諾斯洛普·格拉曼 (NOC) 2003 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Northrup Grumman second quarter earnings conference call.

At this this time, all participants are in a listen-only mode.

My name is Kellera and I will be your conference coordinator today.

If at any time during the call you require assistance, please press star followed by zero and the conference coordinator will be happy to assist you.

As a reminder, this conference is being recorded today, Monday, July 28th, 2003.

I would now like to hand the presentation over to Gaston Kent, Vice President of Investor Relations.

Thank you very much, Kellera.

Good morning, ladies and gentlemen and welcome to Northrop Grumman second quarter 2003 conference call.

Before we start, please understand that some of the matters discussed on this call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements reflect the company's views with respect to future events and prospective financial performance.

Forward-looking statements involve risks and uncertainties, and the actual results of the company may differ materially from the results expressed or implied by the forward-looking statements.

A more complete expression of these risks and uncertainties is contained in the company's SEC filings including the form 10 K and forms 10-Q among others.

During the call we'll discuss second quarter results and the outlook for 2003 and 2004.

Guidance for 2004 will be GAAP measures of sales, operating margin, cash from operation, and earnings per share.

We will also discuss certain non-GAAP measures.

We've provided supplemental information in the form of a PowerPoint presentation, which you can follow on the web.

It's available as an accompaniment to our conference call and it includes definitions of the non-GAAP measures and reconciliations to GAAP.

Those definitions and reconciliations are on charts 12 and 13 in the presentation, which will not be discussed today, but are available for your information.

The presentation will be available for a limited time, and should be viewed in conjunction with today's commentary.

On the call today are our CEO, Ron Sugar, and our Chief Financial Officer, Dick Waugh.

Although I will be handling the prepared part of Dick's presentation, he has a bit of a summer cold, but will participate in the Q&A.

At this time, I'd like to turn the call over to Ron, and the outline of his comments is shown on Chart 3.

Thank you, Gaston and thanks to all of you for joining us this morning.

I want to begin my comments by saying overall our second quarter results were very strong.

Our overall operations demonstrated strength by every measure.

Acquisitions are up 36%.

Sales rose 57%.

Operating margin increased by 10% and segment operating margin grew 46%.

Mission Systems and Space Technology were major contributors, and we had solid double digit sales growth in electronics systems, ships, information technology, and Integrated Systems.

Organic sales growth for the quarter was 15%.

We completed the second phase of our debt reduction program reducing total debt by more than 300 million to $6.6 billion.

For 2003, we are increasing our earnings per share guidance to $4 to $4.25 per share for the previous range of $3.80 to $4.20.

Cash from operations totaled $737 million.

For the year we expect cash from operations to range between $1.1 billion and $1.3 billion, which is before the $1 billion B-2 tax payment.

We continue to look carefully at our capital structure, and plan to finalize our study on that by the end of the year.

Gaston will provide more detail on our guidance later in the call.

The only negative this quarter was the Fuller tanker charge.

It's disappointing to take another charge on this program, especially when overall our operations are performing superbly.

The charge includes cost growth on the third tanker due to unusual weather delays and rework.

The third tanker was delivered to the customer July 21st.

The charge also includes increased estimates to complete the final two ships to reflect more modest improvements in labor productivity and higher overhead costs than previously expected.

We believe these revised estimates are appropriate to complete the construction and delivery of the fourth and fifth tankers.

As our second quarter results demonstrate, Northrop Grumman is performing extremely well.

Mission Systems and Space Technology sectors are exceeding our original expectations for the year.

And the balance of our defense and government businesses are performing at or above expectations.

We are in the target-rich environment with several multibillion-dollar program opportunities.

We're obviously disappointed that we are not continuing in the development phase of the LCS competition.

We can't win every competition, but we've certainly won the big ones like DDX and Deepwater.

These programs, along with LPD, LHD, CDM 21 and the Virginia class submarines are the ones upon which we based our future shipbuilding plans.

We are also recently selected to lead our support -- lead or support nine major areas of the army's future combat systems development program, and Northrop Grumman was just awarded a multiyear classified program worth $875 million.

We are now competing for several other large programs, like Kinetic energy interceptor, targets, pails and counter measure, space-based radar, the battle management command and control subsystems of MC2A, the UK Watchkeeper program, aerial common sensor, transformational communication system, NATO's alliance ground surveillance, and Taiwan's Poshang program, to name a few.

With respect to the federal defense budget, you are all aware that the House and the senate have approved the 2004 defense appropriation bills and are preparing for appropriations conference.

