Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Northrop Grumman Corp. (NYSE:NOC)

Advisory Services Conference Call

November 09, 2009 11:30 a.m. ET

Executives

Paul Gregory - VP of IR

Jim Palmer - CFO

Analysts

Myles Walton - Oppenheimer & Company

Howard Rubel - Jefferies

Sam Pearlstein - Wells Fargo Securities

Carter Copeland - Barclays Capital

Cai von Rumohr - Cowen & Company

Finbar Sheehy - Sanford Bernstein

Joe Nadol - JPMorgan

Presentation

Operator

Good day ladies and gentlemen and welcome to the Advisory Services Agreement conference call. My name is Keisha and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct the question-and-answer session towards the end of this conference. (Operator Instructions). I would now like to turn the call over to your host for today, Mr. Paul Gregory, Vice President of Investor Relations. Please proceed.

Paul Gregory

Great. Thank you Keisha. Good morning and welcome to Northrop Grumman's conference call to discuss our announcement regarding the sale of our Advisory Services business, TASC. The primary purpose of today's call is to answer your questions regarding the announcement in a regulation FD compliant environment. We ask that you limit your questions to the announcement. In addition, our discussions today will be limited to the expected impact of the transaction on Northrop Grumman and we will not be discussing any of the specific contractual details of the transaction as such details are confidential.

Before we begin with some brief formal comments, 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 including timing of the close of the transaction and other factors that are detailed in today's press release and our SEC filings and may cause actual company results to differ materially.

On today's call is our Chief Financial Officer, Jim Palmer. At this time, I would like to turn the call over to Jim. Jim?

Jim Palmer

Thanks, Paul and good morning, ladies and gentlemen. As you know, over the weekend we announced the signing of a definitive agreement to sell our advisory services business, primarily comprising TASC to a partnership of General Atlantic, and KKR for $1.65 billion in cash. As Paul said, the primary purpose of our call today is to answer your questions regarding the transaction.

However, before we begin the Q&A, I'd like to provide a little background on how we came to this decision and why we believe this transaction is in the best interest of our national security, customers as well as TASC, its employees and Northrop Grumman's shareholders.

Most of you are aware of the government's efforts to reduce organizational conflicts of interest. This effort comminuted in the last May's passage of the Weapon Systems Reform Act of 2009. This act established new guidelines to eliminate conflicts of interest for companies that both advice the government on defense and intelligence technology systems and then for contracts to build them as well.

Based on our knowledge of customer's likely direction, we have been preparing for the possibility of a sale for over a year. That is why we chose to combine all of our advisory services business into one entity, when we created the Information Systems sector at the beginning of the year.

When the Weapon Systems Reform Act was passed, we determined it was important that we respond quickly and proactively to address the new OCI policies and to optimize the value of TASC for our customers, its employees and for Northrop Grumman's shareholders. TASC has a 43 year history of Advisory Services to our nation's National Security Communities.

It's not an overstatement to describe TASC as a unique national asset. In order to ensure that our National Security Communities would continue to benefit from its unique core systems engineering and analytical capabilities unencumbered by the implementation of the new policies it needed to become an independent organization separate from Northrop Grumman's other businesses. We also determined that the separation needed to happen expeditiously, in order to prevent any potential degradation of this valuable business.

When this transaction closes, Northrop Grumman will be fully aligned with the new OCI policy.

Once it was clear that we needed to separate the business we then determined that the way to move TASC into independent status was through a sale. We considered a number of alternatives but a clean sale was clearly the best option based on economic value, transaction certainty and timing. It could be accomplished quickly and would be beneficial to our shareholders.

As I said, TASC has been a very important and valuable asset for Northrop Grumman. Over the years, it's generated healthy, organic sales growth along with a good margin rate. In 2009, sales are expected to total about $1.6 billion with an accompanying operating rate in the low 9% range. Under current accounting rules, the 2009 operating results for Advisory Services will be reclassified as discontinued operations, and as we said in the press release, the company expects that the transaction will be neutral to 2009 bottom-line net income and diluted earnings per share.

