諾斯洛普·格拉曼 (NOC) 2006 Q1 法說會逐字稿

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

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

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

We will be facilitating a question-and-answer session at the conclusion of the presentations. (OPERATOR INSTRUCTIONS) I would now like to turn the presentation over to your host for today's call, Mr. Gaston Kent, Vice President of Investor Relations.

Sir, please proceed.

Thanks very much, Jeff, and good morning, ladies and gentlemen.

Welcome to Northrop Grumman's first-quarter 2006 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.

This is available as an accompaniment to our conference call.

The presentation will be available for a limited time and should be viewed in conjunction with today's commentary.

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.

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 first-quarter 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 by operations and the non-GAAP measure total segment operating margin.

Also want to remind you that we are reporting the results of our seven segments in four separate businesses.

Information services, electronics, aerospace and Ships.

Schedule 4 depicts the presentation format.

Schedule 4 also includes 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.

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 hello everyone.

Thanks for joining us.

Overall we had another very solid quarter, and we are on track to achieve our fourth consecutive year now of double-digit earnings growth.

Contract acquisitions were outstanding at a record $12.3 billion.

Top line results were solid in three of our four businesses.

Segment operating margin rose, and our segment operating margin rate expanded.

Earnings per share rose when adjusted for last year's $0.12 benefit from the TRW equity sale.

Our solid operating performance and our substantially lower share count were the primary contributors to this quarter's earnings performance.

The $750 million accelerated share repurchase agreement we executed in March and last November's $500 million agreement allowed us to complete more than $1.2 billion or 85% of the $1.5 billion program, which we announced last October.

These programs combined to generate this quarter's $16 million reduction in weighted average shares outstanding versus last year.

I mentioned the outstanding contract acquisitions for the quarter.

We reversed the dip we saw in last quarters bookings caused by the delay and passage of the 2006 defense budget, and this quarter's acquisitions represent a 170% book-to-bill ratio.

All four of our businesses generated substantial year-over-year increases in contract acquisitions with Ships and aerospace generating the largest increases.

I also want to mention two competitive contract awards we received this quarter.

A County of San Diego Information Technology outsourcing contract for approximately $600 million and the $2.5 billion Nevada test site award.

The Nevada test site award is the first major acquisition for our new technical services sector and it validates our strategy of increasing our focus in this area.

The combination of our competitive follow on awards brings total backlog now up to $58 billion, a solid foundation for the year and beyond.

We have the opportunity to build on this foundation with upcoming competitive opportunities totaling tens of billions of dollars.

We've submitted our proposal on NASA's Crew Exploration Vehicle and an award on this program is expected in the fourth quarter.

And the Department of Defense recently announced that is it has authorized the Air Force to resume a program for buying aerial refueling planes and directed the Air Force to start a formal competitive program to gain the best value for the taxpayer.

A request for information is expected to be issued by the end of April with a draft request for proposal expected this fall and a final proposal due in January.

The contract is expected to be awarded in the summer of 2007.

We also have significant future award opportunities in restricted programs, as well.

The 2007 DOD budget was formally submitted to Congress in early February and the Department is in the process of building the program objectives memorandum for fiscal year 2008.

Northrop Grumman's portfolio of capabilities continues to be well aligned with our customers' strategic direction.

We continue to make steady progress toward full recovery at our Gulf Coast facilities.

We've achieved 85% of our pre-Katrina production staffing levels, and we expect production rates to have fully recovered by the end of the year.

We are also happy to report that our estimate of Hurricane Katrina related property damage has decreased from $1 billion to $850 million.

Looking ahead, we continue to expect 2006 earnings per share to grow to a range of $4.25 to $4.40 per share based on sales of approximately $31 billion.

Continued segment operating margin expansion and a lower share count than in 2005.

We also continue to expect cash from operations of $2.3 to $2.6 billion.

As was the case in 2005, we will focus on driving operational performance, providing disciplined financial stewardship in our cash deployment actions and positioning our Company 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 business.

Thanks.

As Ron said, we are pleased with the quarter, and we are on track to achieve our 2006 guidance.

I will start my comments by providing a broad comparison of first-quarter 2006 and 2005 earnings per share.

There are several adjustments to the 2005 EPS needed to compare year-over-year performance.

First, we need to adjust for the $0.12 TRW equity benefit in 2005.

