諾斯洛普·格拉曼 (NOC) 2006 Q2 法說會逐字稿

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

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

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

We will be facilitating a question-and-answer session at the conclusion of the presentation. [OPERATOR INSTRUCTIONS].

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

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

Sir, please go ahead.

Thanks, Cindy, and welcome, ladies and gentlemen.

I'd first like to give you a short apology.

I know because of the timing of [thorn burrow] we've all sort of stacked up right here at the end.

We'll try very hard not to do that to you in the future.

You've got a very busy day today.

We've 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 and should be viewed in conjunction with today's commentary.

Before we start, please understand that as shown on slide 2 some of the matters discussed on this call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

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

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

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'll discuss second quarter results including the non-GAAP measure for total segment operating margin.

Segment operating margin is reconciled on schedule 2 of our press release.

Today's call -- during today's call, we will also discuss out outlook for 2006.

Guidance will include GAAP measures of sales, operating margin, earnings per share from continuing operations, net cash provided by continuing operations and the non-GAAP measure total segment operating margin.

During the second quarter we finalized our exit from the reseller business and the results for this business are now reported under discontinued operations.

We have provided our restatement for prior quarters.

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

If you would please turn to chart 3 at this time, I would like to turn the call over to Ron.

Thank you, Gaston.

Hello, everyone, and thank you for joining us.

Overall it was a great quarter.

Contract acquisitions were up 52% and our year-to-date book-to-bill was 139%.

All four businesses captured more business than in the prior year quarter, and we ended the second quarter with a total backlog of $58 billion.

During the quarter, Electronics maintained its strong double digit margin rate, and Information and Services, Aerospace, and Ships all posted double digit increases in operating margin.

These latter three businesses also substantially expanded their operating margin rates.

At 9.8%, our consolidated segment operating margin rate approached double digits, and total operating margin reached 9%.

Slide 3 depicts our annual performance since 2003, as well as our updated guidance for 2006.

Our focus on performance is clearly yielding results; and based on performance year-to-date, we are raising our guidance for earnings per share from continuing operations to a range of $4.35 to $4.45 per share.

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

Looking at the businesses, we're especially pleased with Ship's performance this quarter.

We delivered the USS Texas to the Navy.

Texas is the first of our Virginia-class submarine deliveries and our first submarine delivery to the United States Navy in a decade.

We also recognized performance improvements for the Virginia-class Block II program.

Our Gulf Coast operations continue to recover with the sales impact of Hurricane Katrina diminishing with each progressive quarter.

As a sign of that progress, we are very pleased to report that we delivered the fifth and final Polar Tanker in the second quarter.

Ships also booked a $2.4 billion increase in contract acquisitions over last year.

In the Information and Services business we are well underway with the commonwealth of Virginia IT operation known as VITA.

We are successfully transitioning a large number of Virginia's IT employees to being Northrop Grumman employees.

The kick-off has been very successful.

Similarly, we are now assuming management responsibility for the Department of Energy's Nevada test site with the transition during the third quarter.

We're also competing now for the Department of Homeland Security's SBInet, which we expect will be awarded soon.

In the Aerospace business, we have submitted our best and final offer for the crew exploration vehicle program to NASA.

It is expected to be awarded in September.

This is a huge opportunity for Northrop Grumman, one which is critically important to the nation's future in space.

Looking forward, we continue to monitor progress on the 2007 defense budget.

As always, it's a process with quite a bit of debate before Congress reaches final agreement.

And while escalating personnel and operating costs, expenses for the war on terror, and political factors are all pressures on the defense budget, it's important to keep in mind that the President's 2007 request is nearly $20 billion higher than last year's enacted funding.

The request for the investment accounts is $10 billion higher than last year enacted budget.

And while Congress is considering the 2007 budget, the DoD is now in the process of formulating their 2008 program objectives memorandum and budget.

We continue to feel that Northrop Grumman is very well aligned with our customer's strategic direction.

The rate of growth of defense spending is moderating from its double digit rate in recent years, but substantial new opportunities exist for Northrop Grumman in defense and with other customers such as the intelligence agencies, Homeland Security, and federal, state, and local government.

Based on the outlook for the budget and our year-to-date contract acquisitions and backlog, we're confident that this year's positive trends will continue in 2007.

Although we don't have specific 2000 and guidance to share with you today, we do expect moderate top line growth, continued margin rate expansion, EPS growth, and strong cash flow in 2007.

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

Wes?

Thanks, Ron.

My comments begin on slide 4.

As Ron said, overall we're very pleased with the quarter.

Our focus on performance is paying off.

During the second quarter, segment operating margin increased $78 million. 54 million of that increase represents significant improvement in program performance, and the balance is lower expense for amortization of purchase intangibles.

It's especially noteworthy that we generated higher segment operating margin and a substantially higher margin rate while completing the shut down of a non-performing business and taking forward loss provisions of approximately 50 million on two programs in Electronics.

Based on our year-to-date performance, we are raising the guidance for our segment operating margin rate to approximately 9%.

This 100 basis points increase over last year underscores the improvement in performance from our operations.

We're also increasing total operating margin rate guidance to the mid-8% range.

The business components of this improvement are shown on slide 4.

Combined with our share repurchases, which have meaningfully reduces our share count, our focus on performance is driving the strong EPS growth we demonstrated this quarter and supports the increased 2006 guidance we announced today.

Updates to other key components of our guidance are provided on slide 5.

The primary update here is a reduction in our projected tax rate to a range of 31 to 32%.

Slide 6 summarizes our sales guidance for 2006.

