諾斯洛普·格拉曼 (NOC) 2006 Q4 法說會逐字稿

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

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

[OPERATOR INSTRUCTIONS]

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

Thank you, Candace, and good morning, ladies and gentlemen.

We've provided supplemental information in the form of a Power Point presentation that you can access on our Investor Relations website at NorthropGrumman .com. 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. A more complete expression of these risks and uncertainties is contained in the Company's SEC filings, including Forms 10-K and 10-Q.

During the call, we will discussion fourth quarter and full-year results, including the non-GAAP measure for total segment operating margin. Segment operating margin is reconciled on Schedule 2 of our press release.

During today's call, we will also discuss our outlook for 2007. Guidance will include GAAP measures of sales, operating margin, earnings per share from continuing operations, cash from operations, and the non-GAAP measure total segment operating margin.

We also want to draw your attention to Schedule 4 of our earnings release which provides a reclassification of 2004 through 2006 results and reflects the transfer of radio systems from space technology to mission systems that we announced at our investor conference in November. This will be Northrop Grumman's new reporting format beginning with first quarter of 2007. Schedule 4 is provided so that you can adjust your models prior to the first quarter.

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

Thanks, Gaston.

Hello, everyone, and thanks for joining us to discuss our fourth quarter and full-year results. This was another year of very strong performance for Northrop Grumman. We expanded our operating margin by 80 basis points and increased our diluted earnings per share by 14%. Our fourth consecutive year of double digit growth.

We are especially pleased with our contract acquisitions for the fourth quarter and full year. During the quarter, contract acquisitions were more than $12 billion and our book to bill was more than 150%. Our 2006 record acquisitions of $38.8 billion generated a book to bill of nearly 130% for the year and we ended 2006 with a record $61 billion backlog. This is a great foundation for organic growth.

Information and services had a strong fourth quarter and year. We had substantial new competitive awards like Virginia IT outsourcing, New York City wireless, and the Nevada test site. In addition to new business, we were also awarded new production options for the intercontinental ballistic missile program and higher funding for the kinetic energy interceptor.

For the year, higher acquisitions in aerospace and electronics reflect new business awards and funding increases across a variety of existing programs as well as recovery of prior year funding delays. Increases in electronics in the fourth quarter also included several key international contracts.

Ships had a very strong quarter with $3.7 billion in new orders, including a large contract for construction and long lead material procurement for the LPD program. Aircraft carriers also contributed to the fourth quarter and full year increases with continued funding for CVN77, and 78. For refueling and overhaul, we have received nearly $2 billion for the [Vincen] during the year. Some of Ship's fourth quarter acquisitions represent early funding of items planned for the first quarter of 2007.

Turning to other results for the quarter and full year, our focus on performance continues to deliver results. In 2006, on a comparable sales base, we delivered 130 basis points of segment operating margin expansion--margin rate expansion, and 80 basis points improvement in total operating margin rate. These increases translate to a 39% increase in fourth quarter EPS, and a 16% increase in 2006 EPS.

Looking at results for our businesses, Information and Services had double digit sales growth in the fourth quarter and both Ships and Electronics had higher fourth quarter sales. All four businesses expanded their 2006 operating margin rates.

We're disappointed that Electronics includes a charge for the Mesa program, but even with this fourth quarter charge, electronics still earned a solid double digit operating margin rate. We achieved strong cash performance with cash from operations, of $1.8 billion, with $800 million of pre-funding in the fourth quarter, and total pension funding of $1.2 billion for the year. This strong cash performance, coupled with the sale of remaining TRW auto stock for more than $200 million, allowed us to continue executing a balanced cash deployment strategy.

During 2006, we took several value-enhancing cash deployment actions. We increased the dividend by 15%. The third double digit increase in as many years, and a 50% increase since 2004.

We repurchased $825 million in common stock, more than 11 million shares through accelerated repurchase agreements. We announced a new $1 billion share repurchase program, and we now have $1.2 billion authorized for share repurchases. We repaid $1.2 billion of debt, which brought us to 15% net debt to total capital ratio, supporting the highest credit rating in the Company's history, and in the fourth quarter, we pre-funded $800 million in pension liabilities.

In November, we announced the acquisition of Essex Corporation which will enhance our capabilities and participation in the rapidly growing intelligence markets. We just received notice of early termination of the HSR process, and expect closing to occur very soon. We ended the year with a record backlog that provides a solid foundation for 2007 and beyond. We captured several important programs in 2006.

In addition to this strong foundation, we continue to pursue tens of billions of dollars of competitive new business opportunities. For Information and Services, we have numerous opportunities in the rapidly growing intelligence, state and local, first responder wireless, information operations, and information assurance markets.

We are also pursuing programs such as the Aerial Common Sensor Restart, GPS Operational Control Segment, Integrated Air and Missile Defense, Mobility Air Force's Data Links Integration, Technical SIG Information factory, and U.S. Coast Guard Nationwide Automatic Identification System. For Aerospace, opportunities in integrated systems include Fraud Area Maritime Surveillance or BANDs, Navy U-cast, Euro hawk, Long Range Strike, E2D International and of course the KCX. There has been much speculation in the press regarding our bid on the KCX, the Air Force's next generation tanker.

The Air Force has indicated the RFP will be released this month and our bid decision will be determined by how well our offering aligns with the Air Force's requirements. Opportunities in Space Technology include restricted programs, transformational communications satellite, the tracking and data relay satellite, space radar and space tracking and surveillance system.

