諾斯洛普·格拉曼 (NOC) 0 Q0 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the Northrop Grumman fourth quarter earnings conference call.

My name is Oneka and I will be your operator for today.

(Operator Instructions) As a reminder, this conference call is being recorded for replay purposes.

At this time, I would now like to turn the call over to Mr.

Gaston Kent, Vice President of Investor Relations.

Please proceed.

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

Welcome to our fourth quarter 2008 conference call.

We've provided supplemental information in the form of a Power Point presentation that you can access on our Investor Relations website at northropgrumman.com.

Before we start, please understand that matters discussed on today's call constitute forward-looking statements pursuant to Safe Harbor provisions of federal securities laws.

Forward-looking statements involve risks and uncertainties which are detailed in today's press release and our SEC filings and may cause actual Company results to differ materially.

During the call, we will discuss fourth quarter and full-year results and 2009 guidance.

We will refer to non-GAAP measures which are defined and reconciled in our earnings release and supporting materials which are posted on our website.

On January 7, we announced a reorganization that impacts several of our businesses.

The 2009 guidance we present today will reflect our new organization.

For reporting purposes, the reorganization will be reflected in our first quarter 2009 results.

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

Also with us today is Paul Gregory.

Paul is my replacement as Vice President of Investor Relations and will be your primary contact at Northrop Grumman as soon as I push the off button on this call.

He was previously the chief financial officer of our space technology sector.

If you would now please go to slide 3, I'd like to turn the call over to Ron.

Well, thank you very much, Gaston.

Hello, everyone, and thanks for joining us to discuss our fourth quarter and full year results.

Operationally, we had a very strong finish to the year.

We achieved record sales, record cash from operations, and record free cash flow.

Sales increased 6% to nearly $34 billion making us now the nation's second largest defense contractor.

We had a tremendous year for cash generation.

Cash from operations and free cash flow exceeded the upper end of our prior guidance range even after $200 million for discretionary pre funding of our pension plans.

Our adjusted EPS from continuing operations totaled $5.21, which also exceeded the upper end of our prior guidance.

This excludes the previously announced goodwill impairment charge which was driven by the dramatic declines in market multiples.

This noncash charge did not affect our operations.

Jim will report on this in more detail shortly.

The year end number I'm most pleased to report is total backlog.

We begin 2009 with a record $78 billion backlog, a 23% increase over last year's ending backlog.

In 2008, we captured a record $48 billion in new business which comprises substantial competitive wins and large follow-on awards in our core franchise programs.

This represents a very healthy 143% book-to-bill ratio.

Our backlog growth demonstrates two major strengths.

First, our company continues to become more competitive.

We had substantial competitive wins across our business portfolio resulting from our leading edge technologies and innovative solutions for our customers.

For example, we extended our winning streak in the unmanned aerial vehicle space by winning the BAMS program which also demonstrates that our internal R&D investments are really paying off.

Second, we are leveraging our portfolio of large, long-term franchise programs that will provide profitable revenue for years to come.

Ship building backlog is up $9 billion with a $5.1 billion contract for the Gerald R.

Ford carrier and the $5.6 billion contract for block 3 of the Virginia class submarines.

Under the new contract, for submarines, we and our partner, General Dynamics, will begin producing two boats per year in 2011.

This is a strong testament to the success of our industry partnership and its record of driving down the Virginia class cost through teamwork with the United States Navy.

Our aerospace business also posted a multi-billion dollar backlog increase with key restricted awards, follow-ons to franchise programs like the award of 24 F-18 ship sets for Australia and the US Navy, and new B-2 bomber upgrades worth about half a billion dollars.

The strength of our 2008 financial results allowed us to continue our shareholder value enhancing actions.

We increased our dividend by 8%, the fifth consecutive annual increase, and a doubling of the dividend since 2003.

We also repurchased 21.4 million shares of our common stock during the year and we have $945 million remaining our on our share repurchase authorization.

Along with executing our balance cash deployment strategy, we continue to maintain a strong balance sheet.

Even with the goodwill impairment charge and decline in pension plan assets, we ended 2008 with a net debt to total capital ratio of 15% and we continue to enjoy the highest credit rating in the Company's history.

In this economic environment we intend to maintain a strong balance sheet and significant liquidity.

We see continuing solid performance for the Company next year.

For 2009 earnings, we are focusing on performance as measured by pension adjusted earnings.

On that basis, we see year-over-year earnings per share growth of between 9% and 15%.

