諾斯洛普·格拉曼 (NOC) 2005 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Northrop Grumman fourth-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.

Thank you very much, and good morning, ladies and gentlemen. Welcome to our fourth-quarter conference call. We provided supplemental information in the form of a PowerPoint presentation that you can access on our Investor Relations Website at www.NorthropGrumman.com. This is available as an accompaniment to our conference call. The presentation will be available for a limited time only and should be viewed in conjunction with today's commentary.

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 Forms 10-K and 10-Q.

During the call we will discuss fourth-quarter and full-year results, including the non-GAAP measure for total segment operating margin. Segment operating margin is reconciled on Schedule 2 of our press release. During today's call we will also discuss our outlook for 2006. Guidance will include GAAP measures of sales, operating margin, earnings per share from continuing operations, net cash provided from operations, and the non-GAAP measure of total segment operating margin.

We also want to draw your attention to Schedule 5 of our press release, which provides a reclassification of 2003 through 2005 results, and reflects three enhancements to our financial reporting. The first is the creation of Northrop Grumman Technical Services, which we announced earlier this morning. The second enhancement is the categorization of the results of our eight operating sectors. Going forward, Mission Systems, Information Technology, and Technical Services will be presented as Information and Services. Integrated Systems and Space Technology will be presented as Aerospace. Electronic Systems will be reported as Electronics. And Newport News and Ship Systems will continue to be reported as Ships.

You'll notice that Schedule 5 also introduces a revision to intercompany margin recognition and elimination for the Company's operating segments. In order to align our sales and operating margin reporting, and provide a more relevant depiction of the management and performance of our businesses, operating margin for our segments will include margin on intersegment sales. This will be Northrop Grumman's new reporting format beginning with first quarter 2006 financial results. Schedule 5 is provided so that you can adjust your models prior to the first quarter.

On the call today are our Chairman, CEO and president, Ron Sugar, our Chief Financial Officer, Wes Bush, and our Chief Accounting Officer, Ken Heintz. At this time I would like to turn the call over to Ron.

Thank you, Gaston, and good morning everyone. And thank you for joining us. We are very pleased with our overall results in the first quarter and the year. Our focus on performance continues to deliver results.

In 2005 we delivered sales growth, margin expansion, earnings growth and stronger cash generation. Fourth-quarter earnings per share from continuing operations increased 24% to $0.92, and for the year, earnings per share from continuing operations rose to $3.81, a 27% increase over last year. Fourth-quarter net cash provided by operating activities more than doubled, growing to 678 million from $324 million last year. For the year, cash from operations rose 37% to $2.6 billion.

In contract acquisitions, we booked $6.6 billion versus last year's record 11.9 billion. Contract acquisitions were impacted by the delay in the passage of the 2006 defense budget. We fully expect to recover the delayed acquisitions. This also affected funded backlog, but our total funded backlog remains strong at $56.3 billion.

2005 was the third year in a row in which this management team grew EPS at a double-digit rate, and expanded our segment and total operating margin. During 2005 we generated higher sales and operating margin in every business other than ships. We reduced our corporate unallocated expenses and our net interest expense, and we generated gains through the sale of noncore assets.

The Company also increased the amount of cash we've distributed to shareholders through share repurchases and dividend increases beginning in 2003. Our exceptional operating cash performance, along with the additional $238 million in cash from the TRW Auto and Endwave stock sales, allowed us to accelerate the rate at which we returned cash to our shareholders in 2005.

In October, after the early completion of our $1 billion share repurchase program, we announced a new $1.5 billion program. And in November we completed one-third of that program with the repurchase of 9 million shares in a $500 million accelerated share repurchase transaction -- immediately lowering our shares outstanding. In total, we retired 22 million shares of common stock in 2005.

We also raised our dividend 13% -- the second year in a row in which we increased the dividend by a double-digit rate. This was accomplished while we continued to improve our balance sheet. And based on our improving balance sheet and our positive financial outlook, two of the three credit rating agencies raised our rating to BBB+, the highest rating in Northrop Grumman's history.

We are especially proud that this year's financial results and cash deployment were achieved despite the significant impact of Hurricane Katrina on our Gulf Coast operations. I can't speak highly enough about the leadership and dedication displayed by our management and our employees in the face of this unprecedented event. Ship systems fourth-quarter results reflect the impact of continued disruption to our operations from Hurricane Katrina. I am pleased, however, with the steady progress we are now making in the recovery.

In addition to our (technical difficulty) operating performance, we continued to take a hard look at our portfolio of businesses in order to maximize shareholder value. That analysis led us to the decision to exit our IT reseller business, which is no longer a strategic fit for our company.

Our portfolio analysis also led us to establish a new Technical Services sector at the beginning of 2006. Northrop Grumman Technical Services will leverage our existing business strengths and synergies in the rapidly-expanding logistics support, sustainment and technical services markets. It initially will consist of programs and businesses in this market area drawn from Electronic Systems, Integrated Systems, Mission Systems and Information Technology, and we will use this as an initial base for future growth. Jim Cameron, a seasoned executive who knows this business very welcome will lead the new effort.