Overall, Northrop Grumman programs faired very well receiving substantial plus-ups under both bills.

Now I'd like to briefly cover some sector highlights.

Electronic Systems generated double digit increases in both sales and acquisitions.

As the results indicate, ES is performing very well across its portfolio of several thousand contracts.

On the F-16 block 60 program, shortly after the close of the second quarter, we achieved a significant milestone with the delivery of the first agile beam radar production system.

We continue to have excellent flight tests, ten to date, and we're holding to plan on EMD and production materials.

As we've said before, we have a long way to go on the BLOC 60 program but we are achieving critical milestones.

We continue to book a small profit on our other fixed price development program, Wedgetail.

On the Homeland Security front, the United States postal service awarded ES a 17-month contract valued at approximately $175 million to deploy biohazard detection systems in postal processing plants nationwide.

Ship sales rose 19% due to continued rampup of the DDX and LPD programs.

The seventh and final class Helix ship underwent sea trials and is scheduled for delivery in the third quarter.

The LPD 17 "USS San Antonio" was christened July 19th in New Orleans.

Both we and our customer are very pleased with the progress on the LPD program.

Also during the quart christened our 21st destroyer "USS James E. Williams" and started fabrication on the LHD 8.

Newport News completed the extraordinary task of taking the "USS enterprise" and the "USS Ronald Reagan" through cruise and sea trials in the same week, a milestone for ourselves and for the navy.

The "enterprise" redelivered May 7th, and the Navy took delivery of the Reagan on June 20th with a stirring commissioning ceremony on July 12th.

Work continues on the next two carriers, CBN 77 and CBN 21 and on the Virginia class submarine program.

I.T. sales grew more than 11% with government I.T. being the main driver due to new programs like INS, land information war air activity and the GTN 21 program, along with growth and classified programs at task.

I.T. also had a healthy double digit increase in acquisitions, mainly due to awards in government I.T. and technology services.

Mission Systems also had strong sales results.

This quarter marked Mission Systems' fit year as prime contractor of the nation's ICBM force.

Since January, Mission Systems has received. $260 million in options and new awards on this important program and we expect a total of $850 million in 2003.

And last week, we announced the acquisition of Xontech, a science and technology firm specializing in missile defense, and sensor and intelligence data analysis.

Their technology compliments our areas of expertise and strengthens our ability to develop the missile defense systems essential to countering 21st century threats.

Sales at Integrated Systems rose 19%, keeping them on track to generate double digit growth this year.

Acquisitions were up 50% this quarter, and included a $90 million contract to begin low rate initial production on I-CAP 3, a $215 million award for E 10 MC2A development.

And additional F-35 funding.

Integrated Systems has also won the first of two DARPA army contracts for design of U-car, the unmanned combat armed rotocraft.

These programs have revenue potential in the billions as they move into production in the future.

Space Technology also reported strong sales.

They are ramping up nicely on programs like NPOSE, the James Webb space telescope and the space tracking and surveillance system.

Space Technology also had solid acquisition this is quarter, including a $220 million contract to expand the communications navigation and identification system on the army's Comanche helicopter.

The common themes running through each of our sector highlights are first, outstanding performance on our mature defense programs, second, successful ramp-up on our development programs, and third, solidification of our position in the must win areas of the defense budget.

In addition, we are doing very well with the intelligence community and civil agencies such as NASA.

In closing, it was an excellent quarter.

The kind of quarter that reflects our underlying operating strength and financial health.

We are solidly on track to meet our improved earning guidance.

We've assembled what we believe is a unique portfolio of technologies and the best people in this industry.

We are focused on execution, on current programs and optimization of the outstanding technology and revenue synergies available to us going forward.

Now with that, I'd like to turn the call over to Gaston who is pinch hitting for Dick Waugh for a more detailed discussion of the numbers.

My comments begin with Slide 4 which recaps the financial highlights versus last year's second quarter.

As Ron said, it was an excellent quarter with solid organic growth in sales and segment operating margin, even before the addition of Mission Systems and Space Technology.

Operating margin increased 10% and segment operating margin grew 46%, including 8% organic growth.

Due to strong a quarter from Integrated Systems, Mission Systems and electronic systems and slightly lower than anticipated interest expense, we exceeded our own second quarter expectations by a substantial margin.

Much of this was due to improved performance.

There were some timing issues which I'll touch on as I review the quarter results.

Please forward to Slide 5.