Electronics will participate in future F-22 and F-35 production, and they're pursuing the postal services flat sequencing and sorting system, as well as opportunities in counter [matpads] and counter IED. Ship's opportunities include production of the CVN78 and 79, EDG1000, CGX, Fast Response Cutter, LHA6, and other future maritime force deployment ships.

The president's fiscal '08 budget is scheduled to be released to Congress on February 5th. We continue to see bipartisan support for robust levels of defense spending. Our programs continue to be well aligned with the nation's defense priorities and we expect that they will be well supported in the president's 2008 budget.

In summary, 2006 was a very strong year for Northrop Grumman. One in which we continued to capture new business, drive performance, execute a balanced cash deployment strategy, and position the Company for the future.

For 2007, we continue to expect sales to range between $31 and $32 billion. We are increasing our guidance for earnings per share from continuing operations, from a range of $4.65 to $4.90 to a new range of $4.80 to $5.05 per share. This increase reflects improvements in pension amounts for 2007.

We continue to expect cash from operations of $2.5 to $2.8 billion. Our sales growth will be driven by organic growth at Information and Services, Ships and Electronics, and earnings growth will be generated through improving operating performance and a reduction in expenses across the Company.

Now, I would like to 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.

Hello, everyone. I will start by reviewing the results of our operations on slide three. On a consolidated basis, we expanded segment operating margin to 8.8% for the quarter, and 9.3% for the year.

For the year, we expanded our segment operating margin rate by 130 basis points. Total operating margin expanded 80 basis points for both the quarter and for the year, increasing to 7.8% and 8.1% respectively.

Slide four summarizes our 2006 performance and our four businesses. Information and Services improved their operating margin rate 90 basis points to 8.6%. Aerospace improved operating margin rate by 80 basis points. Electronics improved their operating margin rate by 70 basis points for the year, increasing to 11.3%.

The fourth quarter charge in Electronics reflects recent technical challenges we encountered on the MESA program, which includes the Wedge Tail and PC Eagle contracts. We encountered these issues during advanced flight testing and we are implementing hardware modifications to resolve them. This will require us to extend our integration schedule by approximately six months.

The charge was partially offset by performance improvements within Electronics across multiple aerospace, defensive systems, and bio detection programs. Ships also improved their operating margin rate to 7.4%, from last year's hurricane impacted rate of 4.3%. Looking forward, we will modify our reporting to reflect the transfer of the radio systems business from Aerospace to Information and Services as Gaston described earlier.

Radio systems had approximately $400 million in 2006 sales. And Schedule 4 of our press release provides a reconciliation of the realigned segment numbers. This will be a our reporting format beginning in the first quarter of 2007, and our guidance as shown on slide five is based on that new reporting format.

Looking at each of the businesses, based on the positive outlook for spending by federal agencies, as well as continued growth in our state and local and services businesses, we expect high single digit organic growth for Information and Services. Sales for 2007, include Essex and are expected to range between $12.2 and $12.6 billion, with a margin rate of approximately 8%. 2006 was an outstanding year for Information and Services, and we expect their 2007 margin rate to be moderately lower.

The business mix projected for 2007 includes higher technical services sales, primarily due to the Nevada test site. Technical services has an outstanding rate of return on investment, and mid-single digit margins.

For Aerospace we expect revenue to range between $8.1 and $8.3 billion, with a margin rate of approximately 9%. Our outlook for 2007 reflects the transition from development to production for several programs at integrated systems. In Electronics, we expect growth in international and restricted programs to increase sales to between $6.8 and $7 billion, in 2007 with a margin rate in the high 11% range.

At Ships, we will continue to recover from the hurricane related work delays, and will also ramp up on programs like LPD, LHAR, and the Benson refueling and overhaul. With these program activities we expect sales to grow to between $5.5 and $5.7 billion. Ships margin rate should also improve to the mid 8% range.

Looking across our businesses, we are continuing our focus on performance, and the outlook for 2007 is excellent. The key growth drivers in '07 will be new business capture, to accelerate our growth, and program performance to maximize our margin rates. This translates to expected sales between $31 and $32 billion, with a segment operating margin rate and a total operating margin rate, both in the low 9% range.

Slide six provides the other key components for 2006 and 2007. For '07, we expect unallocated expenses of approximately $90 million. We expect net interest expense of approximately $285 million compared with $303 million this year, and we expect 2007 net pension expense to improve to income of approximately $70 million, from an expense of $37 million in 2006.

Our prior 2007 guidance was based on the 2006 assumptions of 5.75% for the discount rate and an expected rate of return of 8.5%. For 2007, we will be using a 6% discount rate and we're happy to report that the 2006 return on our plans was over 13%. So the major drivers of EPS growth in 2007 will be sales growth, continued strong performance at the segment operating margin level, lower corporate unallocated expense, and pension income.

Moving on to cash, slide 7 provides a reconciliation of net income to cash from operations for the fourth quarter and for 2006. Non-cash adjustments for the year include $705 million for depreciation and amortization, $662 million for pension and OPEB, including an $800 million voluntary pre-funding of our plans that we announced last year.

Working capital was a source of $84 million. Deferred and payable income taxes were $44 million. Other items were a source of $155 million, and discontinued operations absorbed $74 million. All of that together brings 2006 cash from operations to approximately $1.8 billion.

Moving on to slide 8, this slide summarizes the key components of cash for 2006, and our estimates for 2007. Depreciation and amortization will increase to approximately $710 million. Pension and OPEB adjustment to net income is expected to be approximately $150 million, due to the performance of the plans, and the pre-funding in 2004, 2005, and 2006.

