諾斯洛普·格拉曼 (NOC) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Northrup Grumman 4th quarter earnings conference call.

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

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

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

(OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded for replay purposes.

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

Gaston Kent Vice President of Investor Relations.

Sir, please go ahead.

Thanks, Lacy, and good morning everyone.

Welcome to our first quarter 2008 conference call.

I would first advise you that our 10-Q has been filed and is available to you now.

We provided supplemental information in the form of a Power Point presentation that you can access on our investor relations website at Northrupgrumman.com.

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

Before we start, please understand that as shown on slide 2, some of the matters discussed on this call constitute forward-looking statements within the meaning of the private securities litigation reform act of 1995.

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

Forward looking statements involve risks and uncertainties and the actual results of the company may differ materially from the results expressed or implied by the forward looking statements.

A more complete expression of these risks and uncertainties is contained in the company's SEC filings, including form's 10-K and 10-Q.

During the call we'll discuss first quarter results including the non-GAAP measures, segment operating margin rate and free cashflow, both of which are reconciled in our press release.

During today's call, we will also discuss our outlook for 2008.

Guidance will include GAAP measures of sales, operating margin, earnings per share from continuing operations, cash from operations and non-GAAP measures total segment operating margin rate and free cashflow.

We also want to draw your attention to schedule 6 of our earnings release, which provides the discontinued operations reclassification for 2006 and 2007 for the Electro-Optical Systems business which has been sold.

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

Please go now to slide 3 and at this time I'd like to turn the call over to Ron.

Thank you, Gaston and good morning everyone.

Thanks for joining us to discuss our first quarter earnings, as we announced last week, we are reporting a charge to earnings this quarter for LHD8 and related impacts at our Gulf coast shipyard.

We believe we have appropriately bounded its impact and we're taking all necessary corrective actions.

Wes Bush will provide additional discussion and the specific milestones by which you can measure our progress as we move forward.

Although the LHD-8 charge is deeply disappointing, the remainder of our first quarter performance was strong.

This morning, we also announced an increase in our quarterly common stock dividend.

The new quarterly dividend is 40 cents per share, up from 37 cents.

This is the 5th consecutive annual increase in the dividend.

We have doubled our dividends since 2003, which represents a compound annual growth rate of nearly 15%.

This most recent increase demonstrates the confidence we and our board have in the company's financial strength and outlook.

We continue to execute a balanced cash deployment strategy that includes dividends and share repurchases.

Our dividend policy calls for maintaining a competitive payout ratio.

This demonstrates our commitment to that policy.

We also repurchased 7.6 million shares of stock during the quarter for $600 million, which leaves us with $1.9 billion for additional repurchases on our current authorization.

And lastly, earlier this week, we closed the sale of our Electro-Optical Systems business for cash proceeds of $175 million and a small after tax gain.

Now, I'll briefly discuss 1st quarter results before turning the call over to Wes and Jim.

With the exception of our Gulf coast shipyards we continue to see performance improvements across our programs and businesses.

It was a particularly strong quarter for new business awards.

We captured $12.1 billion in new business awards, increasing total backlog by 7% to $68 billion, another record for this company.

We continue to see a strong flow of orders across all our businesses with backlog increases for aerospace, electronics and ship building.

The obvious highlight of this quarter was the KC-45 tanker win.

The United States air force selected Northrup Grumman for development and production of up to 179 air refueling tanker aircraft for approximately $35 billion.

The Air Force announced that Northrup Grumman's offer clearly represented the best overall value to the government.

Our competitor has filed a protest of the Air Force's decision with the Government Accountability Office, and we await the GAO's determination regarding that protest, which is due no later than June 19th.

We are looking forward to a successful resolution of the protests and getting on with building the first of the KC-45 tankers which are so greatly needed by our war fighting men and women.

In addition to the tanker award, we are also awarded $1.4 billion for the DDG1001 Destroyer and major components for the DDG-1000.

We also continue to be successful in the restricted arena, with several of our businesses capturing significant restricted contract awards which represent $2.6 billion in new awards.

Shortly after the close of the quarter, our mission's systems sector won a large position on joint taxable radio system or JTRS, AMF, as a member of the Lockheed Martin team.

And this week Northrup Grumman was awarded the Navy's $1.2 billion broad area maritime surveillance contract, or BAMS This award highlights our leadership position in unmanned ariel systems, our legacy of innovative engineering to fulfill critical customer requirements and our ability to win the large important competitions.

BAMS is another key strategic victory the third in a series of major competitive aircraft wins that began with the Navy's UCAST-D last fall and includes the Casey 45 Refueling Tanker in February.

With the UCAST-D, Casey 45 and BAM, we have captured three of our largest near term competitive opportunities, but many more very large new program competitions will be decided this year and next.

These include the joint like tactical vehicle, Ariel common sensor.

Global positioning system operational control system or GPS-0CX.

The VISX, which is a competitive follow on to our successful vehicular inter-communications system.

The Kennedy Space Center supports services contract.

And GOES-R, the environmental monitoring satellites.

In addition to these, we also continue to have a significant competitive opportunity set in the restricted arena.

We also expect a significant increase this year in contract follow on awards from our current portfolio of franchise programs.

Examples are the CVM-78 construction contract.

And follow ons to the Air Force Global Hawk, Space Based Infrared System and the F-A18 aircraft for Australia.

Based on first quarter results, we continue to expect sails of $33 billion.

We now expect 2008 earnings from continuing operations of $4.90 to $5.15 per share.

