諾斯洛普·格拉曼 (NOC) 2007 Q3 法說會逐字稿

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

My name is Carol and I'll be your coordinator for today.

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

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

(OPERATOR INSTRUCTIONS) As a reminder, ladies and gentlemen, 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 proceed.

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

We've provided a supplemental presentation that you can access on our Web site.

Before we start, please understand that our discussion will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

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

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.

A more complete expression of these risks and uncertainties contained in the Company's SEC filings including Forms 10-K and 10-Q which was filed this morning.

During the call we'll discuss third quarter results including non-GAAP measures for segment operating margin and free cash flow both of which are reconciled in our earnings release.

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

We're also introducing a financial metric called New Business Awards, which is defined as firm contractual additions to backlog received during the quarter.

New business awards do not include unexercised options or IDIQ contracts and they may be funded or unfunded.

This is an additional data point to help you understand our outlook.

Funded contract acquisitions, which we have been presenting and will continue to do, include new business as well as funding actions on previously awarded contracts.

The new business awards metric represents the additions to backlog and we think it better demonstrates our business capture activity.

This metric will be more variable than acquisitions but it should aid in your analysis.

On our 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.

Thank you, Gaston, and good morning, everybody, or good afternoon, wherever you may be.

Before I talk about the quarter, let me just mention something about the fires.

I know you're aware of the serious fire situation here in Southern California.

Two of our facilities in San Diego County have been closed as a safety precaution, but we have no reported damage to any of our facilities at this time.

Some of our employees have been impacted, and we have our corporate and local crisis centers in full operation to aid any employees who might need assistance.

Incidentally, I would point out that it's our understanding that the Governor has requested the United States Air Force to make the Global Hawk aircraft available on a 24-7 basis as a very high altitude fire spotter that'll be able to stay well above the air traffic permissions in excess of 20 hours.

And we believe those flights are scheduled to start today.

Turning to the quarter, we're extremely pleased with the third quarter results.

We had record doubles of segment in operating margin, cash from operations and backlog.

Sales rose 7%, EPS grew 60% and segment and total operating margin rates were both double-digit for the first time since 2003.

Cash from operations was outstanding at more than $1 billion for the quarter and more than $2.1 billion year-to-date.

New business awards in the quarter total $11.5 billion and help bring our total backlog to a record $64.1 billion.

One very important award this quarter was the Navy UCAS competitive win.

This $636 million contract will demonstrate the capability of our X-47B.

This autonomous, low-observable aircraft will conduct the first-ever at sea fixed-wing carrier launches and recoveries.

The follow-on and vision for this contract has a multi-billion dollar potential for system design, development and production.

During the third quarter, we also received a $408 million contract for the Navy's next three E-2D Advanced Hawkeyes.

This marks the beginning of a 75-plane production run for the E-2D.

In addition, the Army awarded a sole source IQID contract with a potential value of $462 million to upgrade and modernize its Guardrail Signals Intelligence aircraft.

Under this contract we will provide much needed mission capability until the Army's aerial common sensor is eventually [fielded].

We also won a competitive $331 million contract to continue providing logistical support services to the Army's National Training Center at Fort Irwin, California.

We're the first incumbent ever to win a recompete for this program.

We were also awarded a $286 million contract for construction of the Coast Guard's third national security cutter.

And on the international front, we signed a contract with our partner to supply Mesa radars for the Republic of Korea.

Our restricted program awards also continued to grow substantially during the third quarter.

The largest new business award in the quarter resulted from the successful restructuring of the NPOS weather satellite system.

This accounts for $2.3 billion of our $11.5 billion in new awards.

And shortly after the end of the third quarter, we won a $220 million competitive award from the National Security Agency.

Under this contract we will develop an advanced information management and data storage system that will support efforts to modernize our nation's electronic intelligence and broaden signal intelligence capabilities.

Over and above these new business awards, Northrop Grumman was competitively selected on several IDIQ contracts that have multi-billion dollar potential.

Among the most noteworthy of these multi-company awards are the GSA Alliant contract with a $50 billion ceiling, the Centers for Medicare and Medicaid Services with a $4 billion ceiling, and the Department of Defense Counter Drug and Counter Narcoterrorism effort with a $15 billion ceiling.

Looking ahead we continue to have a solid pipeline of opportunities.

On the immediate horizon, are competitions for BAMS, the Navy's Broad Area Maritime Surveillance System.

TSat, that' s the Transformational Satellite.

GPS operational control system, the tracking and data relay satellite and several more restricted opportunities.

The winner of the KCX Tanker replacement program is now likely to be announced in the first quarter of 2008.

We believe we have a very competitive offering similar to the one chosen in the three most recent international competitions conducted by our allies, the United Kingdom, Australia, and the UAE.

Year-to-date, our results demonstrate sales growth, margin expansion, and 20% growth in both net income and EPS.

We're especially positive about the strength of our cash performance which has allowed us to continue executing a balanced cash deployment strategy.

During the third quarter, we repurchased another 6.5 million shares, essentially completing our most recent share repurchase authorization one year ahead of schedule.

In total we've repurchased 68 million shares for $4.1 billion while at the same time strengthening our balance sheet and earning the best credit rating in the Company's history.

Our balance cash deployment strategy of focused M&A, top tier dividend payout and yield, and share buybacks has benefited our shareholders and will continue to benefit our shareholders going forward.

