consistent segment operating margin rates. This performance, combined with share repurchases, generated this quarter's 6% increase in quarterly pension-adjusted earnings per share. Now, let's spend a few minutes looking at some of the details behind the results. Those results reflect our continued focus on program execution and aggressive cost management and reduction activities. Although operating income declined by the $66 million change in the net FAS/CAS pension adjustment, on a pension-adjusted basis, our operating margin rate expanded 20 basis points to 11.2%. In addition to the pension impacts, operating income also reflects lower volume, which was partially offset by an improvement in corporate and allocated expenses. EAC adjustments for the quarter were a net positive $214 million versus $196 million in the prior year third quarter. The primary driver of the change was a $38 million reduction in unfavorable performance adjustments compared to last year's third quarter. Based on our year-to-date performance, we now expect a 2012 segment operating margin rate of approximately 12%, with a total operating margin rate in the high 11% range. As I mentioned, cash results for the quarter were simply outstanding. During the quarter, we did make a $300 million discretionary contribution to our pension plans which, after tax considerations, reduced third quarter cash from operations and free cash flow by $221 million. Year-to-date, cash from operations is more than $500 million ahead of last year's pace and free cash flow is nearly $700 million higher. Given that performance, we are raising our guidance for 2000 cash from operations and free cash flow. But in doing so, I should caveat that by noting that our guidance does not contemplate any and unusual year end customer behavior due to pending issues such as the debt ceiling, the fiscal cliff, or potential sequestration. Turning to the sectors, Aerospace third quarter sales increased $131 million, or 5%. We continue to see growth in our Unmanned Systems portfolio, principally due to the ramp-up on programs such as NATO AGS and Fire Scout. Military aircraft sales also increased due to higher F-35 volume, which includes deliveries of the first units under the LRIP 5 program for F-35. You will recall that we adopted the units of delivery revenue recognition for F-35, LRIP 5 and we are now recognizing LRIP 5 revenues with the commencement of the deliveries in this quarter. Higher volume for Unmanned and Military Aircraft was partially offset by lower sales for Space System programs, including some restricted programs and the impact of the DWSS termination in the fourth quarter of last year. Aerospace operating income declined by 2%, resulted in operating margin rate of 11.1% for the quarter, compared to 12% for last year's quarter. The major change in the margin rate is the transition to the lower margin multi- year 3 contract on the F-18. For the year, we expect Aerospace sales of about $9.9 billion with a margin rate in the mid-to-high 11% range. Electronic system sales declined by $198 million or 10% due to lower revenue in postal automation, combat avionics, infrared countermeasures and laser systems. Postal automation includes the de-emphasis of our domestic postal automation business, as well as a softening in the international postal sales in Europe. Combat sales -- Combat Avionics sales declined due to lower unit deliveries for several programs, including the F-22. And Infrared Countermeasures and Laser System programs declined due to force reductions in overseas contingency operations. These declines were partially offset by higher volume for some Space Systems programs. ES operating income declined 5% and operating margin rate increased 90 basis points to 16.3%. You may recall that last year's third quarter included a $25 million provision for the domestic Postal Automation Program, and without that provision, last year's operating margin rate would be comparable to this year. For the year, we expect ES revenues of approximately $7 billion, with a margin rate of low-to-mid 16%, up from our prior guidance of low-to-mid 15%. Information Systems sales declined $179 million or approximately 9% for the quarter. About $100 million of that is due to the wind down or completion of programs, including JTRS AMF and several restricted programs. Another $30 million is associated with in-theater force reductions and finally, the sale of Park Air Norway impacted third quarter sales by $17 million. The balance reflects just general market softening due to the uncertainty of the budget environment and the shorter cycled nature of our IS business. Consistent with third quarter sales trends, IS operating margin declined 9%. Our operating margin rate was unchanged at 9.6%. For the year, we now expect IS sales of approximately $7.3 billion, and we continue to expect a 10% operating margin rate for IS for this year. Turning to Technical Services, third quarter sales fell 6%, largely due to lower volume for the KC-10 program. Our previously announced portfolio of shaping actions in Defense and Government Services also reduced third quarter sales. And on an absolute basis, TS operating income was comparable to the prior year, with operating margin rate expanding 40 basis points to 8.3%, due to improved program performance. For the year, we now expect TS sales of approximately $3 billion, with margin rates in the high 8% range. On a consolidated basis, we're looking for 2012 sales of approximately $25 billion, and we are increasing our segment operating margin guide rate guidance to approximately 12%, with total operating margin rate guidance to the high 11% range. Now, let's spend a few minutes talking about everybody's favorite subject, 2013 pension. I should remind you that there are a number of assumptions that are -- that we determine at the end of the year that will principally affect FAS pension cost in 2013. Two of those key assumptions that are critical are the actual return on investment assets in 2012, and then the discount rate used to discount pension liabilities at the end of the year. Now through September 30, our actual asset return, investment return is approximately 10%, compared to our expected long-term rate of return of 8.25%. And I think you will recall that for every 100 basis points above or below the expected rate of return affects 2013 FAS expense by $40 million. And if we had to set the discount rate at September 30, we would likely be looking at about 100 basis points lower than what we've used to discount liabilities last year. And again, just a reminder that I think you know that we are required to set all of these assumptions at the end of the year. And so with a little over 2 months to go, we may continue to see volatility, particularly in interest rates, due to matters such as the pending fiscal cliff or global economic factors. But again, for modeling purposes, just a reminder, every 25 basis points change in the discount rate impacts 2013 FAS expense by about, anywhere in the $75 million to $80 million range. So at the start of the year, and again a reminder, we had estimated our 2013 net FAS/CAS income to be about $250 million. And obviously, that estimate had assumed no change in the discount rate or asset returns above or below the long-term rate of return assumption of 8.25%. Our estimate for CAS for next year has not changed much but obviously, interest rates and plan asset returns, among other assumptions, will have a significant impact on 2013 FAS expense. Well Stephen, in closing, I would say a very strong operational performance that we've seen for the first 2 quarters, continues into the third quarter. Expect a strong finish to the year. As I said, strong cash flow. So bearing any unusual customer behaviors resulting from the uncertain budget environment, I think we're going to have a strong finish to the year. So with that, I think we're ready for Q&A.