And we now expect cash from operations of 2.6 to $2.9 billion and free cashflow of 1.7 to $2.1 billion.

Looking ahead, we are winning major competitions, generating record backlog, growing our sales, expanding our margins and executing our balanced cash deployment strategy.

All of which support our confidence in our ability to achieve the 2012 targets we laid out at the investor conference in February.

We continue to be very confident and excited about the future of Northrup Grumman.

Now, I'll turn the call over to Wes Bush.

Thanks, Ron.

My comments are outlined on slide 5, and will include more detail on the LHD-8 path forward so on future calls we'll be able to update our progress against those milestones.

But before discussing LHD-8, I want to touch on operational highlights on some other programs of interest to you in our electronics and information technology businesses.

I'm pleased to report that during the quarter we continue to move forward on all of these programs, making progress toward completion and working within our current estimates to complete.

Block 60 Falconeete software is achieving intermediate delivery milestones toward scheduled delivery of the 3rd increment of electronic warfare capability in the 2nd half of 2008.

The 2nd of three intermediate milestones was delivered in the 1st quarter as planned and the next increment is backing the schedule.

On Wedgetail we've completed the development, test and evaluation phase of the program and completed the delivery of the software build to support the type acceptance test and evaluation phase, which is scheduled to start this quarter and continue into the 3rd quarter.

The start of this phase was delayed somewhat by customer activities but this does not impact our performance to the EAC.

On our state and local outsourcing contracts, Virginia continues to move through transformation and has completed key milestones.

The transformation activities will be completed this summers and the program will begin to deliver recurring services from the transformed environment on schedule in July.

Ongoing infrastructure consolidation continues to the middle of 2009 as scheduled under the contract.

On our county of San Diego program, we completed transition last year.

We've made good progress through stabilization and we're focusing on recurring service delivery.

The program team is working to leverage transition improvements to drive efficiency and ongoing operations.

The New York City wireless program achieved initial operating capability on March 31.

This first go live event represents a tremendous achievement by our team.

We're continuing to build out the network and anticipate completion this year.

As this impressive capability nears completion, we expect to be adding new services in the future.

Further enhancing the utility of the network for the city.

Now I'd like to discuss LHD-8 and the path forward on the program.

We have reset the schedule based on the revised DAC and established key milestones to measure progress.

The first major milestone is the act main engine lightoff that scheduled during the second quarter.

When this milestone is complete, both the forward and the aft engines will have been lit off.

And both shafts will have been turned.

This milestone establishes that the main propulsion plants are working.

As we indicated last week, a key driver of our schedule is the work to be performed on the electrical cabling of the ship.

During the 3rd quart he, we plan to complete the electrical cabling installations throughout the ship.

Accomplishment of this milestone is key to our ability to support the test program on the revised time line that we've established.

In the 4th quarter of this year, we'll perform the integrated propulsion test that's required prior to builder's trials.

This test simultaneously runs both engines at the power level supportable with Pierce eye testing.

And finally, builders trials at sea will begin in the 1st quarter of 2009, preparatory to schedule delivery in the 2nd quarter of '09.

In addition to identifying a comprehensive set of milestones as a part of the revised schedule, we've changed the profile of our system's test sequence to ensure that we identify any residual issues early in the rework cycle.

As I mentioned on the call last week, I am reviewing progress on LHD-8 on a weekly basis.

And we're addressing the issues that led to costs and schedule growth through a variety of programmatic, systemic and leadership actions.

I'll provide a report on our progress on LHD-8 at each of our quarterly conference calls.

I focus my comments today on the set of programs that we previously identified with operational challenges.

Looking across our portfolio of over 20,000 programs in the company, I think it's important to note that we are delivering high quality products while continuing to improve our program margin rates.

This is the fundamental driver of performance in our company.

And it's on track to support the accomplishment of our long term financial objectives.

So now I'll turn the call over to Jim to discuss the financials.

Jim?

Thanks, Wes.

Good morning, ladies and gentlemen.

In my comments this morning, I'm going to discuss the first quarter financial highlights, including the breakdown of the ship building charge.

Describe our cash trends for the quarter and then move on to a discussion for guidance for the remainder of the year.

I'd like to begin by pointing out a change to schedule 5 of the earnings release.

Today's presentation includes new business awards rather than funded contract acquisitions.

We've made this change because new business awards is a better measure of the business that we are actually capturing.

It can be reconciled to sales and total backlog changes for the period and makes more sense when calculating our book to build ratio for the quarter.

Our old measure, funded contract acquisitions, simply measured funding on new awards or old awards for which funding had just been received.

Thus, it did not represent new business awarded or captured during the period.

Using the new business award ratio, we added very strong book to build ratio for the quarter of nearly [150%].

Beginning with slide 6, we also had a solid 6% sales growth in the 1st quarter, this is net of $134 million reduction for the step back in revenue resulting from the EAC adjustments in ship building for LHD-8.

Without this adjustment, sales growth would have been approximately 7.5%.

The trends in 3 of the 4 businesses are consistent with our expectations and indicate that continuation of the same positive trends we saw in 2007.

For information and services, 6% sales growth includes double-digit sales growth admission systems, mid single digit growth for information technology and a small decline in revenue for technical services.

One of the primary growth drivers for information and services is continued strength in our intelligence business at IT and mission systems.

This strength includes revenue ramp up on existing programs and new business capture as well.

State and local programs like New York City Wireless and the Virginia IT Outsourcing program also contributed to sales growth, but to a lesser extent than last year.