Next, the impact of Hurricane Katrina and the DD(X) restructuring of Ships combined with this quarter's cost of shutting down the reseller business, negatively impacted 2006 EPS by approximately $0.09 relative to 2005.

On the positive side, lower amortization of purchased intangibles and a lower tax rate gave us a $0.05 benefit in 2006.

Improved performance from information services, aerospace and electronics increased this year's EPS by another $0.05.

And finally, our share repurchase program generated an additional $0.05 benefit in 2006.

So performance and our balanced cash deployment program continued to drive our results.

Slide three provides more detail on the sales results and operating margin rate performance for our businesses.

Information and services sales grew slightly, and margin rate expanded by 80 basis points to 7.9%.

As we said last quarter, in addition to our focus on performance we continue to take a hard look at our portfolio in order to maximize shareholder value.

Last quarter we announced our decision to exit the IT reseller business.

We expect to complete that process before the end of the year.

We will continue to account for the IT reseller business and continuing operations until shutdown is complete, at which time we will re-classify its results into discontinued operations.

Aerospace sales grew 7%, driven by double-digit revenue growth at Integrated Systems.

Aerospace also posted higher operating margin, which translates to an operating margin rate that reflects continued performance improvement at space technology as well as the increasing mix of development programs at Integrated Systems.

Although sales in electronics declined slightly, margin rate expanded 120 basis points to 11.7% due to continuing performance improvements.

Looking at Ships, the year-over-year topline results were consistent with our expectations based on the DD(X) restructuring and the hurricane impacts, which together impacted sales of the first quarter of '06 by about $400 million relative to the first quarter of '05.

The change in DD(X) program sales results from the change in the Navy's acquisition strategy.

Regarding hurricane related schedule delays, we continue to make progress toward achieving pre-Katrina production levels.

As Ron said, about 85% of our production staff have returned, and this translates to nearly 80% of pre-Katrina production levels.

We continue to expect to recover the delayed revenue in 2006 and 2007.

The decline in operating margin at Ships reflects the lower margin rates established on the programs at Ships due to hurricane related cost growth and the impact of lower DD(X) volume.

We continue to perform to the cost estimates established on our program subsequent to the hurricane.

Our consolidated segment operating margin rate expanded 40 basis points to 9% from 8.6%.

The driver here was operating margin rate expansion and electronics to 11.7% and information and services where we achieved an 80 basis point improvement.

Reduction in amortization of purchased intangibles represented 20 basis points of this 40 basis point improvement in consolidated segment operating margin.

Total operating margin rate expanded 30 basis points to 8.3% from 8%.

Moving onto cash, slide four provides a reconciliation of net income to cash from operations.

Our cash conversion this quarter was affected by several factors, positive non-cash adjustments for the quarter included $135 million for depreciation, $42 million for amortization and $119 million for pension and OPEB.

Working capital was the use of $859 million, deferred and payable income taxes generated $101 million, and all other items were a use of $11 million, bringing first-quarter cash to a use of $115 million.

Approximately 80% of the increase in working capital relates to billing delays due to the lingering impacts of Hurricane Katrina at Ships, and a scheduled ERP conversion at three of the sectors.

Much of the remaining increase relates to working capital adjustments as we close out the reseller business.

With the exception of these reseller business impacts, all of these others represent timing differences.

We expect to recover these timing differences in the second and third quarters, and we are confirming our guidance of $2.3 to $2.6 billion for 2006 cash from operations.

Moving onto our outlook for 2006, slide five provides guidance for sales and operating margin rate.

There are no changes to the outlook we provided during the fourth quarter conference call.

For information and services we expect sales of approximately $11 billion with an operating 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.

Electronic sales are expected to total approximately $7 billion with an operating margin rate expanding to the mid 11% range.

Ship sales are expected to be approximately $5 billion with operating margin rate expansion to the mid 7% range.

Our guidance for Ships contemplates a return to pre-Katrina production levels by the end of this year.

On a consolidated basis our total sales guidance is approximately $31 billion for 2006.

To provide a perspective on how the performance for this quarter supports our guidance for the year, it is important to understand several aspects of our sales profile for 2006.

First, in information and services our 2006 guidance of approximately $11 billion excludes the reseller sales, which will be treated as discontinued operations once the shutdown is completed later this year.

On a comparable basis excluding the reseller business, I&S sales for 2005 were approximately $10 billion.

