諾斯洛普·格拉曼 (NOC) 2004 Q1 法說會逐字稿

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

My name is Lenny and I'll be your conference coordinator today.

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

We will be facilitating a question-and-answer session towards the end of this conference.

Press star one at any time during the call to queue up and ask a question of our speakers.

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

I would now like to tern the presentation over to your host for the call, Mr. Gaston Kent, Vice President of Investor Relations.

Thank you very much, Lenny and welcome, ladies and gentlemen.

We've provided supplemental information in the form of a power point that you can access at our investor relations Web site at northropgrumman.com.

This is available as an accompaniment to our conference call.

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

In addition we're concurrently filing our 10-Q for the first quarter simultaneously with this call.

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

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

Statement risks results 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'll discuss first quarter results, including a nonGAAP measure for margin which is reconciled on page two of the press release.

We'll also discuss the outlook for 2004.

Guidance for 2004 will be GAAP measures of sales, cash on operations and earnings per share.

Just a reminder that the re-alignment of certain business areas within our information technology mission systems and integrated systems segments was effective January 1st and the restated 2003 numbers are the basis of our first quarter '04 comparisons and 2004 segment projections.

Also, Northrop Grumman will be holding its annual institutional investment conference next week on May 12th and our annual shareholder meeting will take place the following week on May 18th.

Both these events will be Web cast.

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

At this time I'd like to turn the call over to Ron, whose comments are outlined on slide number three.

Thank you very much, Gaston, and good morning, everyone, and thanks for joining us.

I'll briefly discuss our first quarter results and highlights, then wrap up the discussion with some of the upcoming new program competitions.

I'm extremely pleased with the operating and program performance across the company.

All our businesses are off to a strong start this year.

It's the first year over year comparison since the acquisition of TRW, and we exceeded our expectations across the board.

The substantial increase in earnings per share is due to four factors.

First, a 21% sales growth increase.

Second, segment operating margin expansion to 7.9% from 7.4%.

Third, lower pension expense, and finally a lower share count as a result of our share repurchase program.

Even including the impact of the Allison Gas Turbine court decision, we post add 37% increase in EPS from continuing operations.

Net cash provided by operating activities was strong at $263 million versus the use of cash in last year's first quarter of $1.1 billion, which included, of course, the B-2 tax payment.

Contract acquisitions increased to $8.4 billion with nearly every one of our sectors showing strong growth in acquisitions.

There was some large additions to backlog, such as the incremental funding of $853 million for the Virginia class sub marine second flight.

But we also saw a trend of accelerated funding across a broad base of programs.

We ended the quarter with more than $28 billion in funded backlog and almost $58 billion in total backlog.

These are all outstanding results.

They clearly reflect the long-term strategic vision of the corporation and our corporate wide focus on operations and financial excellence.

Since the end of the quarter, we've announced several important program wins.

Space technology is leading one of two teams to develop the next phase of space-based radar under a $220 million 24-month contract.

Integrated systems, mission systems, and electronic systems are collaborating in this effort, and ES, IS, and ST are also members of Lockheed Martin's space-based radar team.

Information technology was awarded a $337 million Homeland Security task order to design, operate, and maintain the department's classified network infrastructure.

This is a major win for us in this important growth area of Homeland Security.

Our NATO alliance ground surveillance team, TIPS, and that stands for the TransAtlantic Industrial Proposed Solution, was selected as the only team to enter the program's proposal phase.

NATO plans on beginning the program with a two-year design and development phase worth about $300 million.

Over the life of the program, NATO AGS is expected to approach $4 billion with a work share to Northrop Grumman of about 25 to 30% of that amount.

And yesterday, we announced that the Air Force awarded integrated systems an $888 million six-year contract for the system development and demonstration phase of a program called MP-RTIP, multi-platform radar insertion program.

As you're all aware, there are several large programs that are expected to be awarded in the coming months as well.

We are participating in many of these competitions assets a lead or major team member.

Electronic systems is leading our team on the aerial common sensor, which is expected to be awarded shortly.

ES is also leading our commercial aircraft countermeasures team where our guardian counter manned pad system recently completed a successful system requirements review.

The next major milestone is an interim design review.

And the next phase of the program after that is expected to be awarded in July.

Integrated Systems is the prime for the total E-10A system.

They are competing for the final piece of that, the battle management command and control system.

We are on the Boeing team for the joint common missile and we are teamed with Raytheon for the literal combat ship mission.

The Navy's broad area maritime surveillance or BAMS program is another another completion that is scheduled for 2004.

And in the international area we have submitted a bid for the United Kingdom's watchkeeper battle fields program.

This is not the entire list but as you can see we have a target-rich environment for new programs.

And our current programs continue to be very well supported in the 2005 budget and beyond and represent for us a solid pipeline of future business.

So in summary, it was a strong quarter.

We're solidly on track for the year, and we believe we're very well positioned for the future.

