諾斯洛普·格拉曼 (NOC) 2007 Q2 法說會逐字稿

Welcome to the Northrup Grumman second quarter earnings conference call.

My name is Bill and I'm your conference coordinator for today.

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

We'll be facilitating a question-and-answer session at the conclusion of the presentation.

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

I'd now like to turn the presentation over your host for today's call, Mr.

Gaston Kent, Vice President of Investor Relations.

Sir, please proceed.

Thank you, Bill, and welcome, ladies and gentlemen.

We provided a supplemental presentation that you can access on our Investor Relations website at NorthrupGrumman.com.

The presentation will be available for about 30 days and should be viewed in conjunction with today's commentary.

Before we start, understand that some of the matters we discuss 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 perspective financial performance.

They involve risks and uncertainties.

The actual results of the company may differ materially from the results expressed or implied by the forward-looking statements.

More complete expression of these risks and uncertainties is contained in the company's SEC filings including the Forms 10K and 10Q.

During the call, we'll discuss second quarter results, including nonGAAP measures for segment operating margin and free cash flow.

Segment operating margin and free cash flow are reconciled in our earnings release.

Today's call will provide update guidance for 2007, which includes GAAP measures of sales, operating margin rate, diluted earnings per share from continuing operations, cash from operations and the nonGAAP measures segment operating margin rate and free cash flow.

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

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

Thanks, Gaston.

Hello, everyone.

Thanks for joining us.

I'll make a few remarks before turning the call over to Wes and Jim.

We generated higher sales and margins, solid growth and earnings per share and substantially higher cash from operations and free cash flow for both second quarter and year to date.

There were several unusual items in the quarter and these items negatively impacted operating margin by $54 million.

But we were able to still increase operating margin by $62 million and improve operating margin rate by 40 basis points.

Overall, a very solid performance.

Funded contract acquisitions were lower than last year due mainly to the $2.3 billion LPD award in last year's second quarter.

The Navy did award us a $2.4 billion contract for LHA 6 this quarter, which is not recognized yet in funded current acquisitions as it will be incremented funded.

During the quarter the Navy awarded us a $191 million contract for procurement of long lead time material and production readiness activities leading to construction of first ship's first Zumwalt-class destroyer.

Wes will provide details on the progress we're making in recovery of our Gulf Coast shipyards.

But I want to personally say that as a corporation, we are focused on delivering the best possible ships to our Navy customer.

I'm very proud of the men and women who work in our Gulf Coast shipyards and the progress that they have made in recovering from Katrina.

We still have a lot of work to do, but going forward we expect to be at an even stronger and efficient yard than we were before Katrina hit.

Now looking at other businesses, in electronics, we were selected to outfit Marine Corps CH53E helicopters with our D-I-R-C-M, or DIRCM missile defense system to protect against manned portable missile threats.

We're confident that this effort will lead to deployment on additional Marine Corps assets.

Right now DIRCM is installed, or scheduled for installation on several hundred military aircraft representing approximately 40 different kinds of large fixed-wing transport and rotary-wing platforms.

We're also applying DIRCM technology to protect commercial aircraft under our guardian system.

Guardian testing is progressing successfully on seven Federal Express aircraft.

These efforts in combination with last quarter's competitive G/ATOR win for a significant new ground-based radar for the Marine Corps are tangible evidence of our success in capturing new electronics business in adjacent markets.

On the information and services side, we were one of several companies the army selected in participate in a 9-year contract ID/IQ contract with a potential total value of $20 billion collectively to provide range of IT services and solutions to support their infrastructure goals worldwide.

Although some companies include ID/IQ contracts in their total backlog, we choose not to until we receive funding, but they do represent substantial future revenue opportunities.

At the end of the quarter, aerospace was awarded a $408 million contract for the first three production E-2D Advanced Hawkeyes for the United States Navy.

The contract is a follow on to our $2 billion system development and demonstration contract that produced two test aircraft.

The Navy plans to procure at least 75 Advanced Hawkeyes that will serve joint U.S.

forces and our coalition partners.

As a company, we continue to enjoy more than $60 billion total backlog reflecting the strength of our business acquisition process.

And our portfolio has a robust pipeline of thousands of new business opportunities, including several large opportunities that we've addressed in prior calls.

The outlook for the '08 defense budget shows strong support for our programs and remains a strong by bipartisan consensus of the need to support continued strengthening of defense and national security.

In summary, even with the unusual items, it was a strong quarter and a strong first half.

Both our backlog and our year-to-date results support our outlook for the remainder of the year.

Based on that outlook, we are refining our guidance for sales, increasing segment operating margin and raising earnings per share toward the higher end of our prior guidance.

And we now expect cash from operations and free cash flow to come in at the upper end of our guidance range.

Jim will review the guidance in detail later in the call, but now I'd like to turn the call over to Wes Bush.

Wes?

Thanks, Ron.

My comments are outlined on slide 4 and will focus on the progress we've made at our Gulf Coast shipyards, as we approach the two-year anniversary of Hurricane Katrina.

