諾斯洛普·格拉曼 (NOC) 2004 Q2 法說會逐字稿

Good day, and welcome to the Northrop Grumman second quarter earnings conference call.

My name is Carlo and I will be your coordinator for 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 presentation.

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

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

Please proceed, sir.

Thank you, Carlo and welcome ladies and gentlemen to Northrop Grumman's second quarter conference call.

We have provided supplemental information in the form of a power point presentation 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 are filing our 10-Q for the second quarter of 2004, simultaneously with this conference 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 meaning of the Private Securities Litigation Reform Act of 1995.

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

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

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

During the call, we'll discuss second quarter results, including a non-GAAP measure for total segment operating margin which is reconciled on schedule two of our press release.

We will also discuss the outlook for the remainder of 2004 and 2005.

Guidance will be GAAP measures of sales, operating margin, cash from operation, and earnings per share, as well as segment operating margin, a non-GAAP measure.

Reconciliation is also provided in our supplemental slides.

Just a reminder that the realignment of certain business areas within our information technology -- I'm sorry do we have someone on the line?

Operator, we're getting additional conversation.

Okay.

Just a reminder that the realignment of certain business areas within our information technology, missions system, integrated systems segments was effective January 1, 2004.

And the pro forma numbers are the basis of our second quarter 2004 comparisons, and 2004 segment projections.

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

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

Thank you, Gaston.

Good morning, everyone and thanks for joining us.

I would like to briefly discuss our results and the outlook for the year, spend a couple of minutes on where we stand in terms of the recently-completed appropriations conference, and wrap up with a summary of upcoming awards.

Overall, I'm pleased with our second quarter operating and program networks.

Year-over-year sales comparisons were strong.

Mission systems, ships, space technology, and integrated systems all posted strong double digit growth which reflects a ramp-up on the major development programs we've won over the last several years.

Earnings per share from continuing operations rose 44%, based on higher segment operating margin, lower pension expense, and a lower tax rate, and a reduction in shares outstanding.

Net cash provided by operating activities was a healthy $610 million.

The only negative for the quarter was the block 60 charge.

During the second quarter, all three major elements of the block 60 program underwent qualification testing preceding production.

On the Falcon Edge electronic worker suite, we experienced environmental test failures and additional delays in obtaining supplies of integrated micro electronic assembly, both factors generated unplanned design changes, retesting and additional cost.

The principal part of this quarter's charge is to assure that we're appropriately reserved for completing the Falcon Edge qualification phase, and then the ensuing EMD and production phases.

The availability of the integrated micro electronic assemblies for Falcon Edge has now improved and the production rate is also improving.

Production of all line replaceable units is being accelerated.

Looking ahead, a major milestone for the program will be completion of all qualification testing on Falcon Edge, which is scheduled for December.

The other major elements of the block 60 program are progressing well, but will require some additional costs to complete, based on the results of qualification testing.

To date, on the internal forward-looking infrared targeting system or IFTS as it's called three quarters of the line replaceable units have completed qualification and production has been accelerated.

The agile beam radar has now successfully completed qualification and its production has been accelerated.

Flight testing on the aircraft has been going very well.

And all hardware should be built by the end of this year.

Block 60 has been a very challenging fixed price development program for us.

But there has been substantial risk reduction during the last six months.

Polar Tanker has been another challenging program, and I'm pleased to report that the fourth tanker is now 98% complete.

Its delivery schedule has been accelerated from the fourth quarter of this year to the third quarter.

This ship should be delivered soon within our established reserve.

The fifth and final tanker is more than 60% complete, and is now scheduled for delivery in late 2005.

Across the rest of our business, the vast majority of our programs are performing extremely well.

And we are focused on driving improvements in both financial and program performance.

Through the first six months of the year, we are exceeding our original outlook and as a result we expect to outperform our original 2004 guidance.

We now expect four of our sectors: ships, mission systems, integrated systems, and space technology, to exceed our previous sales guidance.

Total sales are now expected to increase to approximately $29 billion, and earnings per share from continuing operations are expected to grow to between $2.90 and $3 a share.

We are also increasing our estimate of net cash provided by operations to approximately $1.7 billion.

Now, before I turn the call over to Chuck for a more detailed discussion of the outlook for the year, I want to briefly talk about the recently completed Senate and House Appropriations conference on the defense budget, and on our upcoming competitions.

The $416 billion defense spending bill funds most of the President's defense agenda.

Looking across our broad base of business, most of our key programs were fully funded and several received increased funding.

Our ship systems programs were fully funded and DD(X) and LHAR received increased funding of 84 million and and $150 million respectively.