Our strong acquisitions and solid backlog are providing the platform for second half sales expansion.

Although second quarter sales were impacted by the DDG restructuring, Katrina, and the wind-down of production in several Electronics programs, the record acquisitions we posted in the first quarter and the 52% increase in second quarter acquisitions provide a solid foundation for second half sales.

Overall, year-to-date acquisitions are up more than 50%; and we expect strong acquisitions in the second half of 2006 as well.

First half sales totaled 14.7 billion, and we now expect second half sales of approximately 15.8 billion, for a total of approximately 30.5 billion for the year.

The revised 2006 sales guidance reflects a lower expectation for Electronic sales due to lower than expected international sales and the cancelation and delay of several domestic programs.

We also continued our portfolio shaping this quarter with divesture of Winchester.

This is the third small electronics business we've divested in the last year, none of which were moved to discontinued operations.

Although 2006 sales of electronics are expected to be comparable to last year, Electronics year-to-date contract acquisitions are up 13% and we are addressing numerous opportunities in this business, which lays the groundwork for sales growth in 2007.

Moving on to cash, slide 7 provides a reconciliation of second quarter and year-to-date net income to cash from operations.

The major trend here was the catch-up in receivables collections from the first quarter.

You'll recall three of our segments were implementing ERP system conversions in the first quarter.

Year-to-date cash from operations is 523 million compared with 1.1 billion at this time last year.

There are several drivers to this year's first half cash performance.

Higher cash payments for corporate items like taxes and the nonrecurring cost to shut down the reseller business represent nearly 200 million of the variance.

The major component of the remainder of the variance is approximately 300 million in lower collections at Ship Systems and Electronics.

Ship Systems is still experiencing Katrina-related billing delays, and the variance at Electronics is primarily due to timing of cash collections on international contracts.

We expect to recover the Ship Systems and Electronics variances in the third and fourth quarters, which puts us on track to achieve our guidance for 2.3 to 2.6 billion for 2000 cash from operations.

We also continue to execute our balanced cash deployment strategy.

Slide 8 shows the major elements of the program.

We've completed more than 1.3 billion of the 1.5 billion share repurchase program we announced last October, bringing share repurchases to a total of 3 billion over the last three years.

We raised the dividend 15% in the second quarter, the third consecutive year of double digit increase in the dividend, and in total a 50% increase in our common stock dividend since 2004.

Our balance sheet continues to improve.

We've reduced total debt by more than 500 million a -- year-to-date, and an additional 690 million comes due in November.

Capital spending is on track for the year; and excluding Katrina spending, we continue to bring that down year-over-year.

We continue to execute an active MA&D program to optimized our portfolio and enhance shareholder value.

Over the past three years, we've divested more businesses than we've acquired, and we continually assess potential divestitures.

At the same time, as our customer's needs evolve, we also assess potential acquisitions that will enhance our future capabilities.

Slide 9 summarizes our revised guidance for sales, segment and total operating margin, and earnings per share from continuing operations.

We're on track for the year; and as Ron said, our outlook into 2007 calls for growth and continued performance improvement.

Our focus will continue to be on driving performance and executing a balanced cash deployment strategy.

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

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

Sandy, we're now ready to begin q-and-a.

[OPERATOR INSTRUCTIONS].

Byron Callan, Prudential Equity Group.

Good morning, good afternoon, gentlemen.

Hi, Byron.

A couple of -- couple of quick things.

First, the state of relations with some of your customers, I am particularly curious about the Navy.

There seems to have been some testiness lately, I guess, over some of the claims.

I'm just kind of curious, Ron, how you think that's all coming out.

Well, certainly, Byron, there was some difference of view in terms of the Katrina supplemental.

I would say that was probably a major issue of dispute.

It was clearly a business matter.

We continued to very much value the Navy as a customer.

I believe they value the work we do both in ships, aircraft, and electronics.

We're moving forward.

We have good working relationships with our Navy customers at all levels.

We are committed completely to the success of the Navy and clearly you read various press accounts, but that's the normal course of doing business.

Okay.

Great.

And then, Wes, just a follow-up on Electronics.

You alluded to the international sales and some of the domestic programs.

Can I assume the international sales was the one major Middle East customer and can you provide a little bit more color on the domestic programs that slipped?

Sure, sure.

In terms of international, it's actually a number of contracts that we see as delayed, so these are not escaping our planning horizon, but in terms of their timing they've moved out for this year.

And it represented several countries where we're doing business-- Korea, Jordan, Africa, Japan, and NATO actually were all included in that set of delays that we're experiencing, so that was what led primarily to the reduction in the forecast for this year for Electronics.

There were some smaller impacts relative to domestic programs, primarily things like the F-16, V-10 activity with the Air Force and the recompete of the GATOR program that drove some component of the delay.

Thank you.

Thanks, Byron.

Heidi Wood, Morgan Stanley.

Good morning, Heidi.

Heidi, your line is open.

Go to the next one.

Steve Binder, Bear Stearns.

Yes.

Can you maybe -- just as a follow-up on the international side, international activity for Electronics has actually been weak for a couple years now and it's been a recurring theme, and can you maybe just touch on how much you really think that's a function of weaker markets as opposed to is there anything that you think the Company needs to do in Electronics on kind of reviving that sales activity?

Yes, Steve.

Let me give you a little bit of a flavor of the broader international business.

And you're right.

It's primarily through our Electronic sector.

For some time, we had strong positions on legacy platforms and those sales were fairly predictable and understandable over time.

