諾斯洛普·格拉曼 (NOC) 2003 Q4 法說會逐字稿

Welcome to the Northrop Grumman fourth-quarter earnings conference call.

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

My name is Mike and I'll be your conference coordinator today. (OPERATOR INSTRUCTIONS) A question and answer session will follow the presentation. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded.

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

Please proceed, sir.

Thank you, Mike, and good morning, ladies and gentlemen.

We've provided supplemental information to this presentation in the form of a PowerPoint that you can access at our Investor Relations website at NorthropGrumman.com.

It is available as am accompaniment to our conference call and it includes a definition of 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.

Before we start please understand that, as shown on slide 3, 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 the Company's SEC filings, including the Form 10-K and Forms 10-Q, among others.

During the call we'll discuss fourth-quarter and year-end results as well as the outlook for 2004.

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

We'll also discuss total segment operating margin which is a non-GAAP measure.

Also please note that we have two additions to our quarterly financial press release.

We've added total backlog to our disclosure this quarter for both the Corporation and the six reporting segments.

Total backlog includes our usual funded backlog plus firm orders for which funding is not currently contractually obligated by the customer.

The second addition is a schedule that presents pro forma results for 2003 reflecting the realignment of certain business areas within our Information Technology, Mission Systems and Integrated Systems segments, which was effective January 1st of this year.

The pro forma numbers are the basis of our segment projections for 2004.

And one more housekeeping note, Northrop Grumman will be holding its annual institutional investor conference on May 12th.

We'll be sending further information on this conference shortly so please put it on your calendar.

On the call today are our Chairman, CEO and President, Ron Sugar and our Chief Financial Officer, Chuck Noski.

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

The outline of his comments is shown on slide 4.

Thanks, Gaston, and thank you all for joining us.

Overall I'm very pleased with our fourth-quarter and 2003 year-end results.

Fourth-quarter sales increased 47 percent topping $7 billion for the first time in Northrop Grumman's history and full year sales rose 52 percent.

Our two newly acquired segments, Mission Systems and Space Technology, were major conservators to the increases, but all four of our other reporting segments, Electronic Systems, Ships, Information Technology and Integrated Systems, achieved double-digit sales growth in 2003.

For the fourth-quarter, organic sales growth was 11 percent and for the year 13 percent.

Segment operating margin increased 40 percent for the fourth-quarter and more than 50 percent for the year.

The fourth-quarter was impacted by a $40 million charge for the F-16 Block 60 program primarily associated with the integrated electronic warfare suite, or Falcon Edge as it's known.

We believe the charge we've taken adequately provides for the completion of Falcon Edge engineering, manufacturing, development and production.

That said, as is the case with any fixed-price program, risk will remain until the program is completed.

I also want to emphasize that, despite the charge, Electronic Systems had outstanding operating performance across all its business areas and operating margin met our 2003 financial guidance of nearly 10 percent.

Fourth-quarter funded back -- from the contract acquisitions totaled $10.4 billion, another record for the Corporation, bringing funded backlog to approximately 27 billion and total backlog to 58 billion.

Total backlog includes programs like Virginia class submarines, F-35, DD(X), National Polar-orbiting Environmental Satellite System or NPOES, advanced Hawkeye, and Kinetic Energy Interceptor, and provides more visibility into the pipeline supporting our future growth.

The $4 billion Kinetic Energy Interceptor award was one of our fourth-quarter contract acquisitions.

The KEI award, as we call it, is especially gratifying because it validates our TRW acquisition strategy.

It highlights the success of our cross sector collaboration, and it firmly establishes Northrop Grumman as a prime missile defense contractor.

KEI is being led by Mission Systems, but nearly every Northrop Grumman sector will participate on this important program.

During the fourth-quarter, Boeing received an $8.6 billion multiyear procurement for an additional 210 F/A-18 Super Hornets and a $1 billion contract for system design and development of the EA-18G Airborne Electronic Attack Aircraft version of that aircraft.

Northrop Grumman is the principal airframe subcontractor on the F/A-18 and we are also the principal electronic combat system integrator for the EA-18G.

Our portion of the EA-18G development phase is approximately $500 million.

This is the first step in what we hope will be production of 90 EA-18G platforms.

Ship Systems received two large contracts in the fourth-quarter, a $419 million contract to build DDG 107, the 57th ship of the Arleigh Burke class; and an $817 million award for the LPD 21 amphibious assault ship.

Also during the quarter the Pentagon approved acquisition strategy for a major radar program known as MP-RTIP, which should position us to begin development for the system and the system development phase in the near future.

MP-RTIP will dramatically increase the military's ability to detect, track and identify ground vehicles and low-flying cruise missiles and strengthens our expertise as a system of systems integrator of battlefield systems.

And shortly after the end of the year, Northrop Grumman was one of the three teams selected to participate in the next phase of the Homeland Security Department's aggressive program to develop and test anti-missile systems to protect commercial aircraft.

We'll also share in a newly announced $8.4 billion multiyear contract to produce five Virginia-class submarines for the U.S.