Working capital should be neutral to improving, and cash taxes should be approximately $1 billion. Stock-based compensation expense should be approximately 220 million. All together, we expect operations, cash from operations in 2007 of $2.5 to $2.8 billion. After capital spending of between $700 million and $750 million, we expect to have free cash flow of $1.8 to $2.2 billion.

Slide 9 summarizes our consolidated guidance for 2007. As we look forward, we expect continued strong earnings growth, driven by higher sales and improved performance. Our financial position continues to strengthen, and our record backlog gives us a solid foundation for growth in 2007 and beyond, and finally, our outstanding balance sheet supports a balanced cash deployment strategy that will allow us to continue to invest for the future through capital spending and acquisitions while at the same time returning cash to shareholders through dividends and repurchases.

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

Thanks, Wes. Candace, we're ready for questions and I would ask everyone to limit themselves to one question per turn. You can get back in the queue later if you have another question.

[OPERATOR INSTRUCTIONS]

Our first question will come from the line of Byron Callan of Prudential Equity Group. Please proceed.

Good morning, gentlemen.

Good morning, Byron.

Ron, I understand the position with KCX but it was a pretty guarded comment I thought on where are you with the bidding and I'm just curious, this program, just to clarify, it is going to have multiple literations, there is a KCX, a KCY and a KCZ, so let's just say theoretically you decide not to go after KCX does that really preclude the future portions of this depending on how this all plays out?

Byron, I think my comments really refer to the KCX competition and this is a pretty good case as I said we're going to wait and see how the RFP actually comes out from the Air Force and make our decision on that. I am not aware of any near term KCY or KCZ, there has been discussion of that over time and certainly as that plays out in the next few years those will be decisions we will take downstream.

Okay. Thank you.

Our next question will come from the line of Joe Nadol of J.P. Morgan.

Good morning. A couple of things on the MESA charge. Boeing took a charge on this six months ago, and they talked about flight testing, and I'm not sure if it was the same flight testing that you're speaking of. But could you clarify if that--if the two are related and if so, why there was the delayed recognition on your part of the charge they took quite a while ago? And also, just on some of the offsets that, in the quarter, you already talked about Electronics, but didn't quantify the Ship's pension benefit and also the other income, besides the TRW sale, that would be great.

Nice one question, Joe.

Let me take them.

It is all related.

It is all related. On MESA, Joe, I wouldn't attempt to delineate the components of Boeing's charge. I think that would be a good question for them. To answer your specific question though about the timing of our charge, it really related to the process that we've been going through, in our advanced flight testing, so this is all about the stage of the program in flight testing and where we are and what we discover as we go through advanced flight testing.

As we're going through that phase, we did encounter some technical challenges, relating to some of the performance metrics, and that caused us to commence a process of first quantifying and understanding exactly what those issues were, and then getting to root cause, and once we had a good understanding of root cause, delineating what the actual impacts would be. These are hardware issues, and so we're at a stage in the program where hardware issues mean that we incur costs not only in addressing the hardware fix themselves but also with the scheduled delay that goes with it.

And so that was the process that we went through, a very comprehensive and thoughtful process to make sure we had our arms fully around it. With respect to--you had a question on Electronics, or Ships I think was your next question.

It was Ships and other income, basically you had offsets to the charge--well in three areas that I saw, Electronics, which you already discussed, it was across the portfolio, but also you had a pension benefit I think in Ships and you had other income that is over and above the sale of the TRW gain. The gain on the sale of TRW stock. So if you could quantify those, and I guess discuss what the other income was.

Okay. Let me talk about the Ship's component to it, because I think that is a question that there was a lot of interest on, and let me back up a little bit. Because this all relates to the pension protection act, the PPA. And it is some fairly fine points regarding the nature of that act.

Under the pre-existing law, prior to the PPA, the unique status of some of our former Lytton plans actually prevented us from having KAS assignable costs just the way that KAS worked. We had FAS costs but no KAS costs under the old act.

So once the PPA was adopted it actually increased the minimum contribution levels for the Ship systems pension plans and those KAS costs became billable to the government on the Ship system's contracts. So the KAS pension contributions at Ship systems, we actually satisfied them in many cases by using overfunded assets in the plans and that created some pension credits at the sector level.

Okay.

So that is kind of the technical series of events. And like I say, you kind of have to kind of peel back through the legislation and the unique status of the plans we had at the former Lytton plans and Ship systems.

This is a situation that we think will continue going forward. We do not, however, expect that it would represent a material annual impact going forward.

We called it out in our press release because on a quarterly basis, the fourth quarter of 2006 turned out to contain the full annual amount, because when the law was enacted later on in the year, it was actually retroactive to the beginning of the year so we had to capture it all for a full year effect in the fourth quarter. So hopefully that gives you a flavor, like I say on a going forward basis we don't expect it to be a material annual impact.

With respect to your question on other income, it was primarily the gain on the sale of TRW Automotive for 2006. We had just a little bit of royalty income in there as well. I think what you might have been asking was the comparison year-over-year, because back in '05, we also had some TRW equity sale, but back in '05 we also had gain on the sale of End Wave.

Looks like there was $23 million in there over and above what you stated was for TRW.

That was primarily royalty income.

Okay. All right. And then Wes, can you quantify the pension benefit in the Ship segment for the quarter or no?

Because it wasn't--we don't expect it to be material going forward, and on an annual basis wasn't material, we typically don't quantify impacts that we deem to be not material.