At Integrated Systems, Global Hawk was fully funded and the B-2 program received an additional $30 million in funding.

In other programs like space tracking and surveillance system, advanced, extremely high frequency and intercontinental ballistic missiles and others received full or modestly higher funding.

On the missile defense side, the bill increased spending by 11% over current levels which supports the President's plan to deploy the first elements of a national missile defense system later this year, and funds future elements such as kinetic energy interceptors which continues to receive strong support and will continue to move forward.

Reductions were made to the President's request for substantial spending increases in the early stages of space based radar, transformational SATCOM and joint unmanned combat air system, all of which are future competitive opportunities for us, but we are encouraged that the SIBRS missile warning program received an additional $91 million in funding.

So on a net basis, we're very pleased with the outcome of the appropriations conference, and we believe Northrop Grumman programs faired quite well.

Looking at some upcoming competitions over the near term, several awards are expected.

United Kingdom Royal Air Force is expected to select its preferred bidder for a large AWACS full life support program which is valued at more than $800 million over 21 years.

A decision on the army's aerial common sensor is expected in August.

The initial cost plus a working contract is expected to be several hundred million dollars.

The Department of Homeland Security is expected to award the next phase of it's counter-man pads program in the third quarter.

The next phase will have a period of performance extending to January 2006.

Another important competition which may be awarded in early September is the battle management command and control portion of the E-10 program.

Which is expected to be about $750 million.

So as you can see, we have had a strong performance in the quarter, we faired well with the appropriations conference, and we have very significant opportunities going forward.

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

Chuck?

Thanks, Ron.

And good morning.

My comments today begin on slide four.

I will also cover second quarter and year to date segment results including updates to the previous guidance we have given you for each of the businesses.

On a consolidated basis our segment operating margin rate for the second quarter was basically unchanged versus last year, but on a year to date basis, segment operating margin had expanded to 7.6%, versus 7.4%.

Although for various reasons, four of the six segments had lower operating margin rates than in the second quarter of 2003, all of the segments are on track to achieve our margin rate guidance for the year on higher sales volume.

Total company operating margin for the quarter was 6.6%, versus 5.9% a year ago.

And for the year to date, the operating margin rate was 6.3%, versus 5.8%.

Moving on to a discussion of the business segment, Ron mentioned we've raised our 2004 revenue guidance by approximately $1 billion, so as I talk about each segment, I will discuss the changes in the segment sales guidance that build up to that new number.

Turning to slide five, electronic systems second quarter margin fell 7% on sales growth of 5%, obviously due to the F-16 block 60 charge.

Electronic systems is expected to achieve high single digit sales growth for the year.

And we continue to expect a margin rate of 10% or better due to improving performance across a broad range of programs which means that we expect margin expansion in the third and fourth quarters for this segment.

As you can see on slide six, ship second quarter sales grew 14%.

Again, the growth drivers continue to be the DD(X), LPD, and LHD programs.

Year to date sales were up 17% and based on these results we now expect to end the year with high single digits sales growth, versus our previous guidance of low single digit growth, and the principal driver of that increase is the surface combatant business area, primarily the DD(X) program.

Regarding operating margin, the primary reason for the four-fold increase this quarter was the $68 million Polar Tanker charge we took last year.

Year to date operating margin is 6.2%, and for the year, we continue to expect operating margin of between 6 and 6.5% of sales.

Slide seven.

Information technology operating margin rose 18% on sales growth of 9%.

Based on year to date result, we continue to expect high single digit sales growth with an operating margin rate of nearly 6%.

Turning to slide eight, mission systems margin increased 10% on sales growth of 18%.

Year to date sales were up 23% and we now expect that for the year, mission systems sales will grow between 15 and 20%, versus our previous estimate of high single digit sales growth.

The upward revision is primarily due to a higher-than-expected sales in command control and intelligence system, due to additional growth and restricted programs, as well as higher sales volume across a number of other programs.

Mission systems second quarter and year to date operating margin rate supports our estimate for the year which is in the mid 6% range.

On slide nine, integrated systems sales grew 13%.

Year to date, integrated systems sales are up 25%, and based on those result, we are raising our sales guidance to an increase of between 20 and 25%, versus our previous guidance of 15 to 20%.

The upward revision is being driven by higher air combat system sales, specifically in the F-35 and Global Hawk programs.

The decline in integrated systems operating margin this quarter reflects the higher proportion of lower margin development programs that we have been describing to you for several quarters.

For the year we continue to expect an operating margin rate in the mid 8% range.

On slide 10, space technology operating margin increased 11% on sales growth of 14%.

Based on year to date sales which are up 19%, we now expect high single digit growth in space technology sales versus our previous guidance of mid single digit growth.