Navy, and we recently received a $706 million contract to produce eight more Hawkeye 2000 E-2C planes.

To summarize, we had a very strong fourth-quarter and year with some very important wins and excellent financial results.

It's been a major transition year at Northrop Grumman.

We're moving from a period of strategic transformation into one in which operational and financial execution will be our key focus.

We accomplished a lot in 2003 to sharpen that focus.

We sold TRW Automotive.

We reduced our debt -- our net debt by nearly $2.7 billion, and on top of that we made the $1 billion B2 tax payment.

We've sold three of the six Component Technologies businesses and expect to close on the fourth in this quarter.

The integration of TRW is complete, and we've realigned Mission Systems and Information Technology segments.

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

Looking forward, based on the President's budget, we continued to plan for steady, sustainable growth in national security spending.

The 2005 increase to the DOD investment account is about 3 percent with double-digit increases in areas like missile defense.

The remainder of the future year defense plan shows approximately 6 percent annual growth through 2009.

In today's world we believe that spending on recapitalization and transformation of our homeland security and defense assets will continue to be a national priority with particular emphasis on areas like national missile defense.

Northrop Grumman programs like DD(X), LPD, KEI, F-18, F-35 and the future combat system, to name just a few, continue to be very well supported in the 2005 budget and represent a solid pipeline of business.

We are also pursuing substantial new competitive opportunities, including space-based radar, aerial common sensor, transformational communication system, the joint unmanned combat aerial system, and several international and homeland security programs.

We continue to focus on operational and financial performance and our outlook is for continued growth in 2004 and beyond.

Now I'm pleased to welcome our new Chief Financial Officer, Chuck Noski, to Northrop Grumman and to this conference call.

Chuck will now provide more information on our results and the outlook for 2004.

Thanks, Ron, and good morning.

My comments today began on slide 5 and cover our overall 2003 segment operating margins, segment results and trends, operating margin line items, cash flow and our expectations for 2004.

Total segment operating margin for the quarter was $544 million versus $388 million in 2002, up 40 percent.

The segment operating margin rate for the quarter was 7.7 percent versus 8 percent last year.

For the year, the segment operating margin rate was 7.6 percent versus 7.7 percent in 2002.

For 2004 we expect a segment operating margin rate in the high 7 percent range.

Turning to the sectors and moving to slide 6, Electronic System's fourth-quarter margin fell 2 percent on sales growth of 9 percent due to the charge on Block 60 that Ron mentioned earlier.

Regarding the Falcon Edge program, we've begun delivery of engineering, manufacturing, development and production hardware.

While this program is experiencing cost growth associated with developing and acquiring the advanced microelectronics necessary to meet production specifications and delivery rates, we believe we can complete the program within the latest cost projections.

However, as Ron said, any fixed-price development program -- with any fixed-price development program risk will remain until the program is completed.

The impact of the charge was partially offset by improved operational performance across the sector, as well as several favorable contract closeouts.

For the year, sales rose 13 percent to more than $6 billion and operating margin increased 36 percent.

The segment's operating margin rate expanded 170 basis points to 9.8 percent in line with our guidance of nearly 10 percent.

The year-over-year improvement in sales and operating margin reflects across the board strength in nearly every business area.

Volume was higher in combat avionics systems such as the F-35, F-22 and several classified programs and in marine systems in C4 ISR.

They also had higher volume in defensive systems programs including ALQ 135, Lercolm (ph), MH53 and Lightning.

We expect Electronic Systems sales growth and margin expansion to continue in 2004 with sales increasing at close to a double-digit pace and margin rate expanding to 10 percent or better.

Moving to slide -- Ship's fourth-quarter operating margin increased nearly 10 percent on sales growth of approximately 13 percent.

Operating margin for the quarter was $114 million or 7.3 percent versus $104 million or 7.6 percent in the fourth-quarter of 2002 which included an $11 million margin pick up on the LPD program.

Fourth-quarter sales were $1.6 billion versus $1.4 billion in 2002.

Ship's fourth-quarter sales were particularly strong due to the ramp up on the DD(X), LPD and LHD programs partially offset by lower revenue in aircraft carriers due to the delivery of the USS Ronald Reagan earlier in the year.

Ship's 2003 revenue exceeded our $5 billion plus projection primarily due to timing of revenue on the DD(X) and LPD programs.

For the year Ship's margin rate of 5.4 percent versus 6.5 percent in 2002 met our guidance of 5 to 5.5 percent and reflects both a changing business mix oriented towards more development as well as the second-quarter 2003 charge on Polar Tanker.

For 2004 we expect low single digit sales growth reflecting the deferral of the USS Carl Vincent overall from 2004 to 2005 with an operating margin rate expanding to between 6 and 6.5 percent.

Turning to slide 8, information technology sales rose 11 percent in the quarter and nearly 12 percent for the year and operating margin increased 16 percent in the fourth-quarter and 12 percent for the year.

Government Information Technology was particularly strong in the fourth-quarter and throughout the year, but we saw growth in all of our IT business areas, both in the fourth-quarter and for the year.

