Northrop Grumman Corporation (NOC) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Northrop Grumman Second Quarter 2013 Conference Call. My name is Carla, and I will be your operator for today. [Operator Instructions] I would now like to turn the conference over to your host for today, Mr. Steve Movius, Vice President, Investor Relations. Mr. Movius, please proceed.

Thanks, Carla, and welcome to Northrop Grumman's Second Quarter 2013 Conference Call. We have provided a PowerPoint presentation for the second quarter, which 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 Wes Bush, our Chairman, CEO and President; and Jim Palmer, our CFO. At this time, I'd like to turn the call over to Wes.

Thanks, Steve. Good afternoon, everyone, and thank you for joining us. We're very pleased with our second quarter results. They were achieved through the hard work and dedication of the entire Northrop Grumman team. As a company, we continue to focus on performance and effective cash deployment as major value drivers. In the second quarter, these efforts drove a 9% increase in earnings per share and strong cash from operations and free cash flow. This quarter's EPS growth reflects solid sales, higher segment operating income and lower weighted average shares outstanding. Second quarter sales were slightly higher than last year at $6.3 billion. Segment operating income increased 2%, and segment operating margin rate increased 20 basis points to 12.7%. Jim will provide more detail on the sales and margin rate trends, but the underlying drivers for this quarter's performance were higher sales and strong operating income and margin rates for our longer-cycle businesses: Aerospace Systems and Electronic Systems. These positive trends were partially offset by budget-related top line pressure in our shorter-cycle businesses: Information Systems and Technical Services. Even considering that top line pressure, as I look across our businesses, all in all, it was an outstanding operating performance from our team. As a result of our strong first half results, we are raising our sales guidance to approximately $24.3 billion, and we are raising EPS guidance to a range of $7.60 to $7.80. We continue to expect cash from operations of $2.1 billion to $2.4 billion and free cash flow of $1.7 billion to $2 billion. Guidance for both of these cash metrics is before discretionary pension contributions. We continue to be focused on deploying cash to create long-term value. In May, we raised the dividend 11%, our 10th consecutive annual dividend increase. Our board also authorized an additional…

Thanks, Wes, and good afternoon, ladies and gentlemen. My comments will focus on the second quarter and year-to-date results, as well as our 2013 guidance. As Wes said, this was another really good quarter. Our team continues to focus on performance and execution, and I personally want to add my appreciation for our team's continued focus and dedication. Turning to the sectors. Aerospace Systems sales increased more than $200 million or 9%. The single largest driver was the higher F-35 volume. We have delivered 11 LRIP 5 units this quarter compared with no LRIP 5 deliveries in the second quarter of 2012. You will recall that with LRIP 5, the F-35 program transitioned from cost-to-cost revenue recognition to units-of-delivery accounting. We delivered the first LRIP 5 units in the third quarter of last year. Unmanned revenue also continues to increase. While our Global Hawk program is maturing, we'll continue to ramp up another unmanned program such as NATO AGS and Fire Scout. Space revenues also increased due to higher volumes for AEHF and the James Webb Space Telescope programs. Those increases in space were partially offset by lower volume for our restricted space programs. AS operating margin increased 15% due to the higher sales and a $26 million increase in net favorable adjustments principally for space programs. Based on year-to-date results, we now expect AS 2013 sales of approximately $9.9 billion, with a margin rate of approximately 12%. Expected second half revenues are modestly lower due to fewer F-35 deliveries in the third and fourth quarter of this year. During the first half of the year, we delivered 21 F-35 units, and 18 units are planned for the second half of the year. Turning to Electronic Systems. Sales rose 2%. Higher revenue for international, tactical sensors and space programs more…

Thanks, Jim. [Operator Instructions] Carla, we're ready to begin the Q&A process.