Okay. All right. Thank you.

Thank you, Joe.

Our next question will come from the line of Doug Harned of Sanford Bernstein. Please proceed.

Yes, good morning.

Hi, Doug.

Could you talk a little bit about the outlook for Information and Services? You said that the growth you expect going forward a significant component of that will be the Nevada test site work, but how do you see mission systems and information technology, looking over the next year?

Well, it is not just Nevada test site. That was a significant contributor this year. I think we're going to see some pretty balanced opportunities across all of them.

I went through a set of potential future programs that we're obviously looking to acquire, but I think all three businesses are going to be pretty solid over the next year. I don't think you are going to see a particular one or the other dominating.

And within that say--the areas that would be more appropriate for a task, and I would Essex as well, you're still seeing strong growth in that part of the business?

Absolutely. I think if anything, we have each stronger belief in the prudence of the Essex acquisition, given what we have learned over the last few months and keeping our eye on world affairs.

Okay. Great. Thanks.

Our next question will come from the line of Ms. Heidi Wood of Morgan Stanley. Please proceed.

Yes, I want to ride on the back of that question a little bit. We saw Khaki revise their numbers down and GD only recorded 2% average growth in the IT world. Can you give us a better sense as to why you're not seeing similar kind of slowness? I mean the others are talking about budget tightness elsewhere and a continuing resolution for the federal civilian agencies, and can you also walk us through a little bit of the puts and takes on--

Let me take a first cut, here, Heidi and Wes has some additional detail. First of all, I think it is all about where you're positioned in this area.

I think the portfolio we have is a little different than Khaki's and others. Certainly, in the area of information technology, in the high end work, and certainly the highly secure work information operations what have you, we don't see weakness there. We also have significant expansion of our activities in state and local, where we have been having some good success in terms of competitive wins, and additional programs.

So Wes, do you have some additional color?

Heidi, you asked a question, a very good question about civilian agencies and that has gotten a lot of discussion in the marketplace, not just with us, but with other companies and I thought it might be helpful just to take this opportunity to give you our perspective on where that one is going.

The civilian agency's business represents about 30% of our IT sector's revenues. And we started a process a few years ago to shift our focus within civilian agencies to areas that we saw as over the longer term having higher growth rates, things like Health IT as a good example, and selected areas, within the Department of Homeland Security.

As we underwent that transition last year, we reported a couple of times through the year that the revenue coming out of that civilian agency's business year-over-year wasn't what we had hoped it would be, within that year. Coming into 2007, we expect it to start growing again, because of the way that we're focusing. It won't be--the civilian agency's piece will not grow this year, as--at as high a rate as other components of Information and Services.

Across INS, we expect an aggregate growth rate in the high single digit range and civilian agencies for us, we expect to grow in the low single digit range, but we do expect it to grow, and we think that the work that we've been doing to focus how we're positioned on the civilian side of it will be an important component of that. As Ron said, we tend to focus more on the high end of it, within the IT sector, and we have been tuning exactly what customers we're targeting.

And can you fold in--also explain the growth in mission systems this year?

Mission systems continues to focus primarily on the Department of Defense and Intelligence communities and there has just been very good growth in the areas that we serve, again pretty much on the high end and you can see they have had just a really good year in terms of addressing that customer base, and actually in addition capturing some new contracts at mission systems for the year.

Yes, Heidi, one of the things that we should point out, obviously there is headlines associated with a few large contracts that are won or lost, but one of the things that has happened across the Company, but particular Information Services has been a tremendous success in winning competitive business in all three of those sub business areas.

Great. Thanks very much.

Our next question will come from the line of Cai von Rumohr of Cowen and Company . Please proceed.

Yes, thanks an awful lot.

Hi, Cai.

Yes, hello.

With MESA, you kind of have these continuing non-recurring issues and I know you still have some other watch list issues I think, the Greek EW, could you maybe review for us the status of the things that you view as watch list items and when you think we might be in the clear in terms of these items?

Sure, Cai, it is Wes, let me walk you through those. There has really been three areas in Electronics that we have talked about, because these were our fixed price development activities that we've undertaken for some time. Mesa, the PC Eagle and Wedge Tail programs as I described, we have entered into that phase of the program, when you're testing and you're seeing what is really going on and you inevitably learn something and we learned something late last year that we didn't particularly like and that's reflected in the charge that we took.

On block 60, let me reflect on that one for just a moment, because we have been making tremendous progress on block 60. We're now to the point where all of the prime mission hardware is complete for the radar, for the clear targeting system, and for the electronic warfare system at Falcon Edge. We're in the process of completing the balance of the spare hardware requirements. We expect to get through that by the middle of this year. So that is a lot of very, very good progress on the hardware side.

On the software side, we're also continuing to make very, very good progress. We just recently provided a new complete update of the flight program, the operational flight program and we're currently in flight tests over in the UAE, on that program. We still have some of the technical challenges that we're working our way through on Falcon Edge that were reflected in one of our prior charges on this program. But we're continuing to operate on plan, we laid out then, and within our established DAC, so we're seeing that team really execute to that plan that we put in place sometime ago, so not all of the way through the woods yet but feeling positive how we're doing on block 60.

ASPS as well is another one. ASPS is the program that you referred to, I think as the Greek issue, and on ASPS, we're continuing also to make good progress, we passed our first article testing.

