諾斯洛普·格拉曼 (NOC) 2005 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to the Northrop Grumman first quarter earnings conference call. [OPERATOR INSTRUCTIONS] 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.

And welcome, ladies and gentlemen, to Northrop Grumman's first quarter 2005 conference call.

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

It 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 first quarter simultaneously with this conference call.

Before we start, 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-K and forms 10-Q, among others.

During the call, we will discuss first quarter results, including a non-GAAP measure for total segment operating margin which is reconciled on schedule 2 of our press release.

We will also discuss the outlook for 2005 and 2006.

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

You will also notice that in the first quarter, electronic systems, ships, and space technology realigned and renamed some of their business areas.

Schedule 5 of the release provides the historical data for the new business areas by quarter.

On the call today are our CEO, Ron Sugar and our Chief Financial Officer Wes Bush.

At this time I will turn the call over to Ron whose comments are outlined on slide number 3.

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

I will discuss our first quarter result, spend a little time updating you on the DD(X) program and then I will turn the call over to Wes Bush for a more detailed discussion of the quarter and the outlook going forward.

I am extremely pleased with the operating performance across the Company.

The 69% increase in earnings per share from continuing operations was driven by several factors.

Sales increased 4% in line with our expectations for the year, operating profit was higher in all six of our businesses, unallocated expenses and net interest expense were substantially lower than last year.

And finally, the sale of TRW common stock generated a $70 million pre-tax gain which increased our first quarter results by $0.12 per share.

It was a very strong quarter in terms of operations and financial performance, plus the added benefit of the sale of the TRW shares.

Contract acquisitions in the quarter were a healthy $7.8 billion, and exceeded sales.

Funded backlog at the end of the quarter was nearly $28 billion, and we ended the quarter with a total backlog of $60 billion, which is a new record for the Company.

The other financial highlights during this quarter were the 13% dividend increase that we announced at the investor conference as well as the repurchase of additional an 6.4 million shares of our stock the.

This brings the total share repurchases since the inception of the programs to 26.2 million shares.

Looking forward, you will notice that we've adjusted our sales guidance for 2006 to reflect our current understanding of the Navy's DD(X) acquisition strategy which is currently evolving.

Although the office of the Secretary of Defense indicated that at this time it was premature to go forward with a winner take all recompete, they did give the Navy approval to go forward with the second element of the acquisition strategy, which calls for a restructuring at the Navy's discretion of the existing prime contract.

This will remove subcontract sales previously included in our sales plan.

At this point, it hasn't been clearly determined exactly which subcontracts the Navy will now manage, and which subcontracts will remain with our ship systems business.

For the purposes of our 2006 sales guidance, we've established a range that contemplates the spectrum of possible outcomes regarding the subcontract work.

And also contemplates some opportunities across the Company to offset some of the sales decline at ship systems.

We are currently working with the Navy to define our work scope going forward, but we believe that our current guidance reflects the potential impact of the changes in both 2005 and 2006.

That said, the DD(X) program has been an excellent example of collaboration across the corporation.

The performance of our national team has been excellent.

All major milestones have been met and the program is on schedule.

We're very proud of our performance on the program and feel that we're well positioned for a recompete should it occur.

Although the DD(X) sales impact may be significant, the loss of these subcontract sales translates into a relatively smaller EPS impact.

We continue to expect solid double digit growth in 2006 earnings per share.

As we discussed at our investor conference in March, we are intensely focused on operations throughout this corporation.

We've initiated a program called achieving competitive excellence, or ACE, which is intended to drive more competitive cost structures, leverage the strength of the Company's portfolio, and assure that we have the flexibility to respond to market changes.

This quarter's results reflect the operational and financial strength we are driving at Northrop Grumman.

Now, I would like to turn the call over to our Chief Financial Officer Wes Bush for a more detailed discussion of the numbers.

Wes?

Thanks, Ron.

And good morning, everyone.

My comments today begin on slide 4 and cover our first quarter segment operating margin, segment results and trends, operating margin line items, cash flow, and our expectations for the year.

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

First quarter year-over-year sales growth is consistent with our 2005 guidance.

But the thing that pleases us most about this quarter is that we demonstrated margin rate expansion across the board, at all six of our operating segments.

As we talked about last month at the investor conference, in 2005, we are targeting margin rate expansion in every sector, but integrated systems.

This quarter gives a solid start in terms of the margin rate expansion we're projecting for the year.

Segment operating margin for the quarter was 638 million, versus 560 million at 2004, up 14% on sales growth of 4%.

Our margin rate expanded by more than 70 basis points over last year to 8.6%.