[Operator Instructions] Our first question comes from the line of Doug Harned with Sanford Bernstein. Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division: I'm interested in electronics, where you again had a very impressive margin. And it just feels like after that 6 quarters in a row, that upward adjustments, because of good contract performance, it's just -- it's become almost routine. And when you look forward, and certainly, with your guidance, you're looking at lower margins for the rest of the year. But where are you in electronics and do how you think about performance improvement, cost reduction? I guess, I'm wondering, what inning are we in, in terms of being able to continue to improve the performance of these programs and deliver the kinds of margins that we've seen over the last several quarters?

Doug, I don't know that I would say we're in an inning. We're on a treadmill, and you got to continually run as fast as the treadmill is going. So we are really focused on that. We have had, frankly, the benefit from a much -- from a number of cost reduction actions we've taken on our backlog with, as well, a number of programs nearing completion, given the -- somewhat as a draw-down. So really good, hard work by the Electronic Systems folks. A lot of focus on being prudent about new contracts that we entered into, all of which are being realized at this point in time. At times, I get asked about our benchmarks for the businesses. I do think that this is a 13-, 14-plus type of business on a long-term basis, but we are realizing some benefits from hard actions that we've taken over the last couple of years.

Yes, Doug, this is Wes. I just -- I can't resist the opportunity just to say how much hard work is actually going on in Electronic Systems. There's a team that is just completely focused on performance and in all dimensions. And if you turn the clock back a number of years, you'll recall that we went through some pretty challenging times in Electronic Systems with, in particular, some international contracts that just simply did not perform very well. And to their credit, that team has top to bottom learned that set of lessons really dug in on contract performance, really dug in on cost management. And they're just doing an outstanding job. As Jim points out, clearly, we're getting the benefit of cost reductions, which flow into existing contracts. As we enter into new contracts, that certainly is an effect we won't see forever. But given your question, I just can't help but reflect on the journey that we've been on Electronic Systems and really complement the team for their extraordinary work. Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division: And just related, we're also seeing you deliver some really good aerospace margins. Are those more linked to specific programs such as F-35 maturing? What's driving that?

I would say, Doug, it's across the broad portfolio of products in aerospace.

Yes, I don't think F-35 is quite yet at a point of maturity where I would say that was a big driver for us. But if you look across the portfolio in aerospace, to Jim's point, particularly our manned programs, more legacy manned programs, and also our space program, have been doing very, very well. Unmanned is still earlier in the evolution of things moving into production, so they're probably not quite as far up that curve. But, again, really good performance, really good focus on cost management.

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

Jim, I wanted to ask you just a couple of quick questions on cash. You mentioned that there's some conservatism in your outlook here for 2013 in light of the furloughs. Can you give us a little bit of flavor of how much conservatism you've baked into that? What kind of cushion are you affording yourself? And then, Wes, you made a comment about the impacts of sequester around in 2014 with regard to revenues, profitability and cash flows, suggesting that they would be under some pressure. But I did want to just dive a little bit further into some of the moving things on cash, such as the discretionary contribution that you may or may not make next year and then cash recovery rates going up. I just want to make sure that your comments were excluding other dynamics that are going on with cash flows and that we won't necessarily see negative pressure overall on cash flows as we move into 2014.

I don't think we'll see negative pressures, Jason, on cash flows as we move into 2014. And I did not say conservative guidance. Those were your words.

Those are my words.

I was trying to emphasize that we always have substantial variation around cash receipts at the end of the year, in particular, frankly, as the industry manage its cash flows. And those last day cash receipts can easily vary by $200 million, $300 million, just based on what's happening in the overall industry. So on one hand, yes, there can be some variation around receipts, particularly in the last couple of days of the year. I don't know how to call what may or may not happen with the furloughing of government employees and whether it has any impact at all on cash receipts. So it just seemed premature at this point to bet on potentially higher cash receipts this year. As I said in our prepared comments, I do think this is only a matter of timing, maybe only a matter of timing of days. But I think there could be some rises [ph] of variability of cash receipts, and it could be greater this year simply because of the environment that we're in.