So in closing, for 2007 we expect sales of approximately $31.5 billion.

We are raising our 2007 earnings per share guidance to approximately $5.10 per share, a 14% increase over last year with very strong cash generation.

All in all, a very strong quarter that produced great results and momentum for the future.

Now, I'd like to turn the call over to Wes Bush for an update on operations.

Wes?

Thanks, Ron.

My comments today include an update on Ships as well as a report on our NPOS restructuring.

Ships third quarter results were outstanding with strong performance from both from Newport News and our Gulf Coast shipyards.

On the Virginia-Class submarine program we launched the North Carolina in May and delivery is on track for December.

Work on the next four submarines is also on track and the team is continuing to drive costs out and increase efficiencies.

We and our partner are optimistic that our cost reductions will enable the Navy to increase production to two ships per year.

On carriers, the CVN-77 Bush is more than 85% complete and is scheduled for delivery to the Navy in late 2008.

Despite some early challenges, our performance in terms of both cost and schedule has been on plan over the last 30 months.

On the next generation CvN-78 Ford-Class we continue to make solid progress on preconstruction activities and we expect a construction contract to be award the in the second quarter of 2008.

Our Gulf Coast shipyards continue to recover from Hurricane Katrina and with the delivery of every ship, our business mix reflects a higher proportion of healthier post-Katrina volume.

We are performing, people, processes and infrastructure are in place.

We're making major investments in each of these critical areas.

Our improvement initiatives are driving down the cost of building ships and we're improving the quality to the level our Navy customer expects.

We're coming out of this two-year recovery from Katrina and we and the Navy have agreed on new performance baselines for cost and schedule, which are a direct result of the Katrina impacts.

We're very pleased to report that the LPD 19, Mesa Verde, completed acceptance trials in the third quarter and passed all major testing events.

The Navy has expressed great satisfaction with this newest LPD, and we're very proud of the work that our shipbuilders have done on this ship.

The ship has been delivered to the Navy and it will be commissioned in December.

One of the operational highlights this quarter was the completion of the NPOS contract restructure.

This represents the successful conclusion of a yearlong effort to replan virtually every aspect of the program.

NPOS is now on solid footing and it's moving ahead to meet the operational weather, environmental and climate monitoring requirements of civilian and military users.

The primary remaining challenge for NPOS is the sensors and we're working very closely with our subcontractors to mitigate and retire this risk.

I would add that throughout this extensive joint effort with the Government Program Officer, our team has continued to meet scheduled milestones and NPOS has been essentially on cost and schedule for the past 21 months.

The current schedule calls for the first NPOS satellite to be launched in 2013.

Overall our businesses are performing well and we have a strong focus throughout the corporation to assure improvement continues.

And as Ron said, we have a large opportunity set of new business that we're pursuing.

So now I'll turn the call over to Jim to go through our financials for the quarter and our guidance.

Thanks, Wes.

Good afternoon, ladies and gentlemen.

My comments will begin on Slide 5 and they will summarize the third quarter and year-to-date results as well as our 2007 guidance.

In our fourth quarter conference call we will be providing guidance for 2008.

As Ron has said, this was an outstanding quarter by every measure with the highlights being margin expansion and cash generation.

Third quarter sales were up 7% to $7.9 billion, segment operating margin rate expanded 90 basis points to 10.3%.

Segment operating margin benefited from a $22 million AMSEC gain but adjusting for this one-time positive still leaves us with over 60 basis points of segment margin expansion and double-digit margin rate.

Total operating margin rate increased by 280 basis points from last year when we had a significant legal provision.

But adjusting for that, total operating margin still increased by about 130 basis points.

This drove the 62% increase in net income and the 64% increase in earnings per share for the quarter.

We are very pleased with cash from operations and free cash flow which were all-time highs.

Cash from operations topped the $1 billion mark and improved on a very strong performance in last year's third quarter.

Third quarter free cash flow totaled $873 million.

Year-to-date results were also strong with higher sales, margin rates and earnings per share.

Cash from operations increased nearly $700 million, or 45% to more than $2.1 billion.

Higher cash from operations for both the third quarter and year-to-date is being driven by working capital improvements, which you know, has been an area of particular focus for us, as well as lower pension expense.

Year-to-date free cash flow totaled $1.6 billion, or more than 120% of net income.

So with that performance, we've already met the low end of our guidance range for 2007 free cash flow.

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

Looking at sales, Information & Services as well as Ships were the primarily sales increase drivers.

The increase at Information & Services includes higher volume for intelligence programs, the Essex acquisition, New York City Wireless and IT outsourcing contracts.

In Aerospace, sales declines for the quarter and year-to-date are primarily driven by several large programs as they transition 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.

These were partially offset by higher volume for the F/A-18 Global Hawk and restricted programs.

Electronic sales were up slightly for the quarter and up 5% year-to-date.

Third quarter sales growth is a little less than the prior quarter but we're still on track to achieve our target for the year.

At Ships, the 19% sales increase represents a ramp up in programs like LPD and LHA as well as some catch-up work delayed by the strike.

In total, the strike reduced revenue by approximately $100 million in the first half of the year but we are recovering those sales over time.

The higher volume also includes two months revenue from AMSEC.

Under the reorganization of the joint venture with SAIC we retained the ship engineering, logistics and technical services business.

These businesses are now reported in the Ships segment.

Moving on to Slide 7, the 90 basis improvement in third quarter segment margin rate was primarily driven by results at Ships.