But first I'll discuss about LHD 8 contract adjustment.

During the second quarter we reached an agreement with our Navy customer to rebaseline all of our programs impacted by Katrina.

As part of the rebaselining effort with the Navy, we jointly established ship delivery priorities going forward and this resulted in a reexamination of the schedules for all the ships in production.

The LHD 8 is the largest ship under construction in Pascagoula.

And its delivery was extended the furthest of the ships under construction.

It is now scheduled for delivery in late 2008, an extension of about six months.

This extension also recognizes the impacts of the shortage of electrical craftsman that we've experienced at the shipyard and this shortage was a factor in our approach to rebaselining the schedules with the Navy.

In addition to the dual extension, the integration of new large machinery spaces and motors required changes in our machinery control systems software, which caused rework and additional requirements on the LHD 8.

This program incorporates new capabilities and it does have many characteristics of the first of class ship in terms of its design.

So the contract adjustment resulted from the schedule extension and the cost growth in subsystems.

The adjustment includes a cumulative correction to previously booked margin, establishes a new baseline budget going forward, and provide the management reserve we believe is needed to complete the ship.

Across all our ship systems programs, we are aggressively addressing the recovery challenges we're facing on the Gulf Coast.

While the challenges are substantial, they do provide us an opportunity to restructure our shipyards to reduce costs and increase our competitiveness.

Our restructuring effort has three primary dimensions: employees, processees and infrastructure.

On the people side, we put strategies in place to meet our skilled workforce demands and to stabilize our workforce.

Of the approximately 20,000 employees at our Gulf Coast yards prior to Katrina, about 1,700 did not return after the storm.

We do have a very capable and dedicated workforce.

In fact, our attrition rate today is lower than pre-Katrina levels.

While we continue to be challenged in staffing skilled personnel in a manner sufficient to meet our demands, our strategic outsourcing and contract labor activities, combined with our national hiring program, are projected to provide the capacity we require to meet our commitments.

On the process side we're improving our front-end processees by redesigning our build strategy, larger units with increased outfitting and fewer parts.

We're also implementing a world-class work planning and scheduling tool and MRP system.

We're using proven lean and Six Sigma techniques to improve our processees, and to date we identified $200 million in potential savings across the multiple programs.

In addition, we have a very substantial program to modernize the infrastructure.

We're installing new steel cutting and chafing lines and automated steel processing facilities, expanding our covered areas to enhance the build strategy, upgrading shops, equipment and product flow.

We've also revisited our make versus buy policies and moved significant amounts of front-end work to outside sources.

And as a part of this modernization, we're installing mobile and wireless technologies throughout the shipyards.

Over time, successful execution of all of these efforts will position us to become more efficient, productive and competitive ship builders.

We're addressing all these initiatives in close partnership with our customer.

.As an element of that partnership we received a $98.6 million contract from the Navy for infrastructure improvements that will improve ship building efficiency and reduce production costs on the complex classes of ships that we're building today and tomorrow for the U.S.

Navy and the U.S.

Coast Guard.

We are proud of the fact that in the past two years, as our Gulf Coast team worked to rebuild our shipyards, we've also delivered five ships, christened four ships, laid the keels for three ships and started fabrication on three more.

Of particular note, is the DDG 100, the USS Kidd which recently arrived at its home port in San Diego.

The Navy expressed great satisfaction with DDG 100 and they've told us that it is one of the very best destroyers they received to date.

We've made tremendous progress in our recovery from Katrina.

We are not all the way back yet.

We're certainly not where we want to be, nor are we where our customer wants us to be.

Nevertheless detailed improvement programs are being implemented and we're working closely with our customer to ensure that implementation addresses their needs.

Over time, as our pre-Katrina ships are completed and efficiencies are gained from improvement activities, our results will improve.

I'd be remiss in discussing our ship's business without noting the outstanding performance at Newport News.

We continue to demonstrate excellent performance in the Virginia-class submarines.

The North Carolina was christened and launched in the second quarter and work also continues on the New Hampshire and the New Mexico.

Work on the USS Karl Vincent is in the 21st month of a 40-month refueling complex overhaul with work progressing on schedule.

At the end of the quarter, the USS Bush was approximately 83% complete and outfitting and testing of the ships systems is continuing on track for the ship's delivery, scheduled for late 2008.

As we've said in past calls, this contract was negotiated with challenging targets and our constant focus is on achieving established program cost and schedule goals.

Our performance in terms of both cost and schedule on this program has been stable over the last two years.

The performance on this program is an outstanding example of the ship building capability of this company.

Now, I'll turn the call over to Jim to go through your financials for the quarter and our guidance.

Thanks, Wes, and good afternoon, ladies and gentlemen.

My comments begin on slide 5 and they will summarize second quarter and year-to-date results for sales, segment and total operating margin, cash from operations and free cash flow.

Then I will conclude with a discussion of our 2007 guidance.

For the second quarter, sales were up 4% to $7.9 billion.

