諾斯洛普·格拉曼 (NOC) 2007 Q1 法說會逐字稿

Good day, welcome to the Northrop Grumman first quarter conference call.

(OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

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 go ahead.

Thanks, and welcome, ladies and gentlemen.

We have provided a supplemental presentation that you can access on our investor relations website at northropgrumman.com.

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

Before we start, please understand that some the matters discussed on this call constitute forward-looking statements within the meaning of the Private Securities 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 those risks and uncertainties is contained in the companies SEC filings including Forms 10-K and 10-Q.

During the call we will discuss first quarter results including non-GAAP measures for segment operating margin and free cash flow.

Segment operating margin is reconciled on schedule two and free cash flow is reconciled on schedule one.

Schedule four provides a reconciliation of the 2004 through 2006 data for today's organizational structure and reporting format.

During today's call we will also discuss our outlook for 2007.

Guidance includes GAAP measures of sales operating margin, earnings per share from continuing operations, cash from operations and the non-GAAP measures, total segment operating margin and free cash flow.

On the call today are Ron Sugar, our Chairman and CEO; Wes Bush, our President and Chief Operating Officer; and Jim Palmer our Chief Financial Officer.

At this time, I will like to turn a the call over to Ron.

Thanks Gaston, and hello, everyone, thanks for joining us.

Before I begin my remarks I would like to take a moment to welcome Jim Palmer to our team.

Jim joins us from Visteon Corporation.

Many of you know Jim from his days at Boeing and McDonnell Douglas where he held many operational and financial leadership roles including President of Boeing Capital Corporations, and CFO of McDonnell Douglas.

Jim brings a wealth of aerospace and defense expertise and we are extremely pleased to have him on the Northrop Grumman team.

With the addition of Jim as CFO, Wes Bush now assumes the role of Chief Operating Officer along with the title of President.

I want to thank Wes for his service as CFO and I'm very pleased that Wes can devote his undivided attention to the operations of the Company.

Now I would like to discuss our first quarter highlights.

My comments are outlined on slide three.

This was a strong quarter by every measure.

Sales rose 4%.

Segment operating margin rose 5%.

Earnings per share rose 7%.

Cash from operations increased by $515 million and funded contract acquisitions totaled $9 billion.

It was a very good quarter for new business wins as well.

We captured two of the large opportunities I mentioned last quarter.

We won the $875 million U.S.

Postal Service contract to further automate the handling of large mail items such as catalogs and magazines.

And through our joint venture with EADS we were awarded a $559 million contract for Euro Hawk by the German Ministry of Defense.

In addition to these awards we also announced a $287 million contract from the U.S.

Air Force for the next production lot of Global Hawk.

The Navy awarded us a $267 million contract to continue detailed design efforts on the DDG 1000.

And we also won the $257 million contract for the ground air task oriented radar called G/ATOR which consolidates the missions of five Marine Corps radars into a single multi-low radar system.

This is a very important win as the Marine Corps stated objective is a total of 63 G/ATOR systems and the first phase of the program represents development of 15 production systems.

Last week the Air Force approved the release of full funding for two F-35 aircraft along with long lead funding for 12 planes.

We have had very substantial content on the F-35 and this decision marks the beginning of what we expect will be a very long production run.

We captured some very significant contracts this quarter and we continue to have an unprecedented set of opportunities in front of us in terms of program size and duration.

Some of the larger opportunities include the next generation tanker for the United States Air Force.

The Navy's unmanned aerial combat system.

Broad area maritime surveillance or bands for the Navy.

GPS operational control segment for the Air Force.

The transformational communication satellite also for the Air Force.

And NASA's tracking and data relay satellite along with several large restricted program opportunities.

We also have a robust pipeline of thousands of new competitive opportunities in our information services and in our electronics businesses.

The largest opportunity, of course, is the KCX.

On April 10, we submitted our KC30 proposal which is based upon the highly reliable modern and commercially available A330 platform which will be assembled in Mobile, Alabama.

This platform was selected in the last three worldwide tanker competitions to support the Air Forces of Australia, the United Kingdom, and the United Arab Emirates.

We will be submitting our bands proposal soon and a decision on this program may come by the end of the year.

Bands has a total potential program value of approximately $3 billion.

The Navy UCAST award is expected sometime this summer.

This program could have a potential total value of around $12 billion.

We have also recently submitted a proposal to the U.S.

Air Force's GPS next generation control segment contract to modernize GPS command and control and to enable effects based operations.

Two phase A contracts are expected to be awarded in mid 2007 and a single phase B contract valued at more than $1 billion is expected to be awarded in 2009.

Turning now to to the defense budget, both the House and Senate have marked the fiscal year '07 supplemental and the final bill will now go to conference.

And the President's '08 budget is also moving through congress.

We believe there continues to be bipartisan support for strong levels of defense spending, and with few exceptions our programs continue to be well supported and well aligned with defense priorities.

We ended the first quarter with a backlog of more than $60 billion, continuing to provide a strong foundation for our future growth.

Our strong financial results in 2006 and the first quarter of 2007 allow us to continue to execute a balanced cash deployment strategy that ensures investment for growth and return of cash to shareholders.

During the first quarter, we completed our acquisition of Essex Corporation and the stand-up and integration of that company are proceeding very well.

Essex is proving to be an excellent complement to some of our business development opportunities.

We are very pleased with what we have seen so far and we believe this will turn out to be an excellent acquisition.

We also returned cash to shareholders in the first quarter.

We increased the dividend by 23%.