The other revenue driver in the quarter for information and services was IT's NETCENTS contract for the Air Force.

And last year's 4th quarter we received a task order under this contract for defense knowledge online, which generated hardware and service sales in the 1st quarter.

Moving to aerospace, sales rose 4%.

Both integrated systems and space technology had positive comparisons to the prior year period.

This is a reversal of the recent trend we've seen at integrated systems.

For the last several quarters, the transition from development to production for programs like JSF and Advance Hawkeye have impacted sales.

The slowdown of MP, RTIP and the cancellation of the E10A also impacted sales.

These trends are still in place, but this quarter's higher volume for existing programs like Global Hawk and new revenue from new programs like Navy UCAS-D, restricted work, and KC45 tanker program are more than offsetting these declines.

The tanker sales reflect the work we began before the Air Force issued its stop work order due to our competitor's protest.

Moving to space, the trends here are also consistent with prior quarters, we continue to see higher revenue in the restricted programs and in the James Webb space telescope program.

Sales increases here are partially offset by lower revenue from other programs including AEHF, STSS and TCAF.

Electronic sales rose 2% and include higher sales to the army for the lightweight laser designator rate finders and the vehicle intercommunications systems.

Sales also rose in ship building.

The increase includes $48 million in revenue from fleet support which represents revenue now being booked for AMSAC, as well as approximately $80 million for surface combatant programs.

Increases in other programs were largely offset from the $134 million step back in revenue resulting from the LHD-8 EAC adjustment.

Moving on to operational performance in slide 7, information and services expanded its margin rate by 50 basis points, aerospace expanded its margin rate by 30 basis points and electronics likewise expanded its margin rate by 80 basis points.

In all three businesses, overall program performance improved.

For electronics, program performance improved for electrical optical and infrared counter measure programs as well as land forces programs.

In addition, royalty income was higher than in the prior year period.

The royalty income represents settlements of 3rd party licensing and patent disputes relating to fiber-optic technology originating with Liten, one of our heritage companies.

For our aerospace program performance improved that both integrated systems and space technology in restricted programs the EA-18G, B2 and the airborne laser programs.

On a consolidated basis the ship building charge reduced ship margin rate by a little more than 400 basis points.

Without the charge, segment margin rates would have been nearly 10% compared with 9.5% in 2007 first quarters.

With the exception of our Gulf coast shipyards, we continue to see performance improvements across programs and businesses.

The charge and ship building totaled $326 million.

$272 million of the charge is for the LHD-8 program.

$35 million dollars represents the resource impact and risk adjustments to other Gulf coast ships and $19 million is the noncash writedown of purchase intangibles resulting from the adjustments to EAC's for these programs.

Of the $272 million for LHD-8, about $180 million is for test, integration and rework, and approximately $70 million is for the scheduled extension and the associated level of effort that continues as the schedule is extended.

Our total operating margin rate includes improvements in the net pension adjustment and comparable quarter over quarter amounts of corporate and allocated expenses.

Excluding the impact of the charge, our total operating margin would have been 10%.

A 60 basis point improvement over last year.

Other than the issues in ship building, the positive trends in our businesses are very much in evidence in this quarter's results.

Other notable items affecting the first quarter include the increase in other net , and income of $15 million from the expense of of $8 million last year.

This primarily represents the increase in royalty income over the prior year period which I mentioned earlier, offsetting these improvements is an effective tax rate of 35.7% this quarter.

Since the adoption of FIN 48 in last year's 1st quarter, our income tax expense also includes interest expense related to what FIN 48 would characterize as uncertain tax positions.

Although this interest cost is relatively a stable dollar amount from quarter-to-quarter, it represents a proportionally larger component of this quarter's total tax expense, and increased the tax rate by nearly 1.5 percentage points.

This quarter's higher tax rate also includes the expiration of the research and development tax credits at the end of last year.

Moving on to cash from slide 8, cash from operations was $194 million from the quarter, down from $400 million last year.

Historically the first quarter is normally low, and that is obviously the case this year as well.

In addition during the first quarter this year, two of our sectors were transitioning to an accounting software system that is common with other parts of our business.

This transition had a timing impact on billings that increased accounts receivables by about $200 million, which we had anticipated.

The transition to the common system is now essentially complete, we do expect to recover the majority of this amount in the second quarter.

That leads me to our updated 2008 financial guidance for the business which is summarized on slide 9.

Our sales guidance for each of the four businesses is unchanged.

We continue to expect consolidated sales of approximately $33 billion dollars.

For operating margin rate, we continue to expect low 8% for information and services.

We are increasing our guidance for aerospace operating margin to approximately 10% from the mid 9% range.

Likewise, we're also increasing our guidance for electronics by approximately 50 basis points.

We now expect a mid 12% margin rate there.

The outlook for ships has been adjusted for this quarter's charge and the ongoing impact of the stepdown in margin rates going-forward.

So we now expect margin rates of about 3% for ship building in 2008.

Slide 10 summarizes prior and updated guidance, the change in the segment margin rates, results in a consolidated segment margin rate of mid to high 8%, about 100 basis points lower fan our prior guidance.

And after allocating for expenses and net pension adjustment, we would expect our total operating margin rate to be in the high 8% range for 2008, again about 100 basis points lower than our prior guidance.

We continue to expect a tax rate of approximately 34% for the year.

For our earnings per share from continuing operations, we've adjusted the guidance for the 100 basis point reduction in segment as well as total operating margin rates.

