諾斯洛普·格拉曼 (NOC) 2005 Q3 法說會逐字稿

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

My name is Anne-Marie and I'll be your coordinator for today.

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

We will be facilitating a question-and-answer portion at the conclusion of the presentation. (OPERATOR INSTRUCTIONS) I would now like to turn the presentation over to Mr. Gaston Kent, Vice President of Investor Relations.

Thank you, Anne-Marie, and good morning, ladies and gentlemen.

Welcome to our conference call.

We have 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 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 filed our third-quarter 10-Q earlier this morning.

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

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

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

A more complete expression of these risks and uncertainties is contained in the Company's SEC filings including the Forms 10-K and 10-Q.

During the call we will discuss third-quarter results including the non-GAAP measure for total segment operating margin.

Segment operating margin is reconciled on schedule two of our press release.

We'll discuss the outlook for 2005 and 2006.

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

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

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

Ron?

Thank you, Gaston, and good morning everyone.

Thanks for joining us.

My comments today will include a brief discussion of third-quarter results as well as an update on our Ship Systems operations.

But before I begin those comments, I would like to mention how pleased we are to announce our Board's decision to initiate a new $1.5 billion share repurchase program.

The new program is intended to significantly reduce our share count.

It also demonstrates our confidence in the future, the depth of our financial resources, the strength of our free cash flow, and our conviction that Northrop Grumman shares currently represent one of the best investment opportunities.

Since we began buying our shares in August 2003, we have completed two programs totaling $1.7 billion and representing more than 32 million shares.

We completed each of these programs within 12 months and we plan to execute this new program, which represents nearly 8% of the shares outstanding, over the next 12 to 18 months.

Moving on to our third-quarter results, we previously indicated that third-quarter earnings would be $0.30 lower due to the hurricane damage at our Gulf Coast shipyards.

Looking beyond that event driven adjustment, the results across our other six sectors were strong across the board.

We continue to demonstrate our ability to increase our sales, to expand our operating margin rates, and to generate cash.

The solid performance improvements achieved across our businesses in the first half of the year continued into the third quarter.

Regarding ships, Newport News results were strong and sales increases for both aircraft carriers and submarines were there as well.

And we continued to move as quickly as possible to ramp back up to planned activity levels at Ship Systems.

We now have 13,400 employees back at work at Ship Systems and production work continues to accelerate on the 11 ships we now have under construction in Pascagoula and New Orleans.

An example of the progress we are achieving is the lifting into place last week of the first national security cutter fabrication unit since the hurricane swept through the Gulf Coast.

We are currently making final arrangements to provide on-site temporary housing for more than 1000 returning employees in New Orleans and Pascagoula.

Temporary housing is a key factor in supporting the workforce and our return to planned activity levels.

We are also working directly with government agencies and their contractors as well as nonprofit agencies to speed the processes by which families and communities surrounding the shipyards get the support they need to resume some level of normalcy in their lives.

At Ship Systems, we are making progress every day toward full recovery.

Now looking at the results in our other five segments, it was a strong quarter across the board.

Sales were higher in every segment but ships, with two of the segments posting double-digit sales growth.

Operating margin was higher in all those businesses as well, with three of the segments posting double-digit increases over last year.

Cash generation was a real highlight for the quarter, coming in at nearly $900 million and $2 billion year-to-date.

Both third quarter and the year-to-date cash from operations are more than 20% higher than last year and translate into very healthy cash flow.

We are very pleased with third quarter and year-to-date performance.

We are well on our way to achieving the performance improvements reflected in our guidance for this year and next.

We are very confident looking across our businesses both in our ability to build on the positive trends in six of our seven operating sectors and in our ability to restore positive momentum in Ship Systems.

During the quarter we won several important contracts and we continue to have substantial new business opportunities ahead of us.

We signed a contract with the United Kingdom for the E-3D AWACS support that's valued at approximately $1 billion.

And the Northrop Grumman led team was awarded a contract by the Missile Defense Agency to continue its prime contractor role for the Joint National Integration Center.

This is an indefinite delivery, indefinite quantity contract with a potential of $1 billion over ten years.

Just yesterday, we were informed by NOAA that we have been selected to receive a program definition and risk reduction contract for the GOES-R or Geostationary Operational Environmental Satellite, Version R. GOES-R, our nation's next generation geosynchronous weather satellite system, fits well with Northrop Grumman's global earth observation capabilities.

We are also pursuing the Department of Energy's Nevada test site management contract.

This is a five-year multibillion dollar opportunity with follow-on options that is expected to be awarded soon.

Another multi-million dollar opportunity is the transformational satellite communications system mission operations system known as TMOS.

This ten-year program is expected to be awarded next year and will manage communications over the transformational satellite network.

We also acquired a privately held company called Confluent RF Systems.

Although at $50 million it is a small acquisition in the dollar sense, Confluent's unique set of proprietary technologies will be used on a variety of our programs.

Confluent will become part of the integrated system segment.

So to wrap things up, I would like to say that going forward you should expect the same things from Northrop Grumman that we have delivered over the past two years, revenue growth, margin rate expansion, higher earnings and cash, and disciplined financial stewardship driving a balanced cash deployment strategy.

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

Wes?

Thanks, Ron.

Good morning, everyone.