A significant increase in our payout ratio.

And our fourth consecutive double digit increase in as many years.

And we executed our third ASR, retiring 8 million shares of common stock.

Since we started buying back our stock in 2003, we have purchased more than 61 million shares of common stock for $3.6 billion reducing our share count by 23 million shares since 2003.

We are off to a strong start in the first quarter.

And we are on track to meet our 2007 guidance.

We expect sales between 31 and $32 billion.

Earnings per share from continuing operations of $4.80 to $5.05 and cash from operations from 2.5 to $2.8 billion.

Now we will turn the call over to Wes to provide his perspective on operations.

Wes?

Thanks, Ron.

My comments are outlined on slide four.

The subject of my comments today should be a familiar one to all of you.

Northrop Grumman's focus on performance.

In order to achieve top quartile financial performance we have to achieve world class operational performance.

I'm particularly focused on program processes.

And I will take the opportunity on the call to report on some of our programs.

For information and services we captured three of the largest competitive contracts in the state and local market in winning the Virginia and San Diego outsourcing contracts and the New York City wireless contract.

We are making good progress on all three programs.

The New York City wireless project has successfully completed its startup phase.

The lower Manhattan component of the network is now operational.

And the top level design at the full network is complete.

When completely operational in early 2008, the system will allow police, firefighters, and other emergency personnel to communicate with one another anywhere in the city.

In aerospace we are making good progress on impose.

We have applied broad resources to help our sensor suppliers close the design issues and we are making good progress in gaining approval to proceed to integration and test on the program's most complicated sensor.

All sensor related design issues should be completely resolved in 2007.

Which would support the imposed launch schedule.

In electronics we are focused on managing the risk on our fixed price development programs.

During the first quarter we made progress on Mesa and the F-16 Block 60 program.

On our Mesa programs, hardware and software updates have been transitioned to the aircraft resulting in significant radar performance improvements.

We continue to support Boeing in the integration of the radar including delivery of the first of four major software builds for system checkout.

The program is progressing.

But we are aware that the prime contractor is having difficulty meeting Australian aircraft delivery dates which could result in shared liquidated damages.

On Block 60, all prime mission hardware is complete.

And we are making progress on accomplishing the remaining software development milestones.

Technical challenges remain but we continue to operate on plan and within our established EAC.

SBIRS is progressing very well and program performance has improved to the extent that the Air Force has included advanced procurement funds for a third geosatellite and two additional Hilo payloads in the fiscal year '08 budget request.

At ships first quarter productivity was impacted by the now concluded strike at our Pascagoula shipyard.

We were satisfied with our new labor agreement which includes employee performance incentives.

It represents a good management labor partnership that should enhance our competitive position while acknowledging the increased costs on the Gulf Coast since Hurricane Katrina.

The incentives provide an upside to our skilled craftsmen for improved performance which are facilitating with post Katrina investments in rebuilding facilities and in streamlining processes.

Regarding deepwater, the work completed to date has enabled the Coast Guard to significantly increase drug seizures, order interdiction, and lives saved.

Much has been accomplished and the Coast Guard and Congress have recognized that this is an important program and vital investment in Homeland Security.

There has been a lot of press regarding the conversion of the 123-foot patrol boats.

We are not happy that these older vessels had to be taken out of service.

It's premature to speculate on the causes of the structural problems until all of the analysis is completed.

But as member of the deepwater team, we are fully committed to assisting the Coast Guard in its evaluation.

On the much larger national security Cutter we are well along in the construction of the first two ships and long lead in material for the third quarter Cutter has been placed on order.

This is a well designed ship that will dramatically increase the ability of the Coast Guard to perform its mission.

Lastly, I want to take a moment to discuss our overall focus on performance enhancement.

We are taking significant actions at the Corporate level to strengthen program and financial performance across the board.

We have strengthened the oversight of proposal development and program performance.

We added more up stream review of proposal development and program performance.

We have added more upstream review of proposals so that we can better influence the outcomes.

And we have created corporate wide programs organization led by a very senior executive who is responsible for helping drive improved performance on our programs.

In addition, we have enhanced our compensation system to more directly align management and executive compensation with our operating objectives.

Now, I will turn the call over to Jim to go through the financials for the quarter and the guidance.

Thanks, Wes.

Good morning or afternoon, ladies and gentlemen, and Ron, thank you for your comments.

I'm very pleased to be part of Northrop Grumman team and I'm looking forward to working with Ron, Wes, and our secular management to drive to top quartile financial performance.

I will be particularly focused on driving cash flow through improved working capital management and disciplined capital spending.

I also will be very focused on quickly identifying, understanding, and addressing program and financial issues and opportunities so that we can maximize performance across the Corporation.

I will review the first quarter results by covering in detail sales, segment operating margin, and other elements of the P&L statement and then I will discuss cash from operations free cash flow and then finally our 2007 guidance.

But before I do that, I want to summarize my view of the quarter using a few key financial metrics.

They are, sales up 4%, $7.3 billion.

Net income up 7%, -- or 8%, rather, to $387 million.

EPS up 7% to $1.10 a share.

Finally, cash from operations up $515 million.

A good strong start to the year consistent with our expectations for the quarter and a great foundation for our 2007 guidance.

With that as an overview, let's begin with the details on slide five.

Sales did rise 4% to $7.3 billion.

Driven largely by higher sales for information of services and our electronics businesses.

Although effected by the strike, sales and ships did increase 2% while aerospace reported lower sales as expected due to the transition of programs from development to production.