Electronic systems generated a 36% increase in margin on a sales increase of 16%.

Their results were driven by increased deliveries in aerospace on the F-22 Apache and F-16, as well as increased volume in C4ISR.

Year-to-date, electronics has booked $2.8 billion in sales at a 9.4% operating margin, so they are on track to generate sales between 5.9 billion and $6.1 billion with an operating margin rate of nearly 10%.

Move to Slide 6, please.

Ships increased sales by 19%, but the charge reduced their margin to 1.7% from 7.3% last year.

For the year, we continued to expect sales of more than $5 billion, but ships margin rate is now expected to be in the mid 5% range as opposed to our previous estimate of mid 6%.

On the next slide, information technology sales rose more than 11%, with margin increasing more than 60%, reflecting increased volume, as well as a year over year comparison that includes a $16 million charge in 2002, to reverse an oracle systems sale to the state of California.

We now expect iced tea sales for the year to be about $4.7 billion, down slightly from previous expectations, with operating margin of approximately 6%.

Slide 8, Mission Systems sales were nearly $1.1 billion, driven by new program startups and command control and intelligence along with a scope increase on a restricted program.

Operating margin includes the one-time positive effect of a fee rate change on that same restricted program.

Based on performance year-to-date, we now expect 2003 sales of approximately $4 billion, slightly better than previous guidance.

Along with an operating margin rate of approximately 6%.

Slide 9, Integrated Systems increased margin by 23% on a 19% sales increase.

Second quarter margin was positively impacted by receipt of a Global Hawk award fee originally planned for the third quarter.

Timing of sales, EAC improvements on the B-2, F-18, unmanned systems, E-2 and Joint Stars and better performance than planned on Stars also contributed to the higher operating margin.

As a result of the EAC adjustments and better performance year-to-date, we are increasing margin guidance for Integrated Systems to a range of 9 to 9 1/2% from our previous guidance of 8% to 8 1/2%.

We continue to expect sales to range between 3.6 and $3.8 billion.

Slide 10, please.

Space Technology also reported a strong quarter, ramping up on programs like NPOSE, the James wood telescope and several others.

We now expect 2003 sales of more than $2.6 billion.

We're also increasing our expected margin rate to slightly more than 6%.

The margin rate increase is primarily due to purchase accounting adjustments to FAS depreciation versus the amount recovered under CAS.

Although I'm not going to go through every line item below segment operating margin, I will comment on some of them from both second quarter results and expectations going forward.

Our second quarter corporate expenses were $22 million, lower than our run rate in the first quarter, due to lower than expected deferred state taxes.

We still expect corporate expenses to total $120 million for the year.

Second quarter net interest expense was $102 million.

This is slightly lower than we originally planned and we now expect 2003 interest expense to range between $485 million and $490 million and interest income to be approximately 55 million.

Regarding leverage, we've continued to improve our debt-to-total capital.

However, it's only one of several ratios we track internally.

Some of the others are interest coverage, funds from operation, and total debt to EBITDA.

These ratios, not only important to the rating agencies, but they are also important to us to ensure we are looking at the relationships between operating cash flow and total debt.

As expected, this quarter our tax rate increased to 31%.

The only other change to our previous guidance is a light increase in our projected cash recovery pension due to the chewing up of some of the small pension plans and the previously mentioned increase in our EPS guidance.

Cash from operations was $737 million.

Capital spending of $140 million and depreciation was $104 million.

Also, during the second quarter we agreed to sell the life support unit of component technologies to UK-based Collum for $73 million in cash.

We expect the sale to close in the third quarter, and we continue to actively market the remaining CP businesses.

Let's forward to the last slide to be covered today, which is Slide Number 11, which summarizes our guidance for 2003 and 2004 for sales, operating margin, segment operating margin interest expense, interest income, effective tax rate, EPS from continuing ops and cash from operations.

For the year, we continue to expect sales between $25 billion and $26 billion.

Segment margin in the mid 7% range with total operating margin ranging from 5.8% to 5.9%.

Interest expense has been lowered, as I said, to a range of $485 million to $490 million.

Our expected effective tax rate is unchanged at approximately 28%.

Our EPS from continued operations has been increased from $4 to $4.25 per share.

This reflects our lower estimate for interest expense and improved sector performance in spite of the polar tanker charge.

We expect cash from operations of $1.1 billion to $1.3 billion, excluding the $1 billion B-2 tax payment.

Through the second quarter, we're about half way there with another $600 million to go.