Beginning with slide four, our segment operating margin rate was 6.5% for the quarter and 7.8% year-to-date.

Total operating margin was 5.8% for the quarter and 7.2% for the year.

Looking at the segments in more detail and beginning with Electronic Systems on slide five, for the quarter sales and margin rose 2%.

Year-to-date margin is up 14%, a 90 basis point expansion in margin rate on a sales gain of 5%.

ES sales are on track with our guidance of mid single-digit growth and our 11% operating margin rate through the end of the third quarter is at the high end of our guidance.

We continue to see solid growth in our Government Systems and Defensive and Navigation Systems business areas.

Moving to ships on slide six, third-quarter results include the hurricane impacts to sales as well as lower sales for the DD(X) program; somewhat offset by continued good performance in aircraft carriers and submarines at Newport News.

The decline in operating margin includes the $150 million charge for contract cost growth and a 15 million reduction due to work delay.

For the year, our sales guidance for ships calls for a mid teens decline in revenue versus our prior guidance of down mid to high single digits.

And we now expect a low single-digit operating margin rate versus prior guidance of high 6%.

The degradation is due entirely to the significant impacts of Hurricane Katrina.

On slide seven, integrated systems margin increased 7% on a sales gain of 23% in the quarter and year-to-date margin has increased 14% on a sales gain of 20%.

Results for the quarter include higher revenue in all three business areas.

Revenue growth is primarily being driven by new programs like the E2 Advanced Hawkeye;

EA 18 G.;

J-UCAS; and the MP-RTIP program.

Based on year-to-date results, we're running ahead of our guidance for sales growth in mid to high teens.

For the year, we now expect sales to grow by approximately 20% with an operating margin rate in the low to mid 8% range.

On slide eight, Mission Systems third-quarter operating margin increased 22% on sales growth of 11%.

Year-to-date operating margin has increased 19% on sales growth of 8%.

Margin rate in the third quarter expanded to 7.1% from 6.5% last year.

Margin rate expansion reflects improved performance across a variety of Command, Control and Intelligence and Missile Systems programs.

Year-to-date Mission Systems margin rate is 7.2% versus 6.5% last year, reflecting improved performance in the Intercontinental Ballistic Missile program as well as improved performance across several other programs in Missile Systems and Command Control and Intelligence.

For the year, we continue to expect mid single-digit sales growth and an operating margin rate of approximately 7%.

Slide nine, Information Technology's third-quarter operating margin increased 16% on sales growth of 4% and year-to-date margin has increased 19% on sales growth of 4%.

Third-quarter margin rate expanded to 7.1% from 6.3% last year.

IT's year-to-date margin rate has increased 90 basis points to 6.9% from 6%.

For the year, we now expect sales to grow at a mid single digit rate with a margin rate in the mid 6% range.

The primary driver for the sales change is lower-than-expected sales from Enterprise Information Technology, our value added reseller business, which earns the lowest margin rates in the segment.

Slide ten.

Space Technology third-quarter operating margin increased 18% on sales growth of 2%.

Year-to-date operating margin increased 17% on sales growth of 5%.

Operating margin rate expanded to 8% versus 6.9% in last year's third quarter and year-to-date margin rate has expanded to 7.7% from 6.9%.

For the year we expect strong performance in Civil Space and Intelligence, Surveillance and Reconnaissance to drive Space Technology sales up by low to mid single digits with a margin rate in the low 7% range.

Looking at consolidated operating margin on slide 11, unallocated corporate expenses improved to $42 million from the prior year's 62 million, reflecting lower legal and mark-to-market stock compensation expense.

Year-to-date, unallocated expense totaled 111 million, compared with 216 million in the prior year.

Based on year-to-date results, we now expect unallocated expenses for the year to total approximately 180 million.

We have lowered this estimate from our previous guidance of approximately 200 million.

Our FAS pension estimate for the year is unchanged at 415 million and CAS pension is also unchanged at 395 million.

Net interest expense was essentially flat compared with last year's third quarter and for the year; we continue to expect net interest expense of approximately 320 million.

The effective tax rate for the quarter was 33.8%, versus 34.2% last year.

We continue to expect a tax rate for the year of between 33 and 34%.

Moving on to cash, slide 12 provides a reconciliation of net income to cash from operations for the third quarter and year-to-date.

We had a very healthy cash conversion this quarter and we are on track to meet our guidance.

Non-cash adjustments in the quarter include 192 million for depreciation and amortization and a use of 5 million for pension and OPEB.

Our reduction in working capital generated 260 million.

Deferred and payable income taxes were a source of 178 million and all other were items were a use of 27 million, bringing total third-quarter cash from operations to $891 versus 739 million last year.

Capital expenditures for the quarter including capitalized software costs were 173 million.

Year-to-date cash from operations was approximately $2 billion and capital expenditures totaled 519 million.

We are on track to meet our guidance of cash from operations of 2.2 to 2.5 billion with capital spending of 750 to 800 million.

Through the first nine months of the year, we also generated 280 million from the sale of investments and businesses as we continue to shape our portfolio to improve shareholder value.

Slide 13 summarizes our updated 2005 and 2006 guidance. 2005 sales are expected to range between 30.5 and $31 billion.

For 2006, we expect sales to increase to about 32 billion.