There has been a little bit of a schedule slip unrelated to our company's performance on the program, just related to the overall activities, so we're carefully balancing our work force level. We're projecting that we are going to hold our EAC on ASPS as well. So the team is working hard and making good progress.

But the issue is, that you make good progress until you don't. Could you give us some sense in terms of at what time frame, I mean presumably three years, we're not going to be talking about these issues. Approximately in what time frame should we reach the end point when you are pretty sure--assuredly should be out of the woods on these guys?

For both of the block 60 and the ASPS programs, this year will be the year when we're really--have worked our way through this. We expect, as an example, to complete nearly all of the remaining significant programs--program milestones on block 60, around the end of this year.

Mesa has a little bit longer runway on it. As we get through the hardware modifications over the course of this year, we will then enter into some additional test phases, on it. We of course would not expect to find additional issues as we go through that, but until we actually go through it and see what we find, we won't know.

The type acceptance testing and evaluation phase on the Wedge Tail program which is really that kind of final, what do you know, and how well do you understand all the components of it, we expect to get started on that in the first quarter of '08 and that takes about six months to work your way through. So that is kind of the time frame for these programs.

Great answer. Thank you.

You're welcome.

Our next question will come from the line of Steve Binder of Bear Stearns. Please proceed.

Wes, maybe just finish off on Cai's question with respect to LHD. I don't think you covered that. And obviously, Deep Wood has gotten a lot of press in the last few months and maybe you can touch on both programs.

Well, LHD, this is Ron, Steve, I will take those. LHD is a large program, a large ship, and there, the progress is metered by the productivity of the work force as we've come back from the hurricane.

And we have had a turnover in labor, as you know, because we did lose a few people, quite a few people as a result of the storm, we brought new people on, we're almost fully staffed. There is still a learning curve in some of the areas, so there has been a little slower progress there than we had hoped, but we're managing that, and we expect it to work our way through that.

With respect to Deep Water, a lot of press on that program, it is a very visible program. The roles that we're involved in is basically the sea-born assets, the ships, the National Security Cutter is coming along very nicely and we have both the first and the second National Security Cutters under construction, the first one is in the water, it's checking out well. It is a good ship.

There was some talk--of concern relative to the 123-foot patrol boats, and in that particular case, both we and the Coast Guard had made a decision some time ago to fill a gap in coverage of that kind of a boat, by trying to refurbish existing and aging 110-footers and make some modifications to those to provide some stop-gap service. As a result of that, and as a result of conditions in use and sea, there have been some issues in terms of buckling and cracking, we are in the process now of understanding, root cause investigation on those small boats with the Coast Guard.

Can I just have a follow-up on Electronic systems? It looked like very strong bookings quarter, if the math is correct, it is probably your best bookings quarter in like six years, and you touch in your opening comments on strong international activity. Can you maybe just review, you used to run that 30%, 35% of your sales, where did international comprise in 2006, and is that kind of a growth area for electronic systems in the next few years?

The answer is, is a definite yes, international is an area of strong focus within Electronic systems. To answer your question about kind of what was going on in the fourth quarter, particularly in defensive systems part of the business, we won several substantial international awards in the fourth quarter. There were lightning pods for the Royal Netherlands Air Force, some [inaudible] systems for the NATO AWAX, some additional night vision goggle kits for several different countries, some EW simulators, international sales as well.

So kind of across the board, that full set of product line. We're working the international side of our business very aggressively. We're seeing a lot of interest, and that is an integral part of our growth trajectory in Electronics.

Thank you.

Thank you, Steve.

Our next question will come from the line of David Gremmels of Thomas Weisel. Please proceed.

I guess just one quick follow-up to the question on new order bookings and given the strength of those orders in the quarter, and looking at your book to bill numbers for the year, just really impressive numbers, I guess I'm wondering why we're not seeing more than mid-single digit revenue growth in '07? Does it have to do with the timing or the tails on these contracts or could there be some potential upside in '07?

David, this is Ron. I think it is largely the timing and the tails. These are huge contract awards that play out over a number of years and as you factor them into the plan that is about where we think we will be for '07 which is the first year of the award period.

If I can just ask a quick follow-up, how up Essex revenue is assumed in the INS guidance for '07?

We're not reporting, as we go forward, we're not going to pull out the components of Essex revenue. I think if you recall, what we described at our investors conference, our approach with Essex will be to actually take a part of our mission systems business that is in a similar space, roll that into the Essex operations, if you will, so that we quickly integrate and capture the synergy opportunities there, so we're not going to be pulling those pieces out separately and trying to report it.

Okay. But just to confirm, that is baked into the projections?

Yes. That's right.

Thank you.

Thank you, David.

Our next question will come from the line of David Strauss of UBS. Please proceed.

Thank you. At the investor conference, you laid out long-term margin expectations or opportunity for all of the businesses, and if you look at INS and Aerospace, you're already kind of in that range. Could there potentially be more upside than the 8% to 9% you laid out for INS and the 9% to 10% that you laid out for Aerospace?

INS, I would say that it really depends, as we go forward, on the mix of business that we end up addressing. As I've described a little bit at the investors conference, we are very interested in the technical services space.

We see substantial opportunities for organic growth taking advantage of that full capability that Northrop Grumman as a full enterprise provides and applying it to that space. Technical services is on the lower end of our margin scale. And so the growth there would be solid top line growth, pulling through margin, so it would be certainly accretive to EPS, but it would be dilutive to the margin rate, within INS.

