諾斯洛普·格拉曼 (NOC) 2004 Q4 法說會逐字稿

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

My name is Rachel, and I will be your coordinator today.

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

We will be facilitating a question-and-answer session at the conclusion of today's presentation.

If you wish to register for a question you may key star 1 at any time.

If at any time during the call you require assistance please press star followed by 0 and a coordinator will be happy to assist you.

As a reminder this conference is being recorded for replay purposes.

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

Sir, please proceed.

Thank you very much, Lisa.

Welcome, ladies and gentlemen, to Northrop Grumman's conference call.

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

Available as an accompaniment, it will be available for a limited time and should be viewed in conjunction with today's commentary.

Please understand that, as shown on slide 2, 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-Q and forms 10-K, among others.

During the call we'll discuss fourth quarter and year end results, as well as the outlook for 2005.

Guidance for 2005 will be GAAP measures of sales, earnings per share from continuing operations, and net cash provided by operating activities.

And finally Northrop Grumman will beholding its annual institutional investor conference here in southern California on March 23rd and 24th.

This year's meeting will include tours highlighting Integrated Systems, Space Technology, and Mission Systems programs, as well as presentations by corporate executives and each of our sector presidents.

The presentations will also be webcast.

We hope that you will be able to join us.

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

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

The outline of his comments is shown on slide 3.

Thanks, Gaston and good morning everyone.

Thanks for joining us.

During my remarks today I will briefly discuss fourth quarter and year-end results, our views on defense spending, and I'll conclude with some comments on what you can expect from us in 2005.

Results from the fourth quarter and the year were solid and exceeded our most recent guidance for 2004 sales, earnings per share and cash provided from operating activities.

Fourth quarter sales increased 10 percent to $7.8 billion, and for the year revenue rose 13 percent to $29.9 billion.

Fourth quarter earnings per share from continuing operations increased 62 percent to $0.81, and for the year earnings per share from continuing operations rose to $3.06, a 51 percent increase over 2003.

Fourth quarter net cash provided by operating activities declined 324 million from 773 million last year, but this year's fourth quarter included a $250 million pre-funding of our pension plans, as well as $89 million related to the settlement we announced with Goodrich on December 27th.

For the year, cash provided by operations totaled $1.9 billion.

Fourth quarter funded contract acquisitions totaled $11.9 billion, a record for this corporation, and a $1.4 billion increase over last year's fourth quarter.

Which was a previous Company record.

This quarter's awards bring funded backlog to about $28 billion and total backlog to $58 billion, so we generated a 13 percent increase in sales this year while maintaining our backlog.

Throughout the year we've sharpened our operational and financial focus and consistently improved our risk profile.

Our goal is always flawless execution on every program, but in a corporation this large, with many thousands of contracts, there will be areas where we can improve our performance.

We took a fourth quarter charge in the electronics sector on the Wedgetail program which reflects analysis of technical issues following system [instrument] modeling and qualification testing which we conducted during the fourth quarter.

The new estimate will complete -- to complete will cover redesign and retrofit to elements of the antenna.

Hardware is currently being developed to support flight tests, and a contract is expected to be completed in 2008.

We expect that this charge will be adequate to cover the program, but as with any fixed price development program, risk remains until the program is completed.

Looking forward, the President's budget, which is a key input to our planning process, will be submitted on February 7th.

We're well aware of the press reports indicating that the DoD budget is under pressure, and that Air Force and Naval programs may bear the brunt of spending reductions.

Keep in mind these are proposed reductions to the planned rate of future growth.

At this point we can't address what we think will happen with specific programs, until we actually see the President's budget.

However, if the budget validates everything we've read, the preponderance of the change appears to be in the out years, 2008 and beyond.

We don't see significant impacts this year or next.

We're well positioned and agile enough to respond to the priorities established by our customers and Congress.

We have a diversified portfolio of businesses and programs, and we don't have any large strategic gaps.

Should spending priorities change over time, we will respond as needed to meet our customers' requirements and create value for our shareholders.

As we're all aware the defense budget process involves many iterative steps and won't be completed until Congress makes the final appropriation decisions this fall.

Budget pressures are going to be a fact of life due to the deficits and the war on terror, but spending is still increasing year-over-year, and over the immediate future the budgets, as we understand them, support our positive outlook for this year and next.

Over the immediate future we have a solid pipeline of sole source and follow-on business, and we won some important new programs like the joint unmanned combat air systems program for DARPA, the [Netsense] and E 10-A battle management command and control sub system for the Air Force, and Prometheus, formerly known as the Jupiter Icy moons orbiter which is a project to develop a preliminary design for a vehicle to orbit Jupiter's three ice-covered moons.

Moving on to slide 4, based on our current outlook we are increasing guidance for 2005 sales to between 31 billion and $31.5 billion.

This is about 5 percent top-line growth, which we expect will be accompanied by margin expansion.

We expect 2005 earnings per share from continuing operations to grow to between $3.45 and $3.60 per share.

This represents 13 to 18 percent growth over 2004 which is in line with our previous guidance, and includes a $40 million estimate of the impact of FAS 123, as well as higher pension expense than in our previous guidance.

We are also increasing our guidance for cash provided by operating activities to between 2.2 and $2.5 billion.

Now before I turn the call over to Chuck for a more detailed discussion of the financials I want to thank him for his willingness to step in as our CFO in 2003, in addition to his duties and responsibilities as a member of the Board.

We thank him for the outstanding job he did in both roles.

