諾斯洛普·格拉曼 (NOC) 2006 Q3 法說會逐字稿

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

My name is 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 end of the conclusion of the presentation. [OPERATOR INSTRUCTIONS] I would now like to turn the presentation over to your host for today's call, Mr. Gaston Kent, Vice President of Investor Relations.

Sir, please proceed.

Thank you very much, Cindy, and good day, ladies and gentlemen.

We've 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 the 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 10K and 10-Q.

During the call, we'll discuss third quarter results including the non-GAAP measure of total segment operating margin which is reconciled on schedule two of our press release.

During today's call we will also discuss our outlook for the remainder of 2006 and 2007.

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.

Schedule four of our press release provides a reclassification of 2005 results where applicable to reflect the transfer of additional business to our Technical Services segment from Electronics, Integrated Systems, Mission Systems, and Space Technology.

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.

At this time I'd like to turn the call over to Ron.

Thank you, Gaston, and thank you all for joining us.

I'm very pleased that each of our four businesses posted a very strong operational third quarter.

And although we didn't win everything we did this quarter, contract acquisitions were nonetheless a particular highlight up 25% in the quarter and 47% year-to-date.

All four businesses captured more business and ended the third quarter with higher funded backlog.

This translates into a year-to-date book-to-bill ratio of 120%.

Notable wins this quarter include New York City's $500 million contract for a secure, wireless broadband communications system.

This was a competitive win for Information Technology in the state and local government market, and that positions us well for a range of similar future opportunities.

The United States Joint Forces Command selected Mission Systems to continue providing technology support to the Joint Warfighting Center in Suffolk, Virginia.

The initial 2 year, $218 million contract has a potential value of nearly $700 million over 6 years, if all options are exercised.

And Technical Services received an IDIQ contract from U.S.

Citizen and Immigration Services with a potential value of $750 million to continue Biometric Capture Services in support of U.S.

Citizenship applications and green card renewals.

On a consolidated basis we ended the third quarter with a total backlog of $60 billion, nearly 4 billion higher than at the end of last years third quarter.

So we're nicely positioned for organic growth.

Cash from operations was nearly $1 billion this quarter, bringing year-to-date cash from operations to 1.5 billion.

Sales rose in three of our four businesses.

Information and Services, Electronics, and Ships posted higher sales, and all four of our businesses posted higher operating margin and expanded their operating margin rates.

Electronics improved their strong double digit margin rate and Information and Services, Aerospace, and Ships all posted double digit increases in operating margin.

The focus on performance that we demonstrated in the first half of the year continued to yield results this quarter.

Segment operating margin rate expanded 270 basis points to 9.4% and even after adjusting for the $165 million Hurricane Katrina impact in 2005, segment operating margin increased substantially.

It's been a year since Hurricane Katrina disrupted our operations and we've made substantial progress toward full recovery.

Our Gulf Coast facilities are increasingly capable of producing components and ship sections interchangeably for each other.

That capability, along with the rapid reconstitution of our work sites and the remarkable resilience of our employees has allowed us to deliver an Aegis Destroyer, an amphibious assault ship and our fifth and final Polar Tanker.

And at Newport News, Virginia, on October 7th, we christened the nuclear aircraft carrier USS George HW Bush.

The Navy continues to demonstrate it's confidence in our ship builders awarding Northrop Grumman LPD 22 & 23 construction contracts and design contracts for the LHA6 and the DDG 1,000.

Unfortunately, the earnings from this quarters excellent operating performance were reduced $0.20 per share by a legal provision.

The provision relates to a settlement offer we made to resolve all potential claims related to certain micro electronics parts produced by TRW prior to Northrop Grumman 's acquisition.

As we previously disclosed we were notified of these claims in October of 2005.

While we believe we acted appropriately in this matter, we offered a settlement to resolve all potential claims, avoid litigation and to recognize the value of our customer relationships.

We believe it is in the best interest of all parties and our shareholders to resolve this matter.

This quarter's pretax provision reflects our settlement offer and related expenses.

At this time we're not able to predict the outcome of this matter and cannot say more than we've disclosed in today's press release and in our 10-Q filing.

Turning to the recently passed 2007 budget, overall, our programs fared well.

The final bill signed by President Bush includes includes $11 billion for Navy ship building and it's conversions, and more than $9 billion for missle defense, both important areas for us.

Missle defense funding includes substantial funding for kinetic energy interceptors and STSS.

Eight ships are in the Navy budget including two DVG 1,000 destroyers, one Virginia class submarine and one LHAR amphibious assault ship.

Our other programs receiving substantial funding include ICBM , Sivers, F22-A, LAIRCM, Advanced EHF, Guard Rail, E-10, E-2D, FA-18 EF and Joint Stars.

So our core business is very healthy, and we also have substantial new business opportunities going forward.

These include Navy programs like the DDG 1,000, Broad Area Maritime Surveillance, or BAMS, and the Navy's Unmanned Combat Air System.

Other large opportunities include the Air Force Tanker Transport replacement program, a program to provide flat mail sorting and sequencing machines for the U.S.

Postal Service and the State of Texas IT Outsourcing Program.

So in summary, it was a strong quarter for our operations and business capture.

In 2006, we expect sales of approximately 30.2 billion and earnings per share of $4.20 to $4.25 as a result of our decision to prefund our pension plans in light of the recently enacted pension protection act of 2006, we now expect cash from operations of $1.5 to $1.8 billion.

For 2007, we expect sales to grow to a range of 31 to 32 billion, earnings per share to increase between $4.65 and $4.90 a share, and cash from operations to increase to 2.5 to 2.8 billion.

Now I'd like to turn the call over to our President and Chief Financial Officer, Wes Bush, for a more detailed discussion of our performance this quarter as well as the outlook for 2007 and the remainder of 2006.