So there is opportunity for a higher margin rate, if we have perhaps less growth in technical services than we would like to see. Our focus there is going to be improving total operating margin dollars, and growing that pull-through effect to EPS, if it means that we operate towards the lower end of that 8% to 9% range, then the higher end of that 8% to 9% range, it will be because we made a decision that is the best thing for our total earnings.

In Aerospace, the range that we talked about at the investors conference was sort of a 9% to 10% range. That largely depends on the time line of the actual production ramps on several of the programs where we're transitioning from development to production, and it depends on our success in capturing new development work.

To the extent that we're more successful in capturing new development work, that will be additional sales, but at lower margin rates during the development phases. That is something we would be happy to do, even though it would bring us down lower in that range than closer to the top end, because again, it would be both accretive to our overall operating margins and our earnings and it helps lay the foundation for the continued growth of the Company over time. So those are the variables that will impact where we come out in those ranges.

Okay. Great. One quick follow-up on that, if I may.

Looking at Integrated Systems, you've talked about that business slowing a little bit, as we transition from development through to production this year on some big programs. When is the inflection point when that business starts to actually pick up again as we get further along in production?

If you're just going to focus on the production piece, it is a little bit of a different answer than if you talked about sort of the total pickup on the top line because the top line obviously will be driven by some of the new program capture opportunities that Ron described earlier. Just the transition to production happens over the course really as we get into '08, as kind of the time line that we described. If you look at the E2 program, for example, we were kind of running hot and heavy on E2C, we were running at around I think 5 to 6 aircraft per year in production on E2C.

That is ramping down. I think this year, we're in the range of a couple of aircraft on E2C, and E2D is just going to start up the curve and not really get into pilot production until '08, and [El Rip] is in '09 and '10.

So it takes a couple of years to get through those types of transitions. So again, the two effects, the timing on the production ramp, but also the successful capture of new development work together will impact the top line growth rate.

Thanks, Wes.

Our next question will come from the line of Rob Spingarn of Credit Suisse. Please proceed.

Good morning, everyone.

Good morning, Rob.

I think you were very clear in saying earlier in your comments that your guidance increase reflects the adjustment in the pension assumption but are there any other puts and takes in there? And could you clarify--I think you also said that Essex and albeit, it is small is in the current '07 guidance, was it in the November 9th guidance?

Let me just talk about the two questions separately. First, the total amount of the increase in our EPS guidance is completely the result of the change in pension. Both the change in the discount rate, and the pension plan performance, the return on pension plan assets from last year. So that accounted for that difference going forward.

Essex was not in the guidance when we gave it at the investors conference. It is in this guidance. Essex turns out to be neutral to EPS for this year. So it is almost a fine point in whether or not it was in or not. But going forward, as I was saying earlier, all of our information should--you would expect would have Essex in it.

Wes, I noticed that the sales guidance is the same. Is that just because Essex is so small? Yes, it is well within the range. We gave a $1 billion range on sales guidance so we didn't think it was appropriate just to start shifting things around by those types of amounts at this point in the year. Thank you.

Our next question will come from the line of Eric Hugel of Stephens, Inc. Please proceed.

Are you there, Eric?

Sir, your line is open.

Hello?

Hi, Eric.

Sorry. I didn't--I don't know why I didn't ask a question. I'm sorry.

Okay. Bye, Eric.

Our next question will come from the line of Joe San Pietro of Wachovia. Please proceed.

Good afternoon, guys.

Hi, Joe. How are you?

Good. Good. Just want to spend a little bit more time on the growth prospects for the top line. Ron, you gave a litany of potential upcoming programs that you folks are going after. And my question is, could you kind of handicap and give us some parameters around them versus what was in your forecast already, I guess just sort of a quick [inaudible] analysis if you can?

Well, look, first of all, we will probably submit thousands and thousands of competitive proposals this year. I'm going to guess at least 5,000, maybe more. And the challenge is that while it is nice to pick out one or two, as you can see from the actual results this year, with the blowout competitive acquisitions, that it is really a game of a large numbers. So I did run through a number of interesting programs, many of whom will happen, some will not happen because of funding delays, and of course, we would love to win every single one of them, we won't necessarily. But on average, where we think we are going to be is being able to continue to fuel growth with the Company going forward.

We've guided you through '07. We are not ready to give '08 guidance. Very difficult to really go beyond that frankly, Joe, in any detail. There is no one -- put it another way, there is no one or two or three programs that are going to drive the needle in '07.

Right, and that's exactly right. The great--this is Gaston, Joe. The great preponderance of our '07 sales comes out of current backlog. Those new programs really go into the future.

Okay. And along those lines, the--you said that the IT revenues associated with the civilian agency programs this quarter was delayed. And you said--or I'm sorry, accounted for some of the offset, and did you say it earlier on, I think it was Wes, that these programs are--should be ramping up in the beginning of the year? Health care, and what was the other one?

Joe, what I was saying about civilian agencies was that if we look back over all of '06, it did not grow at the rate that we would have liked it to have grown but in part that was because we had been working to reshift our focus within that market space, to areas that we see emerging with higher growth rates, like Health Care, and some parts of Homeland Security.

So as we look at the comparison between '07 and '06, we do expect to see low single digit growth in our civilian agencies work, it is not the rate of growth that we see in some other areas, within our IT sector, but it is on the right path and we think we're positioning it very well for the future.

Okay. Thank you.

Our next question comes from the line of Robert Stallard of Banc of America. Please proceed.

Good afternoon.

Hello, Robert.