Versus last years 7.8%.

Total operating margin for the quarter was 595 million versus 438 million in 2004.

I will break down where the growth came from sector by sector beginning on slide 5.

In electronic systems I should note that this quarter's year-over-year sales comparison reflects the sale of our Canadian navigation business, as well as the transfer of the printed circuit board and electronic connector manufacturers which are now reported under defensive and navigation systems.

This reclassification did not have a significant impact on 2004 results.

And we have not restated first quarter 2004 results to reflect the addition of these businesses.

For the quarter, electronic systems margin rose 2% on slightly higher sales.

Government systems continues to be a growth driver with the sales increase of 36%, due to continued ramp-up in deliveries of bio-hazard protection equipment to the U.S.

Postal Service.

Defensive and navigation systems also posted solid results, increasing sales by 8%, primarily due to higher sales of infrared counter-measures.

These sales increases were offset by a decline in defense other, which fell due to lower revenue on an international program, as well as the completion of a restricted program.

Another item of note for ES this quarter is the sale of Telvix (ph) which removes about 60 million in sales for the remainder of 2005.

Moving to slide 6, ship's first quarter operating margin increased nearly 21% on sales growth of 5%.

Operating margin for the quarter was 104 million, or 6.9%, versus 86 million, or 6.0% in the first quarter of 2004.

Ships had higher sales and expeditionary warfare due to higher LPD and LHD sales.

Coast Guard and Coastal Defense also had higher revenue due to continued ramp-up on the Deep Water program.

Higher volume in these business areas, and improved performance on the LHD program drove the margin expansion for the quarter.

On slide 7, mission systems margin increased 20% on sales growth of 10%.

And the operating margin rate expanded to 7% from 6.4% last year.

Missile systems and command control and intelligence were the growth drivers, with sales increases of 24%, and 9% respectively.

Growth in missile systems sales reflects higher revenue for the ICBM and KEI programs, and the sales growth in command control and intelligence is driven by higher revenue in restricted programs.

The higher margin and margin rate expansion were driven by the sales increases and improved performance in these two business areas.

Turning to slide 8, integrated systems generated 17% growth in operating margin on 13% sales growth.

And operating margin for the first quarter expanded to 10.5%, from 10.1%.

Airborne Early Warning and Electronic Warfare Systems, sales rose 33%, primarily due to growth in the E-2 advanced Hawkeye and EA-18G programs.

Air Combat System sales were up 10% as we ramped up on the JU cass and MPR tip programs.

The increase in operating margin reflects the higher sales volume and improved program performance.

This quarter's margin rate is significantly higher than the low to mid 8% range that we expect in IS for the year.

We expect 2005 overall results to continue to reflect a changing business mix in this business.

In 2004, development programs represented about 50% of revenue, and we expect development programs to increase to nearly 60% of IS's revenue in 2005.

Turning to slide 9, information technology operating margin rose 20%, on sales that were essentially unchanged from last year's first quarter.

Technology services generated a small sales increase that was offset by a decline in the lower margin enterprise information technology business.

Although sales were unchanged, we are encouraged by the fact that first quarter contract acquisitions rose 8% year-over-year.

This quarter sales results are consistent with our plan, and we're maintaining our growth expectations for the year in information technology.

Operating margin increased to 85 million from 71 million in the prior year reflecting margin rate expansion to 6.9%, versus 5.8% last year.

The higher margin and rate expansion reflect improved program performance in government information technology and commercial information technology.

Slide 10, space technology operating margin increased 22% on sales growth of 7%.

Civil space sales grew 37%, reflecting significant revenue growth in the Impose and James Web space telescope programs as well as the contribution of the recently won Prometheus program.

Intelligence, surveillance and reconnaissance, also had strong double digit sales growth, due to higher revenue in restricted programs.

Space technology's margin rate expanded to 7.2%, from 6.3%, primarily due to improved performance in ISR and civil space.

Looking at consolidated operating margin on slide 11, unallocated corporate expenses declined 80 million from the prior year, to 27 million, primarily due to lower legal and unrecoverable costs.

You will recall that in last year's first quarter, we recorded a $62 million provision for the Allison case.

For 2005, with the deferral and adoption of FAS 123 R, we expect total year unallocated expenses of approximately $200 million.

Our FAS pension estimate for the year is unchanged at 415 million but we have increased our cash pension estimate to 375 million, from 365 million.

Net interest expense for the quarter was 16 million lower than last year, reflecting a lower debt level.

The effective tax rate for the first quarter was 33.2%, versus 33.9% last year.