Even with the hurricane impacts, we expect a total operating margin rate of approximately 7% in 2005, versus 6.7% in 2004.

For 2006 we continue to expect a total operating margin rate of approximately 8%.

Based on our strong third-quarter performance, we are increasing our guidance for 2005 earnings per share to a range of 3.60 to 3.70.

For 2006, we expect to earnings per share to grow between 4.10 and 4.30.

Our guidance for 2006 assumes that net pension expense will be the same as 2005.

Actual 2006 pension expense may vary depending on a variety of factors. 2005 cash from operations is expected to be between 2.2 and $2.5 billion and we expect the range of 2.3 to 2.5 billion in 2006.

The results across our operations and our outlook going forward demonstrate our continued performance -- focus on performance and the benefits of improvements from efforts such as our Ace program.

And today's announcement of the share repurchase program demonstrate our commitment to a balanced cash deployment strategy.

We'd now like to open the call up to questions.

(OPERATOR INSTRUCTIONS) Byron Callan, Prudential.

Ron, can you just comment a bit on your broader thoughts about what is going on with the defense budget?

What kind of changes we could see?

How well-positioned you think the Company is?

DO you think your broader plan is going to be intact when all the dust settles on FY '07?

Well, Byron, that is course the $64,000 question at this moment in time as we're all watching for the smoke to come out of the buildings in Washington.

First of all, the way we see it there will undoubtedly be a range of outcomes.

We think that the portfolio the Company has now is extremely well-positioned and centered on what we think is going to come out.

We are going to need continued focus on Intelligence, Surveillance, Reconnaissance, Precision Strike, all the kinds of systems that we have been involved in.

I think the '06 budget, which is in the process of final review and approval in Congress is one that we are very comfortable with.

We will see how the conferences come out, but we think that we will be treated pretty well on that.

Certainly our expectations for '06 are consistent with that.

For '07 beyond, a lot of discussion now in the building and certainly as part of the QDR and I would tell you that there will be a lot of twists and turns between now and the time the '07 budget is actually passed.

So I would say stay tuned.

It is hard to predict.

I think the fundamental underlying view I have is that the Senate challenges that are facing the nation's military worldwide are increasing in severity, not decreasing.

And despite the pressures we have on budget, deficit, and everything else, I think the nation is going to have to step up to that.

Okay, and then just one quickly for Wes.

Wes, I'm just curious if you can attribute any of the cash flow strength to some of the Ace initiatives at the Company?

Is that getting any traction?

Could you point to any specific developments on that front?

We are making very good progress, Byron, in our Ace programs and their initiatives.

I would say the more near-term impacts are on what we would describe as competitiveness, the rate structure, the costs that go into our contracts.

We are getting a little bit of that improvement flowing through to cash flow, but it is primarily this quarter associated with our strong working capital performance.

Thank you.

Joseph Nadol, JPMorgan.

First question, Wes, just looking at your margin guidance for the year, I know you made a couple of tweaks in some of the various segments, but in each of the segments, it looks like for Q4 almost across the board the full-year guidance for margins is below -- at or below where you are year-to-date.

And I am just wondering is that just pervasive conservatism?

Is there other -- a bunch of things that you are uncertain about?

We're almost in November now.

There's a few components to it.

First let me say though that we expect the fundamental underlying performance in the fourth quarter to be very strong across all our sectors except of course Ship Systems.

So there's a couple of factors that go into getting that total fourth quarter number.

One as we indicated earlier, we expect the Katrina related impacts at Ship Systems to be about $0.10 in the fourth quarter.

But in addition from a total operating margin perspective, our guidance right now has built into it an unallocated expense of about 70 million in the fourth quarter and year-to-date we have been running at around 40 million per quarter.

We are expecting a higher number on unallocated in the fourth quarter to reflect higher mark-to-market stock compensation expense that we have seen in the previous three quarters, as well as a variety of smaller factors that often manifest in the fourth quarter.

And so that is probably the biggest component of what you're seeing.

At the sector level though, fundamentally we are expecting good, strong performance across the board.

Okay, and then the other question I have is in your Q, the 10-Q, there is some new language on an issue in the TRW space business with regard to I guess a classified program.

And because it could be material, I am just wondering if you could bracket that a little bit more or talk a little bit about that?

Yes, I think we would basically refer you to the disclosure there, Joe.

At this point in time, it is very early.

There's no numbers I would give you on that.

All right, thank you.

Steve Binder, Bear Stearns.

Ron, can you maybe just touch on your share buyback program?

Because if you'd back out -- last year you announced the $1 billion plan and it was supposed to be over a 12 to 18 month period and obviously some of that was to offset the CUs which you don't have as a headwind item this year.

And now you're saying 1.5 billion over a 12 to 18 month period.

So arguably you have doubled the size of the buyback program.

And I'm just wondering is that -- and you also made the statement that you plan to substantially decrease the number shares outstanding.

So that's kind of a new twist, new language.

Can you maybe just touch on -- is that a reflection of acquisitions, lack of acquisition opportunities?

Is it a reflection of the confidence in the stock or the confidence in cash flow?

Maybe you can just touch on those issues.

Well first of all, we're very focused on returning the cash to shareholders as part of our balanced strategy, Steve.