As I mentioned this reflects the impact of this quarter's ship building charge as well as the impact for the remainder of the year from the LHD collateral impacts to other ships.

That impacted earnings for the remainder of the year is about $.10.

But the increased margin in ES and aerospace offset somewhat the ship building earnings per share reductions giving us an updated guidance of 4$.90 to $5.15 per share.

Now, looking at cash the impact of the ship building charge reduced our prior 2008 guidance by $200 million.

We now expect cash from operations of 2.6 to $2.9 billion, and free cashflow of 1.7 to $2.1 billion.

And we do expect our cash to be more back end loaded this year, with performance becoming progressively stronger as we move through the year.

This does reflect the impact of the transition to the new common accounting system in the 1st quarter, as well as tax payments which will be made in the 2nd quarter.

I would echo Ron's comments regarding our commitment to our balance cash deployment strategy.

Given the momentum we are seeing in new business awards, our record backlog, the strength of our balance sheet and our strong outlook for cash we expect to continue our balance cash deployment strategy going-forward.

Also as Ron said, we don't see the ship building charge as impacting our long term view of the health and potential of our business.

We continue to have confidence in our 2012 financial targets as shown on slide 11.

This includes our outlook for ship building as well.

We continue to see significant opportunities to improve performance in this business on a go-forward basis.

One of those performance improvement drivers will obviously be completing and delivering the ships that have been impacted by hurricane Katrina.

Although this will take a little bit longer than we had previously anticipated, it is still likely to be essentially completed by the end of the 2009 as we have previously planned.

So, Gaston, that completes my comments at this point.

I'm ready to turn the call over to you for questions

Okay.

Thanks, Jim.

Lacy, we're ready for Q & A, please.

(OPERATOR INSTRUCTIONS).

Our first question will come from the line of Rob Spinarn with Credit Suisse.

Hi, guys, it's Pete Spinarn actually.

Hi, Pete.

On the 3% ship margin for the year, I just want to ask, that kind of implies around 8.5% or so Q2 to Q4.

Do you think of that as being pretty level over the last three quarters or is there going to be a ramp there, and is there any reason to think '09 would be below the level of the last three quarters.

Pete, your perspective on the remainder of the remainder of the air is essentially as I see it as well.

I do expect a ramp as we go through time both this year and then into next year.

Okay, .

In that I wanted to ask as well.

Given that the revenue takedown this quarter in ships, should that lead us to believe your ship revenue guidance is going to be toward the lower end of the year, or is there a possibility we fit the

I think the guidance of $200 million between the low and high is about what I see at this point in time.

So a lot of give and take as the year goes on.

Yes.

Okay, I'll get back in the queue, thanks, guys.

All right.

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

Good Morning On the ships, the 10% margins, you're looking 10% margins aside from the LHD-8 situation.

That is up at the level you're talking about long term.

And the first thing I was interested in understanding is, do you see the shipyard now LHD-8 aside at currently being at a higher level, even closer to what you're long-term objectives are?

Doug, at the investor conference in February, we talked about a longer term view of the ship building business, having the potential to have margins in 10 to 11%.

My view is not changed there on what that long term potential is.

Clearly we, as I mentioned in my prepared comments, getting through the Katrina affected ships is important.

And Mike and Mike Petters and crew responsible for the ship building program are really focused on improvements that we can drive across all of our ship building organizations and implementing those will be the key, I believe to achieving those longer term objectives.

But frankly, again, when I look at those objectives, and past performance, I don't really see a reason why we can't get there.

It does mean, as I said, completing the Katrina affected ships, and being very diligent about processes around ship building as we go forward.

But do you see the performance levels you're at now aside from LHD-8 as getting closer to what you're going?

I guess, let me back up.

If you look at 10%, is this a sustainable type of a margin we're able to take the LHD-8 aside or are there some benefits we saw in the quarter that were one-time in nature.

Doug, as Pete observed on the prior questions, we're really looking at about 8.5% margins on a go forward basis for the rest of the year in ship building.

As I said, that is essentially what is undermining our 3% margins for the year, that's really where I see us for this year.

And do you see any more -- when you go out to '09s do you expect to see any more push back in revenues for the other ship programs as a result of LHD-8.

At this point our guidance reflects everything we know.

Thank you.

Thank you.

And our next question will come from the line of Myles Walton with Oppenheimer.

Please proceed.

Good afternoon.

Hello, Myles.

It looks like book-to-build in integrated systems is particularly strong over two times in the quarter, even excluding the tanker.

You have the tanker under protest, but assuming that goes through, and then BAMS following that, with the win in the quarter.

How much of that recent win activity was kind of anticipated in your five-year plan at the analyst day, and is the spade of wins here putting upward pressure on some of those projections?

Myles, those wins were essentially anticipated in our view of the long-term.

Just as I got the questions immediately after the tanker went about whether we were going to increase our guidance, our thoughts around 2012, obviously we didn't.

Immediately prior to, or immediately after the tanker win.

As we said in our call today, the ship building charge doesn't change our view of the long term, nor does the one quarter book-to-build at this point in time.

As both Ron and I, Wes said, we continue to have a great deal of confidence in our 2012 targets.

And obviously the book-to-build events of this quarter are important to achieving that, but we all know one quarter doesn't make the trend for the 5-year period.

So, we feel good about it, feel good about the 2012 targets.

And as Ron said, a lot of opportunities ahead of us, and we're going to go after those as aggressively as we have the three ones that we've achieved this year and last year.

Okay, I appreciate that.