So with that, I'll turn the call over to Chuck Noski, our Chief Financial Officer for more detailed discussion of the numbers.

Chuck.

Thanks, Ron, and good morning.

My comments today begin on slide four and cover our first quarter operating margins, segment results and trends, line items, cash flow and our expectations for the year.

Obviously, as Ron said, it was a very strong quarter from our operations.

Year over year sales growth, and in some cases operating margin rate exceeded the sector level annual guidance we provided in our last conference call.

Some of the sales growth in the quarter is due to timing and early deliveries.

This gives us a solid start in terms of the growth we had projected for the full year.

Our expectation is that the quarterly pattern for the remainder of the year will be more ratable than in the past.

At this point we're comfortable with our sales guidance of $28 billion and even with the impact of the Allison Gas Turbine court decision we continue to expect to achieve our EPS guidance of $5.60 to $5.90 a share.

Total segment operating margin was $558 million versus $433 million in 2003, up 29% versus sales growth of 21%.

So as Ron noted we saw solid margin expansion versus last year.

Turning to the sectors and moving to slide five, electronic systems first quarter margin rose 31% on sales growth of 15%.

Sales for government systems rose more than 40% and defensive systems and C-4 ISR enable systems each increased nearly 20%.

In C-4 ISR enable systems we had higher international sales and fire finder deliveries and in defensive systems sales increased due to deliveries in the ALQ-135, MH-53 and a ground laser target designated programs.

We expect electronic systems sales growth and margin expansion to continue in 2004 with sales increasing at close to a double digit pace and the margin rate expanding to 10% or better.

Moving to slide six, ships first quarter operating margin increased nearly 15% on sales growth of 21%.

Operating margin for the quarter was $86 million or 6% versus $75 million or 6.3% in the first quarter of 2003.

Both surface combatants and amphibious and auxiliary were up approximately 50% in sales.

The main drivers were the DDX and LPD programs, and to a lessor degree, the LHD, deep water and Virginia class submarine programs.

Ship's margin rate contracted a little bit in the first quarter due to changes in program mix but we're in line with our guidance for the year, which calls for 6 to 6 1/% operating rate.

Despite the strong performance in the quarter, we still expect low single digit sales growth due to the movement of the Vincent Overall contract which will impact the second half the year.

Turning to slide seven, information technology operating margin rose 16% on sales growth of 13%.

Government information technology was, again, the growth driver this quarter due to new programs like the national geo spatial intelligence agency engineering program, federal aviation administration tactical assistance contract two, the command communication survivability program and [ INAUDIBLE ] as well as growth in INS teams and land information warfare activity.

For 2004, we continue to expect high single digit sales growth with an operating margin rate of nearly 6%.

On slide eight, mission systems margin increased 36% on sales growth of 28%, and the operating margin rate expanded to 6.4% from 6.1% in 2003.

All three business areas and mission systems had double digit growth.

Missile systems and command control and intelligence both grew by 30% or more, and tactical services sales rose 14%.

Growth in missile systems sales reflects the acquisition of [ INAUDIBLE ] higher ICBM volume and startup of the KEI program.

Sales growth in command control and intelligence reflects new classified programs and higher volume across other programs.

For the year, we expect mission system sales to grow in the high single digits with a margin rate in the mid 6% range.

Slide nine, integrated systems generated 32% growth in operating margin on 39% sales growth.

Airborne Early Warning/Electronic Warfare Systems sales rose more than 50% primarily due to growth in the E-2 Advanced Hawkeye program.

Air combat system sales were up 38% as we ramped up on the F-35 Global Hawk and MP-RTIP.

The decline in rate is as expected given the higher volumes on these development programs.

Even with the contraction, integrated systems is running ahead of guidance for the full year primarily due to higher sales volume on F-35 Global Hawk and E-2 advanced hawkeye programs.

For the year we continue to expect 15 to 20% sales growth and a margin rate in at least the mid 8% range.

Slide 10, space technology operating margin increased 59% on sales growth of 24%.

Software defined radio sales grew 68% with key drivers being the F-35 and F-22 programs.

Simple space sales grew 31% reflecting significant revenue growth in the NPOESS and James Webb Space telescope programs.

Intelligence surveillance and reconnaissance had strong double digit sales growth due to higher classified sales with new and ongoing contracts.

Our margin rate expanded to 6.3% from 4.9% primarily due to improved performance in software defined radios, satellite communications and technology business areas.

For 2004, we expect mid single digit sales growth with a margin rate in the high 6% range.

Looking at consolidated operating margin, unallocated corporate expenses rose $80 million from the prior year primarily due to an additional provisional for legal and interest cost relating to last week's decision by the Indiana court of appeals in the Allison Gas Turbine case.

This year over year increase also includes increases for mark to market on stock compensation and environmental remediation accruals.

We previously estimated $330 million and $305 million for FAS and CAS pension expense respectively.

As you saw in this morning's press release we now expect $145 million in FAS expense and $320 in CAS expense.

So from an EPS perspective, there's no significant change.