Our expectation for space technology's operating margin rate continues to be in the high 6% range.

Looking at consolidated operating margin, unallocated corporate expenses rose $31 million from the prior year, primarily due to higher mark-to-market stock compensation expenses, and deferred state taxes.

Effective tax rate for the second quarter was 26% versus 31% last year, as we recognized additional tax credits of $31 million related to research and development and export sales activities for the years 1997 through 2003.

For the year, we now expect an effective tax rate of between 32 and 33%.

Looking at our cash performance for the quarter, net cash provided by operations decreased to $610 million, versus $737 million last year, due to higher tax payments than in the second quarter of 2003.

Year to date, net cash provided by operations was a positive $873 million versus last year's use of cash of $375 million.

Capital expenditures for the quarter were $131 million, and $267 million year to date.

During the quarter, we continued to strengthen the balance sheet and we repurchased 2.4 million shares for $120 million.

We still expect to complete the $700 million share repurchase program we began last year, by the end of this year.

Looking ahead to 2005, as we told you at our investor conference in May, we continue to expect margin expansion on higher sales, higher net cash provided by operations, and solid double digit earnings growth -- earnings per share growth from continuing operation.

And with that I'll turn the call back to Gaston..

Thanks Chuck, Carlo we're ready for questions now.

Carlo?

Yes, sir.

We're ready for questions.

Thank you, sir.

Ladies and gentlemen, at this time if you would like to ask a question, press star, one on your touch-tone telephone.

We will take questions in the order they are received.

Once again, star, one for any questions.

One moment.

Sir, your first question is from Byron Callan with Merrill Lynch.

Good morning, gentlemen.

Hi, Byron.

Ron, a couple of very general questions.

You know, you mentioned the Congressional action on the FY '05 budget and I think it does kind of stand out that some of the more aggressive technology program, space based radar, transformational communications, the UAV programs have gotten clipped here.

Is there a broader message that Congress is trying to send to the Department of Defense?

And does that in any way shape, or form have an influence on your business strategy going forward that maybe some of these technologies are too aggressively being pursued here?

Well, Byron, that's a a good question.

I think what we saw is that the proposals to start, big wedges for some new program, is really going to be pushed off probably another year in the cycle.

I think there was a determination, I'm guessing here but a determination amongst the conferees that we couldn't make everything fit, including the cost of the war, and get these big new programs off and running.

I think there is no question in most people's minds that they're coming.

The question is when.

And the major cuts which occurred were cuts to substantial increases year-over-year proposed by the President and generally Congress does not like to see substantial year-over-year increases in funding, on any given program because they're concerned about executability.

You know, if you take a look at what was reduced, in the UAV area, it was the joint unmanned combat air system, which is a future competitive opportunity for us of course, the basic program, Global Hawk and some of the other activities like Fire Scout that we are involved in were very fully funded.

Okay.

And then just, I know Chuck walked through the changes and forecasts.

I'm trying to maybe parse this out a little bit more.

How much of it was new contract activity?

In other words programs that got turned on that you hadn't been expecting to get turned on.

How much of it may have been cost growth or expansion and work scope on some of the ship programs, for example?

Is there any way to parse that out given your prior guidance?

Byron, that's tough.

As you saw, we had pretty broad-based sales growth improvements across virtually all of our segments, I think.

Yeah.

I was thinking, more, Chuck, the guidance, the change in your sales expectations for this year.

Not so much the quarter.

Yeah, I think it was somewhat -- speaking to the quarter, I think it was somewhat funding, and in some cases, particularly in our software-based businesses, I think you're just seeing us be more successful in terms of orders, as well as funding.

Okay.

Great.

I will turn it over to someone else.

Thanks.

Your next question is from Cai Von Rumohr with SG Cowen.

Yes, could you comment on cash redeployment?

You've expressed in the past some interest in the defense I.T. sector, some of the prices of some of the stocks are down, are you more interested?

How do you look at the whole M&A issue?

Cai, our view with respect to the use of cash is really unchanged from our investor conference in May.

We talked about our priorities which would obviously include strengthening our balance sheet, improving our credit rating, to a degree.

We certainly, as you saw in May, were comfortable in increasing our dividend, we're going to continue to focus on an appropriate payout ratio there going forward.

We're still in the midst of our $700 million share repurchase program.

As it relates to M&A you know, we've said that we are going to be selective and do the kinds of niche and bolt-on acquisitions that we think will out some of our gaps and we don't think we have got any significant gaps we have very a pretty substantial information business already.

Ron, I don't know if you want to comment further.

But we don't have any -- have any big plans, but we do watch the marketplace.