Not trying to rob the numbers, just trying to get a feel for what was contemplated with respect to those.

And then if I could, probe a little bit on the classified side, I appreciate you sharing the bookings.

Can you put that in context to kind of what you do on an annual basis with respect to classified and just how much of an uptick is that that you've gone out and highlighted it.

Yes, Myles, my perspective on the classified or restrictive, is that it is even more lumpy than any of the other businesses in which we participate, so, as we have mentioned in the past, we saw good opportunities in that restricted area, we've obviously brought some of those home this quarter.

But we do see some other significant opportunities on a go forward basis that we're pursuing.

And what's your annual restrictive revenue?

We don't disclose that, Myles.

I thought I'd try, thanks.

( Laughter ).

Our next question will come from the line of Ronald Epstein with Merrill Lynch, please proceed.

Good afternoon, guys.

Hi, Ron.

On some of the upcoming programs you've got JLTV, common sense some other stuff.

When do you expect a decision on Aerial Common Sensor

I think Aerial Common Sensor is probably in the next year, there are a number of ways that the army may choose to go fork forward on that, there is the competition that we're gearing up for and we feel comfortable about our position there.

In the meantime, as the army is looking at that, they're continuing provided upgrade to the existing Legacy System, Guardrail and others.

And we're actually participating very strongly in those as well.

I would say next year for the ACS.

Okay.

ALTV we expect the down select to occur in the early part of the summer to get into the TD phase on that program.

The TD phase, of course, being the first phase.

It's not huge dollars, but extremely important for the three or so people that get involved in it.

And that leads into follow ons later.

Okay.

Great.

And then just a follow up on another shipyard question.

You highlighted on the call, I guess a week or so ago, and then today some management change.

Can you go into more color on that, how are you changing the management in the shipyard so that ?

Yes, Ron, it's Wes.

Let me give you a broader view of that.

First and foremost, as you're aware, we have announced earlier this year the integration of Newport news and what we previously called Ship Systems Sectors into our single integrated ship building sector.

And as a product of that decision, we are naturally going through the process of identifying both organizationally and on a personnel basis what the best assignments are and the best structure is to take the shipyard forward.

We made an announcement just about a month ago that Irwin Edenson from Newport News would be coming down from the Gulf coast to take on general management responsibilities.

We've made some other announcements regarding individuals that are both supporting the ship building sector and supporting Irwin.

Again, this is a stepped process to go through, and look at how we want to form this integrated organization going-forward to best execute the opportunities and the programs in ship building.

I guess maybe more specific, my question is, after you guys learned about the LHD-8, did you make any management changes at that point?

Yes, we certainly have gone through the process of looking at the way the organization is approaching LHD-8, we made some changes in leadership on the program itself.

And we're also, of course, incorporating those lessons learned as we form the overall organizational approach for the integrated sector.

Okay, great.

Thanks.

Thank you.

And our next question comes from the line of Heidi wood with Morgan Stanley.

Please proceed.

Good morning, nice quarter, guys.

Thank you, Heidi.

All but.

A couple questions, Wes, just a point of clarification on the milestones that you put out on the LHD-8, are those the long polls in the 10 that will give you visibility as you progress as to whether the charges you've taken are sufficient?

Or are there other things you'd point to as you pass through that would help us have confidence that again what you took was sufficient.

Heidi, I would characterize those milestones as critical in the overall sequence of event that is have to occur.

The schedule that we've laid out is, as you may imagine is probably better characterized by a comprehensive approach delineating all the work paths that have to occur.

There are numerous paths, if you want to talk about critical paths through there, that are important to getting us through it.

We laid out those milestones, because they represent major increments of accomplishment.

There are other things that we will include in our quarterly progress descriptions on how things are going to give you a fuller sense of of the progress, and to your point our confidence in our ability to execute within the EAC that we've established.

Okay, great.

And then to understand a little bit the guidance on the electronics, obviously that was pretty impressive and it looks like now you're thinking this is a little more sustainable.

First, can you talk about what the royalty income was that you talked about in the 1st quarter?

And also what is underneath in electronics what are the businesses that are driving the bulk of this great performance.

The royalty amount for the first quarter was about a $19 million improvement over the prior year.

To a certain extent it was offset by some environmental cost accruals as well, so even though the royalty amount is $19 million, there were some smaller offsets to it from an environmental cost accrual perspective.

In terms of the areas that were driving the program proponents improvement, essentially the items that I mentioned in my comments, which were the -- we'd have to go back and find them here exactly.

Electro-Optical and basically electrical optical areas.

I would just add that broadly, , in our Electronic Systems organization has put a lot of attention over the last couple years on really driving on program performance.

We're seeing the benefits of that comprehensively across the organization.

And the improvements that we've made in our performance within our EAC's on programs that had previously been challenging for us.

Those improvements obviously contribute to improved performance across the board on electronics.

It's a

I would back that up a little bit.

Several businesses of ES, there's a remarkable consistency across the board.

A good performance on all those businesses, not one star.

Yep.

All right, good, and then Ron, I have two questions for you, if you don't mind.

We're seeing it looked like a little bit of pickup in M & A activity, Lockheed sort of talk about it.

We're seeing it happening in Raytheon.

Can you talk to us about your perspective and degree of interest and pricing properties?

What should we be anticipating in terms of Northrup's interest in M & A over the next year or so?

I would say no change from what we told you in the last year or two, clearly when we see something that we think is extremely important or strategic to us, we think there's value there for everybody.

We'll go for it, we've done that selectively.