Looking ahead, the 2006 defense budget, signed into law on December 30th, supported our programs with some significant plus-ups. Shipbuilding as a whole was increased $300 million to $9 billion. The Virginia class submarine and the CVN 21 programs were funded as we expected, with the CVN 21 receiving an additional $62 million in funding. For DD(X), the budget provides 1.1 billion in R&D and 717 million in procurement.

Other major programs that were fully funded to the President's request include Kinetic Energy Interceptor, LHA 6, [NPOS], Advanced EHF, B-2, Large Aircraft Infrared Countermeasures for the Air Force, and the [CGX] radar development. Only a few of our programs were negatively impacted to any great extent. These include TSAT space radar and the B-1 bomber radar upgrade. Non-DOD programs such as the Coast Guard Deepwater program, infrared countermeasures for commercial airliners, and the James Webb Space Telescope, also received full funding.

The 2007 DOD budget request will formally be submitted to Congress in early February, and the department is beginning the Program Objectives Memorandum, or POM, build for fiscal year 2008. Our understanding of the QDR process indicates that Northrop Grumman's portfolio of capabilities remains well aligned with our customers' strategic direction.

We ended the year with a strong backlog that provides a solid foundation for the Company into 2006 and beyond. We captured several important programs in 2005, most notably the $2 billion Virginia IT outsourcing agreement, the $1.9 billion award for the refueling and complex overhaul of the USS Vinson, the $1 billion United Kingdom AWACS support program, and the $1 billion award for the Missile Defense Agency's Joint National Integration Center.

In addition to this strong foundation, this company has tens of billions of dollars of competitive new business opportunities ahead. My 2006 priority list includes multibillion dollar programs like the Air Force's next generation refueling tanker and transport aircraft, and NASA's Crew Exploration Vehicle, which would place Northrop Grumman at the forefront of the new manned space initiative. And there are several upcoming restricted programs urgently needed by our nation's intelligence community to defend against evolving threats.

These are just a few of the major opportunities that North Grumman will pursue in 2006. There are also hundreds of important new business opportunities in the information and services area that we will aggressively pursue as well.

Based on our drive to improve [performance] we are raising [2005] guidance for earnings per share to a range of $4.25 to $4.40, supported by continued segment operating margin expansion and a lower share count. And we have also raised the upper-end of our guidance for cash from operations, as we now expect cash for operations of 2.3 to $2.6 billion.

2005 was a strong year for Northrop Grumman, one in which we drove operational performance, provided disciplined financial stewardship in our cash deployment actions, and positioned the Company well for the future.

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

Thanks, Ron. Good morning, everyone. As Ron said, we are very pleased with the Company's performance in 2005, and we are expecting very solid performance in 2006 as well. I'll provide some detail on the underlying numbers to give you some additional insight.

Beginning with slide three, we expanded segment operating margin to 7.9% for the quarter and 7.8% for the year. This year's total operating margin was 7.1%, a 40 basis point improvement over 2004.

Our 2005 segment performance is summarized on slide four. Beginning with Electronic Systems, margin is up 6% for the year on a sales gain of 4% -- a 30 basis point expansion. Our results include a fourth-quarter charge for the F-16 Block 60 program, specifically for completion of the Falcon Edge Electronic Warfare Suite.

While we continue to make progress as expected, and deliver hardware on the radar, targeting pods and ground testing equipment, during the fourth quarter we encountered unexpected problems in the Falcon Edge software integration and testing. Recognizing that more challenging integration and testing remained, we undertook a comprehensive independent review of the estimated cost to complete the program.

Based on that analysis we established a higher EAC, which is reflected by the charge. We expect that our increased EAC will capture the remaining work. However, risk remains until we complete this fixed-price development program.

The Block 60 charge was partially offset by improved performance from other business areas at Electronic Systems. Ship sales declined 7%, with a 38% decline in operating margin due to the impacts of Hurricane Katrina. Strong performance at Newport News helped to somewhat offset the Katrina impacts in the second half of the year.

Integrated Systems increased operating margin 15% on a sales gain of 18%. Revenue growth has been driven by new development programs, and the lower operating margin rate at Integrated Systems reflects this larger content of development-stage contracts.

Mission Systems increased operating margin 19% on sales growth of 8%, and expanded their operating margin rate to 7.1%. This strong performance for the year reflects continued growth in performance in Command, Control and Intelligence, as well as Missile Systems programs.

Information Technology increased operating margins 18% on sales growth of 4%. IT's 2005 margin rate expanded 80 basis points, to 6.8% from 6%. Sales growth in IT for the fourth quarter and the year continued to be impacted by declining sales and lower performance in Enterprise Information Technology, which is our reseller business. As Ron mentioned, we've decided to exit this business, and we have adjusted our consolidated 2006 sales guidance accordingly.

Space Technology increased operating margin 15% on sales growth of 4%. And for the year, ST's margin rate expanded 70 basis points to 7.5%. The strong results in Space Technology reflect higher sales in civil space and intelligence, surveillance and reconnaissance, as well as improved program performance in intelligence, surveillance and reconnaissance.