The use of pension adjusted EPS estimates eliminates the distortive effect pension accounting has when comparing our 2008 results with our outlook for 2009.

Now turning to the defense spending environment, President Obama has made strong choices for his national security team.

Secretary Gates provides critical continuity with his understanding of the many complex issues facing DoD.

Clearly, the new administration well understands that the threat environment we have out there is not diminishing.

There is also universal consensus that our service men and women deserve the highest quality weapon systems and security solutions.

Our government's challenge is to balance persistent critical national security needs with the very real economic crisis that is putting unprecedented pressure on government spending.

In his recent testimony before Congress, Secretary Gates stated that the DoD must make tough choices.

The President's team will make his priorities known with the release of the 2010 budget and the quadrennial defense review.

We will know more in the spring.

However, we expect that the majority of our programs at Northrop Grumman will be supported in the 2010 budget process and we believe that going forward our portfolio is sharply aligned with both the traditional and emerging priorities.

Program execution, innovative solutions and value to the war fighter will be the key competitive differentiators for Northrop Grumman.

In addition to the formidable traditional threats our nation faces, we must now respond to new unprecedented nontraditional threats.

To paraphrase the director of national intelligence, cyber attack may pose the 21st century's most serious economic and national security challenge.

Hostile penetrations of the cyber systems in the United States are widespread, successful, and growing and the government will spend substantially to address these risks.

We believe that this will be a priority mission under the new administration, and Northrop Grumman is a leader in this area.

We are currently supplying cyber security systems to many agencies, and we are integrating those capabilities to address the cyber security challenge.

Organization structure should follow strategy, and by recently combining our mission systems and information technology business sectors, we have concentrated the majority of our leading capabilities into a single entity, our new information systems sector led by Linda Mills.

The air refueling tanker will be another priority of the new administration.

We are very encouraged by the administration's commitment to a rapid process to replace our aging air refueling tankers.

Our nation and military service men and women urgently need this new tanker.

We are fully committed to this program.

We won this competition once, and we intend to win it again.

We are proactively addressing the increasingly competitive environment for our products and services.

In January we announced a reorganization of our seven segments in to five.

These organizational actions are aimed at strengthening our alignment with customers, improving our ability to execute on our programs and win new business and enhancing our Company's cost competitiveness.

My number one priority for Northrop Grumman is program execution.

While there is more work to do we are making solid progress.

Wes will update you on program execution during his comments shortly.

In summary, we had a strong operational finish to 2008.

We're focused on performance improvement and competitive positioning.

We are financially solid and making the necessary investments to capture new programs.

We are positioning the company for the future.

Now I will turn the call over to Wes for additional discussion on Northrop Grumman's operations.

Thanks, Ron.

Good morning, everyone.

My comments today are outlined on slide 4.

This quarter I will talk about our business capture efforts, highlight some of the programs we are pursuing, and finish with an update on our program execution.

The tremendous effort we put into our business capture processes is succeeding, as demonstrated by the growth in our backlog.

Just as important as the level of that backlog is the quality of the contracts that we're entering into with our customers through an adherence to more stringent bid criteria.

We are being more selective, our total backlog is growing, and the quality of that backlog is improving.

As we continue to have a very high quality, robust multi-billion dollar pipeline of opportunities, in addition to tanker, we're pursuing the scalable agile beam radar upgrade for the F-16, CANES or the Consolidated Afloat Networks and Enterprise Systems program, the airborne ISR programs called EPX and ACS, the TSAT program, and the GPS OCX program, and we also continue to have substantial opportunities in the restricted area.

As you can see with the expansion in our backlog, we are becoming more competitive as we address this robust pipeline.

Turning now to our programs, my key operating priority is superior execution across all of our 20,000 programs.

I will focus my remarks this morning on the progress we're making in retiring risk on our key watch list programs.

On block 60 we successfully delivered on schedule the Falcon Edge software increment in the fourth quarter, representing a substantial risk retirement milestone.

There will be one subsequent key software update to complete the Falcon Edge electronic warfare capability later this year.

We continue to perform within our EAC with the primary remaining risk mitigation milestone being final contract close out.

In last quarter's Wedgetail update we were waiting for the customer go ahead to begin type acceptance testing.

In the fourth quarter we reached a customer agreement that allowed us to start TAT&E.

The ground testing phase began in December and flight tests are scheduled to begin this quarter.

Successful completion of these tests will represent another major risk mitigation milestone.

On the New York City wireless program, we continue to make good progress in building out the network.

On January 13 we achieved a key milestone conditional acceptance, and we now have 95% coverage across the city.