Wes?

Thanks, Ron.

My comments begin on slide three.

As Ron said, we're very pleased with the performance our business has generated this quarter as consistent with the performance improvements we've seen throughout 2006.

During the third quarter, segment operating margin increased $210 million.

Now much of that improvement came from Ships where we went from a hurricane related loss of 65 million in last year's third quarter to 76 million in operating margin this year.

But the remaining increase is from improved performance in Information and Services, Aerospace and Electronics, along with approximately $25 million in lower expense for amortization of purchase intangibles.

Information and Services expanded their operating margin rate by 110 basis points for the quarter.

Year-to-date, their margin rate has improved by 120 basis points to 8.9%.

We do expect this expansion to moderate in the fourth quarter, but based on year-to-date performance, we're raising our expected 2006 margin rate for Information and Services from approximately 8% to a low 8% range.

Aerospace also had a very strong third quarter, and year-to-date performance with margin rate increasing 150 and 90 basis points respectively.

Like INS, we don't expect this pace to continue in the fourth quarter, but for the year we are raising our guidance for their 2006 operating margin rate from approximately 9% to the low 9% range.

Electronics continues to post strong double digit margins throughout the year and we now expect their margin rate to increase to the mid to high 11% range.

Based on our year-to-date performance, we expect total segment operating margin rate at the Company level of a little more than 9%, a substantial improvement over 2005.

We expect the fourth quarter segment operating margin rate to be a positive comparison to last year's fourth quarter as well.

We are adjusting our expectation for total operating margin rate to the low 8% range to account for the legal provision we took this quarter.

Slide four summarizes our sales guidance for 2006.

We've modified our sales guidance to approximately 30.2 billion, which reflects slightly lower expectations for Information and Services and in Aerospace.

Information and Services sales expectations are primarily driven by the civilian agency's business in IT.

In Aerospace, the adjustment is largely due to the [end pose] restructuring and some small changes of Integrated Systems.

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

The updates here are on increase in unallocated for the legal provision and a reduction in our expected effective tax rate to approximately 31%.

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

During the third quarter, working capital was a source of more than $400 million, reversing the trend we saw in the first half of the year.

Discontinued operations were also a small source of cash, as we recovered some of the collections still outstanding after the shut down of the reseller business.

We generated nearly $1 billion in cash this quarter bringing our year-to-date cash from operations to about $1.5 billion.

As you saw in our press release, we planned 800 million in pension prefunding in the fourth quarter.

The recently enacted pension protect action of 2006 results in increased funding for one of our large pension plans over the next few years.

Because this additional funding would occur in the near term , we determined that it would be economically advantageous to prefund the plan this year.

Based on that decision, we now expect 2006 cash from operations of $1.5 to $1.8 billion.

On the investing side, following the completion of the 750 million ASR in the second quarter, we did not repurchase any common stock in the third quarter.

Approximately 175 million remains on our current buyback authorizations.

Year-to-date, capital spending is 493 million, including approximately 120 million for Hurricane Katrina.

Through the end of the third quarter, we've incurred total costs for clean up, repair and restoration of 348 million, and we've recovered 264 million from our insurers.

Our balance sheet continues to strengthen.

Through the third quarter we've reduced total debt by more than 500 million and we plan to retire another 690 million in debt that is maturing in November.

Net debt to total capital was 14% at the end of the quarter.

Slide seven summarizes our revised guidance for 2006 sales, segment and total operating margin, and earnings per share from continuing operations.

And slide eight summarizes our outlook for 2007 which calls for growth and continued performance improvement.

Guidance for earnings per share is based on current pension assumptions.

We'll discuss the details of our 2007 guidance, at our investors conference on November 9th.

As was the case in 2006, our focus will continue to be on improving our performance and executing a balanced cash deployment strategy.

That strategy includes continued execution of an active MAND program to optimize our portfolio and to enhance shareholder value.

We continually assess potential divestitures to enhance shareholder value ,and at the same time, as our customers needs continue to evolve, we are also assessing potential acquisitions that will enhance our future capabilities.

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

Wes, before we do that, let me reiterate what Wes said about the investor conference on November 9th.

If you haven't responded to our invitation to that please do so so that we can get our headcount down, we would appreciate that and also for the tour the day before.

With that, we're now ready, Cindy, for questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] And your first question will come from the line of Joe Nadol of J.P. Morgan.

Please proceed.

Thanks, good morning to you.

Good morning, Joe.

Could you comment on bookings?

I guess specifically the quarter, what you're looking at over the next several months , and then specifically on international bookings and Electronics which I think it slipped in the first half, were there better results in the third quarter?

Okay, Joe, go ahead, Wes.

Yes, bookings I think as you can see from the number, continue to be very strong, and we're expecting a very good year in total for our acquisitions and of course that drives our backlog for the year, so, Joe, I would characterize our view on it as continued strength.

We were helped a little bit, as we mentioned earlier this year, just in this year's number because of the rollover from last year, but that as we've gone through the year has continued to be a smaller part, the overall improvement that we've seen in acquisitions, so that overall I think is a real area of strength that we saw in the quarter and our expectation for the year continues to be very strong.

And your comment with regard to Electronic Systems is right.

As we indicated in the second quarter, there had been some delay of international acquisitions that were a component of the reduction in our forecast that we announced in the second quarter for Electronic System sales for the year.

With respect though to where that stands, there's really no change from what we described at the second quarter.

That business continues to be on the horizon for us, continues to look robust, and we were dealing more with the timing issue.

International continues to be a strong component of our sales Electronics Systems.

And then just in terms of major upcoming awards, either competitive or not?

Yes.

Joe, we are tracking a number of significant programs.