Net income was up 7% to $460 million, and fully diluted earnings per share is also up 7% to $1.31.

And finally, cash from operations and precash flow are both higher by $103 million and $64 million respectively.

On a year-to-date basis circumstances the same basic trends continue with sales up 4%, net income up 8%, and fully diluted earnings per share also up by 8%, but the real headline is that we're up $618 million, 118% in cash from operations, and $564 million or almost -- or slightly over 280% in free cash flow.

Overall, we're off to a really good start, particularly in cash.

Our quarterly and year-to-date results reflect continuing improvement in our business and are consistent, if not slightly better than our expectations, despite the unacceptable charges.

With that as an overview, let's begin with the details on slide 6.

Looking at sales, the trends in our business are consistent and on track with our expectations for the year.

The double-digit increases and information in service sales for both the second quarter and year to date, reflect three major trends.

First, revenue from new programs, such as the Nevada test site, IT outsourcing activities for Virginia and San Diego county, the New York City wireless program and KEI.

Second, we have higher volume in intelligence programs, and, third, the Essex acquisition.

In aerospace, mid-single-digit declines in sales for the quarter and year-to-date are primarily driven by several large programs that are transitioning from development to production this year.

These programs include the E-2D Advanced Hawkeye, the F-35 and the EA-18 Growler.

In addition, volume on the E-10A is down due to significant customer directed scope changes and the J-UCAS program is nearing completion.

Electronics sales rose 7% for the quarter, and 6% year to date, in line with our expectations for the year.

Increases continued to be driven by higher sales for army programs, postal automation in our government systems business area, and volume in a new restricted program.

For ships, sales are down 5% for the quarter, 2% year-to-date.

The lower volume revenue for the quarter and year-to-date is primarily driven by lower volume on the DDG 51 and the LHD 8 programs due to now concluded strike in our Gulf Coast shipyards.

And lower revenue on the DDG 1000 as it transitions from engineering to construction.

In total, the strike reduced year-to-date sales by approximately $100 million, but we do expect to recover those sales over time.

During the quarter we also had lower volume for aircraft carriers than submarines and higher volume for the LPD and LHA programs.

Moving on to slide 7, second quarter 2007, segment operating margin rates were comparable to last year with year-to-date segment margin rate improved by 10 basis points over last year.

As Ron mentioned, the second quarter had the unusual items that affected three of our business group, but which only reduced segment operating margin by $4 million and the rate by 5 basis points, and I'll go through the details of those in a few minutes.

Total operating margin increased $62 million, or 9% for the quarter, and $139 million or 11% year-to-date.

Operating margin rate for the quarter improved by 40 basis points to 9.4%, and year-to-date increased 50 basis points to 9.3%.

The improvements for the quarter and year-to-date are due to higher segment margin from our businesses, lower net pension expense, and lower post-retirement benefit expenses due to the change in our benefit plans.

These improvements were partially offset by $50 million increase in corporate provisions, which is included with our other unusual items in the quarter.

In total, unusual items negatively impacted operating margin by $54 million in the quarter, or by 70 basis points in terms of rate.

Our effective tax rate in the second quarter was 29.4%, compared with 25% in last year's second quarter.

On a year-to-date basis the tax rate is 31.8% versus 27.9% in the prior year.

This quarter's effective tax rate included a $16 million benefit due to a favorable settlement with the IRS, while last year's second quarter included tax benefits totaling $48 million due to reversal of previously established expense provisions for audits of the B2 programs in '97 through 2000.

The unusual items are detailed on slide 8, and I'll briefly describe each of them.

Beginning with aerospace, we had a $27 million settlement of prior year's overhead cost, in electronics the shut down of ITD, our Springfield, Missouri, operations and other consolidations generated a charge of $11 million.

This is less than the $20 million announced in our May press release due to the timing of the closure.

Our overall estimate hasn't changes, but the scheduled completion dates for final deliveries at the facility has stretched out a little longer than originally anticipated, so the remaining consolidated expenses have moved into the third quarter.

When the closure is completed, the results of this operation will move into discontinued operations.

Electronics also recognized a $27 million contract earnings adjustment on the F-16 Block 60 program due to higher estimates of the software integration costs to complete the Falcon Edge electronic warfare suite.

This quarter we reached basic agreement with our customer on flight program capabilities needed to support the Block 60 aircraft mission, and -- indeed an important step towards contract completion.

Unfortunately, the scope of those agreed-upon capabilities were greater than what was planned at the end of 2006 and extended the program completion scheduled which generated the adjustment to our EAC.

We do believe the EAC captures the risk of remaining development activities, however, given the complexities of this development effort, some risk always remains until final contract close-out is complete.

In ships, we reached agreement with all but one of our insurers on the first $500 million layer of coverage for Hurricane Katrina and during the quarter we collected about $120 million of which $62 million was allocated to lost profits.

You will recall we took $150 million charge in the third quarter of 2005 and reduced margin rates and all ships under construction at the time of the hurricane.