We do think about valuations, and we certainly do think about value.

Okay.

And then I think you also mentioned you might do portfolio shaping, getting rid of smaller businesses.

Is there any more of that to be considered?

We're considering that currently.

But we don't have anything to announce today.

The last one, a technical issue, the unallocated expense number is up for the year.

How much of that is, you know, what is the major reason for that?

Well, as we said in our earlier comments, it is primarily mark-to-market adjustments in the stock compensation element of our compensation expense, as well as state deferred tax, that as you know are not allowable.

I would say for the full year, it is largely the things that you've seen through six months.

I would expect, as you see, I think, in the last chart of our package that's on the Web, we've given you some indication of where we see the full year, Cai, and we will probably grow to that level ratably over the rest of the year.

Thank you very much.

Thank you, Cai.

Your next question is from Steve Binder with Bear Stearns.

Good morning.

Good morning, Steve.

Good afternoon, whatever.

Ron, to start out, you know, you made some comments back on the first quarter conference call that some of the supplier issues and the micro electronics area were improving, you know, in the block 60 program.

You know, and you did say at the time that there was still a chance -- there was challenging issues there, there is no doubt about it, but you did say some improvement was being realized and you talked about the qualification process.

What was the change from that point to now?

Well, the actual performance of the suppliers did have some kind of inflection.

This is very challenging program.

The technical specs drive us and our suppliers, sort of to the edge of the performance levels of these devices can get, and yield is a problem.

What I mean by that is you can get a certain number of them to meet those spec, but not all of them do in the distribution.

So you need to get sufficient quantities so you can keep production going.

The other thing is we are going through pretty heavy qualification testing now in parts of the units and frankly, test results were not what we hoped they would be at the unit level as well.

So we are where we are at this point in time.

We are pleased that at this point in time, we've seen a pickup in the IMA, that's the integrated microwave assembly production of volume, the yield appears to be stable, and so far, we're moving forward.

All right.

Chuck, with respect to cash flow in the quarter, I was wondering, you know, a couple of things.

One was, you know, looks like you had like $140 million pickup in reduction, working capital in the quarter, so, you know, it looks like inventories were down, you know, about $100 million, receivables were up a bit.

What were the other pluses in the quarter, you know, advances or were tax payments light?

I think you see some -- some improvements in advances as well, Steve.

Actually, our tax payments were probably a little bit heavier in this quarter, versus this time last year.

As we mentioned in our first quarter call or perhaps it was in our fourth quarter call in January, we did expect to be a bit more of a taxpayer this year than last year.

Excluding the B-2 tax payment.

I believe we told you about $500 million in tax payments for the full year and we're a little bit past the half-way mark in terms of that payment.

But a good portion of that was in the second quarter.

And as far as the share buy back is concerned, you tempered a bit in the second quarter, compared to what we saw in the prior couple of quarters.

Is that price-driven or what was that?

No, we actually provide some guidance and some pretty fair latitude to the folks that do the buying for us, the external folks that we turn this over to.

And so I think what you're seeing there is just their response to the -- to the direction we gave them, but we do expect to continue that program post this announcement, and go back into the market over the course of the remainder of the year.

And with respect to ES, are you, you know, -- you know, this is the second year in a row -- I guess we've seen the last couple of years a need, to some degree, realize some benefits elsewhere, whether it's contract cost overruns or you know profit accrual pickups, to pay for the -- maybe you don't want to look at it that way, but pays for the cost overruns on the F-16 side.

Do you still see upside margins beyond double digit in the next couple of years out of ES?

We can start by saying that the thing that we really like about ES is that it is one hell of a strong business.

And it has a lot of really good programs that are generating some good profit for us.

And in fact, we've been able to drive some of our performance in the last six months to a year on some of those programs better than perhaps we had expected.

And yes, there is a block 60 now and then that comes along that offsets it but it's fundamentally a very strong business.

You want to address the question of margins, Chuck?

In terms of -- you said are we going to do better than double digit margins.

That's kind of wide, Steve so I'm assuming you mean low double digit margins.

Obviously we see ourselves doing better than, you know, 10% or better, including the impact of the block 60 charge.

We do see margin expansion in the third and fourth quarters for the sector.

And this is still a very strong, very profitable business for us.

So you are going to obviously see some margin improvement in the second half of the year that is going to look very strong versus the first half.

And two last things, cash flow in the second half historically does a strong fourth quarter, and I know you had some issues this year, but you know, you mentioned tax payments were pretty full in the quarter, what happens to, kind of, I mean, you are looking at kind of a flattish second half from the first half from a cash flow from operations standpoint.