I just wanted to ask you a question about the acquisition pipeline. You made the Essex deal relatively recently. Should we expect further deals of this sort of size over the next 12 months, and would you be prepared to pay the kind of price you did for Essex again?

Robert, this is Ron.

Well first of all we won't comment on any specific acquisitions but we have told you that when we talk balanced capital deployment we are talking about acquisitions where they make sense and where they fit. We have obviously a clear interest in three areas that tend to match where we think our strategic emphasis is going to be, C4ISR, Technical Services, and IT, particularly in some of the expanding market spaces.

Clearly, value is important to us. And what we pay for a particular company will depend upon what it is worth to us on a discounted cash flow basis so I would say that we will look at each one of these as they come up. I can't give you any specific predictions of if and when and how or how large.

Okay. Thank you.

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

Good morning.

Hi, George.

Ron, if you could go through, back on the KCX, I mean there has been a lot of stuff written about what you would like to see in the RFP. Can you go through at least a couple of specific things that you're looking for that would make the decision as to whether you bid for that program or not?

George, we are now pretty much on the eve of receiving the--what we expect to be the final request for proposal from the Air Force. We have had very thorough and engaged discussions with the Air Force as part of the process, reviewing two draft RFPs.

Our communications to the Air Force, we have not publicized those, that is between us and the Air Force. And I guess what I would say at this point in time is we will wait and see how the actual RFP is structured and we will make an assessment of that and based on that determine if we have a competitive offering and that is really about as far as I can go at this point, George.

Okay. And just a different area, in Ships how much are you feeling at this point that you are still being penalized, whether it be margin, or revenues, because of the lasting effects from Katrina?

Yes, George, that is a good question.

You will recall that we, at the end of 2005, went through a very thorough process of looking at all of our booking rates on all of our programs down at Ship systems, and built into our booking rates, the effects that we saw from Katrina, that resulted in both a cumulative correction that was a charge in the third quarter of 2005, but also it resulted in lower booking rates for the lifetime of the contracts that we had in place at that time. And that is in effect that lasts through this year in a bit into 2008.

If you look at the new contracts that we're taking on, obviously we're building in to those new contracts the full cost effect that is a result of all of the Katrina activities. So the newer contracts don't represent that much of a drag, but certainly through '07, and for some of the programs, where the contracts were in place, at the time of Katrina, there will be some lasting effects into '08.

Can you quantify it at all or no?

No, it sort of goes contract by contract, and we look every quarter, very carefully, contract by contract, how we're doing against what we had set up, so it is a lot of low level details on a piece by piece basis. I guess I would say, if you look at where we are on our overall reporting, if you look at our release and where we are on Ship systems, or total ships right now, you can see that it is not the level of margin rates that we have enjoyed historically. Newport News is operating very, very well, and operating at their--I would say at historic levels of really good performance. But it is being offset by the performance down at Ship systems. So in terms of quantifying it, it is more of a contract by contract assessment.

Okay. Thanks.

Our next question will come from the line of Howard Rubel of Jefferies. Please proceed.

Thank you. First, to remark, I think it was very helpful, Ron, that you started out with the highlight of what you're thinking in terms of opportunities, and also the presentation in general is a bit more organized, and it is very helpful to have the data.

Thank you, Howard.

Because you don't always get that, and I know how much work that involves so I appreciate that up front.

You bet.

And on that note, you seem to be functioning so well, have you given up on the CFO search?

Well, Howard, we have a wonderful CFO here, but we also have other things we need to have him do, as we look to improving our operating performance now and then. The search is underway, and as soon as we have a decision, and an announcement, we will announce it.

And--well, I'm not even going to go any further than that. Thank you very much, gentlemen.

Thank you, Howard.

Our next question will come from the line of Joe Campbell of Lehman Brothers. Please proceed.

Good morning, all.

Good morning, Joe.

I have a question again about--it has been asked several times about sort of the revenue and the growth rate and so on. You have--maybe we just don't appreciate the amount of work that it takes to feed a $30 billion beast, but have you $39 billion of acquisitions which looks tremendous compared to what you did before, and yet if I read the guidance right, it seems like the segment operating margin before the pension and the headquarters stuff, it looks like it is going to grow 3% or something.

And I'm wondering if this is--have you taken--does this fully consider all these big new budgets we've all been talking about, and is it--I mean is this reaccelerating or is just this--this just kind of what happens as the outlays from all of these big budgets we've had for several years now, kind of get to more equilibrium, because it is not a lot of growth rate for all of the excitement we've had about budgets, and all of the excitement that I am sure you feel for $39 billion of acquisitions.

Well, Joe, this is Ron. Well, first of all, there is obviously a timing issue but there is also characteristics of these large budget outlays which I think you're referring to the federal budgets and the supplementals.

Northrop Grumman, it was not structured to position to play for supplementals. We obviously get some benefit from them but we do not probably significantly benefit as perhaps some other companies do, and over time, those are going to hopefully make way to the normal budget as well. So we play more in the normal RDT & E and procurement accounts.

Secondly, the awards come in chunks, as you know. We're absolutely thrilled this was a blowout quarter and year for us for acquisitions and by the way, many of them competitive acquisitions, which many of which did make headlines--did not make headlines, but a tremendous result there, and they will play into the system over time.

You're right, it is a $30 billion machine, you've got to bring in $600 million a week to stay even and a little more to grow and we have given you the '07 growth rate, which is our best judgment, and much of that is affected by acquisitions that have been made in previous years, and what happens in '08 and beyond, we will see, as we roll toward that forecast.