We have come out and made I think a pretty strong statement about several things.

We do have a substantial buyback.

We have an announced timeframe over which we're going to do that buyback and we do plan to reduce the shares outstanding.

We do not have the ES view overhang that we had in the last buyback.

However, I would also tell you that while we are looking at the share buyback, we are also considering where appropriate opportunities such as this very small one we talked about today on the call, of Confluent RF Technologies, where we can potentially improve the Company's overall competitiveness.

But in fact based upon the share price and the value we see to our shareholders, we think this is the right thing to do now and we're moving full speed ahead on it.

All right.

Wes, just two items.

One was cash tax.

It looks like from your Q it is just slightly over 300 million year-to-date.

It looks like you had a kind of net refund in the quarter.

Are you still expecting 550 million cash taxes for the year?

And also payables, that's an area that still -- we have -- I think the company has a potential opportunity but we have not seen it yet.

Do you see much headway there going forward?

Yes, Steve, with respect to cash tax payments, you are right.

The year-to-date number does include tax refunds we have received and we'd now expect cash taxes of about 325 million for the year.

And that reflects the refunds that we have been receiving as well as what we see for the rest of the year.

With respect to your question on payables, we did see some progress on that in the quarter, not a huge progress.

This is one of those things that is going to be measured a quarter at a time over many, many quarters as we continue to focus on all the component's working capital and drive that forward.

So I think to answer your question directly, are we still focused on it and driving it?

Absolutely.

And cash taxes, what is your assumption for '06?

We have not given guidance on that yet.

Okay, thank you.

Sam Pearlstein, Wachovia.

Good afternoon.

I wanted to just follow up.

On one of your slides you talk about declining capital spending in 2006.

I'm wondering if you can just frame the size of that?

And then just thinking about some of the work that still has to happen down on the Gulf Coast, would that be an impact that might change that capital spending and somehow make it an increase rather than declining?

All right.

Sam, this is Wes.

For 2006, excluding the impacts of Katrina first just for a moment, we do expect our CapEx to be reduced relative to our 2005 levels.

We have been through a period of having to address a number of CapEx investments around the Company to get our capabilities in line with our programmatic status.

And we see ourselves coming down a curve and going forward relative to that number.

We have not given a specific number next year that would represent how much of a reduction, but it is a meaningful reduction in 2006 over 2005.

But as we think about the impacts of Katrina, we may incur additional CapEx in '06 associated with the shipyard recoveries as we work our way through the insurance reimbursements and the timing of those reimbursements.

We are absolutely committed to ensure the restoration of adequate capabilities down in our shipyards to perform on our contracts, and so we're moving out as appropriate to get that done.

We're not going to leave our customer hanging as we work our way through that.

Over time, we expect the impacts to free cash flow of these timing differentials between our expenditures and our insurance recoveries to be mitigated.

So there is a timing component to it.

Exactly how that will manifest itself in '06 is a bit early to tell.

But to your earlier question, the underlying fundamental CapEx profile that we are on is coming down and coming down in a meaningful way.

Thank you.

And then just following up in terms of the order outlook and the backlog, we have now seen two quarters in a row where we started to see the backlog shrinking.

I'm wondering can you just comment a little bit about the near-term order activity?

And do you have any assumptions as to where the backlog could be at the end of the quarter?

Yes.

If you look in our book-to-bill for the quarter, it is about 70% and that is reflective of the seasonal pattern that we have in our business.

Last year's third quarter was about 63%.

So this one was just a little bit stronger.

If you look at that seasonality, we typically have a strong first quarter, weaker second and third quarters followed by a very strong fourth quarter, which as you know turns out to be the first quarter of the government's fiscal year.

So we're very satisfied with the number for the quarter and the profile that it fits into going forward and continue to see our backlog as quite strong.

Okay, thank you.

Cai von Rumohr, with SG Cowen.

Good quarter.

You have sales guidance of 32 billion for next year.

Could you give us some color on the trends by specific areas?

For example, you're now looking at 20% type growth at Integrated Systems.

Should we raise the number for next year?

So just give us the color you feel comfortable with for trends by sectors and maybe the same for margins.

All right.

As you know, we have not given any specific sector by sector for next year.

We'd reserve that for a little bit later in the year as we complete our planning activities.

But just to give you a little bit of flavor broadly, you mentioned Integrated Systems.

Integrated Systems has had a tremendous amount of growth over the last few years and capturing new programs.

We expect to see that settle out for next year, still very, very good performance, but not growth at the kind of levels that we have been seeing in the last few years.

We need to do a little bit of digestion of the success that we have had there as we start executing on those programs.

Now there are some big opportunities that could potentially get awarded next year that would change that answer and we will see how that plays out.

But from where we are today, it looks like we will be settling out a little bit in IS.

Three sectors I would point to is as good, solid, continued growth into next year.

ES, clearly the Electronic Systems business is continuing to be very healthy.

And our two sectors that are in the information and systems integration space, both IT and Mission Systems, are addressing a wide variety of opportunities in market areas that themselves continue to grow.

And so we are continuing to see good, healthy performance there.

Ships, at Newport News I would say is a good, steady performance into next year.

Ship Systems, we have given some guidance just reflective of the kind of recovery curve that we continue to be on.