For the quarter excluding reseller sales I&S grew about 4% year-over-year, so I&S sales growth in 2006 is somewhat backend loaded.

The ramp up in new contracts like Virginia IT, San Diego and the Nevada test site will drive second half sales.

In aerospace we expect 2006 sales of approximately $9 billion which is comparable to 2005 and reflects a typical transition pattern as we complete major development activities and move into production.

Sales increased 7% in the first quarter, but we expect the second half of 2006 to reflect the impact of the development to production transition.

We are pursuing several large new development opportunities in aerospace.

Should we win any of these we would not expect them to substantially impact our aerospace top line in 2006 due to the timing of the expected awards.

In electronics we are expecting to grow from about $6.7 billion in sales last year to approximately $7 billion this year.

For the first quarter our sales in electronics were slightly down year-over-year for two primary reasons.

First, the reduced sales on Block 60 as we continue to make progress in completing the program and second, the divestiture of our European subsidiary Teldix in 2005.

We had strong acquisitions in the first quarter this year at electronics, supporting our outlook for the year.

And finally at Ships we expect 2006 sales to decline to approximately $5 billion from about $5.8 billion last year.

And the first quarter we were down by a larger percentage, about 25% year-over-year due to having the DD(X) program in its former contract structure in full swing during the first quarter of 2005.

And the ongoing Hurricane Katrina recovery in the first quarter of this year.

The profile of sales at Ships for the year is heavily weighted in the second half based on the expected hurricane recovery profile that we've described before.

So in aggregate we see this quarter as very much on track to support our overall sales guidance for the year.

We expect our total segment operating margin rate in 2006 to expand to the mid 8% range with total operating margin of approximately 8%.

First quarter performance supports this operating margin expansion for the year.

Slide six provides additional guidance to 2006 compared with first-quarter results for these items.

Unallocated expenses were $35 million in the first quarter, and for the year we continue to expect unallocated expenses of approximately $140 million.

Net pension expense for the first quarter was $10 million.

For the year we expect net pension expense of approximately $25 million.

Net interest expense for the quarter was $77 million and for the year we expect approximately $300 million.

This reflects the retirement of $430 million in debt this quarter.

We continue to strengthen our balance sheet and our credit profile, a trend which Moody's recently acknowledged by improving our credit rating outlook to positive from stable.

Capital spending in the first quarter totaled $173 million, including $54 million for Katrina related expenses.

For the year before Katrina related expenses we expect capital spending to range between 700 and $750 million.

The timing of insurance recoveries may result in additional expenditures related to the recapitalization of the shipyards, but we expect to recover those expenditures over time.

First quarter insurance related recoveries were $54 million.

Through the end of the first quarter we have recovered approximately $180 million from our insurance carriers.

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

As we look forward, the first quarter provides a strong start for the year.

We expect 2006 to be a year in which we continue to build on the strong results of 2005 and the first quarter demonstrates those trends.

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.

As we begin the Q&A, we ask that you limit yourself to one question and one follow-on.

Jeff, we are now ready to begin Q&A, please.

(OPERATOR INSTRUCTIONS) Joseph Nadol, JPMorgan.

Thanks.

Good morning to you.

First question or I guess my question is on the bookings in the quarter.

You mentioned a couple that fit into your information and services business.

But if you look at the platform businesses, both within aerospace and Ships, your book-to-bill was about two roughly in each of those.

I was wondering if you could comment on maybe some of the major drivers there.

Yes, Joe, this is Wes.

You're right, it was stronger across the board.

We called out in our earlier remarks a few things in I&S that were successful competitive wins.

But just to kind of reinforce the profile of our business, the majority of our ongoing acquisitions come from a sole source follow-on awards.

And that was reflected, as you noted in both Ships and aerospace in the first quarter.

In Ships particular there were a number of large items.

The Vinson is one very good example of that in terms of the magnitude of the acquisitions.

In aerospace it was simply the ongoing volume of acquisitions that are associated with the ongoing programs.

One of the things that we noted during the conference call in the fourth quarter was that some of our acquisitions were delayed in the fourth quarter because the delayed passage of the DOD budget.

And what we are seeing in the first quarter is a full recapture of those delayed acquisitions across all of our businesses.

Okay.

For my follow-on in the ship area, I clearly understand the year-over-year comparison when margins are down.