And, finally, Wes has already described this quarter's contract adjustment on the LPD program.

Slide 9 provides a reconciliation of net income to cash from operations and free cash flow from the quarter and year-to-date.

The major items driving the strong cash performance are higher net income, working capital improvements and less cash used for discontinued operations.

Capital spending during the quarter was $140 million, outsourcing contract and related software costs totaled $50 million, bringing us to free cash flow of $551 million for the quarter.

Year-to-date we saw the same trends driving strong cash performance with year-to-date capital spending offer $298 million and outsourcing contract and software-related costs of $80 million, bringing us to free cash flow of $763 million, an improvement of more than $.5 billion over the first half of 2006.

Now, let's move to guidance for the year on slide 10.

We now see sales of approximately $31.5 billion, plus or minus $250 million, with the sales outlook for each of our four businesses still falling within our prior guidance ranges.

Our sales guidance includes M&A transactions completed or under contract, as well as our view of the new business growth and reduced program funding affecting current year sales for programs like KEI and the E-10A.

Segment operating margin rate is now expected to improve to the mid-9% range, versus our prior guidance of low 9%, reflecting our results to date and expectations for the second half.

We expect segment operating margin rate to be slightly higher than the total operating margin rate while we continue -- which we continue to expect to be in the low 9% range.

Segment margin rate and total operating margin rate in the second half of the year are expecting to be lower than the first half margin rates reflecting sales growth in some of our lower margin businesses and resulting overall business mix that comes from that sales growth, as well as the impact of the first half performance usual items.

Based on all of that, we refining our guidance range for earnings per share, our new range is $490 million to $505 million and cash performance continues to be strong.

So we now expect cash from operations and free cash flow to be at the upper end of our prior guidance ranges.

In summary, we're satisfied with year-to-date results and are well positioned for the remainder of 2007.

Gaston, with that, I think we're ready for some Q & A.

Okay.

Thanks, Jim.

Ladies and gentlemen, we'll go to Q&A now.

I would ask you to limit yourself to one question per turn.

Bill, ready for you.

Thank you very much, sir.

(OPERATOR INSTRUCTIONS) Questions will be asked in the order they are received.

(OPERATOR INSTRUCTIONS) And our first question comes from the line of Heidi Wood of Morgan Stanley, please proceed.

Good morning, guys.

Good morning, Heidi.

I have a quick question about share repurchase.

It looked a little light in the first half.

I wonder if you could address that and talk a little bit about what we should expect in the second half?

Well, Heidi, you might remember that we announced an ASR for roughly $600 million in December or January.

That ASR was completed in early June, so all of the announced repurchase programs have been completed -- all the announced programs have been completed.

There is roughly $580 million, or so, remaining under the authorization, and I believe our public position has been that we will complete that remaining authorization over the next year and a half, or so.

At this point in time, that is essentially where we are on share repurchase programs.

We obviously will look at cash deployment as we go through the year and make decisions about how we go forward.

Alright.

Great.

Thank you.

Thank you, Heidi.

Thank you very much, ma'am.

Ladies and gentlemen, your next question comes from the line of Joe Nadol of JPMorgan.

Please proceed.

Thanks, good morning.

Morning, Joe.

My question is a followup on the great detail you gave on the ship systems issues.

Which is basically is -- can you tell us more about the LHD 8 contract?

I was I guess--is it fixed price or cost-plus?

Are you running at zero margin now going forward?

As an adjunct to that, can you just talk about percentage of sales in your Gulf yards in total that are attributable to fixed price versus cost-plus contracts?

Thanks.

Yes, Joe, it's Wes, let me parse your question into the pieces there.

LHD 8 is one of the types of programs that are fixed price incentive, and so as you come down the share line, you eventually come to a point where you get into total assumption.

LHD 8 was one of the programs where we made a substantial adjustment, subsequent to Katrina, that carried us substantially down that share line as part of our overall impacts to Katrina.

And as we done this reprioritization and scheduled alignment with the Navy, it carried us even further down that path.

So if you look at the programs that we have that have a fixed price or some degree of fixed price incentive aspect to them today, that is certainly the destroyer programs, at ship systems, as well as the LHD 8 program, the newer versions of the LPD programs we've just undertaken recently, are also of that character, but the earlier LPD programs, the ones that were primarily impacted by Katrina, are cost-plus.

So hopefully that gives you a sense of the portfolio of contracts that we have there.

Yes, that's helpful.

And on LHD 8 are you now on zero margin going forward?

Essentially we're at -- Joe, Jim Palmer -- essentially we're about zero, yes.

Okay.

Thank you.

Thank you, Joe.

Thank you, very much, sir.

Ladies and gentlemen, your next question comes from the line of Steve Binder of Bear, Stearns, please proceed.

Yes.

Good morning, can you maybe just touch on tension, I think the FAS-CAS difference in your previous projection was $70 million of income and you're running almost that in the first half of the year and I thought first quarter was running obviously heavy and we're going to see for FAS-CAS expense in Q2 because of your plans.