Sales for information and services increased 10%, reflecting higher sales at all three segments.

Mission systems benefited from two months of Essex sales.

Information technology's 12% increase reflects new state and local programs and higher volume for intelligence programs.

And then finally technical services had a 36% increase in sales driven largely by the Nevada test site program.

For the year, we expect information and services sales to range between 12.2 and $12.6 billion.

Aerospace revenue is down 5% due to a 10% decline for integrated systems.

Sales in that segment continue to be impacted by programs such as the E2D Advance Hawkeye, the F-35, and the EA18G transitioning from development to production.

This program life cycle change was somewhat offset by higher revenue for mature programs like the F&A18 and B2 support and new international program the Euro Hawk.

The increase of space and technology primarily reflects higher volumes for satellite communications and missile and space defense programs.

For 2007, we expect aerospace sales to range between 8.1 and $8.3 billion.

Turning to electronics, sales rose 6%, primarily due to higher volume for government systems and Naval and Marine systems.

For the year, we expect electronic sales to range between 6.8 and $7 billion.

And then finally, the last business area, ships, where sales rose 2%.

Revenue was higher for the Virginia class submarines.

The USS Carl Vincent and the Gerald R.

Ford aircraft carriers and then the LPD program.

The strike did impact first quarter sales by about $50 million.

And we expected that the second quarter will be an impacted by a similar amount as we returned work on April 10.

We do expect to recover these sales over time.

For 2007, we continue to expect ship sales of 5.5 to $5.7 billion.

Moving on to slide six, first quarter segment operated margin increased 5% to $683 million.

And our segment operating margin rate increased to 9.3% of sales, from 9.2%.

All four businesses we posted higher absolute operating margin and aerospace and ships also improved their operating margin rates.

Information and services operating margin rate was 8% in line with our guidance for the year.

While mission systems rate of 8.7% compares to 9.3% last year and the change is principally attributable to favorable adjustments for risk adjustments recorded on the ICBM program in the first quarter of 2006.

Information technology margin of 8.3 versus 8.6 last year reflects a changing mix of business as we ramp up on the new state and local programs.

And then the margin rate for technical services reflects the additional Nevada test site revenue which, as you know has a lower margin that offers a very attractive return on investment.

Aerospace operating margin increased 120 basis points to 10.8%.

Reflecting a comparable rate year-over-year for space technology, but an increase of 200 basis points for integrated systems.

The increase at integrated systems more than offset the impact of lower volume due to favorable adjustments in the F&A-18 and B-2 programs.

The delivery of an additional F&A-18 unit and the wind down of some development programs.

For the year, we expect the margin rate for integrated systems to moderate from this level and for 2007 we still expect aerospace operating margin to be about 9%.

Electronics operating margin is 11.4.

Slightly lower than last year.

Lower amortization expense for purchase intangibles was more than offset by the timing of favorable performance adjustments.

Last year's results included favorable adjustments and contract closeout in several programs and aerospace and defensive systems.

We continue to expect electronics to achieve a margin rate in the high 11% range for 2007.

The margin rate for ships on the other hand increased 80 basis points to 6.8%.

Primarily due to improved performance in the Virginia class Block II submarines and LPD programs.

The strike reduced operating margins in ships by about $12 million, $0.02 a share.

A portion of which we expect to recover over time.

Operating margin for ships for 2007 is still expected to be in the mid 8% range.

Slide seven depicts the key components of earnings per share for the first quarter compared with our guidance for the year.

Our consolidated operating margin rate increased 80 basis points to 9.3% from 8.5% last year.

Reflecting growth in both segment sales and margin rate as well as a $43 million improvement in net pension cost.

Pension cost improved due to the $800 million of prefunding provided to the pension plan in the fourth quarter of 2006.

As well as the favorable returns on the pension plan assets for that year.

Although comparable to last year, unallocated expenses included a $10 million charge for the first quarter, and net interest expense was slightly higher due to lower cash balances than in the prior year.

And other expenses increased $8 million due to a government overhead adjustment.

Finally, our effective tax rate for the first quarter was 34.4%.

Compared with 31.2% in last year's first quarter.

Last year's first quarter did benefit from an $18 million in tax credits related to Hurricane Katrina and if we adjust for those tax credits last year's effective tax rate would have been a comparable 34.6%.

Moving on to slide eight, we provide a reconciliation of net income to cash from operations and a calculation of free cash flow for the quarter.

Non-cash adjustments for the quarter included $169 million for depreciation and amortization and $47 million for pension at OPEB.

Although improved from last year by approximately $400 million, the change in working capital was a use of $384 million in the first quarter.

The improvement we reflects higher net collections on programs in process and less cash expended for discontinued operations.

You will recall that last year's working capital was impacted by billing delays related to Hurricane Katrina, the scheduled transition to a new ERP system, and the shut down of our reseller operation.

For the quarter, cash taxes were $173 million less than accrued taxes.

And other items were a source of $8 million resulting in cash from operations of $400 million.

An improvement of $515 million from last year driven largely by the improvements in working capital.

Capital spending for the quarter was $158 million and it included $17 million for Katrina related items.

Versus $173 million in the first quarter of last year.

Which also included $54 million of Katrina related capital expenditures.

To reach our definition of free cash flow we are also including outsourcing contract costs related to the Virginia IT contract.

After capital expenditures and outsourced contract costs, free cash flow for the first quarter totaled $212 million compared with a negative $288 million and last year's first quarter.

An improvement of $500 million.