Yes, Jason, it's Wes. I just -- I would add. I think what we're all worried about in different ways is what the real impact will be of this furloughing of the civilian workforce. It was just the other day that Secretary Hagel had to basically say, "Look, if this keeps going, we may be furloughing in the next fiscal year as well." And if anybody thinks that, that has no impact, they are not thinking about it with a clear head. It's -- the civilian workforce is an integral component of how our defense and national security infrastructure operates. And it's not just paying the bills. It's manning centers, running intelligent centers, it's -- you name it. Our civilian workforce is extensively deployed throughout the national security framework. So I do think that there is some concern about what that means as we continue to experience this. These are really important people doing really important jobs and trying to predict exactly what the impact of these furloughs will be. It's a very difficult thing. So I think what you should take away from it is sort of an expression of a risk factor, if you will, that's out there in some respect. But as Jim said, ultimately, it's a matter of timing. It's not a matter of do we get paid or not, it's a matter of timing.

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

Wes and Jim, you're not afraid to do something that's unconventional. And so sort of 2 questions. One is, why, with what you've defined as sort of an uncertain environment, how you provided an element of certainty with respect to your share repurchase program?

Yes, Howard, let me say a few words about that. I'm sure Jim would be happy to join in as well. We've tried to be as clear as we can over these last few years about the way that we see the value creation opportunity in our company. And clearly, it all rests on performance and improving how we've been doing over the years in executing on our contracts and delivering on our commitments to our customers. Everything starts there. And I'm really proud of how our team has been working so hard over these last number of years to demonstrably improve our performance. We're not perfect, we still have a lot of work to do and we're pressing in every corner of the enterprise to go after that in terms of program execution and cost management, you name it. It's across the board. But the other thing that we've been, I think, pretty clear about is the importance of the way in which we pull our capital in creating value. And obviously, it takes a number of forms, whether we're making long-term investments in our pension plan, which ultimately do add value over the long term; whether it's increasing our dividend, and as I said in my prepared remarks, we've taken a very long and steady approach to year-after-year consecutive dividend increases; or whether it's been about share repurchase. And the interesting thing about share repurchases, obviously, we do that when a market condition is permitting in the market from quarter-to-quarter. And we often get the question of, "Gee, is this just something that you guys are doing right now? Or do you see this a continuing part of your strategy?" So as we thought about that question, and we took a hard look at our forecast on a go-forward basis, and as you might imagine, we looked at it in a variety of scenarios in terms of what might happen in the budget arena and programmatic decisions. But as we looked across that range of scenarios, we developed a great degree of, I wouldn't say comfort, you can never be comfortable in running a business, but yes, I would say we developed a great degree of confidence that the cash flows in our business supported taking the action that we took, which was to be clear about where we see ourselves going so that there wasn't this sort of constant question about what are we going to be doing. We indicated what our goal is, and we laid that out there. And we're off executing on it. So we found it just to be an important part of our continuing dialogue with our shareholders about the way we think about creating value, and that really is the essence of our thinking. Jim?

Obviously, Wes, I would echo exactly what you said. The only thing I would add -- remember, folks, that we announced our share repurchase, and then about a week later, we also announced that we would go on to the capital markets for our debt transaction. Having made those decisions, we thought it was important that we communicate both pieces of the decision. So all of the information was out there for the market in its entirety. So clearly focused on driving shareholder value, see a significant opportunity there, but also try to be very transparent with all of the market on what our intentions were.

I -- no, I understand that. And it makes -- it's just you have been so conservative to be -- to step out like this clearly underscores your confidence or your, I guess, your confidence in the outlook. And then related to that, I'm sure this wasn't lost on U.S., is that Cisco yesterday bought Sourcefire for something like 7x revenues. And there's a whole host of your cyber business and other things that clearly operate in some of those same markets. How do you react to something like that?