I should point out though that there is a proposed accounting rule change for the treatment of discontinued operations that if adopted before we report our 2009 results would require the Advisory Services business to continue to be reported as a continuing operation as part of Information Systems. The buyers as you know are experienced investors who have a proven track record. We believe they fully understand the importance of TASC, its customer's missions, the sophistication of its employees and their unique expertise. The current management team of TASC will continue to lead the organization in partnership with the buyers.

Regarding the specifics of the transaction, it's an all cash sale for $1.65 billion; we expect the sale to close by year end upon completion of regulatory approvals and after tax as we expect to generate cash proceeds of about $1.1 billion.

The taxes that will be paid on this transaction reflect the low tax basis in the business. And as I said we expect the impact to 2000 earnings to be neutral. Our board has also approved a $1.1 billion increase in our share repurchase authorization. And we expect to be able to repurchase enough shares from the net proceeds to offset the loss of earnings from this business.

So, thereby essentially being neutral to earnings per share on a go-forward basis. On a go-forward basis, our Information Systems segment will consist of three major businesses, defense, intelligence and civil systems. All three of these businesses have considerable scale with defense and intelligence representing about 75% of the Information Systems revenues on a go-forward basis.

Information Systems will continue be a market leader with core domain expertise and C4ISR cyber security and Federal IT services.

So, in summary the outcome of this process aligns Northrop Grumman with our customers, new OCI requirements, it allows our customers to continue to benefit from TASC extraordinary capabilities and it returns value to our customers.

So, Paul I think with that brief introduction, we are ready for a Q&A.

Paul Gregory

Terrific, thanks Jim. Keisha if you want to go ahead and queue up the Q&A, we are ready.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Myles Walton with Oppenheimer & Company. Please proceed.

Myles Walton - Oppenheimer & Company

Firstly, a question on the share repurchase authorization. I am curious if there was discussion to authorize more than the proceeds of the transaction. I guess I would have thought even without the transaction, you would have need to do an authorization going into next year?

Jim Palmer

We normally have a conversation with our board around our planning process. Our planning process as you know is in process at this point. And so we were not prepared to have that further conversation around the bigger authorization at this in time. It doesn't mean we won't, its just timing associated with the sale.

Myles Walton - Oppenheimer & Company

From an investment standpoint, should we look at the $1.1 billion as incremental to what you would have otherwise been planning for repurchase?

Jim Palmer

Clearly, it reflects the use of the proceeds from the transaction.

Myles Walton - Oppenheimer & Company

In terms of the [DAR] contribution what was [DAR] for TASC or the Advisory Services in '08?

Jim Palmer

That business is not a very capital intensive business so there wasn't much [DAR] associated with the business.

Myles Walton - Oppenheimer & Company

And regarding you ran through intangibles?

Jim Palmer

We had already ramped through the intangibles so the [DAR] if you will the depreciation is only related to a small amount of fixed assets.

Operator

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

Howard Rubel - Jefferies

Is there anything you need to do in terms of looking at overhead now that this business won't absorb some of the overheads that you might have?

Jim Palmer

Well we have been, as I said in my comments, preparing for this possibility for over a year. We did as you know combined the information technology business and Mission System business into information services at the beginning of the year. As part of that process, we took out a significant amount of overhead to begin with.

We will probably still have to continue to refine our overhead structure as we go forward but we got a good leg up on that what we need to do to begin with the just correction of the information services business at the beginning of the year.

Howard Rubel - Jefferies

Are there any regulatory issues other than Antitrust that domestically that we should be aware off?

Jim Palmer

No, it's basically the normal Antitrust requirements.

Howard Rubel - Jefferies

Thank you.

Operator

Your next question comes from the line of Sam Pearlstein with Wells Fargo Securities. Please proceed.

Sam Pearlstein - Wells Fargo Securities

A question on the after tax proceeds of $1.1, it just seems like that's an awful high amount of tax, even if you had zero cost basis for it. And so you I would have thought you'd have been paying a capital gains rate, is there anything you can shed some light on.

Jim Palmer

Yeah, it has got a capital gains rate; it is an ordinary income rate. Obviously, here is a basis in the business, it is not large as we said in the comments but it is a probably the difference in your calculations versus the actual is ordinary income versus capital gains.