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

[Operator Instructions] Our first question is from the line of Myles Walton from Deutsche Bank.

Wes, I know you alluded to 2013. You'd have some top-line pressure, regardless of the sequestration situation that evolves. Curious, could you comment on the margin side, Jim or Wes? Regardless of -- or let's assume, no sequestration. What kind, if any, headwind on the margin side we should anticipate? Obviously, you had a strong performance on EACs and the negative EACs continue to come down. Just don't know how much more opportunity there is for the unfavorables to come down. If you can kind of elaborate, maybe just at the high level?

Myles, let me give you a range of thoughts here. Clearly, 2012, we've had a benefit from the cost reduction activities we've undertaken over the last year and a half in terms of our existing backlog. Some of that backlog continues to have those benefits on a go-forward basis. Secondly, I would observe that the contracting environment is -- it's a little more difficult that it has to been in the past. It means that we got to be diligent about terms and conditions and contract structure. And most importantly, it means that we have to do what we are charged to do, manage our programs. Thirdly, we do take a look every year at long-term rate of return assumptions for our 4 business areas. I'm very comfortable with where we are, but we'll take another look at that. Based on what we see, as in -- as performance in the industry. And we may revise or we may continue to hold the long-term rate of return assumptions that we have today. But again, I feel very good about where we are in terms of the businesses. Clearly, our job is to do better than those long-term rate of return assumptions and we've been able to do that over the last couple of years, basically through a combination of affordability initiatives and then managing the programs. And then finally, we're not standing still. We continue to take actions to improve affordability within the company, which again, it will give us an advantage on the existing backlog even for new contracts that we negotiate today. So in summary, I would say just outstanding performance from the team for this year, and we feel good about the long-term view of the businesses and what the margin ought to be able to generate. And it's up to us to manage our programs.

[Audio Gap] the line of Doug Harned from Sanford Bernstein. Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division: I'm interested on the -- in thinking about the top-line outlook, because if you look at what you all have done over the last few years in terms of reshaping the portfolio, exiting some businesses, ramping down some things like activities in the postal automation area. And then OCL funding coming down. So you've had some things that have taken the top line down. A few contract inflations [ph] . So are we at a point where you can sort of reset the business? And if we set sequestration aside, are we at a point where, as you look forward, are we looking at something that's stable, declining or even maybe some modest growth out over the next few years?