Effective tax rate for the first quarter was 34.3% versus 18% last year.

As you recall last year's results included a $26 million tax credit for additional research tax credits covering the years 1981 through 1990.

For the year we continue to expect our effective tax rate to be in the range of 34 to 35%.

Net cash provided by operating activities in the first quarter totaled $263 million.

Northrop Grumman usually follows strong positive fourth quarter cash from operations with the use of cash or negative cash flow in the first quarter of the next year.

We reverse that pattern for the first time since the first quarter of 2000, which we find quite encouraging.

Capital expenditures for the quarter, including capitalized software cost were $131 million.

We continue to plan capital spending of approximately $800 million for the year.

The increased spending provides for growth of if you programs as well as recapitalization and modernization at our three shipyards.

First quarter depreciation expense was $118 million, and we expect depreciation to be just over $500 million in 2004.

During the quarter, we continued to strengthen the balance sheet and repurchase shares.

Through the end of the first quarter we purchased more than 4 million shares under the repurchase program we announced last August at an average price of $93.56.

We also divested another of the component technologies businesses [ KESTOR ] for $60 million in cash.

As Ron said we're off to a good start and on track to achieve our financial targets.

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

Thanks, Chuck.

Lenny, we're ready for Q-and-A now.

Ladies and gentlemen, as a reminder to ask a question of our speakers please key star one on your telephone.

Our first question comes from Joe Nadol with J.P. Morgan.

Please go ahead, sir.

Thanks, good morning.

Morning.

Morning, Joe.

My first question is on the legal item.

I look back in the 10-K and there wasn't anything in there.

This must have been a surprise.

Chuck, do you want to take that one?

Sure.

Joe, it was a bit of a surprise.

If you look back at our disclosures and our filings over the past few years, we originally won this case.

We lost the case on appeal.

And as we indicated oh, a year or so ago, we indicated or we believe there was some factual problems and other procedural issues which would have caused us to receive substantial relief upon appeal.

So we were surprised, and the provision that we took in this quarter we believe fully provides for the ultimate outcome.

We have not yet decided whether we will appeal this to the Indiana Supreme Court.

That's a judgment we'll make in the weeks ahead.

But from a financial statement and earnings standpoint, we are covered going forward.

Okay.

You noted in the corporate expense line that there was some other items as well.

Is it fair to assume that $30 million is no longer a good kind of run rate?

Yeah.

I would, Joe, from an expectation standpoint, I would add this delta for the year -- excuse me for the quarter to the guidance we previously gave you for the year.

Okay.

So the other items, then, are much smaller?

Yes.

The principal portion of the $80 million increase is the provision for the Allison Gas Turbine case.

Okay.

In all of the operating segments, were there any cumulative adjustments on an aggregate basis that boosted your margins?

I know you don't like to get into specific cum-adjustments, margins were pretty high in the quarter above your guidance for the year.

Seems like there might have been some items there?

I would say, Joe, broadly what you're seeing in the quarter is some very favorable timing in terms of deliveries, award fees and other events really across all of our businesses.

So there are not any significant one-time true-up cumulative type things.

There's contract closeouts.

Nothing in particular that I think really perturbates the margins that much.

Okay.

I just want to push back a little bit in the sales guidance.

You've done obviously a little more than 25% of your sales for the year.

Last year I went back and checked.

It was 22.4%.

So it's really if you look across the segments it's really every segment your guidance calls for lower growth for the year -- far lower guidance than he did in the quarter.

Do you think your guidance at this point might be a little bit low?

How should we think about the fact this is not one or two items, it's really broad-based?

Joe, I would say broadly speaking we're trying to be prudent with our guidance.

The kind of performance that you've seen in the past has typically been very strong fourth quarters.

As we look out today, we see pretty ratable performance over the remainder of the remainders of the year, not a lot of variance from quarter to quarter.

But I would only caution you that we are only talking about having visibility to the first quarter performance as we sit here today, we're only 90 days away from our original guidance to you.

Okay.

Thank you.

I'll turn it over.

Thanks, Joe.

Thank you.

The next question comes from George Shapiro of Smith Barnes.

Please go ahead.

Yes, similar question to Joe on the perspective of a couple of things.

If you look at integrated systems in the margin of 10.1%, I mean, what was abnormal in that margin that makes you still say the guidance might be a little bit better than mid 8%?

I'm just trying to get at what the issue might be.

Well, George, as we told you last quarter, a good deal change in margin guidance for integrated systems this year versus their performance last year had to do with mix.

What we saw in this quarter on the operating margin side was strong performance in E-2.

J-Stars, we had early delivers on F-18, a contract closeout and EA-6B and the like.

We had a lot of things that kind of went all the right direction for us.

We do think, if you recall last quarter, we did say we were going to be in about the mid 8%.

I think given this quarter's performance and our current outlook, we've readvised that slightly to indicate we expect to be at least in the mid 8s.