What happened there?

What's the outlook for the year?

Steve, when I look at the numbers you're right that it has been running a little heavier than prior forecasts.

Essentially in terms of forecasts or guidance for the year, updated all of that, and the way I looked at it, frankly, was to look at the corporate unallocated as well as the pension FAS-CAS differences.

That net difference at the beginning of the year, in terms of guidance for the year, was about minus $20 million.

I see that kind of difference doubling, kind of the minus $40 million for the year, effectively largely driven by the $50 million of legal and investigative reserves offset by somewhat higher pension and then just a little bit of other noise and changes in there.

And --

Hopefully that helps.

Yes, and Jim, maybe can you touch on that $50 million of provisions you took in the quarter?

What is that associated with?

Well, as we said in the press release, and I will say here, we -- every quarter we go through a pretty rigorous review of all of our pending legal and investigative matters.

And I -- and based on that overall review, we've identified a number of items that we thought we needed to make an adjustment to, to reflect their current state.

We did so in doing that.

Obviously, it was based on events that occurred during the second quarter, and so it was really looking at the portfolio of issues and making adjustments based on that review.

And lastly, is your statement, Jim, on the EACs, on Block 60, does it represent stronger confidence that your EACs are satisfactory than what management saw three months ago?

I guess it is hard for me to make that comparison, Steve.

I do know that the electronics folks, as well as the number of us back at corporate, spent the good deal of time on that estimate update, and we've tried to take a good hard look at it through clear glasses, and based on that we do think that we have a very good estimate of the cost to complete.

Now, it goes without saying that obviously these development programs are really tough and it always remains to be -- you need to finish these development programs, and once you get them finished, you really know that they're finished.

And our history, as you know, has not been that stellar on this.

So given all that, I'm confident of where we are, but I also know that you're really not finished until you're finished.

Alright.

Thank you.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Cai von Rumohr of Cowen & Company.

Please proceed.

Yes, on Block 60, do you feel you will be able to meet all of the specs included in the contract?

And if there are any areas where you think you will be short, do you have contractual agreement with the customer as to what the price give-up could be -- should be?

Cai, this is Wes, as you know, from your long involvement in the history of this program, we took on a very challenging set of specifications and requirements, and as we've worked our way through the program, we have worked closely with the customer to better align what the system actually has to do in terms of those detailed specs, in order to meet the overall mission requirements.

And so that focus has been on meeting the mission requirements, not just the individual detailed specs.

This last round of additional work that we've recognized in the EAC that we put on the table, takes into account that set of discussions with the customer, and in particular the capabilities of the software in the Falcon Edge electronic warfare component edge block of Block 60, the incremental deliveries that we're going to be making in the next coming months over the course of the next year, in that set of capabilities to specifically address getting to mission requirements.

Now, as Jim said, it is not over until it is over on a contract like this.

But I do think this represents a very substantial step forward in narrowing the edges of that box in together for us?

But just so you and the customer now agree on a set of mission requirements that you feel you will be able to achieve.

Is that correct?

Yes, we've long had a common vision of what those mission requirements are.

In a system of this complexity the challenge is more often getting to an agreement of what the detailed specs on the subsystem performance elements need to be, so that in aggregate they perform well at the mission level.

So I would -- I want to be careful not to make it sound like we've had some new realization of what the mission is.

That's been in place.

The progress we're making is in goo recognition of what the detailed components of the things that we're delivering need to actually do to get us there, and so it is good progress.

Okay.

Thank you.

Thank you, Cai.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Myles Walton of CIBC World Markets.

Please proceed.

Thanks.

Ron, as you look to beyond the current conflict and maybe to what lessons learned, feedback into budget priorities, could you just conceptually go off into what those might be to shifting the way the budgets come down to in the out years, similarly to maybe what prior engagements played out as budgetary priority changes.

And then also is there anything within Northrup's portfolio that you think may be -- you should position it better to take advantage of some of those priorities.

Myles, there are some good points there.

Clearly the current conflict is consuming an enormous amount of time and energy, probably appropriately in the part of leadership in both the administration and the congress.

But if you do look at the budgets being put together, there is a increasing concern about the long-term competitiveness of our defense posture for the day when we're finished of this current conflict.

If you look from concerns from the Navy and Air Force, and in the intelligence communities, there are very, very serious needs that have to be handled in the near-term and the out years after the conflict is over.

Clearly there is going to be an enormous need on the army's side to recapitalize and replace equipment.

That goes without saying.

That's getting a great deal of attention.

Perhaps not as well understood is the fact that the strategic capabilities in the nation are also in great need of recapitalization.

Example of that would be the tanker program, significant work on ships.

Keep in mind that the ship-building issue, even though we have great deals of media attention on it and certainly near-term focus, the nation needs more ships, more capable ships and needs to produce a Navy which is even more capable.

Space is going to be very, very important.

The whole area which we call C4ISR is extremely important.

Unmanned air vehicles.

We're going to see a lot of those.