By the way I should point out that while we get an awful lot of attention and we spend a lot of time looking at the competitive awards on the margin, a tremendous amount of our sales and backlog, in fact the vast majority is from follow on business, and those are really most of the big strokes are but some of the upcoming competitive targets that we're tracking, of course the Air Force Tanker Transport program, which depending on where the government comes out on the scheduling, will probably have a down select probably by the middle or late part of next year with draft requests of proposal out currently and probably a final request for proposal out perhaps around the end of the year.

We'll see how that plays out.

There's no question in my mind that that program is going to go forward and it's going to be huge and creates a tremendous upside opportunity for this Company as we proceed.

DDG-1,000 construction is ahead of us, as we mentioned.

The design contracts, which are substantial in themselves, have been awarded and we're proceeding on those, but of course the construction of our DDG 1,000 in the Gulf will be very important.

The broad area of Maritime Surveillance Program, which I mentioned, is the Navy unmanned air vehicle, and there, we see an RFP coming out fairly shortly and a down select in the near term.

These are probably not the fourth quarter events but they are probably first half of next year events.

The same thing with the Naval U-cast, the unmanned combat air system.

The flat sequence program is an interesting one we haven't told you about that before.

That appears to be a sole source procurement of up to 100 production systems in support of the U.S.

Postal Service, and it could be on the order of $300 million in the initial [trounch], and another $5 or $600 million next year, depending upon how the Postal Service proceeds.

We're competing on the State of Texas IT Outsourcing job, very similar kind of arrangement to the one which we were able to win in Virginia and also in San Diego county, and something on the long range horizon but one which we will have some nearer term potential, probably later next year will be the long range Strike System which would be the Air Force's next generation bomber, and while that bomber may not get actually fielded until 2018, there will be some early funded efforts on that probably starting later next year.

So a lot of things on the horizon and probably several hundred smaller things we don't mention.

On the IT front, I think you noted that you reduced your revenue guidance slightly for the year.

Could you comment a little bit more on any weakness you're seeing in the IT market?

And you have been augmenting your business by going after more state and local, is that due perhaps to, I guess you're looking ahead and seeing some slow down there?

Yes, Joe, it's Wes.

Let me give you a little bit of characterization of what we're seeing in the IT space.

We're continuing to see very strong growth opportunities in the intelligence side, in the defense side, and to your point, the commercial state and local.

In fact, we've had quite a bit of success over the course of the past 12 months in the commercial state and local with the Virginia outsourcing job and the San Diego job as well, and so we continue to see that as a lot of opportunity.

The place where we have seen the weakness has been in the civil agencies business.

That represents about 30% of the revenues in IT.

It has turned out to be the most challenging market segment for us relative to growth and I think that's a broad characterization, not just for us but for that market space as well.

So it is an area that we are continuing to drive on.

We have had some recent successes, some recent new awards in that area but they really haven't translated into the type of top line sales growth that we're seeing in the other three parts of our IT business.

So continued focus, we do see opportunities emerging in that space, but it is primarily the civilian agencies performance for the year that's reflected in the slight moderation in our projection for sales for '06.

Just on that, Wes, do you think is it a market issue or a shared issue in the civil?

It's a market issue.

We see it as a market issue.

Okay and then just one more.

On pension, you noted that you haven't changed your assumptions as part of your '07 guidance but you are making that large contribution in Q4.

Are you factoring in, I guess, an improvement in pension net-net '07 over 06 just because of that contribution?

Yes, let me be clear on what I mean when I say we're not-- that we're using the same pension assumptions.

Those are the assumptions that we use that we go through in some detail in our 10-K.

Things like the discount rate, the pension returns.

We make an assessment of those at the end of each year, based on the economic conditions that are in place at the end of the year, so it's premature for us to make any changes in those, so as we've talked about our guidance for next year, those assumptions are the same.

Now, that's a little bit different than saying that FAS and CAS numbers are all the same because those have a lot of other variables in them as well.

We'll go through that a little bit in detail at the investors conference a couple weeks from now.

Okay, thank you.

Thank you, Joe.

And your next question will come from the line of Byron Callan of Prudential Equity.

Please proceed.

Yes, good morning, good afternoon, gentlemen.

Good morning, Byron.

Wes, you talked a little bit of acquisitions.

I realize you're probably not going to comment about divestitures, but what are you seeing or what are you thinking about here?

You had people like BAE and SEIC probably have some more powder in their horns with some recent changes at both companies.

I mean, are you still talking about kind of niche touching acquisitions or something larger?

Well, look.

We obviously can't be too specific at this point, Byron.

We have said that we're going to continue to look at potential acquisitions that make sense that would bolt on to our core businesses.

Areas of particular interest to us are [inaudible] arena, the Technical Services arena where we've made a significant organizational move and have had some very good recent success, and also in the IT space fairly broadly.

We're also looking at our portfolio at all times to see if there's some pieces that may be worth more to somebody else than to us and our shareholders can benefit from that activity so we are looking at that.

We're fortunate to have a very strong balance sheet.

We have the flexibility if we need it, but we're also putting in some very significant discipline in our thinking in both sides.

Okay, great.

One follow-up if I can.

Just I know you really haven't talked about the individual break down in sectors for 2007 but, on Information and Services on the civil side, I mean, is that something you expect to just moderate in 2007 or is it going to continue to be a headwind?

No.

We expect to see that moderating based on what we can see today.

But again, we'll go through some more detail on that a couple weeks from now.

Understood.

Thank you.

Thanks, Byron.

And your next question will come from the line of Steve Binder of Bear Stearns.

Yes, Ron, maybe you can just touch on some of the, I mean, it's not news about the high profile losses that the Company had in the quarter, but maybe you want to touch on kind of lessons learned on any debriefings you've had with respect to a couple of those contracts?