I want to spend a few minutes, though, with you in looking at the third quarter trends for all of the four businesses.

Aerospace and Electronics margin rates and dollars are generally consistent with what we have seen throughout the year.

In Aerospace, integrated systems have improved performance in several programs which allowed them to post higher operating margins at a higher operating margin rate despite lower revenues.

For the year we expect Aerospace operating margin rate to be in the low 10% range.

Electronics margin rate is also a little higher than our run rate for the year, and this reflects performance improvements in the quarter.

Third quarter results for Information & Services and Ships are a bit different than what we saw during the first half of the year and I'll take a few moments to describe the results of each of these businesses.

The decline in margin and rate for Information & Services was largely driven by IT outsourcing programs and our information technologies sector, and to a much lesser extent, technical services.

For information technology that transitioned to the new outsourcing environment for one of our IT outsourcing programs has been challenging, taking a little longer and with a larger scope than we had originally thought.

Third quarter operating margin in IT reflects the impact of these higher outsourcing contract transition costs which includes $22 million of amortization of deferred and other period expensed outsourcing cost.

We are comfortable that these transition spending levels for this program is finishing and that the impacted program is entering a steady, ongoing state delivery phase.

For the fourth quarter we expect IT's margin rate to rebound and for the year we continue to expect Information & Services to have an operating margin rate of about 8%.

Ships margin rate more than doubled and operating margin rate increased to 12.5% from 6.1% in last year's third quarter.

There are four drivers for the increase.

First, we recognize the favorable impact of retiring risk on programs as a result of completion of contract actions.

Individually, none of these adjustments is extraordinarily large, but in the aggregate risk reduction represents $45 million of improvement over last year.

Second, we recognize performance improvements on several contracts.

The third factor is that our business mix at Ships continues to be positively impacted by the growing proportion of post-Katrina contract work which is characterized by a more normal margin rates than ships whose production was disrupted by the hurricane.

And lastly, there is the $22 million gain on the AMSEC restructuring.

However, the third quarter margin rate for Ships is not sustainable for this business at this time.

In the fourth quarter margin rate will return to a more normal run rate.

Year-to-date, Ships' margin rate is nearly 10% and because of the strong performance this quarter, we now expect them to have the margin rate in the low 9% range for the year, better than our prior guidance.

For the Company, year-to-date we've expanded segment margin rate by 40 basis points and total operating margin rate by 140 basis points.

Total operating margin increased $258 million, or 47% for the quarter and $405 million, or 22% year-to-date.

The improvements for the quarter and year-to-date are due to the higher segment margin from our businesses, lower pension expense, and post retirement expenses and then lower legal provisions.

Our effective tax rate in the third quarter was 33% compared to last year's 35.4%, and this quarter's effective tax rate was favorably impacted by the tax treatment for the AMSEC gain.

Slide 8 provides a reconciliation of net income to cash from operations and free cash flow for the quarter as well as year-to-date.

The major items driving a strong cash performance are working capital improvements, reduced pension spending, less cash used from discontinued operations, insurance recoveries and lower tax payments.

I said on the first quarter conference call that we would be focused on driving cash flows through working capital improvement and disciplined capital spending.

We are seeing the results from that focus both in the quarter and the year-to-date results.

In the third quarter we reduced working capital to $182 million, and year-to-date working capital has expanded by only $55 million despite $1billion increase in sales over the period.

Capital spending during the quarter was $133 million and outsourcing contract and related deferred software costs totaled $9 million bringing us to a free cash flow of $873 million for the quarter.

Year-to-date we saw the same trends driving a strong cash performance.

Year-to-date capital spending is $431 million and deferred outsourcing contract and software costs are $89 million bringing us to free cash flow of $1.6 billion, which is an improvement of nearly $700 million over 2006.

With all of that, let's now move on to guidance on Slide 9.

As Ron has indicated, we are on track for sales of approximately $31.5 billion.

We continue to expect that 2000 sales for all four of our businesses will be within our prior guidance ranges, our expectation for segment operating margin rate is unchanged.

We are increasing our guidance for total operating margin rate to be in the mid 9% range versus our prior guidance of low 9%.

Fourth quarter segment margin is expected to be about equal to third quarter segment margin after adjusting for the AMSEC gain and Ships risk retirement from completion of the contract actions.

Higher fourth quarter volume is expected to offset slightly lower margin rates for the quarter.

We also expect a somewhat higher tax rate in the fourth quarter to get to an overall tax rate of about 33% for the year.

Based on all of that, we are raising our guidance for the year.

For earnings per share we expect 2007 earnings per share of about $5.10 versus our prior guidance of $4.90 to $5.05.

For cash from operations and free cash flow we still expect to reach the upper end of our guidance ranges for the year.

In summary, it was a very strong quarter.

We're headed for the finish line with solid year-to-date results, double-digit earnings per share growth, strong cash flow, and we're well positioned for 2008.

With that, Gaston, I think we're ready to turn it back for Q&A.

Great.

Thanks, Jim.

Ladies and gentlemen, we would ask you to limit yourself to one question and a logical follow-up, if there is one, just to give everyone a chance to get their question in.

Carol, with that, we're ready to go.

Thank you, Mr.

Kent.

(OPERATOR INSTRUCTIONS) Gentlemen, your first question comes to you from the line of Cai von Rumohr of Cowen and Company.

