諾斯洛普·格拉曼 (NOC) 2003 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Northrop Grumman third quarter earnings conference call.

At this time, all lines are in a listen-only mode with a question-and-answer session to follow.

You may register your question at any time during the presentation by keying star, 1 on your phone.

Again, key star, 1 to enter a question to enter the queue if you like.

At this time, I'd like to turn the presentation over to your host, Mr. Gaston Kent, VP of Investor Relations.

Sir, you may proceed.

Thank you very much Gene (ph) and welcome ladies and gentlemen to our earnings 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 perspective financial performance.

Forward-looking statements involve risks and uncertainties and the actual results of the company may differ materially from 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 will discuss the third quarter results and outlook for 2003 and 2004.

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

We will also discuss certain non-GAAP measures.

We have again provided supplemental information in the form of power point presentation, which is available on our Web site.

This is available as an accompaniment to our conference call and it includes definitions of the non-GAAP measures and reconciliation to GAAP.

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 Chairman, CEO and President, Ron Sugar, and CFO, Dick Waugh.

At this time, I like to turn the call over to Ron.

Please continue, his comments shown on slide three on your presentation.

Thank you Gaston and thank all of you for joining us.

We're delighted to report another excellent quarter.

Sales rose 57%.

Segment operating margin grew by nearly 80% and operating margin increased nearly 40%.

We had double-digit year-over-year sales growth in electronic systems, ships and Integrated Systems.

Third quarter organic sales growth was approximately 17%, and approximately 14% year-to-date.

Mission Systems and Space Technology were major contributors and cash from operations totaled $400 million and approximately $1 billion year-to-date before the B-2 tax payment.

At this point in the year we are comfortable raising our guidance for cash from operations before the $1 billion B-2 bomber (ph) tax payment to approximately $1.5 billion for the previous range of $1.1 billion to $1.3 billion.

Also, based on performance year-to-date, we expect sales between $25.5 billion and $26 billion and we are increasing guidance for earnings from continuing operations to $4.20 to $4.30 per share, from our previous guidance of $4.00 to $4.25 per share.

For 2004, we continue to expect sales of approximately $28 billion, with segment operating margin in the mid-7% range, total operating margin of more than 6% or double-digit growth in earnings per share assuming pension cost are the same next year as in 2003.

Over the long term, based on our outlook for defense spending, our portfolio of programs in our opportunity set, we continue to expect strong top and bottom-line growth with very strong cash generation.

I know there's been a divergence in perception in the investment community regarding the sustainability of growth in defense spending.

Everything we see points to solid sustainable growth.

We aren't likely to see year after year of double-digit defense budget increases of the magnitude we saw in 2003, but the national security threats are real, the need for re capitalization and transformation is real and the motivation is real.

Congress just approved a $369 billion 2004 defense budget that included $140 billion for R&D and procurement.

Northrop Grumman programs were well support with more than 60 programs receiving plus-subs of $800 million above the president's budget request.

As I have said before, we believe we're correctly positioned to meet the nation's high priority national defense and homeland security missions.

We've won the major programs we need to ensure growth, including a significant new role on the army's Future Combat System.

We're serving as prime contractor on 10 of that program's 21 concept and development teams for a total that could exceed $450 million.

We have several multibillion dollar program opportunities ahead, like Kinetic Energy Interceptor, Targets and Car Measures, BMC 2, a space based radar to name a few.

So strategically speaking, I'm very happy with our portfolio of businesses, technologies and programs.

I'm also very pleased with where we are year-to-date from a tactical standpoint.

It's been a major transition year for us.

We're moving from a decade-long period of acquisition and integration into a period where operational and financial execution will be the key focus.

We have accomplished a lot through the third quarter to allow that focus to sharpen.

The $1 billion B-2 tax payment was made last March.

We sold TRW Automotive and retired a substantial amount of debt with the proceeds.

We've sold three of the six component technologies businesses.

The integration of TRW is essentially complete and we are implementing a market-focused realignment of several Mission Systems and information technology business areas.

We settled three major lawsuits, two of which we inherited.

We established additional reserves on the Polar Tanker program, which we believe are adequate to complete the program.

All in all, we've gotten a lot behind us since the beginning of the year while delivering solid operating performance.

This is our fourth consecutive quarter of solid results from our defense and government operations.

As result of reduced risk and strong performance we announced $700 million share repurchase program.

To date, we've bought approximately 550,000 shares and Standard & Poors increased our debt rating to BBB.