Slide 12 provides a reconciliation of net income to cash from operations.

Noncash adjustments include 178 million from depreciation and amortization, 45 million from pension and OPEB, 162 million from deferred and payable income taxes and 20 million from stock-based compensation.

Change in working capital was the major use of cash at $481 million.

All other items combined primarily representing the gain on the sale of the TRW auto stock accounted for an adjustment to operating cash of 70 million.

First quarter cash from operations totaled 263 million, unchanged from last year's results.

This quarter included the $99 million Robinson settlement and last year's first quarter included more than 100 million in nonrecurring tax refunds.

Following a strong fourth quarter, this is solid cash generation which supports our outlook for the year.

Capital expenditures for the quarter including capitalized software costs, were 197 million.

I would like to conclude by walking you through our guidance for 2005 and 2006 on slide 13.

We continue to expect our segment operating margin rate to expand from 7.7% in 2004 to the low 8% range in 2005.

With further expansion to the high 8% range in 2006.

We expect our total operating margin rate to expand to the low 7% range in 2005, from 6.7% in 2004.

And to the high 7% range in 2006.

We've increased our guidance for 2005 earnings per share from continuing operations to a range of 370 to 385.

The largest element in this increase reflects the delay in the adoption of FAS 123 R. Our prior guidance included 2005 expense of $40 million, associated with FAS 123 R. Another item contributing to the guidance increase is the $10 million reduction in our expected net pension expense.

For 2006, our expectation for solid double digit EPS growth is based on the 2005 earnings per share range, excluding the $0.12 per share gain from the sale of TRW auto stock.

Our 2006 EPS guidance is also before any expenses associated with the adoption of FAS 123 R. You will recall that our guidance at the investor conference included an estimate for 2006, FAS 123 R expense.

The Company continues to evaluate the impact of the new standard on future compensation plans.

And finally, EPS guidance for both 2005 and 2006 now includes the full range of potential impact resulting from our current understanding of the program changes associated with the Navy's evolving DD(X) acquisition strategy, as Ron described.

So as Ron said, we're off to a very good start and we're on track to achieve our financial targets.

This quarter's results reflect our intense focus on operational and financial execution and we were pleased to see solid performance across the entire company.

And with that, I will turn it back over to Gaston.

Thanks, Wes.

Rachel, we're ready for questions now.

Thank you, sir. [OPERATOR INSTRUCTIONS] Our first question comes from the line of Byron Callan with Merrill Lynch.

Yes, good morning or good afternoon, gentlemen.

Good morning.

Can we just sketch out what the full range of these different scenarios are for DD(X)?

I mean we talked about this range, but could you kind of tie the numbers to maybe some of these different outcomes?

Well, Byron, this is Ron, Byron, it is a little difficult at the moment but certainly the removal of the combat system work, as we go as a direct prime contract to the government, would be a good slug of that.

There is a variety of other subcontracts which are currently under the program over our -- under our current responsibility, which as we move forward would be directly run by the government.

It is hard to give any more color than that.

I think the range we have pretty much encompasses it, and as we had indicated, because it is subcontract sales, the margins on those sales are not as large as the margins we have on our own internal work.

And Byron, this is Wes.

Just to be real clear about our EPS book as well.

We have included that full range of potential outcome, as we currently understand it, in both our EPS numbers for this year and solid double digit growth for next year.

Okay.

So just to understand, I guess -- what I'm trying to understand what the baseline assumption is on this.

The baseline assumption, Byron, is that a significant amount of subcontract work is taken to go direct to the government.

Right.

Therefore it is not what we will have, that there will be some time probably at the end of the '06 period or perhaps shortly after that, the winner take all decision, but that is not factored into our plans for '05 or '06.

Understood.

Currently, that's in flux.

Okay.

And just I know it has been relatively short period since the investor meeting in March, Ron, but any additional thoughts or perspective on what may be going on in Washington?

I'm kind of interested in some of the things that have been talked about, acquisition reform, the things that have been raised about not necessarily your contracts, but commercial contracts or OTA, is the environment changing or is this just kind of business as usual?

I think it is the normal process, Byron.

Clearly, we're in the authorization cycle.

We'll be starting appropriations soon.

The supplemental was passed by both houses, I believe they're in conference right now and they're trying to get that finished so that we can get the necessary funding for the troops in Iraq.

There has been discussion about the need for some acquisition reform, some of the testimony came along in that line and clearly that's something we would completely support.

At the moment, we see no specific changes to any of our contracts and clearly this would be a longer term process not an instantaneous set of changes I would think.

Understood.

Thanks.

I till turn it over to someone else.