Over the last few years, we've been going through some transition of introducing new products, and as we've done that -- MESA is a good example.

The IRCM product line is another good example.

As we've done that, there's a bit of a transition in what the composition of those sales look like.

We have a number of ongoing great opportunities.

So we like the international business.

We think it's a very important and healthy part of the Company, but I think what you're seeing is a bit of that transitional effect.

All right.

And then, Ron, can you maybe just touch on the share repurchase program and capital allocation in general?

Last couple years, Northrup's been kind of best in class if you want to use that term for return of cash to shareholders.

You've only got a couple hundred million dollars left in the share repurchase program.

You've talked about using it up by year end.

But typically around the fall, you've committed to a large share repurchase program.

Do you plan to continue to return a large majority of free cash flow to shareholders, or do you think you'll change that kind of strategy?

Steve, why don't I take that one.

We have as, you point out, over the last three years been very active in the share repurchase program as an integral part of our overall balance cash deployment strategy.

As we mentioned this morning, we continue to see as we go forward a desire to have a balanced approach to cash deployment, and that's share repurchased and dividends on the side of returning cash to shareholders.

But we also do have an active MA&D activity.

As I pointed out a little bit earlier, we're thinking not only on the divesture side, which has been our more active side over the last three years, but we are giving some thought to the acquisition side as well as we continue to align our portfolio for the future.

And just a follow-up on divestitures, is there anything else planned by the Company beyond what you've announced so far that we could see this year?

We can't really comment at this point in time, Steve.

We won't comment on it.

Thank you.

Thanks, Steve.

Robert Stallard, Banc of America.

Good afternoon, everyone.

Just a couple of quick questions.

First of all, I was wondering if you can give us an update on the Katrina insurance situation?

Certainly.

The -- as we've indicated in the past, we do have a dispute with the insurance provider of the coverage amount in excess of 500 million.

That litigation is moving forward, and we have a date set with a court in April on the issue of coverage.

More broadly where we stand, to date we have expended about $311 million and we covered about 233 million, so we are continuing to make progress on both fronts.

The folks at Ship Systems are continuing to do just an extraordinary job of rebuilding the shipyard and recovering the operations there, so we see ourselves making progress along the track that we had contemplated when we began speaking about this around the end of last year.

Great.

Thanks.

And just a follow-up, you mentioned that you expect modest revenue growth in 2007.

What's your expectations for how margins are likely to progress, given your already strong expectations for '06?

We're continuing to drive margin expansion.

As you correctly point out, the more we expand the harder it gets as you move up, but across the operations of the Company we are focused on margin expansion, so our expectation is that we'll enjoy some additional benefit there next year.

Great.

Thank you.

Thanks.

Heidi Wood, Morgan Stanley.

All right.

So can you hear me now?

Yes, Heidi.

All right.

There we go.

We accidentally were online, so sorry about that.

I want to get your reaction now that GD has closed on Anteon and they're talking about doing more prime work, competing head-to-head in many arenas that are your core backyard.

Ron and Wes, can you talk about how you see the competitive landscape changing here?

Do you think that pricing becomes in any way more challenging?

Well, we're -- certainly people have figured out where some of the growth is going to be going forward, and as I point out to you, we made some acquisitions of some premium IT and systems integration businesses five, six, seven years ago.

We certainly will expect increasing competition.

But that's okay.

That's what makes great defense systems.

As far as pricing is concerned, I mean, each company makes its own decision on pricing.

I can only speak for ours.

We're going to price in such a way to make sure we return value on the contracts that we take on.

We're not going to be taking on contracts we think are bad contracts.

Okay.

And just to touch on your comment about the pick up in acquisition and -- or strong acquisition activity in the second half just to make sure I got it right.

Are we -- should we expect sort of a similar size in terms of activities we saw in the first half or slightly bigger?

No.

I think, Heidi, you'll see the second half moderate relative to the first half because we've had some tremendous -- tremendous pick-ups.

Of course, the first quarter, as you know, was a little bit of a catch-up for some of the delays due to legislation delays in the previous fiscal year, but second quarter is just very strong.

Okay.

And last question, you talked about lower volume on the DDG-1000.

Can you give us a little bit of sense as to what the skyline looks like for that program over the next couple of years?

It's a little hard to tell, Heidi.

Certainly, it is our expectation assuming the four congressional committees converge on the Navy's recommended plan that there'll be two DDG-1000s.

And for those of you that are not familiar, that's the new name for the DD(X).

Two DDG-1000s procured in parallel between ourselves and General Dynamics.

And we'll get to work on those boats in advanced design and construction in parallel.

And then following that, I think the plan calls for something like on the order of 7, 8, or 9.

I can't remember the number.

And that plan is continually being revised.

So I think it's anybody's guess how many will actually be purchased, but for now we'll be working hard on the first of the boats.

All right.

Great.

Thanks very much.

Thank you.

Howard Rubel, Jefferies.

Thank you very much.

I wanted to go back to two charges you had.

One was on the fixed price R&D contracts.

Two kind of subpoints there.

One is what were they on, and I thought, Ron, you've been pretty adamant about being very careful about taking on programs like this.

Could you elaborate a little bit, please?

Yes, Howard.

Let me -- let me give you the facts and figures on what the programs are, and to your second point both of these are programs that we've had in our stable for awhile.

One of the programs is a program you might not have heard of before.

It's called ASPIS II.

It's an airborne self protection program where we are a subcontractor to Raytheon and the ultimate customer there is the Greek Air Force.

And that is a fixed-price development contract developing a radar warning receiver subsystem.