Chuck has been instrumental in guiding us through the financial and internal control compliance requirements of Sarbanes-Oxley, initiating a successful capital deployment strategy, helping us position the Company as we scaled up to become a $30 billion enterprise, and was responsible for a initiating and directing a Company-wide effort focused on enterprise competitiveness.

We all wish Chuck well in his future endeavors.

We both agree that Northrop Grumman has outstanding opportunities ahead of us and that the best approach for the Company continues to be a balanced cash deployment strategy, that includes appropriate capital spending and debt reduction, regular reviews of dividend and share repurchases and selective acquisitions to shape our portfolio and enhance and accelerate growth.

Now I'd like to turn the call over to Chuck for more detail on the financials.

Thanks Ron and good morning everyone.

My comments today begin on slide 5 and cover our fourth quarter and 2004 segment results and trends, operating margin line items, cash provided by operating activities, and improvements in the balance sheet in 2004.

Total operating margin for the quarter was $573 million versus $362 million in 2003, up 58 percent.

The total operating margin rate for the quarter was 7.3 percent versus 5.1 percent in 2003, an increase of 220 basis points.

That margin expansion reflects 17 percent growth in profit from our operations, lower pension expense, and lower unallocated corporate expenses.

For the year, total operating margin increased 39 percent and the operating margin rate expanded to 6.8 percent from 5.6 percent in 2003.

The two drivers in the margin expansion were higher operating margin from our segments and lower pension expense which was offset to some extent by a $110 million increase in unallocated corporate expenses.

Turning to the segments and moving to slide 6, electronic systems margin rose [23] percent on sales growth of 4 percent.

Improved operational performance across the segment was partially offset by the impact of the $42 million Wedgetail charge.

For the year sales rose 6 percent and operating margin increased 14 percent.

This translates to a margin rate of 10.4 percent, 60 basis points higher than 2003.

Moving to slide 7, ships fourth quarter operating margin declined 6 percent on sales growth of approximately 12 percent.

Operating margin for the quarter was $107 million, or 6.2 percent, versus $114 million or 7.4 percent in the fourth quarter of 2003.

This year's operating margin and rate reflect a greater percentage of development program revenue at ships.

For the year, ships operating margin increased 32 percent on sales growth of 15 percent and their operating margin rate expanded to 6.2 percent from 5.4 percent.

Turning to slide 8, information technology fourth quarter operating margin rose 4 percent on sales growth of 5 percent.

For the year, sales increased 9 percent and operating margin increased 12 percent.

IT's operating margin rate improved to 6 percent versus 5.8 percent in 2003.

Government information technology and technology services were the primary growth drivers here.

On slide 9 you can see mission systems fourth quarter operating margin grew 18 percent on sales growth of 9 percent with a margin rate of 6.4 percent versus last year's fourth quarter operating margin rate of 5.9 percent.

For the year, mission systems operating margin grew 21 percent on sales growth of 19 percent.

The operating margin rate for the year was 6.5 percent versus 6.4 percent in 2003.

Slide 10.

Integrated systems fourth quarter operating margin rose 28 percent on sales growth of 26 percent.

For the year operating margin increased 7 percent on sales growth of 23 percent.

The operating margin rate declined to 8.7 percent from 10 percent last year.

Both the sales and operating margin trend reflects continued ramp-up on new development programs.

Slide 11.

Space Technology had another strong quarter with sales growth of 15 percent.

Operating margin was flat in the fourth quarter due to favorable contract settlements in last year's fourth quarter.

For the year Space Technology's operating margin increased 15 percent on sales growth of 16 percent.

For 2005, we anticipate operating margin rate expansion at the sectors and on a consolidated basis.

Each of our sector Presidents will provide a more detailed outlook for each of their businesses at the March investor conference.

Slide 12 presents additional details of our 2004 actual results along with estimates for 2005.

You can see pension expense for 2004 was $350 million and CAS pension expense was $338 million.

For 2005, subject to refinements for participant census data and pay-as-you-go plans, we expect pension expense of around $415 million, and CAS pension expense of around $365 million.

Our 2005 estimates are based on a 13 percent plus return on plan assets in 2004, a 5.75 percent discount rate, and an 8.5 percent long-term expected rate of return.

Effective tax rate for the fourth quarter was 35 percent, and 32 percent for the year.

We expect that effective tax rate of between 33 and 34 percent in 2005.

Cash from operations in the fourth quarter totaled $324 million bringing full-year cash from operations to $1.9 billion.

Capital expenditures including capitalized software costs were $245 million in the fourth quarter, and $672 million for the year.

We expect capital spending in 2005 to be in the range of 750 to $800 million including capitalized software expenses.

Depreciation in 2004 was $514 million and we expect approximately $550 million in 2005.

Amortization and purchase intangibles was $226 million in 2004, and will decline to around $220 million in 2005.

Slide 13 summarizes our cash deployment actions in 2004.

During 2004 we did some relatively minor portfolio shaping, increased the dividend by 15 percent, implemented a 2-for-1 stock split, repurchased $800 million of our common stock, and reduced net debt by $1.6 billion.

Net debt to total capitalization has declined from 26 percent at the end of 2003, to 18 percent at the end of 2004.

This reflects $1.9 billion of cash provided by operating activities, the early redemption of $250 million of 9 and 3/8 notes due in 2024, and the retirement of $350 million of 8 and 5/8 notes that matured in the fourth quarter.

We also monetized the payment in kind note that we had received under the terms of the sale of TRW Automotive for net proceeds of $494 million, and we received $690 million in proceeds from the settlement of our equity security units in the fourth quarter.

We also successfully remarketed the ESU-related debt at a very favorable interest rate.