Thanks, Byron.

Thank you our next question comes from the line of George Shapiro with Citigroup.

Yes, on integrated systems, Wes, the margin always seems to be higher there than what you think.

I think for several years you guys have been saying it's going to come way down and it doesn't seem to.

I mean is there something there that we're all missing and this margin is going to continue to be higher?

Yes, I think if you look back over the course of last year, George, you would see at a very strong first quarter as well, but a reduction over the course of the year as the amount of these development programs continued to increase, which by the way we think is fabulous in terms of establishing a very solid foundation for our future, we're glad to see a very high volume of new development work coming into IS.

In the first quarter of this year, we did see a very large number NIS, and it was primarily associated with some cube. catch-ups that we had in the business.

As I indicated in my earlier comments, we do see it over the course of the year having again an increasing amount of development content over the year, and are still holding to the projection that we put forward at the investors conference.

So Wes, what was the percentage of R&D business in that sector this quarter relative to the 60% you've been expecting for '05?

It is less than that now because we're ramping up over the course of the year.

I can't tell you the precise number right now, but we -- as we go through the year, are expecting the addition of some new development work that will increase us up to the 60%.

Between 50 and 60.

Yes, clearly 50% was last year.

Okay.

And then in space, I mean you were talking of expecting no growth this year.

Does that -- are you backing off of that?

Or does that mean we're actually going to see some down quarters later in the year?

We're not changing our guidance for the year.

We certainly feel very good about the strong performance that we saw in the first quarter.

But there hasn't been much time passed since the investors conference and really hasn't changed our state of knowledge or views for the year on space.

So what happens in one of the later quarters that would cause the revenues to drop below last year's level?

Yes, the real issue there is going to be the timing between programs that are ramping down and programs that are ramping up.

There are some programs that are doing very well in terms of completing their activities on time, and ramping down, advanced DHF is a good example of that where we're making really good progress in that program, and as usual, it depends on the timing on ramping down versus some of the newer activities that are under way.

And then given the strength of this quarter, it would seem like you should have raised the guidance somewhat more, so I guess I'm curious as to maybe it is just early in the year, as to why you didn't go any further.

Yes, we thought this was the appropriate thing to do for where we are in the year and our view of the remainder of the year.

Okay.

Thanks a lot.

Thank you, George.

Thank you.

Our next question comes from the line of Joe Nadol with J.P. Morgan.

Thanks, hello.

Good morning, Joe.

Good morning.

Good afternoon.

Wes, I was wondering if you could comment on the press release, the announcement a couple weeks ago that there is some slight changes in the financial organization.

Yes, the addition of Ken Heintz to the team brings in a strong experienced leader.

We're delighted to have him here.

Delighted to have Sandy Wright take on our financial planning activity in the organization to really help us bring some new perspectives and some discipline into the planning approach that we're using, and looking into the future.

And we've also launched a very focused process initiative that I asked Barbara Barcon to take on for us to really enhance our internal financial processes and take them to the point that we would all be satisfied in calling them world class.

So it is a bit of a change in terms of what the individual leaders are focused on, but we still keep the leadership team we had with the addition of Ken Heintz coming on board.

So I am very excited about how this positions us for the future.

Do you foresee any change in systems enterprise software, that sort of thing?

We have a continuing set of evolutionary work that we're doing across the Company in the system software that we use for our financial processes.

This organizational change is not particularly aligned with any particular change we're making in those systems.

But it will certainly be a key part of what we're looking at as we're going through a process view of the way we do business.

Okay.

And then secondly, Ron, there were some relatively strong comments on the hill over the past couple of weeks on the tanker situation, which came out of the blue.

I think a little bit somewhat with regard to whether you met team with Airbus.

Do you have any thoughts or any comments on that?

Well, Joe, certainly this is an interesting program, it has gotten a lot of press, it could potentially be a very large program opportunity for the defense industry.

At this point in time, the direction of the program is still not quite sure, they're still looking at alternatives, but this is certainly something that we've said that while we're looking at it carefully we have not made any definitive decisions and we've not announced any particular alignments or even a bid decision.

And that's where we are at this point in time.

Okay.

Thank you.

Thanks, Joe.

Thank you our next question is from Steve Binder with Bear Stearns.

Good afternoon.

Hi, Steve.

I guess number one was you touched on it before, George's question, up in IS, but that was a cube. adjustment basically on advanced Hawkeye in the quarter?

We had some adjustments on a variety of programs, there were some cube catch-ups as well as we had some contract close outs.

Most of that was focused in that business unit that you're referencing.