Well, thank you, Steve.

Obviously, we would rather win than lose and we would like to win every single bid we go after.

We do have a pretty rigorous lessons learned process that we use for not only the ones we don't get but also the ones we do.

We have had debriefings with the customer.

Each bid is different.

In this particular case, we felt we had an extraordinarily strong proposal offering.

Our customer selected another player and we have had the debriefings.

We're doing lesson learned on that one.

We're applying it as we move forward to the next set of competitive procurements.

We've had a significant number of wins.

A few got away.

Overall, I would point out that the acquisitions have been up substantially overall and that's what's ultimately driving our top line going forward and then of course our bottom line.

So, we like to win.

We like to get better.

Iron sharpens iron and that's what competition is all about.

All right Wes, in the MD&A, there's talk in the space group you had some benefit from the sale of the patent in the quarter, and in ultimate electronic systems it looks like you had some headwind in margins with respect to performance and adjustments on several programs.

Can you maybe quantify the gain and talk about is that some of the same programs that we saw in Q2 that were headwind?

In terms of the FT, the patent item was very small.

I think the margin was up in ST of like around 1%, so that was just a very small item.

In Electronics, we continue to do well is the way I would characterize it, Steve.

The programs where we describe some headwind in the second quarter are continuing to move forward, on the Wedgetail activity we have entered into the INT activities, and of course we're finding the types of things you would expect to find in INT and dealing with those as we go along, but we've been able to demonstrate the functionality of the system and continue to make good progress.

Good progress as well on Block 60 and Aspes, which was the program where we took a charge in the second quarter, is moving forward and continuing to operate well within the reserves that we set up.

So we're continuing to see good forward progress at Electronics.

We will see some variability quarter to quarter in the actual margin rate, depending on the corrections that we make from time to time, but I wouldn't characterize anything that we saw as being indicative of any challenges on any particular program.

And lastly, on the share repurchase, I mean, this is the first quarter you didn't buy stock I think since second quarter of '03, and you touched on a reason why earlier, but last year, you announced your authorizations program was a 1.5 billion and I believe on the same day of the earnings release, should we anticipate an authorization program being announced in Q4?

Steve, let me just say that we still have some amount remaining in the prior authorizations and that's about 175 million remaining, and we really won't be in a position to talk about any new authorizations until we have completed the current authorizations and our Board has thought about the cash deployment opportunities going forward so I wouldn't want to get out ahead of any of that.

Okay, thank you.

Thanks, Steve.

And your next question will come from the line of David Gremmels from Thomas Weisel Partners.

Please proceed.

This is actually Alex Motamed.

The first question was, the Air Force is looking at the MPR Tip Program in [inaudible] and might be looking at scaling those back.

Can you talk about how much of a contribution those programs have been making?

Yes, it's Alex, right?

Yes, it's Alex.

I'm sorry, Alex.

It didn't come through.

The E-10 program, as you know was the surveillance airplane and the MPR Tip radar is destined to be on that aircraft as well as ultimately on Global Hawk.

The budget for the '07 was fully funded by Congress.

The President's request was fully funded and that was about a $391 million request for '07.

The Air Force in it's internal process of planning for '08 and beyond the palm has zeroed both the E-10 project and the radar that goes with it, however, we believe the Global Hawk version of that radar will continue.

So we'll see how this all sorts out.

I think that there's a long distance between the putter and the hole on this one.

There is going to be some discussion about this particularly important program and where it might end up in '08.

Currently, we've had no input of any change of our plans for the '07 time frame and we're obviously going to work with the Department of Defense to see how we can move this thing forward, particularly the radar piece of it which we think is extraordinarily important technology for the future.

Okay, great and a follow-up if I may.

On the working capital trend, you turned it around in third quarter.

Do you expect that to continue in fourth quarter?

Yes.

We've clearly demonstrated a change in the trend line going from the first half of the year into the third quarter and if you do the math on where we are versus where we are projecting we'll end up at the end of the year that we clearly anticipate some continued improvement.

Great.

Thank you.

Thanks, Alex.

And your next question will come from the line of Robert Spingarn from Credit Suisse.

Please proceed.

Thanks, guys, well I wanted to ask you a couple questions.

I thought I would just start with your implied guidance for two segments, for Information and Services and then Aerospace for the year, which implies a downtick in the fourth quarter.

Is that all sales driven?

You talked about sales softness.

Is that expressly what it is?

There's a little bit of sales softness in Information Services that I talked about earlier on the civilian agency side of IT.

And a little bit in the Aerospace, primarily [in pose] at ST and a little bit of a mixed bag at Integrated Systems, but I think your question related more to the difference in the margin rates if I heard you right?

Uh-huh.

Yes.

And there, we've had a very strong performance in the first three quarters of the year.

We are expecting that the rates will go down in both of those segments as we look at the fourth quarter, and so that's reflected in the guidance that we've given and that reduction in rate is really just what or how we expect the program performance to be reflected.

The first part of the year had a number of strong, cumulative correction recognitions on program improvements.

We'll certainly get the benefit of those improved booking rates into the fourth quarter but not necessarily the benefit of the corrections.

So I think that's what the you're seeing primarily.

Rob I think it's important to notice that it's in line with what we've been saying all year.

It has been.

The way that we've projected the whole year.

Right.

Yes, it's the strength that we've seen so far, so far begs the question.

Just switching over to portfolio shaping, if I may, Ron, in your early comments at the beginning of the call, you mentioned the biometric space.

Could you talk a little bit about whatever existing presence you have there and if there's any interest in perhaps building any critical mass, perhaps by acquisition and then as a follow-up to that, are there any divestiture opportunities?

Well, the biometrics base is something we've been in for awhile.