Strengthening of our balance sheet resulted in positive actions by all three credit rating agencies during the fourth quarter.

Fitch changed our BBB rating to a positive outlook.

Moody's upgraded our rating to BAA-2, and S & P changed our BBB outlook to positive.

It's been a very productive year across the board, especially in terms of performance and predictability.

Finally I want to assure investors that my decision to leave Northrop Grumman was not due to any concerns about the integrity of our financial information or systems, or any accounting or financial issues, and I certainly echo Ron's thoughts regarding the Company's future.

With that I will turn it back to Gaston for the Q&A.

Thank you very much, Chuck.

Lisa, we're ready for questions.

Ladies and gentlemen as a reminder if you wish to ask a question please key star followed by 1 on your touch-tone phone.

Our first question comes from the line of Cai Von Rumohr of SG Cowen.

Good quarter.

Two issues at electronics.

First, it looks like did you 13.8 percent if you back out the Wedgetail.

Were there any favorable contract close-outs?

Secondly, maybe give us a little more detail in terms of the wickets we should look for to tell us that Wedgetail is totally out of the woods.

Cai this is Chuck.

We really had an -- X the Wedgetail charge, we really had an excellent quarter at really across the board at electronic systems.

As you know this is a sector that has literally thousands of contracts, number of close-outs wrapping up some very successful performance on a number of programs.

There's really not one I can pick out for you, but I would say that that kind of margin improvement X the charge, is probably not repeatable going into 2005.

Yeah, let me also add, Cai, on the Wedgetail program this is a very large state-of-the-art airborne radar program.

As you know we're developing under fixed price contract to Boeing.

It's high power, very sophisticated, probably one of the most complex L-band antennas ever being built.

The recent qualification testing we went through in this last quarter revealed our performance did not meet the model projections we had, modeling these kind of antennas is a complex matter.

It can sometimes happen on antenna programs.

The testing dictated we would have to redesign and retrofit some elements of the antenna.

The charge we've taken now encompasses everything that we now know would be necessary to get this program completed.

We think there's adequate reserves to do this but it is a fixed price development program.

So you never can say never, but this is where we think we are at this point in time.

The test program looking forward to your question about what's next, in the second and third quarters will be undergoing full system tests, both of the antenna and then on the aircraft and I think by the third quarter we'll after pretty good sense that we're over the hump.

Again, the program does continue through '08, but that will probably be an important set of tests as we look through the third quarter.

Thank you very much.

Thank you, Cai.

Thank you, sir.

Ladies and gentlemen, our next question comes from the line of Byron Callan of Merrill Lynch.

You guys mentioned guidance and sales had increased.

Can you identify specifically what has changed?

Is this new contract wins?

Is it expansion of scope of work?

Could you walk through that a little bit more?

It's really across the board, Byron.

With the exception of Space Technology and our Ships business that really had outstanding top line performance in 2004, we see growth in all of our other segments going into '05.

I'm just trying to think of what triggered it compared to last quarter.

I guess that's what I was looking for.

We update our forecast in the fourth quarter as we lay out our operating plan and we review them internally and with our Board, and we determined we had greater strength and revenue for '05 than we had previously estimated.

Ron, the Company's had a pretty sharp focus on, on the conventional war fighting capabilities, particular this whole notion of precision engagement.

If we look at some of these things, like the Defense Science Board [summer] study, some reports about the QDR guidance that's coming out, it would suggest these aren't just budget pressures that are having a force or changing defense spending, they're some real underlying fundamental changes in how threats are being perceived, and I'm just curious how you respond to that and how well you think Northrop Grumman is positioned to address these changing market needs and opportunities.

Byron, we're closely following this and, in fact, as we see the QDR process develop and unfold we'll obviously provide input and look at it.

I feel very good about the positioning of the portfolio because we're sitting with, first of all, a broad portfolio.

We're in all sorts of things that make a difference whether you're going after a regional power, or frankly trying to find folks down in the weeds hiding in the clutter.

If you think of the ISR, Intelligence Surveillance and Reconnaissance attributes of the Company and where we're focused, that's going to be incredibly important under anybody's scenario going forward.

If you look at Information Technology as applied to both conventional and perhaps the emerging concerns of the threats, that's also going to be there as well.

I should also point out that because of the shift of emphasis that might occur you're not going to immediately decide you don't need a Navy, an Air Force, or tanks, or anything like that.

You're going to need all of those things and more.

If you take a look at unmanned air vehicles and other kinds of complex information gathering and decision tools, these are all going to be necessary, and I think the nice thing about the portfolio is that we play into all of that.

Great.

Thank you very much.

Nice quarter.

Thanks, Byron.

Thank you, sir.

Gentlemen, our next question comes from the line of Steve Binder of Bear Stearns.

Yeah, good morning.

Good morning.

Chuck, I wanted to wish you the best of luck.

You did a good job while you were at Northrop.

Thanks, Steve.

Ron or Chuck, just touch on block six, give us an update on milestones, and how you feel about your EAC on that program?

Sure, Steve, let me take a shot at it.

Chuck, feel free to add.

We're proceeding very nicely, we're on track.

We're meeting our milestones.

We're operating within the reserves we've established.

This is a very complex program with many moving parts.

As you know there's radars, there's targeting systems, there's electronic warfare.

The pieces are coming together.

Now, again, it's a fixed price development program and you never say never so there is risk, we've always said that.

But at this point in time, things are moving fine.

We've got a series of tests on the Falcon Edge system which is the one piece of it as you recall, the electronic warfare piece, which has been the most troublesome.

Radar and some other pieces have been pretty well under control.