Please proceed, sir.

Yes, cash flow, you've done a terrific job there and you have a plan of a target, I guess, of getting $500 million in improvements.

Could you tell us, a, how you're doing in terms of what you think you can still do from this point on?

And secondly, walk us through some of the cash flow risks like the DOJ issue, the Katrina insurance recovery.

Thanks.

Yes, Cai, you're right, cash flow has been strong.

As I mentioned on this call and before, I do think we have further opportunities to continue to improve our working capital management and therefore cash flow.

We continue to have unbilled receivables, or receivables we can't collect until we complete some of our fixed price development programs.

So as we complete those programs, those are significant cash milestones associated with those programs.

So that would be an area of working capital improvement.

The secondary would be in just the day-to-day management of working capital.

We have thousands -- tens of thousands of contracts.

We all know about the very large ones, but there are, as I said, tens of thousands of programs and so addressing the billing procedures around all those other contracts, the non-major contracts that we're all focused on, is really important because you can't collect until you can bill and so getting those things billed on a very timely basis is a very significant cash opportunity for us.

And then I do also believe that we still have some opportunities on the management of our liability side.

So all in total, I think over the next few years there's a fairly significant opportunity for working capital improvement in our business.

In terms of risk associated with insurance recovery, at this point our guidance does not anticipate any further insurance recovery for this year.

There really isn't the risk associated with that.

No, the question is, if we look forward that you have this disagreement with your insurance company as to the upper levels that they will cover them, then kind of how does that look for next year and basically getting that issue settled?

I think, you know, we do have in the third quarter here a favorable judgment associated with the litigation with FM.

We have a summary judgment that effectively says that we do have coverage.

Obviously, there's expectation that they may appeal that judgment.

And so from a go-forward basis, we think that we're probably over the next couple of years working through this coverage issue and resolving the quantum issues.

So essentially at this point in time there is an upside associated with potential insurance recovery during that period of time.

But in my prior thoughts about cash flow improvement, I've not included anything associated with Katrina recovery.

Thank you very much.

Thank you, Cai.

Thank you, gentlemen.

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

Please proceed.

Good afternoon.

Hi, George.

How are you?

Jim, if you could just go through a little bit Electronics margin seemed abnormally high.

You talk favorable adjustments and clearly have benefited from lower UAE F-16.

Can you just talk about where we are on that particular program?

And then the same question in Ships, where you get the extra, you know, what's the chance of getting further negotiation benefits from the ship contracts?

I'll do Electronics first.

I'll do the two margin questions and I'll let Wes talk a little about the actual program.

On margins in Electronics, when I look back over the year, we've kind of bumped around 11.5% margin, which is the average year-to-date margin rate.

We've been around that, kind of up and down each of the three quarters.

On a go-forward basis our guidance is in the mid 11% range for Electronics.

I kind of think that's where we're going to end the year.

So, yes, it's been, you know, kind of up and around 11.5%.

This quarter is a little bit above.

Second quarter was a little bit below but on average, 11.5 feels pretty good.

In terms of Ships, you know, very strong margin this quarter.

Part of that is due to the one-time gain associated with AMSEC that will not repeat.

The margin rate adjusting for that is still strong.

And as I said in my comments, I don't expect that the rate for the year to be at that same level.

It will come down in the fourth quarter.

Those risk retirements related to contract actions don't occur every quarter.

They are the result of a lengthy process sometimes associated with contract actions and we recognize them largely when they're completed.

But are there more -- is there more potential from those types of contract settlements with the Navy?

Not for this year.

Okay.

And then maybe if Wes could address where we are on the UAE F-16 and the further risk associated with that program.

Sure, George.

As you know, I think I've described on the previous calls that we're already at a state where all the hardware on the program has been delivered.

We've continued to make good progress.

The radar, the targeting system software is now delivered and is really demonstrating excellent results.

We're headed into a phase for those pieces for formal acceptance testing in the early part of next year.

So with respect to the radar and the targeting system our development efforts are largely behind us, we're moving into the product support phase.

Our primary challenge, as we've described all along, has been on the software development for the electronic warfare part of the program.

That's what we call Falcon Edge.

And we're maintaining our scheduled, our delivery schedules across the board and we've also just recently come through a big step with the second phase of the software now being approved for retrofitting on all the customer aircraft.

So what we have in front of us really is on Falcon Edge, the next step of risk reduction is this third phase of software development.

We expect to be retiring that risk over the next 12 months or so with incremental deliveries along the way so that we can make fine-tuning and adjustments as we go along and find out how that is performing.

So I would characterize Block 60 overall as performing to plan, certainly performing within RESCs and making very, very good progress.

Some risks continuing to be retired in front of us largely over the next 12 months.

Okay.

Thanks.

Thank you, George.

Gentlemen, your next question comes to you from the line of Joe Nadol of JPMorgan.

Please proceed.

Thanks.

Good morning.

Hi, Joe.

My questions, I guess, dig into the service businesses a little bit and Jim, you've already talked about them and some of the reasons for the lower margins in the quarter.

I'm just wondering, you've talked about the non-sustainability of some of the higher margin in Ships in particular.

I'm wondering if you have sort of these items circled and if we should expect a full bounce back to where we were kind of tracking before this quarter, both in IT and in the technical services area, or if there's some lower booking rates there coming as a result?