Slide nine summarizes estimates of the key components of 2007 cash flow compared with the first quarter results.

There are no changes to any of these 2007 items from the fourth quarter conference call.

But as in the prior slide, we have included outsourced contract costs in order to calculate free cash flow.

After capital spending of between 700 and $750 million and outsourced contract costs of 100 to $140 million.

We expect free cash flow of 1.6 to $2 billion for the year.

In summary, first quarter segment sales growth and operating margin expansion together with lower net pension costs drove the improvement in pre-tax income.

Those results are consistent with our expectations for the quarter and support our 2007 guidance as shown on slide ten.

Sales growth through a range at 31 to 32 will be driven by organic growth at information and services, ships and electronics.

Integrated systems will be continued to be impacted by the transition of programs we mentioned from development to production, segment operating margin rate is expected to be in the low 9% range comparable to last year.

And total operating margin rate increasing to the low 9% range.

We continue to expect earnings per share to range from $4.80 to $5.05 with growth last year reflecting sales growth and improved operating performance.

And cash from operations is expected to range between 2.5 and $2.8 billion.

We are off to a good start with our first quarter results.

And with that, Gaston, I think we were ready to open it up for questions.

Thanks, Jim.

As we begin our Q&A, I would like to ask that you limit yourself to one question and one logical follow-up.

Bill, we are now ready for Q&A.

Thank you very much, sir.

(OPERATOR INSTRUCTIONS] Our first question comes from the line of Joe Nadol of JPMorgan.

Good morning to you, and welcome back to the industry, Jim.

Thanks, Joe.

My first question is on bookings.

You had a good quarter and it was really driven by electronics.

I'm wondering if you can give some color on what was included in there among the various contracts that you booked and what percentage of that was international?

I guess, Joe, this is Ron.

Postal, G/ATOR and in terms of international, I don't remember anything particularly standing out in my mind on that one.

Keep in mind that a year ago we had a catch-up from a late bill, defense bill.

That was the $12 billion last year.

$9 billion this quarter is pretty good as well.

Those are basically it.

Okay and secondly, just looking forward a little bit the supplemental, is going to be delayed and the Army has talked about shifting funds around to pay for the war.

And arguably that could impact the IT services portion of the budget.

Any thoughts on -- are you seeing anything yet and do you anticipate an impact on your second quarter?

Joe, we don't really have that much exposure -- we have a little but not that much exposure to the supplemental and not a tremendous amount to the Army's need to move funds around.

I don't see that as a significant impact and don't foresee anything for the second quarter, particularly in the IT area.

Your next question comes from the line of Heidi Wood of Morgan Stanley.

I am going to echo Joe's comments, Jim, welcome back, nice to see you here.

Thanks, Heidi.

Can you discuss with us out of the initiatives that you are engaging in within Northrop or as you come in and take a look at the enterprise where the biggest metrics that you would like to see improved to move toward that goal of being a top quartile company?

Well, I guess I'd emphasize the two points I made in my opening comments on working capital management or free cash flow management.

I do think we have opportunities there.

Then secondly, working with Wes and Ron, the sector management folks to really focus on understanding exactly where we are in our programs.

What our opportunities as well as issues are and what we can do about them.

Really working to drive to performance and then convert performance to cash.

Well, I wondered -- actually, I was trying to get just a little more explicit on this working capital management.

Do you have any particular metrics that you would point us to where you want to head there?

Heidi, I'm spending time understanding where we are.

I'm not ready to throw numbers out at this point in time.

I need to do a little bit more homework.

Again, my view coming in as well as my now six weeks here tell me that I think we have an opportunity here.

What I do see is that the Company has been focused on this area.

I think we were making progress.

I still think we have a ways to go.

Great.

Then a question for Wes and Ron.

You had again, a great bookings quarter in electronics up 17% year-over-year and yet you are guiding 7% gross in sales for the year.

Are you seeing the duration of the backlog extending out or are you just being conservative for the year?

Long term programs and some of them are important strategically.

So I think that would be the right answer.

As you know, when you get a booking it has a variable length.

Typically our electronics and our platform business have longer duration programs, our IT and services business are much quicker turns in terms of book-to-bill.

How long do they average tend to spend out, Ron?

I can't give you a number off the top of my head, but usually the major programs in electronics and platforms are several years.

Great.

Thanks very much.

Thank you very much.

Your next question comes from the line of Byron Callan of Prudential Equity Group.

Please proceed.

Good morning, gentlemen, and hello, Jim.

Hey, Byron, how are you?

Great.

Ron, can you comment a bit on the overall state of relations between industry, congress, and the Department of Defense?

It's come up on some of the other conference calls.

There has been a lot in the press lately.

Have things really -- have they really changed that much?

If they have changed from an industry perspective, what do you think we need to do to get them back on track?

Byron, I have been in this business about four decades and I will tell you that there is always a probably constructive for the most part tension, sometime unconstructive amongst the three players and what I would call the three body problem here.

Clearly there are expectations for performance of industry which are not being met in some cases.

However, as we all know it's a complicated mix between congressional oversight, DoD policy, and procurement regulations and frankly, also the performance of industry.

I don't sense any particular difference.

Clearly there has been a lot of press.

A lot of press has written about comments made by various folks.

There are always going to be programs going well.

And that you never hear about, and I would certainly say of our tens of thousands of programs that are going well you never hear about them.

There's always a few that you do hear about from us and others.

They get a lot of attention.

There is always a rhetoric about changing laws and regulations.

I got to tell you that we probably have more laws and regulations associated with the oversight of defense procurement than I have ever seen.