I think we have been clear that post Katrina is going to take us about 9 to 12 months to get Ship Systems back up to where we would want it to be.

And Space is another good, solid performer for next year.

So that gives you a little bit of color and again, we really have not come out with any specific sector by sector information for next year yet.

And then just one follow-up.

You mentioned, Wes, you have large opportunities at ISG.

Maybe you could kind of go through and just mention the three or four biggest opportunities company-wide that could impact the number in 2006.

Sure Cai.

This is Ron.

Let me take a shot at that.

We have a number of big programs in play.

They include programs such as the Nevada test site I had mentioned earlier; the Virginia Information Technology Agency bid, which will be decided very shortly;

The NASA program to replace the space shuttle called Crew Exploration Vehicle, CEV, that is a fairly big opportunity and one in which we are priming.

We have a bid out now for the air operations center weapon systems integration program that is AOC-WSI.

That is an important new Air Force program.

We are obviously involved in a lot of restricted work which we cannot delineate on this call, but there are a number of important opportunities there for our potential future backlog.

We're tracking programs of a little bit longer time horizons such as the Air Force's air refueling tankers and I might mention that yesterday we just announced the selection of the site for the Northrop Grumman military modification facilities in Mobile, Alabama which will be basically co-located with the EADS/Airbus initial assembly facility that was announced earlier.

And that is going to be a significant program and that is one we will be participating in.

In addition to that, we will see some future opportunity on DD(X) and the CGX (ph) to follow it.

That is the new advanced cruiser.

And then there are a number of Homeland Security opportunities as well, the most significant of which is America's Shield which we will probably develop some time next year.

So we've got a lot of targets we're tracking and we're hopeful that we're going to win at least our share of those.

Bu you used to factor these programs so you would make some assumptions about probability of win, size of the program.

Are you continuing to use that methodology?

You bet we do, Cai.

We look at probability of GO, that is the probability the program is going to go; the probability that it will be funded; and then the probability that we could win it.

So we try to take a fairly careful and sober look at the realities of both our probabilities of winning and more importantly these days, the probability of funding and that the program is actually going to happen.

And those are all factored into our planning and estimates, and of course nobody has a perfect crystal ball, but if you think about the fact that in this company no one program accounts for more than about 2.5% of our total revenue, I think we are able to get it right on balance, and that is how we are able to give you the kind of guidance we do on the revenues.

Thank you very much.

Nick Fothergill, Banc of America Securities.

Ron, in your discussions on the Hill and in the Pentagon particularly with the Navy at the moment with the incoming new Chief of Naval Operations, can you tell us how or if you think the naval shipbuilding program might stabilize going forward and whether you think what the shipbuilding program might look like next year and the year after?

Well, Nick, I think that with the realization that this nation needs a great Navy, and a great Navy needs really good ships and enough of them and enough capability on them, I think there is a renewed focus on the part of Navy leadership to make sure that we get the right kind of force structure over the next 10, 20, 30 years and get the right shipbuilding program in place now.

I think that Congress has been looking to the Navy to really say what do they really want going forward?

And I certainly know that the new CNO and his team are working hard as we speak to figure out what the force structure ought to be.

I would say that I am more bullish on the potential for the future of shipbuilding, certainly as it affects the kinds of ships we build, which are all the major classes of warships for the nation going forward.

I think there is an increased sentiment in providing a reasonably stable level of funding over time, so the industrial base such as ourselves and others can make the right kind of plans and investments necessary, both capital investment and frankly also workforce investments.

Finally, I think the impact of Hurricane Katrina hitting the Gulf yards that we had really was a significant wake-up call to everybody, not only in the Navy but in Congress, that this is an extraordinarily important national resource.

And while it is easy to point to the fact that sometimes ship building is expensive and sometimes we are not able to get the right number of ships to the fleet, it is absolutely essential going forward to any view of the defense cost or the company.

So I think I'm cautiously optimistic, and I think that we will see over the next few months revelations by the Navy of its thoughts going forward.

My follow-up question is if you exclude the Katrina effect in 2005, you would show earnings growth around 7.5% at the midpoint.

Are there any particular program awards?

You did mention a whole list of them, but any particular ones that would allow you to guide up towards the top end of the range?

And also anything in your performance related actually internally within the business that you feel if Canegood (ph) could get you up to the top end of the range?

Well, obviously what we have given you is our best shot of how we think we're going to be able to do, and we set expectations for ourselves that we're going to do reasonably well.

So I would hesitate, Nick, to single out any one or two programs here.

As I had indicated to you, the Company has a very, very wide and large set of individual programs.

Clearly we are pushing as hard as we can to get to the top end of the range in all the guidance we've given you.

But the guidance is the guidance.

I don't think I would comment on that further.

Wes, did you want to add anything to that?

Yes.

I guess, Nick, in the general thrust of your question about what good shape, where we are in that range, I would tell you that we have included in our guidance a certain level of share repurchase that avoids dilution from stock grants.

The rate at which we actually implement the announced share repurchase program may represent some upside to our guidance.

And once we are actually into executing the repurchases and seeing how we're doing, we may elect to modify the guidance if appropriate.

But that is kind of we will see when we get into it.

Thank you very much.

Doug Harned, Sanford Bernstein.