I think we will see some modest improvement over the guidance we saw for the full year.

But integrated system's performance for the quarter is largely a timing story.

If you go back over the last couple of years, integrated systems has tended to outperform the guidance all along.

I don't know if you were just being conservative or what keeps causing it.

But it never gets down to the levels you think.

George, again, we've just finished the first quarter, and I hope you're right.

Okay.

Another question, how much did you book in mission systems for the KEI contract win?

It was very low.

There's not much funding on that contract yet.

Because I was just wondering, because Raytheon has booked like $2.1 billion.

And I was just wondering why you would be booking so much different.

I just assume they are booking the total amount and you're only booking the funded amount.

That's right.

I believe is it not true that the total amount is in our total backlog but the funded backlog only has that that's been funded which is a very small portion of that.

That's right, Ron.

That's correct.

Okay.

That's it for me.

Thanks.

Thanks, George.

The next question comes from the phone line of Steve Binder with Bear Stearns.

Please go ahead.

Steve, are you there?

Let's move to the next one, Lenny.

Our next question comes from the phone line of Cai Von Rumohr with SG Cowen, please go ahead.

Yes, let me join the people congratulating you on a good quarter.

Thank you, Cai.

Thank you.

Receivables and inventories were up in the third quarter.

How much of that reflected back end loading of the timing pluses?

Chuck, you talked a little bit about hoping to kind of improve working capital turnover.

And maybe tax payments.

Maybe update us, if you could, on any progress from that front.

I think, Cai, overall we're very pleased with our cash performance for the quarter.

I think, as you know, historically after very strong fourth quarters, the company has gone negative in cash.

So we are focusing much more on delivery payments and managing working capital as well as ringing the best we can out of advances.

So overall we're pleasantly surprised with the performance for the first quarter.

We thought we would see that more in the second quarter.

In terms of tax payments, I don't think we have anything new to report.

The second will be a period where you will see us make some substantial tax payments.

So I would be surprised if second quarter cash performance equaled the first quarter.

But we're still looking good for the full year guidance we provided.

Okay.

And a follow-up on kind of the tactical questions we've been having about performance.

You had particularly good margin performance at electronic systems.

If we go back in time, more typically, the lower margins earlier in the year and the year end margins are better.

Why was it so good?

How do we feel about the UAE?

Is there as there appears an IAG a potential upside in electronics?

Cai, let me comment on the margin performance and let Ron speak to the programs.

Overall I think that the electronic systems management team is really doing an outstanding job focusing on cost, focusing on program performance.

And I think you're seeing that in our first quarter performance, and I think our first quarter performance is pretty indicative of what you should expect from them for the full year.

Let me just jump in on UAE, which is the Block 60 program.

We're making good progress on that program.

We're pretty much on contract performance and scheduled for the age I will [ INAUDIBLE ] beam radar and the navigation sensor part of it.

As you know, the part that's been troublesome for us has been the integrated electronic warfare suite which we call Falcon Edge.

We are making progress there and the integration is going fine. [ INAUDIBLE ] the program is going fine.

The advanced microelectronic deliveries from our suppliers are improving, and we do have, of course, some challenges remaining on this program.

We're on track right now to support our customers selloffs, but there is risks that remain in the program.

And this thing is what we're going to keep watching quarter by quarter.

The current reserve is holding.

Thank you.

One last one.

If you could update us on any kind of problem or troubled programs.

And specifically, where are we on LPD-17?

Okay.

Fortunately we have about 30,000 programs in this company and there's very few we would treat as trouble.

The LPD-17 program as you know is a cost-plus program where in the year which we're going to deliver the ship -- we're planning to deliver the ship within the year, probably toward the end of this year, we'll see how the schedule plays out.

We have had cost increases in the program.

And we have been working closely with the Navy.

The assistant secretary of the Navy has recently stated that the program remains within the Navy budget.

And this is just a classic, first of a kind ship getting it out the door.

It's a fabulous ship.

The tests we're performing are working great.

Just a matter of grinding it out.

And we expect to do that.

As far as Polar Tanker, which is one of our other favorite programs over the years, I'm pleased to say while it is still a watch program in the company, we're progressing very nicely.

We have two remaining ships, ships four and five are progressing within our EACs.

We're scheduled to deliver the ship four on the fourth quarter and ship five about a year later.

Ship four is 95% complete and ship five is 55% complete.

We put in a significantly improved and new management team in there over the last six to nine months and we're seeing a tremendous impact of that.

And beyond that, I don't think there's a lot more to talk about in terms of programs, unless there's a specific one you had in mind, Cai.

No.

Thank you very much.

Next question comes from Steve Binder with Bear Stearns.

Please go ahead.

Can you hear me now?

Yes.

Good morning, Steve.

Good quarter.

Thank you.

Chuck, just follow up on Cai's original question on cash flow.

If you look historically at the receivables inventory performance really wasn't that different than historical Q1 performance, up about $4 million.

Where did you get the uptick in performance in cash was it advances in the quarter, was it payables?