Moving on to slide five, you can see a reconciliation of net income to cash from operations for the fourth quarter and for 2005. We had very healthy cash conversion this quarter, and for the year we exceeded the upper-end of our guidance. Non-cash adjustments for the year include $774 million for depreciation and amortization, and a use of $20 million for pension and OPEB, including a $203 million voluntary prefunding of our plans.

Working capital was a source of $32 million, deferred and payable income taxes generated 392 million, and all other items together were about 67 million -- bringing 2005 cash from operations to approximately $2.6 billion.

Capital expenditures for the quarter, including capitalized software costs, were 305 million, which includes approximately 80 million in Katrina-related spending. For the year, capital spending totaled 824 million.

Moving on now to our outlook for 2006, slide six provides guidance for sales and operating margin rate in our new presentation format that Gaston described.

For Information and Services, we expect sales of approximately $11 billion, with the margin rate in the mid-7% range. For Aerospace we expect sales of approximately 9 billion, with an operating margin rate in the mid-8% range. Electronics sales are expected to total approximately 7 billion, with an operating margin rate expanding to the mid-11% range. 2006 ship sales are expected to be approximately 5 billion, with margin expansion into the mid-7% range. Net of eliminations of approximately $1 billion, this brings us to our total sales guidance of approximately 31 billion for 2006. This guidance contemplates our exit of the reseller business as well as the divestiture of some small-business units. We expect total segment operating margin rate in 2006 to expand to the mid-8% range.

Slide seven provides additional guidance for 2006. We expect our unallocated expenses to decline to approximately 140 million for the year. We expect net pension expense of 25 million, and net interest expense of approximately 300 million. Capital spending before Katrina-related expenditures will range between 700 and 750 million. The timing of insurance recoveries may result in additional capital expenditures related to the recapitalization of the shipyards, but we expect to recover those expenditures over time.

Depreciation and amortization will be approximately 580 million and 135 million, respectively, and we expect an effective tax rate of approximately 33%.

For 2006 cash from operations, we expect that our adjustment for non-cash pension and OPEB will be approximately the same as 2005, and working capital is expected to be about neutral. Cash tax payments, net of refunds, will range between 650 million to 700 million. And all other items together will be approximately the same as 2005, adjusted for the TRW and the Endwave equity sales.

Slide eight summarizes our consolidated guidance for 2006. As we look forward, we expect our performance will continue to build upon the strong results we demonstrated in 2005. The Company has a clear focus on driving operating performance, and we also remain committed to executing our balanced cash deployment strategy.

We would now like to open up the call to questions.

Thanks. We're ready for Q&A now.

(OPERATOR INSTRUCTIONS). Joe Nadol, JP Morgan.

First question is on the Ships area. Wes, I thought we had said last quarter that you were going to have $0.10 of impact to EPS from residual Katrina issues. You guys did pretty well in there; just wondering if you could help out with what changed the past couple of months.

There were really two things there, and the $0.10 did turn out to be pretty accurate with respect to Ship Systems. They did a little bit better than that. To their credit, that team is doing an amazing job on recovery, and demonstrating a real commitment to the customer in doing that. But most of the improvement -- if you recall that we report Ship Systems and Newport News together as the Ships segment -- most of that relative improvement in the fourth quarter actually derived from Newport News. They had very strong performance in their aircraft carrier business the last part of the year, and that was reflected in the fourth quarter.

So in terms of $0.10 of impact, if I take literally $0.10 of EPS back into your operating margin, add it to your operating margin, that's what you would have done ex the Katrina issues? That would be very, very high margins.

There's a lot of puts and takes in there, but in aggregate, that's just about right. Like I said, they did a little bit better than the $0.10 just as a result of their hard work and determination. But that's the ballpark.

One more on this. When you get -- when you recover some of your capital spending from the government, how is that accounted for? Is that booked as profits, or does that just flow through your cash flow statement?

We don't recover that from the government. Were you talking about insurance recoveries?

I guess insurance, and also in some of the Katrina aid that has been set up by Congress. (multiple speakers)

What Congress did was they enacted a piece of legislation that actually provides the flexibility to the Navy for the Navy to go in and make an assessment of the impacts related to Katrina. We are at the early stages of working that with the Navy. There's a substantial set of determinations that need to be made as to how the performance of the contracts was impacted by Katrina, and how the Navy wants to treat that going forward. To the extent that some of the cost growth is recognized in those contract adjustments, over time we'll naturally reflect that in our EACs and our booking rates on those contracts. But it's a little bit too early to tell how that all shapes up.

Let me just add, Joe, if I may. The Navy's flexibility has been provided to correctly fund the contract side. It has nothing to do with insurance recovery or capital investment or reinvestment in the shipyard.

Those are two very different things.

The capital reinvestment is basically our business in conjunction with our insurers, not the United States Navy.

Okay. Switching gears to bookings; understand that the budget was signed very late. Do you have expectations for bookings in 2006, given your delays from Q4? Do you expect a healthy premium to your sales, a book-to-bill over one?