We've not done a lot of it, but we've done it selectively, we're pleased with the Essex situation.

That's worked out extremely well for us.

So, Heidi I would say probably while we don't normally comment on M & A, we would be thinking about our overall balance cash strategy.

We'll have adequate resources.

You saw the dividend increase.

We have $1.9 billion in our share repurchase.

And as we see opportunities in the market.

We'll look at.

I wouldn't signal any significant change in the direction we've already announced.

And then finally, I mean, I think I'm going to give you a little bit of a victory lap.

Because I remember a couple years ago, it seemed that Northrup was really struggling to win.

It seemed like there were a number of things that you had lost and were disappointments, and I really feel like over the last couple years, I've seen that turn around quite visibly with a number of of impressive wins even.

Can you talk about the fundamental changes you've implemented within the organization that might help explain sort of what we're seeing, the change and approach to competitions?

There may be a charge on some outsiders that you may be aggressively pricing to account for the wins.

But what would your response be as to kind of why we're seeing these big wins?

A couple years ago we had a couple high profile competitions, one or two, we thought they were longshot opportunities for us.

We didn't win them.

We got hammered pretty heavily for not winning what we thought were longshots.

We fundamentally determined we had to put together as we have on our operating sides, process improvements in business acquisition in terms of learning better about the customer markets that we're proceeding with.

Shaping these markets better, and frankly putting substantially more executive horsepower and strength on them, personal engagement for myself and the top team.

We laid out a set of what we called corporate priority wins.

We have that list, all companies do, but we put particular energy into them over the last several years.

And we also basically had a fundamental belief that the technical solutions we would offer would in fact be the best value for the customer.

We had to make sure they understood that as well.

We've done an awful lot in that regard.

What you're seeing here in a series of very very successful outcomes is probably a lagging indicate he of a lot of hard work that's been going on the last couple years.

And I will tell you that the intensity for this competitive spirit has not changed one bit.

In fact if anything, has gotten stronger.

All right, thanks very much.

Thanks, Heidi.

And our next question comes from the line of Cai von Rumohr of Cowan and Company.

Quick housekeeping one, was there any difference in number of billing days or workdays and how does the year roll out in that respect?

To my knowledge, there's no difference in billing days or workdays in the quarter.

Yes, the number of billing days or working days, however you want to -- However you guys look at it.

I don't know of any difference there of any magnitude at least.

Okay.

Secondly, you know, on your LHD call, I guess we discussed that, since about 8% of the southern shipyard's workforce is going to be on LHD-8 and working on things where they don't make any money for a while, there would be a ripple effect in terms of revenues and profits on the rest of the shipyards.

Could you walk us through those numbers and how should we think about how that works?

Cai, yes, there's going to be people associated with the LHD-8 for a little bit longer period of time.

That would have moved to other ships, so, essentially that delays the work on other ships, resulting in a delay of revenue and earnings on those ships.

So essentially that's the model that we've built into our guidance, the delay in other ships is important, but it is not of a magnitude.

Frankly as I said, causes those Katrina affected ships to move out beyond 2009 in terms of completion.

So it's a little bit of movement between now and that period of time.

Let me add just a comment, Cai.

To put a little more perspective on it.

The workforce that's needed on LHD-8 is a certain set of skills that are needed to address the rework and the testing profile.

So it is that set of skills that are delayed from accomplishing task on some of the other ships.

The challenge then that we have is to make sure that we are doing everything we can to maintain schedule to the extent we can on the other ships, and that sometimes is done by reprofiling that work so that the skill sets can be redeployed in a different sequence.

So I would not want anyone to have the perspective that because we're doing something longer on LHD-8, we're stopping work on other ships, that is not the case, we're continuing to make good progress.

We're simply having to adjust the deployment of resources.

And some extent accommodate the implications of those work flow changes in the recognition of scheduled progress that we have on some of the ships in the yard.

Also add in there, Cai, a note from Jim's comments, he said that the collateral effect on those ships if you will is about $.10 this year, in earnings.

Okay.

And then if we think about your win on BAMS and the tanker, how much is in your '08 estimate for those?

Kai, you know, we really don't talk about how much is individual programs, our guidance 490 to 515, frankly, takes into account the range of possibilities on when tanker would be turned back on, what the funding levels might be.

Obviously, we are under control on BAMS, have received funding and the guidance anticipates both of those events essentially accounted for in that range.

Okay, well, the reason I ask is that the integrated systems had pretty good revenues, $1.340 billion.

And I guess normally it slapped it out in the second.

But I would assume it would be picking up in the second half.

I assume you have to do at least 5.3 there's got to be opportunity that there could be more of a pickup.

Is that a fair assumption.

It really becomes one tanker, when the protest is decided and what level of funding is available at that point in time will be key factors on how much work actually gets accomplished this year.

Okay, great.

And last one, you mentioned winning $2.6 billion of lack of classified awards.

And yet in you're release you talk about 688 of restricted program awards in the 1st quarter, you know, could you kind of clarify the difference between those two numbers?

688 is last year's classified or restricted awards.

Okay, okay, excuse me.

Excellent, thanks.

Thank you.

Thanks, Kai.

Our next question will come from the line of Steve Vinder, please proceed, sir, with Bear Stearns.

Maybe just touch on Electronic Systems.

It looks like a couple head winds in the quarter, government systems and I think naval marine as far as sales being down.

Just wondering, is that simply just a timing issue, and is that a lifecycle going on there in programs?

Largely timing issues, Steve.