Clearly, we watched very carefully what's going on in that whole market space, because as you point out, Howard, we have some extraordinary capabilities in addressing elements of that market. One difference, obviously, is we continue to focus on the very high end of the cyber arena to help our nation address the big challenges that we're facing in that regard. We've not put a huge energy into sort of the commercial side of that. And so there is some difference in sort of market perspective and how different companies look at those things. But I would tell you that just if I were standing in Cisco's shoes, I can understand what they're doing. This was an important area. I think it just continues to grow in challenge and complexity. And as we've talked about a little bit on our calls in the past, there's several different aspects of the flavors of cyber, if you will, from -- ranging from the sort of the purer traditional perspectives on cyber to, increasingly, the view on what actually needs to get embedded in the hardware, if you will, the capabilities. And from our perspective, that might be platforms or sensors, but it might also be networking equipment and other things. So I think it's just a representative example of how this issue is becoming more and more pervasive...

Growing importance.

It is. It's an absolutely critically important perspective on its growing importance. And I think we're going to continue to see it become a part of just about every aspect of the technology landscape that we all rely upon to make our world work the way it works today. So from my perspective, this was just another indication of the importance of this arena.

Our next question comes from the line of Joseph Nadol with JPMorgan. Joseph B. Nadol - JP Morgan Chase & Co, Research Division: Wes or Jim, my comment -- or my question is on backlog. So backlog is down. I'm focused on funded, and I understand the issue in IS in the unfunded area. But just focusing on funded, you're down about 10% year-to-date and sort of in equal amounts in Q1 and Q2. Some other companies' backlog has tended to be a little bit more seasonal than yours. Yours doesn't seem to be as much so. But obviously, market conditions are tough. So wondering if you could comment on where specifically you think you might end up the year on funded backlog. And then maybe, Wes, if you could just go through each of the businesses quickly, particularly AS and ES, and comment on what the major moving parts might be.

No, I would just -- I think I addressed this a little bit on our last quarterly call, kind of trying to call it for the end of the year on backlog. I wouldn't do it at this point. There are so many variables out there that are shaping not only the decision space but what I would call the behavior space of our customer community. Many of our customers are just very, very concerned about decisions they make this year, having to flow through into the next few years, and they're kind of holding back, waiting to see what may or may not happen. And I understand that behavior. I understand that difficulty in making decisions when, in fact, they're getting asked to turn out a whole new idea on budget every few weeks. They're getting put through an enormous number of what-if cycles. I actually admire how they're handling this in light of all of the challenges that they're facing. So where this all comes out and how that will translate into specific contracting behaviors over the course of this year, it's really hard to tell. So I wouldn't want to get in front of our headlights on that and try and call it. But what I would say is that it has put an emphasis within our company on working with our customers to really help understand where things need to get put on contract to actually reduce cost, because as we all know, the longer things take, oftentimes, that means there is additional cost induced by that delay in getting things on contract. So it's an intense source of effort across our enterprise to work with our customers to try and balance out the challenge that they are dealing with, as well as what it takes…

I do understand that. Maybe just if you could give -- if you characterize one part of this, which is the uncertainty that you have and the reason you don't want to answer the question yet. Is it more the competitive items that are out there? Or is it the timing of the follow-on items, whether they flip out of the year or not?

It's both. Even the follow-on things are being slowed down just because the system is operating more slowly. So it is both aspects of that. And on the follow-on things, obviously, in general, it's usually not a matter of whether it's going to happen. It's usually a matter of when. But as the customers are going through their internal debates on priorities, it is challenging for them to go on and get out there with those decisions.

Our next question comes from the line of William Loomis with Stifel, Nicolaus. William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division: Looking at Information Systems, so looking at the backlog write-down, just tell me if I'm looking at this right, if I had it back to second quarter backlog, it says that you had roughly a one-to-one book-to-bill in Information Systems in the second quarter. Am I looking at that right?

Will, I don't recall the numbers, but I think it was around 90%. William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division: Okay. So, I mean, that's still a very good number given awards...

A lot of gross awards, yes.

Gross awards, yes. William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division: Yes. That's a good number considering that award activity has been relatively light. What does that say -- what prompted you to write down the backlog and then you obviously had good awards in the second quarter?