But did I understand, and I mean it wasn't quite clear to me what you meant by low nine whether you were sort of signalling that the overall segment OM margin, not the operating margin, but at the segment level, whether that is actually contracting a bit, but of course, you said well, we've got some faster-growing low margin stuff, so I just tried to do the arithmetic on the segment OM growth rate, and it is benefited by the Essex acquisition and there may be something else I forgot in there but I mean it appears to be less than 3%, and I'm trying to figure out whether we should simply think of this as the sort of decelerating aircraft carrier that is $30 billion of Northrop, or whether--despite your reluctance to talk about '08, whether we should think of this as something that could reaccelerate or not?

Yes, Joe, this is Wes.

Let me touch a couple of things that you talked about. On the OM side, we're giving you our view for '07, as we see it today, contemplating what we think that mix looks like, and so we have talked about the mix, I think you referred to it as well in your question itself, and the two big mix things are the mix on the ramp into production, and the--in aerospace, and the mix of technical services, within INS. And those are probably the two biggest factors.

There is some variability in that, in terms of how those actually play out over the course of the year. And as we gain more and more insight as we go through the year, there may be some differences in the rate. We're--I will tell you more focused on the absolute number than the rate itself. As we look at that growth component, and we see the year-over-year numbers on our absolute numbers continuing to track pretty well.

Your question on acquisitions on the pull-through, if you look at Schedule 3 of our release, there is a fair amount of detail on the source of those acquisitions, and if you add the numbers up, you can see that more than half of it comes from Aerospace and Ships. Those are long-term programs. So they typically don't land a lot of additional growth in year. But it does provide us tremendous long-term visibility into the sales opportunities for the Company.

Thanks very much for your answers.

Our next question will come from the line of Brian Jacoby of Goldman Sachs. Please proceed.

Hello?

Let's go to the next one, operator.

Our next question will come from the line of Myles Walten of CIBC World Markets.

Thanks. Good afternoon. Thanks for taking the call.

Hi, Myles.

I think in the last couple of years you have been one of the few defense contractors that I actually had somewhat reducing employee count, and my guess is that's largely because of Ships, but I think it was down maybe 4% in the last couple of years, so if you can just correct me, if it is not just Ships, where else is it, and have the other segments grown in head count, and then as you look to '07, are you anticipating that growing?

Yes, we have had obviously balancing the mix, the information services area, we've had growth, and in Aerospace we've had growth and we have been flat in Electronics and in Ships we have gone down and a lot of the man power by the way is related to the work we do here, a substantial portion of the actual revenues that we deliver are as a result of subcontracted work. So there will be changes in mix over the time we actually do a contract, how much we do inhouse and how we acquire from subcontractors. We, of course are concerned about head count and employment, but we don't manage to maximize head count or minimize head count.

We are hiring people significantly now. As all companies in our situation, we are looking for highly talented people. We hire thousands and thousands of people each year. We had a little bit of a set back in The gulf because of obviously some of the impacts of the hurricane but we have hired probably 7,000 or 8,000 people down there in the last year to come back pretty strongly to almost the strength we had prior to the hurricane.

That's helpful, and just one quick one. On the unallocated corporate expense you have done a really good job of pulling costs out of that. Could you highlight for us just where that 50% reduction is driven from?

The primary change from '06 to '07, if you just look at the run rate activities, so I'll take out the legal settlement charge that we had in the third quarter, the primary difference there are results from changes that we made in some of our long-term benefits programs, and so it simply reflects the pull-through, the accounting for those changes in the benefits programs.

All right. Great. Thanks.

We have a follow-up question from the line of Byron Callan of Prudential Equity Group.

Gentlemen, I'm just curious, more of a generic question because China recently had this ASAT test that has now been publicized and I'm just curious, has it caused to you guys to think any differently about your space sector, about maybe new opportunities that come up--will come together over the next year or two as we deal with that new reality?

Byron, obviously going on--based on what is reported in the newspapers, it is pretty clear that there are new dimensions to the threat, but the future is not just about boots on the ground or armored vehicles. It is going to be about some of the more challenging technical issues in space, as well. We certainly have a significant play in space, and I think that there is probably no surprise here, in terms of the fact that this is going to create new attention in that area.

I think the challenge the nation faces is going to be on a lot of fronts and while the attention is probably justifiably focused on Iraq, and to a lesser extent to Iran and Korea, there are other issues out there longer term, and where Northrop Grumman participates is in the long-term investment accounts to position the country technologically for the future. Clearly, the demonstration that was reported from the ASAT is an example of things we're looking at very closely.

Ron, does it reinforce current programs, or there's been this whole push on responsive space and maybe thinking about new architectures or new--really new products, new satellites new launch systems, you have this little stake I think still in Kissera, and that's kind of where I was going with this.

We're probably not playing heavily in the launch systems area. We certainly do have interests in responsive space, and I think there is going to be a lot of attention to space and space assets, their survivability and the opportunities to add capability there. You can see the battle ground is definitely there.

And I'd echo Howard's comments earlier about the details. Thanks a lot.

Great, thank you.

Okay. What I would like to do now is wrap it up. We're at the end of the hour.

Let me just say for the quarter and the year, again strong operating performance across the board, we're very pleased with the record new business acquisitions, and backlog. Returning the cash to the shareholders. Excellent returns there both in terms of share repurchases and dividends, and we are moving into '07 with a very solid balance sheet.

Thank you all, very much, for joining us. We will talk to you next time.

Thank you for your participation, ladies and gentlemen. Have a great day.