A lot of the electronics businesses we use a units of delivery revenue recognition mode.

And if you actually look back, you'll see that traditionally revenues are very strong and electronics in the 4th quarter reflecting the buildup of deliveries that occur.

And then lighter as we go through time during the quarters, and essentially that's what's happening this quarter as well.

The revenues are lighter in terms of those parts of the business that use a units of delivery revenue recognition model.

All right.

And Jim, what was your return so far on your planned assets year-to-date.

I'm sorry.

Pension fund.

Oh, we are negative for the first quarter about 5%, I believe.

And then you know you touch on the issues affecting collections in the quarter, were there any customer related issues there at all or just internal.

Largely, you know, there are always questions around timing since our billings are such large dollar amounts.

So, whether you get paid the 31st or the 1st or 2nd of the following month is really important to cashflow.

We always have those kinds of issues, but largely the issues were the internal conversions to common accounting system.

And Ron, maybe you can just touch on ships in your feelings about the pluses and minuses of spinning off that business in the future.

And I ask that question simply because Newport News was obviously, you're familiar with it, was a very successful spin-off solution and I'm just wondering, do you see any merits there.

Yes.

Well, first of all, Steve, we remain committed to our ship building business, we see significant opportunities to drive improvement in the business going-forward.

The fact that we took the step to unify the management structure of these businesses and provide best practices both up and down from the various locations I think is evidence of that.

We're doing the things we think we need to do to drive performance there.

Obviously, we have a lot of work ahead of us, however, we're committed to that.

We see it does fit overall into the portfolio of Northrup's substantial platform business, the opportunity for other add-ons as a result of that.

So at this point in time, I see no change in our direction.

We're committed to moving forward and we think that we're the folks who can drive the most value out of this business going-forward.

One other thing, as far as restricted work, the $2.6 billion, is it fair to say, is it primary in space emissions systems, and is that long duration business awards?

I really can't be more specific about that, other than to say it spans a number of sectors and a number of different programs.

Thank you.

Sorry about that.

Our next question will come from the line of Joe Nodal with JPMorgan.

Hello, Joe.

Good afternoon, good morning.

Start with I guess a couple questions on the tanker, it's 1.5 billion?

Not that was added to your backlog?

Correct.

How is the split between funded and unfunded.

1.5 total contract value, roughly $60 million dollars was funded.

Okay.

And I know you mentioned it's all kind of in your guidance for the year in terms of EPS.

Specifically, does it matter to your guidance whether it comes in or out, or is it just at this point 2008 within the range.

Well, for 2008.

Does it matter?

Yes, it matters.

For this year's earnings, I mean.

Not so much, but frankly not so much for 2008, but the program is very important to us as we go forward.

So yes it does matter.

Oh, of course.

But frankly, for 2008, it's a small change, whether or not it's in or not.

And then on the margin in that segment, integrated systems, any better sense as to what the performance improvements were with these key adjustments?

You raised your number for the year, but you were still below where you were for the quarter, can you give us a better sense there?

As we do every quarter, we look at individual contracts and their performance.

So, we did have some adjustments as frankly everyone does in the industry.

On a go-forward basis, we look at our forecasts for the year, and where I think the business can go.

Traditionally, I would tell you that business has been very strong in performance.

I know we are spending some unallowable costs on the protests, so I factored that into my thinking as well as I think about their earnings guidance or range of margins for the year.

Essentially all of that has been in my thinking at this point in time.

Okay, and then just one final one on the ship building side, the $35 million, am I reading that right that that includes some other EAC adjustments that were not related to the LHD-8 delay, and if that's the case, could you give color on those.

It does include some other EAC adjustments, and as we mentioned last week, when we had our preannouncement, we essentially took a look at the lessons learned or issues that were identified on LHD-8.

And then looked across the portfolio to see whether or not there would be similar type items or related type items on the other programs and considered that in our EAC's for them as well.

Okay.

So is it fair to say there were wiring problems elsewhere?

Not necessarily wiring problems, but just any kind of rework or schedule extension, those type of items.

Okay.

All right, thank you.

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

Please proceed.

Hello, Joe.

Joe?

Hi, hi, we had our lines crossed here.

Good afternoon, good morning still.

I read in the paper Ron, that you and Jim McNerney had a meeting with the Air Force.

But the sense we had from the public commentary was a suggestion was that the Air Force was unhappy with the sort of the tone, the argumentative tone or I don't know what you want to call it about the protests.

But I wondered if you could just give us any color on what the Air Force is saying about how all this is going on beyond, we're all waiting for the GAO to do their thing.

First of all I won't comment on customer meetings, I will tell you that Northrup Grumman has been delighted with the selection.

We continue to work hard to get ready to build these things, we've totally supported the Air Force's position, the Air Force is not able to say anything at this point in time because of the rules, once protest is in place, they have to go silent.

And so all I can say is that we're anxiously awaiting successful resolution of the protests, get ready for tankers.

Terrific.

Thanks, Joe.

And our next question will come from the line of Howard Rubel with Jefferies and Company.

Thank you very much.

A couple things, one is the EO business that you sold, looked like it wasn't making, in fact it looked like it lost money last year.

You're right.

Yep.

And this year break even.

So I mean, that probably has what, a half of the reason why you've improved guidance in the segment on margin basis, is that fair?

No, no, really it's just looking -- because that business was being sold, we've already backed out with the discontinued operations, their margin.

So, we were looking at the margins on the rest of the business, and that's our thought process around the change in margins.

It is really the improvements in the business ex-EOS piece of business.