Sam Pearlstein - Wells Fargo Securities

And then as a follow-up when you say that it's going to be relatively neutral to earnings. Are you thinking about buying back in the open market over some period of time or some sort of one-time transaction that can reduce the share count?

Jim Palmer

As you know, we've been an active market participant over the last couple of years, we are comfortable with open market transactions and what we, I am not going to pre-announce that we are changing, how we are approaching the market. But as I said we've been, open market purchases have been a mechanism that we are very comfortable with. So we will probably start that way and we will see whether or not we want to make a change as we go through time.

Sam Pearlstein - Wells Fargo Securities

Okay. Thank you.

Operator

Your next question comes from the line of Joseph Campbell with Barclays Capital. Please proceed.

Carter Copeland - Barclays Capital

Actually it's Carter Copland. I want to hit the kind of obvious question here about the discrepancy between and the public market value we observed for Northrop Grumman and the private value of a piece of Northrop Grumman demonstrated by this transaction and I don't want to make specific value judgments about what other parts of Northrop might be worse but one could argue that there are certainly pieces that are worst more than TASC. So, the heart of the issue here, what stops you from keeping going on this path?

Jim Palmer

Well, as we have talked with you and investors and others clearly that the market multiples for the industry Northrop is included are not reflective of what we have seen over a long period of history. They are very low in comparison to that market multiples. We normally get questions about whether seller's expectations of businesses have declined given those market multiples and as we have replied a number of times when you all have asked about us and trying to buy businesses that we haven't necessarily found that many of those sellers expectations around their businesses have declined correspondingly to the market multiples. And I think we are dealing with a situation where the overall market has a view of companies and uncertainty or the viewed uncertainty around the defense budget, that's affected overall market multiples and when you look at an individual business and its backlog and trend, you get different views.

Carter Copeland - Barclays Capital

Just a sort of keep going on as if I mean what's demonstrated here is that the market at least in this specific case is wrong. So, if it were the case that the markets were to not readjust the expectations and change the evaluations accordingly would you consider doing another transaction?

Jim Palmer

Carter as you know we have had a history of looking at our businesses overtime we have sold other business as we have looked in the past AOS transaction for example last year. And so as I said part of our planning process we normally go through and looked at each of our business and their opportunities in future and we make decisions about each of those businesses as we go through time. So I'll leave it at that.

Operator

Your next question comes from the Cai von Rumohr with Cowen & Company. Please proceed.

Cai von Rumohr - Cowen & Company

So Jim you mentioned that you put all your Advisory Services in this business; also you presumably get rid of all of your OCI issues. But given that you are retaining Intel may be give us the breakdown of what you are selling I mean you are selling TASC and what else is in there and how big of this one [fix] is TASC?

Jim Palmer

Well Cai we essentially at the beginning of the year when we combined information technology and mission systems, did a careful review of all of our contracts to see which of those might have at OCI implication. And obviously as we went through time and we got the final regulations, our views of that were adjusted and refined. So at this point in time we have what we believe are all of the OCI-related contracts into this new Advisory Services business which many of you call TASC. But it's not just TASC; it is anything that was associated with the OCI business.

And again TASC is the brand name that's associated with the business. It is a legal entity that is part of the Advisory Services, but it is not all of that and at the same time, there were a few contracts in the old TASC legal entity that did not have the OCI conflicts and were moved into other parts of the business.

Cai von Rumohr - Cowen & Company

Okay.

Jim Palmer

Realistically it's the Advisory Services Business that fits the OCI requirements today.

Cai von Rumohr - Cowen & Company

Got it. But just so we have a sense of what you're selling, approximately what would the breakdown be between Intel festival and other things approximately.

Jim Palmer

Today, all the OCI related businesses is in the Advisory Services.

Cai von Rumohr - Cowen & Company

No, I am saying of Advisory Services, what's the breakdown of it? How much of it is Intel, how much of it is festival?

Jim Palmer

I don't have that breakdown Cai.

Cai von Rumohr - Cowen & Company

And the last question is, of the businesses the Advisory Services, what was their upcoming recompete risk. Approximately, what percent of their revenues over the next 12 to 15 months are out for recompete?