On the back of that, this one particular outsourcing program where you have encountered these difficulties, I'm wondering if that issue is completely circled and you're beyond that or if you're still in that phase?

Joe, what I try to say in my comments is that we're in the finishing stage of those transition efforts so I do think at this point it is largely behind us, that we are entering a more steady state revenue service model on a go-forward basis.

In terms of margins for IT, let me do the first Information & Services.

I did say we expect their margin rates to improve in the fourth quarter and to come back to an overall rate for the year of around 8% which is consistent with our guidance from the very beginning of the year.

I think technical services margin for this quarter is kind of a little low.

I do it -- probably I expect a little bit of improvement in the fourth quarter but the business there, the size of the business, is not the major driver in the Information & Services sector in total.

Information technology is one of the principal drivers there and I expect their margin rates to improve in the fourth quarter from where they were in the third quarter.

But on an overall basis, again, Information Services, I think, are going to have margin rates for the year consistent with their guidance at the very beginning of the year.

In terms of Ships, as I said, the third quarter rate was not sustainable for the business and I want to emphasize at this point in time I do think that they will improve.

My expectation for the year is an improved margin rate for the Ships overall business from our guidance at the very beginning of the year.

We're now looking at kind of a mid 8 type range from, I'm sorry, a low 9 range from mid 8 at the very beginning.

So I do see improvement in the Ships business as we've gone through the year.

And as I've told many of you, just as we transition more of the pre-Katrina ships and replace them with post-Katrina ships, the margins at our Gulf Coast yards ought to return to more normal margins as we go through time.

Just to clarify in the IT segment specifically, not the overall group, but IT, you generated some very nice margin expansion in the last several years from high 5s up last year into the mid 8s and now you have a little bit of a bump in the road here.

I'm just wondering if that sort of 8% plus rate you generated last year and really where you were in the first half, if that's a good run rate going forward or if the lower booking rates are going to imperil that and get us more into the 7s?

Although I'm not giving guidance for '08, Joe, I do think that the margin rates that you saw in the past might be more representative of what we ought to expect.

Okay.

Perfect.

Thank you.

Thank you.

Gentlemen, your next question comes to you from the line of Steve Binder of Bear Stearns.

Please proceed.

Good morning.

Good quarter.

Thanks, Steve.

A couple of things.

One, on Electronics, the books-to-bill in '06 was strong.

The book-to-bill is turning out to be very strong in '07.

Solid bookings quarter in Q3.

I'm just wondering, are we going to start seeing some, I know you don't want to talk about '08, but directionally, is there some acceleration of activity going on here as we go forward or do you see just growth [rates] sustained?

Yes, good observation, Steve.

As I mentioned in my comments, 5% increase in sales third quarter was actually down a little bit from second quarter, but as you noted, their backlog is up about 25% from the beginning of the year.

So as we've gone through the year they've been quietly winning a large number of programs adding to their backlog.

And Ron, you know, you touched earlier on all the program wins this year, at least touch on some of them in the quarter.

Just wondering from a funding standpoint, are you seeing any, you know, slowdown, or is there any essentially slippage in some of the new program wins as far as being turned on?

The ones we've won, I think, we're in good shape on.

We're already rolling on the UCAS program.

Obviously, the budget is in conference between the House and the Senate.

The nominal expectation is mid November.

We're on a CR now, as you all know.

The programs that affect Northrop are very well supported.

There were a couple of issues surrounding the E10 program and MTR [tip] funding, but overall, the vast majority of what we have looks pretty good for '08.

We are seeing some source selection dates moving to the right on several competitions.

The BAMS competition, that is the Navy Broad Air Maritime Surveillance, is moving to February or perhaps even a little later than that.

Tanker is rumored to be moving into the first quarter, although I'm not sure they officially slipped that date and I think that'll happen when it happens.

TSat probably in January.

TDRS we might see this year, that's the NASA competitive program and probably also the GPS program later this year.

So by the end of the year, so we'll see.

So there is some slippage in actual award dates, but at this point in time overall funding for '08 looks pretty solid for our account.

And just last, Jim, if you strip away kind of the events that you've referred to in Q3 in Ships with respect to AMSEC and also with respect to a $45 billion benefit from the contract resolution issues, and you take away the one-timers in Q2 in Ships, it looks like the margins are kind of even in Q3 versus Q2.

So the performance improvement that you noted across various programs including the increasing level of post-Katrina activity, is that kind of like on a similar basis as Q2?

I mean is there any real change with respect to profit (inaudible) adjustments in Q3 versus Q2?

Actually, Steve, I need to do the math, first of all.

But Q2 adjustments at Ships, you know, we had the insurance recovery but that was largely offset by the LHD 8, and so from what I see it basically is better performance.

Clearly, it's better performance than third quarter of last year, which was 6.1%.

If you just take that for its face value and do the math that you just did taking out both the AMSEC and the risk retirement, you still get almost 8% margins this year versus the 6.1% last year.

So I am seeing performance improvement in those shipyards.

All right.

Thank you.

Thanks, Steve.

Thank you, gentlemen.

Your next question comes to you from the line of Doug Harned of Stanford Bernstein.

Please proceed.

Good morning.

Good morning, Doug.

Again on the backlogs which did look very good across the board.

One question.

On a couple of the programs that have been restructured such as KEI and E10, have you had to take any reductions in backlog associated with those?

No, I don't think I have.

Maybe some very minor adjustments here and there but generally the way we provide the backlog is based upon what we really see coming.