We try to, on an ongoing basis, look at our backlog. And as you might imagine, the most variability is in the shorter-cycle business, particularly in those areas that have ID/IQ contracts, which, by their very nature, provide some level of flexibility or variability on the actual amount of revenue that you recognize from each of those individual TASC orders. Just to reiterate, ID/IQ means indefinite delivery, indefinite order. So there's variability associated with it. So yes, in this environment, we try to look at any kind of activity that may have potential for an adjustment, and we make those as soon as we know about them. William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division: And to be clear, you are putting feeling in that figure before? You were just looking at awarded TASC orders, and that's what you wrote down?

Correct. Correct. William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And then any -- and you had good awards in the second quarter there. What do you see in the second half? I mean, typically, we see in the September quarter on the short cycle side pretty robust period. Is there anything that you've seen to date that you think differently about that?

I think we all have been speculating about what might happen here at the last quarter of the government fiscal year, but it would be simply that, speculation. And so I think I'll just leave it as we have that issue every year. Will it be different this year? It's really hard to say whether or not it will be any different. William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And then separately, just -- if you can just review on Global Hawk specifically, just the different variants where we stand now, not in terms of where Congress is but where you are in terms of production and revenue and kind of visibility based on what's funded in hand now.

So on Global Hawk, the kind of remaining issue out there is the Lot 11 [ph], the Block 30, and we're in active discussions with the Air Force on that. William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division: But you're still completing prior orders?

Yes.

Yes, absolutely. Yes.

Yes, not finished.

Yes. William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And that will continue -- you have visibility on that through '14 completing those orders?

There's a staging of what those orders look like, some this year, some over next year, but there's really been no change in that.

Our next question comes from the line of Cai Von Rumohr with Cowen and Company.

So the one pattern I think we're seeing in the industry is that short-cycle businesses, the revenues are under more pressure, generally. Margins are under more pressure, and the weapon systems seem to be basically knocking it out of the park. As those longer-cycle businesses come under more pressure, should we expect greater pressure on your margins? So to the question of the margins just continue to get better and better beyond everyone's expectations, what's it going to take to continue that? If we do see sequester impact on the top line, will that start to throttle those margins back? Is that the key variable?

Cai, as I think about this, the nature of our business is both some longer-cycle and shorter-cycle businesses. In the longer-cycle businesses, as Wes alluded to earlier, we have the ability to work off of our backlog. And to the extent that we don't have any unexpected surprises, so program cancellations or terminations, the nature of the contracting process normally provides you with some visibility on where the customer intends to go in the future. My point simply is, in those types of businesses, you have a longer period of time to react to what may occur. We also made a comment -- had made a comment for a number of quarters now that we've been conscious about trying to take cost reduction actions in advance of where we thought the market, our customer was going. And so we've realized that benefit on our existing contract backlog. As we negotiate new contracts, they will be negotiated based on our current cost structure, and it will be harder to maintain the margins that we are realizing today out of the existing backlog. That's the natural ebb and flow of the business.

Cai, I would also offer one other perspective. It's perhaps a little bit tangential, but I think it's important in a broader view. The nation took a procurement holiday for strategic systems in the 1990s. Over the last decade, we've been largely focused on dealing with the issues surrounding terrorism around the globe and have really not still been able to recapitalize our platform infrastructure in any meaningful way. We have an aging platform capability as a country. And we are going to have to replace that. Things just don't last forever. And so if there is any forcing function to continue a support for, I think, kind of the class of weapons capabilities that you were mentioning, I think that's actually an important strategic one. Now what will the sequester do to that? And what decisions might the department be forced to make? Hard to tell. But that is a real force that's out there right there today. And I think it needs to be understood as a driving factor in the decision space here.

But essentially, what you're referring to is whether or not we're going to have more production programs as the mix, more production programs than development programs?

Exactly right. Exactly right.

[indiscernible] point in time.

Yes.

Our next question comes from the line of Carter Copeland with Barclays.