We have a key test coming up in the first quarter, second quarter time frame on those which will continue to give us increased confidence in the program.

We're cranking out hardware, we're providing equipment to our partner Lockheed on the aircraft, and I will tell you the information that I've seen shows that the equipment looks like it's performing very well.

And with respect to the cash flow outlook for 2005 you bumped it 400 or 500 million, I guess part of that, the earnings hasn't changed, but the quality has, you're digesting the stock option expense and you've bumped this FAS CAS adjustment but there seems to be a pickup of working capital of at least $300 million, close to it, versus your previous plan.

Can you touch on where that's coming from?

Sure, Steve.

Keep in mind with the provisions we took in 2003 and 2004 with these underperforming programs, obviously you're spending money, and not generating any earnings, so part of is it the burn-off of contract loss provisions, loss reserves in '05.

There's also some, if you will, the utilization of some advances as we earn advances on some of our international programs.

It's largely in the electronic systems and our ship segment.

But that's going the other way, Chuck.

I meant you're increasing your -- the reduction of working capital is going to be greater in '05 than your previous plan, right?

Well, there's timing and collections, and certainly we've been putting an additional emphasis on not only working capital and managing the balance sheet but also, you know, our ability to predict I think is also much improved.

Steve I'll also remind you this is Gaston, we advanced $250 million of pension funding into '04 out of '05.

Okay.

And lastly, the share repurchase, you stepped it up in the fourth quarter, to a little over $300 million, you're running below 200 million a quarter in the prior three quarters.

Can you maybe just touch on, is that -- we're going to see that continue at this higher rate in the first half of the year?

To kind of offset the share creep?

Well, we're certainly committed to offset the share creep, Steve.

I think you're going to see us be, oh, probably in the last three-quarters of the year be a little bit more stable in terms of that.

Obviously this is something that the Company will evaluate regularly and, of course, always dependent upon market conditions.

All right.

Thank you.

Thanks, Steve.

Thank you, sir.

Our next question comes from the line of Joe Nadol of JP Morgan.

Good morning.

First question is on your margin guidance for 2005.

Could you provide -- I realize that you're going to provide more granularity on a sector basis in a month or two, but could you provide any more specificity as to where you're going to see the improvement, you know, either by sector or just more generally speaking do you see margin improvement X the nonrecurrence of the charges that you took on block 60 and Wedgetail in '04?

Joe, this is Chuck.

With the exception of Integrated Systems, you're going to see modest margin improvement across the board in our other segments.

As you know, at Integrated Systems they ever a large volume of development work which as we've told you now for over a year, was going to drive margins down to the high single digits versus the more traditional low double-digit margins that that particular segment has enjoyed.

Overall our consolidated operating margin we would certainly see going over 7 percent.

As you know, I think it was 6.8 percent for this year.

We will certainly exceed 7 percent going into 2005, including all the unallowables and the unallocated elements that we don't charge to our segments, including the increased pension expense and the estimate that we've given you for the implementation of FAS 123 in the third quarter.

Okay.

Secondly, just going back to the question that Steve was asking on cash flow, the pension issue for cash in '05, are you saying that your CAS expense will be in excess of your cash pension contribution, and is that contributing for cash relative to earnings?

Because it looks like you are projecting a conversion ratio of 110 -- or 115 percent of your earnings next year.

No, Joe, that's right.

The CAS pension expense in '05 will exceed the cash contributions by virtue of the prefunding we did in December.

Finally, on the ship budget, I recognize that a lot of the changes are in the out years.

One thing I think that's a little more near term is the elimination of one carrier from the fleet, and, Ron, I was wondering if you had any color on any implications if that were to take place, on the services business at Newport.

Well, the -- obviously, it depends on the kind of carrier.

There is talk of eliminating the U.S.S.

Kennedy from the fleet which is a conventional carrier and if that's the case there will have to be some dismantling done.

I'm not sure if that will come to us.

More likely to go to Naval shipyard.

Most significant impact on us, would be if there was a decommissioning of a nuclear carrier which we don't see in the near term.

Enterprise might be the first one to be considered there.

That probably would have to come to us, just because of the way we're equipped at Newport News, kind of uniquely positioned.

We've not yet decommissioned a nuclear carrier.

We've been building them for several decades.

I think the most important thing for to us watch is the rate of progress on the CVN-21 program, and that program might experience some slippage in the budget.

However, we've kind of factored all of that in our planning for '06 and beyond, but other than that I don't see any significant or dramatic impacts as a result of taking a carrier out of the fleet.

And that would apply as well to timing of refueling?

Yes, obviously if refuelings happen sooner, the work comes in sooner.

The refueling and overhaul for us is about a three-year, $1.5 billion job.

If you think about -- we don't have it in our backlog, but if you look at every one of the nuclear carriers out there, we've refueled a couple of them.

We're finishing the Eisenhower, but the remainders are going to have to go through that, that's in addition to new carrier construction over the next 5 to 10 years, but I don't see any intent to do them sooner than necessary because you want to get as much service life out of these as possible.

As you know, last year we talked about the fact that the Vinson, U.S.S.

Vinson, was actually experiencing better life in its nuclear core than expected, and as a result the carrier refuel was delayed a year, which gave us some concern.

However, it turned out that working with the Navy we were able to provide a bunch of other repair work because of the surge required for the previous war.

Thank you.

Thank you, sir.

Gentlemen, our next question comes from the line of Nick Fothergill with Banc of America Securities.

Good morning.

Couple of questions if I may.

First of all, cash deployment.