The burnoff of the $68 million polar tanker charge will be about $20 million in '03, $30 million in '04, and $18 million in '05.

For 2004, we expect sales of $28 billion to $29 billion, with operating margin of 6% or greater, assuming pension costs remain the same as in 2003.

Sector operating margin remaining in the mid 7% range.

Interest expense of $435 million to $455 million and an effective tax rate of 32% to 33%.

All of which should translate into double digit growth in EPS from continuing operations.

Cash from operations in 2004 is expected to be approximately $1.5 billion.

In closing, it was a very strong quarter, and we expect to continue to have solid performance this year and going forward and now we are ready to begin the Q&A session.

Ladies and gentlemen, if you wish to ask a question, please press star one on your telephone.

If your question has been answered or you wish to withdraw your question, please press star two.

Again, if you wish to ask a question, please key star one.

Your first question comes from Cai von Rumohr of SG Cowen.

Please go ahead.

Yes, good quarter.

Could you walk us through a little more detail on the polar tanker, you know, the impact of the weather and the rework, how much of the charge was for the third ship, and why the charge looks so be relatively big, because by my calculation you've got about 150 million of accrued revenues yet to go, so quite a large charge compared to what you have to go.

Cai, this is Ron.

Let me take a stab and then Dick can add.

We have about 230 to go with about 75 on D and 155 on E, round numbers.

The breakout is about 13 million on tanker three, 25 on four, and 30 million on five.

We had an extremely wet spring.

We had unusual weather delays and we had some test failures and schedule problems disrupted the ship's completion and some of the work flow.

More importantly, on the fourth and fifth ships, we just didn't see the progress in recent months on the productivity improvements that we hoped to put in place for the remaining two ships and some of the overhead issues, and so what we've done is taken a more realistic approach in evaluating the remaining costs to go.

We're working our way through the program.

We have three very big ships which have been delivered with two more to go.

We're looking forward to getting the ships finished as soon as we go k and getting them to our customer.

Okay, and in Integrated Systems, could you tell us how big was the Global Hawk and, you know, while you've raised your guidance, you, yet again, look like you're going to see a sharp falloff in the third and fourth quarters.

The last couple of quarters you've come in better than expected.

Is there opportunity that this sector, yet again, could surprise us by coming in a little bit above expectations?

Cai, this is Dick.

The Global Hawk was about $11 million.

Obviously, there was some pull forward into this quarter and that's the reason that we're giving the forecasts that we are.

We did increase, obviously, their margin rate for the year.

There's always the possibility for doing better in all of our sectors.

So I would not say that there is but that's our best estimate at this point in time.

Last question.

You talked about kind of looking at your capital situation with thoughts of maybe doing something toward year-end.

Could you talk to us about, you know, your kind of prioritization of the alternatives, stock repurchase, dividend, how do you think about all of that?

Well, Cai, we're obviously concerning all of that in the mix, both here in management and with our board.

I'm not prepared today to give you a prioritization of them.

Clearly we need to lay out for you by year-end, maybe sooner, we'll see, what we really want to go do going forward.

So I don't think I want to give you any further divinitization yet.

Before we have another question, let me correct something.

I read a word backwards in there.

The CAS recovery decreased slightly, not increased, as I stated it.

Sorry.

Let's have the next question, please.

Your next question comes from Joe Nadol of JP Morgan.

Please go ahead.

Thanks, hello.

My first question is, looking at your net cash and debt balances at the end of the quarter, Dick or Gaston, who was cap ex and were there any other major items in the cash from investing activities part of the cash list statement?

Hang on just a second.

Joe, cap ex was 140 for the quarter.

Okay.

Depreciation was just a little over 100 million.

And what was your other question?

Were there any other items in that cash from investment activities part of the cash list statement?

I'm just trying to reconcile, you know, cash from operations and your Q1 end balance sheet with your Q2 end balance sheet.

Let me go through those quickly for you, Joe.

Thanks.

We had an additional -- as you were saying we had cash from operations of 737m.

And we had an additional repurchase of debt during the quarter.

It was a follow-on to the repurchase of the TRW of 235 million and other debt payments of 197, say roughly 200.

We paid down debts under lines of credit about 70 we had some preferred stock redemption of 117 as Gaston just noted we had cash and dividends to a total of 258.

Starting with a balance of 408 at the end of last quarter, that should get to you the balance of the end of this quarter of 268.

I think it was the preferred stock redemption I missed.

Okay, any progress on the final settlement of the auto divestiture?