Now, I'd like to briefly touch on some of the sector highlights.

Electronic Systems sales grew approximately 16%, nearly 15% year-to-date, primarily due to increased volume in aerospace systems F-16, F-35 and Avionics classified programs as well as both electronic and infrared counter measures in defense systems.

We are continuing to make progress on the F-16, Block 60 program while holding to our EAC.

Engineering development is nearing completion on the radar, Electro-Optical and EW Systems and we've delivered all the required California Falcon Edge hardware for the first flight.

We have a long way to go here, but are pleased with progress to date.

We are ticking off important milestones on the Wedgetail program.

Antenna Number Two was delivered to Boeing in September allowing us to meet a performance instead of the milestone event.

We now have a second customer with Boeing's award of $160 million MESA Radar contract for Turkey.

This second customer order folds nicely into our production effort for the Wedge Tail programs and it also positions us to take advantage of near-term opportunities with other friendly nations.

MESA Radar is now an ongoing program with a bright future.

Ships sales rose 24%, more than 18% year-to-date, due to continued ramp-up on the GDX and LPD programs as well as higher revenue on the LHD-8.

As I mentioned earlier, we are very pleased that Congress put $135 million into the '04 budget for advance procurement of LPD-21, which puts it on track for full go-ahead in 2005.

Polar Tankers number 4 and 5 are 80% and 40% complete, respectively, and on schedule for delivery in late 2004 and 2005.

During the quarter, the Navy awarded our partner Electric Boat, an $8.7 billion Block 5 contracts for six Virginia-class submarines.

Our revenue share on this contract, which Congress has approved as a five ship multi year buy, is approximately $4 billion.

IT sales rose 9%, 12.5% year-to-date with government IT being the main driver due to new programs like INS, Land Information Worker Activity and Global Transportation Network 21, along with growth in classified programs.

Enterprise information technology solutions also had solid growth this quarter.

Acquisitions increased 13% due to several new business awards, including the Dimmer's contract with Defense Integrated Military Human Resource System.

This is a contract for the development of a fully integrated personnel and pay capability for all military branches of the DoD.

Mission Systems continues to log strong sales exceeding the $1 billion mark for a second consecutive quarter.

Command, Control and Intelligence Systems was the strongest performer but all four-business areas are growing.

During the third quarter, we announced a re-alignment of several businesses between Mission Systems and Information Technology.

The re-alignment will become effective in January and will allow us to focus greater critical mass to serve better our defense, homeland security and civil government customers.

You will see the change reflected in our financials in the first quarter of 2004.

Sales of Integrated Systems rose 21%, or nearly 14% year-to-date.

Sales increases continue to be driven primarily by growth in the F-35 and Global Hawk.

IS received a $1.9 billion contract for Advanced Hawkeye.

Year-to-date acquisitions are up 19% primarily driven by new orders and increased activity on Global Hawk, F-35 and the EA6B programs.

On September 30, IS delivered the first production Global Hawk.

The Global Hawk deployed in operation Iraqi freedom was a pre-production model that performed superbly, targeting over 55% of all-time critical targets destroyed while flying only 3% of the high-altitude sordi’s (ph) in that conflict.

Space technology also reported strong sales as they continue to ramp up on programs like Impose, the James Web Telescope, the Space Tracking and surveillance Systems, and F35 and F22 production.

Lastly, I'd like to focus on contract acquisitions and booking and backlogging (ph).

It was a terrific quarter.

We won some very large, very important contracts and year-to-date acquisitions in backlog are ahead of our internal estimates.

I've already mentioned $1.9 billion Advanced Hawkeye award, the contract (inaudible) Virginia class submarines will be about $4 billion.

Since we book only funded acquisitions and therefore backlog, you don't see a corresponding increase in third quarter contract acquisitions or backlog because using the Advanced Hawkeye as an example of the $1.9 billion contract award only $24 million was funded.

So, we only book $24 million in our acquisitions number for the quarter.

On the Virginia-class submarines, we’ve only booked about $400 million of the $4 billion of acquisitions year-to-date .

We are currently evaluating whether to report acquisition in terms of both funded and full-contract value in our fourth quarter results in order to provide you a better picture of our book of future business.

In summary, I want to iterate our positive outlook going forward.

We are in a target-rich environment.

Our mandate is to maximize that opportunity set and become our customer's most trusted provider of system and technology for national security.