We're doing the national fingerprint identification system over in the UK and some related programs in other places.

It is an area of interest.

I wouldn't want to comment specifically about acquisitions in that specific area.

I did say earlier that we would be looking at a broad range of IT related acquisition potential if it made sense.

As you know, we did make an acquisition last year to position ourselves more strongly in the healthcare records business within [inaudible], and I would say that we'll continue to look at IT broadly.

I can't recall the second question you had, Rob?

On divestiture.

Anything in particular you're looking at?

No, other than to say that we are looking at the entire portfolio, are dozens of individual businesses, and as you can imagine in a $30 billion company, there's always going to be some areas that you think might be more valuable to somebody else than you, and where that pops up we'll obviously consider [inaudible] it up, but at this point I couldn't make a specific comment about a specific acquisition-- or divestiture.

Okay and then just finally on the KC-30, clearly Airbus is going through some issues in general and I think the general view is that some of their programs have lost focus while they concentrate on A380.

What can you do to offset that to keep your side of the program moving along?

Well, Rob, first of all, EADS, the parent of Airbus, is a very large, very successful, and by the way, financially strong Company.

And they do provide about half of the world's commercial transport aircraft to mostly airlines around the world.

The focus of their attention has been on getting 380 production unscrambled, obviously, and they had their own investor conference here a couple of days ago.

We're basing our design upon the A330.

The A330 is a very successful, very mature production program which has already produced hundreds of airplanes that are currently flying.

A lot of satisfied customers.

We think that's the best platform to base the Air Force tank replacements on.

We're working with the folks in the military side of EADS, particularly the folks in Madrid, and we have a great program under way there.

They are, I would point out, already producing tankers for the Australians and at one program they will be starting soon, we believe, for the UK, using very similar technology to the technology that we are going to jointly work with them on, so, it's a big company.

This program is a long term program.

We don't see EADS going anywhere away.

We expect they will get through their issues over time.

We're very excited about the partnership and the offering that we're going to provide the Air Force.

Thanks, Ron.

Ladies and gentlemen, in the interest of fairness, I'd appreciate it if you'd limit yourself to one question and then come back in the queue.

Thanks.

And your next question will be from Joseph Campbell of Lehman Brothers.

Please proceed.

Hi, good morning.

I have just one.

It looks like at the mid point of the revenue growth for '07 compared to 06 it's a little over 4% and I wondered if you could give us a couple of things.

One a sense of sort of what's happening to ship building within that total, and I'm wondering whether 2007 will have kind of more normal comparison for Ships or whether the impacts of Katrina will still be effecting the business next year?

And secondly, I perhaps was mistaken, but I was under the impression you were going to divest the old written guidance in Navigation Business and I thought this might be what was keeping your sales forecast sort of a bit lower than what we see from other people and I wondered if you could give us just a bit more color around this sort of the components of what's going on in the sales guidance?

Thank you.

Thanks, it's Wes.

Let me talk a little bit about Ships and I appreciate you asking that question.

As you know, as we've gone through this year, we've had a negative comparison in most cases year-over-year with Ships due to a couple of things.

One is the DDX restructuring and the other is of course the impacts related to Katrina.

As we go into next year, I think you actually characterized it well.

We would expect to see a more normal characterization of the Ship sales profile.

We're expecting the recovery, the Katrina recovery activities to be largely complete around the end of this year, the early part of next year, a couple of variables in that of course are the labor equation, which we continue to address, as well as simply the rebuild out of the shipyard which is progressing very, very well.

So to answer your broad question about that characterization , I would say yes, next year, we would expect a more normal profile on the top line for sales with Ships.

Now the one caution I would give is that when we took our booking rates down for the programs associated with the impact of Katrina, it will take a little bit of time for that set of programs to run out, and so when we're talking about the margin rates in Ships there will still be a lingering effect of those lower booking rates for some period of time, certainly into 2007, and we'll go through that in some more detail when we get to the investors conference.

With respect to your question about divestitures, we simply do not comment on divestitures.

Any point in time when we make a decision as to a plan to sell, we make a firm decision to do that, and then of course we would move things into discontinued operations and our guidance would then reflect that.

But at this point, I would not have anything else to say about any plan of divestitures.

Just to be clear, the 4.3% is not being held down by lower than average Ships, nor does it include any planned divestitures that you know about but we don't in the numbers ?

Yes.

That's correct.

That is correct.

Thank you very much.

Thanks, Joe.

And your next question will come from the line of Ron Epstein of Merrill Lynch.

Please proceed.

Yes, good morning.

Good morning, Ron.

I was wondering, Ron, if you could walk through some of the international activity going on and maybe some of the international prospective things that you guys could win?

Well, there are a variety of programs, some of which we can talk about fairly openly, a few we cannot just because of the sensitivity of the nations we're involved with.

I can certainly say that in Electronics, we have a significant set of overseas activities.

One we can talk about is the work we're doing in Jordan with their air defense and [C4ISR] programs.

Another area that we've been very excited about and doing a great job on has been the UK's AWACS program, in that program, we're involved in overhaul maintenance upgrade of the UK's AWACS fleet and we believe there will be a variety of other activities there that will naturally stem from that and that program is going very well for us right now.

We have some opportunities as well in the Far East.

The Mesa product line, working with our partner Boeing, the near term opportunity there is with the republic of Korea.

This as you recall is a 737 based airborne warning control system.

We're doing upgrades on F-16 for Pakistan and potentially with India working with Lockheed Martin who is the aircraft prime there we have significant Electronics content as well, so a variety of things around the world.

I would also mention that there's considerable interest in Japan and other countries in the Pacific rim who are allies in the potential of unmanned surveillance aircraft basically a Global Hawk derivative, that's something which is increasingly a concern to them given the concern about obviously the Korean [belligerency] that's emerging, [inaudible], as well as concern about the ability to do Maritime control.