We will be commencing discussions with TRW Auto toward the end of this week with regards to finalizing our purchase price adjustment.

Okay, but there was no cash impact during the quarter?

No activity.

No, there was no activity with regards to that, no.

Okay, and then could you -- you already quantified the Global Hawk award fee.

Could you quantify a couple of the other items you mentioned so we can get a better feel for the run rates in some of the segments?

There's the Mission Systems.

Joe, our preference is not to do so.

We're obviously noting that they're a little better than we expected, and we, therefore, just prefer to leave it at that.

None of them were of the magnitude of Global Hawk and Mission Systems was classified, so we can't talk about it anyway.

Okay, but there were no big income adjustments in I.S., none of them were bigger than the Global Hawk award fee?

That's correct.

Okay, I'll leave it at that.

Thanks.

Thank you, Joe.

Your next question comes from Steve Binder of Bear Stearns.

Please go ahead.

Good afternoon, good quarter.

Thanks, Steve.

Can you just touch on your interest in tax payments in the quarter, what did that amount to?

Hang on.

Hang on here.

Okay, we've got 98 for interest.

Quite frankly, if you're really interested in our tax payment, I think we'll follow on that question sometime.

From a working capital stand pint, it looks like it's always 350 million or so.

I was just wondering, can you give a little color on operationally, you know, it looks like it's receivable, inventories and I imagine a few other liability accounts.

Business wise, I don't know if there was any one business that threw off a lot of cash, any increase in the advances in the quarter?

Let me say, every sector is up in its working capital.

There's no real major distinction.

We've had no major advances that I'm aware of in the quarter.

So primarily the cash from our -- you know, our cash from operations is up 600 million of the sector over last quarter but it really is attributed to collections on our programs.

Um-hum.

Can you touch a little bit on the second half of space and Mission Systems?

I think if you look historically at TRW, both businesses typically have at least second halves that are at least as strong of the first half if not stronger.

I don't know if you're just being conservative or what.

In Space you're suggesting a lower half and mission even.

Is this time issues or conservativism.

We try give what we think is a reasonable estimate for the year, and there's, you know, dynamics going on in the programs, we think that's a reasonable estimate at this point in time.

Again, its hard for us to compare to TRW in the past.

Obviously the way we account for things aren't exactly the way they accounted for things.

I will say that we're fairly confident that that's the profile for the balance of the year.

Again, it could be a little better, but --

We did have at ward fee from Mission Systems this quarter that was not expected this quarter.

So that goes to next quarter.

And the context of margin, there was an award fee that was better than expected.

Dick, do you expect the final purchase price with the TRW to result in a source of cash?

Yes.

I mean, is it in the three-digit range or is it going to be less than that?

I really don't want to get into that at this point, Steve.

Lastly, can you talk about if there was a purchase price adjustment in the quarter on the TRW acquisition, how much it was and what actions did it reflect?

No, Steve, there wasn't a purchase.

That's what we're going to be --

I meant with respect to any changes in the goodwill account.

Oh, yes, there was about a $50 million increase in goodwill roughly.

We were chewing up some things, a little over $50 million.

Thanks very much.

Your next question comes from Howard Rubel of Soundview Technology.

A very nice cash quarter, gentlemen.

Thanks.

Just to start on the goodwill question for a second, was that attributable mostly to the fixed income side or was it individual business units that caused the increase in goodwill?

I'm having a little trouble hearing you.

I'm sorry, Gaston, is that better?

Yes.

First with respect to the goodwill for one second, was the increase attributable to the purchase of the debt or was it more -- I mean I think Gaston, you alluded to one of the elements sort of a change in depreciation.

Could you talk on that for a moment?

Howard, let me say, there were a lot of little nicks around asset valuation, fine tuning.

And the second thing is that, most of your businesses are going to have some fairly significant momentum behind them especially Space Technology, and Mission Systems, and could you elaborate a little bit why the second half would tend to be slower, given that you've continued to grow both the backlogs on balance and seem to be capturing more business than maybe you had expected?

You know -- this is Ron.

I'm not sure what you're referring to, but I will tell you that we are dealing with fiscal funding constraints on the part of our customers, and there is the likelihood that will could be some stretching on a couple of programs.

This is kind of our best net estimate of what we see.

I mean, hey, if it comes in better in the next couple of quarters, we'll all be delighted.

That's the way we see it today.

It sure does look like you're going to do a little bit better other than what your guidance points to.

I hope you're right.

Two things.

One is you talked about the reversal of the CAS pension expense being somewhat lower.