And, of course, missile defense.

We're very concerned with the war in Iraq now.

We're concerned with terrorism, very important threats to deal with, but I'll tell you that the threat of ballistic missiles and potentially nuclear-armed missiles is a very, very serious one indeed the nation has to address.

So while I'd like to be optimistic about the near term outlook for the strategic threats out there, the fact is the world is not getting safer, we said that before.

And we think the portfolio here is pretty well positioned.

Information and services will be very, very significant play, certainly for our company as we move forward.

I think you saw this quarter a very strong performance in that sector.

Thanks, that's helpful.

And maybe if I can slide in a quick one.

In the near-term, though, do you believe that strategic weapons will come under more and more pressure for cannibalization, if army reset functions continue to gobble up more of the budget?

I don't think so.

In fact, we're looking now -- for example, we are the prime contractor, prime integrating contract for the nation's ICBM forces, a program you don't hear a lot about.

It is a very, very substantial program for the company.

We're now working for our customer, United States Air Force, to look at how we extend the capability here beyond the year 2020.

If nothing is done in this regard, the ability to certify a solid land-based deterrent will in fact diminish.

So we see the need for that, both in terms of strategic forces.

Long-range strike, another important areas of the Air Force is putting significant energy and allocated budget dollars against for the next five years, in the next five-year plan.

This will be the next generation bomber, it is also known as that.

These are areas which are going to continue to be well funded.

And while we are not as a corporation playing heavily in armor, replacement of treads and tracks, and bombs and bullets, and those are very important things being done in the near-term, in many cases by others, we do see the underlying strategic in longer-range technological capability of the forces really playing to our strength.

That's great.

Thanks.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Robert Stallard of Banc of America.

Please proceed.

Morning.

Morning, Robert.

Actually it's good afternoon now, sorry.

Following up on the budget issue, there has been some discussion in the congress that appears to be sticking, there should be additional ships versus the president's plan in FY '08.

How do you think this could flow through for Northrup Grumman.

Do you see a healthy return to growth if these plans come to pass?

We are certainly aware that the president's ship building plan, which has been pretty stable the last couple of years and there seems to be a resolution, a resolve to make a stable plan to get ultimately back to 300-ship -- 313-ship Navy, is underway.

We have obviously seen the House Appropriations Committee mark.

We have not heard the Senate mark.

But the House Appropriations Committee increased ship building substantially and we understand an additional LPD has been added to that particular bill.

So I think we see a congressional sentiment for ship building, which is perhaps even stronger than what you see out of the president's budget.

So how does that affect Northrup?

Clearly, it shows there should be good long term stability.

And frankly as we work our way through the first of class ships that we're working through now, which are always challenging ships, and we have more stable production and stable funding of repeats, we see it as a significant positive for the business.

And just to follow up, there have been reports of disagreements with the Navy on LPD.

Is there anything significant going on here?

Well, I don't think it is appropriate to comment on a call of the discussions we have with our customer.

We have lots of discussions all the time, but I will restate what I said in my initial remarks, we are absolutely committed to providing the Navy with the highest-quality ships, aircraft, radars, information systems.

That is our mission, that's our job and that is what we strive to do.

Okay.

Thank you.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Doug Harned of Sanford Bernstein.

Please proceed.

Good morning.

Good morning, Doug.

In ships, you had a great margin this time, 9.9%.

Now, that had the benefit of a $62 million insurance recovery, but it also had what you described as a one-time item, the $55 million associated with the LHD.

So if I look at that margin, is this -- this is a very high margin.

Is this something we would expect to see in the future?

Or how do you look at this?

Doug, it is Jim.

Again, looking at our ships business for this year, our guidance at the beginning of the year was kind of a mid-8%, 8% in terms of operating or segment operating margin.

Frankly, as I look at the year on a basis -- on a go-forward basis given the results to date, as well as expectations for the second half, I really don't see much change in that segment operating margin for the year.

So, kind of mid-8% is my expectation for the year.

You're right, there is a $62 million plus and $55 million negative.

And so that in terms of overall impact on margin has little impact.

But can you say what is -- what drove this to the 9.9% that is unusual then this quarter, when we're expecting an 8% margin for the year -- mid-8% for the year?

Ships is a total of Newport News and ship systems are the Gulf Coast yards, and dependent upon progress upon individual boats, we can have differences in the margin on a quarterly basis.

And so, again, when I look at the overall margin for the year, as well as I said, expectations, kind of where we expect to be in the mid-8% range.

Okay.

So that means a lower back half, then.

Yes, essentially.

Okay.

Okay.

Thanks.

Thank you, Doug.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Joe Campbell from Lehman Brothers.

Please proceed.

Good morning, can you tell us a little more -- I know Steve asked you to go over this $50 million reserve.

I mean, are you talking about losing lawsuits or provisions for it?

Have you had some new ones that we haven't seen yet?

Or is this just a lot of legal fees that you expect to incur?

It is a lot of money just for a lot of little things.