And finally, I would tell you that in Europe, in Germany, there is interest in the Euro Hawk ,and we believe we're close although we haven't seen it yet, but close to potential start there with our partner EADS who is priming it from their side but we're providing the Global Hawk airframe for that opportunity.

So a lot going on, a lot of potential opportunity.

And just one follow on if I may.

You talked a bit about the civilian agency IT work.

Can you say, how is that work structured?

Is a lot of that fixed price, is it cost plus, particularly in the civilian world?

In the civilian world it tends to be more cost plus.

Sometimes their IDIQ contracts with fixed rates but in fact, variable work authorizations, task orders, so it tends to have the characteristic of being lower risk, but also lower margin than you might be able to get on a firm fixed price long run if you do it right.

In the civilian state and local you might tend to see more of the other.

It is a mixed bag, Ron, and obviously when we bid these things we look very carefully at the risk reward and determine how do we make these bids and sometimes we will not make a bid because we just don't see the economic opportunity for the Company.

Okay, great.

Thank you.

Thank you, Ron.

And your next question will come from the line of Robert Stallard of Banc Of America.

Please proceed.

Good morning, everyone.

Good morning.

I was wondering if you could give us an update on the Katrina insurance situation and your expectations for when you are going to get the recovery of these moneys.

Well let me, Wes, you want to take this one?

Sure, I mentioned earlier that we are making progress in recovering the funds in that first layer of insurance up to $500 million.

We recovered about 264 million.

With respect to the amounts above 500 million, and that's about 850 million in property damage, and also in August , we did submit our claim for business interruption insurance and that's a little over $350 million, those claims apply, as I was saying, to the amounts over 500 million that we have a legal dispute with the provider of the insurance itself.

The trial date for that dispute has been moved to June of next year, and so we certainly would not expect any resolution earlier than that, and I certainly would not want to predict what the timeline might be associated with that legal process.

But you would expect the element up to 500 million to be refunded in a fairly steady basis?

Yes, yes.

Now, we've been working very well with all of the providers in that block and we expect to see that continue to progress in a positive rate as it has been.

Okay, thank you very much.

And your next question will come from the line of Heidi Wood of Morgan Stanley.

Please proceed.

Yes, good afternoon, gentlemen.

You talked about the opportunities on the international side.

I wondered, Ron and Wes, if you could also take us through what you see as sort of key program competitions in '07 that we should watch for?

Well, Heidi, we did go through those but let me just highlight it one more time.

Clearly, the biggie is going to be the Air Force Tanker Transport program.

That's a big one.

The BAMS competition, the naval UCAS, the Unmanned Combat Air System is going to be a significant competitive activity , the State of Texas IT Outsourcing, those are three or four or five that kind of jump out.

A long range strike, the next generation bomber will start to formulate an early set of technology competition.

It's nothing anywhere approaching an actual down select to provide a bomber, but that effort will have some significant dollars put against it we believe in the Air Force palm and certainly Northrop Grumman, who built the B-2 bomber, and has been involved in all sorts of this kind of stuff will be very much involved.

So those are some examples and there's probably dozens and dozens of other ones.

I would point out, Heidi, that one of the things that we have to keep focused on is that the competitive bids are very highly visible and they are fun to watch and they could move the needle a percent or two in terms to top line.

The most significant work that we do is because of our positioning and we're able to get follow on business which is very substantial which accounts for the majority of our acquisitions in backlog at any given time.

Just a quick follow-up.

When you look at the balance of your guidance for 2007, sort of the risks and the opportunities that you've got, Ron, I thought that maybe one of your greatest opportunities for margin upside might be in ship building, but I think Wes addressed that.

So where do you see the greatest opportunities for up margin upside in 2007?

Yes, Heidi.

We're going to cover that in some detail at the investors conference in a couple of weeks, but I would simply say that across the business, we continue to work on margin expansion.

We've made quite a bit of progress this year, I would say, so, as we think about where our opportunities lie, Ship Systems will be-- or the total of Ships, between Ship Systems in Newport News continue to show some improvement but tempered, as I said earlier, by the fact that the lower booking rates from Katrina will still be in play for some of the programs, but for the other three segments, continued focus in working our way up the curves.

INS has had very strong performance this year, and their opportunity for continued expansion will be somewhat less, I would say, simply because we have captured so much of that margin rate improvement.

But across-the-board, it continues to be very very strong focus for the Company.

And Wes, I'm sorry, just one last one.

The margin trends on the nuclear side, can you talk to us about what's happening at Newport News, specifically?

Newport News continues to do very very well.

We had a very strong quarter in the second quarter because we had some material incentives on the submarine activities that we recognized in the second quarter.

That provided a big bump in that one quarter that I would not want anyone to understand as characteristic of the run rate of that business, but in aggregate, Newport News continues to do very well, high single digit-types of margins.

Yes, Heidi if I could just add, we're really pleased with the progress in that yard in the last year or two, not only the excitement of commissioning the CVN77, and the delivery of the Texas which is the first submarine that yard has delivered in a decade, but as we look at the upcoming submarine work, we're seeing improvements continuing improvements in terms of productivity, of man hours, and we're very excited about that, and over time we're going to get the two submarines a year jointly with our partners General Dynamics and that will happen in either 2012 or potentially even earlier.

There is some view that should happen earlier and that Congress may, and the Navy may in fact propose that earlier and that will just give us additional momentum there.

That's not something we can count on or bank on, and it's certainly not an '07 issue but that yard is doing very well.

Great.

Thanks very much, gentlemen.

Thanks, Heidi.