Information Technology 2003 sales exceeded our goal of $4.7 billion by about $50 million and our 5.9 percent margin rate met previous guidance.

For 2004 we expect high single digit sales growth with an operating margin rate about the same as 2003.

On slide 9 you can see that Mission Systems generated fourth-quarter operating margin of $62 million or 5.7 percent on sales of $1.1 billion.

For the year, Mission Systems generated 6.3 percent margin on $4.1 billion in sales, exceeding both our sales and operating margin guidance.

For 2004 sales were expected to grow in the mid to high single digits with stable margins.

Turning to slide 10, Integrated Systems generated $1 billion in sales for the first time since the fourth-quarter of 1999 and is on a solid growth trajectory.

Fourth-quarter operating margin grew 44 percent on a sales increase of 23 percent.

Fourth-quarter margin expansion reflects higher Air Combat systems sales, improved performance and favorable contract closeouts.

For the year the IS margin grew nearly 15 percent on sales growth of 16 percent. 2003 sales of $3.8 billion met our increased guidance and the operating margin rate of 10 percent met the high end of our guidance.

Looking ahead to this year 2004, we expect 15 to 20 percent sales growth and a margin rate in the mid 8 percent range.

These trends reflect continued ramp up on lower margin development programs like F-35, unmanned vehicles, advanced Hawkeye and E-10.

Slide 11.

Before I move on to Space Technology, I want to point out that our 2004 projections for Information Technology, Mission Systems and Integrated Systems are based on the pro forma 2003 results depicted in this slide and provided for you in this morning's earnings press release in the schedule titled segment operating results before and after realignment.

As Gaston mentioned, the realignment of certain businesses within these three segments was effective January 1, 2004.

This slide illustrates the pro forma comparisons and guidance for 2004.

Turning to slide 12, Space Technology also had another strong quarter with $700 million in sales and an operating margin rate of 7.6 percent.

For the year Space Technology sales totaled $2.8 billion, but by Intelligence, Surveillance & Reconnaissance and Civil Space with a margin rate of 6.8 percent. 2003 sales were significantly higher than what we projected at the beginning of the year, and for 2004 we expect mid single digit sales growth over that higher base with a stable margin rate.

Turning to slide 13, as I said, for the company as a whole, the 2003 segment operating margin rate was 7.6 percent, approximately even with 2002.

And for 2004 we do anticipate modest margin rate expansion to the high 7 percent range along with volume driven increases in operating profit.

Looking at consolidated operating margin, corporate expense in the fourth-quarter was $72 million versus $22 million due to increased legal costs and higher estimates of unrecoverable costs.

For 2004 we expect unallocated corporate expenses to again total about $140 million.

Slide 14 presents our 2003 actual results along with estimates for 2004.

Pension expense for the year was $568 million, and cash pension expense was $265 million. 2003 returns on our pension plan assets exceeded 20 percent, and as a result an additional minimum pension liability we recorded last year was largely reversed.

For 2004 subject to refinements for participant census data and pay as you go plans, we expect pension expense on a GAAP basis of $330 million and cash pension expense of $305 million.

Accordingly, we expect the impact of pensions on our 2004 performance to equate to an improvement over 2003 of approximately 93 cents per share which is net of the associated increase in state taxes due to the lower pension expense.

The effective tax rate for the fourth-quarter was 31 percent and 29 percent for all of 2003.

We expect an effective tax rate between 34 and 35 percent in 2004.

Cash from operations in the fourth-quarter totaled $773 million, bringing full year cash from operations to $1.8 billion before the $1 billion B2 tax payment.

The $300 million increase over our previous guidance reflects improved year end cash collections at Newport News, Integrated Systems and Mission Systems.

Capital expenditures, including capitalized software costs, were $235 million in the fourth-quarter, $635 million for the year versus our guidance of $720 million.

We expect capital spending in 2004 to be approximately $800 million.

The increased spending provides for growth in new programs as well as recapitalization and modernization at all three of our shipyards.

Fourth-quarter depreciation expense was 119 million, 455 million for the year, and we expect depreciation to increase to a bit over $500 million in 2004.

Amortization is expected to continue in 2004 at the same level as in 2003.

Our balance sheet is substantially stronger than a year ago with net debt to total capitalization of 26 percent versus 34 percent at the end of 2002.

We expect net debt to total capitalization to continue to improve in 2004.

Through the end of 2003 we purchased approximately 2.2 million shares of Northrop Grumman stock at an average price of $89.50, which represents $200 million of our existing $700 million repurchase program.

We expect a portion of our 2004 cash flow will be focused on completing the $700 million share repurchase program we announced last August.

On a consolidated basis then we expect 2004 sales of approximately $28 billion with earnings per share growing to between $5.60 and $5.90 per share.

Even with the better than expected cash performance in 2003, we continue to expect cash from operations in 2004 of around $1.5 billion.

With that I'll turn the call back to Gaston.

Thanks, Chuck.

Mike, we're ready for questions now.

(OPERATOR INSTRUCTIONS) Sam Pearlstein with Jefferies & Co.