Where did you see a surprise?

Steve, it was very broad-based.

I think it represents and reflects upon the increased focus that we've asked our operating units to place upon cash.

I think it's really managing every element of the, if you will, working capital calculus.

It certainly payables.

I think it's advances to your point and Cai's point.

I think we have more opportunity for improvement in terms of our recovery on -- our improvement in working capital management.

That will be a focus later on this year.

Okay.

Secondly, I don't know, either one, Ron, if you want to tackle this.

Your bookings in the quarter, what percentage of your bookings for the quarter were actually classified programs?

Maybe you can touch on ES's bookings, what percentage of ES's bookings were actually internationally based.

I don't have at my fingertips the classified fraction.

I'm not sure how much we would disclose on that anyway.

Does anybody have the answer on that?

No, we don't have that.

I'm sorry.

In international, there was no major booking of international programs.

I think you'll see that later in the year, Steve.

So do you still expect international, you know, to be represented by 30 plus% of the overall bookings this year for ES?

I think that's a little high.

Okay.

And with respect to a full year, you didn't want to really make a bet at the end of the fourth quarter, I was just wondering do you want to tackle what you think your bookings will be this year?

No, I don't think we've given that forecast, Steve.

Okay.

That's it.

Thank you very much.

Thank you.

The next question comes from Sam Pearlstein with Jefferies, please go ahead.

Good morning.

Good morning, Sam.

In terms of the ISS margin, I guess what I have understood was you were going to change the way you were booking the award fees so you'd have a much smoother run rate in the quarters this year.

So is it fair that the upside relative to the mid 8% where you've said it would be is the closeouts for the EA-6B or are they not that large?

That's not all that large, Sam.

I would say other than perhaps smoothing out our earnings and revenue recognition a bit with respect to award fees with integrated systems, this is largely performance, when you think about the full year.

So it's not an accounting matter.

Okay.

And then was there any EPS impact from the [ KESTOR ] sale?

Did you have a gain on that at all?

No, it was trivial.

Okay.

We've talked in past conference calls about just the overall overcapitalized balance sheet and where you stand at the end of this quarter.

You've talked in some forms about your view on dividends and, I guess, the potential for more buyback activity.

Can you just update us in terms of what you're thinking about now whereas to the balance sheet?

Sam, I would say really no change, as I mentioned in my earlier remarks, we're making good progress on the overall share buyback, having re-purchased through the end of the quarter over 4 million shares.

We expect that to continue.

As you recall, we re-purchased $2 million in the latter part of 2003.

We're currently in the midst of a $500 million buyback and I think it would be probably premature to be commenting on future buybacks while I'm in the midst of a buyback.

With respect to other distributions to shareholder shareholders, we are reviewing not only our credit rating targets as well as other appropriate uses of cash.

And that kind of review will certainly be ongoing.

Okay.

And with respect to the pension, do you have any plans to fund that in excess of the minimum funding requirements?

No.

Okay.

Thank you.

Thank you, Sam.

Next question comes from the phone line of Howard Rubel of Schwab SoundView.

Please go ahead.

Thank you very much.

Good morning, gentlemen.

Good morning, Howard.

Good morning, Howard.

Thank you.

Could you discuss for a moment the planning process and when you might decide to take the developments that have occurred in this quarter and factor them in to consider whether or not you're outlook is too conservative?

Howard, I kind of feel like you've given me the when did I stop kicking my dog question.

Howard, as we said last quarter, we we want to give you good, credible, yet conservative guidance.

I think that's what we gave for the year.

I think it's fair to say had we not taken the charge for the Allison Gas Turbine litigation, which was certainly unexpected, given our previous outlook on the litigation, we would have been guiding you today to the top end of our previous guidance.

Okay.

Second thing is could you talk about the TRW lockout for a moment, when you expect it?

Could you refresh my memory as to when it expires and what you might be able to do?

I think if you look out over the course of the next 12 months, Howard, as you know we own about 17 million shares of TRW Auto.

I think absent the lockup, and as you see reflected in our accounting that's described in the 10-Q we're filing this morning, there's about 3 million shares that we would be able to dribble out, absent any registrations.

We have the opportunity in 2005 to sell a more substantial amount.

I don't have the exact amount at my fingertips for you.

But over the course of the next -- over the course of 2004, I think we have a maximum of about 3 million that we could sell, and then more including the ability to, perhaps, to register an offering in 2005.

And then last -- thank you.

And then last, this Homeland Security contract that you won the other day.

If I did the math on it, it appears to celebrate rather substantially and actually have a meaningful impact on the information technology business.

Could you address it a little bit, Ron?

Is my assumption correct.

Howard, this is program which if all the options are exercised through '06 will be about a third of a billion dollars.

It's a very important win.

If you think about the reason for having a Homeland Security Department is so that all these 22 agencies could somehow talk to each other in a secure and critical way.

This is the network which will enable that.

We've been entrusted with the responsibility to do it.