The program is currently going through the integration and test phase, and this particular phase of the program has turned out to be more difficult than we had originally contemplated.

So we've gone through a very rigorous review, and set up a forward loss provision that we believe is very appropriate given the work that we see in front of us as we go through IMT.

So that represented roughly half of the 50 million total in charges that we took for the quarter on the two programs.

The other programs is Peace Eagle, and Peace Eagle is one of the MESA programs you most likely heard of before.

And there, most of the charge that we took, which was about the other half of the 50 million, related to increased antenna production costs for additional test and demonstration assets that we determined that we would need to appropriately complete the program.

So both of these programs have been with us for awhile; and as we're working our way through them, this is a recognition of what we believe it's going to take to get the job done.

Yes, Howard.

If I could add -- this is Ron.

I think about 40% or so of our business is fixed price.

And we make actually some very, very good margins across the board on our fixed price business, and we have thousands of contracts.

There are occasionally some contracts like this which we'll slip in.

We do our darnedest to manage them, to bid them correctly.

You don't get every one of them right.

I think you can see why we're extraordinarily focused on making sure that we do take some discipline around fixed price development contracts going forward.

On the other hand, I will tell you that -- that we have other programs which we bid fixed price that we, in fact, exceed our initial bid estimates on.

So it is a portfolio.

Ron, I would expect that, and frankly, sometimes you lose a little bit but you gain a market opportunity, so I'm very conscious of that.

I just wondered whether this was anything out of the ordinary, and frankly, it really doesn't seem that way.

The second is, on discontinued ops where you put the reseller business, is -- if I'm not mistaken, if I do the math, shouldn't that be a larger number than the $0.03?

What else is in there that's sort of offsetting the loss?

There's a gain or something?

Howard, I would point you to, I think, it's schedule 4 of our press release.

That kind of walks through what the impacts are of the discontinuation of the reseller.

All right.

I'm sorry.

Thank you.

I've got it.

Joe Nadol, J.P. Morgan.

Good afternoon -- or good morning for you.

A couple of things.

I guess just starting off on the Peace Eagle and the Wedgetail, as I'm sure you saw, Boeing took a $0.5 billion charge this quarter on the program, and you took a very small one or relatively very small one.

I'm just wondering if you could give us any color around where you are on risk reduction there.

They said that they did some flight tests in May and June that caused them to reevaluate and take their charge.

In terms of your commitment to them, is there any disagreement on the program, et cetera?

Joe, in terms of the work that we're doing on Wedgetail, things are going very well.

Most of our -- much of our development work, naturally, would precede the phase that Boeing is in today.

From our perspective, and again, we're just a subsystem of the overall system that Boeing is developing, but on our side, the hardware design is stable, and the flight test program is actually going very, very well.

The production program is on our build plan, and we're still expecting the -- the hardware production to complete in the early part of next year, so, so far so good.

We're operating to our plan, and within our established EAC for Wedgetail.

And naturally, there are a number of demonstrations and tests still in front of us, so there are some risks that remain, but relative to how we're doing to date and the reviews that we've conducted, we believe the EACs that we had established before are continuing to hold up well.

Okay.

And then secondly on Ship Systems, you had some nice performance in the quarter.

It looks like there may have been some one-time boosts, maybe an adjustment on Virginia class specifically, and material incentives.

I'm wondering what those are and if you could kind of give us a sense as to what the run rate -- normalized run rate might be for margin there.

Joe, have you it exactly right.

The improvement that we saw in the quarter did relate to the milestone-driven operating margin adjustments that we took at Newport News primarily associated with the material incentives on the Virginia class program.

We -- again, the slides that I briefly went through earlier, you can see our projection for the run rate for this year -- the operating margin run rate for this year in Ships of about 7%.

Okay.

Okay.

Thank you.

Thank you, Joe.

Ron Epstein, Merrill Lynch.

Yes.

Good morning.

Ron, can you just walk through the laundry list of programs that are on the horizon, the potential wins that you guys could get?

Yes.

There's a number of big contract awards that are ahead of us.

I'd start out with the crew exploration vehicle for which, as I mentioned, we submitted our best and final to NASA.

And we're expecting a decision on that probably very early in September.

We'll see what the schedule looks like that.

And that's -- that's a very significant program, a franchise program, and we put tremendous effort in that.

We're very excited about the possibility there.

The SBInet program, which is a major bid to the Department of Homeland Security for border control.

We're also, as you know, very actively pursuing the Air Force Tanker Transport program, and there we will be expecting a draft RFP in another few months and probably an award within about a year if the schedule holds.

We're waiting to hear soon about the decision in the electronic systems center of the Air Force on something called AOC/WSI.

That should be awarded shortly.

And of course, the DDG-1000 contract to get on with the actual production will be a very large amount of money.

So those are some of the things kind of in the immediate future; and of course, we have literally hundreds and hundreds of other smaller programs which are coming in every week.

Great.

And then just a quick question for Wes.

When the FASB Phase 1 pension rules go into effect, doing a rough calculation, it looks like your shareholders' equity could drop by about maybe 15%.

Do I have that right, and are you going to do anything about it?

You have it right that it's primarily a balance sheet issue, not a P&L issue.

The exact number I wouldn't want to comment on at this point as that thing is still working its way through, and obviously as a company -- as most large companies do, there is an opportunity for comment and interaction.

So I think we'd want to reserve our comments -- public comments on -- until we have a little bit more clarity on the outcome.

Okay.

Thanks.

Thank you, Ron.