As the answers start burning off in the second half?

Or are there any other items to, you know, temper what we typically see as a robust second half?

I would say, Steve, it's mostly taxes.

You're right, we have tended to historically have a very strong fourth quarter, as you know, and as we've talked, we're working extremely hard to be more disciplined throughout the year, in how we bring cash in, and we think we're making some good improvements.

There you can see we're -- I think doing pretty well on a year-over-year basis, year to date.

So as you saw, we raised our cash guidance for the remainder of the year by $200 and we are quite confident that we can achieve at least that level.

One last thing on acquisitions.

There's some talk about some I.T. properties on the market, you know, privately held.

Can you guys -- I mean you've talked about wanting to do niche acquisitions.

You touched before in your opening remarks on your I.T. business being fairly broad as it is today.

Can you see yourself possibly doing a billion dollar-plus deal this year?

Well we're not going to speculate on any specific M&A deal, Steve.

We have said over time that we'll look at bolt-on opportunities as they come along.

They've got to be good values.

They got to make sense.

One of the things we are happy with is that the fundamental I.T. business we have now is we think pretty much the best portfolio in the industry with Legacy,TRW, Logicom, PRC, Task, et cetera.

But if we see opportunities we will obviously consider them but we are not going to speculate on anything.

Okay.

Thanks very much.

Thank you, Steve.

Sir, your next question is from George Shapiro with Smith Barney.

Yeah, good morning or afternoon.

If I would assume that electronics would have made a normal 10% margin this quarter, then the net of the 60 million in which you termed close-outs would have netted to about a $20 million negative.

Is that about the right way to look at it?

I think you're a little light.

I think you're a little light, George, by maybe $20 million.

So that implies the underlying margin in electronics this quarter would have been 11%?

Right around that.

Maybe a little light of that.

Okay.

And then Chuck, that's the kind of margin you think is doable then in the third and fourth quarter, excluding the charges?

I think you're going to see some strength in the third and fourth quarter, George.

Okay.

Just to make 10% it has to be about 11 in the back half.

Right.

I just wanted to check.

Okay.

Chuck, the unallocated expense, I mean you mentioned it due to deferred state and higher compensation, what do you figure the normal run rate for that?

I mean we used to be running maybe $35 million a quarter.

I think George, if you look at the -- at our -- the last numbers chart in our package on the Web this morning, or this afternoon, we're suggesting a number of around $250 million for the full year.

Oh, okay.

I would say well, look at the year to date number today versus the full year, and expect that to move ratably, obviously there is some variability depending on share price because that does impact our stock compensation expense and that's, as you know, sometimes difficult to predict.

And then in the ship area where you raised your revenue guidance in this quarter, was particularly strong, what has actually happened there?

I mean you listed the programs and I think they are the obvious programs.

But shipbuilding is usually a pretty predictable business.

So did something happened there now that you are seeing acceleration from what you would have thought you would see?

Well, George, as you know, that is a part of our business, particularly in our so-called ship systems sector that has been a bit challenged from an operational standpoint in prior years.

The management team there has been working very hard to not only improve predictability but performance, and I think what you are seeing in the guidance that we are reflecting today is a real effective effort and attention by that management team to improve the performance and the operations and the productivity at that business.

And I think that's what you're seeing.

Okay.

And then just -- I noticed the backlog was down in I think all of the sectors, I mean the comment on that is it just timing or what would you expect by year end?

George, it is really just timing.

We are frankly, on a year to date basis ahead of our internal projections with respect to where we should be on new orders.

Modestly, at least.

And so we're feeling good about that.

This is a bit lumpy, and so I think what you're looking at is principally timing.

With respect to a year-end backlog, I don't think we're at a point right now as we evaluate what Ron had described earlier in terms of the actions in Washington that we will start -- that we are going to start predicting year-end backlog.

Okay.

Thanks a lot.

Thanks, George.

Your next question is from Joe Nadol with J.P. Morgan.

Thanks, good morning.

Good morning, Joe.

Just back to the block 60 for a minute.

Ron, I know you already gave some qualitative comments on where you are, but is there any way to quantify or bracket in any way where your risk reduction efforts are on the program, you know, a few months ago or a few quarters ago, today, and then when you expect to get to more or less full risk reduction?

Obviously, we have multiple parts to this.

In the internal FLIR core targeting system, three quarters of the units have been qualified.

In the agile beam radar, which is a very big part of this job, the entire qualification has been completed, and as I mentioned earlier, the production has been accelerated.

With respect to the problem child, the Falcon Edge, we are about 50% of the way through the quall (ph).

And we expect that quall to be completed by the end of the year.