Are there any areas, Ron, that you would identify with your portfolio of businesses that you would like to add to, via acquisition, and if so what sort of scale would you be looking at?

That's the first one.

Obviously we have said consistently that we're going to do portfolio reshaping.

I think that without being specific about individual opportunities or specific areas, I think you'll see that we'll make a potential move from time to time in areas that are in the business we're in, where we can add some things.

The good news here, Nick, we're not sitting here with a gaping hole where we have a strategic problem or a great concern depending upon which way the QDR goes.

I think we're pretty agilely set up for that, but I think you might see some bolt-ons there, I think obviously, we're very concerned about a balanced cash flow strategy and we're not going to look at anything that doesn't make sense from a value creation standpoint.

And you'll also continue with a small disposal program as well, I guess?

Yes, that's correct, Nick.

As any large company has from time to time we have units that don't meet strategic criteria or don't fit in some way, and we have as you know in the last year or so, shed a few of those things.

I think the good thing is that we're not in a massive housecleaning mode in this Company, because almost everything we have does fit, and we're excited about how it fits together in the whole.

Then also on future programs for 2005, Ron, could you just quickly walk us through what is flashing up on the radar at the moment and give us a quick identification of what scale it might be, and what time frame it might be?

Yeah, Nick.

Let me take a shot at that.

First of all, let me say that for '05 the overwhelming majority of our revenues which we're forecasting are the basis of ongoing contracts or very high probability sole source follow-ons, and so, but what we do want to focus on, is on the edge of these things, the competitive opportunities that can position us for the future.

We see growth opportunities in a number of areas.

The Intelligence Surveillance Reconnaissance area which is a broad area, which encompasses a lot of what we do.

Information Technology, these are big opportunity areas.

I get to specific programs, some of the key programs that we're tracking are the space-based radar, which we're participating as both a prime competitor, and also a supplier of radars to our competitors on a prime basis.

The transformational communications satellite program, potential additional work on the advanced EHF program.

We're also lining up and have announced a new teaming relationship with Boeing for the NASA crew exploration vehicle, a program which we think will turn out to be a very, very large, large multi-year, multi-decade program for NASA.

We are taking the role as the prime for the initial phase of that, working with Boeing as our partner.

The Air Force personnel rescue vehicle helicopter, which is something that we're working together with our partner Eurocopter on, the NATO air-to-ground system.

There's a big new program that is potentially coming our way, or certainly we are a piece issued, in the Homeland Security program, America's Shield.

Finally an area that has significant impact for us, but I can't be specific about in that we have a number of restricted opportunities that are very important for the future.

So I think we have a set of opportunities out there for competitive bids, but as I mentioned the majority of our revenue in sales the next couple years are based on what's already in the pipeline.

Thank you very much, Ron, and good luck, Chuck.

Thanks, Nick.

Thank you, sir.

Gentlemen, your next question comes from the line of Miles Walton of CIBC World Markets.

Good afternoon.

You highlighted in the press release bio-detection sales growth, specifically in ES, and I was just wondering if you could elaborate more about size of that business?

It appeared that one of the few areas in the proposed budget adjustments was actually they plused up bio-detection on the order of 200 to 300 million a year in the fit-up, so I'm just curious about that, and also the broader question of your exposure to Homeland defense in general.

Miles, why don't I take first part, and Ron can talk more broadly about the opportunities in Homeland defense.

The business overall is about a half a billion dollar business for us.

It's up over a $100 million this year versus the prior year, and it's a great opportunity for us and really brings together the different capabilities of Northrop Grumman to serve this very special and new requirement.

If I can add on that, you know, we've all been watching the Homeland security market develop.

Some of us have been more impatient than others in terms of seeing it.

Today with the bio-detection business, we have a very important product line coming out of electronic systems.

Also keep in mind the Coast Guard Deepwater program is probably the largest Homeland Security program and there, unlike some of the pressures we're seeing in budget and defense in the out years, there is increasing Congressional support for increasing the rate of production of the badly needed cutters, that replace the ones that are deteriorating now for the Coast Guard.

We're also doing a lot of work on potential defense of airliners against ballistic missiles using infrared counter measure techniques and even some other techniques, which may or may not turn out to be a significant growth opportunity, we'll see, but we're certainly going to be positioned if it is.

So while we don't see Homeland Security ever reaching the magnitude of materiality of the company that the basic defense and intelligence budgets are, we see it continuing to grow, and we like where we're sitting in it right now.

Then just a quick question on CapEx guidance for '05, I guess I was under the impression it would be coming down a bit in '05.

Was that just a push forward of kind of unrealized CapEx in '04?

That's right, Miles, but I do think post '05 you'll begin to see the decline you're expecting.

Great.

Thanks.

Thank you, sir.

Gentlemen, your next question comes from the line of Howard Rubel of Jefferies & Company.

Ron, one of the things you talked about earlier on, was a risk reduction.

Any way for you to quantify the number of programs you had, let's say at the beginning of '04 that were on your watch list, and the number of programs you have today?

Yeah.

I can't give you exact numbers but let me give you a couple of the programs by name.

Obviously we were watching -- we've been watching, and continue to watch block 60 a lot.

We certainly feel better about that program today than we did this time last year.

In terms of the Wedgetail program while we never want to see a test result which doesn't validate our theory, we certainly have a better understanding of it now.

If you take a look at the Polar Tanker program which has given us some challenges over the last couple of years, we're 80 percent complete with the last tanker.

That's moving right along track.

The tankers we've delivered are great tankers.

We're getting very good reports from our customer, ConocoPhillips on that.