This means maintaining technology leadership, performing on all our programs and winning new programs while creating a capital structure that ensures a strong investment grade rating and allows a financial flexibility to enhance shareholder value.

Now, finally, as all of you know, Dick Waugh has announced his plans to retire effective December 1st this year, at which time, Chuck Nosky will succeed Dick as our new Chief Financial Officer.

Since this will be Dick's last earnings call and before I turn the call over to him, I do want to take this opportunity to specially recognize him and thank him for the outstanding contributions he has made during his 25 years of service to Northrop Grumman Corporation and especially during his tenure as CFO over the last decade.

Dick is an outstanding financial executive who working along side Kent Cresa and also in the last few years with me, played an invaluable role in implementing the strategic transformation of Northrop Grumman into the top-tier defense enterprise it is today.

Dick, I want to personally thank you for all you have done for this enterprise and wish you all the best in your upcoming retirement.

Now I’ll turn it over to you.

Thank you, Ron.

I will tell everybody I am blushing.

I didn't see that in the prepared script that I have.

So, I thank you very much.

Let me say my comments begin with slide four, which recaps the financial highlights versus last year's third quarter.

As Ron said as an excellent quarter with solid organic growth in sales and segment operating margin in addition to the contributions from Mission Systems and Space Technology.

Segment operating margin organic growth in the third quarter was 38%, and approximately 20% year-to-date.

Looking at slide five, we had solid performances across the board beginning with Electronic Systems, which posted operating margin of 10.6%, a very favorable comparison on last year's third quarter when we took $65 million charge on the F-16 Block 60 program.

Even factoring that in, however, we had a double-digit margin increase driven by volume increases in various program performance improvements.

Year-to-date ES Sales were $4.4 billion with close to a 10% operating margin rate.

They are on track to generate sales of approximately $6 billion with operating margin rate for the year of nearly 10%.

Slide six..

Ships increased sales by 24%.

With an operating margin rate of 6.1%.

Again, a favorable comparison to last year's third quarter which included the negative $18 million net impact of a polar tanker charge and an upward contract adjustment on the commercial cruise ship program.

For the year, we continue to expect sales of more than $5 billion, with an operating margin rate of between 5% and 5.5%.

Slide seven.

Information technology sales rose approximately 9% with a margin rate of 6.2%.

Last year's third quarter included a one-time positive contract adjustment of $20 million on a technology services contract.

We continue to expect IT sales for the year to be about $4.7 billion, with operating margin of approximately 6%.

Slide eight.

Mission Systems sales were over $1 billion, driven by new program start-ups in command, control and intelligence based on performance year-to-date, we continue to expect 2003 sales of approximately $4 billion , along with an operating margin rate of 6% or better.

Slide nine.

Integrated Systems earned 9.4% margin rate on the sales of nearly $1 billion.

We now expect sales to be approximately $3.8 billion and we are once again increasing our expected margin rate for the year to between 9.5% and 10%.

Slide ten.

Space Technology also reported strong quarter ramping up on several programs like Impost, James Web Telescope and several others, altogether generating an operating margin rate of 7.1%.

We now expect 2003 sales of approximately $2.8 billion for the year, and we're also increasing our expected margin rate to approximately $6.5%.

Corporate expenses for the third quarter totaled $17 million, which includes a $17 million net gain.

For the year we expect corporate expenses to total between $110 and $120 million, which implies fourth quarter corporate expenses of between $40 and $50 million.

The fourth quarter increase reflects higher corporate unallowables.

Third quarter net interest expense was $102 million.

Cash from operations was $400 million, capital spending $171 million, including $9 million of capitalized software cost and depreciation was $116 million.

Now, let's go over to slide 11 which summarizes our guidance for 2003 and 2004 for sales, operating margin, segment operating margin, interest expense, effective tax rate, EPS from continuing operations, shares outstanding and cash from operations.

For the year, we now expect sales of between $25.5 and $26 billion.

Segment margin in the mid 7% range with total operating margin of approximately 6%.

Interest expense for 2003 will total approximately $500 million versus the previous range of $485 to $490 million, and this is due to impact of FAS 150, which became effective in the third quarter and requires that the dividend on mandatorily redeemable preferred stock be treated as interest expense.

This has no impact on overall results.

FAS 150 will create an increase in our effective tax rate because even though preferred dividends are now treated as an interest expense, they are not tax deductible, so you will see a slight increase in our 2004 expected effective tax rate.

Earnings from continuing operations have been increased to range of $4.20 to $4.30 per share.