So that's kind of where we are at this point in time.

I mean it's a -- this is a very, very challenging but carefully managed program.

We have tremendous attention on it.

And significant risk has been reduced in the last three to six months as a result of the actions we've taken.

Okay.

So all of your charges in the program to date have been on Falcon Edge; is that right?

The vast majority?

The vast majority, yes.

Okay.

And so that's really -- it's really probably two more quarters before we can write that one off as fully through the risk phase?

Well, look, this program has risk.

We've said this all along.

And it ain't over until it's over.

But there has been a lot of risk reduction.

We have a couple of quarters to go on Falcon Edge and this is our best shot at where we think the thing is going to end up.

Okay.

And then on cash flow, was there anything specifically that drove your upward revision for the full year?

Is it working capital or taxes or just I guess partially your conservatism in earlier forecasts?

Chuck?

Joe, I don't know if I should take offense at your suggestion that our last guidance was conservative.

It was certainly our best judgment at that point in time.

You're really seeing good cash performance in the first half of the year through all of our businesses.

Virtually all of the segments, but not all, are cash generators, at this stage, I think it's really all of the above.

There is no one unique item that is driving that.

I think we won't -- I think I will stop there.

I think that is really our best judgment.

Okay.

Is it too early?

You know, you're now most of the way through your authorization for share purchase.

Is it too early to think about, you know, what you are going to be doing next with your cash?

Because, you know, looking at a larger cash balance than expected for the end of the year.

Yes.

Okay.

Thank you.

Thank you, Joe.

Thanks, Joe.

Sir, your next question is from Howard Rubel with Schwab Soundview Capital Management.

Well, gentlemen, a couple of things.

Ron, first you talked about your satisfaction with the appropriations conference.

How do you think that impacts your anticipated growth rate?

You know, it's a little early to say how we're trying to run the traps on that and look through, because it has to do with the outlays, some prior year funding that we don't have and some of our work comes through subcontract, so in the process of rolling all of that up and we weren't prepared for this point in time to give an instant flash report on that so stay tuned.

No, no, no.

But, it would seem that if there is nothing in there that is really a -- you know, maybe the biggest sort of thing that was held back a little bit was KEI, but X that, you basically got plus-ups or for example, the biggest risk carrier was probably LHA.

Is that fair to say?

Yeah.

And that's been put to bed?

Yeah, I think we pretty much ended up where we hoped we'd be.

We see growth for next year for sure.

Although, I might mention in KEI that there was a reduction to the significant increase requested year-over-year by the President which will result we believe in an increase in that line for us when the dust settles.

This Defense agency has to plan that out obviously in detail.

But our view still is for growth next year.

You spoke to the fact or I guess Chuck spoke to the fact that your bookings appear to be ahead of plan through the six months, is that win rate more than anything else?

And could you comment on what you think your win rate has been?

Well, you know, it turns out that a substantial portion of what we book is not competitively a source.

So win rate has been good.

I don't have a number off the top of my head, Howard.

But a lot of this is basically funding timing on the -- on the increments of funding on major ongoing programs which really accounts for the bulk of our backlog.

And as you -- I know you've been very careful over the years to take care of risk where necessary.

And other than the Falcon Edge program, is there any other major -- I mean what percentage of your R&D business at the moment is fixed price?

Howard, I don't think we've got that number handy for you.

I would say that as we look across our portfolio of contracts which I think number something like 30,000 or more, and obviously, we're managing that -- those programs one by one, but it is a pretty broad portfolio, we don't see anything like a Falcon Edge or a block 60 elsewhere in the portfolio.

Do you have any redress from your suppliers on some of this overrun?

And did you have to pay any penalties because it appears you will be a little late?

No, not that I'm aware of.

No.

And then --

I would say no on either account.

Well, that's too bad on at least on one of those counts.

Yeah. (LAUGHTER)

Well, I'm sure Chuck is going to fix that at some point.

And then the last thing on marine, I guess some of the trade publications have indicated that the Virginia class submarine has a little more risk in it, and I know again, you drafted the contracts so that there is an enormous amount of risk avoidance on your part.

Could you sort of comment on where you are and how you're dealing with the cost growth?

Yeah, the Virginia class is two flights.

The first flight where you're probably seeing the published reports of cost pressure is the first four boats, which are cost-plus, fundamentally.

We are a subcontractor, Electric Boat which is part of General Dynamics, we do about half of the work.

Obviously, first of class ships tend to be challenges in cost.

That's why we do them as cost-plus jobs.

We're doing everything we can, together with our partners, Electric Boat and the Navy, to manage the cost on these things.