A couple other programs that we paid a lot of attention to, which didn't have as much direct impact on financials, but the [Sibers] High program in which we were providing payloads, that program has made enormous strides in progress this year, in terms of its technical performance, scheduled performance.

Also I would mention that the LPD program which for quite a number of years has been probably one of the Navy's and our most challenging programs, we're getting very close to delivery of the first LPD in the first quarter of this year.

At least we'll go to sea trials at that point in time.

The ship is beginning to look like a fabulous ship.

The Navy and the Marines are quite excited about it, so that, coupled with a number of the significant balance sheet, TRW related issues, et cetera, that Chuck has talked about, I think we've done an awful lot to clean out some of the cobwebs in the attic.

In anything it's sort of, which brings me to the second question, sort of one of opportunity.

You ended the year growing about 9 percent or so, yet for '05 we're looking for growth of only 5 percent.

I'm sure some of it is in shipyard more than anything else, as you talk about mix change.

But why shouldn't we see a deceleration to that sort of level when, you know, I would say the continuation of the business usually has a pace and cadence to it that would cause it to be a little bit higher for some time.

There's always momentum.

I mean, look at what you've continued to show in Mission Systems and in Space Technology.

I say that we really performed well this year, and particularly in the second half of the year in terms of revenues and pull-through.

The projection is a projection and it's the aggregation of thousands of programs and puts and takes and adjustments, and every program has its own lifecycle.

That's our best shot.

That's our guidance.

We think 5 percent is about right and it's made up of a lot of moving parts, so obviously it would be great if it were higher this is what we think it's going to be.

Howard, let me add to that, if I may.

We're going to give you guidance in more specificity at the March investors conference, but I think if you look across the segments for '05 with the exception of 2, you're going to see pretty good revenue growth in those businesses.

However, Space Technology, which has experienced really extraordinary growth over the last two years, isn't reasonably sustainable.

I think they grew by 16 percent this year, and as you know they've really moved from about a $2 billion business to a $3 billion a year business.

We don't see that kind of growth continuing to scale over the next couple of years.

Similarly, in our ship building business, we had very strong revenue growth in 2004.

That's probably going to tail off some in '05.

Howard this is Gaston.

I would like to congratulate you.

That's the first operator who has ever pronounced your name correctly.

I'm not even going to go any further, Gaston, you're the best.

Thank you very much.

I would remind you we've actually increased our guidance in sales.

I actually had 31.5 already.

A little bit, and the phenomenon that Ron mentioned, really, that '04 came in so strong, it's just on a rate basis it's lower, but we've actually increased our guidance for sales.

That's fair.

That's a good point.

Thank you.

Thank you, gentlemen.

Your next question comes from the line of Troy Lahr of Legg Mason.

Wonder if you could comment on unfunded backlog, in the third quarter it was up about $4 billion, and then in the fourth quarter it came down about 4 billion.

Was there a shift?

Did something shift from unfunded to funded, or what was going on there?

I think it's, as you expect, it shifted from one to the other.

I don't think there's any one program or anything unique.

Remember, of course, going from the third to the fourth quarter you've got the beginning of the government's new fiscal year.

So that may have affected it as well.

There was no significant debooking if that was your question.

The UAV market, are you seeing an increase in competition for the -- specifically regarding the Global Hawk, or how is that platform shaping out?

We control right now or participate in nearly half of that market in terms of revenue basis, and Global Hawk is a very key part of that.

Everybody sees the benefit of UAVs, and UAVs go from small hand-held devices all the way up to the scale of our Global Hawk.

Yes, of course, there's competition.

The nation is hard at work trying to make these systems, as are we.

So there's competition but there's also growth in this area.

It's clearly a market whose time has come.

The benefits of it in Iraq and Afghanistan were clearly demonstrated, and we're excited about our prospects and we move forward, with our current and our B version of Global Hawk.

Keep in mind also we're involved in the Hunter program and the Fire Scout program as well, two other unmanned air vehicles of a smaller class.

On integrated systems, when are we going to start seeing a shift back more towards production, I mean is that beyond kind of '06 time frame?

It begins in '06 then really kicks in after that.

Okay.

Great.

Thanks, guys.

Thank you.

Thank you, sir.

Gentlemen, your next question is from the line of Rob Spingarn of Wachovia Securities.

Can you talk a little bit about your ship margins going forward, and perhaps specifically comment on the cost performance on CVN-77?

With respect to the margins as you might expect as we finish off the Polar Tanker during 2005, we'll see some improving margins, beyond '05 I think you'll continue to see that improvement.

Historically, this has been a business that should be around 10 percent margins.

We had about a 1 percent penalty associated with amortization of purchased intangibles, so if you think about a theoretical goal to move the overall segment to its probably around there, and I would see that occurring ratably over a number of years with improvements in both '05 and '06.

With respect to CVN-77, I don't have the figures in terms of the details.

This is a long-cycle program.

It's five, six years, five-year program, and what we do is typically book the margins at a basis that we expect to be the outcome for the life of the contract, and as we move forward in the contract it has opportunities and risks.

Also we have some impacts occasionally that happen as a result of Navy-furnished equipment which may or may not be on time or work correctly.

Think about the carrier as having a nuclear reactor and other kinds of electronic equipment that we put together, so I don't really have anything specific to offer in that regard, except to say that it's a key program and we're making good progress on it.

Is the sharing arrangement similar to that on a previous carrier?

I'm just thinking back to some of the overruns on Reagan, which I guess occurred before you acquired Newport News.

There is a share line on it.

It's a fixed price incentive where you have a share line, and I can't recall, 70/30, or whatever it is, but it is a relationship like that.