For the quarter cash from operations was $400 million after payment of $191 million in legal settlements.

We now expect cash from operations for the year to come in at approximately $1.5 billion, excluding the $1 billion B-2 tax payment.

The increase is due to improved cash generation and information technology and Integrated Systems.

Information technology has improved their DSO's by about 20% since the start of the year, and as a result expect approximately $100 million improvement in cash for the year.

Integrated Systems is expected to come in with $200 million of additional cash due to working capital management and improved margin performance across several programs.

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

Segment operating margin remaining in mid-7% range, interest expense of $460- to 480- million, again the increase is due to the change in the preferred dividend treatment, and effective tax rate of 33% to 34%, 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.

Now, I'd like to turn back to Gaston Kent to start the Q and A.

Thank you, Dick.

We're ready for Q and A now.

Thank you very much, sir.

Ladies and gentlemen, if you like to ask a question, key star, 1 on your own touch-tone telephone.

If you want to withdraw your question, key star, 2.

Once again key star, 1 for a question.

We'll pause for just a moment.

Please stand by for the first question.

We are taking the question from Howard Rubel of SoundView.

Please proceed.

Well, that's a new way to be called.

But, anyhow -- thank you.

Thank you very much.

Dick, it's been a pleasure. that's not scripted, either.

Couple things quickly.

One is tell us where you are with respect to finishing the sale of TRW and discontinued operations?

As we said, we have sold three of the six and obviously our intent is to dispose with the balance of the three.

The three operations are Caster, ITD and Winchester.

We're actively engaged in that.

With regards to the closeout of the TRW, we had a purchase price adjustment pick-up in terms of that agreement little bit in excess of $50 million in terms of additional purchase price that we got.

You are done, you are closed on auto?

You now, you have settled everything there?

We still have some outstanding issues, but, net-net, that is where we think we are.

That's pretty good.

Couple of quick things.

One is you talked about 17% organic growth, which is terrific.

And you have given us some guidance that clearly indicates that it is going to slow a little bit.

Can you, Ron, talk a little bit about obviously it is partly contract awards and partly some other things.

In terms of what you think you’ve created in terms of a sustainable level of growth going forward?

OK, well Howard, obviously space has been huge this year.

We've seen a very substantial increase in that.

And I think we'll see more reasonable normal growth next year.

We've -- we'll obviously have guidance for you at the end of the fourth quarter in detail, which we’ll go through all the key parameters.

We are in the process now of going through that.

We still see significant strength and we see a solid growth.

Then, finally, sort of if you do the math, I know this is a little bit of knit.

You end up sort of indicating to the world that the fourth quarter is not going to be strong as what we might have expected.

Is this just partially the third quarter is attributable to timing or we are going to find out that you have some additional risks that get retired as the quarter expires?

Let me say, Howard, we expect sales in the fourth quarter to be as you can subtract, comparable to what we've had this quarter.

And quite frankly, the only really variance of any consequence is a negative one is the fact that we are going to be have, we expect booking a higher amount of unallowable costs, which are at the corporate office, as I mentioned.

And if you take that into account, it is pretty comparable.

Thank you very much.

Thank you Howard.

Your next question comes from Joe Nadol of J.P. Morgan.

Please proceed.

Thanks.

Good afternoon.

Hi, Joe.

Hi, Joe.

First of all, could you, Ron, maybe give an update on some of the programs which I guess are yellow or have been yellow in the past?

You gave brief comments on Polar Tanker, but how about Block 60, how are things going along Wedge Tail?

Joe, I actually did cover them.

Just let me reiterate we are making good progress on all of them.

On the F-16 Block 60 contract we have passed key tests and delivered some hardware.

We're still moving along here.

We have got a ways to go yet on the program.

But we are certainly comfortable today with our EACs there.

Wedgetail, we’ve had some good test results.

I think the acquisition of the program from Turkey which will compliment the one we have developed going along now from Australia (inaudible) of course we are working through Boeing as our prime will also help us because it will give us some additional critical mass in the program.

So, we're holding fine there.

The Polar Tanker, we've put a tremendous amount of attention, as I think you know and we discussed on the last call, to not only putting in a more detailed earned value management system at Avondale, but also bringing in a number of additional highly experienced executives and individuals who not only know how to build ships, but how to run programs.

We've brought people from a couple of other sectors, as well as positioning some people from within the sector from Ingalls over to Avondale.

Today we are managing and holding to the EACs that we've established.

OK.