But you were down from Q4, and of course DD(X) and the hurricane issues were impacting you then.

Is there anything else going on either in Q4 on a onetime basis or Q1 that caused the negative comparison sequentially?

Yes, Joe, absolutely.

In Q4 Newport News had a very strong quarter, primarily associated with carrier related work.

And that was an unusual spike in their activity in the fourth quarter, and so that Q4 to Q1 comparison is influenced by that.

And had to do with contract closeouts.

Contract closeouts in the carrier areas.

Okay, so we should generally expect a gradual upward trend as you recover from the hurricane from an 80% to 100% over the remainder of this year?

That is correct.

Yes, that is.

That more heavily weights Ships' performance towards the back end of this year.

Okay.

Thank you.

Byron Callan, Prudential Equity Group.

Good morning, gentlemen.

Two quick things.

Ron I think in your prepared remarks you mentioned some classified program opportunities.

I'm curious if that is competitive or sole source follow-on.

I guess I can't say too much about that, Byron, but I think it's both.

Okay.

That's a good answer.

And just more generically on Ship Systems, you guys really don't have a major role on the Littoral Combat Ship, and that does look like one of the keener growth opportunities at least if you can kind of sort through some of the Navy documents.

Is there any way to kind of break into that, or do you think there will be any change in how the Navy thinks about that program longer-term since it effectively is still a development program at this point in time?

Well, interesting Byron, we actually do have a role in this program.

Ironically we were not selected to provide a hull, but we did competitively win the mission module integration module work, which was done as a competitive competition separate from the hull.

That activity was actually done in our Integrated Systems sector or the aerospace business as you showed in our core business reporting thing.

So we actually now do have a play in LCS, and its basically the topside role as opposed to the hull role.

I was thinking more specifically on the Ship Systems side, I understand under the (multiple speakers).

No Ship Systems activity of any significance in LCS.

Okay, great.

Thank you.

Steve Binder, Bear Stearns.

Wes, can you maybe just touch on the two ASR's as far as what's still [outstand] on each program?

Certainly.

We, as you know, completed the ASR that we announced last November.

We completed that in March of this year.

We're working our way through fulfillment of the ASR that we announced in March, and we are a bit more than halfway through the fulfillment of that.

So (technical difficulty) process and still going very well for us.

Then with respect to I&S and Mission Systems margins, which were in above the full year average that was expected, can you maybe just touch on whether that is any favorable (indiscernible) adjustments or is that just mix?

Within Mission Systems we did have one area of favorable adjustment related to our ICBM activities.

Across IS, because of the diversity of the program base, there were some adjustments but I would more broadly characterize that as mix in the quarter.

And just for cash flow are you still expecting cash taxes of $650 to $700 million this year?

In that range, yes, that's the guidance that we've given and based on what we can see today.

As you know as you go through the year your insight into cash taxes gets a lot better a little bit later in the year, but that is where we are today.

Okay.

Thank you.

Doug Harned, Sanford Bernstein.

Good morning.

On the Nevada test site win, this was a big win.

When you looked at this program how did it look differently from Los Alamos, which you decided not to go after?

Well, first of all we looked at both.

It is interesting they both came at the same time; we did not see the economic opportunity at Los Alamos in terms of the kind of margin rates that would be appropriate given the amount of management talent investments that was required there.

That is different here.

In this case, obviously, we are going to be on a five-year program with some I believe, some renewal options.

So this thing will kind of ramp up to about a half $1 billion a year.

It is a more attractive business proposition, and it is something which we think gives us a nice stepout from where we were before.

And when you go forward are you expecting to see a significant number of similar opportunities?

And if so, what types of contracts would you go after?

What are the characteristics you are looking for?

There would be a whole bunch of these kinds of contracts in the future not only with the DOD and the DOE but others, and I think we're looking for the characteristics which would be -- you know they have to be economically attractive; there has to be a return on our investment to do these jobs.

They typically don't require a lot of capital but they do require some management attention and we have to make sure the kind of returns we see makes sense.

It has to be something that we can actually do well.

And we see the whole tech services area as an area that we are focusing on more and more.

As we integrated TRW and Newport and others we focused a great deal on integrating and operating what we had, making sure we got that right.

And now we've had a chance to think about how we expand into those other parts of the both defense and civilian markets that are going to be growing at a good rate.