The system is up and running and providing service to the customer.

We expect to achieve full system acceptance in the first half of this year and we're operating within our EAC.

The San Diego contract continues to perform to its plan as well.

Future profitability on this program will depend on the level of revenue from future county service demands.

And on the Virginia IT program, we've made solid progress towards completing the transformation phase of the commonwealth's infrastructure transition to the new common IT environment.

The focus item on this program will be the time line for transitioning the remaining agencies over to this new environment.

Our approach to state and local opportunities continues to be very disciplined.

We are not bidding on programs unless they meet our stringent criteria.

This more selective approach has led to declining revenue from state and local IT programs and this drove the slower growth rate for our IT sector in 2008.

I'm also pleased to report that our ship building team continues to make solid progress.

LHDA achieved its fourth quarter milestone, the pier side integrated propulsion test, and we began builders trials ahead of schedule with an initial trial in December.

In that trial we demonstrated all the primary capabilities with the exception of the full power and endurance runs for the propulsion system.

These tests are planned to be performed with a final builder's that's scheduled for this quarter.

Acceptance trials will follow shortly thereafter.

We're on track to deliver the LHD-8 in the second quarter of 2009.

We continue to perform well against the EAC and were able to recover some reserve in the fourth quarter as we retired the risk.

So, in summary, we continue to make good progress on these programs as this quarter's results demonstrate.

And, with that, I will turn the call over to Jim.

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

My comments begin with slide 5.

I will discuss the fourth quarter and full year 2008 results, the goodwill impairment charge, update you on pension performance, and then conclude with a discussion on our 2009 guidance.

Our operating results for the fourth quarter were very strong, as Ron has mentioned.

As you know, I place a lot of emphasis on the importance of cash flow so I'm particularly pleased with our cash from operations and free cash flow results for the year.

This year's performance represents a net income conversion of 135% before the goodwill impairment charge.

I'm very proud of what our team accomplished in 2008.

Due to the strong year end collections, we reduced trade working capital even while increasing sales by 6%.

We exceeded the high end of our guidance range by a substantial amount even after considering the $200 million of discretionary pension pre funding.

This quarter's large goodwill impairment charge was driven by the dramatic decline in the equity markets.

This caused a sharp decline in market multiples for our industry and for Northrop as well.

As many of you are aware, the annual testing for goodwill impairment is a process that compares the fair value of each business to its recorded book value.

We determine the fair value of each business based on its discounted cash flow forecast.

Cash flows for each of the businesses change from year to year but the calculation is really dominated by the terminal year market multiple.

Had market multiples on November 30, 2008, been at the same level that they were the prior year, November 2007, the goodwill for ship building and space technology would not have been impaired.

Moving on to pension on slide 6.

During last quarter's call we gave you some sensitivities that we thought would be useful to model our 2009 pension cost.

That model was based on a 7% discount rate and a negative 10% return.

We also noted that at the time of our third quarter call in October, our planned investment returns was about a negative 20%.

Now, what happened?

Interest rates held fairly constant to that 7% level until the last couple weeks of the year when they declined substantially.

So the discount rate applied to year end pension liabilities turned out to be 6.25%, which is lower than the model we provided to you.

However, our investment returns improved in the fourth quarter.

We ended the year with a negative return of slightly more than minus 16% or negative return of 16%, which is very strong relative performance.

Earlier in the year we decided to underweight equities, a decision that really paid off and reduced our investment losses from what they would have been by about $1.7 billion.

Based on our actual plan returns and our expected CAS expense, we estimate that our net FAS/CAS pension adjustment in 2009 will be an expense of approximately $335 million, or about $0.65 on a per share basis.

Our underlying assumptions are an 8.5% long-term rate of return and a discount rate of 6.25%.

We also updated some of the underlying pension plan actuarial assumptions to reflect the current economic situation.

The sensitivities we provided last quarter are before those changes in actuarial assumptions.

I would also remind you that we absorb the full 2008 asset valuation impact in the calculation of 2009 pension expense rather than smoothing the impact over several years as many of our major peers do.

On a cash basis, our minimum pension funding requirements for 2009 is about $130 million.

Our current plans call for an additional $500 million of pension pre funding in 2009.

At the end of 2007, the funded status of our plan stood at about 104%, and at the end of 2008 the funded status was 84%.

This change in funded status results in a $2.8 billion reduction in shareholders' equity on an after-tax basis.

Now let's move on to guidance on slide 7.