As you know, we typically -- or actually we don't at all give guidance with respect to what we call acquisitions for the year. But in response to your question -- yes, there was someplace in the range of 3.5 to $4 billion of acquisitions at the end of the year that we had expected to get that we did not receive as a result of not having a defense bill. And so early in the year we expect that we'll begin to see a lot of that come in as a result of the customers now being enabled to take the actions that they require to get their jobs done. The challenge will be, of course, what happens at the end of this year, and do we see similar phenomena occur. So it's hard to predict how all that comes out. But I think to answer your question, we do expect to see a recovery with respect to those acquisitions, as the customers are able to take the contractual actions that they need to take.

One quick housekeeping one. On the segments, are you going to continue to give us -- to break out the different businesses within Aerospace and Information Systems on a sales and operating profit basis, or are those going to be consolidated when you report your earnings?

Our intent is to consolidate all of that into the segment level, but you'll see plenty of description from us with respect to what's going on in the individual pieces of the businesses.

So space and aircraft. But you're going to tell us -- you're going to break out the sales but not the profits. Is that accurate?

No, we'll show the sales for space and the profits for space. We're going to continue reporting the segments as we're reporting it today. I thought you were referring to that next level of detail down (multiple speakers) okay. You'll continue to get segment reporting information as you are today, which is a fair amount of detail. And then there will be commentary that goes with that, of course, that describes what's going on in the business areas.

Byron Callan, Prudential Equity Group.

Nice quarter. Ron, I wonder if you can just comment -- you've seen this draft floating around on the QDR. Any surprises or anything that varied significantly from the way you guys have been thinking about the world? You mentioned you were [aligned] with it, but there were some program-specific things on more UAVs and I guess some changes in the E-10, but go ahead.

Actually, we obviously have been tracking this pretty closely. It's difficult to do one of these in Washington without having some visibility into it from the outside. There's nothing that's coming out of this that we've seen so far that is terribly surprising. We did indicate that pretty much what we're seeing is aligned with the way we're positioned. If there's going to be additional emphasis on UAVs over the next five to 10 years, that's great. That works with us just fine. Additional surveillance and reconnaissance work plays to our strengths as well.

If you take a look at what really drives this company's sales and profits, it's the budgets. And the '06 budget, of course, was pretty much put together before (indiscernible) influenced a little bit by it. The '07 budget has been informed by the QDR process, although QDR is not finished. As we see the '07 budget shaping up, again, we think it's pretty much aligned. And the '08 is in, as we said, concoction now. So I don't see anything that would be particularly alarming; in fact, most of what we see is very consistent. It's good to know that we're going to have a navy. The Navy is going to need great ships, and that's something we do well. So I think overall we're pretty pleased with what we see coming out.

Just maybe a follow-on to that, because I realize we're dealing with kind of an apples and oranges comparisons in your 2006 guidance for sales, and compared to 2005. But just directionally, can you guys give us any parameters on what you're thinking for 2007 and 8? Are you going to grow pretty much at the same rate of defense spending, or are there things that you see happening like shipbuilding that may allow you to grow sales at a faster rate? Any thoughts on that, Ron?

It's hard to say. We don't give guidance, obviously, for '07. But if you look at the macro environment, we don't see defense spending reducing in the near future, because we don't see the threat to the nation reducing. We see very significant, frankly, upward pressures on the need to keep defense spending solid. So we are pleased with the fact that there appears to be some stabilization in shipbuilding, and that's a good thing. It's certainly good with respect to the other parts of our portfolio. Again, as I said, we're very pleased with the way the portfolio is positioned for what we see now as we look into '07 and beyond.

George Shapiro, Citigroup.

A follow-up on the shipbuilding comment, Wes. It looks like revenues in shipbuilding were around 400 million higher than what your guidance was at the third quarter, where you had the year down mid-teens, and you wound up down only 7%. And the margin was up a little over 4%, and you'd implied a little lower than that. I'm just trying to reconcile the fact that you still say there's $0.10 a share difference.

The $0.10 relative comparison number goes back to where our own views of how we were going to come out at the end of the year were going to be prior to Katrina. So it's a little bit of a difficult process to give you traceability to that. But fundamentally, as I said, we did see some improvement at Ship Systems, a little bit better than what we had considered in the earlier guidance that we gave. And that probably helped sales more than it did margin, quite frankly, just given the amount of impact that we have on the cost growth on those programs.

But I want to be very clear. Newport News really delivered nicely in the fourth quarter. We had three major aircraft carrier programs down there late in the year. We had the Eisenhower, we had the Enterprise and we had the Washington. Those are major activities. We did very well on all three of those activities, and that's reflected in the results that you see.

When we were giving the $0.10, we were talking specifically about the implications of Katrina associated with Ship Systems. The fact that we report these things bundled up sometimes leads to a little bit of confusion in that regard.

If I take it one step further -- for '06, you're giving ship guidance to sales about 5 billion, and if you maybe lost 300 or 400 million this year from Katrina, so you're really seeing sales in ships come down from maybe 6 billion to 5 billion. Is that primarily lower DD(X) revenues, or can you go through what else is causing that decline?

You've got it right, George, it's primarily the combination of DD(X), which is actually the biggest contributor, the year-over-year comparison, combined with the continuing ramp backup associated with Katrina recovery.

Okay. And then if I go to the new Aerospace sector, it looks like you're projecting revenues of about flat with where you were in '05. And given the sharp increase we had in Integrated Systems, I would have expected a little further increase there in space to grow a little bit. If you could tell us what's happening, why you're projecting basically flat sales in that new sector.