Cai von Rumohr, Cowen & Co.

Yes.

You've had these two write-offs and these programs kind of are there dormant.

And then all of a sudden, you can figure out that there's still an issue.

Could you tell us as you look at the programs that are on kind of your watch list, what are, maybe, the top three or four?

I mean, you obviously -- the tankers that's -- Polar Tanker's behind you.

What are they and are there any new ones kind of coming into the mix?

On -- obviously we do have a fairly good watch list of programs.

A lot of these programs are cost plus programs and we're very concerned about our performance on them.

But they wouldn't be the kinds of things that would result in a significant charge.

But the -- obviously the aircraft carrier programs are quite large.

The Virginia class submarines, those are going very well.

The LPD programs we're making good progress on those, and with the -- the new award of the 2.5 billion or so of new work on the next three ships, we should have contractual conditions on those which will allow us to make a little more money than we've been able to make in the past on the LPDs.

ASPIS II, as Wes mentioned, is certainly on the watch list.

And we're not proud of that fact that that thing sort of popped up as a problem here this quarter.

But as you can well imagine, these are complex programs and a lot of things going on.

But we do -- as soon as we recognize the issue we jump on it and report it to you.

Other programs on our watch list, the Global Hawk program, which went through Nunn-McCurdy recertification successfully, and we're moving forward on that.

The NPOESS program went through a Nunn-McCurdy recertification and we have an executable program going forward on that.

Both those programs are cost plus programs.

A lot of good work going on on the F-35 Joint Strike Fighter -- now called the Lightning.

And as you know, we have a significant role in that program with our prime partner Lockheed Martin.

I think -- a variety of the restricted programs.

We watch the F-16 Block 60, of course, and Wedgetail and Peace Eagle.

Those are examples of sort of programs we have.

Out of that list I've mentioned, just a small number of them are fixed price, and -- but obviously we're watching all of them carefully.

Excellent answer.

Thank you.

And one quick one.

You talk about M&A&D and obviously as you point out more recently everything you've done has been D. I sense kind of that you're a little more focused on maybe considering A, acquisitions.

If so, what areas and what's changed?

Why do you appear to be a little more interested today and what --?

It's interesting.

This is Ron, Cai.

It's interesting.

When we completed the acquisition of TRW and everybody had us pegged as serial acquirers and were terrified over the next few years we'd do nothing but make acquisitions, what we did is manage this Company for performance and value.

And it in the process of doing that, it just turned out that because of the richness of our portfolio and many of the acquisitions we had made there were better value opportunities to make some portfolio pruning moves, which we in fact did.

That does not mean that there weren't opportunities considered for acquisition.

It just turned out that -- that nothing really passed the screen.

It's not that we didn't have the fire power to do it.

We certainly do have that financially.

We're pretty darned disciplined here.

Going forward, we're going to continue to look at both sides.

We're going to look at any other pruning opportunities that might be valuable for our shareholders; and clearly if there are strategic acquisitions that make sense from a value stand point that help us to enhance our growth in value, not just revenue growth, that we're going to look at those as well.

The kinds of areas that we're talking about, Wes, why don't you give a couple of details on that?

Sure.

Cai, in terms of kind of the broad strategic areas of interest, I guess I'd outline three areas that make the most sense as we look at it.

First, I would say because of the broad impact across all the services and across all of the future threat scenarios that we envision as we think about our customers' needs for the future, we continue to see C4ISR, that broad arena of activities and capabilities, as very attractive for the long-term.

It plays into just about every circumstance that we can envision that our customers need to address.

So being -- having a very robust portfolio and C4ISR makes a lot of sense to us.

We also see logistics sustainment and services as very attractive.

And with respect to IT, we do have a very, very strong portfolio today.

Ron mentioned in response to one of the earlier questions that we went through a process of building our IT portfolio some years ago, and captured a lot of the premier franchises in that part of the space.

But we do want to continue to look at that, particularly as we see opportunities to broaden the customer base for that franchise.

So I would put that as another one of the areas that we're giving some thought to.

Thank you very much.

Thanks, Cai.

George Shapiro, Citigroup.

Yes.

You raise the guidance dime and nickel depending on which end of the range, and yet this quarter had a $0.14 gain from the taxes.

So I was wondering, effectively, you're levering the guidance for the second half of the year in the operation part of the Company.

Is that just reflecting the lower Electronic sales expectation now?

George, there were a number of moving parts here.

And let me just kind of touch on them at a very top level.

You correctly point out that tax has gotten better.

Early in the year, we did anticipate that we had some potential opportunities to do better than the statutory tax rate, and so we had originally guided around 33%, I believe.

And so today, we've reduced that tax range to 31 to 32%.

But we've also increased our projection for our segment operating margin and our overall operating margin.

We're projecting segment operating margin now up around 9% and overall operating margin in the mid-8% range.

On the down side, you correctly point out that we reduced our expectations for sales in our Electronics business, which is one of our higher margin businesses.

And in addition to that, perhaps a little bit more subtilely it was stated in the release we did take a recognition in the quarter for a reduction in some marketable securities.

And -- so that was a little bit of a downer that we took.

It was about $13 million, shows up in the other category.

So there's -- there are a number of moving parts in there.

You kind of have to track your way through them to calculate into the guidance number.

Okay.

And the other thing, Wes, you mentioned you had lower amortization, both in Mission Systems and Electronics.

Can you just break out how much was each?

Yes.

This year throughout the year, we've gotten some -- we have some improvement, some overall benefit in the amortization.