Wes, I wanted to ask, not really ask, but just get your perspective on this EAC question and margin issue a different way and sort of apply it to capital deployment. I wonder what the observation of the improvements you've seen in performance over the last couple of years now tells you about what the performance must have been 3 to 5 years ago, which is sort of the last time these stocks were at these levels. And when you think about in the intrinsic value of these companies, Wes, we get several of both your stock, the stocks of your peers at levels that are now once again on all-time highs. How do you think about the intrinsic value of the firm and that of your peers now that you've improved the performance? I mean, obviously, the profit policy hasn't changed. The budget's lower. So does it sort of make the case that, intrinsically, the companies were much poorer at their old prior highs and now they're much better and it still makes a lot of sense to buy back stock here? I'm just interested in your perspective.

You have to look at it, I think, from a number of different angles. Clearly, the marketplace makes some decisions around EBITDA multiples. And if you kind of look at that historically, I think that's illuminating. And I know a number of folks on the call that looked at EBITDA versus EBITDAP as better predictors over time. But if you look at that historically, you'd say, "Well, we're probably actually in a reasonable place with the value opportunity that's still in front of us." So when we think about share repurchases, and I've said this a number of times on our calls. We think about it over the long term, the long-term value of the enterprise, how we see ourselves generating cash, how we see ourselves with the ability to deploy that cash both internally to create longer-term value and directly to the benefit of our shareholders. And all of those things go into our thinking around the core economics of doing share repurchase. Obviously, we've concluded it makes sense. We've been pretty vocal about that. And it actually stated a goal for where we would drive our share repurchase activities here through the -- over the next couple of years. So everybody takes a little bit of a different view on this, but I think you can be informed by looking at it from a couple of different angles. But fundamentally, it comes back to how you see the long-term performance and portfolio of the enterprise and how that aligns with the nation's needs and the needs of our allies. And that's really the core of our thinking.

And do you think it's correct to say that it implies that the understanding of what performance was possible 5 years ago, let's say, is very different today than what it was then?

I'd hate to try and Monday morning quarterback what happened a number of years ago in the marketplace. I know there were a lot of different factors in play then, but all I can do is sort of snapshot my view of where we are and what I think our future looks like. And that's really the framework for decision-making.

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

Can we focus a bit on the specific of the F-35? And obviously, you moved into LRIP 5 here. It's adding nicely, too, on the top line. It presumably is not dilutive to the margin either. So I was hoping you could comment. 5, 6 and 7, I think, are roughly the same quantities. It would imply that you're not going to have much of a revenue growth rate, but I'm curious of the margin potential over the next several LRIPs. Is there a lot of margin potential, number one? And the second piece of it is, how much of those contracts are fully definitized at this point?

So Myles, let me say a few words, and then -- and Jim certainly can add in. And you're right, the LRIPs are pretty flat in terms of the number of units being built. So I think over the next near-term period of time, we're going to see F-35 continue to kind of be where it is. And we're still in LRIP land, obviously. We're not into whole rate production and the multi-year productions. And so inherently, the margin rates during development and even LRIP are not what the potential margin rates could be later on as we move forward into the program. I hope we're going to be able to start up that curve in a more meaningful way, but we do have to get all the things done that are necessary at this stage of the program to be able to achieve that. I think we're making really good progress on this program. And I would give credit to Lockheed Martin. I think they're doing a great job as the prime on this. I think we have a really good team with Lockheed and Northrop and BAE Systems and Pratt & Whitney all together on this. We are working together on it in a very, I would say, highly aligned, team-oriented way with our customer community. So I am of a mind that this program is making really good progress, and I'm proud to be on this team. I think it's got some really good future in front of it. Now, how does it get interfered with potentially by all of this budget challenge that's in front of us? I don't know. That's a hard one to call. But the job we have in the industry is to continue to drive to make it more affordable and to demonstrate the extraordinary capabilities of this aircraft and that alignment with what not only the U.S. needs but all of our partner nations need. And I see an increasing alignment around that on this program. So number one, really important, but as you point out, these LRIPs are sort of going to hold us flat for a while until we can get up a more substantial production curve. And over time, I would hope to see the margins come with that.