And that is where the tech services is focused.

Is there any margin level that is relevant here as a hurdle?

I think it depends upon the program, and I think you have to look at the economic returns in total.

Lower margins are acceptable if you have good return on assets or good cash flow; higher would be necessary if you have to put more capital in.

It would be the typical disciplined business equation we look at each one of these things separately on.

Okay, great.

Thanks.

David Gremmels, Thomas Weisel Partners.

This is actually Alex Motamed in for David Gremmels.

You only have about a little over couple hundred million dollars left in your share repurchase authority, and you talk about taking the rest of the year to get that done.

That would be quite a slowdown from the pace you have had the last year or so.

Is there -- do you see adding another chunk of authorization authority in the near term, or are you looking towards maybe acquisitions or something else for cash deployment?

Well, we're still sort of in the middle of fulfilling the second ASR, so it is a little bit early for us to talk about another program until we have gotten our current program completed.

So I wouldn't want to speculate on that in particular, but let me say that when we announced the program we said we would complete it within a year to eighteen months.

We're obviously running ahead of that schedule, and we do plan to complete the remainder of the program before the end of the year.

We do have another -- it's around $690 million of debt that matures later this year.

So that is a part of our thinking as we look at our overall cash deployment.

The Company does have quite a bit of financial flexibility.

So we will certainly be looking broadly.

And I think you can get a good idea of how we're thinking about it by what we've been doing.

Right, and just a quick follow-up on F-16 starting to wind down and that's going well.

Is there any other items of watch, on typical watch list like the Wedgetail or Polar Tanker, or anything that is starting to raise some flags?

Well, why don't I just give you a little bit of an update on each of those things since you raised it?

On F-16, as you know we took a charge in the fourth quarter associated with the Falcon Edge electronic warfare system.

The progress on that continues to go very well.

With respect to the Falcon Edge in particular we are on track with our restructured engineering plan; we are actually hitting the milestones we've laid out on the delivery of the software that is supporting the program.

And so far so good with respect to performing within the projection that we established in the fourth quarter.

So that is, I would say performing well and we are quite satisfied with it.

On Wedgetail we're also making very good progress.

The design of the hardware is stable.

We have a set of changes that we made for EMI.

And those final changes are with Boeing and awaiting their direction.

We feel good about that.

Now the system has completed safety of flight testing at high-power, which is a big milestone.

And it has also completed six successful functional checkout flights.

We've got some additional flights that are going to be starting -- these are systems requirements flights that will be starting in June.

And overall development test and evaluation is on schedule with the test plan that we've laid out.

So there are some -- obviously some work ahead of us in Wedgetail, some opportunities for additional discoveries on Wedgetail, but I would say we're feeling good about that as well given how things are going.

The third program on the watch list that we pointed out in the past is Polar Tanker, and I think you are familiar with the fact that Polar Tanker was impacted by Hurricane Katrina.

The customer has worked with us to reset the scheduled delivery milestones.

And we are running on track with that, expect to deliver in the early part of the summer.

Great.

Thank you very much.

Joe Campbell, Lehman Brothers.

I have a couple of questions both of which are kind of accounting based.

One is on the tax rate it was I think less than 31% for Q1 yet the guidance for the full year is 33%.

I wondered if you could highlight what items caused the tax rate to be low and then on the opposite side, what will cause the tax rate to rise to more than 33% in the back half of the year.

And then the second piece is just, I wondered if you could parse out that almost $900 million worth of working capital that went to the three big buckets you mentioned and sort of a bit more about why and how they reversed over the course of the year.

Thank you.

Let me tackle that one.

The tax rate is lower in the first quarter than we expected to be over the course of the year primarily because we recognized in the first quarter a tax benefit associated with tax credits, that came with the qualified wages that were paid to employees affected by Hurricane Katrina.

So it was a recognition of those wages and the associated tax credits that went with them.

And again, this kind of just goes into the overall shaping of the profile of the tax rate that we're projecting over the course of the year.

Should we be thinking that is an EPS benefit?

I can calculate the arithmetic, but -- sort of a onetime benefit in the quarter?

Yes.

Absolutely, it was about 18 million net tax benefit associated with those tax credits.

Great.

Thanks.

And with respect to the working capital, I gave a little bit of a description in my remarks there.

And let me just give you a little bit more flavor on that.