Yes, Joe, there is -- you obviously can look at the Q that's filed this morning.

There really isn't anything new that I can think of.

So it essentially is new developments on existing items.

Can you be a little more -- what's going on?

It's just a lot of lawyers or you're planning on losing something?

Again, if you read -- if you take a look at the Q, you'll see that there is descriptions of changes that occurred during the quarter.

For example, one of those changes is in the Cogent matter, where there was a ruling, but -- so that was an item that was taken into account.

It is by no means the whole reason for the reserve.

But, again, I think if you take a look at the Q, you'll find some of that data.

Okay.

Thank you.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Robert Spingarn from Credit Suisse.

Please proceed.

Good morning.

Morning, Robert.

Speaking of the Q, what I was looking in there at the insurance comments on Katrina recovery, you talk about $366 million in lost profit claims, and, of course, you recorded the $62 million in the quarter.

How should we think about the rest of those funds?

Are those potential future reimbursements or are those claims that were not awarded?

How does that work?

Essentially, it is potential future reimbursements.

It is all also true that it is wrapped up in the dispute with FM Global over the second layer of coverage.

Essentially what we tried to say in the -- in our press release, and in the Q, is that we settled with all of the insurers in the first layer, but for one.

And essentially at this point in time have collected a total of $475 million, $466 million which relates to the shipyards, small amount which relates to other damage that was -- occurred in the Gulf Coast for other facilities nonshipyard.

So a big part was shipyards, $466 million for shipyards, $475 million collected in total.

There is one remaining insured in the first layer that we need to finalize the collections on to get to the $500 million first layer, and then essentially we're all into the dispute or potential litigation with FM Global for any amounts above $500 million.

Their coverage runs from that $500 million level up to about $20 billion.

But I saw that in there, it looks like your total claim is about $1.2 billion?

That is true.

You have to move past this first $500 million ceiling to get the rest of that?

Correct.

Okay.

And then just related, but somewhat separate to Katrina and the Gulf Coast, there is talk out there that the first DDG 1000 might move to Bath.

Can you comment on that?

Yes, this is Ron.

I don't really have anything to say about that.

Obviously we're in discussions with the Navy in terms of how they want to proceed on the award of the construction phase, both we and Bath are working very closely in the design -- this ship.

We are co-designing it essentially for all practical purposes, and at this point I think I would defer to the Navy.

Ron, would that call for some change in the guidance?

Would there be an economic impact there?

I think the guidance we've given you is guidance for the year as we see it.

Right.

Thank you.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of George Shapiro, Citigroup.

Please proceed.

Yes.

Good morning, I want to pursue ships maybe a little differently.

Hi, George.

I want to pursue ships, maybe a little differently.

Can you just provide roughly what the margins at Newport News currently is running versus the overall Pascagoula and Avondale?

Because I figure 40%, 45% of the revenues are from Newport News.

Yes, George, we don't give the break-out between the two -- essentially the two different shipyards.

It is, I think, fair to say that our experience has been greater in Newport News in recent history, consistent with their experience over a long period of time.

Whereas the experience in the Gulf Coast has been affected by Katrina.

Obviously, as I said in my prepared remarks, we took on $150 million charge when Katrina hit, and then we lowered the earnings on all of those contracts on a go-forward basis.

And so until those contracts are completed in the Gulf Coast, we have lower earnings as those ships are completed over the next roughly couple of years.

So --

Yes, I was just trying to get to how much -- how much lower.

I mean, you're saying you booking zero on the LHD, there have been issues on the LPD, which seems you're probably not booking very much there.

So I was just kind of wondering are we talking 15% versus 3%?

That kind of ballpark?

Or is it something less dramatic than that?

No.

It is much less dramatic than that, George.

Essentially what I said is the Newport News experience has been kind of high single-digit rates, if you look to the public company history -- if you're at kind of a mid-8% for the ship business as a whole, you can almost do the math after that.

Okay.

So there is not that much difference then.

Because I thought when Newport News was public they were making higher margins than that.

They were making mid -- 14%, 15% kinds of margins.

I don't think so.

Okay.

Maybe there was more like 11% or 12% margins then.

Okay.

Obviously you're going to go as far as you're going to go.

Let me just ask a different one, then.

With the $62 million profit recovery you showed in ships, should I deduce, then, that when you get to the $500 million from the $466 million that that additional $34 million would also go to profit recovery?

There will be some amount that probably or likely would be allocated to the profit recovery.

It would be a -- it would be a percentage of that difference.

But it's a small percent.

Okay.

And then just the last one, just to detail.

If you could break out what you -- FAS-CAS, as I think Steve asked earlier was going to be, the guidance was $70 million for the year, you're at $61 million in two quarters.

If you broke that out separately, do you just double that and expect $120 million for the year now?

And what's causing it?

Just higher CAS recovery or did you make some FAS assumptions?

I believe it is largely just FAS expense being trued up after the -- after the completion of the guidance.

You do your FAS expense based on 12/31 actuals, the guidance was prior to 12/31, and so just those kind of normal differences, if you will, that occur as you go through time.