And some of these programs may change out in the out years in the tails but that has not affected our backlog.

A couple of quarters ago we did have a reduction, total backlog AEI.

Right.

That was (inaudible) several quarters ago.

But nothing in the line --

But nothing new.

And then related to this, where you're seeing growth in integrated systems and you're talking about a transition from development to production, now, the margins look quite good there.

Are those surprising to you?

Q3 looks a little higher than I would have thought given that transition.

Those guys have continued to be wonderful performers this year as well as in the past.

They've really taken on the challenge of improving performance in their business while at the same time they're devoting significant resources to three major competitions this year, UCAS, BAMS, and tanker and so just really strong performance from those people.

There is a little bit of a mathematical phenomenon there going on, Doug.

If you think about it, with those developmental programs tailing off, we still have very strong production from our core programs like the F-18 and such that are still very good then that brings the whole rate up for the sector.

Development to production transition primarily drives the top line.

Yes.

And you get some benefit by having more production on margin rate.

But again, we continue to perform very well on those programs.

Good performance.

Okay.

Great.

Thank you.

Thank you.

Gentleman, your next question comes to you from the line of Heidi Wood of Morgan Stanley.

Please proceed.

Good morning.

Again, let me echo a very nice quarter, gentlemen.

Thank you, Heidi.

So looking ahead to 2008, either for Ron or Wes, the Navy and the Air Force are facing vacancies in the acquisition positions heading into the last year of a lame duck administration.

I'm just curious in your mind, how are you band [withing] your expectations for revenues in terms of contract awards and revenues?

Well, Heidi, I think life will go on in the United States government.

It's a pretty robust organization.

I think we'll get through the CR okay.

We believe there will be a defense bill.

I think there has to be.

The nation demands it of the Congress.

What we see, as I mentioned, in the '08 appropriations we think is very good.

We're pleased with that.

I think that you're going to see contract awards.

You'll continue to see the normal slips in award dates.

This is not uncommon and not unprecedented.

There may be a few that will be subject to higher scrutiny.

Maybe on a few protests more than we're used to seeing in the past depending upon how the selections are done, but life will go on.

I think for us and most of our peers a substantial portion of the '08 revenue will be independent of the decisions made on the margin on some of the new programs, because those programs won't always start in the beginning of the year and the funding will ramp up anyway.

So I think we've kind of factored this in our thinking in the guidance we've not given you for '08.

All right.

So I mean it sounds like even though we're in this last year, you think it's going to be the normal slips as opposed to risk that we're seeing greater risk, I meant more in terms of contract awards than revenues.

Yes, I see no dramatic to cause for alarm at this point in time.

Great.

Thank you.

The system is still operating.

Thanks a lot.

Thank you.

Gentlemen, your next question comes to you from the line of Ronald Epstein of Merrill Lynch.

Please proceed, sir.

Yes, good afternoon, guys.

Afternoon, Ron.

Just wanted to ask a broad question.

When you look out on the horizon of major programs that could be coming up in the next 12 to 18 months, can you just maybe walk through some of them and give us some color on your expectations and what you see out there?

Okay.

Let me take a cut at that.

A lot of restricted program work we can't talk about publicly but it's an important part of our business.

We talked about the BAMS contract already coming along.

That's a three-way competition we understand for the Navy unmanned surveillance plane.

That's a Q1 opportunity and we think we have a strong offering there with our Global Hawk aircraft.

The tanker, everybody knows more about that, I think, than perhaps all of us, because we all read about it every day.

It's a very big program.

We talked about the award date on that.

The E2, we have actually have had discussions with the UAE for an E-2Dsales.

We believe they're in a decision process between that and the Wedgetail aircraft.

I would point out that we also participate as a partner on Wedgetail.

A lot of work coming up that we can't identify specifically in information operations and information assurance.

An increasing area of interest and, certainly, some of the reasons behind our thoughts on Essex and other parts of our mission systems business.

We see a restart coming perhaps next year on the aerial common sensor but if it does not, we are given a tremendous amount of work on Guardrail upgrades and modernization in the meantime as a gap filler.

As you know, that program was competitively sourced and then canceled and as a result of that the Army has had to come back and provide requests for additional effort there which we're doing.

GPS we talked about.

TSat we talked about.

TDRS.

CVN-78, we are responding to the Navy's RFP for the construction phase of CVN-78, this is the new class Gerald Ford aircraft carrier.

We're several billion dollars into this program in terms of advanced design work, but the actual construction contract we would expect will settle probably early or mid next year in that timeframe.

And then right on its heels will be some early work on CVN-79, which would be the second of that class.

And the DDG 1000, which is the next generation destroyer, we're in the process now of discussions with the Navy and also with our partners at General Dynamics in terms of the construction process there.

We would expect construction to begin on those contracts soon.

There's probably going to be a reversal in the order of the construction based upon the delivery of the GFE, and both companies are actually participating in building certain class work for the other company no matter who ends up with the first construction award.

So those are all coming.

We've got some international activities that are cooking.

We are involved in the Mesa program in Korea.

We've got lightning pods for Finland.

A lot of work on air-to-air radars for Pakistan.

Air defense opportunities in North Africa.

We're also participating with our partners on F-18s for Australia, India, other countries, and as I mentioned earlier, E2.

So a lot in the hopper, a lot out there.