And your next question will come from the line of George Shapiro from Citigroup.

Please proceed.

Good morning.

Good morning, George.

If you looked at the Mission Systems business, you commented lower volume of the ICBM stuff.

I wonder how much of that is timing and how much is just ongoing because I mean, that's kind of been a traditionally long term program that you had, and then in the other side, the Technical Service is a big step up primarily as you mentioned from the Nevada Test site.

Is that a new run rate for that business going forward?

George, the ICBM program has been a wonderful program for the Company.

In fact it goes back to 1953 in various forms.

The Air Force has a very high level of activity under way now but that activity is going to be phasing down in the next couple years as we complete the current cycle of modernization of the ICBM's out on the silos.

And so we would probably see that as a trending down in the next year or two in terms of revenue, and frankly, as the kinetic energy interceptor comes on stronger we would hope that that would more than fill the gap going forward.

These are of course always subject to Congressional decisions.

Wes, you want to say something about the-- ?

Sure.

George you said it right.

The primary driver for the increased sales is the ramp up in the Nevada test site program, which is a long term program for us, and we expect to continue to see strong revenue there.

Also, in July, the first of July, we did transfer some businesses into Technical Services from Electronics Information Technology, Mission Systems and a small piece from Space Technology as well.

We included a schedule, Schedule four in the press release that shows how the reclassification worked between the sectors.

But that also increased, it was reflected in the increased number.

I would just say broadly though that we do see Technical Services as a growth area for us and as we look to the next few years, we would expect to see a very good growth rate coming out of that part of our Company.

And Wes, is the Nevada test program then pretty much up to full rate here or it's going to ramp up in the fourth quarter and then kind of hold?

Yes.

I think that it will get up to full rate probably this next quarter and then hold.

It's a remarkable program.

We transferred and brought on 3,000 people around the middle of the year here and it's very interesting and sophisticated work.

It's a very significant opportunity set for this Company.

We've never been very significant in the DOE space.

This is a huge opportunity and we think there will be some other related opportunities as a result of our performance here.

And one last one if I can.

The space technology and margin where you said it's 1% benefit from a patent and improved performance.

Can you split how much was the patent, because I assume the improved performance continues and the patent doesn't.

Yes, the improved performance in advanced CHF will continue.

They were both very small, George.

They were offsetting a little bit of downside that we saw in some of the other parts of the business which we would not expect to see on a run rate basis, so overall, we're continuing to see ST demonstrate continued margin rate expansion.

Okay, thanks a lot.

Thanks, George.

And your next question will come from the line of Doug Harned from Sanford Bernstein.

Good morning.

Good morning.

On the Aerospace, two things that I come away with is, one, you've had some very good margin performance over the last two quarters, and then on the other side the revenue growth has been very flat, and when I look at that compared to the very large backlogs you've got there, total backlogs, what is happening there?

Why is that flatter?

Yes, Doug, let me give you a little bit of flavor on that.

There's two pieces to Aerospace, of course there's a Integrated Systems piece and the Space Technology piece.

On the space technology side of it, there's a relatively low growth rate, low to flat growth rate ST comes in big chunks with big program awards, and it has done very well over the last few years in capturing some meaningful program awards but it is executing on those and we expect that we'll continue to see that sort of very low rate there.

With respect to Integrated Systems, we have a different situation.

Integrated Systems, we're beginning this transition on a number of programs from design to production, and typically, and I'm just going to use the E2D program as one example because it was something we described for a little bit in the release, typically when we see that transition between design and production, we do see a sales dip as we go through there, and we will expect to see some of that ,certainly as we enter the fourth quarter and going into next year as well.

What happens typically is when you're working hard on the design phase, you staff up to really get the detail design completed to get yourself through the critical design reviews, and then you go into a period like on E2 when you're in transition, and for example, on E2, we're going into the period of time where we'll be doing the pilot production and then entering the long range initial production and so we expect to see good margin opportunities.

We expect to see long term very good sales on that production business, but it's this transition period that will be reflected in lower sales.

But on Integrated Systems, it's been very impressive, the margins you've gotten in the last two quarters and if you think of this as, it's been something that you've looked at as more development oriented and moving to production with some potential margin expansion in the future.

Is what we've seen in the last two quarters, are these to some extent due to one-time items or are you getting better performance than you would expect given the business mix?

It's a combination of two things.

There are some improvements that we've seen as we've gone through the development programs and we've been able to hit the risk retirement milestones on those development programs , we're able to make upward adjustments in the booking rates that capture the cumulative corrections, so those I would characterize as more of the one-time.

There are other areas though where we have entered production and we're doing well that are sustainable, a good example there is the FA18.

We are generating good margins on that business and that certainly is sustainable as we go forward, so it's a mix of both effects that you're seeing and the work that what you have seen so far this year.

Okay, great.

Thank you.

And your next question will come from the line of Cai Von Rumohr of Cowen & Co. Please proceed.

Yes, thanks so much.

If you could explain a couple of things of margins and the implications.

The margins in Tech Services were 6.5 which looked pretty good given the build on Nevada test presumably is very low margin.

Should we expect that to continue?

And secondly, in Ships, you're back down to a 6% type of margin.

How much of that is mix?

How much of it is performance at the southern shipyards?

And as we go into the fourth quarter should we see the normal kind of hocky stick at Newport to kind of lift us?

Yes, Cai, let me touch on both of those.

Tech Services, 6.5% is a very good rate for Tech Services.

We typically would not expect to see it running quite in that range.

We did have some actions in the quarter that boosted a little bit.

Typically we would be on the lower end in Tech Services and big programs like Nevada test site, typically have much lower margins but are very, very good cash generators with almost no cash investment, so they are very good return businesses.

So your characterization going forward there is correct that we should expect slightly lower margins in Tech Services than what we saw in the quarter.