The largest piece of that impact was associated with a set of ERP conversions that we took on it, three of our eight operating sectors at one time during the first quarter.

And for those of you that have been through ERP conversions, you know how the process goes.

And we paid special attention as we went through that conversion to making sure that our supplier base was getting paid, that we did not take any disruption in the business operations and going through it.

And I would say that the conversion went well but the billing side of the equation went up during the first quarter.

We expect to fully recover that over the course of the second and third quarters.

The other big piece of it was delayed billings at Ship Systems as we continue to get all of our operations back in place subsequent to Katrina.

And again that is something we will recover over the course of the year.

There was a small part of it, less than about 20% of the impact on working capital that was associated with the shutdown of our reseller business.

As we are shutting down that business we are making all of the working capital adjustments that go with basically clearing out that working capital part of the overall equation for the business.

Thank you very much.

That is very helpful.

Cai Von Rumohr, Callan & Co.

Thank you very much.

A question on the margin patterns, specifically at Ships you did 6%.

You're talking of mid '7s which would suggest maybe approaching eight by year end.

And while I know that you get a hockey stick impact at Newport News, it would look like on paper most of the growth from this first quarter number would be recovery in Ship Systems which is a lower margin business.

Could you explain why the margins go up?

Is it accrual rates, and how comfortable do you feel, and is there opportunity to do better?

If you think about the course of events really in the two separate sectors we do have activities in both that would drive margin adjustments over the course of the year.

And they are all specific milestones driven program performance events, that we encounter both at Newport News and at Ship Systems.

Newport News I would describe as more of the ongoing program maturity milestone driven adjustments over the course of the year whereas at Ship Systems it is more the recovery driven milestone adjustments that we would expect over the course of the year.

So you're right, we'll need to perform better in later quarters obviously to achieve the guidance that we've given for the year given that our numbers in the first quarter were slightly under that guidance, and that is our expectation based on those program milestones.

Can you just tell us, do those milestones lay out relatively even over the rest of the year, or do they -- is there any kind of particular lumpiness to the pattern?

There is a bit more in the third and fourth quarter than there is in the first and second.

Thank you very much.

George Shapiro, Citigroup.

Good morning.

Just follow up on Joe's question if you got the tax benefit in this quarter, then what gets you higher than 33% tax rate in the subsequent quarters so that you didn't lower your tax rate guidance for the year?

That is a large accumulation of the variety of tax components.

No single one of which I would point out as being a key driver on our overall tax rate for the year.

But it is simply a profile that we expect as we go through the course of the year.

The number that I gave earlier in response to Joe's question of the $18 million benefit is not a huge number if you think about our overall tax amount for the year.

So there isn't anything in particular that drives it substantially over the course.

Okay.

And then if you looked at the Aerospace sector, I think the average 9.6% margin this quarter, your guidance is say mid 8 to 8.5.

What quarters will get particularly weaker?

Are you going to have to get a few of them at 7.5 to 8% if you don't beat your guidance?

Yes, primarily in the fourth quarter.

One of the things that we have been working hard to communicate effectively on is this transition that we are going through primarily at Integrated Systems from development programs to production programs over the course of really this year and next year.

And there is a transitional phase that you go through typically as you make that switch.

And it does impact the overall margin rates.

And this year we will be rich with the remains of that development activity, and we would expect it to be towards the back end.

Because I would think that as you are transitioning from development to production you would get some help to the margin as opposed to hindrance.

You do; it is simply the crossover period that we are describing here.

You're absolutely right, George, that a year into production your margin rate opportunity is substantially higher than it is during development.

And that is the profile that we expect as we get into the latter part of '07 to begin enjoying the benefits of being more heavily weighted on the production than on the development.

There is simply a transitional period that you typically experience as you make that switch.

Okay.

Thanks very much.

Ron Epstein, Merrill Lynch.

Good morning.

Wes, just had a question for you regarding pension reform.

Have you given much thought to what implications the FASB reform could have?

And also what is going on in Congress?

I guess specifically what could happen to the balance sheet and potential out your cash flow?

As you said there is really two things that are going on right now.

One is the recent FASB announcement on their thinking about what they might implement.

And I will tell you that we're still getting our arms around it.

It is almost exclusively a balance sheet impact.

It would require balance sheet treatment of items that would if placed according to at least the draft that we've seen would affect shareholder equity in the balance sheet.