So I think the status is pretty much normal.

I don't see a dramatic trend.

I think with respect to fixed price contracting, I think we all believe in this company, I think others in the industry would echo this that there is a time and place for fixed price contracting.

We have a good chunk of fixed price work in our company and in general we make very good margins on it because that's business that we understand, the customer has specified what they wanted, their stability.

For those things involving new programs and new developments where there is advances in state of the art, where there is uncertainty requirements.

That kind of contract mechanism is not as appropriate.

Okay.

And then on a more discreet level, given some of the changes that are occurring in the Total combat ship, does it open up any room for opportunity on the national security Cutter?

It's a pretty interesting ship design and maybe fits some of the parameters for LCS.

Have you had discussions with the Navy.

Would you expect anything to open up on maybe more Navy interest in that ship?

Well, certainly, the National Security Cutter is going to be one heck of a ship.

It's going to be delivered here by the end of the year and we are really proud of it.

We do believe the Navy has plans to consider competition in the 2010 time frame for LCS and clearly the major ship builder we are going to look at opportunities if this particular class of vessel is something that would fit the requirements we are clearly going to be interested and we will see how that develops.

Thanks a lot.

Thank you very much.

Your next question comes from the line of Steve Binder of Bear Stearns.

Please proceed.

Good morning.

Couple things.

Maybe I mixed the FAS CAS discussion but you had $33 million of income.

You're projecting $70 million for the year and usually it's typically spread out for the four quarters.

Why was it front end loaded this quarter?

Steve, it's Jim.

We got some programs from plans rather that are more annual-type plans.

So they hit more in the first quarter than spread throughout the year.

The $70 million is still our guidance for the year.

Frankly, when we look at guidance, we look at the whole range of elements that go into it.

And as I said, we are comfortable with the guidance for the year.

And Wes, you touched on a wedge tail program and in Q you talked about, depending on the liquidated damages you might need to take a charge as much as $40 million.

Is that pretty much of a Q2 decision?

And also do you think you can cover that?

Steve, it's Jim.

As with any program, we take a look at our EACs on a regular basis based on what we know about the program at that point in time.

What we try to do with the Q is highlight that we are aware that the prime contract remains, the deliveries of the aircraft.

We don't know whether or not there is going to be any liquidated damages or not.

So if there are we will have to address it at that point in time and under the contract we share in those liquidated damages up to a max.

At this point all we can do is really highlight that there is a max potential exposure.

We don't know whether there is any exposure at all.

All right.

And then also with respect to working capital, Jim.

You touched on the $400 million improvement from last year, and last year you had the collection issue down in Katrina and also the ERP issue that you addressed earlier.

Would you characterize the $400 million improvement as pretty much a catch-up or rectifying the issues from last year plus lower cash used with discontinued operations or was there really anything fundamental going on here?

Fundamental improvement, i.e.

some progress being made on unbilled receivables for example?

Well, the turnaround from last year actually occurred throughout the year.

And then so if we look at versus the first quarter, that's -- we did have a usage of working capital.

It was improved from where we were last year.

I do think that, as I said we have more areas to improve in working capital management.

We do have quite a focus on unbilled receivables and making sure that we are getting our billings out in a timely fashion.

I'm not ready to declare success.

Again, opportunity and we are working it.

One other thing, why didn't you increase aerospace margins for 2007 given the strong first quarter performance in IS?

Well, we, as you know, almost everyone in the industry looks at contract EACs on a regular basis.

They don't occur throughout the year.

They occur whenever you update EACs so you get lumpiness or some s-curve, if you will, to the year.

We completed our review of some of those major contract EACs in the first quarter and we recognized our improved performance on them.

My point was even if you back out the $17 million of favorable adjustments it looks like you still have very strong margins in that segment for the quarter, especially in IS.

You are completely right and we do continue to have some of the transition to -- from development to production occurring throughout the year.

That's why sales are down in that segment and then that whole aerospace business area as you know is a combination of space and integrated systems.

And the space business has, because of its cost-type nature has lower margins generally.

Thanks very much.

Thank you very much.

Your next question comes from the line of George Shapiro of Citigroup.

Please proceed.

Yes, welcome back, Jim.

Hey, George, how are you?

Okay, thanks.

Net interest expense in the first quarter was 82 and you have been guiding for 285 for the year.

Did I miss something as to what was abnormally high in this first quarter?

No, you didn't miss anything.

We did close a little bit earlier on Essex than what we had anticipated when we developed the plan.

So that is a factor on net interest expense for the quarter.

We still feel good about our guidance for the year.

Follow-up in the mission systems area you took out the Essex acquisition, the revenues were down.

Is that reflecting a decline expected in the software radio business?

If you just go through the status of that business?

I guess I can't really comment specifically on the software radio business.

I'm still trying to get up to speed on everything.

But our expectation, frankly, for mission systems is up even without Essex for the year.

Well, then maybe if you can answer, Jim, why excluding Essex it was actually down in the quarter?

Just mission systems is a combination of thousands of programs and it's just all the individual programs, George.

I don't think I can put my finger on a single program that accounts for the small decrease.

Okay.

Then just a last one to follow-up on Steve's question about aerospace.

Given how high the margin was in the first quarter, I mean, what happens in subsequent quarters to get you a margin at 7% or something to basically net you out at the 9% guidance you have been talking about?

Well, George, I will be real frank.

We take a look at the total company and our guidance for the total company.

Things move around, some of them may be higher, some of them may be lower.