We have had a substantial run-up in revenues in both components of that new business area, both in the Space side and the Integrated Systems side. And frankly, this is basically a catch-up period now as we are executing. So the rate of growth has slowed for this year. But as you can see, the backlog is very strong in these areas.

I would add one other thing in that at both Integrated Systems and at Space, there's been over the last couple of years an enormous amount of success in capturing the new development activities that were available to those businesses. And so you've seen that ramp-up in development contracts that's been reflected in the topline growth that's had a little bit of slowdown on the margin rates because it's largely development content. As we move forward into this year, and I think we'll see it even more noticeably next year, we're really looking at transitions in those businesses -- transitions from development-stage activities to production-stage activities. And this sort of a topline pause as you go through that transition is very typical of going from a development stage to a production stage.

And we have a substantial number of opportunities ahead in that business area, both in the space and the airplane side.

One more. If you look at electronics and take out the 65 million or so, the underlying margin would have been over 13%, which strikes me as pretty high. I'm guessing there were some contract closeout benefits there, and if you could quantify what those benefits might have been.

As you know, we have a variety of very long-term defense contracts in Electronic Systems, and very large contracts. So we generally do have margin adjustments related to contract closeouts. And also as we make adjustments in our views of the expected cost to complete the programs, those also can result in either favorable or unfavorable adjustments as we go through our normal activities.

We saw a fair amount of favorable results in that regard in 2005. We did have several adjustments as we got into the fourth quarter. Some of the bigger ones, to answer your question specifically, were recognized on our biodetection contracts, where we've been doing very well, our Longbow contracts, and our airborne surveillance contracts. Many of those matured in there period of performance during this timeframe, so we were able to appropriately recognize the outcomes there.

Maybe one -- just one for Ron. My recollection is this is probably the third charge on that Block 60 program. What's your confidence that this is the last of them?

This is our best shot based upon everything we know right now. This is kind of like having a cold, and we are moving along. The body is healthy, the Company is doing very well. We have 20,000 contracts; this one has been particularly troublesome, as you know, the last few years, and it's typical of a fixed-price development contract. This is where we are today. It is our best guess.

When does that development contract end now? Does that change at all?

We're continuing to work on it this year and, I think, well into next year. Many of the actual dates on completion will, naturally, go with the integration activities and the aircraft and the customer's acceptance.

Nick Fothergill, Banc of America Securities.

Nice quarter. A couple of quick questions. The first one is -- did you experience in any of your defense businesses other than ships an effect in your income at all due to the delay of the passage of the 2006 defense budget? And if you did, are you seeing a return to that spending level as you go into the first quarter of this year? And likewise in backlog; obviously, that was a factor you mentioned in your release. Are you seeing backlog starting to pick up as we go into the first quarter?

We didn't notice a very substantial impact on the actual sales. Many of those sales were sort of pre-loaded with respect to the funding that the customers were able to provide under their contracts. It was a very small effect that we noticed in that regard. It was primarily the impact on new acquisitions -- that was the customers' ability to grant new authority to spend money under the contracts that we have -- as well as the customers' abilities to enter into new contracts and provide the authority to spend monies. So it was primarily isolated to the acquisitions, and consequently, the backlog for the Company.

Are you seeing that start to pick up, Wes?

Yes, we are. We are beginning to see it pick up. It will take some time for that to happen. As you know, a healthy process would be to have that legislation in place in October, so that throughout that fourth quarter those things get done. The legislation didn't -- did not get done until the very end of December, so it will take some time for the contracting organizations to get all the slowdowns they require within the departments to -- for us to actually see it going. But we see everything lined up in the right direction to make it happen.

Just let me add that we had some really big programs that got delayed in terms of funding -- ICBM, the Vinson program, CVN 21, the LPD program, F-35, and I could go on. And these are long-term solid programs that will be in the defense program for many years to come, so we're not concerned about the revenues coming, but the [patenting] on these things did affect us.

Another one for Ron. Admiral Mullen's [draft] shipbuilding program seemed very positive, as I'm sure you're aware, moving from an average of 8 billion to 13.8 as we go over the next five years. How in your experience is this faring on the Hill in terms of acceptance? And also, if it does go through at the level that it's being shown, am I right in saying that CVN 21 would bring in an additional plus 3 billion or so to the Newport News business by '08?

We are very pleased with the progress that the Navy is making. The CNO has a pretty clear view of what he wants to do; he's talking about a 313-ship target Navy. Shipbuilding budget stabilization is something that we and General Dynamics and other members of Congress have been asking for for sometime. I think this is going to play quite well.

I think the Congress has been concerned with the deterioration in the size of the Navy in terms of numbers of ships. I think the Congress would very much like to see stability in the program. So I think overall it's going to be well received, it is being well received. Clearly the Navy has to balance its new funding requirements versus its operating accounts, and that's really the juggling act that the Navy has to do.

With respect to the CVN 21, we did receive a plus-up of a little over $60 million this year to give us the potential to accelerate that ship. The question will be what the actual submittal will be for '07 from the President's budget, and whether the Congress would decide to accept that or consider an acceleration. Right now I believe we're looking at a formal start of '08, but it is a potential that if it gets plussed up it might happen in '07. We will just have to wait and see how that happens.