Overall in the second quarter it was around 24 million or so -- 24, 25 million.

About 16 of that is in Electronics, and roughly 7 of it is in Mission Systems.

In the quarter.

Okay.

I'll get back on for more.

Thanks.

Thanks, George.

Doug Harned, Sanford Bernstein.

Good morning.

Good morning, Doug.

Good morning, Doug.

Could you talk a little bit about the Virginia class and how that's proceeding?

I know the Texas was -- Texas was a challenging boat, and how is it going with North Carolina and now that you're heading into the fixed price boats?

Well, actually, Doug, it's going very well.

The performance on the Texas and getting to the first delivery of a submarine in ten years has been a tremendous accomplishment for the team at Newport News.

We're very proud of it.

We're working very closely with our partner at Electric Boat General Dynamics as we alternate each delivery and in fact share lessons learned back and forth.

I would have to kind of give you the headline that says that each boat is getting better.

Each boat is getting more efficient.

Each boat is showing significant progress.

And as a result, we are more optimistic about the Block II Virginia-class boats than even the Block I. And as you know, there's four in Block I and five or six in the next block.

So we're actually very pleased with how it's going.

We're working very hard with our partner to get that unit cost down so we can get to two a year as soon as possible.

The current program of record has going to two a year by the year 2012.

There is discussion within the Navy and the Congress of would it be possible to do that sooner, and clearly the sooner that happens, the more efficient even then both we and Electric Boat can come in producing these -- these important submarines.

As you know, these attack submarines are absolutely essential for the fleet, and the current Los Angeles class is coming out pretty quickly.

And as they are coming out, we need to replace -- replace them, so we got to continue the build rate and accelerate the build rate on Virginia class over the next five, ten years.

So overall, I would say we're pleased with the progress in the last year or so.

That progress is being reflected in our booking on the program.

Exactly.

Okay.

So that -- okay.

Okay.

Great.

That's in fact -- we mentioned that in our earlier comments, that the Block II in fact, we reexamined that booking rate and made it more positive.

Okay.

That's great.

And then, separately on integrated systems, they're very, very strong margins there.

Is that primarily a mix issue or does this reflect some improved performance on the development programs?

I would -- I would tell that you that it's both, actually.

The -- the first half of the year, integrated systems has just done a fabulous job on performance, in a very broad way across its full mix of activities, ranging from the B-2 support contracts to the E2 to the F-18 to the F-35.

And, Gaston, I probably left one or two out.

But just across the board, they have been doing very well.

And so in the first half of the year, we did have some booking rate adjustments and some -- basically some [cume] catch-ups that go with that that are reflected in that strong performance that you're seeing.

And there was a heavy mix E2s.

Okay.

Yes.

There was a big E2 delivery, obviously.

It trails off in the back half.

Right.

Okay.

Good.

Yes, that's what I was -- that's what I was wondering.

Okay.

Great.

Thanks.

E2 is going through a transitional phase in the program, the E2C deliveries are tailing off, and on E2-D we're completing the development phase of that activity and going through the little dip that you typically get between the transition from development to production on E2-D.

Okay.

Robert Spingarn, Credit Suisse.

Good morning.

Good morning, Robert.

Hi, guys.

Do you think you'll be bidding on the LOGCAP 4 project?

What's the name of the contract?

We couldn't hear you.

The LOGCAP 4.

This is the Halliburton contract, that the LOGCAP 3 that finishes up

Yes.

I guess I'm not sure that's something that's on our screen.

Obviously, we're going to look at all the opportunities we have, but that's not something which we're prepared to --

Yes.

There -- there may be some small -- relatively small components of that that might be of interest, but in a broad sense that, today, is not a -- an area that we have a strong focus on.

Okay.

Okay.

And then just switching gears, GD is refocusing again on the commercial ship business.

Perhaps they're in a different position given the status of their yard, but what are your thoughts on that?

Yes.

We just delivered our last tanker, and it was a great event.

We're not actively seeking at the moment any additional commercial business either in tankers or cruise ships.

Do you think, Ron, long-term it makes sense?

They seem to have a different kind of game plan going forward than in the past?

Yes.

I guess I can't speak for General Dynamics.

I can tell you that the way we're structured and where we're focused, we're focused on naval and Coast Guard vessels.

That's what we're very good at, and that's what we know how to make money at.

Okay.

And just finally on tanker, you brought it up before.

Any thoughts to platform?

Does Airbus' latest iteration of A350 enter into the picture at all?

Actually, we're very comfortable with the A330 as the basis for or KC30 offering.

And the A330 is a very stable, mature aircraft well into production, very popular aircraft.

I don't see the A350 as being particularly relevant, and the time frame would be out in the future beyond when we've have to make a down select decision.

I would tell you, though, that the announcement on the part of Airbus of introducing a -- an A330 freighter version gives us an additional advantage as we move forward to the tanker, because as you know, the tanker is a multi-role tanker transport, and rather than converting from a passenger plane, we'll be able to work with a freighter version which will give us a leg up.

Thanks.

Thank you, Ron.

Myles Walton, CIBC World Markets.

Thanks.

Good afternoon.

Hi, Myles.

Wes, I just wanted to congratulate you on your appointment, and as a follow-up, how are your roles between you and Ron going to evolve as you take on the role of President first of all?

And second of all, how is the permanent CFO search progressing?

Let me take that one, Miles.

As you know, we're in the process of a transition, and we have a -- an internal/external search under way.

And as we announced publicly when we appointed Wes to the additional responsibilities of President, we would go through that process through the rest of this year and make sure we ended up with a good configuration.