And then with respect to electronic systems can you maybe just talk about the international environment, because that's really where your international business is pretty much located, your plan was to kind of keep it a roughly a third of your business.

Is that -- would you -- how would you characterize the bookings environment there?

I'm sorry, say the last part again, Steve.

Yes, how would you categorize the international bookings environment for ES this year?

Do you think at least a third of your bookings will be from international programs?

I don't have a number at my fingertips.

My guess it might be a little weaker than that, in the past six months to a year.

Yes, I think that's accurate.

And on the other hand, we do have some opportunities going forward that we're pursuing pretty vigorously so it is going to obviously ebb and flow in terms of percentage.

But it is certainly something we're continuing to pursue very aggressively and we do have a good amount of ongoing work now in that area as you pointed out.

One that we mentioned specifically at the investor conference is called Runitel which is a fairly significant international opportunity, and that's electronics.

Your CapEx ran kind of high, I mean you were talking about a 750, 800 budget this year but you always underrun your budget.

CapEx started out strong.

I imagine is that in the ships area is that what caused the strength?

Because typically you're more back end loaded with respect to CapEx?

Can you maybe touch on that and how do you feel about that budget this year?

Let me address that, Steve.

CapEx expenditures were strong relative to the first quarter that we've seen in other years.

It was primarily a reflection of much of the program specific CapEx that we have around the Company associated with the new development activities we've taken over -- taken on over the last several years.

Ships was certainly a component of that in the ongoing ship's budget.

We're quite satisfied that the first quarter is very much in line with our plan for the year and we're not changing our view of the total year CapEx.

Okay.

Great, thank you.

Our next question is from the line of Cai von Rumohr with SG Cowen.

Yes, could you talk a little bit about the IT business?

Even if we take out the enterprise business down, the growth was not particularly impressive and way below what most of the other public defense IT guys are doing.

Yes, Cai, this is Wes.

The first quarter really reflects the timing associated with the start of some key new programs, within IT, things like the U.K.

AWACS, the IDENT1, and the NetSense activities as well as the funding profile that is in the civil federal marketplace in particular the Homeland Secure Data Network that we have.

We did also have some lower volume in our value-added reseller business within the IT sector.

But we're very pleased with what we saw.

We see it as consistent with our plan for the year.

We certainly have not changed our expectations for this year, the expectations that we laid out at the investors conference, primarily because of the robust new business opportunities that we're addressing in IT.

You heard Jim O'Neill go through those at the investors conference.

We continue to see those as driving the outcome for the year that we put forward a few weeks ago.

Okay.

Were there any delays, any kind of unexpected delays other than the federal issue in any of those businesses?

I mean you sounded a little more tentative in terms of your comments about that sector's prospects for the year.

No, timing is the way I would describe it, timing over the course of the year.

No intent to sound tentative on it.

We're very positive about IT for this year.

Okay.

And the reduction in the unallocated expense, is that where the 40 million FAS 123 comes out?

Yes.

Yes, and that takes us to down to the roughly 200 number for this year that we're projecting.

Got it.

Thank you very much.

Thanks thanks Cai.

Thank you.

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

Good morning, Ron, Wes, and Gaston.

Ron, you know we tend to think of the defense companies as kind of going up and down together, and I wondered if you looked out for either this year or even into next year, what are the two or three Northrop Grumman specific things that are -- that are unique to you that are going on either on the good side, on the bad side, or initiatives that either you, Ron or Wes have?

Well, Joe, obviously a lot of things.

When the market goes up, we like that.

When it goes down, we think we should still go up.

But clearly, the focus that we have on driving our operating margins and our bottom line performance is something which I can't speak for other companies but I can certainly tell you at this company, we're very seriously focused on this.

The ACE initiative we discussed with you all at the investor conference, gave you some sense of what we're up to there, and I think that what you will see from this company is a pretty relentless focus on that.

And we think there is some room to move in that.

Clearly the portfolio we have is a pretty broad portfolio.

It is pretty well diversified.

We really have a tremendous play in all the electronic and information technology expansion and transformation, which is going to be going on for many years as we go forward.

Sometimes we think of ourselves as a ship builder, as an airplane company, but if you stand back and you look at our revenues and where we get most of our revenues from today, we're driven by information technology, systems integration, and electronics, as much as anything else and certainly more than anything else.

So I think those are some examples that I can kind of list through individual programs, but we kind of did that at the investor conference.

So I don't think I would repeat that at this point.

Great.

Thanks.

Thank you.

Our next question comes from the line of Heidi Wood with Morgan Stanley.

Good morning.

Very nice quarter, guys.

Thank you, Heidi.