You had mentioned the $1 billion increase to equity from reversal of the pension liability, and now you're clearly well below the 30 to 40 percent debt to cap that you've talked about in the past.

You mentioned that completing the authorization in '04, but I guess is there more -- should we see more aggressive activity in terms of getting that leverage back up?

Is there something -- can you talk about what your current view of the dividend is at this point and other methods I guess to increase that leverage?

I think, as we have previously indicated, we've got a set of capital structure priorities that we're focused on.

First, we want to make sure we've got a solid investment-grade rating.

You saw in recent months two of the three rating agencies upgrade Northrop Grumman, and I think there was even some favorable commentary by the third rating agency that chose to hold their rating.

So we're going to be focused on that.

We also want to make sure that we've got a reasonable level of flexibility for further strategic activities.

I think Ron has previously indicated, we will look for and be open to bolt-on types of acquisitions, but we don't at this point anticipate any significant strategic activity, unlike the past.

We certainly want to ensure that at least to the degree that our shareholders are bearing dilution from option exercises and other compensation related equity that we want to insulate the shareholders from that.

Beyond that, we will continue to look for opportunities to return cash to shareholders, whether that be in the form of additional share repurchases.

We will consider and reconsider the dividend policy as we get into 2004.

We're obviously not prepared today to make any such announcements along those lines.

But we are sensitive to our shareholders' interest in the actions that we can take to enhance overall shareholder returns for our long-term investors.

Just to follow-up, you mentioned the increase in the capital spending in terms of modernization at the shipyards.

Is that something that should be complete in 2004, or does some of that modernization continue, and see a high rate of CAPEX into 2005 as well?

It will continue into '05.

I'm not sure, Sam, I would say that you should expect the same level of spending in '05.

Okay, thank you.

Steve Binder with Bear Stearns.

Good quarter.

Chuck, can you maybe just touch just briefly on the margin guidance for '04?

I think your predecessor had said back in the third-quarter you're expecting stable -- sector operating margins in '04.

You kind of talked about a modest increase in '04.

Is that a function of mix of sales in '04, or is it a function of a little bit stronger ship margins than you might have previously expected ship or ES?

Steve, I think as you can see on charge 16 of the materials that we've posted on the Web, we are expecting an improvement in margin.

I think it's a combination of mix across all of our businesses, as I mentioned in my earlier remarks.

And we are seeing several of our sectors do a bit better.

So I think it is a com -- as you suggested, it's a combination of those.

And can you maybe just in the quarter quantify -- you talked about in the release favorable contract adjustments in ES and IS.

Can you maybe quantify how much that was?

I don't think, Steve, we're going to get into specific numbers on that.

As you might expect, as you true up the year and we do a pretty extensive review and assessment of the profit rates on all of our contracts as well as, obviously, we have programs that close out, and there's always some residual either up or down from there.

If you look across it, and we have, I think you would see just a wide array of items going both ways.

All right.

And Ron, can you just touch on the EAC issue with respect to the Block 60 contract?

Back in the third quarter, obviously you touched on some comfort level with EAC at that time; can you maybe touch on what happened in that last 90 days there to increase it?

Sure.

These are costs that are basically projections of the cost to complete, which takes us through the end of the contract out the next year or two.

These are very complex -- first of all, let me just say that three of the four Block 60 subsystems are in great shape and progressing very well.

One of the four is this electronic warfare piece.

And this particular one is involved with the problem of complex RF components.

These are components which were designed and being tested and tuned to an extremely high level of performance.

One of the issues is how much yield can you get in these units?

In other words, how many of these units that you produce can actually achieve the performance level and how many do you have to basically not use or discard?

Over the last several months of the final quarter we've actually been in the hard testing phase, and we've discovered the yields of these units is less than we had hoped for.

And as a result, it has some impact in terms of delivery rate and cost to produce each unit.

That's the new fact that's developed over the last several months.

And roughly, in the quarter and for the year, excluding the deferred tax payment, what was your -- were you in a net refund position for '03?

Steve, marginally for 2003 we had the $1 billion tax payment for B2 and really had no other substantial or significant taxes beyond that.

And so for '04 do you have a projection on cash taxes?

Yes.

We expect it's probably around $500 million for the year.

Thanks very much.

Cai von Rumohr with SG Cowen.

Good quarter.

Ships, it looks like the revenue guidance for '04 is off a bit and, as Steve mentioned, that the margin target is off a bit.

Could you give us a little more color on that specifically, also commenting on the profit catch up on LPD 17?

The profit catch up on LPD 17 was in 2002.

That's (multiple speakers).

We're trying to get you to apples-to-apples.

Okay.

But it looks like -- the ship numbers look a bit stronger, what does that reflect?

I don't know that there's anything in particular, Cai.

This is pretty well in line with our expectations.

You know, we did have -- we are basically expecting that we're going to proceed with Polar Tanker and get the fourth one delivered this year and most of the fifth one completed.

We're not going to have, in our anticipation, the repeat of some of the issues we had in the past year on that.

So we'll see some margin changes there, I'm sure.

Okay.