I think based upon numbers I saw recently, the cost growth on these ships are probably the lowest of any first of class in memory in most of the shipbuilding business, so that doesn't excuse the fact that there is cost growth, but I think it is -- you have to put that in proportion.

The next flight of five after that, is going to be a fixed price, but those are based upon a different set of assumptions and we don't start construction of those for a while.

Thank you, gentlemen.

Thank you, Howard.

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

Yes, thank you.

If I could trouble you a little bit to give us some indication of where 2005 might look like, do you think sales are going to continue to grow in roughly the same way that they -- you're predicting in '04?

And really, what might the margin look like?

How easy is it going to be able to achieve margin expansion in '05 as you go into potentially what might be a greater mix of development due to a very good period of contract winning that you have been achieving over the last six months to a year.

Nick, we went through some fairly detailed numbers in May at our investor conference.

And I'm going to follow those numbers.

But if start at the bottom and work up, we feel comfortable with a strong double digit improvement in earnings per share from continuing operations.

That is reflective of I would say a respectable improvement in operating margin, segment operating margin, we would see exceeding 8%, or getting into that low 8% kind of range.

And the way we're going to do that is the way we have been performing over the course of this year, which is with an awful lot of attention to detail and awful lot of focus upon being cost effective in how we spend our money.

So we feel good about the margin improvement opportunities, and again, you have to look across all of our sectors to look at that development versus production.

Our integrated systems business, for example, has got a very strong backlog of development programs, but on the other hand, our electronic systems business continues to do -- be doing quite well, X, box 60 in terms of its margin performance and its ability to wring out better margins and we see good opportunities really across all of our sectors from a profitability standpoint.

In terms of revenue, we certainly see revenue growing in 2005.

We're in the midst of our planning process.

We're also evaluating what has just occurred and just announced recently in Washington that Ron covered earlier in our prepared remarks, so we see, you know, very respectable revenue growth, but we're probably going to update our view on sales later in the year as we complete our planning process.

Great.

And a follow-on for Ron, if I may, and a follow-on from the first question that was asked by Byron which is on space.

As we see some of these more challenging programs getting a little bit cut back, I guess, by Congress and the Senate, do you think that might have an effect on mission systems in space in the longer term?

Or have you got enough business in that pipe already to at least see you through the next two to three years?

Well, Nick, we do have a tremendous amount of business in the pipe.

I think one of the reasons why the Congress has been careful not to rapidly expand the funding on some of these brand new programs is that there is a tremendous pipeline to -- they've got to fund, a good portion of that comes to us.

Programs such as advanced EHF, programs such as the NPOS, and a few other major programs, SIBRS for example.

And those are I think -- those are programs that have to be funded and have to be completed over the next few years.

I think there will be expansion in these new forward-looking programs.

I think probably the rate of growth of those will be only what the budget can support.

There is only so much money they can spend on space and it is a mix between existing and future programs.

So I think the good news is that we're very well positioned in the existing programs, and we would view any significant growth in future programs as some good upside for us.

Great.

And one very last one for Chuck.

You did very well covering all of the divisions except I think you left out space technology, and explaining why there might be some sales growth there in 2004.

And also why there may be a slightly lower margin anticipated.

Not so much over the year, but between the recent quarter, and then the full year as a whole.

Well, actually, Nick, I think we reconfirmed our margin guidance so I don't see any deterioration in margin.

They are really hitting on all cylinders across all of their programs.

There is not any particular program which jumps out at me as being notable.

Right.

There was a small decline year over year comparison I think that is what you're looking at, Nick.

That is just mix.

Okay.

And then the top line growth looked very good for that, and I just wondered why you got off to this little high end, high single digit end for that division.

Again, I think Nick, it is really across the -- across all of the programs.

They are doing very well, very focused as you might appreciate, in some of these development programs, particularly in the cost-plus world, the key is having enough of the right kinds of engineers and scientists and capability to be doing the work, and I think we have been successful in attracting outstanding people to the company, in order to perform on those programs.

Great.

Thank you very much.

Thank you, Nick.

Sir, your next question is from Jared Naroff with Prudential.

Thank you and I joined late so I apologize if you already answered this, but the integrated systems you note that the margins are going to be depressed because the level of development work that's going on and your guidance for the year has (INAUDIBLE) range for the operating margin.

Can you give us a flavor of when we might see an improvement to more historical levels, when the bulk of the development work may be behind you, just in a general sense?

Not looking for --

I think we're a couple of years out.

A couple years two, or a couple years four or five?

A couple years two.

Great.

And again, I apologize if you went over this previously, but in electronics systems, there were some closeouts that offset the -- that offset the block 60 charge, is that right?

Yes.