Ron, really in the past 18 to 24 months, your senior team basically the leaders in each of the businesses with the exception of integrated systems are new.

And if I look at this, you've now got a team in place that I would expect we'd see there for some time.

Could you talk a little bit about any changes when you are working with this group, and Wes as well, in the way you are seeing the future of the Company?

Any new initiatives that you're thinking of putting in place with this team?

I am absolutely thrilled with the team we have in place.

We have had through a series of retirements generally the opportunity then to make selections of replacements to executives.

This set of executives is a terrific group.

They are highly focused on operating performance.

They understand what we need to do.

They are incentivized in their own compensation very much along the lines of the performance of our Company and its stock.

We have initiated the Ace program here over the last year, which we expect will have some long-term benefits to us.

Each one of these executives is personally committed to the Ace initiative both Company-wide and the element that they are responsible for individually.

So I think that what you see is an extraordinarily and diverse group of folks who have an understanding of the seven sectors and the various staff functions of the Company where they can focus on what it is we are supposed to do here.

And I think you have seen over the last eight quarters or so the underlying operating performance, the focus on the operating performance, and the drumbeat that we keep hitting internally relative to how we want this business to run.

We have talked about margin expansion.

We have done the margin expansion.

A few years ago we talked about integration effectiveness and not having any issues there and we delivered that.

And we've also talked for some time about balanced cash deployment.

And today I think you see another example of what we're talking about there with our share repurchase plan.

I think this leadership team is the right one and I do expect that we're going to be together for a good time doing some good things in the future.

To follow up on one specific program and that is the Air Force Tanker.

Now this is one where it has been very important for EADS to establish the manufacturing base in the U.S.

And as you think about investment levels and planning for this program and given the uncertainty still in how the Air Force is going to approach this and what decisions will be made on the Hill, how do you think about investment and planning early on for this?

Well first of all, this program will go through several very well-defined steps.

And the way we plan to do it is we will make the investments commensurate with the gaits of basically decision and award.

Or to put another way, we are not making a massive investment in advance of a potential RFP or in advance of a potential award.

We have plans for the program which allow us to gape (ph) the investments commensurate with the actual progress of the program.

So we're looking at this thing with a very keen eye on the business aspects of it.

And frankly creation of the military modification facility is not the same level of investment as a shipyard.

And we have done this before.

We have done this very successfully in the Joint STARS program and others.

We understand what we're getting into.

We are also working with the State of Alabama and the local authorities to provide the right kind of incentives as we move forward on this.

Okay, great.

Thanks.

Joseph Campbell, Lehman Brothers.

I wondered if either of you could comment on what is at stake for Northrop Grumman in the FY 2006 conference committee adjustments, including the supplemental differences?

There's some rather large differences up there.

What do you expect to actually happen and how does that jive with what you want?

Well, I don't see a whole lot of impact as a result of supplemental dollars, but in the basic appropriations --.

I mean there's $6 billion difference there in the sub.

There' nothing in there that is important for you?

There probably are some things but frankly we're looking more at what is in the basic appropriations bill, Joe.

That is really more the swingers.

And I will tell you that this year the range of outcomes -- or there is certainly outcomes that is actually narrower than it has been in the last several years.

The last several years we were looking at ranges of plus ups and cuts in $1 billion range.

I think it is much less than that.

We're looking at a plus up on the CVN 21, about $87 million on the Senate side I guess and the House side is not and we're hoping to get that moved to the upper portion.

There is some question regarding the DD(X) program, but I will tell you that we have taken a pretty conservative view in our thoughts and guidance so that what we have planned on for you going forward.

We hope that any outcome there will be positive for us if that happens.

Do you expect to get that 700 million back?

know, I don't think the 700 back.

I'm dealing with the range of outcomes in which in one bill I think the President's program is fully funded and the other one, the DD(X), is cut but the money was added for DD(G)s (ph), which is (multiple speakers).

And I think we will let the Congress sort all of that out and I think are guidance will be fine irrespective of that outcome, Joe.

So I think (multiple speakers)

One of them takes 700 million out of DD(X) and then pluses up the construction of an older ship (multiple speakers) How would that be indifferent for you?

There's a lot of other companies that are involved in that going forward because the program is restructured so that we are no longer going to be in charge of that entire amount of money.

The money is going to be sent out to people building combat systems, weapon systems, guns, propulsion systems, and some of it will go to us.

But what I am saying to you is that we have factored in the range of outcomes there.

We do not see that as being a significant driver for our guidance for next year.

Okay, but you don't have any views on how these will come out?

No.

I wish I had a crystal ball but again I will just comment again that the range of uncertainties between the two houses and their marks is much narrower at this point than it has been in any previous year in the last few.

So I think what we have based our guidance on is pretty well understood.

Ron, if I could just ask, what are the big three or four things that you personally have on your plate?

Not issues of performance or capture that the divisions have but what you as the CEO of Northrop Grumman are sort of focusing your precious time on?

Well, there's a lot of things to be thinking about.

I would say first and foremost, Joe, is operating performance.

And I spend a lot of my time on that with this team and that is a message that everybody understands here.

I spend time clearly helping to think through what we think the future is going to be and how we can shape it and making sure that we have ideas that are going to our customers to help them in their thoughts as they think through (technical difficulty) and future four structures.