Could you comment on your bookings outlook for 2004 and where do you see your firm backlog ending the year?

I don't think we can give you a number on firm backlog.

Certainly our funded backlog number now is about a year's worth of sales.

We typically like to bring in at least as much as we spend.

Beyond that, I can't be more specific.

I would say that in general the government is eking out the funding on contracts more than they use do so there's more quarter to quarter funding, so the total backlog is becoming sort of a more meaningful number, you need to look at the two of them together.

But it is difficult to project how much actual funding will be on contract at any given point in time.

I think, Cai, as well in Ron's earlier remarks he identified a few of the major opportunities that we're looking at.

Those are big swing items for us.

Okay.

Last one.

You mentioned in response to Sam's question strategic opportunities.

Are you looking at any additional M&A, and if so what are the parameters you're looking at?

Well, obviously we haven't closed our M&A shop.

We're always looking at ways that we can either add or remove businesses.

We don't comment on any specifics and so I don't think we can give you any more specifics at this point in time.

Okay.

As I recall, on the third quarter you seemed to suggest no large deals.

Any parameters -- are we talking about niche fillers both ways?

Yes.

I think as opposed to deals of scale with TRW I'd say that's most unlikely for a lot of reasons.

However, clearly niche fillers is something we're always looking at for places that we can bolt things on -- Chuck used the term bolt-on, I'll use it as well -- smaller businesses that can be acquired.

We did actually acquire a couple of very small businesses this last quarter or two.

But we'll continue to look at those as they make sense.

Cai, I think you can expect we're going to be in a continual process of some portfolio shaping, which is both continuing to reassess the elements of the businesses that we have, as well as considering whether or not we've got areas where we can fill in.

But it's that scale of activity, as Ron suggested, rather than any large-scale acquisitions.

Thank you very much.

Joe Nadol with J.P. Morgan.

Good morning.

My first question is, were there any cash receipts in the quarter outside of the cash from operating activities line that were unusual, either be it divestiture or anything else?

Joe, I would say other than the Poly-Sci sale -- but that's not really cash from operations.

Right.

No, that's what I mean.

What was the -- I guess what were the receipts on the Poly-Sci sale?

I don't know that we've announced that publicly -- I'm not sure we can.

Okay.

I think you had like 100 or 200 million more of cash balance then -- I would've thought, which is good.

Could you give more detail on the corporate expense line?

You came in a little higher, I think 20 or 25 million more than you thought in Q4, and you guided for a little higher next year than you were previously indicating.

Different things going on, Joe, in 2003 versus 2004.

In 2003 we took some additional provisions for some estimated legal costs, and we also, as we look at the wide array of activities that we have going on with our government customer, we made a determination that there's probably a higher level of certain costs we incurred in 2003 that we expect to ultimately be unrecoverable.

And so we wanted to reflect those in the 2003 results.

Those -- we don't see those recurring in 2004.

What's in the 2004 guidance we gave of about $140 million is increased state taxes, as well as some levels of additional unrecoverable costs.

Okay.

Your '04 guidance does not contemplate any activity with regard to your auto stake.

Is that correct?

That's correct.

I would point out, though, that we do have that stake on our books at $170 million, and I think based upon yesterday's closing price it has a market value of about $460 million.

Okay.

Have you given any public indication of what you're interested in doing there?

No, I think it's fair to say obviously we're going to honor our obligations to TRW Auto and to the Blackstone Group as a part of that transaction earlier this year.

But I think it's fair to say, Joe, this is not a strategic asset to us, and we do have an interest in monetizing that in an appropriate fashion at an appropriate value.

And just one final one.

In the sales breakout of your ES segment, the Aerospace Electronic Systems was down from last year.

Was that a result of the Block 60 charge or was there something else going on there?

Let me get back to you on that. (multiple speakers) It was not a big variance, Joe.

I don't think there was anything -- any one unique item.

Thank you.

George Shapiro with Smith Barney.

Just following up a little bit on one of Joe's questions, how long have you agreed not to sell any of these TRW shares?

There are two elements to this, George.

Obviously I think there's about a six-month period where we would not be selling beyond that.

Working with them I think we have an opportunity after that.

We do have by March of 2005 the ability to in effect true-up our -- the percentage ownership we have both pre and post the IPO.

That probably equates to about 3 million shares.

Beyond March of 2005 we can sell down -- we have registration rights and also have the ability to sell down pari passu with any offerings that Blackstone may choose to make.

Okay.

And then the sales guidance for the year that you had given at the end of the third-quarter was 25.5 to 26, so you obviously beat that at 26.2.

What Ships primarily the area that you beat the sales by, or was there anything better than you would've expected in the quarter in other areas?

It was largely ships, George.

Okay.

And then, without the 45 million charge in the electronics area, that margin would've been 11.9 percent, which is above -- we've seen margins 10.5 to 11.

Is it fair to assume that maybe 1 percentage of that was reflecting the onetime pickups and adjustments that you referred to in your earlier comments?

George, I think our full year guidance for '04 gives you a good idea of the sort of the run rate.

And I do want to point out that the provision for Block 60 was 40 million, not 45.