Again, when I look at the total I think we are okay.

So you all may be right.

We will wait and see.

Thanks, Jim.

And welcome again.

Thank you.

Thank you very much, sir.

Your next question comes from the line of Doug Harned of Sanford Bernstein.

Please proceed.

On ship systems, you're projecting mid 8% operating margins for the year.

Q1 was well below that.

Could you talk about what the sources you see -- be looking at very good performance for the rest of the year and what are the sources of that performance?

And also, how are things going in the Gulf?

We do -- you are correct.

We are seeing or projecting improved performance both in Newport News and ship systems for the balance of the year.

As I mentioned in my comments, the Virginia class submarines have been performing very well.

We are projecting continued good performance there.

And aircraft carriers as well.

Then finally the -- we have been coming off the effects of Katrina.

We now have the strike, but our plan always has included improved performance at ship systems.

The strike is going to have a little impact on that.

Delay that somewhat.

But we are still expecting improved performance at ships as well.

But is there a way to quantify where that is coming from even in the sense of how is it primarily Virginia class?

Is it primarily recovery from Katrina?

There is a way to see where the balance of this is?

Well, we are seeing more, or the greater proportion of the improvement would be coming from Newport News.

But also some improvement in ships as well.

And just one more aspect of this.

Recently a number of House Democrats have talked about adding five ships to budget.

John Winder and Admiral Mullen have made statements to the effect that that is interesting, but we're not sure the industry can really handle that right now.

Certainly on Virginia class LPD17, those would be your programs if ships were added.

Could you comment on where you stand in terms of the way things are going in the Gulf, in particular, and the ability to handle more there?

Well, first, this is Ron, Doug.

First of all, with respect to Virginia class, I think there is no doubt that we and our partner could handle two a year.

I think the issue there is a concern by the CNO and the Secretary that don't start it if you have to stop it.

In other words, if you go to two year go to two year and sustain it and make sure that's part of the ship building plan.

I think we have adequate capacity there and then some.

In terms of the Gulf, we were coming back pretty strongly and in fact, when these ships get ordered they don't immediately get built the first month they are ordered.

These are long term construction contracts.

And we are coming back pretty well.

We had more than 90% of the people come back after the strike and we are seeing improvement from there, so fundamentally we are working with the Navy.

Whatever the plan is, we will capacitize appropriately for.

The only think we've asked over time in recent years is just make it a stable plan.

Thank you.

Thank you very much.

Your next question comes from the line of Cai von Rumohr of Cowen.

Yes, mission systems, could you tell us how is Essex doing now that you have owned it for two months.

Yes, Cai, it's Wes.

Essex is doing really well.

We have gone through a stand-up process to get all the alignment that we need to make sure that the operations are integrating into mission systems.

You may recall that when we announced the acquisition of Essex we said that we actually intended to roll apart of the ongoing missions systems business into Essex to align and actually get the synergies out of it.

So far I would say outstanding in our performance with Essex both in terms of just the actual stand-up.

But more importantly the integration of the people, the alignment on the programs, and the working together with the customers.

We have been really pleased with it.

The technology as we have gotten into the Company and really gotten our arms around the technology I would say we are even more pleased with this acquisition than when we first announced it.

And a quick follow-up to George and Steve.

If you look at Aero it does look like on paper like you're being conservative.

In formulating this estimate are you kind of taking into account that you might have an exposure on (Inaudible) and wanting to be a little conservative elsewhere so that you can overall hit your estimate, is there some process like that that is working?

Well, Cai, I would admit to looking at the individual pieces and the total and when I look at all of the individual pieces and the total and look first at the total I'm comfortable with the guidance for the year.

Things move around as you know, throughout all the sectors.

We are not trying to -- I would tell you we are not trying to cover anything at this point in time.

It's really looking at each of the individual sectors and what we think first of all their sales and margins are going to be on a sector by sector basis.

Then looking at some of the corporate items as well.

So it's kind of a complete roll-up process and looking at the variations between each of the pieces.

Thanks and welcome back.

Thank you very much, sir.

Your next question comes from the line of Howard Rubel of Jefferies and Company, please proceed.

Thank you very much.

I want to go back to ships for a moment.

If we do the math, Wes, you have heard me ask this before, but it looks to me like you are not making money in the Gulf yards; is that correct?

We finally got the button pushed.

Howard, no, we are making money in the Gulf.

We are doing well in the Gulf, we are working our way back up the curve and I think that is what your map is showing you that compared to where we were before Katrina, we are not doing as well and I would say that's to be expected.

We had indicated that it would take us a bit of time to climb back up the curve but we have 12 ships under construction down in the Gulf, we have three DDGs, we have six LPDs, and LHD and two NFCs so there is a lot of work.

We are making money on those contracts but as you know when we took the setups we redid the EACs subsequent to Katrina, and we took our booking rates down substantially to reflect the additional cost impacts.

We are working our way back up that curve.

Credit to the team that we have down in the Gulf.

They are performing to that recovery plan and as we move our way through what we call the Katrina ships, those that were impacted by the storm we should expect to see over the course of time continued improvements there.

Then you have this fixed price incentive contract under the Virginia class program.

Could you talk a little bit about you have been able to manage the risk and clearly here you have been able to capture some the upside and I have a feeling there is probably more to go as you gain experience with this second five lots that you are working on?

Howard, I have never known you for softball questions but thank you for the question.

This is Ron.

Hey, listen, we are absolutely pleased and thrilled with the performance in the Virginia class program.