We spend a lot of time with our employees and the communities because certainly most recently this affect of the hurricane.

And I will say, Joe, that the strength of the Company and the resilience of the workforce of this Company was magnificent.

I cannot imagine a bigger wallop than the one we took down there, 21,000 people displaced.

A large number of their homes were destroyed, and yet this workforce came back very strongly.

And we are absolutely committed to getting those yards recovered and restored.

And by the way, we are going to come back stronger than we were before we got hit.

I think the final comment I would make is that I do spend a lot of my time thinking about how do we enhance the value to our shareholders or their ownership of this Company, which by the way is ownership we as a leadership team have too personally.

And I think the cash deployment issues are things that have taken a lot of my time, Wes's time, and rightly so.

I think the statement today again about the share repurchase plan is an example of what we're talking about in terms of driving shareholder value.

Ron, thank you very much.

George Shapiro, Citigroup.

Good morning.

A couple of questions for probably more Wes.

The Electronic Systems revenue were weaker than I thought it would be and if you isolated it, it looks like it’s isolated to Aerospace Systems and Defense and other.

So I'm just wondering what you could say about that, particularly Aerospace Systems sequentially the revenues were almost down $90 million.

George, this is Wes.

In terms of Aerospace Systems for the quarter, I think what we're seeing and particular to the quarter is we're nearing the completion of the Long Bone multiyear buy and so that is showing a trend line in Aerospace Systems.

We are expecting to see that turn around as we have some other programmatic activities -- take that on.

In the Defense Other during the quarter we had lower volume on some classified activities relative to the comparison to the same quarter last year.

Say you expect that fourth-quarter revenue to be at least 300 million or so higher than the third-quarter revenue?

We're not giving the guidance down at the business area level if that is where you are --?

No.

If I generalize to all of Electronic Systems. (multiple speakers)

In terms of the total for Electronic Systems, as we indicated as I went through the earlier part of discussion this morning, we are still expecting this mid single digit sales growth for the year.

And so you can do the math between the difference of the outcome of the year and where we are today.

Continued strong performance in ES.

The fourth quarter I think as you know historically, George, is often driven by the international business that seems to clump sometimes in the fourth quarter.

We are continuing to see that perform very well and expect that to be healthy as we get into the end of the year.

Last year's Q3 to Q4, the revenues were up almost 200 million.

That's why I was wondering whether this year would be up potentially more because of what is a relatively weak quarter?

As I said, the fourth quarter should drive us to where we are giving the guidance for the total segment there for the year.

So yes, it should be a strong quarter for us.

On the other side, integrated systems where you upped the guidance, we've seen particular strength in airborne early warning where the business is up over 40% year-over-year.

Now can you just go through this?

There's handful of programs in there but can you just go through which ones are upped to drive that sector that much?

Yes.

There's two that are really driving and it's Advanced Hawkeye and the EA 18 G program.

Those are two very substantial programs coming up a very strong curve on program volume in each area and those are the two primary drivers.

Last, in the ships area if you backed out the loss you had a very high margin actually, like 7.9%.

I assume some of it is due to what you say that you had better performance in some of the other areas.

I'm guessing some of it is due to lower development revenues on DD(X).

Can you provide any further explanation or why it would be that much above what you are projecting for run rates?

George, we appreciate your noticing that actually.

The real driving performance there came out of the performance in aircraft carriers and submarines for the quarter.

We've got within aircraft carriers -- we had a good, strong performance on the Enterprise in Washington.

And there has been strong volume and good performance so far on the Virginia Class Block Two activities.

So those were the big drivers for us.

So without the charges as we go forward, sometime in the next year or so we could actually see the shipbuilding margin get up closer to 8%?

Yes.

Over time we expect that our ship segment should be able to demonstrate margins that are more aligned with traditional platform businesses throughout our industry.

And I would put a plus sign behind that 8% in terms of where we're trying to drive that.

And the lower revenues on DD(X), was that all due to Katrina or there was some delay because of the uncertainty of the program?

No that was all due to the delay.

In fact the role that we had was we were able to continue very strongly on the design and the design review, but it was really a result of the contract structure change.

Okay, thanks very much.

George, it took the major subs out from under us.

It has been fundamentally restructured so the comparison was to last year when we had all that subcontract work in-house or through us, flowing through us.

Okay, thanks a lot.

Ron Epstein, Merrill Lynch.

I just have two detail questions for Wes.

When you look at FAS 123R, what impact are you factoring into your guidance for 2006?

It is about 12 million for next year.

12 million total?

Yes.

You might recall that in our last quarterly announcement we indicated the change in our plans for stock compensation going forward.

Okay, that's great.

And then just a second question.

If the insurance disagreement does not turn out favorable for you, would we expect an additional charge or how would that be handled?

No, in terms of the insurance profile, let you remind you what we had said in our release a couple of weeks ago.

The issue that we're dealing with is the insurance provider for coverage of property damages, losses over 500 million has advised us of a disagreement regarding coverages for certain things above the 500 million.

And as we said then, we do take the view and feel very strongly about the view that our coverage is very enforceable.

And that we feel very positive about recoverability here.

But to be clear regarding the accounting question you are asking, the net book value of the assets that were damaged plus the cost of the cleanup and recovery are estimated to be within the first 500 million and the disagreement that we described is for coverages above 500 million.