Our guidance for 2009 GAAP earnings per share is $4.50 to $4.75, versus the 2008 adjusted EPS, excluding the goodwill impairment charge of $5.21.

A significant driver of the year-over-year variance is the change in net pension adjustment from income of $263 million in 2008 to an expense of approximately $335 million in 2009.

This nearly $600 million swing translates to about $1.20 on a per share basis.

Negative pension plan returns and our pension accounting method caused a large distortion in our GAAP earnings comparison.

And, as many of you know, under Federal Government cost accounting rules, we are reimbursed over time for our pension costs through our contracts.

So it is really the cost accounting expense, or CAS pension expense, that drives our margin rates along with ERISA, our pension-related cash flows.

For both of these reasons it makes much more sense to use pension adjusted EPS to understand Northrop Grumman's underlying business trends.

So on a pension adjusted basis, our earnings per share guidance for 2009 is $5.15 to $5.40, which represents growth of 9% to 15% over the 2008 pension adjusted EPS.

The year-over-year improvement reflects a sales increase to approximately $34.5 billion, a higher pension adjusted operating income rate and a lower share count.

These are partially offset by higher corporate unallocated expense and a reduction in other income due to the nonrecurring nature of the patent infringement settlements in 2008.

For 2009, I expect the higher -- we do expect higher sales but they will be offset somewhat by lower revenues in missiles, ship building, and state and local IT which will, as I said, partially offset the growth in other businesses.

We provided the same adjusted comparison for segment operating margin rate and operating margin rate, so on an adjusted basis, segment OM rate improves to the low to mid-9% range from 8.6%.

So we do expect segment margin rate expansion in 2009 which will be primarily driven by higher ship building margins.

Operating margin rate on a pension adjusted basis improves to the mid-8% range for 2009 from 7.9% in 2008.

We expect GAAP reported margin in the mid-7% range and our expected tax rate is approximately 34%.

Turning to cash generation, we expect another strong year of cash generation.

Before any pre funding of the pension plans, we expect cash from operations in the range of $2.7 billion to $3.2 billion and free cash flow of $1.9 billion to $2.4 billion.

For 2009, cash flows again will be weighted towards the second half of the year.

During 2009 we plan to continue our balanced cash deployment strategy by investing in the business through disciplined capital expenditures as well as potential acquisitions.

Managing the Company's liabilities, including voluntary pension contributions, will be an area of focus as well as returning cash to shareholders through dividends and share repurchases.

As Ron mentioned, we have $945 million remaining our on our current repurchase authorization.

As many of you know, we have returned substantial cash to our shareholders.

Over the last three years, we have spent more than $3.5 billion to repurchase 48 million plus shares and we have doubled our dividend since 2003.

So, in summary, putting aside the market multiple driven goodwill impairment charge, we had a very strong quarter and we ended the year with strong results and a solid foundation going into 2009.

So, Gaston, I think with that we're ready for some questions.

Okay.

Thanks, Jim.

Oneka, we're ready for questions.

Thank you.

(Operator Instructions) Your first question comes from the line of Myles Walton with Oppenheimer & Company.

Please proceed.

Thanks, good morning.

Good morning, Myles.

Maybe, Jim, I was wondering on the goodwill impairment, if we can probe that just for a second.

There's two variables, one is the market multiple and the other is the future outlook for cash flows.

You commented that if the November market multiple was the same as last year you wouldn't have taken a charge, but could you elaborate if there have been changes in your forecast for the future cash flows on a negative basis for the businesses that you took the charge on, and what that might mean for the 2012 targets?

Myles, as I said, there's always year-over-year changes in cash flows.

The key driver, as I said on the call this morning, was market multiples.

Again, the predominance of cash flow of values determined from the discounted cash flows is market multiple driven.

There are some lower cash flows coming out of the businesses as I look at them today but, again, the predominant driver is the terminal value market multiple applied to that terminal year and the five years of cash flows.

Should we read anything into the charge with respect to your 2012 targets?

I don't think so.

Okay.

And then maybe another follow-up for you, Jim, on the pension expense.

How much is flowing through the segments in terms of CAS in 2009 as maybe a head wind to margins?

And also if you could comment on what FAS and CAS would look like in 2010 if everything kind of hit the plan.

So CAS is increased in 2009 over 2008, about a 10% level, those kind of rough numbers.

On a go-forward basis, assuming we hit our 8.5% long-term rate of return, I would expect to see a small increase in FAS expense and, again, a general increase, or a consistent increase in CAS expense as we go through time.