Secondly, you bought back some shares in the quarter.

Obviously you had your authorization come through I think in the middle of the quarter.

Could you give any more color on how you're viewing the purchase authorization?

Are you viewing it tactically, (inaudible) to offset dilution or is there a chance you could start viewing it strategically in the fourth quarter and down the road?

I think that is a broad question.

Obviously we are in the market and we are going to buy back $700 million shares and we are going to do it in a way, which we think is in the best interest of shareholders as we do it.

You know, I would hesitate to talk about market timing strategies or buyback strategies, but we're in there buying them back.

Clearly if we didn't think it was worth doing we wouldn't be buying them.

Let me say, obviously, we've made a strategic judgment to buy back shares which now turned into a tactical execution in terms of what we in fact announced and as we go forward, we already commented on the fact of how we thought through this from a strategic standpoint.

So, as our cash and our balance sheet improves, you know, I think it's fair to speculate what would be our intention in the future, but obviously we can't get ahead of our Board.

OK.

Any chance you can comment on some of the legal reserves you took to offset the Newport News reversal?

For obvious reasons, our preference is not to talk about those and we don't talk about litigation.

I will just say that we did what we thought was appropriate and reasonable with regards to those issues.

I will add that Settling these three major suits I think is a very significant event for us and certainly something that we made progress on through the year.

OK.

But, the reserve you took this quarter weren't related to the settlements, they were related to potential future events, is that -

Exactly correct.

Those that are settled are settled and gone.

Finally, I think you have given sector revenue guidance in the past for '04, I'm not sure of that, which you didn't do this quarter.

Is there any chance you can break down kind of where you are looking for double-digit growth and where your growth plan for '04 may have moderated?

Obviously on Ships.

Let me comment that, as Ron said, you will be getting a full view in the fourth quarter when we have a more -- our plans have a detailed review going into next year.

No, we have not broken out sales by sector or segment going forward into '04.

So, you haven't missed anything.

OK.

No, we've not done that.

What we done is kept sales at the top.

But obviously, We believe everybody is improving.

OK.

Thanks and good luck, Dick.

Thank you.

Your next question comes from Byron Callan of Merrill Lynch.

Hello, gentlemen.

Couple of things.

First, on this higher unallocated corporate cost in '04 quarter, can you elaborate on what those are?

My preference is to say that there are several things in there, we had some legal costs that we had to book.

There is also the fact that we had to true up some deferred comp, our stock plans and valuing our stock plans.

And how we're achieving in terms of our performance factors with regards to that which in fact we have been doing very well.

We want to obviously accrue what we think the payout is going to be and get that captured for this year.

We've done that.

Those are probably two of the three or two of the major items that flow through there.

OK.

On cash flow 2004, you mentioned some of the specific gains, I guess that had been made, one of the units had done better.

But, in this quarter, I am just wondering when you look at 2004 if there are other things you might be able to highlight in terms of specific areas you are working on to improve cash flow from the company because net-net it is still kind of a flattish comparison obviously excluding the B-2 bomber contract.

I assume maybe there is conservatism in your 2004 projection.

Byron, let me say that 2004 may look relatively flat to 2003, but let me also comment on the fact that in 2003, if you recall, we acquired a significant amount of TRW debt out of the marketplace and we paid a premium on that.

The premium appropriately so for financial accounting was treated as part of our purchase price adjustments.

But, for tax purposes that premium was tax deductible.

If you will, the Bagley settlement we had for $111 million is tax deductible, we had a number of other (inaudible) items that created tax benefit.

If you recall in our K, we had a number of carry-over items in terms of R&E credit and AMT carry-over that were utilized for this year.

So in fact For this year, we paid significant amount of tax, obviously on the closing of the B-2 program, a billion dollars, but we've had being able to utilize these other tax benefits if you will have been a benefit this year which we will not enjoy again for next year.

So, that needs to be taken into account and thinking through 2004 versus 2003.

OK.

Finally, Ron, can we once again review priorities of the use of free cash flow for the company, the capital structure is still relatively conservative?

I gather you really don't think there are any large strategic transactions in Northrop Grumman could execute, how do you think about using cash going forward?

We didn't say we are totally out of the acquisition business.

If there are opportunities for both (inaudible), we will obviously consider them.

We are not currently considering any substantial game-changing acquisition like TRW.

We are clearly today focused on purchasing shares back for the market.

We're in that plan now and we will take a look at this down stream and decide whether we want to continue or what we want to do.