So that's going to be a good thing.

Of course it's one program.

Keep in mind, though, that our IT sector is nearly a $5 billion sector, so this one win alone while it's very important is not billions and billions.

No, but it opens doors as well, does it not?

Yes, it does.

One of the things we're watching cautiously is the emergence of the Homeland Security market.

The deep water program is certainly the largest we have.

The work we're doing with the Postal Service on anthrax detection systems is an important item.

The work we're doing on the guardian for potential protection of airliners against missiles is another one.

This Homeland Security data network we're also doing work on the infrastructure for the immigration and naturalization service.

So piece by piece these things are starting to emerge.

We're putting a lot of attention on it in terms of predicting the market, who knows?

But we're putting a lot of attention there.

Thank you very much, gentlemen.

Thanks, Howard.

The next question comes from the phone line of David Gremmels of Thomas Weisel Partners.

Please go ahead.

Thanks.

Good morning.

Good morning.

Your ship's systems margin is down from last year and a bit below our estimate.

Some of that obviously is mix.

Just wondering if any of that margin decline is at all related to any surcharges from your steel suppliers?

You know, steel accounts for probably 10% or less of the cost.

Most of our contracts are either variably priced or have provisions in them for adjustments.

The increase in steel cost is a perspective issue rather than a retrospective issue.

Most of the work we're doing now is based on steel that's already been purchased.

Okay.

Sounds like your risk going forward would be mitigated by that.

Generally it is.

The contracts are either cost flow or have some provisions.

You're not totally immune from it but you have a reasonable hedge.

As I said, it's 10% or less than the cost of the ship.

Got it.

Kind of an interesting press report out talking -- basically reporting your KEI profits are tied to successful missile tests.

Sounds a bit extreme.

Wondering if there's unique contract characteristics on that program?

There are.

It's an example of the opportunity to earn some very, very substantial profits for performance, which is exactly the kind of game that Northrop Grumman wants to be in.

We're obviously prudent as we proceed in terms of our booking rates.

And we obviously want to make sure that we don't get out ahead of ourselves.

This program will have quite a number of years to run and will obviously evaluate our booking rates every year consistent with what the likely outcomes are.

But there will be profit booked in the meantime?

I think the first shoot down isn't scheduled until '09 or something like that.

Chuck are you familiar with the details of the booking rate?

We're booking at a pretty conservative estimate of that outcome on a discounted basis.

So we're trying to be prudent.

But we're not going to wait until 2008 to book our first profit dollars on this contract.

Got it.

Last one on the Allison Gas Turbine decision, do you have a sense of, you know, what the timing would be on any cash outflows associated with that?

I think it really depends, David, upon whether or not we make the judgment to appeal this decision to the Indiana Supreme Court.

And then, of course, the state Supreme Court has the authority to determine whether or not they want to hear the case.

I think that will be the first threshold.

That set of judgments probably occurs over the next three or four months.

Then depending on the outcome of that, it's probably if we do choose to appeal, and if the court chooses to hear it, we're probably into next year before we make any payments.

Great.

Thanks very much.

Thank you.

The next question comes from the phone line of will Will Hamilton with Pershing.

Please go ahead.

I was just wondering if the slip in total backlog was due to Comanche cancellation and how much possibly?

I don't have a specific number for you for Comanche.

But that was a relatively small impact to us.

So, if anything, if you notice our funded backlog increase, our total backlog declined very modestly, $600 million on almost $58 billion spread across all of our businesses.

So there's no real news there.

Okay.

Thanks.

Thank you.

The next question comes from the phone line of Andy Caplowitz with Lehman Brothers.

Please go ahead.

Good morning.

Could you update us on your piece of sippers high program?

I know Lockheed had to make a small adjustment for it and I was wondering how it was going with you.

We're obviously teamed with Lockheed Martin on the program.

We provide the sensor or payload.

The program is a cost-plus program.

I think it's been well publicized that the program has been very challenging technically and programmatically.

We're in the process with Lockheed and the United States Air Force in looking at the plans going forward on the program.

We have not taken any adjustments on the program, relative to our profit rates.

We're working hard to make the first delivery of the sensor, we're making good progress there on the First Bird, which is called the HEO Bird.

And the second one we had some technical challenges in electromagnetic compatibility.

I think we're past most of that.

And we're focusing on the geo stationary birds which follow that.

So I think fundamentally it's a program which has a tremendous amount of attention in this company.

It's one of which we're bringing all the resources of the company to bear.

It's classic for a very challenging, first of a kind new satellite program.

Great.

You said that without the provision, the Allison Gas Turbine provision, you would have thought about at least going to the top end of your earnings guidance.

I'm wondering given the first quarter's strong cash flow if the 1.5 is relatively conservative.

Are we just kind of in the beginning of the year and we'll have to see how it goes?

Andy, this is Chuck.

I think you've got it exactly right, we're 90 days into a 360 day year.