Okay, I thought I said 40.

Okay.

And then if you -- is there any way that you care to breakout the higher unallocated expense between legal and unrecovered, or do we just kind of assume they're roughly half and half?

I wouldn't assume they were roughly half and half.

But you don't want to break it out?

I think my general counsel would be unhappy with me if I did.

Okay.

And last one.

Other companies have had lower CAS reimbursement this year relative to last year, and your guidance -- you're actually up a little bit from the 265 that you had last year.

Is there anything unique to that or it's just how it comes out for you versus some of the other companies?

I can't comment specifically on the other companies, George, but I can tell you that, perhaps distinguishing us from the others beyond the accounting method that we use would be the fact that beyond our Northrop Grumman legacy pension plans, as you know, in recent years we've made a number of acquisitions, and we have several acquired pension plans, which are still requiring funding.

And so as a result we've got more costs to allocate to U.S. government contracts under cost accounting standards.

Okay, that's interesting.

And the strength in the cash flow in the fourth-quarter, was there any acceleration or pickup in terms of the quickness that the government paid?

Because I notice that you're actually showing somewhat lower guidance in '04 despite the fact that earnings are up.

Actually, George, clearly all of our units did a great job in maximizing cash in the current year.

In fact, we consent that behavior obviously consistent with working effectively with our customer.

Actually our guidance for cash in 2004, we're really reaffirming what we've said previously, so we haven't reduced our guidance in '04 notwithstanding the fact we had much better than expected performance, something on the order of about $300 million in our cash performance in the fourth-quarter.

But it's largely a very active and focused set of efforts to accelerate cash collections wherever we can.

Okay, thanks a lot.

Good numbers.

Nick Fothergill with Banc of America Securities.

Very nice quarter.

Ron, could you -- you rattled through some of the competitions that are coming over the years, Space Based Radar, Aerial Common Sensor and a few others, and later on in the call you referred to these as quite big swing items.

Can you pick out one or two of those and tell us what scale they might be to you and roughly the timing or when the decision-making may be made on these?

Let me take a crack at that.

Let's see -- the Space Based Radar is a fairly significant item.

It's going to be in competition.

We are offering a prime offering on the program, we're also supporting another team in terms of technology.

That's for the first phase of that program.

It's not the -- it's probably not the multibillion dollar scale program yet but it's probably in the 100 to 200 range, in that order.

Aero Common Sensor is a fairly significant program, very competitive program.

That's probably a $1 billion class program, something to be determined probably in the spring.

Transformational (ph) Communications System is more of an advanced study in technology phase.

We do have a couple of other classified programs we don't specifically call out which could be interesting as well.

Can you give us at least the scale of some of those classified programs?

If you added them up together would they be $1 billion plus?

I really wouldn't want to comment at this point on those.

Fair enough.

Secondly, a number of people have asked questions about the margin upside you're alluding to in 2004 in your guidance.

And Ship Systems move from 5.4 percent up to 6 to 6.5 is the range.

Are you now prepared to record a bigger margin from almost a zero margin at (indiscernible), are things improving there and are you prepared to take a profit (indiscernible) now?

I think, Nick, keep in mind, on an apples-to-apples basis in '03 we took a charge on Polar Tanker in the third quarter.

Obviously we don't anticipate, given the good progress that's Ship Systems is making on that program, we don't expect that to continue or problems to continue.

And we certainly don't anticipate any provisions in 2004.

And so, you really need to normalize 2003 for that second-quarter Polar Tanker charge, and you'll see obviously improved margins, but roughly a 0 percent booking rate going forward on Polar Tanker.

Okay.

And then on Block 60 and any other fixed-price development programs you're still at, I wonder -- that was actually a reasonably small charge you took there and you did warn us that there may be some charges following and they would be in the scale of 10s of millions, so I guess that's what happened.

But you talked about it not being over really until those programs go into delivery, I guess.

Could you give us a rough idea when you expect that to be?

Well, it's never over until it's over, and all fixed-price programs are fixed-price programs until the end.

We will expect probably by the end of the year we'll be in a place where we'll pretty much have most of this behind us.

That's great, okay.

And one last one.

Pension, the expense rate was down obviously quite significantly relative to guidance.

If one is prepared to look forward into '05, do you think that's going to -- you're going to see a similar drop, all things being equal on economics and discount rates?

This is Chuck Noski.

Actually I don't think we previously gave any guidance on pensions in '04.

Obviously, as you may be aware, we, unlike most (inaudible) of a major nature in this industry, we tend to recognize the performance, the investment performance of our pension plans more rapidly than others.

And so when markets improve, we have improved pension expense relative to the prior year and relative to our competitors and when the market goes down we will have a similar offsetting effect.

So in order to answer your question I have to predict how the markets will do in 2004, and I don't think any of us are clairvoyant enough to do that.

So I think it will depend a lot, and particularly for us, on the performance of the pension funds in 2004.

Okay, that's fair enough.

But at least obviously your amortization rate is quicker than many of the others in the rest of the group (multiple speakers) and could, I guess, come out of the woods earlier than everybody else.