And when that happens, then Wes' focus will move entirely to the President's side in addition to what he's doing now.

So he's sort of straddling both.

So it's a gradual transition.

Wes, as a CFO, having had operating experience in the past, has always had an operational bent as well as the financial responsibilities, and we'll see more of that.

We'll have additional focus on performance improve, on process improvement, and I think you'll see a fairly seamless management approach going forward.

I think when -- Ron, when you assumed the role and Kent was still there, it was -- you were very much in the mode of M&A and allowed Kent to focus a lot more on the strategic part of the business.

Is that a similar kind of partnership that you envision?

I think you'll see a pretty seamless partnership, and this is a much bigger operation than it was when I showed up.

I think when I showed up we were in the 7 or $8 billion range and now we're in the 30 range.

So there's a lot more going on in the Company, a lot more opportunities, a lot more complexity, a lot more opportunities to kind of expand our thinking, so I think we're going to find everybody's going to be busy, and I don't think you're going to see a -- a simplistic delineation of responsibilities.

Great.

Thanks.

Byron Callan, Prudential Equity.

Ron, I just want to follow up on a broad thought.

You usually have these conversations on the calls and mention that Northrop Grumman has been well-positioned to meet defense needs, but if you think back over the last four or five years, there's some pretty significant markets that you guys have missed out on, particularly related to Army needs, communications, force protection, things like that.

And I'm just curious when you think about the business over the next three to five years, do you think that defense spending kind of comes back into some of the things that you guys have historically excelled at, or -- or are we going to see kind of a continuing reiteration in funding on ground forces needs and maybe -- maybe you do think to need -- to bulk up in that part of the business?

Well, certainly the ground forces piece has been the lightest part of our portfolio, just by the nature of the way things came together, and we've had a tremendous surge of business associated, frankly, with overhaul, repair, and replacement of worn out equipment in Iraq and Afghanistan.

And we've not largely participated in that boom.

In other words, we've not been living off the supplementals as a number of our compadres in the industry have been.

Over time, my view of the future -- and I think our view, is that the fundamental core of C4ISR, IT, and additional O&M and services is going to be kind of the core place long-term steady state.

Communications for sure, but I think communications is not just building radios or electronic devices.

It's really the integration of software-based radio systems and networks, and then it becomes almost indistinguishable from what we call C4ISR.

We have a number of businesses in that area.

We don't typically make radios per se, but we're doing a tremendous amount of integrated communications network work as well.

I can't predict what the -- what the next strategic conflict will require.

I will tell you, though, that the missle defense is going to be critically important.

I think that the -- the demonstrations on the tactical side of what's happening in the Middle East today and what just recently happened a few weeks ago in Korea underscores that -- that missle threats are very serious, whether they're strategic or tactical.

That's an area the Company is positioning itself very strongly.

Thanks for answering that.

David Strauss, UBS.

Thanks.

Can you just give a little bit of color on the organic growth rate at Information Technology?

It looks like the bookings in that business are pretty strong, yet organic growth rate's been in the low single digit rate -- range for about the past four to six quarters, so any color there would be helpful.

Thanks.

Yes, broadly I would say that Information Technology, the enterprise, is doing well.

We've been not only pursuing the opportunities within the DoD and the Intel space, which is our traditional core of that business, but expanding it out beyond that to a broader federal base as well as the state and local.

You've seen us be successful in our pursuits with the Virginia outsourcing contract and San Diego as well.

I think to give you a little bit of the color you're looking for, I would say that in terms of organic growth, intelligence -- certainly state and local -- and also the defense side.

They're all outperforming what we would see the market rate of growth within those parts of the business.

The place where we're seeing some constraint right now on growth is -- and we do see it as temporary, is really within the civil agencies part of the business.

That's about a third of the revenue in IT altogether.

We expect that business broadly to be flat to low single digit growth in '06 versus '05, really due to the timing of the new program awards that we see representing the organic growth opportunities there, largely in '07.

So we -- and we've captured some of the key ones this year in '06 -- the end of '05 and '06.

The IRS tips business is a good example.

The Department of Homeland Security Eagle Activity and the USAID PRIME contract as well.

So we're seeing that marketplace be alive and working, but our profile on the civil part of it, which, again, is about a third of it, represents lower organic growth in the other pieces.

So I think that's probably what you're observing.

Thanks, Wes.

Steve Binder, Bear Stearns.

Yes.

Wes, can you maybe just touch on the -- in your 10-Q filing about the Goodrich claim for additional relief with respect to the aeronautical acquisition?

I mean, do you expect that to be resolved this year and are you reserved for that at all?

That's a -- sort of a late-breaking thing for us, and so the extent to which I would feel comfortable commenting on it is described in our 10-Q, so for now I think we want to just rest with the description that we have in the 10-Q until there's a little bit more clarity around it.

Okay.

And then the other thing with respect to -- we're attacking margins a lot of different ways, but it was obviously a very strong quarter.

Mission Systems, even with the benefit from lower amortization to be close to 10%.

I mean, you've got businesses there with Space Technology and Mission Systems where at least three-quarters of your business has been cost type business.

And you're running at very high margins there.

I think you had a cume adjustment on the deep water program if I'm not mistaken, as well as Virginia class which has very strong margins across the board this quarter.

I mean, is 10% something -- is that something -- double digit margins something that you're striving for, or are we seeing some anomalies this quarter?

Well, we're continuing, Steve, to push for margin expansion across the board.