Will that be a continuation in subsequent periods?

Let me say, there are some very small plans that we have to modify as we go through the year.

Some of them are even pay as you go.

They're very small, and you know it could be $1 million here or $1 million there, but CAS is not going to be moving that very much.

In other words, it's going to be very marginal in terms of the adjustment to CAS, but there can be some adjustments.

Some are nonqualified and we charge on a pay as you go basis on what we pay out.

The final question, is returning to ships for a moment, if you were to sort of look at the mix of business, how would you sort of say what percentage of your business today has zero margin?

The whole sector?

The whole sector would be --

I think the only zero margin program is the Fuller tanker and it's a pretty small fraction of the total ship's business.

We can certainly say that on our LPD program, because of some of the difficulties in that program last year were not earning the kind of margins we hoped we ultimately might in the next few years.

I'm not aware of any other zero margin programs.

Everything else we're making positive margins, in some cases pretty healthy ones.

Thank you very much, gentlemen.

Thanks.

Thank you, Howard.

Your next question comes from Sam Pearlstein of Jeffries and Company.

Good afternoon.

With respect to the backlog, was there anything that took place in that?

I looked at the sequential change.

It looked like it was down almost in all the segments but especially the Mission Systems where it seems like there would have been about $500 million few ear wards this quarter than last quarter.

Yes, the quarter was a little light on acquisitions.

It was timing from what we can tell.

There's no pattern going on right now.

Acquisitions do tend to be lumpy in our business, particularly chips tend to be lumpy.

So we don't consider it a major issue.

Okay, and with respect to the current budget in FY '04 and beyond, it looked like the LHA program might be getting some funding taken away, and can you talk about the Virginia class funding impact in terms of whether it's a multi-year or not and how that affects the ship systems outlook?

Let me talk about the Virginia class.

That's obviously a very important program.

We are geared up now to do a block build of Virginia class.

That means a year-by-year purchase but a contract which covers at least five options.

Right now, the House and the Senate appropriators are split on whether or not they want to authorize a multiyear.

The economics for us are pretty much neutral from the standpoint of our shareholders.

As a taxpayer and an American, I hope they go with the multiyear because it will save the better part of about $1 billion over the next block of ships for the country, but either way the run rate will be about the same.

LHA is a longer range program, and there's going to be some puts and takes and it depends on whose line item you're looking at.

In terms of significant revenues in '04, LHD will be significant, of course the LPDs of course.

The last question, there was a litigation settlement, I think about $110 million, $111 million that you said went' going to impact this year.

Did that occur this in this quarter or is that something that occurs later in the year?

No, we haven't paid that yet.

I think it happens in the third quarter.

Okay.

It obviously influences or cash outlook and that's why we gave you the numbers we did.

That's in our cash from ops.

Thank you.

Let me also make an observation with regards to Fuller tanker.

Those sales are going to be something less than 100 million this year, on 5 billion in ships for the overall sales.

It's something less than 2% of sales for the ship segment.

Your next question comes from Nick Fothergill of Banc of America Securities.

Hello, good afternoon.

First question really to Ron, I suppose.

The 7.5% operating margin that you're still targeting for 2004, I understand this may be being held back a little bit by R&D and the mix and purchase accounting for Litton.

If it was possible to beat this number, which segments or programs should we be watching out for that could possibly help you do that next year?

Let me lateral this off to Dick, Nick.

Okay.

Well, let me say, our projection for next year is still mid 7% for segment operating margin.

We have an increasing amount of, you know, cost-type programs, which we're extremely pleased and delighted that's the case and a lot of transition of production programs that, you know, are various forms of incentive, if not cost type.

So we're pleased to maintain our same mix, if you will, in terms with kind of an increasing mix toward dole.

And maintaining our margin rate, we're pleased with the increase in our overall revenue top line.

So if you're asking what areas could we possibly do better in, my answer would be seemingly, we could possibly do better in each much our sector, but quite frankly, that's the overall mix for the company going forward was best we could tell at this point.

Dick, thank you.

Then one for Ron.

You gave us a very comprehensive list of up and coming competitions in your, what you described as a target-rich environment.

I wonder if you could very quickly, Ron, go through the big ones in that list and just tell us roughly when you think the competitions will be announced, and roughly what financial scale they might be.

Nick, I'll give it a shot.

Obviously we're at the mercy of our government and our foreign governments in terms of timing and scale.