Doug, let me frame it this way. If we look at 2013 in particular, clearly sequestration is a big, big variable in all of this so, but to the point of your question, if we set it aside, the other reality that we are dealing with now is this continuing resolution, 6 month CR. And it's a pretty tight CR in terms of the way that it's crafted. It puts an enormous number of constraints on our customer community, with respect to what they can do on new starts or transitions into production, or even under IDIQs. So given that, that appears to be at least a 6-month concern, and that will put negative pressure on the top line, sort of across the board. That's going to be a fact of life that we're dealing with. So ultimately, stability in our top line will go sort of hand-in-hand with greater stability and how the government is appropriating and executing the budgets that are allocated for defense, and the other agencies that we serve. The other factor though that I would say, needs to be considered, even if you set aside sequestration, is just how much money is going to be allocated for defense, ultimately in the budget environment? We all know that there is a substantial deficit situation, and that there are some tough decisions that lie ahead to be made regarding the outcomes for each component of that budget. So it's a little unclear today, from where we are, how to predict, how that will go. But to the point that you made, we feel good about how our portfolio is positioned in that regard. We feel that we've done a good job of getting aligned on priorities. So when those budgets get set, it's our expectation that our portfolio will do well in a relative sense against those priorities. The other longer-term opportunity for the company continues to be on the international side. As you know, our international sales, historically have been largely confined to our Electronics business. And while we've been very pleased with those sales and the team at Electronics has done a great job of making those sales very effective for us, we see additional opportunities emerging, particularly in our Aerospace Systems business, but also in IS and TS as we take a broader look and engage with our DoD customers in terms of their strategy on what they would like to see our partners around the globe, be able to do. We see a growing push to take some of the capabilities that historically we've had some challenges exporting. We see a growing push to make those more available to our partners. So that's not the near-term thing. It takes a while to get those through the policy arena and then actually execute it in terms of specific programmatic decisions. But we also see our portfolio as being well-aligned for some of the important thrusts that we see from an emerging policy perspective and supporting our allies around the globe.

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

I'm sorry to kind of try and do 2 parts here, but just Wes, just to continue on the continuing resolution question, isn't the absolute level of the CR higher than what the original request is? And so wouldn't that actually, in some ways, be beneficial? And maybe you can talk about some of the starts that you expected this year that get pushed out.

Well, it is just very slightly higher in a total magnitude sense, but what ultimately counts is what the constraints are that get implemented program by program. So you have to sort of peel that apart. And I -- we're all glad that the total number for the CR was a good number relative to the President's budget. But when it comes to executing programs, particularly programs that are in any form of transition, if it's a transition from development to production, if it's an IDIQ contract where you're finishing off a task, an order on an IDIQ contract and they want to issue a new task. And, if you're just looking at the broader set of constraints that went with -- and this was a very tightly prescribed CR. More tightly than we have seen in the past. So that, that was really the comment that I had on why that is an issue relative to how the top line will work out. Just about every program in our community has a fair amount of variability around where the funding is coming from, what the line items are. And when you start putting those types of constraints on it, it does have implications on what our customers can do. So that's all of our hope that we move through this CR as expeditiously as we can and get a real piece of legislation that really does the appropriations the way they need to be done so that our customer community can go and execute on their mission. That's our, I would say at a, the top-level, our primary concern. I think it tends to impact our shorter cycle businesses more dramatically, but even some of our more substantial programs that are making that transition from design into production could be impacted by those constraints, depending on the timing of the actual appropriations language and how long we actually live under this CR environment.

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

I just wanted to ask, when I'm looking at the balance sheet, it looks like you'll end the year close to or in a small net cash position. Rates are particularly low out there right now. I wonder how you just think about the right level of balance sheet utilization. And there's obviously plenty of uncertainty ahead, particularly in the near-term, but you could add a significant amount to the balance sheet and still keep your leverage metrics fairly low? Or perhaps you just want to wait until the sequestration outcome is resolved? But if you could just speak to how you're thinking about that, probably that'd be very helpful.