Great. The last one was referring back to a question that George had, which you were talking about the transition from development to production. And obviously just recently that's held you back in one of your segments as the mix has shifted adversely. You did just mention that -- am I right in saying that '06, you may see a switch back into more production across the group, and then that should build up in '07, positively affecting your margin?

It's more of an effect in '07 than it is in '06.

And specifically in Aerospace.

Yes, particularly -- specifically, heavily noticed in Integrated Systems within Aerospace. So most of the margin benefit that we would expect there we would see beginning to really accrue in '07.

Last quick one for Ron. Ron, can you just give us a quick run-through of the major programs that you've got coming up on your radar that you're watching very closely?

We have a number of potential contract awards. One is an award with San Diego to perform IT outsourcing. This is a very large award. We're coming down the homestretch on that one. We are obviously playing very aggressively in the new aerial refueling tanker transport program, and I think you've been following that. We are expecting that the Air Force, with the right approvals from the DOD and Congress, may well issue an RFP for that by midyear. We're very much involved in that with our partner EADS. We are also very aggressively pursuing the NASA CEV program. This is the Crew Exploration Vehicle. We have a number of restricted programs also that we're working on that are very significant we can't discuss on this call, and probably dozens of other smaller ones. But those are sort of the big ones that we're looking at awards on.

Doug Harned, Sanford Bernstein.

I wanted to talk a little bit about Information Technology. After you won the State of Virginia deal, and it looks like the City of San Diego deal, these appear somewhat different than a lot of the contracts you've been in in the past. Do you see a shift in the way the Information Technology business is moving when you look at growth in the future? Are we going to see more of this kind of a contract as opposed to some of the more traditional programs, I would say some of the task-like -- task programs on the defense side?

Actually, this is quite typical of the kinds of programs we've had, where we've tried to focus not on commercial outsourcing with other companies, but on government agencies where feel we do very well. The scale of these is a little bit larger, and that's a good thing. And we've been very effective in competing head-to-head in the marketplace against some pretty formidable competitors in both of these. So I don't see this as a change in direction, I see this as a significant growth of something we've done well in a portion of the IT sector. That sector, of course, has done this sort of work. It's done a variety of other commercial state and local, it's done a lot of federal, and of course it's done work for task, the task work with the intelligence community, as well as some legacy Planning Research Corporation, PRC, work. So it's quite a broad range of IT skills and capabilities, but this is very definitely not something new to us. It's just the scale and success are what's new and exciting.

I guess that's more what I was getting at. It seems like the scale is really stepping up, and I was interested in understanding is this a direction that you want to step up further in. And then also, does this mean -- I'm assuming you're looking at some acquisitions out there. Are there specific types of capabilities that you're looking at to grow in this area?

The advantage of having put together really what amounts to some of the premier IT franchises in the industry, between legacy TRW and legacy (indiscernible) and legacy Northrop Grumman, has been our ability to focus on much larger-scale opportunities, to really go to market for a very, very large set of activities. I have used the expression big dogs need big bones, and these are big bones. So I think that overall this gives us some significant competitive advantage. We obviously don't comment on mergers and acquisitions, but I would point out to you that as you look at the combined revenues of this new reporting element, we are something around $11 billion in this (multiple speakers) in Information and Services. And that gives us substantial critical mass across the full range of skills we need to compete in this business.

You don't see anything really missing there?

I think at this point in time we're pretty pleased with what we have, but obviously we would not consider passing by something that might be interesting if it made sense, it was value-creating. But we're very pleased with the structure of the portfolio as it stands today.

One quick last one, which is on the new segments, does this have any implications for organization or management reporting relationships?

No, it does not. We will continue to run the company with the eight sector presidents. The reason we do that is that each sector has a very focused area of responsibility, and we expect our presidents to have their hands around their businesses. We can aggregate for the purpose of reporting to give you a much clearer picture of how we think about our business overall, but there is no reorganization implied in this.

Howard Rubel, Jefferies.

Also to follow-up on IT for one moment, could you elaborate a little bit more on your decision to exit the reseller business? Other than these $0.01 or $0.02, as you really didn't comment very much on that, will there be a charge? What will you do with the resources to generate some cash from this? Could you address some of those issues first?

Our decision to close or to exit the Enterprise Information Technology business -- and I'll make sure everyone understands the business is referred to by several names; sometimes it's called Enterprise Information Technology, sometimes we refer to it as our reseller business, sometimes we refer to it as our computing systems business -- it is all one in the same business. Our decision to exit there was based on a strategic review that we conducted of our portfolio to really understand what pieces of the business were aligned with where we are headed as a company, and also what pieces of the businesses are really interconnected to the point that we're creating value because they are a part of Northrop Grumman.

When we did that review, this stood out as a business that was not particularly integral to the strategic vector that we're on as a corporation. And none of our other businesses within the Company were particularly reliant or had a synergistic capability in working with the business. So that was our thinking behind this, that it really was not a good fit to the portfolio where we want to focus our management attention. And we are in the process of evaluating a variety of exit mechanisms, and we'll probably reach a conclusion on that in the not-too-distant future.