Not -- most everyone amortizes over a three to five year period, and we recognize it under the current recognition method in the forthcoming year.

That's great.

Thank you very much.

Byron Callan with Merrill Lynch.

Great quarter.

A couple of quick things.

The range, Chuck, that you've talked about for 2004, is there any way to kind of highlight maybe the two or three issues that might bring you to the upper end of that range or the lower end of the range?

Well, Byron, across a pretty diverse set of businesses you might imagine that that's a bit of a challenge.

I think clearly one of our focuses, as Ron said, is on operational execution in 2004.

We have to look back at 2003 and acknowledge that in the second and fourth quarters we took charges related to fixed-price programs that I'm not sure anybody anticipated at the time.

So one of our jobs will be to work hard to ensure that we don't have those kind of events in 2004.

Similarly, we're very focused on margin improvement at all of our units, and, as you know, in some of our units we reflected guidance of stable margins.

That's not a laydown hand.

Everybody's got to work pretty hard to achieve those margins and -- but we will be driving this year across the board to see if our businesses can do better.

Okay.

But there -- now we can't even skinny this down a little bit more to specific sectors or even programs that there may still be some risk in thinking through 2004?

One of the nice things about the portfolio of the company now an it's constituted is we have so many things going on and no one thing or sets of things is that significantly material that goes one way or the other.

Okay, great.

Back to Ship Systems again.

It looked like at least some of the quarter to quarter comparisons and surface combatants and the Amphibious & Auxiliary ships were the largest swings.

I'm just curious, what would've driven that specifically?

Is it DD(X) and surface combatants, was it work related, some of these ships coming back from deployments?

Is it cost growth on programs?

Could you maybe delineate that a bit more?

Well, certainly DD(X) is a much larger fraction of the revenue for that period of time than it was a year ago.

In our surface combatants areas we don't have a tremendous amount of work in terms of repair and overhaul.

So it would be hard to put our finger on that.

Okay.

And last thing, Ton, you won KEI, I think that was held as an example -- one of the first examples of the different units in the company working together with the TRW merger completed.

I just wonder if going through your list of major program opportunities, is that same factor at work or are these programs really much more the ownership or property of an individual sector?

Do you kind of expect to see the same coordination and integration at work across the different business units, that if you win these that will be another sign that this has all come together?

I think it's a mix, but there are a few key programs that we have multiple sectors participating on in a way that was never possible before we acquired TRW.

A couple of our space programs, Space Based Radar, Transformational Comm, we're bringing different elements of the company to play on that.

And certainly in Aerial Common Sensor, we have three or four of our sectors playing.

As we look at the work on the CBN 21, which is the next generation aircraft carrier, we're getting participation from a number of places in addition to that of Newport News.

So where it makes sense we are participating.

I'll tell you, the KEI win by itself probably blows through all the synergy assumptions we had relative to revenue synergy over the next few years from the acquisition, and there's going to the more to follow, I'm sure.

Great.

Thank you.

Chris McCray with Deutsche Bank.

Ron, you mentioned KEI.

Obviously that's a big win.

I sort of thought that high single digits was a plan pre that win.

Does that really factor in all the upside you think you could get in '04 or could we really be in the double-digit range?

Our guidance is our guidance, obviously, and it really is the aggregation of all the different factors.

I will tell you that with respect to KEI, the '04 funding line on that is a little less than $100 million.

If you look at the '05 budget it goes up to quite a number of hundreds of millions of dollars.

So I think we're going to see a slow deliberate start on that program in '04 and it's going to start cranking up big-time in '05.

Okay, that's helpful.

Also, back on your cash from ops guidance, are there any specific items that would lead to the 300 million difference in '04?

Is it really conservatism on the collection side assuming that maybe fourth-quarter performance just doesn't repeat?

Really two things in looking at the comparison, we really did a superb job in the fourth quarter of accelerating cash collections.

It was a real focus by all of the segments of our business.

On the flip side, when you get to '04, we're going to be just as diligent there, but, as I mentioned, we are going to be paying on an apples-to-apples basis about $500 million more in taxes.

Right.

And I know you don't break it out, but can you just point to maybe -- were there any heroes within the divisions in terms of cash flow in the year or any major variances, or was it pretty strong across the board?

Is was strong across the board.

And again, as you might expect, the opportunities for strong cash collections are pretty unique to individual programs.

Right.

Lastly, can you discuss any priorities you might have with regard to the fiscal '05 budget which in itself didn't look very surprising on the key programs, but when you look at getting plus ups, which were pretty meaningful last year, where's your focus this year and where might you hope to see some upside if there were any?

One of the things which was gratifying with respect to the budget was that while we're obviously going to look at potentials for plus ups, almost every single key Northrop Grumman program that means something was basically provided for in a way that we were very pleased with in the President's budget.

Clearly we'll be looking at some issues in terms of advanced procurement on some future warships, maybe we can get a little more work sooner in to make sure that we can level our work flow in our shipyards.

But unlike the last couple of years where we've had to work very hard to look at ways to get plus ups to key programs, for the '05 budget it's looking pretty good.