If you think about it, it was ten years between deliveries of submarines in that yard.

We did deliver the first of that class.

And now we are working on the North Carolina, that was the Texas.

We are seeing continue and steady improvement in learning curves, productivity.

Both in our yard, and as you know, we work very very closely with our partners at General Dynamics and the work between the yards, the moving of work back and forth, the sharing of lessons learned, this program is coming along very, very nicely.

We are all driving to the lowest possible unit costs so that we can get the two year sooner rather than later.

We know that that's economically very good for us.

It's also extremely important for the nation because we do need two subs a year.

This is a success story.

I happened to notice some recent information out of the Pentagon about expected costs of programs and non maturities and cost growth and I noticed that the internal estimates the Pentagon for this program actually have a reduction in expected cost over a period of time.

All in all, I think a very good story and we are really proud of the progress there.

And just to kind of wrap this all up.

And I won't give you -- throw a hard one right here.

Please, don't.

No, no.

I mean you have the most upside leverage of any of your business opportunities in ships.

Margin clearly be higher by 50% or more.

But just for a moment, can you just sort of tell us what you think your exposure is to deepwater given sort of -- I mean, sometimes the headlines are a lot worse than the actual events.

Right.

Let me just summarize.

Deepwater is a program in which we are a joint venture partner with Lockheed Martin, as you are well aware.

Our role as the joint venture overseer is a very small amount of revenue.

The majority of our revenue, well over 90% is associated with the large National Security Cutter.

Running couple hundred million dollars a year on the program.

That program is going very well.

There have been debates about some of the structural issue on it.

It's a good ship.

It has a 30 year service life.

We see no issues there.

We are working with the Coast Guard on terms of some modifications on future vessels to put increased factors of safety.

But there's no problem with that ship as we see it today.

The other issue on the deepwater program has been the smaller boats, the 123-footers.

Those were conversions from old 110-footers built by Bollinger and extended by Bollinger under our direction.

That activity is no longer underway.

We are in the process working with the Coast Guard to understand the root cause of some of the issues there.

I will tell you we still do not nor do I believe the Coast Guard understand the fundamental root cause.

We are continuing to look at data and trying to understand that.

That is not a current source of revenue nor does it projected future source of revenue.

Thank you.

Thank you very much, sir.

Your next question comes from the line of Robert Stallard of Banc of America.

Please proceed.

Good afternoon.

Just to follow-up on the ship issue.

Secretary Winter made a speech recently talked about a range of issues.

One of the things he mentioned is that he saw no reason why ship margins couldn't move up beyond 10%, I think he said 15% is a target.

He basically implied that contractors would have to put up more money themselves to say CapEx and IT systems.

Do you think this is something we should expect going forward, would Northrop Grumman be prepared to do this?

Well, I will tell you that Northrop Grumman has made a substantial investment in property, plant, equipment, training, technology, and processes and we are going to continue to do that and that was going on absent the Katrina impact and significantly larger as a result of that.

And I think that the idea of a win-win opportunity working with the Navy to improve margins with better investment from the yard is a great idea.

We had discussions with Don on this.

And also frankly, the other issue in terms of making sure we can forecast demand in the stable way.

For any large capital intensive business, it's difficult to make significant investments when there is high fluctuation in demand.

We are very pleased that the last couple of years now the Navy ship building plant has had a degree of stability we have not seen in recent years and that's a very promising sign.

So certainly we are working with the Navy closely to see what we can do on our part to improve both their ability to get ships and more cost effectively and our ability to get better returns for our shareholders.

Thanks.

And just as a follow-up, Essex is now closed.

Have you got any other acquisition candidates in the pipeline?

Well, we always are looking at potential acquisitions.

We do not announce them until we have acquired them.

We stated repeatedly we have a balanced capital deployment strategy which will involve potential acquisitions generally of small to modest or moderate scale in a number of areas where we have outlined before in terms of growth.

We have a lot of things that we are looking at.

We are not announcing anything today.

Thank you.

Thank you very much.

Your next question comes from the line of Joe Campbell of Lehman Brothers.

Please proceed.

Good morning.

And welcome back Jim Palmer.

Hey, Joe, how are you?

Well.

I wondered if -- to turn this on a more future note about potential campaigns.

Could we just go over the things that are out there for Northrop Grumman that you are hoping to win over the course of the next quarter or two and maybe I noticed you always put these contract acquisitions in the quarterly results.

Maybe you could put it in the context of the most important ones that you won and maybe you could just remind us of the ones that you had hoped to win but they didn't work out in Q1?

Thanks very much.

Okay, Joe, let me take this and then ask for help from Wes and Jim.

This is Ron.

We have got a lot out there and, of course, as we all know, you don't win 100% of what you go after.

There is a lot to go after.

First of all, let me state that there are several thousand competitive bids that we are in the process of preparing as we speak.

If you take a look at our business base, it is really driven by the aggregate of that and in addition, there are a number of very large individual discreet bids which get probably a very disproportionate amount of media attention and you like to win those, too, for a lot of reasons.

I think I went through them but I'll just repeat tanker, the BAMs program, Naval UCAST.

We are looking at the potential restart of the ACS program that was the army single intelligence program.

TDRS, satellite, the space radar program.

T-SAT, those are some of the very large visible platform programs.

In addition to that, as I said, there are thousands, literally thousands of other programs that are in competitive bid across the mix.

Largely in information services and electronics.

Information services is our largest business and has been our fastest growing and there we have a lot of very specific individual discreet opportunities.