You're correct, Noah, in your observation. We have a very conservative balance sheet at this point in time. We view flexibility as very important. The cash balances provide us that flexibility in this uncertain environment. Having some certainty around future budget outlooks would be really important. We're mindful of where interest rates are. We've watched that very carefully. I don't know that we're going to see a significant change in interest rates in the near-term. I'd like to believe that we are, but I doubt that we are. So I think that the market flexibility will likely remain for a reasonable period of time, that if we wanted to take advantage of that, we would have the opportunity. But in today's environment, having the flexibility that our capital structure reflects today is really important.

Your next question is from the line of Joe Nadol from JPMorgan. Joseph B. Nadol - JP Morgan Chase & Co, Research Division: I'd like to get back to a strategic question that is not new, but just to get your latest thinking on it for either or both of you. It has to do with share repurchase. You guys are continuing to -- it's your primary use of free cash flow. It's about half of what you're looking for in terms of cash flow before pension contributions this year, is what you're on track to do. And you're indicating that sales are going to face pressure next year. You're indicating that margins are still above their long-term rate. And so, when you evaluate the value in your stock to repurchase it, and I'd just like to maybe get an update on how you think about doing that, and how you plan to modulate your repurchase activity based on where your stock is?

Joe, it's Wes. I touched on this a little bit in my remarks, and I think it's important to be clear about how we think about this. As I said in my remarks, we are a long-cycle business and when we think about this, we're looking at longer-term value. We're a business that generates good cash flows. And as we assess how that's going, in terms of how the market is valuing our shares, we play that directly into our own model of long-term value creation. And our assessment is that share repurchases have, continue to be, a very, very good use of our cash. In fact, as I pointed out in my remarks and as we announced a few weeks ago, the board increased our remaining share repurchase authorization to $2 billion to make sure that we've got appropriate flexibility as we go forward. So we continue to look at share repurchase as a very good use of our cash. We clearly compare that to all the other alternative uses. And first and foremost, we always make sure that we're investing appropriately in our business to make sure that we are realizing that the opportunities that are represented by the strength of our portfolio. So that is always our primary thinking. We pay a lot of attention to our pension plan to make sure that it is in good funding condition, and we continue to do that, you saw that just here in the quarter we made an additional investment in our pension plan. And I think we've been in a good place on our dividend, we raised our dividend 10% this year. And when we mix all those things together, we like what we've been doing on share repurchase. We do think it is a very good use of our -- of the cash flows that we're generating. And like the opportunity that it presents for value creation in our company. Jim, was there any other perspective you'd like to add to that?

I would just reiterate your comments. We continue to have a balanced cash deployment strategy, investing in the business, managing our balance sheet and returning any excess cash to our shareholders. And traditionally, our dividend and share repurchases kind of have been in a 20% ratio for dividends, the balance in share repurchases, if you look back over a quite a bit, a long period of time, absent last year's large share repurchases after the spinoff of Shipbuilding. So -- you and I are in the same place.

Your next question comes from the line of Robert Stallard from RBC Bank.

I'm not sure if it was Jim or Wes, one of you mentioned about the shorter cycle areas of your business being a bit weak in the quarter. I was wondering if you could quantify maybe how much this might be down, and if you expect this to perhaps catch up at some point in the future? And also, if you're seeing increased competition in some of these short cycle areas?

Actually, book-to-bill ratios in the -- both on a quarter and a year-to-date basis are essentially around 1, or above 1, and I think in all of our businesses, except TS, we're at 0.97 on a year-to-date basis. So frankly, compared to last year, at this point in time, our book-to-bill is ahead of where we were.

Yes, I think one of the comments we made earlier was, as we look ahead into the CR environment, we do have a little bit more concern about some of the shorter cycle businesses given the constraints on new starts, if you will. And the CR has been implemented, so that sort of programmatic funding issue that we would have, that I think would manifest in the shorter cycle businesses. But as I pointed out, it can even impact our longer cycle businesses at the point that programs are transitioning in some way that would be impacted by the constraints of the continuing resolution.