A question for you, when I look at the space business, the ISR revenues really did pretty tremendously this quarter.

How sustainable is that going to be going forward?

And is it fair to assume that even under a cost-plus contract, that is a very good double digit margin business?

We're not going into specific business margins okay, within sectors?

Heidi, let me talk about our view --.

The sustainability of the growth then?

Sure, absolutely.

ISR has over the last number of years continued to be a very healthy and robust business, and while just about all of that business is classified, what we can say, obviously, is the world is not getting any safer, and the nations need to really understand what is going on, not just in localized spots around the globe, but truly in a global manner, requires a continuing growth in the number of assets that are deployed to enable that to happen.

So yes we do continue to see nice growth opportunities there.

Then would it be safe to say that part of the margin increase that we saw there and the margin increase for the year in going forward is due to change in mix towards ISR?

In terms of the margin rate expansion, I would say that's an accurate view.

Okay.

A question, moving over to the Navy for a moment.

Can you talk a little bit about, Ron, the new small submarine the Navy is looking at, what timing we might be expecting to see a program?

Well, Heidi, I'm not sure if we're thinking of the same thing.

There was some money which is being put in the budget to look at undersea dominance in the future, which could take the form of submarine, it can take the form of something else as well and obviously we're working with the Navy now and I think it is very early and I don't really have much more to add to it than that.

Okay.

Then on DD(X) if you don't mind --.

Heidi, unless you're referring to the ASDS, the advanced seal delivery system which we do produce, which in fact we think has some very good prospects going forward.

This is a special forces submarine which piggybacks on the back of an attack submarine.

I was more referring to the small virgin class sub that they seem to be considering.

Yes, and all I can say there, Heidi, is that for many years, the Navy has looked at a whole range of options, both on surface and subsurface combatants and I'm sure that this is an important study that is going to be done.

Question, Ron, for you on DD(X) and then I will let someone else ask a question, as we understand it, some of the premise about DD(X)'s outlook has been on the premise that you can then take the technology from DD(X) into CG(X), but if we were to disconnect that, if CG(X) was not going to be viable, do you think there is still enough case for DD(X) on a stand alone basis?

Well, certainly if you stop the production of the DDG line, which is the current hourly work class, the DDG 51 class you are going to have to have some kind of surface combatants in the future which fit a mission need which are not the same kind of a ship as a CG(X) and then of course you have frankly, going forward the retirement of the Ticonderoga class cruisers which will create a need for CG(X)s which are air warfare and missile defense and a variety of other mission, slightly different than the DD(X) mission.

It is really hard to say.

I think that there is a lot of thought going on in the Navy Department, in the Pentagon as a whole about what the right force mix should be for the Navy in terms of surface assets, how many large ships, how many small ships, surface subsurface and this set of debates is going on now and one of the challenges we have as an industry is to be able to respond to these and be able to capitalize and invest in technology appropriately so we can build the right ships at the right prices as we go forward.

I think we've all called for some -- hopefully some stability in terms of the outlook in the requirements for these kinds of ships and certainly as a company we will do whatever is necessary to support the Navy.

All right.

Great.

Thanks very much.

Thank you.

Thank you.

Our next question comes from the line of Howard Rubel with Jefferies & Company.

Thank you very much.

Two questions, one, Wes, you talk about 2006 guidance, I'm just sort of going to bring it down to the bottom line, and you talked about excluding FAS 123 R from '06.

Two parts to the question.

One is that if you did include it, would you still be able to have double digit gains in '05 to '06?

Yes, Howard, we excluded it to have confidence in our ability to stake solid double digit gains and I would just leave it there.

Howard, there is a double dip there, since you don't have it in '05.

That's right so we're starting, when we're calculating the double digit, we're starting from the higher base this year that we're projecting.

No, I understand.

And I'm just trying to bracket it a little bit and figure that this might be an interesting way to get there, but having said that the second part of the question is can you talk about some of the issues that -- I mean I think you're right to postpone it and not do it this year, that's terrific, but what's -- can you talk about what you still need to do for '06 with respect to that and sort of the magnitude of the change?

Does this also sort of impact sort of some of the things you have with respect to compensation, because clearly, when you measure something that is not necessarily appropriate, which is what FASB has done here, you kind of get bad decision making, so how are you avoiding that bad decision making?

Yes we're spending some time this year carefully thinking through what it really means and also thinking through relative to the market environment that we're in what is really the appropriate way to employ stock based incentive programs to make sure that we continue to align the interest of our shareholders with the way that we're incentivizing management.

It is way too early for us to say anything publicly about our conclusions there.