Just to add, Myles, based on the planned quantities that we see ahead of us for all the LRIPs, we really don't see F-35 revenues ramping until about 2016. And as Wes just said, the team's -- the entire team's focus is really on driving affordability, how do we get unit cost down. We all recognize that that is going to be an important factor in being able to realize the quantities that are ahead of us. So a lot of focus on how to drive affordability, reduce cost, improve performance, deliver on time.

And the margin potentially across the 3 LRIPs, is it roughly the same? Or is there pressure to the downside as you move out at flat quantities and customer wanting lower prices?

I wouldn't -- I don't know that it's worthwhile commenting on margins by individual programs at this point in time. We're really working hard to drive...

Yes, this is really about -- this is about affordability.

Our next question comes from the line of Noah Poponak with Goldman Sachs.

I wanted to go back to the share repurchase conversation, a little bit more just on the mechanics of that in the near and medium term. So when you announced it, you had said you could issue debt to buy back stock at a faster rate. You've then added some debt not long after that. Was that what you're referring to? Or could we see more balance sheet capitalization changes? And then given you did that, should we look for a faster pace of buyback in the back half of the year? Should we specifically be looking for ASRs? Anything you can give to help us there would be great.

We make all of those decisions essentially every quarter. And looking at the pace of our share repurchase program, we did, as you pointed out, go to the capital markets and raised some additional debt and net of $2 billion to increase our overall financial flexibility. We could use some of that cash for accelerating share repurchases, but essentially, our message was around the -- our goal to reduce our share count by about 60 million shares or 25% by the end of 2015. Make it real simple. That's 11 quarters, kind of like 5.5 million shares per quarter on a pro rata basis. And we can do that on a pro rata basis. We can do it on an accelerated basis. We have the flexibility, the financial resources to think about what makes the most sense and each time that we address a new program. Could we do ASRs? Yes, it's a possibility. It's something that we look at on a regular basis to see whether or not we make -- whether it makes sense. No commitment to any kind of formal transaction at this point in time.

And is it pro rata that's in the updated 2013 earnings guidance?

The guidance for 2013 was based on weighted average share reduction of 7%. We still expect to get a 7% reduction. On a weighted average basis, it's going to be really hard, given that we're halfway through the year to having meaningful change in that average for the year. So I still feel really good about the overall 7% reduction for the year. Our guidance anticipates that.

Our next question comes from the line of Robert Spingarn with Crédit Suisse. Robert Spingarn - Crédit Suisse AG, Research Division: I just wanted to go back to IS, a follow-on to Bill's question earlier, and the discussion about short cycle. Wes, in the past, you've characterized your IS business as being a little less commoditized perhaps than others, but it seems like the pressure is still pretty strong there. And particularly on the margins, Jim, you did mention fewer EACs and a couple of other things, but is this a trend that continues? I know you've said the margins reverse a bit here in the second half, but we really -- we haven't bottomed here in the short-cycle pressure. So how should we think about this going forward and into next year?

So Rob, let me make a little bit of a distinction because I think sometimes this gets lost in the communication. When we talk about commoditized, we talk about the way the market operates. So if there are many players, and it is essentially a race to the $0.05 or to the $0.01 contract-by-contract, that's commoditized. That means that you're really having difficulty competing on the basis of technical differentiation or knowledge or intellectual property. That's the framework we mean with commoditized. Short cycle, some commoditized businesses, most commoditized businesses probably are short cycle, but those 2 are not fully overlapping circles in the Venn diagram. When we think about short-cycle businesses, we mean those business which inherently have shorter-term contracts. Those may or may not be commoditized. In fact, many of our short-cycle businesses are businesses that take extraordinary engineering skills to perform, rely on our ability to provide intellectual property and an experience base that simply is not commoditized. But yet, they are still short cycle by nature of the way that customer buys. So I just would want to make sure that those 2 don't get confused in the dialogue. And we have, in fact, moved away and have been doing this now for a number of years from those businesses that we see as more commoditized, because we don't see that that's necessarily a place where it makes sense for us to invest a lot of our time and energy and resources. We have focused in IS and more across the board in those areas where the differentiation occurs on the basis of the intellectual capital that can be brought to whatever the particular competition might be, which inherently shrinks the field of competitors. And, in fact, if you look at that smaller field that we tend to go after more on the system side of this, I think you'll see in the marketplace that has all of these earnings releases have been coming out, they were all kind of having the same experience, that because a lot of that type of capability is purchased on these ID/IQ contracts, the customer has a lot of flexibility to throttle up or throttle down. And given the budget uncertainties, we're seeing more throttle down than throttle up in that space right now. So from a strategic perspective, we're on the track that we've talked about. We continue to focus our portfolio in the areas where we see our ability to be differentiated as creating longer-term value. But we're going through a budget environment that is, for these shorter-cycle components of that, causing this type of variation. Robert Spingarn - Crédit Suisse AG, Research Division: So Wes, are you saying that what we're seeing here in IS is not pricing-related? Because it's not -- this is about demand in volume and periods of softness.