Kinetic Energy interceptor is probably a down to around the end of the year and depending on how Congress comes out on the funding of the program this is a multibillion-dollar scale effort.

There's obviously issues right now in terms of the funding we're going to see in '04.

Congress is trading between different programs but that's the scale.

Targets, payables and counter measures is again probably something at the end of the year early next year and probably on the billion-dollar dollar plus scale.

Space radar will be down to perhaps two competitors here for a definition phase which will go on for at least a year before we'll see any further downslick for a major hardware start.

I would think.

Let's see, the UK Watchkeeper, probably within, less than a year on that one.

The transformational Com system is probably more farther out than that.

The Poshang, we're expecting a decision in the next quarter.

We can't move the Chinese legislature any faster than they're going to go but that's pretty much where they're looking.

Great, and then last one, fixed priced development contracts like on the F-16 and Watchkeeper and you said Watchkeeper is starting to book a small profit.

When do you see you're able to pass given milestones that might allow you to take a larger profit intake?

First of all, Nick, it's not watchkeeper.

I meant wedge tail.

Watch keeper is the UK program.

I got the Ws mixed pup.

Gaston you want to address the milestone differential.

Yes, our current expectation is that we will not have margin on the Block 60 program.

We took the charge, which slowly amortizes as we go along in the program.

Expectation is that the future is essentially zero on that.

As far as milestones are concerned, getting completely through the test program is really the most important aspect to Bloc 60.

Then we know the hardware we're actually producing will be as it was designed at this point in time, and that happens.

The test something under way now and it winds down through the end of this year, early next year.

Very last one, back to Ron.

Obviously throwing off reasonable cash now, and I know you're intending to take questions later probably on dividend and potentially share repurchase, but do you think there's still scope for medium scale acquisition or do you think you've probably done enough to date with TRW and those before or do you think there are certain segments you could still add to in the kind of 500 to 1.5 billion arena.

Nick, I think we're certainly not looking at anything of the scale of TRW or Litton.

Absolutely first there's something that fits that's in a smaller category, which you've indicated, we'll take a look at it.

We're also looking at a couple of our businesses within our sectors to see if they're better strategically with somebody else but again, there will be smaller puts and takes.

I don't think there's anything that we see coming down the pike which will significantly strain the balance sheet.

We don't see any other major moves at the moment.

Great, thank you very much, indeed.

Thank you, Nick.

Your next question comes from George Shapiro of Smith Barney.

Please go ahead.

Good morning.

Very good numbers.

Thank you.

Thank you.

Ron, if you looked at this Space business for TRW, and it looks like that business organically was up like 40% plus over last year's TRW reported numbers.

I know you mentioned some of the program, the big programs that were in there, but I mean, is there something else that's giving you that kind of growth rate?

It's the things we talked about.

There's also a classified dimension of the business that we are not explicit about, and that's, of course, been one of at fractions of that business from the time we first acquired it.

Then along those lines, and other people have tried to get at this, why would that kind of revenue growth in this quarter slow so dramatically that the second half revenues would actually be worse than the first half?

Well, we upped our estimate for the year for their sales.

I know.

It still seems you did more than half the year in the first half, but we'll see.

I mean, I sure got to believe that you're too low on that number.

Look, we'll go back and look at that, George.

It's a good point.

Keep in mind, though, that the sales rate is driven in some sense by fiscal funding expenditures on these programs, by program, and this is how we've built the estimate up, and the guys there are pretty good at predicting.

Most of their business is cost reimbursable.

Sales are done on a cost incurred basis there.

When the costs are incurred, then we recognize the sale.

Okay, and Dick, quick thing.

If you could just repeat the number you said as far as how much preferred redemption you had in the quarter?

Okay, you're going to make me find the number again here.

It's about 117.

Okay, and then also, what's your expectation for depreciation for the year?

Because this quarter, if it was just a little over 100, was actually somewhat less, a little bit less than the first quarter.

In the first quarter you only had TRW for a couple of months.

Yes, our estimate at this point in time is about 500 million.

For '03, of course.

And in '04, it would seem like you'd have the opportunity, at least, at the interest expense would drop by more than what you're showing in the projection.

You have to have debt you can't pay down, George.

We have a lot of fixed rate debt out there that sometimes it doesn't make sense to try to buy it out of the marketplace with obviously the mark-to-market premium you have to pay.

All right, so then cash will build at that point, and then it raises its issue that awe dressed initially for the deployment of that?

Exactly, and that's, as the next quarters do unfold it will be timely to lay all of that out for you.