But it is clearly a part of our thought process.

That's encouraging and that's sort of what I wanted to hear.

An then the second question is, one of the things that Ron and Kent did when you put together Northrop Grumman is you sort of created a company that in many ways is independent of units, and the Department of Defense seems to be buying fewer large systems and larger units going forward.

Ron, for a moment, can you just step back for a moment, and offer a couple of other examples of where you think that will enable you to continue to gain market share?

I mean the ship debate, if you will, sort of says, hey, we can't have as many units as we used to but we need them to be more effective.

Yes, if you take a look at the amount of work that it takes to build the DD(X), it is a lot more content both in terms of the hull, mechanical, electrical, the combat system, the software, the weapons systems, than in a current DDG.

If you look at the CVN 21 and its capabilities, the same thing is true.

By the way you're getting some advantage for the Navy in terms of long term recurring costs because you're taking manning down dramatically by a factor of two or three on the surface combatant and you're taking out, goodness, hundreds and hundreds of people off the destroyer and there is an operating expense for that, so while you might have smaller units you're probably going to have higher value units, you're going to need strong technology in those units going forward.

In the case of unmanned air vehicles, clearly this is an area where you're going to see a continued proliferation of the vehicles and we're pleased to be part of the Global Hawk program.

We have Fire Scout.

We are a competitor right now in in the army's ERMP and we're involved in the Hunter so we see that playing, and certainly with regard to Global Hawk there is a lot of content on that aircraft and that can be certainly upgraded with additional sensing over time to give it more mission effectiveness.

I think the same thing is true of spacecraft.

So if you take a look at our two sectors, mission systems and IT, you have there an aggregate of 10 to $11 billion of revenue that has nothing to do with platforms.

It is all about integration, software glue, mindware and we think that's -- those are very strong businesses with strong outlooks.

Thank you very much, gentlemen.

Thank you.

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

Thanks.

There may not be a whole lot new to say from the investor conference, but can you give an update on the Block 60 program, and assessment of remaining risk, and milestones to watch for there?

David, I thought you would never ask.

We got through about nine or ten questioners and we thought that would be amazing.

Look, on Block 60, it is going pretty well.

All the Agile Beam Radar hardware has been delivered the IFTS system, the IFTS system is ramping up in its production, it is qualifying final -- I'm sorry, qualification testing on the pod.

This is a targeting pod.

The Electronic Warfare Standard One, which is a development milestone, did pass design acceptance tests this quarter, and the hardware continues on our recovery plan.

And the test equipment, which we call the combined intermediate level automatic test equipment, the first test set has been delivered in country and the final set is tracking to September deliveries.

So you know we always knock on wood when we talk about these fixed price development programs but I think Block 60 continues to make good progress.

There is always risks ahead.

But this was a good quarter.

And I know you would also love to talk about Polar Tanker as well so I will throw that one out there.

You're on a roll, David.

Polar Tanker is 87% complete.

It is tracking within the established reserve that we have had now for quite some time, probably a year and a half or more.

They're doing good job.

It is scheduled for delivery in the fourth quarter of this year and it is going to be a great ship like the first four.

So that program is tracking fine.

Great.

Thank you very much.

You bet.

Thanks, David.

Thanks for asking, David.

Thank you.

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

Good morning.

The first question is you very kindly gave us in integrated systems, the mix of development contracts versus more mature delivery programs, could you do the same right away across the group for this year and how that might transition into next year?

I don't think we can do that off the top of our head, Nick.

I can kind of size it for you, a little bit.

If you look at space, that's almost all development.

It is primarily a development environment.

Even the production looks a lot like development.

Right, low volume production.

If you look at electronics, they're in the order of 25 to 30% development.

If you look at -- obviously MS and IT, everything is a one-off.

There is no production there at all.

And if you look at ships, they're getting close to 50% development because of DD(X) and CVN 21 and Coast Guard.

Do you move into a higher level of development next year or does that shift away back towards delivery?

It is sort of flattish next year, and then tails down after that.

We're close to -- we're over 50% development right now in the whole corporation when you consider space.

It is about the same next year.

And then should turn down a bit.

Okay.

Great.

Unless there is something else big.

And we would be delighted to do that.

Of course.

That would be very helpful.

And then the second question is, Ron, I wonder if you can give us a quick run through, the major programs that are on your radar at the moment and roughly what scale they are and when they are to be decided, and also, do you think you are going to be a beneficiary of the supplemental tool, or is that more of an '06 phenomena, even if you are?

I will take the second one first.

The -- there are a few things in the supplemental which help us but I would say it is not -- it is not a dramatic impact.