In terms of trying to quantify that, we're not ready to do that yet but we are certainly planning to be actively engaged in discussion around that proposal.

With respect to what is going on in the legislative arena, there are at least three different variance of outcomes that are being discussed.

And again, it is an area that we are actively, not only monitoring but engaging on; a little bit too early to speculate how that might come out.

Great.

Thank you very much.

(OPERATOR INSTRUCTIONS) Troy Lahr, Stifel Nicolaus.

Just one question;

I read somewhere that the Navy is starting to wants improvement I guess six major shipyards, production design and engineering works and quality control issues and also some IT upgrades in enterprise planning.

Have you had any discussions with the Navy on they want you to improve any of your shipyards at all?

Certainly.

This is Ron.

Clearly as you look at the strategic importance of shipbuilding going forward, the Navy is dependent upon the six shipyards, embodying the two companies, ourselves and General Dynamics.

And as we go forward we are working together to try and figure out how we can do this more efficiently.

On the one hand what is most helpful from our perspective is to have congressional appropriations and a shipbuilding plan which provides some stability of funding and predictability so we know how to make the capital investments.

From their perspective what will be more appreciated was if we were able to continue to drive the productivity of our workforce and to make our capital investments more particular to those needs.

And this is basically a partnership that we are working together on going forward.

And it is a challenge because there is no, as you know, large commercial shipbuilding base of work in this country.

And so we're very much mutually dependent between ourselves, the industry and the Navy.

It is a challenge;

I think one thing that I would applaud is the efforts on the part of the CNO and the Secretary of the Navy to work with Congress to try and establish a more stable, prettier shipbuilding plan than perhaps what we've had in the past.

And of course it is incumbent upon us then in that envelope of stability to be able to drive our own operating improvements.

Okay, so just kind of normal ongoing discussions back and forth, nothing really new from what they are seeking?

We always have to keep working on these areas.

Okay, and any new insight into the bomber, the next follow-on to the bomber?

It seems like that has kind of been delayed and the Air Force really doesn't know what they want right now.

Have you heard anything?

What we did see that came out of the QDR and is a clear and compelling need to have some kind of a long-range strike capability that would be available by the year 2018 I believe which is actually very, very soon if you think of the technology required to get in place to get something fielded by then.

And so what that really has done is in a positive way for us put on the front burner something we thought would be further down the road.

I think at this stage of the game there is a lot of discussion about exactly what are the requirements for such a system, should it be manned, should it be unmanned, what speed should it go at?

How stealthy does it need to be?

What kind of capacity?

What kind of range and payload does it need to hold.

So I think we will see in the next couple of years a variety of trade studies to try and define what this thing should be.

In parallel I believe we will see some contracts being left to industry on advanced technologies and stealth materials, engines and what have you.

And I think over the next couple of years there will probably be a coalescing of these into what I would expect to be a program going forward.

I think it is too soon to say exactly what it will do, but it no question there is going to be a need for this.

Great.

Thank you.

Howard Rubel, Jefferies.

Thank you very much.

The advanced field delivery system was I guess canceled or terminated.

Could you give us a little bit of background behind that, Ron, and then sort of whether you're seeing a change in attitude, or is this just sort of one of those things that you tried your best and it didn't work?

Howard the advanced field delivery system has been in progress for probably over a decade and it started out as a very different kind of a concept and over the course of working with the Navy it morphed into a very frankly very sophisticated submersible submarine.

It is a very capable machine.

We have completed the first boat.

We have done some sea trials; we're in the process of making some modifications based upon what we learned in the process.

The second and the third boat -- funding for the second and third boat was removed from the plan, and the focus was made on let's see how we get the first boat to get to be what we want it to be.

I think after that is done I think there will be an assessment of how this thing operates, how it performs, and a comparison with the future requirements for this kind of a vehicle.

And we will see what happens next.

Our focus at this point in time is on finishing and getting this first ASGS working as well as it can work.

It is a good machine and it has got some enormous value to the Navy and to the Seals.

But one can't really draw any major conclusion from this; this is just a little bit of -- as you describe it -- let's focus on what we're doing here and then kind of do an assessment after it is really fully tested?

I think it will be up to the Navy and the Seals to decide what goes next.

I'm clearly disappointed that we weren't able to be farther along than we are.

And I'm clearly disappointed that the funding for the second and third boat were taken out of the plan.