And the amount of those was somewhere around 40 million?

No, about half that.

About half that?

Great.

Thank you.

Your next question is from Marty Pollock with NWQ Investment Management.

Yes, just a couple of questions.

When you are talking about the F-16, block F-16 there, when you refer to that, do you see significant risk reduction, you're referring specifically obviously to the execution of the program, but again, even though everybody has brought this up, what do you see as still the financial costs associated with the completion or at least the next two quarters, additional costs that, you know, that are still a problem, associated with the program?

Marty, this is Ron.

I think the charge we took truly is our EAC, that is our estimate of complete up for the entire program for all parts of it, so the place we think we're going to come out.

That's our best shot today.

And as far as your guidance, the guidance seems to -- I think it seems to suggest that, you know, you are up around 10 cents.

How much of that is tax-related, better tax outlook?

Is that part of that change guidance?

Well, certainly, the revised guidance, Marty, does reflect the $31 million in tax credits that we -- that we announced and recorded for this quarter.

As well as the block 60 charge that we've been talking about over the course of this call.

So it is an all-in impact.

It does include the effect of that $31 million of tax credits, as well as what we see as margin improvement in some of our businesses in the second half of the year.

Okay.

And if you would, just remind me, on that first quarter, what was -- was there a -- there was also the charge on that -- on the -- on that F-16.

What was the F-16 block --

No, in the -- Marty, in the first quarter of this year, we did report a charge.

That was associated with the decision in Indiana state court with respect to the Allison gas turbine litigation.

Oh, okay.

There was no block 60 charge in the first quarter.

Okay.

Thanks so much.

Thank you.

Sir, we have a question from Gary Liebowitz with Jeffiries.

Thanks.

Can you tell me where, if at all, pension contributions rank on your list of cash deployment priorities?

Gary, as you you might appreciate, what tends to focus our attention with respect to pension contributions is the allowability and the contract recoverability of our contributions, as well as the tax deductability.

And so we will tend to look at levels of pension contributions that not only conform to the tax regulations, fulfill our legal obligations, clearly, as well as the funding levels that are permitted by U.S. government cost accounting standards.

So we tend to play in that envelope, if you will, in terms of contributions.

Okay.

Also, can you talk about some of the technical challenges on SIBRS high and where we stand with respect to delivering the first sensor payload.

There have been a lot of reports of cost overruns on that program.

Yes, we are providing the payload of the infrared payload and that's -- that's our principal responsibility.

The first payload is called HEO 1 a high elliptical orbit one, it is basically in the process now of being delivered.

We set a set of milestones out in January.

As we rebased the program, we have been holding to those schedules.

We're working very closely with our partners Lockheed and the Air Force on that.

There has been some very considerable forward momentum which we've picked up on this program in the last three to six months.

This is also a challenging program, it's a cost-plus program, state of the art program, very important for the nation's security.

But we are making progress on that program.

The next delivery will be called HEO 2.

That will be fall -- I don't have a date off the top of my head and then in the next few years we'll be delivering the GEO versions.

Thank you.

Thank you, Gary.

Sir, we have a question from Steve Binder with Bear Stearns.

Actually, two questions.

One was following up on SIBR side, you didn't take an accrual adjustment in Q1, I gather you didn't take one in Q2, either?

That's correct.

Okay.

And two, with respect to the auto business, and the aeronautical systems business, you put in the past that you have warranty, post retirement, and other liabilities that you have retained.

What's the timing on the settlement of these liabilities and are you expecting a cash outflow there of any material note?

Well, there are provision, Steve, in both of those -- the cases that you're referring to, for a process for settlement, and depending upon whether or not there would be some form of global resolution, as opposed to a piece by piece or transaction by transaction element, that could stretch out or it could fall in a particular year.

We don't think it's going to be particularly notable this year.

And frankly, you know, we think that the accruals that we've made are going to adequately handle those exposures.

I was really referring to cash, not so much earnings.

I mean, can the cash outflow be material?

Meaning, you know, in the three digit category.

In the aggregate?

Yeah, well --

In the aggregate, I would say in the aggregate, between the two, if everything was settled, which is not the way we are required or obligated to settle it, it could be -- it could be in the low triple digits.

Okay.

Thanks very much.

Okay.

Ladies and gentlemen, we are going to have to end here.

Ron?

Yeah, let me just cap this off by reiterating that we -- we had very strong performance in the quarter, we're very pleased with how the quarter came out.

We faired very well in the defense appropriations conference.

And we are excited about some of the competitive opportunities that we have going forward.

Thank you all for joining us and we will talk to you next time.

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

This concludes your presentation.

And you may now disconnect good day.