Yes, I would characterize it as a market condition, not so much a competitiveness perspective, because the work that we've been doing in IS, I'm convinced, has us in a very competitive position. So it's more about what we're seeing in the market.

Rob, a couple of other perspectives on this. In my prepared comments, I talked about a $27 million adjustment or reduction in favorable adjustments. I also mentioned commercial contract revenue timing, a smaller impact, as well as the ramp-down of in-theater programs. Frankly, a big part of that $27 million reduction in favorable adjustments is a result of some adjustments in last year's second quarter, resulting from immediate needs on production-type products in-theater.

Right. There was...

I don't anticipate that those would always be there. Margins of almost 11% last year in IS in the second quarter, well above what we consider to be the benchmark for this type of business. Performance on a year-to-date basis in IS basically in line with, again, what we see as the benchmark for this business. So, frankly, I think you're seeing an anomaly more in last year's favorable performance than an unfavorable performance in this year. Robert Spingarn - Crédit Suisse AG, Research Division: But even so, you're talking about a lower margin in the second half than you addressed in the first half.

No. We're basically saying consistent with the 6 months margin in the second half of the year with the first half.

Which is consistent with the benchmark that we see for the business.

Yes. Robert Spingarn - Crédit Suisse AG, Research Division: Okay. And by the way, Jim, on that, do you see EACs -- are they -- could they continue to trend down as this is a business where just maybe the maturity of the contract base suggests that's going to be a lower portion of your profit going forward?

Frankly, if we're again still talking about IS, the IS, being a short-cycle business, the amount of the adjustments that they traditionally have is relatively small. Robert Spingarn - Crédit Suisse AG, Research Division: So this really is an anomaly? Or last quarter was an anomaly?

Last year's second quarter was much more.

I think so. Robert Spingarn - Crédit Suisse AG, Research Division: Okay. And then just while we're on the topic, the other businesses, which are more long cycle and have more EACs, Wes or Jim, are we at a point -- given that the new starts are fewer and farther between and programs are closing out, just how do you see those trending EACs?

Our objective is to win every new start we can that makes sense that's going to be profitable. So if we're successful in that regard, that inherently will hold the margin rates down a little bit. So just in terms of our desires for our business, we like winning.

Well, this concludes the Q&A session. We ran over a little bit because we couldn't quite get to everybody. So I apologize to those that are still in the queue. I will be at my office to answer additional questions. At this point in time, I would like to turn the call over to Wes for final comments.

I'll just say thank you again, everyone, for your continuing interest in our company. I'd also like to say thank you to the team here at Northrop Grumman for continuing to work so hard on performance and delivering value to our shareholders. I'd also like to say thank you to our customer community. They are dealing with an extraordinarily difficult set of challenges. I really admire and respect how they are dealing with it. It is not a situation that any of us should be putting them in as they work so hard to defend our nation. So we ought to all keep that in mind as we go forward and hopefully find some resolution to these challenges. Thank you, everyone.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. Have a great day.