But so would the number for the year now would be more like $120 million versus the $70 million guidance before?

Well, the way I look at it, George, as I said, is I looked at all the corporate unallocated costs and the pension and legal reserves, and when we guided those numbers netted to a minus $20 million for the year, I see that essentially doubling, or so.

Okay.

So maybe you're adding $30 million a year then.

Okay.

Thanks a lot.

Thank you, George.

Thanks, George.

Thank you very much, sir.

Ladies and gentlemen, our next question comes from the line of David Strauss of UBS.

Please proceed.

Thank you.

Could you just give us an update on walking through each of the fixed-price development programs, Wedge tail, Block 60, and ASPIS, when you now expect risks to be retired on each of those programs?

Yes, this is Wes, let me go through each of those.

We have been making good progress across the board on all of those programs.

I think we touched on Block 60 a little bit.

In terms of really bringing that -- the contract resolution to closure, the extension of the work that is associated with this contract adjustment, we took this quarter now puts us out into the, I would say, early 2009 time frame for contract resolution on Block 60.

Wedge tail continues to make very good progress over what we call is MESA.

We're currently in the development testing and evaluation phase.

We're expecting to complete that set of activities on schedule here in the fourth quarter of this year.

We've been making good progress with the software updates and getting those integrated with the aircraft, so we can demonstrate the radar performance, with Boeing integrating that into the mission computing system.

So overall the MESA activities continue to be on track and performing within the EACs that we established.

In terms of looking out in time on that one, we expect to get through this DT&E phase as I said around the end of the year.

Then we get into what is called typed acceptance testing and evaluation, and that takes about six months.

So as we get into probably the third quarter, maybe fourth quarter of next year, I think on Wedge Tail we'll really have our arms around all of the performance, all of the things that really have been driving us in terms of the developmental nature of the programs over that period of time.

The other one I think you asked about was ASPIS.

Yes.

Yes.

ASPIS as well continues to make very, very good progress.

ASPIS is electronic warfare upgrade program for a foreign air force and we got through first article testing, we passed that.

And we've also completed flight testing, some evaluation tests we do in flight in country against some of the threat emitters.

And that has given us a lot of confidence on how we're moving forward on ASPIS.

Again we're continuing to operate within the established EAC.

We think we're going to get through the evaluation test phase in the spring of next year and that would be sort of big milestone for overall risk reduction on ASPIS.

Great.

Thanks, Wes.

Could you also talk about how progress is going integrating Essex, how the acquisition is performing?

You obviously have pretty good margin mission systems in the quarter.

I don't know if Essex had anything to do with that?

Yes, Dave, I'll take that one.

This is Ron.

We are delighted with the performance of Essex since we completed the acquisition earlier in the year.

It's doing very well.

We have moved other Northrup capabilities into Essex under the leadership of the Essex team.

That gives us more critical mass in areas where they're expert.

We're seeing strong contract performance.

We're seeing very significant new business opportunities and realities there.

So I couldn't be more delighted.

And that strong margin you saw mission systems in the quarter, was that attributable at all to Essex or what was going on there?

It really couldn't be differentiated that way, David, because that is not as large a material portion of mission systems.

Okay.

Thanks.

Thank you, David.

Thank you very much, sir.

And ladies and gentlemen, our final question comes from the line of Joe Nadol of JPMorgan as a followup.

Thanks.

Just a followup on disclosure.

I think you changed your presentation format this quarter to exclude the specific segment guidance.

You already mentioned that the ship margin you're looking at consistent margin with your original expectations, I'm wondering, A, do you not plan to give segment guidance going forward?

And, B, is there any other thing else you can tell us on any other changes you might have made from the original guidance beginning of the year?

Let's see, Joe, I look to guidance and I -- as I said, I think sales for all of the segments are going to be within the prior guidance, margin is obviously moving around a little bit on the four business areas.

Essentially, at this point I would see kind of as we said on an overall basis the segment operating margin going from lower 9% to kind of mid-9%.

I don't see a whole lot of change in information systems.

Aerospace, given its performance to date, I expect them to be up, maybe up about 10% in terms of change in their margin rate.

ES I think will be down a little bit from the prior guidance, which was kind of high 11% probably looking at mid-11% now, given the charge.

And, as I said earlier, I don't really see any change in ships.

So I looked at all of that to think about the guidance.

I don't know that it is necessary to give individual guidance for all of these different line items, but to really think about the overall company performance as a whole, and that is what I did.

Okay.

Thanks, Jim.

I would say from my standpoint the more transparency in guidance, the better, I guess.

Segment guidance is something that a lot of -- most companies in this sector give, and I think that is something I would like to see.

Thank you.

Thank you very much, sir.

That concludes our Q&A session for today.

I'd like to turn the call back over to our speakers for any closing remarks.

Okay.

Nothing much more to say.

This is Ron.

I want to thank you all for joining us, and we look forward to talking to you next time.

That you, sir, and 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.