Jim Palmer

I think we had a normal amount of recompetes essentially ahead of us.

Operator

Your next question comes from the line of Peter Skibitski with Credit Suisse. Please proceed.

Peter Skibitski - Credit Suisse

I was just wondering, when I hear of TASC I think cyber security to some degree and I am just wondering how much of your capabilities from cyber are going to migrate out of the company post deal.

Jim Palmer

I don't think it's very much at all.

Peter Skibitski - Credit Suisse

Okay, so your cyber is not going to reside. You don't lose much and it's all going to reside in your Intel unit now?

Jim Palmer

Much of our cyber is in the Intel unit but it's not all of it, no.

Paul Gregory

And just the term cyber security in and of itself is a pretty broad categorization. So, I think we will retain a significant amount of cyber security work, hopefully.

Peter Skibitski - Credit Suisse

And at the time, a lot of your peers talk about waiting for the guidance, the formal guidance to come down after February. But, within the government, NRO is said to be the brash that's really been ahead of the rest of the government. So, was this kind of NRO driven thing?

Jim Palmer

Hey those really are our decisions based on our perspective on where we thought this was ultimately going to go. As I have said, we have been working on this for about a year and based on the regulations as well as our knowledge of where our customers are likely to go, we made the decision to move now.

Peter Skibitski - Credit Suisse

Is NRO pretty big customer for TASC though?

Jim Palmer

I don't think I'm going to talk about individual customers for our business here. I don't know if that necessarily that relevant here. It really is the customer community in whole.

Operator

Your next question comes from the line of Joe Nadol with JPMorgan. Please proceed.

Joe Nadol - JPMorgan

Jim, you alluded to this in your prepared remarks, but just wondering why given the very tax leakage that, why you didn't do a spin?

Jim Palmer

Well, we did look at as I said in my prepared comments, a number of alternatives, [spend] being one of those, but as we thought about the time and dislocation to try to get that done, we concluded a faster transaction such as a sale made more sense. We also looked at the shareholder base and concluded there would be a significant churn if we were to do a spin. But ultimately, trying to get a transaction done as quickly as possible that maximize value for shareholders in the face of some recompetes we thought was the best alternative.

Joe Nadol - JPMorgan

Is their any earn-out associated with the deal?

Jim Palmer

This is a fairly vanilla straight forward sale transaction. As Paul said, we're really precluded from getting into a lot of the specifics of the transaction, but I think it's fair to say as I said, its straight forward vanilla sale. No unusual terms and conditions.

Joe Nadol - JPMorgan

And then finally just from a GAAP standpoint, any gain or loss expected?

Jim Palmer

There's probably at this point a small gain on sale associated with the transaction that would be as I reported in discontinuing ops. Likewise, there is some cost associated with the transaction that for government cost accounting rules will probably be reported or will be reported in continuing ops. So essentially, those two offset each other. So I kind of get to my neutral kind of comment.

Operator

Your next question comes from the line of Finbar Sheehy with Sanford Bernstein. Please proceed

Finbar Sheehy - Sanford Bernstein

Can you tell us anything about sort of the balance sheet impacts and in particular, whether tax assets or liabilities that are part of the tax affect that you're referring to or is that all essentially just the game versus your existing basis?

Jim Palmer

I am not sure I really understand your comment or question, but the biggest impact essentially will be removing some of the goodwill associated with the prior purchases. So, in terms of movement on the balance sheet, that would be the biggest number or asset number that would be reduced by the transaction.

Finbar Sheehy - Sanford Bernstein

And then any liabilities or other existing tax bills or credits that would be going into this, or wrapped up in it?

Jim Palmer

Nothing of significance that I can think of.

Operator

With no further questions in the queue, I would now like to turn the call back over to Paul Gregory, Vice President of Investor Relations for closing remarks. You may proceed.

Paul Gregory

Great. Thank you Keisha. With that, that concludes our conference call and we appreciate your participation. Thank you and good morning.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Northrop Grumman Corp. Advisory Services Conference Call Transcript
This Transcript
All Transcripts