So when -- we wouldn't -- we would have also referred this outside looking in as your lowest margin business.

That's correct.

So there's a lot of sales, and there have not been a lot of profits associated with this for some time. And it ties up a lot of resources, probably in inventory and some other things. So that's an equal element of what you're trying to drive at here.

Yes, that's exactly right.

The second -- that's terrific; I appreciate that. The second thing I wanted to follow-up on is that if we look at Newport News for a moment, and assume that the benefits of subs and carriers was on the order of $50 million, is some of this just catch-up from good performance and just recognition in this quarter, and then we'll go back to a more normalized level of probability as you? Or is this a new level for a while until these particular carriers and the other contracts are completed?

It was a particularly good quarter in terms of performance. But at the same time, I will say that the team at Newport News has a very focused drive on performance improvements, working on expanding their operating margin in the business, and working very closely with their customers to put in efficiencies and actually execute on these programs in an improving -- continuously improving fashion. So they are on an upwards vector, and we're all very pleased to see that. But I would caution that the fourth quarter was particularly well done with respect to just the volume of opportunity that was there for them to realize in the quarter.

I wasn't wrong in thinking this is a high-teens kind of level of probability at the business unit in the quarter?

It wasn't that high, but it was a more substantial operating margin level than we typically see.

And then the last question; I appreciate that. The last question is, if we look at revenues and try to say, okay, ships we understand -- it's down; that's one item. And then we take out the reseller business, and that's another item. And then we sort of look at the growth all in for the remaining elements of the Company. Is it appropriate to think of organic growth in the 6% range?

I think that's a little bit high for 2006. The adjustments that you're making are the right adjustments. I think it's probably closer to the 4% range once you go through those adjustments.

Troy Lahr, Steifel Nicolaus.

The draft QDR talked a lot about Global Hawk and doubling capabilities and capacity there. Do you guys have excess production capacity, or are you guys pretty maxed out right now, and it would take some time to ramp back up on that?

We would be delighted to see additional orders. We have significant capacity, and we are, obviously, proceeding now with production of the B model, which is the larger Global Hawk, which provides more capability. But certainly if there were more appetite, we would find a way to accommodate it.

And I guess there was some talk about eliminating J-UCAS and also E-10. Are those both out of Integrated Systems?

Yes, they are. The Joint UCAS program will probably go through some form of transformation. We believe the Navy is going to kind of pick up the ball and continue to focus on carrier-suitable applications for this. And as you probably know, our participation in the program has been heavily engaged and directed at carrier suitability, although it has been a joint program with the Air Force as well. With respect to E-10, this is a program which would be the follow-on to the Joint STARS aircraft. There is considerable debate now as to what to do with this program long-term. It does appear that we will have a first aircraft, which will be a demonstrator of the new capability, which will include a very substantial improvement in radar, the MP-RTIP radar. Beyond that, I think it's to be determined what the Air Force will decide to do. And in lieu of that, or in spite of that, we still expect to see some continuing upgrade work on the Joint STARS fleet over time as well.

The upgrade, though, on the Joint STARS, was that more of the engine, or is that stuff that you guys actually handle?

We actually perform the upgrades of the full aircraft. But certainly if there were a decision later to retrofit a more capable radar, that would be something we would do as well.

The last question on Block 60. How far along are you now? I think in March you said you were like 50, 60% of the way through that. Can you just give us a percentage of where you are?

Let me give you a little bit of a perspective on the Block 60 contract. I think it's helpful to kind of dissect it into pieces to understand the progress. Block 60 is comprised of 80 ship sets and spares of three integrated sensor suites. There's the radar, the targeting system, and the Electronic Warfare system; the EW system is called Falcon Edge. And in addition to those three suites, there's also some automated test equipment and software to meet the weapons systems specification requirements. Let me kind of tell you where we are on all four of those pieces.

The radar hardware has been delivered, and initial production flights have been accomplished. So really good progress there. The targeting system is complete through the hardware qualification, and production is ramping up. So also very good progress on targeting.

On the test equipment side, that too has been delivered and it's been installed at the in-customer location. So there again, good progress. On Falcon Edge, the electronic warfare system, let me break it out between hardware and software to give you some insight. The hardware deliveries are on track, and we're driving towards completion in the timeframes that we have talked about in the past on the hardware. But while the hardware is making good progress, the real issues we encountered in the fourth quarter related to some unexpected discoveries on the Falcon Edge software.

And there, we were going through software integration testing. We do that in phases. We had done a first set of testing earlier that was very successful, but as we went through some more complex software testing, we encountered some problems that had not been identified earlier. We did some initial corrective action and some analysis to really penetrate what was going on. We also assembled an independent review team to come in and take a good scrub of what the software profile looked like. And those activities together resulted in this new EAC that was reflected in a charge that we took in the fourth quarter. So we've taken a lot of actions to get that on track. We have some distance to go in front of us to actually see that we're making the improvements on the schedule that we played out for the software. It's a very complex set of software. And as you would, I think, understand, it will be a little bit of time before we really have the progress on that in the state where we can talk about kind of a completion profile. We believe that we've captured appropriately what it's going to take to get that done.