Not all of it's going to happen, not all of it will happen timely but as we mentioned, we think we have a pretty robust pipeline of future work.

And as you can see from backlog numbers, $64 billion of backlog numbers gives us a tremendous place to be.

That's great.

Perfect.

Thank you.

Thank you, gentlemen.

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

Please proceed.

Good afternoon, guys.

Hi, Robert.

On the space side, perhaps you could talk a little about your strategy with your recent acquisitions.

The full buyout of scale composites, et cetera.

Okay.

Well, first of all, our principle interest in scale composites was associated with the special technology they have in composite materials and the innovative culture they have in terms of very rapid prototyping of advanced high-performance aircraft.

And that is our principle interest there.

In addition, what comes along with it is a participation in the ability to get into near space.

That is not a principle motivator for our purchase but it comes along with it and we're certainly pleased to have that.

Are these meaningful contributors at some point?

How should we think about that?

Or is this really just technology incubation kind of thing?

I think in terms of sales revenues 2008, no, but in terms of incubation for future competitive advantage on some of the important advanced aircraft programs that we're going to be involved in in the next few years, very, very important, very strategic to us.

And then just slightly different track, there's so much activity on the ground vehicle side.

How will you guys participate with regard to things like Blue Force Tracking, et cetera?

Well, as you know, we're not a platform provider for ground vehicles.

We don't make armor or tract or wheeled vehicles, however, we do participate, as you mentioned, in the electronics side of it.

Certainly, things like Blue Force Tracking, the command post program.

I did mention a really important competitive win for the Army at Fort Irwin in terms of the service side of maintaining a lot of these vehicles and upgrading them.

So we have a lot of activity which is under way there.

Of course, Guardrail itself is a significant adjunct for the Army.

So as you know from our pie chart, the Army is not the largest of our services we supply.

I think we're in the couple of billion dollars a year range, maybe a little bit more, but our entree here is through electronics systems.

We're also participating, by the way, in future combat system in the networking side.

Do you have a long-term growth target for that $2 billion?

I wouldn't offer one at this point in time.

Obviously we're looking at opportunities that make sense for us.

We're not making MRAPs.

Those who are are getting the benefits of that, we're not, but we're doing other things which we think will have long-term importance and the ability to help us reset that force.

Okay.

Thanks.

Thank you, gentlemen.

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

Please proceed.

Good afternoon.

Hi, Robert.

Just a couple of quick ones.

First of all on Essex, you had that in the corporation for a while now.

I was wondering how that's tracking to your original plans, whether you've been able to generate any sales synergies from the acquisition?

Absolutely.

We're very pleased with what we've seen so far in terms of their performance.

We won't, obviously, give specific numbers on sales for them and a number of collateral connections that have already occurred.

This is in a fast moving current in the intelligence world.

Can't say too much more about it than that.

We're also thrilled with the quality, caliber and contribution of the people that came with that acquisition and that team has been intact and we're seeing tremendous benefit from their being here and their participation with the rest of our company.

So I know that some of you had questioned the thought of this acquisition.

Some of you thought we paid a good price for it.

It was a really high-quality property and we're very pleased with how it's coming.

Secondly, you financed an accelerated buyback in the quarter.

Do you anticipate doing another one of those?

Yes, Robert, Jim Palmer.

As you probably know, we, on an annual basis we look at our cash deployment strategy.

We're right in that planning process now.

We will go to the board with a recommendation here in the fourth quarter.

But from everything I see, our balance cash deployment strategy, focused on investment in the business, capital expenditures, IR&D, targeted acquisitions, healthy dividend payouts and share repurchases is likely to continue.

So there is some assumption within the guidance with regard to buybacks.

There is no assumption within the guidance as to buyback.

Okay.

Thank you.

Thank you, sir.

Gentlemen, your next question comes to you from the line of Myles Walton of CIBC World Markets.

Please proceed.

Thanks.

Good quarter.

Thanks, Myles.

Wedgetail, I think it was coming up for eval and test in 4Q.

Can you give us an update on the progress there?

It's one of the programs that you didn't mention so I assume it's well but I just want to make sure.

You have a very good memory, Myles.

Let me just step you through where we are on Wedgetail and Mesa.

We are making good progress, we're continuing to perform within REAC.

And as you recalled, we are currently in the development test and evaluation phase and we're expecting that to wrap up here in the fourth quarter.

So far, so good.

Next step is what we call the type acceptance test and evaluation phase and that begins testing the first part of the year and we're expecting that to be completed around the end of the second quarter.

We're also expecting that the electromagnetic interference testing gets completed around the first quarter of next year.

So performance continues to be good as the testing is moving along.

We do expect that the technical risk will be retired at the culmination of the test phases around the end of the second quarter of '08.

Okay.

That's great.

And maybe just a follow-on if I could.

On the '08 guidance which you haven't provided, I'm curious, Ron, for the past couple of years you have and I'm just wondering what's motivating kind of the shift in stance?

Are there really big swing items?

And if you could, just kind of point those out.

Well, look, we're obviously sitting here without a budget for next year.

We have a good sense of where that's going to be.

We're in a process of making our final determinations on that.

We review that with our board, and we'll roll the guidance out when we're ready.

And we've talked about that in conjunction with the fourth quarter.

And in times past we've done it in the fourth quarter, occasionally have done it sooner.

This year we've opted to do it the other way.

Fair enough.

All right.

Thanks a lot.