In Ships, we are on track as we indicated in the earlier part of the call to bring it in right around 7% for the year.

I think year-to-date we're at around 7.2%, so the annual forecast pretty much aligns with the year-to-date performance.

There was a bit of variability as I mentioned earlier in the second quarter where we had a little bit of a pop-up due to the recognition of some material incentives at Newport News.

To answer your question though about what is shaping, what is the mix and what is shaping that, your thought is correct.

The Newport News margins are substantially higher than the combined outcome and the performance in the Gulf yards are substantially lower still reflecting the impacts of Katrina.

Okay, thank you.

Thank you, Cai.

And your next question will come from the line of Eric Hugel of Stephens Inc.

Good afternoon, guys.

Wes, Ron, can you discuss the growing use of IDIQ contract structures and what that means for the overall top line and margin predictability of your business going forward?

Well, Eric, you have to think of it as a portfolio as a hunting license.

What you end up doing is winning along generally with many other contractors the right to be able to participate in responding to task requests from an agency, and then you really basically put in a set of mini proposals on a task by task basis, so if your entire backlog depended upon one IDIQ contract there would be a high level of volatility and your ability to predict, but there are in fact many, many of these that go across our Company and they do in fact tend to give us some sense of predictability on the aggregate.

There are a couple of them, in particular, one, that we just received which is a very large IDIQ contract where we were the sole provider, and those tend to be more interesting because we do know the budget that the agency has and we know that the barring something unusual, most of those tasks are going to come to us as a result of being the sole guy.

So it's an increasingly interesting market that we're in, but that's the market that we are in and I think in the aggregate we can give you some general prediction and our guidance reflects that.

I would note that, our practice as far as IDIQ is that we don't put it into our backlog and we do get a funded task order from the customer.

So even though you see large numbers and the potential, it's not in the backlog.

Yes, the backlog is just those who are firm orders.

They are only reflected in the backlog.

Thanks.

Okay.

And your next question will come from the line of Howard Rubel of Jefferies.

Please proceed.

Thank you I have a question sort of to cover some of your cash comments.

When you talk about your outlook, you include this $800 million pension contribution.

What about the tax implication there?

And then also the same with the legal settlement, I mean because in both of those cases, those are significant differentials between just merely subtracting the $800 million, Wes.

Yes.

We do as we think through it, model of course the entire set of implications, both in the P &L side and on the cash side, Howard so we have thought through the tax part of it too in that in the way that we're looking at our guidance.

But that would mean that because of the legal settlement, your cash is going to be a little bit better than your original outlook.

Would that be a fair thing to say?

No.

I would not necessarily draw that conclusion.

Cash will follow payments on legal settlements, and as we indicated earlier, we're not in a position to predict at this point what the outcome would be there.

That was a provision to earnings, Howard.

Right exactly.

But [inaudible] this year, well all right.

And then the related thing is the fact that you didn't repurchase any shares in the quarter, you talked about sort of looking at the business.

Is there, could you elaborate a little bit on this ongoing issue, that's sort of preventing you from buying more stock the way you've been doing it of late?

Well, let me address that in particular.

To date, this year, we have spent about $825 million in our share repurchase programs and that was finishing off the final payment of the ASR that we announced the end of last year and executing the ASR that we implemented earlier this year, so $825 million was a substantial amount of cash.

If we look across our total cash picture for 2006, just to give you a little bit of a flavor of all of the moving parts , we have the CapEx that we talked about earlier, 700, 750 plus, probably around another another 200 million associated with the additional capital spending timing differences at Ship Systems, what we spend versus the insurance recoveries.

The other, another major area of cash out flow this year has been in retiring debt.

Through the third quarter we retired about 510 million in debt, and I mentioned a little bit earlier that it's our expectation that we're retiring an additional 690 million in debt later this year.

Combine that with the pension prefunding amounts and we're just being very disciplined in how we're managing our overall cash utilization for the year.

We do have about 175 million remaining in the current authorizations.

We had indicated we would get it down in 12 to 18 months and we still expect that we will complete it on that timeline.

Thank you very much.

Thanks, Howard.

And your last question is a follow-up from the line of Joseph Campbell.

Please proceed.

Hi, Joe.

Hi.

I wondered if you could give us a sense of how you think you're doing versus your peers with regard to sort of sales growth and EBIT and stock price performance?

And I wondered the extent to which you think that Katrina has held you back and just sort of how you think you're doing?

Well, Joe, obviously, it's our job to do the best we can and to do better, and while we've had significant share price appreciation we would like to see more but that's really the markets decision.

Katrina has been a very significant impact to the Company, and we've been fairly open in public about what that has been and the management attention required to deal with it.

I'll tell you I'm extraordinarily proud of how the Company is dealing with it and the people are dealing with it, and I think those who might have made early predictions that would have knocked us off our legs, they can go down and see the significant recovery.

I think they would be very impressed.

I know we've had our Board of Directors there and many others have been there.

But this Company is more than just a ship building story.

Ship building probably accounts for only less than 20% of the business.

There's a lot of other things going on, and in terms of our margins and sales in growth rates we would like to do as well was we can and we'll leave it to you all to measure us and judge us against the others.

Okay, great, Ron.

Thank you.

Okay.

At this point in time I guess we probably ought to wrap up, iI know you have other calls to go to.

So to summarize, very strong operating results this quarter, significant expansion of our backlog, we're looking for good growth in '07, and we are looking forward to seeing each of you at our investors conference and with our management team on November 9th and we'll see you in New York City.

Thank you, all.

Thank you for your participation in Northrop Grumman's third quarter earnings conference.

This does conclude the presentation and you may now disconnect your lines.

Everybody have a wonderful day.