So obviously there is an incentive for us as the contractor to manage the costs.

On the other hand there's also recognition of the fact that things will impact us that are out of our control.

Just as a final question, Ron, on, you know, regarding your target, let's say, of 9 percent in an ideal world for this business, where does capacity rationalization fall into play there?

Is that something that could be accelerated by what we're hearing about out there, in a broader sense on the ship building manifest?

Well, today, obviously we and General Dynamics are the big players in ship building, and I think it's no secret that there's significant excess capacity.

We could be building more ships than the Navy is ordering right now.

I think the question of capacity consolidation is one that the Navy is thinking through.

Obviously we would work with the Navy, if there were a specific plan there.

Right now we have reasonable sizing for the business that we have for the next two years.

We're building carriers, we're building -- we've planned on one submarine a year jointly with electric boat for the next few years.

We've signed a multiyear contract on that.

We're producing LPDs.

We've got a whole run of PDG destroyers to complete, and we've got we believe a few DDX's to get going on, not to mention our amphibs.

Clearly if there was some intent to reduce capacity, that would be something we'd participate in, but our business plans assume the current capacity.

Are you able to quantify what your utilization is?

Reason I ask, Newport News used to talk about the fact that at least at one time it could handle most of the ship building activity by itself.

That's not necessarily the case today, but is there any way to quantify?

I don't have a number but certainly if you look at the needs for docking space for dry docks, for building ways, for manufacturing areas, for combatants of all kinds, you need more than one yard for sure.

Thank you very much.

Thank you, Rob.

Thank you, sir.

Our next question comes from the line of George Shapiro, Smith Barney.

Good afternoon.

Hi, George.

Hi, Chuck.

Wish you the best.

I don't know whether to speculate on where else you might be or what.

George, you know I never speculate.

But thank you.

Chuck, in electronic systems, a little bit more from a question earlier, if you took out the $42 million charge, the margin is abnormally high, it's almost like you probably would have had about 40 million of one-time, or maybe not one-time, but benefits from contract close-outs and stuff, that would pretty much equal that.

Would that be fair?

This is spread across literally hundreds of programs, George, so it's tough to single one out.

This is the number of close-outs just getting to the end of programs, where we try to be, you know, rational but a bit on the conservative side as well as, if you will, the truing up of profit rates that are done in connection with our year-end close, across the whole enterprise.

I think if you think about 2005, though, you're probably looking at very modest year-over-year margin percentage improvement for that sector.

Okay.

And then if you could break out a little bit in unallocated, it was abnormally low and you broke out to a -- you mentioned a couple of items there.

Could you break out how much, say, was lower estimates of unrecoverable costs?

Because I figure unallocated was probably 30 or 40 million less than what I would have expected it to be.

George, you'll recall in earlier quarters we had some pretty substantial provisions for legal settlements, and we did not have anything like that in the fourth quarter of this year.

If I look --.

But you had mentioned in the release you had lower estimates of unrecoverable costs as well as the lower legal.

This is 2003.

So would like 50 million a quarter in '05, kind of be an effective run rate?

Yeah, I would -- in getting to that number, George, that would exclude the estimated cost that we've given you for the implementation of FAS 123.

Right.

At this stage we have not made a judgment as to whether or not those costs will be allocated to the segments, or treated as a cost that would be below the line in our unallocated costs.

Okay.

I think for purposes of your modeling, until the Company makes that judgment, you could add that to your estimate of unallocated for '05.

Okay.

And then ship growth in '05 given how strong the fourth quarter was, it would seem to me that ship revenues probably wouldn't grow very much in '05.

I know you've kind of been alluding to the but just to pin you down a little bit more.

I think you'll see ship revenues flat to down '05 over '04, George, and a lot of that will depend upon the performance of some of the major cost-plus programs.

Okay.

And then last one, you had strong sequential backlog increase, you know, like particularly in Mission Systems, IS and IT.

Could you kind of walk through if there were specific programs that drove that?

Well, one that affected Mission Systems I think was the ICBM program where we had signed towards the end of the year, a major traunch of new work on the propulsion replacement program part of that.

I think the rest of it doesn't --.

it was mostly just contract funding.

Contract funding.

Saw several hundred million dollar announcements during the fourth quarter of additional funding we got on several contracts.

Yeah, we got some incremental funding on some big ship programs.

Again, this relates to the government's fiscal year, the first quarter of their fiscal year kind of caught the fourth quarter of ours.

Okay.

Thanks very much.

Thanks, George.

Thank you, sir.

Our next question comes from the line of Joseph Campbell of Lehman Brothers.

Good morning, Ron, Chuck, and Gaston.

I had a question about just whether you could bring us up to date on the tax business for the shipyards.

Did that completed contract methodology stuff get passed, and what does it mean for you?

Joe this is Chuck.

It did get passed.

As you can appreciate, though, it relates only to contracts entered into after a specified date.

So the benefit that you're going to see to the ship building business and the industry, for that matter, is going to phase in over a number of years.

The impact in 2005 is quite modest.

And on ships as the government thinks about tinkering around with work loading and the shipyards, historically, this has led to problems because the mix of fixed price and cost-type contracts with the change in work loading.

There get to be all kinds of issues about whether the fixed price contracts get in trouble.

Can you just give us a high level view of what the vulnerability or the sensitivity of the contracts, and of course, the ship builders' view is always that you have to, you know, sort of make this right, and I just wondered whether, looking at your own yards, and potential ups and downs in the work loading of the yards, whether there's these kinds of issues which we've seen in the past?