Clearly, the cost accounting standards have a much greater smoothing effect associated with them, so anyone that had negative pension returns in 2008 will have higher CAS expense as we go through time over the next few years.

Okay.

Then, Ron, maybe follow up with you, last one, with respect to capital deployment.

Could you comment on given your strong balance sheets and relatively no interest income coming in from any cash balances, the priority with respect to M&A, has that picked up at all or are you still more favored towards dividends and share repurchase at this point?

Myles, I don't see any changes in our stance here.

We've tried to maintain a balanced look here.

We've done some very small M&A because of some extraordinary opportunities we've seen.

We certainly will continue to look for those opportunities in the future, but as we look at the balancing needs of share repurchase, pension pre funding, some debt retirement, we're going to continue to kind of balance it as we go.

The 15% debt-to-total capital ratio is a good number.

That's not necessarily a target for us, but we want to maintain a high degree of liquidity and flexibility in the next year or two just because I think, as everyone else, we want to make sure that we're adequately managed for whatever might come at us in the economy.

Okay.

Thank you.

Thanks, Myles.

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

Please proceed.

Yes, thank you very much.

Could you give us some more color?

Jim, you mentioned actuarial assumptions.

Briefly, what were they and the impact on your FAS/CAS for 2009?

The actuarial assumptions are, Cai, much more driven to the FAS side than the cost accounting side.

The principal changes were, as I mentioned, were tied to economic assumptions.

We have a cash balance feature to our pension plan and that cash balance feature has an interest rate applied to the balance that is credited to individuals' accounts, and obviously with lower earnings rates we thought it was -- made sense to reflect what we're going to see as actual credits for the cash balance plan in the near term and then trending back up to more historical levels.

We also expect that in a -- for a short period of time, we're going to see a delay in early retirements, given economic situations, so we reflected a slide in the period of time that we expect to see those early retirements, and then the final assumption really dealt with salary scale.

Again, depending -- given the economic situation, we thought that there's going to be a little bit of delay in the growth in salary scale as compared to what we had seen in the past.

Those assumptions essentially tended to somewhat mitigate the change in the discount rate from the 7% level that we had assumed at the end of the third quarter to the 6.25% that we ended up at the end of the fourth quarter, end of the year.

Thank you very much.

Last one, could you give us some color on where we expect royalty, general corporate and other income in 2009?

I don't -- we had a very successful year in 2008 in resolving a number of the patent infringement suits where those are largely behind us at this point in time, so I don't expect any kind of significant level of royalty income.

We traditionally have a few million dollars a year, but it's -- it is really just that, on a normal run rate, a few million dollars a year.

The other expense piece of the other net, again, is largely influenced by the nonqualified benefits that we have, and to a certain extent that is market driven.

From a planning perspective, I'm looking at an additional cost there for this year.

Okay.

Thank you very much.

Thanks, Cai.

Your next question comes from the line of Joseph Nadol with JPMorgan.

Please proceed.

Thanks.

Good morning.

Good morning.

On the sales outlook, I thought the numbers were a little bit light and you were looking for less than 2% sales growth for 2009, and I guess taking a step back you have a $42 billion target out there for 2012, so we're looking at lower than 2% growth in 2009, and then that would need to step up to 7% CAGR the subsequent three years to get to that level.

I know you are excited about your backlog and the outlook, but obviously there's uncertainty in the budget.

What would you say, Ron, on how you feel about that outlook right now?

Joe, let me take the near-term piece of it and then I will turn it over to Ron for the longer term piece.

As I mentioned in my comments, we do see sales growth to the $34.5 billion level.

There's -- I can expect that some of you may be thought the sales growth could have been higher.

There are, as I mentioned in my prepared comments, three areas where there are some significant declines in revenues on a year-over-year basis between '08 and '09.

They are in the ships area, where we have essentially a dip in activity as we complete the Bush and then transition to the new Ford carrier, as well as completing the RCOH on Vincent and then transitioning to the Roosevelt.

Likewise, we see a decline in missiles resulting from basically a completion of activity around the ICB —-yeah, IPIC program and then, finally, as both Wes and I commented, lower revenues in the state and local arena.

Those three areas are about -- probably about $800 million decline on a year-over-year basis.

Joe, let me just tag on to that in terms of the long term.

A year ago we laid out what we thought ought to be reasonable targets to address given our then understanding of the defense market, the economic world that we are in, and frankly also the pension performance market that we thought we might be able to continue to have.

Clearly, we have a different environment now.