And your next question is from the line of Howard Rubel from Jefferies. Howard A. Rubel - Jefferies & Company, Inc., Research Division: You have changed your focus on bidding, it seems, Wes, and maybe for a moment you might want to talk about that? And it looks like it's impacting, maybe your capital spending as well? In a sense, it's much more information technology. It may be less capital-intensive, and more intellectual-intensive?

Yes, our focus in our bidding has really been to make sure that we are pursuing the business base that will be high-quality business for the longer-term, for the company. And your point within our Information Systems business is right on. We have, over time, transitioned that business from a business that had a much greater fraction of, sort of lower commodity businesses to a much higher end, more intellectual capital, much more engineering-content business. That's a transition that's been underway just these last few years, and I think that's serving us well. It allows us to be very thoughtful about where we are, applying our resources, both our capital as well as our internal R&D and then proposal investments. And it's allowed us to make sure that the businesses that we pursue there really have some form of competitive, sustainable, competitive differentiation that generates value, so that we're not just turning them over, in a very quick mode as we would often see in the lower end commodity businesses. We've been making that transition in Technical Services as well. And over the last couple of years of really fundamentally transformed the portfolio of businesses within something ES, to go after the areas that require more intellectual capital, if you will, around modernization or some of the training solutions. Or even in the services side of that, the areas that require the broader applications or the capabilities we bring forward as a company. So that transition has been underway. It continues, still, a little bit, but I think we've come much of the distance we needed to go to make that transformation. I like where it positions us in the marketplace when it comes to the areas of highest priority for us to pursue, the things that we've talked about extensively. Cyber Security is a good example of that. The modernization work that we're doing in Technical Services is another good example of that. So it's been an important shift for us. Jim, anything you'd like to add?

I'd just observe, Howard, that the decline in CapEx that you're seeing, you might remember that we moved from California a year ago, bought a building? That's probably the biggest driver in the decline.

Year-over-year.

Year-to-year.

Your next question comes from the line of Cai Von Rumohr from Cowen & Company.

So just a question on pension. It looks like, with your good return, your underfunding will be down this year. And so that, I mean, by my numbers, if the discount rate went up by something like 50 to 75 bps we might actually be fully -- very fully funded. And so, taking that into account, I mean, do you think it's a good -- do you plan on making more pension contributions next year if we kind of close where we are today? And if so, how do you view the attractiveness or lack thereof of being more than fully funded?

I think, Cai, I think there's an advantage to have a very well-funded plan. There are some practical limits to that as well. And so, if and when we see a move-up in interest rates that reduces the liabilities back to, frankly, a move back to more historical levels, you're right, that will significantly improve the otherwise underfunded situation that we see today. Given where interest rates are, not only is a 25 basis point move in discount rate, which we talked about being potentially 100 basis points lower, and contributing to the pension expense of $75 million to $80 million, a 25 basis points move to $750 million of liability, pension liability. So you're right in observing that a move-up if and when we get that in terms of interest rates, will have a significant impact on funded situation of the plans. And we do, just like with a view of the company, this is a long-term decision that we made for providing employee benefits for our employees. We need to think about it in that way. I don't have significant cash contributions. I don't have any -- it might require contributions next year, at this point, look to be in the range of, let's call it $75 million. So not a significant use of cash. But as we've mentioned before, when you think about our cash deployment across the total opportunity set that we see, we clearly want to invest in the business and continue our, I think, leading portfolio. We want to manage the liability side of our balance sheet by both investing in the pension plans when it makes sense. We have debt that matures in only the next couple of years, and so we need to be thinking about what we want to do there, whether we replace it or pay it off when that matures. And then ultimately, we'll return excess cash to shareholders. Our view really hasn't changed, and we need to think about the pension plan on a long-term basis, and if and when we do see changes in interest rates moving up, it will improve the funded situation of the plans and likely will have a similar impact on our required funding.

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

I just wanted to drive down a little bit to get a sense from you on sequester and potential sensitivities around that. It would seem that shorter cycle businesses would be the ones that would get hurt the most, the quickest, given the fact that you've got annual renewals on a lot of contracts. And I was wondering if you could just talk a little bit about it, whether you have visibility on -- kind of what percent of your firm's overall business would -- you would characterize as short cycle at this point, and would be subject to kind of the winds of sequester and the short-cycle nature of pressure that we might see?