We are in the process of paying pretty a competitive dividend in terms of pay out ratio and obviously over time we will determine whether or not that is something we want to continue to do or change it.

We will see how we go.

Great.

Thanks and it's been a pleasure, Dick.

Thank you, Byron.

Next question from Nick Fothergill of Banc of America.

Please proceed.

Good evening from London.

The first question is regarding a follow up from what Byron was talking about just now.

You have done quite well on the cash front in working capital in Integrated Systems and Info tech, are there other segments you could probably do similar improvements over the next year or two?

Let me say, this is Dick, we are always working to improve even where we are doing well.

Quite frankly, if you look at our working capital sales we are doing extremely well.

So, I don't want to say we can't improve, but you know, I think I'm fairly proud of what we have in fact achieved in terms of our working capital ratios.

We will obviously be working to improve.

Now, obviously in those areas in which we have cost-type contracts and as you well know, we have a lot of cost-type contracts because we've won a lot of things that are in the development stage that lend themselves to cost-type contracts.

You have payment terms that are not the same kind of payment terms which you can get when you are dealing with fixed price contracts and negotiate let’s say performance-based payments, which by the way, we've been doing very well with because we have been meeting our milestones either on time or early.

Sounds great.

Second question is on the segment margin guidance for 2004 is roughly the same as it was before at 7.5%.

Can you talk about the stresses and strains around that?

Obviously you are still in quite a lot of cost-type programming at the moment and also you are running off a fairly heavy acquisition run rate.

Are there other things there that you can talk about that might give you some upside during 2004?

Is it still too early to say?

Let me say that as I have chatted about before on different sessions, in a way, I hope it stays 7.5% because it means we have a healthy mix of development work going forward.

If you get too high a rate you need to worry about whether the company is too mature in its program mix.

So, I will say that I think the 7.5% and obviously we are working hard to make it better than that, but it's not -- you have to take into account all the amortization we have and et cetera with regard to purchase accounting for all the acquisitions we have had in terms of normalizing if you will what in fact we are getting from operational standpoint.

When you look at that, you will see we are doing pretty doggone good in the context of the overall mix of our business, which is very healthy.

Thanks.

Ron, quick question for you.

You talked about the opportunity set you have available to you in 2004 for new contracts, Kinetic, you mentioned targets BMC-2 and Space Based Radar.

Can you give us a bit more insight as to when you think these may possibly get announced and what kind of scale they are?

Let me start with Kinetic Energy Interceptor, it's a scale, which probably in the multiple billions range, and it is hard to tell exactly how large, $3 billion to $5 billion over a period of a decade or so.

We think the down select will be completed by the end of the year there.

Of course, we have no guarantee of how fast the government will do that.

That is the current plan.

The Targets payloads and Counter measure is probably first quarter event for down select.

BMC-2, probably about the same timeframe, I am not as close to the actual latest timing on that RFP.

Space Based Radar, the government there has to decide if it wants to go from 5 or 6 competitors down to 2 or 1.

And they will make that decision, I would think probably early next year, as well.

And even if it is down to 2, there will be significant work for '04 and '05 timeframe.

Aero Common sensor is another program that is a significant one.

That is probably a billion plus, maybe 2 billion, who knows.

This is providing reconnaissance aircraft.

That is probably something that will be down selected early next year.

Again, predicting government schedules for down selection is a risky business because as you know, these things tend to slip.

All these programs are important programs so I am sure they will be selected at some point.

Thank you, Ron.

Good luck, Dick.

We will take a question from Sam Pearlstein.

Please proceed.

Good afternoon.

Ron, you mentioned the orders in the quarter and in terms of only counting the funded orders in the backlog.

I guess just looking at it there has now been two quarters, where we see book to bill that shows up significantly less than one.

I understand the tale of Virginia-class, multi years, et cetera, I guess I am just wondering if it is ahead of plan, what are you expecting in terms of total orders for the year and what the backlog will look like as we end 2003?

We have not been predicting backlog or acquisitions for you in terms of guidance, but we are expecting a fairly significant Q4, both Q2 and Q3 have been blessed with some very significant awards, but as I mention, we only give you the funded portion of it.

You worry about that if the programs are shaky programs or that may or may not ultimately be funded.

But programs like Virginia Class and Advanced Hawkeye and others are absolutely main-line programs.

Clearly the level of acquisitions we expect this next quarter will support the guidance that we're laying out for next year.

OK.