I'd like to see a bit more performance before we declare victory on cash, but a good start and a very solid first quarter.

Okay.

Thank you.

The next question comes from the phone line of Nick Fothergill with Banc of America Securities.

Please go ahead.

Good morning.

A couple of quick questions.

First of all, on ships, very good in the quarter on surface ships.

You talked about the mix holding you back a little bit on margin.

What do you think, Ron, gets you to 6 1/2, as the top end of your target margin rate, is it margin uptick at Litton, did you take any margin at all a Litton this quarter or is it post-Iraq ship maintenance coming in in this sort of second half of the year?

Chuck, do you want to handle that one?

Sure, Ron.

Nick, we're not anticipating any kind of a surge of new business or maintenance business that will supplement that.

As you might imagine, as we have with the polar tanker program, we're booking a lot of sales, and we're notebooking any margin associated with it.

As that runs through and the relative mix or volume of our profit bearing sales versus the sales that are not generating and recognizing any profits is really what drives that mix differential.

It's more really down to Polar Tanker runoff, I guess?

Largely, and future performance on LPD.

Okay.

Then Ron, you talked about the plethora of new programs that you're facing.

And you're talking about a fairly target-rich environment.

Yes.

Would you try to encapsulate that a little bit more for us in terms of scale.

How does it compare when you look out over the next six months or a year compared to even the same time last year or the year before?

If you added them all up, is this a bigger total number you're facing as a potential opportunity?

Well, you know, that would be hard to characterize it that way, Nick.

I've always said we need to bring in over half a billion dollars of new business a week in this place to keep it running and growing.

We see that coming.

A good portion of the business that comes in is frankly follow-on business from well established programs.

So the competitive programs tend to be on the margin.

It would be hard to look forward and see some of the scales of joint strike fighter.

On the other hand, I think the aggregate of new competitive opportunities is about the same, absent that one, as we've seen in the past.

I would say also the DDX win was a very, very large win for R&D program, but we were selected by the Navy recently to be the sole source to lead the first ship actual production contract.

So I'd say overall the prospects are about the same.

Ron, you didn't mention the net sense program that's coming up towards the end, I guess, of September, the big 135 U.S.

Air Force base sort of telecommunication revamp.

Is that something you're also pitching on?

I'm sorry, Nick, net sense?

Yes, I would like to think your IT business must be pitching on that, certainly general dynamics is and others are on it.

It's a very, very big program.

Does anybody recognize that term?

I don't recognize that name, Nick.

But I'll tell you what, we'll go talk to those guys and find out why they aren't bidding.

Sometimes it falls under the radar because the Nortels and the Cisco's are pitching on that, apparently it's 50% going to defense company.

It could very well be one of those things we have a participation on someone's team.

I just don't know the answer to that.

Fair enough.

Just another brief one.

Looking at the UAV world, are you getting a sense that spiral technology may be dragging forward some of your opportunities earlier in this area?

Is this something you could make more in-roads in in the near term, or is this something that's still pretty steady as she goes?

I think there's no question that the unmanned air vehicle world is going to be an area of continuing growth.

Every military commander I talked to who has used these systems in combat, both Iraq, Afghanistan, have come back saying this is the future, we need more.

So I think we're going to see that trend continue.

Certainly the spiral development approach that was successfully used on the Global Hawk program is continuing, and we're pleased.

We can certainly build these things faster if the government needed them.

In fact, the future looks very strong there.

The fire scale program is similarly coming along.

As a contractor who could supply these, we'd obviously love to go faster.

I think we're going to see demand pull continuing.

Last one, this is a little bit semantic, I'm afraid.

Any reason you decided not to give guidance on '05 at this stage?

Chuck, do you want to handle that?

Sure.

Nick, as Gaston mentioned we have our investor conference next week in New York City.

At that meeting we would hope to be able to give you a better view of the near-term future.

Fair enough.

Look forward to seeing you there.

Thank you.

Thank you.

The next question comes from Marty Pollack with NWQ Investment Management.

Please go ahead.

Just a quick one on the sales side.

In effect, you're suggesting first quarter pulled forward to the year.

As we look toward the progression of the year, when you say ratably for the rest of the year it seems that $28 billion would suggest whatever the modeling would have been for the fourth quarter, it's going to be -- it's immaterially lower.

Is that the way we should interpret that, or should we interpret that really you pulled forward from the second quarter and end of the year will more or less be on track, normalized pattern?

I think it's the latter view, Marty.

Okay.

Essentially maybe more for the second quarter?

Yeah.

I think if you look at the second quarter, clearly it is -- it's impacted by the favorable timing that we experienced in the first quarter.

We don't see a drop-off on either an absolute or relative basis in Q4.

Okay.

With regard to, you know, the other components of the TRW, I guess the Blackstone note, what is the status of that and what would be the intent for that in terms of, you know, is this something you can monetize or is there any reason not to keep that?

Well, Marty, it's clearly not a strategic asset for us.