So Jason, let me -- and I appreciate the question because this is an area where, as I mentioned in my remarks, there's a lot of uncertainty, first and foremost about whether or not sequester would happen. But then, should it happen, how that would all roll out. As I think I mentioned in my opening remarks, we would not expect to see obligated funding hit in sequester. It is, I think, the case that it would take a little bit of time for the -- each of the departments and agencies to sort through what they would need to do contractually as a result of sequestration. Just the pure mechanics of that process would be daunting, if I were putting myself in the shoes of our customer community to really deal with such a thing. So it's hard to predict. And so I wouldn't want to get too far off ahead of trying to predict how that would actually work out. But I do think that the principle that you indicated is probably correct, that the services businesses would, if a sequester were to occur and persisted for some period of time, would probably be impacted sooner, in that they have the higher turn rate of their contracting base. And consequently, they burn through the obligated amounts and they encounter a new contract decision more quickly. And also, the customer, more likely, would be in a position where it would be having to deal with those types of contracts sooner than the longer cycle development and production contracts. Although ultimately, if that sequester persisted, all of those things could be under a lot of pressure. So it's a little bit hard for us to come up with some percentages on that. We've done a lot of modeling for different scenarios. I wouldn't want to go on record pinpointing a particular scenario that I thought was most likely, because as I said, this is going to be a very, very dynamic environment. Should we find ourselves in that position of a sequestration actually getting implemented. And it's going to be -- it would be very, very tough on our industry, but I would also say it will be very, very tough on our customer community and the challenges they would face and the decisions they would have to take, none of us envy anybody being in that kind of a position.

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

Just to expand on that a bit, Wes, and you say you've evaluated a number of scenarios. I wondered, just to kind of be specific about something that's hard to be specific about, is there a scenario where the impact to revenues, earnings and cash in 2013 is greater than the cut we'd expect to see to DoD outlays in the event of sequestration if, as you stated previously, obligated funds on contract are unaffected. I would think it would be difficult to see an impact of that sort of magnitude, but I wanted to see if you'd agree with that based on what your evaluations of the scenarios show today.

Yes, I think ultimately, just if you think about the mechanics, there is the factor around the obligated funding that we mentioned and yes, that's sort of a consistent way of thinking about it. But there's also the factor, the real factor of just the time it would take for a turn on contracts and the rest of it. So it probably would not be an overnight thing. It would take a little bit of time to manifest. But the real problem, I would say, is not just an in year issue, it's the long-term impact that would result from the set of actions that would be taken, that would fundamentally disrupt programs and the industrial base in a profound way. And that's why, from our perspective, we've said it a number of times, this would certainly impact sales and profits and cash flows, but we are all as concerned about what it would mean to the stability of the programs, the stability of the industrial base, the people in the industrial base. All of the other aspects that would ultimately translate into the ability to deliver the National Security Solutions. So just working the mechanics of it, and there's a lot of speculation about how mechanics would work. Long-term, I don't think I'd have to speculate when saying that the impacts would be profound, and very, very negative. And it would take us all a long time to turn back the cycle on that. Jim, I don’t know if you want add anything to just some -- part of, from the financial aspects of your thinking on it?

All of which I, again, would agree with, and Carter, if you think about the nature of the accounting method percentage of completion, that we and the industry use, essentially significant changes in your cost structure have a cumulative catch-up impact. And so yes, I could imagine a situation where a change in cost structure or revenues by X amount results in a different percentage change in margins for the company or the industry.

Your next question is from the line of Robert Spingarn from Crédit Suisse. Robert Spingarn - Crédit Suisse AG, Research Division: Apologies for this, but I want to continue in this direction, mainly because the irony is that while I think most of us think there might be a negotiated settlement here at some point. What's on record is the most onerous outcome. And maybe another way of approaching this, Wes, is how do we think about the dispersion in the outlay form of the FY '13 funds to Northrop, via the request over a chronological time period? So those funds the Northrop would receive, through the President's '13 request, if it were to go through, when do those outlay, in which fiscal years for Northrop? Is it 25% in '14, some number in '15 and '16? How do we think about that?