So we're not expecting an additional charge related to this issue.

Okay, that's great.

Thank you very much.

David Gremmels, Thomas Weisel Partners.

Good morning.

A question on the IT sector.

You lowered the full year plan for revenue growth to mid single digits, but I think that still implies a pretty dramatic acceleration in the fourth quarter.

Do I have my numbers right there?

And if so, what is changing for the better in the fourth quarter?

Yes, this is Wes, David.

Let me give you kind of a broad view of what is going on there.

The sales in our higher margin core business areas like our Government Information Technology business are growing.

And the sales in the lower margin business, the reseller business that we call Enterprise Information Technology, has been declining over the last several quarters.

If you're talking about the quarter-to-quarter comparison of this quarter, quarter three, to the coming quarter, quarter four, you are right in that we do expect overall sales to be up.

We have a number of programs that are in their startup phase, with activity just starting now that will contribute to that growth.

But again we are primarily looking at the business areas other than the Enterprise Information Technology business for that growth in the fourth quarter.

Okay, and one question on Ship Systems.

You mentioned earlier that your expectation that margins over time will get to 8% plus, but what are you assuming in the '06 guidance with respect to Ship Systems margins?

Does Katrina fall out keep you in the 6% range but you also have polar tanker completing so that is going to help?

So what are you thinking there?

You are right that there are some puts and takes here.

Katrina does represent a continued margin pressure on ships in the next year.

But you mentioned polar tanker.

There are a variety of things that also are uppers.

Again, we have not given sector specific guidance for '06.

But I would say that you should expect ships to be on a strong recovery path moving up towards the longer-term expectation as we go through next year.

But we still will be in a recovery mode in '06.

Got it.

Thank you.

Robert Springarn, Credit Suisse First Boston.

Wes, I just wanted to make sure I understood you correctly.

Are you saying that your guidance for '06 anticipates a flat share count?

Fundamentally the guidance for '06 does include a repurchase rate that avoids dilution for stock grants.

I'm always reluctant to use the word flat because you never know where someone is starting their measurement point from.

But in that context, there is the opportunity for obviously enhancement in EPS if you just do the math, if our repurchase rate substantially exceeds the dilution rate.

Rob, you'll notice that our share count actually is down already.

Right.

It has been (multiple speakers)

Actual count at the end of the quarter versus the average.

Right.

It has been decreasing over the course of this year and so using the average for this year, it would be different than using the endpoint for the year.

Okay.

And then just going back to the Enterprise Business and IT, I think you just said that you might expect some continued similar performance in the fourth quarter as per the third.

And if so, does that suggest perhaps some kind of a portfolio shaping might be on your mind?

Let me just say -- this is Ron -- this is a business which as you know has significant revenues -- margins are low, but also capital tied up in it is very low as well.

It has a value to the overall business because it allows us to pull through product which we use for other things.

So at this point in time, we're working to figure out how to make our margins a little stronger and how to get some reversal on the revenue reduction.

But that is where it is right now.

Thank you.

Miles Walton, CIBC World Markets.

I am not sure you will be able to give me much color on it but I will try anyway.

When you or when Lockheed originally competed (ph) on sea (ph), I think you were the exclusive supplier.

And given the work shift that has taken place back to Lockheed, do you see an opportunity in that for Northrop and is that already considered in your guidance?

Miles I just can't comment on that because of the nature of the classification on the program.

Fair enough.

I had another one standing by.

Lockheed did move to a -- or stopped its defined benefit program for new hires as of January 1.

Is that something that you are thinking about?

Is that a material opportunity for you?

Does retaining a pension plan actually distinguish you amongst new hires?

Miles, this is Wes.

Let me give you a little background on that.

We have been at this for a couple of years.

In July of 2003, perhaps without very much fanfare, we did implement a new benefits platform that was designed to address many of the same issues that Lockheed is addressing with its recent changes.

At the time that we made our changes, we drove towards what we're calling a cash balance defined benefit plan that gets to many of the fundamental issues that I think you have heard Lockheed describing in terms of predictability of the cash flows and helping to better manage our overall pension liabilities.

We feel very good about the structure that we have.

We feel it is very competitive.

And see it as a strong part of our commitment to our employees to continue to provide good at both pension capability as well as access to health coverage in their retirement.

One last one.

Some sensitivity on the pension numbers you have used if you can provide those?

The 25 basis point shift in discount rate or realized rate of return would be helpful.

Sure.

We're doing very well on our pension returns year-to-date.

It is performing to our expected return rate and as we had disclosed earlier, our total return rate assumption for the year is 8.75%.

You are asking for sensitivity on discount rate.

A 25 basis point reduction in the discount rate if it were to be reduced and we're not seeing that trend right now but if it were to be reduced, that would impact FAS pension expense by around 70 million.

Okay, great.

Thanks.

Let me wrap up at this point in time.

We're at the end of the hour with three points.

First of all, we are continuing our strong focus and operating results.

Secondly, we are making steady progression in our ships recovery activity.

And finally, the share buyback which we just announced today we believe makes a very strong statement about our focus on shareholder value.

Thank you all for joining us.

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

This does conclude the presentation and you may now disconnect.

Have a great day.