And then, just in terms of when we saw the real upside in the second quarter from the ISS segment, you kind of hinted that I guess it was timing of award fees really pulled some of the business into the second quarter.

And I guess to hit your guidance it still seems like we have to see a much more significant sequential decline in margins down into that 7% range.

And I guess I'm wondering what is it that is driving that?

I actually was expecting a bigger fall-off in the third quarter than we saw.

It almost seems as though it is performing better than we expected.

Yes, let me say, that's where our planning went awry.

This is Dick.

Because we were somewhat expecting the fourth quarter, also, but they have been banging away so well that they achieved milestones in the third quarter and got the awards in the third quarter and sucked the well dry for the fourth quarter.

OK.

And then the last question is you essentially increased your cash flow guidance this year for working capital by $2 to $400 million.

I guess can you talk about really what the main drivers are?

Because it certainly didn't look like receivables or inventories was a substantial change.

I'm trying to think about what were the real drivers, is it advances and advance payment expectations or anything like that?

Let me say advance payments and things like that do go into our working capital numbers.

So, it really is in the working capital, we have improved working capital.

And you know, we have done very well with regards to as I said with regards to generating higher award fees and otherwise were in our plan originally, which obviously generates cash.

So, I will say from a program performance standpoint, as we've been raising our guidance, it has a caboose on that of raising your cash.

And we have been doing a good job in terms of managing our working capital better than we thought we were going to do in terms of the year.

OK.

Thank you very much and let me add good luck guys.

Thank you.

Your next question of the day comes from Cai Rumohr of SG Cowen.

Yes, Thanks a lot.

When you made your change in guidance because of the carrier, my understanding at the time was that that was a discreet event that was announced and therefore you had to change your estimate because of it.

But, that you didn't true-up for other issues which could include the fact that the Navy was sort of interested in putting some additional business into the yard and we've seen strong funding, you know, so and a supplemental and congressional add-on.

So, obviously there were some other things also happening that presumably were not reflected in that one change in guidance.

Could you comment just qualitatively on some of those things? how are we doing in terms of getting additional work into Newport to take care of the bathtub and are there any other sorts of things just qualitatively that makes '04 look better or worse?

Yes, Dick asked me if you needed your boat repaired, we could probably accommodate you.

Cai the number we showed you was a net number and it was net of the movement of the Vincent, which is a substantial amount of work for this ship.

But we in fact did presume a partial fill in of some of the work, which we would lose.

It's not just an issue of total work we have to make sure we have work, which maintains some of the key skills that we have in the yards.

We have nuclear trained technicians and we have pipe fitters and electricians and etc.

We are still in the process of working with the Navy to sort out exactly how we will lay in the various workers.

As you know These ships don't just sit around waiting.

They have to come out of the fleet they have to be in their own maintenance cycle associated with fleet operations.

But we felt the number we gave you was a reasonable net impact of moving the Vincent and a reasonable likelihood of work that we would expects to see filling in.

And then as the next several months progress, those schedules will get firmed up.

OK.

And was the move of the Vincent does that have any negative implications for profitability on the Virginia submarine given that it is going to be fixed price multi it is going to be a multiyear?

Yes, It will obviously play to the general overhead number, but most of the work on the new tranche of Virginia for the current tranche, by the way, has a cost nature to it.

So, the future fixed price work most of that won't be hitting us hard until several years out in terms of heavy workload.

And we've made certainly assumptions in terms of levels of work in the yards.

One silver lining in the moving of the Vincent, is that it really does help smooth out some valleys and gaps we would have in the out years in the 08, 09 timeframe or 07 to 08 or 09 timeframe.

So, it's not totally a bad thing.

We obviously would like to have the work sooner, but as you know it was determined by the Navy that the core of the Vincent had effectively another year of life on it and given the issues of strategic importance of the Western Pacific it was determined and rightly so, that we should keep that ship in the fleet for another year before we bring it back.

Let me add Cai with regard to our guidance for '04, that overhead impact was taken into account, obviously --

OK.

And as far as for pension, you said, kind of all this is assuming flat pension.

I guess you have one of the lower discount rates kind of going into this year of 6.5, but presumably if we close the books we would bring it down.

Can you give us any qualitative sense like how or what is your plan actual return year-to-date?

We know that may not be how you finish the year, just to give us some sense in terms of how we think about how pension might actually come out next year?

We will all take a vote.

Cai, let me say that our plan to date is about 12.5% is what we’ve achieved to date.