We're always concerned -- Joe this is Ron.

We're always concerned about work load variations.

On some contracts there are labor-based clauses which help ameliorate some of that but in general, because even on the fixed price jobs there's a sharing relationship.

It turns out to be in both the Navy's and our interest to try and make sure there's not dramatic swings in the base of labor in the shipyards, the good news is the cycle times are not measured in days and weeks but rather in years, so we have some time to prepare for it.

One of the things we're working very hard on is to make sure we're right sized so we have the right fixed cost structure and the most efficient overhead structure, so that we have the ability to flex a little bit with the movement of the work.

In Newport News, for example, when we thought we would not be getting Vinson we took some additional measures, we got some fill-in work.

The Navy worked with us to make sure that we didn't have a significant valley or gap for the couple years where Vinson was being delayed and, of course, we took actions as well, so it's like any other production management challenge you've got to take a look at the business you're going to have and manage your capacity and your overhead structure accordingly.

Lastly are there any items -- we've got so many classified contracts these days that the contractors have significantly less risk than they frequently had in these big buildups, but we do have the issue of overruns and so on, and I wondered if you could tell us whether there are any items that we might see as either new, [non Mccurdy breech] kind of items in the Northrup portfolio, or whether there are ones already in there that are going to have meaningful changes when we see that list later.

Yeah, Joe, I think the only ones, and it's old news, would be the Sibers program which we perform as a provider to Lockheed Martin of the payload, and that's been through a non-Mccurdy situation.

I don't know if it's a breech, as much as a notification.

That's gotten a lot of attention and publicity.

In the LPD program.

And as I said on LPD, we're rounding the final base here in getting the LPD-17 delivered.

We've got 3 or 4 more behind it, in the building ways being constructed.

Those are the two that would come to mind immediately.

I'm not aware of much else.

Thank you, Joe.

Thank you very much.

Chuck, I hope we see you somewhere else.

Thanks, Joe.

Thank you, sir.

Gentlemen, your next question comes from the line of Doug Harned of Sanford Bernstein.

Good morning.

Chuck, I'll wish you the best, too.

I add question on Information Technology.

And I know this is an area you've talked about raising margins in, and in this quarter I know there's an increase in the technology services portion which is lower margin, but I'm interested in how the government information technology business is proceeding.

Are margins growing there?

Maybe give a perspective on that.

Yeah.

Let me just say that the -- what we call this Information Technology melange, is an aggregation of lots of things including Engineering Services, high end and medium and even a few low-end service areas.

One example of an area that has been doing just fabulously for us has been the subsidiary task.

Task is a very significantly growing piece.

It's a high-end Engineering Services capability.

It does a lot of work for the intelligence and restricted community, so we're very excited about the growth there.

We're seeing margin expansion in Information Technology, we're pushing hard on our folks to make that happen, and as we've scaled up from a smaller IT provider and IT services provider, to now one that has quite a large scale, maybe a third of the corporation one way or another might be involved in this area, we're finding that on the bigger programs we have more leverage and we can actually help ourselves quite a bit.

When you look forward what are your expectations in terms of growth?

I'd say both organically and potentially through acquisition for this area.

Doug, I think Jim O'Neill's target that he described at our last investor conference is that this segment of our business, MGIT, should be a 10 percent growth kind of business.

Obviously we will take a -- be taking a hard look at potential acquisitions but we are going to be pretty thoughtful about valuation.

But you see it as a 10 percent growth business, even on an organic basis?

I'm speaking of an organic growth rate.

Thank you.

That's very good.

Thank you, Doug.

Lisa, we have time for one more question.

Thank you, sir.

Your next question comes as a follow-up from the line of Byron Callan.

Talk a little bit about capital expenditures for 2005 and 2006.

I've been assuming 2005 is kind of the peak year, and most of this increment is on ship systems.

Is that still the proper way to think about this?

Yes, and I would say, Byron, the fact that we fell short of our estimate for 2004, reflects really, a push-out to the right of some of that kind of spending, but I think your assumption about '05 being the peak is correct.

Can you provide a little bit more granularity on what exactly it is you're doing at ship systems where -- is the spending concentrated in [Pascagoola], is it spread around all the yards?

What are you hoping to gain out of this?

That's a good question.

We have all the yards in different areas.

At Newport News we're putting in a significant expansion of a pier, so we can accommodate the new CVN-21 ship, and also some additional building and construction capabilities will be using heavier gauge steel in that ship than we have in previous nuclear carriers.

That's required some capitalization for what will be a multiship run over next few decades.

In the Gulf we've covered our building ways to improve productivity.

We've added additional dock area along the side in one of our facilities in Gulfport we've put capital in to improve the handling of composite materials, which will be a future material to be used on deck houses and also potentially hulls of ships.

So across the board we're also looking at improving productivity, safety, replacing cranes, which in some cases have been old and because of their inefficiencies have reduced our productivity, so overall I think it's affecting all of our yards and we're trying to make prudent investments.

I might also add certainly in our Gulf yards, about half of this is also being matched by the states of Louisiana and Mississippi, partnership relationship.

We are able to leverage the capital of those states and that's good for them as well, because it creates better, longer-lasting jobs there.

Great.

I'll finish.

I'd also like to say thanks, Chuck, it's been a pleasure working with you, and I wish you the best.

Thanks a lot, Byron, I feel the same way.

Let me just wrap up and say again how pleased we are with the quarter, the year for the Company.

And we're also very excited about '05 and looking forward.

Thank you very much for your support and interest.

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

This does conclude your presentation, and you may now disconnect.

Have a wonderful day.