Thank you.

I mean, that's pretty fair, so.

Part of any discussion with the Navy is -- well, when you reschedule these ships in discussion with the Navy, what kind of feedback have you gotten from them, that helps how supportive have they been with this change.

Let me take a cut at that.

First of all, we're working very closely with the Navy.

And I think that while we're not happy with the delay, and they're certainly not happy with the delay, the working relationship is very strong, not only on the ship but across the other ships, we have a common objective here, which is to get good ships to them as fast as we can.

They're our partners in this, they have several hundred people working in the ship shipyards with us, shoulder to shoulder.

This is a joint responsibility in some ways.

We take responsibility for our part of this thing.

I would say the relationship is very positive and strong going-forward.

And we're on the same page.

I appreciate that, Ron.

And the last thing, a steel prices have gone up substantially recently and we're all seeing a little bit of inflationary pressures.

What do you do -- are you seeing any of that as it affects your business, and what are you doing to mitigate it.

Howard, obviously steel price is a component of our total cost, but I will tell that you labor and labor efficiency, labor quality, quality processes tend to be more important to us than the actual raw cost of the steel.

By the way these ships have a lot of electronic and machinery content as well.

While steel prices going up is not a positive thing, it doesn't move the needle quite as much as the ability to improve our efficiencies and processes.

Okay, thanks.

Howard?

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

Good morning or afternoon.

Good morning, George.

If I look at electronics, it seems like the guidance for revenues you left the same despite selling effectively nearly $200 million.

So, it implies that for year-over-year electronic sales are going to be up close to 9%, but the first quarter's up only 2%, can you tell us what's going to accelerate or help the back end to get to the 9%?

And I use the mid point $7.1 billion to calculate it.

As I mentioned earlier, we traditionally have higher unit deliveries in the latter part of the year?

The electronics business.

A significant part of the electronics business uses the unit of delivery method for revenue recognition.

So, if you look back at a number of years or quarters, you'll find that traditionally they have more revenue growth in the first part of the year, and stronger revenue growth in the latter part of the year.

Essentially reflecting that volume of increased unit of deliveries in the second part of the year, second half of the year.

But why isn't that just a seasonal issue, why does it mean you should see accelerating year over year increases?

They've been winning a lot business, George.

If you look at their backlog.

Schedule 5 of our release, George, has a nice profile of the total backlog, and if you take a look at their performance in electronics year over year, you can see a tremendous growth in their backlog and this is the manifestation of that successful business capture.

You're figuring your capture an additional $200 million in revenues because you didn't lower the revenue guidance for the adjustment of the sale of Electro-Optics.

Yes, exactly.

Okay.

And the same question in ship building, it doesn't look like you lowered the revenues there, except you commented that you had $134 million hit to revenues in the quarter because of the charge entity.

The Gulf shipyards you're going to have less revenues because of your adjusted EAC's, so does that just mean you're getting more business in Newport News?

Not necessarily more business in Newport News, but obviously, part of that $134 million set back will be now recognized in the remaining part of this year.

So, as I alluded to earlier, I feel good about our revenue forecast for ship building at this point in time.

Okay, and the drop in margin that you're saying were the rest of the year will be about 8.5% versus 10%, is that just reflecting the lower margin at the Gulf shipyards and Newport News is going to be comparable to what it was in the first quarter or there's something going on there as well?

Well, first of all, the guidance for ship building for the year was low 9%, if I remember correctly.

So as we go forward, essentially it is performance at both shipyards on a go forward basis for the programs that they had.

No, but what I'm asking, Jim, we know the Gulf shipyards are going to be lower because of the $36 million dollar adjustments that you made, I'm just wondering whether Newport News is also going to be lower for some other unknown reasons.

Not that I know of.

So it's really just going to be the Gulf shipyards?

Yes.

And then one last one, the aerospace margin always tends to do better than what you think it's going to do.

But to get from 12.7% in the 1st quarter to the range that you're given requires a fairly substantial stepdown in subsequent quarters and it doesn't look like there are one time items in the quarter, I'm wondering what it would take for that to occur.

Part of it is the new programs which we traditionally start out at lower earnings rates to begin with.

And frankly as I commented to one of the other questions, we did have some catchup adjustments in this business in this quarter.

It's hard for me to project whether I'm going to have any further adjustments, if I knew about them, I should be recognizing them now, right?

Right.

Correct.

To your point they've been strong performers, I alluded to that as well.

The guidance at this point reflects what I know about their business, including the cost that we're incurring on the protest on allowable costs.

And so, when I think about their margins, performance they have been strong performers, I expect them to continue to be strong perform .

We're adding some volume with new development contracts with lower revenue, lower margins at the beginning and we have protest costs as well that

You said how much the cume catchups were, would it be fair to say the cume catch up were the bulk of the difference between your expected margin for the year in what you reported.

That's part of it, yes.

Okay.

That's my questions, thanks.

All right, we're going to cut the questions off, we're running out of time.

Let me just make a final remark.

First of all, as we told you last week, and this week, and as Wes delineated in some detail.

We are taking action on LHD-8, we will emerge stronger from this situation than we did before.

We see significant opportunity for improvement of the ship building business.

The remainder of the company is clicking on all cylinders, and we continue to be extremely confident about the future of this company.

So thank you all for joining us this morning, and we'll talk to you next quarter.

Ladies and gentlemen, thank you for participating in Northrup Grumman's first quarter earnings conference call.

This concludes your presentation and you may now disconnect.

Have a good day.