However, we're focusing completely on making sure the first boat can be everything it can be and then we will see what happens from there.

And then one of your visions has been to make Northrop TRW a full satellite platform service entity.

And are you at the point where you are starting to see those opportunities play out?

And could you address them a little bit please, Ron?

I guess I am a little -- help me a little bit, Howard, on what my vision was supposed to be.

I don't recognize the wording.

Say a little bit more what you meant there?

I'm not trying to put words in your mouth.

That would be unlikely to do that.

No, what I'm saying what I am trying to say is that there were elements of TRW, and there are elements of Northrop where you can either provide the platform or the payload.

And now you have the full capability.

Could you sort of --

Okay.

You're now at the point where I think you're sort of grown-up.

Is that fair?

Clearly as we've come together we've done so in a way which has given us some significant opportunities.

We are also mindful of the consent decree that was placed on the merger about three or four years ago, and that consent decree has a seven-year term, and we're observing it and operating by it.

Our strategy is to basically be the best prime contractor we can be within the consent decree which means that we will go to market with the capabilities but not deny payload or subsystem capabilities to other competitors.

In fact, work with them in many cases in direct competition, and that is the way we've operated for many years.

An example of where we've come together with the capabilities of the two companies that has been very helpful to us which was not subsequent to the consent decree was the Kinetic Energy Interceptor program where we were able to take some of the most significant capabilities of TRW with its missile defense knowledge and the prime contracting capabilities of Northrop.

A third example would be the CEV, the Crew Exploration Vehicle in which we are able to take our very extensive legacy of manned aircraft experience and large-scale platform integration work out of the airplane side of our business with the long-standing experience in the TRW side in unmanned space exploration, space vehicle design.

And so that program in conjunction with our partner, Boeing, has allowed us to bring everything together that we think is necessary to follow on the shuttle.

Thank you very much.

[Christina Fernandez], UBS.

It's actually David Strauss.

Thanks.

I just want to clarify on the revenue guidance for the year, the $31 billion or excludes the reseller business, but it is still -- the resold business is actually still included in the numbers as of today?

That is correct, yes.

Yes, as I indicated in the remarks, they will be included in our reporting until we have successfully completed the shutdown, and then we will move it to treatment as discontinued operations.

Okay, but the $31 billion guidance I thought had assumed that it wouldn't be in there for the full year.

That is correct because we expect to complete that shutdown later this year.

So the $31 billion excludes the sales from reseller for the year.

Okay.

Thanks.

And two programs you didn't touch on if you could just give us an update on NPOESS and SBIRS?

Sure.

Let me take that one.

NPOESS is the national polar orbiting environmental satellite system.

It is a critical environmental monitoring system.

It is a joint activity led by the Department of Commerce under NOAA with participation by NASA and the Air Force.

It is a very, very significant and major program.

The Air Force formally notified Congress in January that the cost had risen by more than 25%, and this of course triggers a Nunn-McCurdy process so that Nunn-McCurdy review process is currently underway, and the Air Force with assistance of the other agencies will go through a process to determine what is going to come out of that.

Obviously we take the Nunn-McCurdy situation seriously.

Our difficulties in the program have been driven by some of the subsystems that we've been provided, and we're working hard to make those things work right.

This is a very, very important capability for the nation both militarily and commercially.

And we believe that a variety of options which we are looking at going forward are going to be reasonable ones we see through it.

We will see how it comes out of Nunn-McCurdy.

With respect to SBIRS, SBIRS is as you know the high-altitude infrared system.

Northrop Grumman's performance continues to be good.

We are on the same path we set in '04 for recovery on the payload portion of cost and schedule.

We've delivered a couple of payloads for the high-altitude satellite.

We've been through thermal vacuum on the geosynchronous satellite.

Overall we're working with our prime contractor Lockheed Martin and with the Air Force to make this thing come out right.

So far so good and we will see how it plays out.

Thanks very much.

At this point in time I think what we would like to do is thank you all for your interest.

Again, we're very pleased that we had a solid quarter.

We are looking forward to the guidance we've given you for the rest of the year.

Thank you very much for your interest.

Bye-bye.

Ladies and gentlemen, this concludes the question-and-answer session of the call.

Thank you for participating in Northrop Grumman's (technical difficulty) this concludes the presentation.

You may now disconnect.