Now, that having been said, recognize that this is the President's budget.

The congress will make the ultimate determination in terms of authorization appropriation.

So it's kind of interesting -- six months ahead as we go through that whole process.

But we do believe there's very strong support in Congress for the programs that we're involved in.

And the good news this year is that we're not going to be fighting hard to get Congress to think about adding things that the President forgot.

I think an interesting thing on the budget, in spite of all the clamor over the last several months over what that budget might be was frankly how dull it was because it was almost exactly what he said it was going to be a year ago.

I mean, they're operating to plan.

I hear you.

Thanks very much, guys.

Howard Rubel with Schwab SoundView Capital.

Just a few questions.

First, Ron, you talked I think at the beginning of the call about 11 percent organic growth.

And I think part of the growth has been driven by missiles -- excuse me, Mission Systems and Space Technology, is that correct?

No, organic growth actually excludes both the TRW sectors acquired, and it was 13 percent for the year.

If you were to consider what the growth was on those businesses, would they have been double-digits?

Well, we -- let me just say that we're very pleased with how they performed relative to the expectations we had when we bought them, although we have not formerly given you a comparison because we don't have a common revenue recognition -- but let me just tell you that they did very well.

Well, I mean --.

I think it's fair to say, Howard, that in the Space Technology area they just had a blowout -- if you were going to try to compare revenues for the year before our acquisition and obviously in our first-year post acquisition, this was very, very strong double-digit growth, almost -- it would be very difficult to replicate this.

It was in the 10 or 20 to 30 percent kind of range.

So I don't think you would expect that in almost any business in this industry.

MS also had very solid growth but certainly nothing approaching the stellar year that Space Technology has had.

I mean, I would agree with you.

Space Technology is in the sweet spot of the transformation communications world as you've defined it.

So, I'm struggling a little bit to understand why you're sort of looking at a single digit growth number for the business given, A, the backlog and the wins and --?

(multiple speakers) cranked up from an historical run rate which was substantially less than what they came out of '03 with, Howard.

So, which really represented even earlier timing on some of the growth than they had projected.

So if you look at over a couple of years, the growth rate will be very, very strong.

They got a tremendous surge of it in '03.

So what we've given you year-over-year is where we think they're going to be.

We basically haven't changed our guidance for '04 at all.

It's exactly as it was, it's just that they had such a strong '03 that the growth rate comes down but the numbers are still exactly the same.

Right, exactly.

But given your win rate -- I don't want to beat this dead horse -- but it just seems to me you're being very conservative given the sweet spot you are in the market.

The second question is, you have continued to a nice job of paying down debt, and your interest rates -- and the market continues to be very favorable with respect to interest rates.

What would you expect with the way of interest expense in the upcoming year?

I know that's a thin ice question, but if you wouldn't mind, give us a general range, I won't hold you to the nickel.

I would say it'll be a bit less than 2003, Howard.

That's very clear.

And then on the tax rate, it seems you're being a little bit conservative there as well.

Are you assuming something with respect to ETI or with respect to a change in the R&D tax credit?

No, I think you should appreciate, Howard, in the -- the sub 30 percent tax rate that we enjoyed in 2003 reflected a lot of prior year R&D tax credit activities that our tax department brought home.

And so those are not going to be able to be fully replicated in 2004.

But I think we perhaps have been a little conservative in our tax rate for the year, but we have more work to do before we could consider changing that.

It would be unlike you not to find an opportunity there, Chuck.

Well, Howard, that's my history.

And then the last question, since I dug a hole in this a while ago.

I know you said at December 31st you were going to talk about impairment of goodwill.

And if one looks at it on a multiple basis there is an issue, but if you look at it on a present value of the cash flow the intangibles look fine.

Could you talk a little bit about the process that you went through at year-end and how you also considered that against the investment in the TRW asset which has done so well?

Well, Howard, let me take the pieces of this.

The TRW Auto asset I think is an upside to our business case, if you will, as you think about the overall realizability of our goodwill.

But what we did as of the end of the year with respect to the newly acquired TRW units that we're retaining is we did a pretty extensive test based upon our future projections of cash flows and other considerations and reached a determination that as of 12/31/03 that there was no impairment in the goodwill or the carrying value of the assets that we acquired from TRW.

And so we didn't try to offset it by some value associated with the TRW Autos.

So I would view that as an upside, if you will.

Or perhaps some additional cushion.

With respect to goodwill associated with our other acquisitions, we did that testing consistent with generally accepted accounting principles.

Earlier in the year we did take another look at that at year-end and we were comfortably within the envelope there as well.

Thank you very much, gentlemen.

We're going to have to cut off our Q&A here.

We have other scheduled activities coming up.

Ron.

Let me just close by saying again how very pleased we are with Northrop Grumman's fourth-quarter and 2003 results.

And we are very excited about the prospects for 2004 and beyond.

I'd like to thank all of you for joining us this morning.

Have a good day.

This concludes your Northrop Grumman fourth-quarter earnings conference call.

Thank you for your participation today.

You may now disconnect.