Thank you.

Thank you, gentlemen.

Your next question comes to you from the line of Howard Rubel of Jefferies.

Please proceed.

Thank you very much.

Couple of things.

Talk about Ships for a moment.

To parse it while you said while a substantial amount of improvement continues to be from some other things, haven't you also received some funding from -- there was a contract that the Navy had asked for to help you with Katrina recovery.

Was that part of your risk reduction?

Howard, let me take that.

No, that was not.

That was a contract on the order of $100 million directed specifically to investments, really capital investments and infrastructure improvement for the future.

And you can think of it as sort of as capital expenditure not as revenue or profit.

Thank you on that.

And then second, it's been, you've had a number of legal items that you've settled and I believe Cogent was taken care of earlier in the year, but yet it still looks like a corporate non-allocated continues to be a little bit higher than what you first indicated, Ron, at the beginning of the year.

Is there anything else that's there and going forward, how are you thinking about it?

There really isn't anything unusual there, Howard.

You're correct, the numbers are a little bit higher than what we had thought at the very beginning of the year.

We have incurred some legal fees as you might expect and getting to resolution on a number of items and so that's essentially what the changes have been.

I wouldn't characterize it as anything out of the ordinary or unusual.

So maybe, so are we at a point now where, Jim, you're better able to, you put lot of other risks behind you and there's not much that you can point to where there's a problem?

Maybe you're sending the lawyers home?

Yes, we put a number of the risks behind us, Howard.

There are, as you can tell from reading our 10-Q, we have remaining risk that we are working to resolve very diligently but I don't know that we're going to have necessarily the spin level the fees associated with that that we may have had in the past.

But really all those things are going to be event driven as we get to a resolution on any of those items the costs tend to go up in the short period of time that you worked to resolve them and then they fall back to a more normal sustaining level.

Thank you very much.

Thank you, Howard.

Thank you, gentlemen.

Your next question comes to you from the line of David Gremmels of Thomas Weisel Partners.

Please proceed.

Thank you.

Most of my questions were asked already but I did have one left here.

On the Gulf Coast shipyards you've mentioned some challenges in the past in terms of kind of competing with oil companies for welders and other skilled labor and we're dealing with some turnover issues.

How are you addressing that problem and are you seeing any stabilization on that front?

Yes, David, you've probably heard us talk a number of times about some of the specific crafts where we have some challenges.

I would continue to point out that it's really the electrical crafts trades that are continuing to be our biggest concern.

Back in the second quarter we talked about its impact specifically on LHG 8 and the schedule extension that resulted from that.

We've made some good progress, I would say, on a number of those areas.

As a part of the process of going through the strike, we came out of that with a new agreement with the labor unions.

We incentivized worker retention, the number of hours that workers were putting in on a weekly basis, and we are seeing much lower attrition and we're also gaining in our recruitment activities.

So it's slow.

It is hard work.

There is a lot of competition.

I would not want to underestimate the continuing issues that we're addressing there, but I see us making good progress.

Great credit to the team down there at Ship Systems who are really attacking this on every single front to make sure that we're not only getting head count but we're also getting quality, talented individuals and training them appropriately so that we can have the appropriate impact on our shipbuilding schedules.

Thanks.

That's helpful.

I guess one other.

As long as you've already been hit up on F-16, Block 60 and Wedgetail, I thought I'd ask about, throw ASPIS in there as well.

Any changes to EACs or just general progress toward retiring of the risk there?

We're continuing to make good progress on ASPIS, continuing to perform within the EAC.

There has been just a small delay in actually getting to the testing program driven entirely by the customer, not by us, so that will not impact our EAC.

But we're continuing to perform as we had planned.

And when is that risk effectively retired?

We expect that to get retired over the next couple of quarters.

Great.

Thank you.

Yes.

Gentlemen, your final question comes to you as a follow-up from Cai von Rumohr of Cowen and Company.

Please proceed.

Thanks.

Just a brief one.

Pension for the year.

Do we expect FAS CAS to continue at a $30 million clip?

And for next year, can you just comment, I know your fiscal year ends for the pension December 31st.

You know, how has your investment performance been so far this year, just approximately?

A couple points there, Cai.

We, the $30 million kind of difference run rate I expect to continue into the fourth quarter.

In terms of the earnings performance of the plan through the third quarter has been favorable to our long-term rate of return assumption.

So if the market holds for the fourth quarter, we would expect that we would have some benefit coming out of that.

Secondly, at this point in time looking at interest rates as of the end of the third quarter, they are a little bit higher than what they were last year.

So again, if that holds into the forth quarter, our discount rate used to discount the liabilities could also be favorably impacted as we set pension expense for 2008.

But again, both of those, the investment performance and the discount rate are determined investment performance for the full-year so fourth quarter is very important.

And discount rate is set as of December 31st point in time.

But at this point in time, favorable trends towards a year-end rate there.

And then finally, you know, if our cash flow continues to be as strong as I think it might be, we're going to also look at the potential for pension prefunding opportunities here in the fourth quarter as well that would have a small impact on the pension expense in 2008.

Terrific.

Thank you very much.

Thank you.

All right.

Well, that wraps up the call.

We really appreciate everybody joining us.

We'll talk to you next time.

Ladies and gentlemen, thank you very much for your participation in Northrop Grumman's third quarter earnings conference.

This concludes the presentation and you may now disconnect.

Have a good day.