Yes, I won't go through the details of that. Obviously, it's been a part of our modeling. It varies, as you might imagine, by the different components of our businesses. Some of the monies that get appropriated, the actual outlays occur over several years, sometimes 2, sometimes 3, and some of the appropriated monies get burned up in the cycle. And you can imagine which of these businesses go with which. So there is a burn through of all of that. I think perhaps though, a bigger question is should our customer community find themselves in a situation where there's been either by overt decision or by failure of the Congress to actually change direction, basically a national conclusion that we're going to do something as draconian is implement a sequester. What actions will our customers have to stand back and do -- take from a broader strategic perspective? So there's kind of the mechanical part of outlays and obligations and all of that. But the real question at that point in time would be strategic. And what the longer-term implications would be of having to rethink a fundamentally much smaller budget within which to execute the national security mission, while the threats around the globe and the issues that our servicemen and women are called upon to execute continues to grow. To me, that's actually the bigger question here. It's not so much the in-year outlays and the implications of the mechanics in 2013, it's -- is where would that take us. And that's what I think we've -- we need to be mindful of.

[Operator Instructions] Our next question comes from the line of George Shapiro from Shapiro Research.

I just wanted to get an update. I don't think you've signed a Block 4 contract. You haven't signed Block 5, because Lockheed hasn't either. So how do you decide what to book for profit when you're making these deliveries under those contracts? And then just one other one I'd throw in. Where do you stand with Block 30? It doesn't look like anything's happening in terms of canceling that either.

Yes, actually George, we're negotiated on Block 4 and 5. We're negotiated, so we have a good basis for thinking about marginal rates on the contracts.

George, let me take on the question around Block 30. We continue to work closely with the Air Force on all the blocks of Global Hawk. The Air Force has continued to fly the Block 30s and we continue to support the activity, and we continue to work with them to make sure that all of the capabilities and operational activities that are needed to continue to make that asset valuable to the Air Force and more broadly, valuable to the co-coms, are being implemented. So the category that we continue to work very closely with the Air Force and the combatant commanders continue to ask for the asset to be utilized.

And your next question is a follow-up from the line of Howard Rubel from Jefferies. Howard A. Rubel - Jefferies & Company, Inc., Research Division: Jim or Wes, one of the other issues that's going to happen with the sequester, I guess, is the civilian workforce also would be cut very sharply. So that probably has as much of an impact on what would happen as anything else. Is that a fair way to think about it?

It's a very fair way and it's one of our very big concerns. Clearly, the civilian workforce and the DoD and the intelligence community represent an enormous foundation of knowledge and perspective in implementing the National Security Mission which we're all focused on executing. So the concept of a major reduction in that workforce would have very, very long-term implications. It's also a big concern beyond the DoD and something that I think is sometimes not illuminated adequately in this discussion around sequester, half of sequester goes to the DoD and sort of the national security side of the budget. The other half, fully, the other half goes to the other federal agencies. And so we're talking about impacting individuals who support Air Traffic Control, individuals who support all of the federal enforcement agencies and law enforcement agencies across the board. We're talking about potential impacts to food safety, to the activities that are underway to ensure that the nation is able to deal with diseases and epidemics. All those sorts of issues are on the table every bit as much. When you think about those other agencies, they don't have as large a procurement budget as does the national security side of the equation. In a sense, they don't have as large a procurement budget when they go to take this full 50% of the hit, it will translate into even greater impacts on the civilian employees of those agencies. So this a broader set of national issues and national concerns than just the defense community. And I think that deserves more illumination in the debate around the appropriateness of using this very blunt instrument of sequestration to address the fiscal challenges.

At this time, gentlemen, there are no other questions. I'd now like to turn the call back over to Mr. Steve Movius for your closing remarks.

Thank you, Frances. I think I'll turn the call over to Wes for his closing remarks.

Okay, thanks. Well, let me summarize quickly by saying again, we are very pleased with the performance of our businesses in the quarter and all the way through the year. Clearly, this continuing focus on performance, on cash deployment and on our portfolio is making an impact, is making a difference, and we are pleased with the outcomes that we're seeing this year. We certainly appreciate all of your interest in our company and thank you, again, for joining us on our third quarter call. Thanks, everyone.

And ladies and gentlemen, this concludes your presentation. You may now disconnect and have a good day.