And you know, we have a presumed rate of return of 9.

We're currently using a discount rate of 6.5.

Quite frankly, from what we see, there may be, may be appropriate to reduce that discount rate which obviously increases the liability and therefore increases the FAS 87 cost.

But, quite frankly, you have to wait until year-end to reevaluate all the assumptions to determine what is in fact an appropriate assumption.

So, I hate to speculate too much because whatever I say it is going to be really wrong.

So, I’d just rather say where we are.

I will say in terms of variance analysis.

If you want a variance, we try to give some guidance with regards to that, but know what you can do with it.

For about every 25 basis point change in the discount rate, it's about $25 million.

In other words, if we go down 25, it costs you about $25 million.

If you have an asset gain of 1%, it improves by about $25 million.

And if you have, that is with regards to the actual performance of the fund for the year and if you change your expected rate of return, it's going to be, let's say 50 basis points, which would be about $75 million impact.

So, if we were to go up or down by 0.5%, it would improve or degrade by $75 million.

Again, nothing to do with how we actually fund for Orissa or how we charge government contracts.

Excellent.

Thank you very much.

George Shapiro of Smith Barney.

Good afternoon.

Hello, George.

I wanted to pursue a little bit the backlog, because I recognize there is timing issues here.

If I look at Space Technology, I mean backlog was down over $400 million and it is only a business with over $700 million in revenues.

So, did anything unique happen there?

Were there any cancellations or it really is just a timing issue?

No, nothing unique, nothing special, it’s just a question of the timing of the formal funding and as we mentioned, we have a conservative way of telling you what backlog is.

We have to have it fully funded.

These are ongoing programs.

We don't have any programs which we are worrying about because they haven't funded that we are going to get into a (inaudible) condition or maybe they will get canceled.

Ron, the same question, and I will stop pursuing this, on Integrated Systems, the backlog is down like over $600 million.

The sector only has $950 million in revenue, is it just the fact you hardly signed up anything this quarter again?

I think the Advanced Hawkeye is probably the most significant example of that.

That is almost a $2 billion program.

They gave us a small squirt to get started.

Funding on Global Hawk and F-35 come in increments.

OK.

In the electronics margin, I think you that had mentioned early on there was some sort of an incentive that you got for sending an antenna to Boeing, was that a significant impact on what was a pretty robust margin in the business for the quarter?

No, that was a very small, almost non material item.

We gave it as example because it involved the Wedge Tail program just to show that we are making progress on that program.

As you know, We are booking small positive margin on the program.

Right.

OK, one little thing, probably for Dick.

Other income had minus $5 million in it this quarter.

Usually that's some small positive number.

I was just wondering what might have happened there.

Well, let me say, George, that account is made up of interesting items as royalty income, gain or loss on sale of assets, income expense of unconsolidated subs and other miscellaneous items.

Quite frankly, what happened is, we didn't have -- we have been in the business of selling off a lot of real estate.

I must say, We have been doing a very good job of doing that.

We didn't have anything significant in the area of real estate sales for the quarter, which is kind of bad news for financial accounting, but good news in terms of getting the stuff out of backlog, if you want to think about it that way.

So, that's probably the biggest item of them all as to why you see a flip in the numbers.

OK.

And may be one last one.

Could you just give me the proforma space and Mission growth in the TRW businesses?

Obviously we didn't report it because they were reported under TRW.

If you do numbers to numbers, Mission was 8 or 9%, Space was again over 40%, as we said in the second quarter.

Those are not official numbers.

They may not match up exactly.

Let me say, you can't presume revenue that their revenue recognition is the same as ours.

We have to throw out all these caveats in today's world, as you know, George.

Yes, OK.

Thanks a lot and lots of luck, Dick.

Thank you George.

Ladies and gentlemen, we have to cut it off here, we do have some media interviews coming up with, Ron you want to -

Yes, let me say in closing, we had a terrific quarter in all respects and 70% organic sales growth on top of the contribution from two TRW sectors, strong margin performance and outstanding cash generation.

We've increased our guidance for the year in sales, cash and EPS.

We’ve significantly reduced the risk profile of the company during the first nine months of the year and we've initiated a share buyback program.

We've got an outstanding book of business going into next year with potential for some very large wins in the near term.

All in all, a great performance and a strong outlook.

We appreciate your continued interest in our company and thank you all for participating on our call.

Thanks, ladies and gentlemen.

Ladies and gentlemen, thank you for your participation in today's conference.

You may now disconnect.