And the characterization I would give in terms of the way we see, not just the quarter because any quarter can have cume corrects and a whole variety of moving parts in it, but I think to answer your question I would point you to the guidance that we're giving for the year at our segment operating margin level of 9%.

That's 100 basis point improvement over last year, something we're really proud of because it is the focus of the -- the operating organizations to continue to drive, and I think the other part of your question inherently is are we done at 9%, and the answer is no.

We're going to continue to push.

All right.

Thanks a lot.

Howard Ruble, Jefferies.

Thank you very much.

Wes, I think I wasn't clear before.

You said you took a $50 million charge in discontinued operations for shutting down the reseller business.

That would be about a dime a share, and yet I think you have a $0.03 charge, so there were some positive operating elements somewhere else in another business unit or something like that?

We did not take a 50 million --

May -- perhaps -- Howard, I don't know if I misspoke or if it came through garbled in some way.

But the $50 million charge we took in the quarter related to the two programs in Electronics Systems, the ASPIS program and the Peace Eagle program.

We did sell a business in the quarter in Electronics called Winchester, but that did not result in any material impact to the P&L.

That's de minimus.

I recognize that.

Okay.

All right.

And then, just the other thing on marine, you've been struggling for some time to make -- eek out some profitability in the Gulf yards.

Are you at the point yet where we're starting to see some change, or is the majority of the profit -- or is almost all of the profitability still coming from Newport News?

In the quarter -- it's certainly true the first half of this year, the preponderance of the profitability is certainly coming from Newport News as we're continuing our recovery from Katrina.

When we took the charge in the end of the third quarter last year, we indicated that that was a recognition of a lower booking rates we were establishing on the programs in the Gulf.

And so there -- a lot of that initial charge was a cumulative correction that went with those lower booking -- lower booking rates, but those lower booking rates are continuing, obviously, as we work through the recovery phase on all of those programs down in the Gulf.

Just to give you a little bit of a status on that, we're continuing right now, I would say, to track pretty well within the -- the framework that we laid out when we established those lower booking rates.

There continues to be pressure, primarily on the people side of the equation, the staffing.

As the recovery -- the broader recovery in the Gulf kicks into gear, there is an increasing demand for the type of talent that we require to build ships, and I would say that's probably our biggest variable as we look into the future with respect to our program performance, which of course, is what drives our booking rates there.

So we're coming back up the curve.

It -- the net result is, as you suggested, that if you look at the total margin that we're generating in our -- in our reported ships segment, it is more heavily dominated by the Newport News contribution.

It's impressive you're sticking to the numbers given the uncertainty there.

Yes, it -- there was an enormous amount of work that went into projecting what the impacts would be on those programs, and we're tracking within that framework today.

Thank you very much.

George Shapiro, Citigroup.

Yes, Wes.

I just want to pursue a little more the margin question that Steve touched on earlier.

If you looked at Electronics and adjusted for the amortization that you gave me and the charges, you would have made about a 13% margin in Electronics.

Now, was there some one-time benefits from the other programs?

You talk about good performance.

Or is this -- are we going to actually see an ongoing run rate of around 13%?

If you'd just provide some more clarity.

No.

There were some improvements that were recognized in the cumulative way in Electronics during the period.

So that was off -- that, together with the amortization, was somewhat offsetting of the -- of the 50 million charge related to the two fixed price development programs.

So I would not characterize the math that you demonstrated there as representative of the ongoing run rate.

Okay.

And as -- in the Mission Systems it looked like if you took the amortization, you still did 9-3 or so which is about what you did in the first quarter.

I mean, is this kind of a new rate for Mission Systems where we have been used to running in the high 7's maybe?

Mission Systems has been working hard on enhancing their overall margins.

This quarter, though, was -- had some additional help in that regard with some improved performance recognition on a few Army contracts, so it represented more than I would characterize as the ongoing rate, but they have been making good progress, and we expect that of them.

We expect them to continue to expand their operating margins.

Okay.

And just the last one, in Ships I assume with the delivery of that fifth Polar Tanker there wasn't any reserve reversal or anything to also help that Ship margin.

It was just due to the Block -- the Virginia class?

The positive -- the recognition in our Ships reporting segment for the quarter was certainly primarily due to the Virginia class incentives.

There were other moving parts, of course, to that equation, but it was predominantly the Virginia class recognition.

Okay.

Thanks very much.

We have time for one more.

Cai von Rumohr, Cowen & Co.

Yes.

Just a quick one.

If you run in the middle of your tax rate range, 31.5, you get a 35% tax rate.

Is that right and how come so high?

The 31 to 32 guidance is for the remainder of the year.

And is that what you're saying?

Total year.

Yes, I'm sorry.

For the full year.

Are you suggesting second half equivalent rate?

Well, the second half, if that's what you run for the year, it runs around 35% and I just -- I'm not -- I want to understanding why.

Yes.

A lot of that just goes to the timing of the -- of when we're recognizing the particular tax benefits through the year, so I wouldn't necessarily pen to an exact number there, Cai, but we certainly recognized in the first half of this year two substantial improvements.

The B-2 and then earlier in the year we had some tax benefit associated with some of the Katrina-related tax programs.

Excellent.

Thank you.

Thank you, Cai.

Okay.

Well, let me just wrap up.

And again, we're very pleased with the quarter which we had, and I want to thank all of you for your questions and your continued interest in the Company.

Have a good day, everyone.

Ladies and gentlemen, thank you for your participation in Northrop Grumman's second quarter earnings conference call.

This concludes the presentation, and you may now disconnect.

Have a wonderful day.