Lastly, are you still going to do cap ex of close to 700 million for the year?

It seems like you're clearly well under that rate for the first half.

Yes, something coming close to that.

I mean, probably not more, maybe a little less, but somewhere in that area.

We have told you about a pretty big pickup in ships, because of certain investments are being made there, and that should kick in the last half of the year.

Okay, thanks very much.

Thank you, George.

Your next question it, appears Mr. Friedman has dropped.

Your next question comes from Chris Mecray of Deutsche Banc.

Thank you and good quarter.

I'd like to touch on ships.

Going back a couple of quarters you were projecting sales of less than $5 billion.

You upped that to five last quarter and now it looks like we're around 5.78.

What is driving the increase?

It's a pretty good step up.

I don't have the numbers right at my finger tips but clearly the DDX program has been moving strongly.

The LPD program has been moving up strongly.

We've also seen some significant work at Newport News in terms of complex overhaul and repair and the LHD program, which is LHD-l, large amphibious assault ship is coming on.

I think all of the above is causing all of that to happen.

It's a good story.

We've won basically all the major programs.

Deepwater is also starting to kick in.

We said more than 5 billion.

I want to shake sure we said the numbers right -- for ships, Chris.

I think I may have heard 5.8.

This surprised me.

No, that would be a nice thing but we didn't say that.

Well, that corrects that.

Thank you.

You know, when I look to Integrated Systems, the back half margin, you know, would be well under 8% to get to your guidance after such a remarkably strong first half, even backing out the 11 million from this quarter.

What changes or what's the profile there?

Is it something in particular that steps that down in the second half?

Well, let me say, as we noted there were a number of awards that we expected to capture in the third quarter that were, in fact, captured in the very end of the second quarter.

So some of that was timing, and so --

Or fees.

What we thought were going to be third quarter events turned out to be second quarter events.

We're pleased that that happened.

It demonstrated the programs are going extremely well, but the timing of them and our plans were just a little bit off.

We're also ramping up on our development programs like F-35 and Global Hawk and so the mix is not quite the same as it was when we were more, on a more mature production mode earlier in the year and last year.

Okay, and it's sort of the opposite, I guess for electronics system.

You tend to get good volumes in the back half, is that really what's going to drive up the step up in there or are there other award fees you expect?

It's volume but we also expect the absolute rate to go up.

Okay, great, and the biggest component of that other, the last line item of electronics system is maybe the postal contract or what is it causing quite a good step up in volume there?

Yes, that is correct.

And it's also our technology contracts in there as well.

Which we've been doing a very good job of capturing contracts.

Yes.

Okay, good I'll pass it on.

Thanks.

We have time for one more question before Ron has to leave for some interviews.

Gentlemen, your final question comes from Brett Grise of Prudential Securities.

Please go ahead.

Since I'm the last guy, can I ask two?

Sure.

First one is, on the Berry amendment, I follow some of these small defense industry suppliers, and they're a little nervous about changes, contemplated changes in Congress on the Berry amendment.

If that happens, is it good, bad or a nonevent for Northrop Grumman?

I'm not sure that it has an enormous material impact to us.

We're probably watching more closely the buy America legislation that was put in the House appropriations language that was not put in the Senate appropriations language.

Okay.

Now, with respect to the postal contract that you talked about, are we working on or can we expect other awards with maybe other foreign postal services, or even with some domestic carriers of freight and mail in the United States?

Can you give us a color on that?

I think the only thing I could say is that we're doing prototypes at a number of post offices.

If things go as we expect and the postal service expects that should be able to scale up in the next year or two across the country.

Beyond that, I frankly, don't know really how we're proceeding.

Okay, thank you.

Okay, well, look, let me just if I could, just wrap up.

First of all, let me say, again, we're delighted that we're able to offer you a good quarter here a strong quarter, good results, good operating performance.

We are seeing the benefit of integrating the various elements that we've acquired over recent years.

We had great performance from our recently acquired businesses along with our legacy businesses.

We're able to up our guidance for this year.

We're holding our forecast for '04 to be double digit.

Overall, we're seeing the opportunity to be a Tier 1 player.

The company is getting stronger.

We can feel it.

We see the results reflecting that.

We're in a position now where we should be able to provide solutions and compete against anybody from undersea to cyber space.

We do appreciate your support and your interest, and we look forward to talking to you again.

Thank you, ladies and gentlemen.

Ladies and gentlemen, this concludes your conference call.

Thank you for your participation today.

You may now disconnect.