It is about $400 million of funding of additional activity for Northrop programs and it is basically in the guidance we've given you.

If you take a look at some of -- oh, I could also say a couple of programs in there are more lightning pods, more night vision devices, as you can imagine the soldiers will want to have those, some more work in directional infrared counter measures to protect military aircraft, a whole bunch of surveillance activity and some potential patrol boats interestingly enough is part of Department of Homeland Security.

In terms of the big things on the radar screen, I think the list hasn't changed a whole lot Nick from what we showed you at the investor conference.

The CEV program, the NASA program is potentially in some state of flux revolution.

We are teamed with Boeing.

They are getting ready to submit a fairly comprehensive proposal.

If anything, we think the mandate that the new administrator is going to have is to accelerate that program to provide earlier capability to replace shuttles than before so that could be an interesting opportunity.

I think that we just saw an announcement today that the -- that NATO has signed the contract with us that we're teamed with EADS on the NATO air to ground surveillance, NATO AGS system, so that's a step moving forward.

We are pursuing the Los Alamos national laboratory opportunity, which is an interesting management bid opportunity.

We have things involving the advanced THF potential additional satellites and follow-on there, such as transformational com and of course space radar continues to have significant interest and attention not just the main line program but potentially a shorter term experiment which could provide some interesting opportunity for us.

So there is a lot in the hopper.

It is pretty much as we described when we got together last time.

And then follow-up, quick strategic one, Army is obviously a big growth sector at the moment.

You used to have about 7% or so of revenue in that area.

Now with TRW on board, is there any way that you can expand your business opportunity in the growth segments for the Army, particularly obviously in the ISR you've talked about?

Yes, Nick, we had about 5% I think is our current -- or a billion and a half of business we can trace directly to the army and command and control, certainly the new command post program, which Don Winters sector MS just won is key, a lot of ISR work, and certainly the Blue Force Tracking, too, so a lot of the things that involve the electronification or the adding of information to the -- to the Army.

We're also a significant player on the future combat system and irrespective of the future direction of that program and it was obviously the contractual terms were announced to be restructured here, we're playing a key role there and we're working a lot in the area of networks and unmanned air vehicles.

Thanks a lot.

Thank you, Nick.

Thank you.

Our next question comes from the line of Doug Harn with Sanford Bernstein.

Good morning.

Good morning, Doug.

On information technology, I know one of the important pieces here has been to expand margins in that area, and the margins this quarter were I think the best they've been in a long time.

Forever.

Forever.

That's a long time.

Yes.

Now, could you talk a little bit about what has driven that?

Because when I look at tech services going up, I would think that would be something that would pull it down a little bit.

The value added reseller portion going down would push it up a little bit.

Are we looking at something that is primarily around mix or are we seeing better performance?

It is both.

Although I would say for this quarter, it was primarily mix.

The margin rate expansion did reflect higher sales from the higher margin businesses in the mix.

And lower sales from the lower margin businesses in the mix.

And there is, though, within IT, a substantial focus on improving program performance and expanding margin rate and we did see some of that as well in the quarter.

Did you see that in the state and local area?

Yes, in that that's combined with -- it's overall our commercial business.

Right.

And that did have good margins.

No No, they did.

They were helping bring up the margin in the overall sector.

And I'm assuming the TASK was again a good growth part of this?

TASK is a very strong performer.

Okay.

Great.

Well, okay, that was my question, thanks.

We have time for one more question, Rachel.

Thank you.

Our final question today comes from the line of Jared Muroff of Prudential.

Thank you very much.

Most of my questions have been answered.

I guess the one or two I have is on unallocated expenses, it appears your guidance is for that to more than double, I guess, or close to double over the remaining three quarters of the year on a quarterly basis.

Just wondering why it was so low in the first quarter, what was in there, and what change is moving forward?

Yes, this is Wes.

I think if you look back over time, you will see that unallocated has a little bit of variability quarter to quarter.

There are a variety of things that go into that.

Each quarter ranging from litigation expenses to the amount of recoverable costs that we actually see in the quarter.

So you're right.

And mark-to-market is the rest of it.

And so over the rest of the year, we anticipate seeing a higher amount in each of the remaining three quarters to get us up to around the 200 million for the year.

Okay.

Thank you.

Okay.

Thank you.

Well, I would like to thank all of you for joining us and thank you for your continued interest.

We're very pleased with the progress.

This is the first quarter of four this year.

We're off to a good start.

And the management team of this company is focused on continuing to drive our operating performance and generate the shareholder results that you expect.

Thank you all.

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.