And the last charge was on the hardware side of Falcon Edge, the last charge that you guys took?

Which (multiple speakers)

I'm sorry; last year. I think what the last -- prior to discharge.

It was a variety of issues, primarily hardware-related.

In the interest of time, we're going to have to limit people to one question here. We are running short on time. We will take the next one.

David Gremmels, Thomas Weisel Partners.

A couple of housekeeping here. On the exit of the VAR business, how much revenue and margin was contributed by that business in '05? And when do you expect to close or to sell it?

If you look in our -- in the press release that we put out, you can see that on Schedule 4 you can actually get the revenue number for 2005. It's the part of the business that we refer to as the EITF business in that schedule. So I will refer you to that, just to make sure you get exactly the right number. Here it is. For 2005, the actual number was $728 million in revenue. And as Howard noted earlier, it's a very, very low-margin business. And we don't report the exact margins of the individual business areas, but it was very small.

It's a grocery store.

I know I don't have much time, but does the '06 guidance assume any further share repurchases?

We have built in to our expectation in '06 that of course we're going to continue the share repurchase program that we announced last fall. We announced that we would complete that in 12 to 18 months, and we're determined to get it done.

So completion of the existing. Thanks very much.

David Strauss, UBS.

Looking again at ships and the performance in the quarter, I know the Newport News performed better than expected, but was there any recovery in the fourth quarter of the charge that you took in the third quarter for cost growth? In other words, are you performing better than what you thought you would back when you took the charge in the third quarter for the cross-growth component?

No, we have not taken any reflection of that charge as we've gone through the fourth quarter. The charge that we took in the third quarter was associated with the estimates (indiscernible) that we were able to put in place for all of the contracts basically, using our best estimates of what the recovery profile would look like. And those estimates continue to hold on track for us. So there's no reversal, if you will, of any of that charge in the third quarter.

On the programs that were affected as a result of the hurricane, are you booking a lower margin on those programs than you were prior to the hurricane?

Yes, absolutely.

And could you give us an update in terms of the status of your work with your insurance providers, and what a timetable might be in terms of you recovering your capital costs?

There's two aspects of that. There is the side of insurance providers that we're working with for recovery of the damages up to the first $500 million. That work is proceeding on track. We've been getting recovery from the insurance carriers with the adjustment process that we have in place. To date we've recovered 133 million from the insurance carriers in that layer of the coverage. So we're satisfied with the relationship. We're satisfied with how that progress is moving. It requires a lot of vigilance. It's an amazing amount of work on both our part and on the part of the insurance carriers and their adjusters down there because of just the extent of the damage that we're dealing with, but I think a credit to all parties that we're making good progress.

The second part relates to coverage for damage above 500 million. And as we had indicated last year, the insurance provider for coverage of that damage loss over 500 million verbally advised us of a disagreement regarding coverage in that excess layer. Notwithstanding that disagreement, we believe that those insurance policies are enforceable, and we've entered into litigation to resolve the matter. I'm not going to make any comment on the status of that litigation. We don't comment on litigation on any topics. But we continue to feel very strongly about our position and about our ability to recover for those damages.

One quick housekeeping one. Your unallocated expense in the quarter, 79 million higher than the level you've been running at. Was there anything special in that number?

Yes. In the fourth quarter we reflect a mark-to-market for stock compensation expenses, and that component drives that piece up towards the end of the year.

Miles Walton, CIBC World Markets.

Also in the IT segment -- so if we do the number, it's about 700 million in revs and low margin. It looks like you're already -- within your new Information and Services business, you're already at the mid-7% operating margin range, and that's the outlook for '06. But I thought that some of the intangible runoff, or a good percentage of that, was also flowing through Information and Services. So is that just a conservative outlook for Information and Services on the operating margin for '06, or is there something else?

Let's see Miles. In terms of the -- you can go into our detailed filings when they're available to see what the components of it are. But if you look at the information technology, the difference from '05 to '06 is fairly small in terms of the intangible amortization difference. It's on the order of 5 to $6 million. So it's not a major contributor to the level of improvement we're talking about.

The big drop-off in intangibles in '06 is in electronics, not IT.

Electronic Systems has the preponderance of that change.

Great. Finally on Technical Services, you've broken that out as a new segment; clearly it doesn't have the scale of any of the others. Is that a signal that that would be the place you'd be looking to acquire growth?

No, I think we're looking to grow the business. We think we have significant organic opportunities by focusing that business. We do quite a bit of this kind of business, but it's been a part of several of the other sectors. And I think this will create more attention and focus. So our principal intention is to grow the business. Obviously, we don't comment on M&A; if there's opportunities we will consider them. But our primary focus here is to grow the business based on the significant base we're starting with.

Is that it?

Yes, sir.

Let me wrap up and thank you all for participating. This was a very strong year for the Company, and the operating performance, the financial discipline, and the positioning we have in terms of our future growth make us very optimistic about what's (technical difficulty). Thank you very much for joining us, and we will talk to you next time.

ladies and gentlemen, thank you for your participation in Northrop Grumman's fourth-quarter earnings conference. This concludes the presentation, and you may now disconnect.