And we will continue to explore ways to appropriately monetize it.

There are some limitations on our ability to do that, just under the terms of the note.

But we're taking a look at that.

At the present time we don't have any immediate plans to liquidate it.

But it is something we are actively exploring.

Okay.

Thank you.

Thanks.

The next question comes from Joe Nadol with J.P. Morgan.

Please go ahead.

Hi, just had a follow-up for Ron on the ship business.

Ron, there's been some talk recently at the Marine Corps might be shifting around some of its longer term priorities, including sort of how the next LHD might look.

I was just wondering if you could update us on what you're thinking there.

Is there any risk to that class of ship not being built at [ Ingles ]?

The LHD, which is the large flat deck amphib have been our bread and butter there.

We are working on LHD-8.

The Navy and Marine Corps went through a series of trade-offs recently and concluded what they would like to have is the next ship is something they will call an LHAR, LHA Replacement, which will look very much like the LHD.

It will have the similar hull form, it will have significantly more aviation capacity, will not have the landing deck inside of it, so that is now in the program of record for the Navy and will continue.

And I think the ship will be authorized in the next couple of years fully funded.

And we're working to get some advanced funding now so we can bridge the gap.

I think the Marine Corps and the Navy have come to the right answer in their minds.

We're pretty happy with that.

That will proceed.

On the LPD program, the program for today is for 12 ships.

We have heard discussion about the thought in the future there maybe some change to that plan in the out years.

But that would happen many years after today, if there were some changes there.

And there would have to be some alternative ships built instead of those.

These sort of things swirl around every month.

As far as we can see on the LHD, LHAR that will replace it, that seems to be pretty solid.

Okay.

Thanks for the full answer.

Next question comes from Steve Binder with Bear, Stearns.

Please go ahead.

Ron, you mentioned earlier on [ INAUDIBLE ] that there was no profit adjustment taking in the quarter.

Lockheed talked they took one in the most recent quarter.

Is that a fair statement, then, that you did not -- there was no dinging of award fees for you in the most recent grading period?

Well, I can't speak to what Lockheed did or did not, I don't know the nature of their contract with the Air Force.

In our contract, this was a program which we acquired from our acquisition of AeroJet Electrical Systems and [ INAUDIBLE ].

This is a program we've known had some technical challenges. wwe've been conservative on how we handled the profit.

I don't think we're booking a tremendous amount of profit on the program at all.

But it is a cost-plus program.

I don't believe we did if I kind of accum-adjust, for example, to take anything down.

We've been booking it at a fairly low level.

Did you want to add anything to that?

Did I get that right?

I think that's right, Ron.

Okay, thank you.

Lenny, we have time for one more question.

Okay.

The last question will oncome from the phone line of Eric Hugel with Stephens.

Please go ahead.

Ron, can you talk about your thoughts on liability surrounding Homeland Security programs and if, you know, sort of how you're outlook would be for really jumping into that market or protect commercial airliners if you can't get those laws changed?

Sure.

This is an area of importance to us and everybody in industry.

Probably about a year, year and a half ago, I testified before Congress if we wanted to unleash the full capacity of American industry, we need to make sure there was, you know, some reasonableness to the exposure.

We're very careful in the kind of contracts we take on at Northrop Grumman.

We don't take on contracts which we believe have extraordinary liability.

There is a safety act now which helps.

There's some concern in that that medical details are such that sometimes you have to bid a job contingent upon getting approval in the safety act.

We're not putting ourselves in harm's way on any of these.

Clearly before we under took anything as significant as, say, an anti-man pad system, we would have to make absolutely certain that the financial risks were reasonable for our shareholders.

We see this as a significant growth market, but we are wary, relatively tiff to the financials.

I would say on the program we do have, which are very significant at the moment, the anthrax detection we spent 10 months negotiating with the Post Office before we got the terms and conditions we felt were correct, they felt were correct before we moved forward.

The deep water program is kind of a standard program.

The most recent homeland security secure data network, which we just won, does not have any of the unusual conditions.

I think we're mindful of it and will obviously be cautious as we move forward.

Ron, just as sort of a follow up on the recent award of the Homeland Security program.

Do you think this is sort of a sign they are maybe getting around to sort of implementing some larger sort of systems program spending?

Yes, I think they are.

I was with the deputy -- administrator of the Homeland Security department yet yesterday.

They are very concerned about those kinds of things.

Integrating the various 22 agencies and having the ability to speak securely over classified links and be able to reach and connect through to the FBI and the CIA and all the other agencies is absolutely essential.

In some ways you would say why did it take so long?

They have thought it through and are moving out.

I think clearly this is the future and we're going to do everything we can do to help it along.

Great, thanks a lot.

Ron, do you want to wrap up?

Yes, let me wrap up by saying we are very pleased with the operating results for the quarter.

It was a heck of a performance.

We are focusing this team on operating program execution and delivering financial results for you.

And we appreciate your continued interest in the company.

Thank you all.

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

You may now disconnect .