Obviously we want to win them all.

We can't win them all.

The ones I mentioned that came in this quarter were kind of nice.

And the things which don't have quite the sex appeal or sizzle of a large aerospace platform, but this postal sorting system is a better part of a $1 billion job and we are going to make good money on that and we are going to provide a good product to the Post Office.

Great.

Thanks very much

Thank you very much, sir.

Your next question comes from the line of David Strauss of UBS.

Please proceed.

If you look at the ships revenues, even when you adjust for the $50 million strike impact, it still looks like revenues were pretty light relative to your post Katrina run rate.

Could you just talk us if there were any timing issues or what exactly was going on there?

David, Jim Palmer, if you look at ship's revenues versus fourth quarter, they were a little light if you want to characterize it that way.

Part of our revenue recognition as I think you know is on a cost-to-cost basis.

The cost input was higher in the fourth quarter, just due to timing than it was in the first quarter so we have some of those effect coming through on this quarter.

As we look at the year we have taken into consideration those kind of timing issues.

So again, as I said, even with the strike the estimate of revenue for ships for the year we feel good about the guidance.

Okay, thanks.

On the litigation side, can you give us an update of any progress with your insurance carrier above $500 million and as well any progress in the negotiations with Goodrich.

Yes, David, it is Wes.

With respect to the insurance matter, we are still on track.

That trial in the early part of the summer.

Just as we had indicated I believe, last time that we spoke.

There is really no additional update to provide either on that or on Goodrich at this point.

Okay, thank you.

Thank you very much, sir.

Your next question comes from the line of Ron Epstein of Merrill Lynch.

Please proceed.

Good morning.

I just wanted to follow-up with the comment that Wes made.

You mentioned that the compensation for executives is going to be better aligned with the program performance.

Can you elaborate on that?

Do you have details on what metrics you are looking at and how you are doing that?

Let me give you a little bit of a flavor there.

Program performance is the heart of our company and in some ways you can think about our company as a portfolio of I think it is more than 20,000 programs that we have.

And we have been doing quite a bit of work over the last few years in getting the incentive structure aligned with the way we were actually measuring program performance.

And a lot of that manifests itself in the more direct line of sight measures, margin that derives from the program when we are doing well in the program we ar recognizing good margin so it is good for the customer and good for us and the point that Jim was making earlier, cash generation.

So those are direct line of sight measures that have assumed an increasing emphasis in our annual compensation system that we have implemented this year.

We continue to use longer term metrics, of course, for the long term incentive system.

Things like measures related to the CFR align metrics that we have used for sometime.

In terms of the annual incentive plan we are increasing the emphasis on those line of sight metrics that tie out directly to program performance.

And cash.

Yes.

Great.

Thanks.

Thank you very much, sir.

Your next question comes from the line of Robert Spingarn of Credit Suisse.

Please proceed.

Good morning.

Hi, Robert.

Quick question in the information and services area.

But you talked about the state and local business is building its transitioning and maturing.

How should we think about the margins?

You mentioned New York specifically.

That's basically installed.

What is the -- how does the revenue model work as you move forward?

And how do the margins become affected by that?

Robert, it's Jim.

We talked about all three programs.

They are all on the front end of, if you will, of their life, [Vyda], the Vyda contract, Virginia's a ten year contract.

Revenues increase over time.

It's a combination of both service revenues and hardware revenues and margins are skinnier on a front end and will step up over time as we go through the life of the contract.

A little different on New York wireless and San Diego.

Not as much hardware component if you will.

But again longer term contracts and expectation for improved margins over time as we get better or more through the contract and understand exactly how strong the performance is.

Given the long tail on these contracts, should there be any near term expectation for margin expansion throughout 2007?

All of our margin consideration is already reflected in our guidance for 2007.

Okay.

And then separately in the tech services area, the margins were somewhat volatile last year.

You did about 6.5% for the year.

Little lower than that this year.

You talked about the Nevada component.

How do the current bookings, I know they aren't large relative to the overall corporation, but what kind of margins did you book in the first quarter when they start to deliver?

Just like with any other business or segment, we look at the individual programs in our cost estimates for each of the individual programs and we come up with our overall margin on, essentially on a contract by contract basis.

As you can see from the press release, aggregated 5.4% for the quarter, margins down from 6.3% last year.

Then again, affected largely or significantly by the, as you can see the revenue grew significantly quarter over quarter and that is, a big part of that is due to the Nevada test site which as we have said has lower margins.

Essentially a management fee type concept although we are booking the total cost throughput as revenue and then recognizing just that management fee as the earnings component, very little working capital investment in that business, so from a return on investment much strong, much stronger return on investment than just a traditional long-term aerospace-type contract.

Jim, I think I follow that, but with regard to the newer business that was booked during the March, is that a similar kind of margin opportunity?

Or is that something that's higher level than Nevada?

In other words, do we have an inflection upward at some point as that business begins to deliver?

Well, at this point Nevada is the unique item, if you will, within that business at this point in time.

Okay, if I could, this is Ron, what I would like to do is just wrap up.

I know we are at the end of the hour and you all have probably other calls to go to.

Let me just summarize by saying that this has been a very solid quarter in our financials.

Very strong underlying operating performance.

Very strong bookings also for the quarter.

And as you can see the management team here continues to be focused on execution.

And with that I really appreciate your interest and help and we will talk to you next time.

Thank you very much, sir.

Thank you, ladies and gentlemen, for your participation in today's conference call.

This concludes your presentation, and you may now disconnect.

Have a good day.