However, I will tell you that our view of the opportunities for the long term margin rates that we think we can achieve in this business has not changed.

And how about the top line, Ron?

I mean, it sounds like you are maybe coming off that number, but do you expect the top-line growth to accelerate I guess from 2% to a more like a mid single-digit number, or is that something you don't want to address right now?

I can't address beyond the guidance we've just given for '09.

Clearly, we want to see how the 2010 budget and the QDR layout in 2011 budget.

I think that, frankly, will be a more important determiner of top line.

At this point in time we're reasonably comfortable that our program set is solid but, like everybody else, we are going to wait and see how the President's budget actually lays out for 2010 and beyond.

Okay.

And then just on the same lines, Jim, thanks for the color on the sales, along the same lines, just looking at margins, just the Company overall, the segment margin overall.

Coming into 2008 we were looking at mid to high 9's and then obviously there was the LHD-8 issue, and then a number of other pluses and minuses, but your baseline expectation for the business excluding all that stuff was mid to high 9's.

Now we're coming into 2009 looking for low to mid 9's.

How would you characterize the difference in the outlook one year ago today going into 2008 versus today just given the mix of business and frankly the lack of items that are affecting either one?

Joe, as I think about our forecast or guidance for this year, it's really based on what I see today.

Clearly, there are always risks and opportunities.

We intend to address those as we go through time.

We'll update you as those opportunities are realized and we mitigate the risk.

I think, as Ron said, our view of the long-term margin opportunities for these businesses still holds.

It really hasn't changed.

So we are essentially confirming that long-term opportunity view of margin rates.

In terms of year-over-year change, as -- I forgot if it was Myles or Cai that asked previously, there is some growth in CAS cost, cost accounting pension cost.

As we look forward, we have tried to reflect our view of the impact of those costs in to our expectations for margins for 2009 as well.

Okay.

Let me slip one more in.

The ship building margin outlook, you are at 8%-ish.

You did better than that in the fourth quarter.

And I guess things look like they're working their way up a little bit on performance, certainly in terms of LHD-8.

Are you being conservative there because of that transition you talked about in your sales outlook or is there something else going on?

That is an impact in 2009.

2000 -- let me just comment a little bit on 2008 fourth quarter margins which were, frankly, strong at 9%.

We did have some risk retirement on VCS, the submarine program, block 2, which contributed to earnings, as well as Mike Petters and his team have really actively managed overhead throughout 2008 in anticipation of the dip in revenues in 2009.

So frankly we had some favorable performance on actual 2008 overheads versus what our expectations were, all of which were positive contributors to earnings in the fourth quarter.

So, again as I look forward into 2009, I know we have the dip in revenues that has an impact on overhead absorption.

I do see improvement, underlying improvement in the operations of the shipyards, all of which have been reflected in our guidance for margin rates for 2009.

Okay.

All right, thank you.

Your next question comes from the line of Joseph Campbell with Barclays and Company.

Please proceed.

Good morning all.

Ron, I just wanted to take this opportunity to thank you for Gaston and to thank Gaston for so many years, even decades of putting up with us all.

He's earned a lot of purple hearts and awards for valor as well and we're going to miss you, Gaston, and we wish you all the best.

Paul, welcome, I hope you've got your [flack] jacket.

Thank you.

Those are kind remarks, Joe.

I'm not going anywhere, by the way.

That's good.

We're delighted, and I'm sure Ron and the team are as well.

Ron, could you talk philosophically and kind of managerially about what this reorganization that you announced earlier in the month really means?

And sort of what was behind it.

Some of it looks like it was sort of integration that might have happened a long time ago when you bought TRW, but maybe personalities or management wasn't quite ready for the shifts, but others of them, I'm not quite sure what's going on with some of these groupings and maybe you could just shed some light on that.

Sure, Joe.

Obviously over time all companies reorganize and, as I mentioned in my initial comments, your structure needs to follow your strategy.

And as we look at becoming even more competitive and being able to more agilely deploy talent to different major programs, both either capture them or execute on them, it struck Wes and me that the combinations of a couple of these units would be something we ought to go forward and do.

It creates some larger entities, but they do have more critical mass.

Let me just take the two key combinations, which we've done.

By putting our two aerospace businesses together, our aircraft and our space business which are, by the way, largely co-located within a couple miles of each other here in southern California, we see an opportunity to very substantially improve the ability to move talent between the businesses.

We see an opportunity to pursue the strategic initiatives involving the space and air continuum and strategic ISR.

We think between unmanned air vehicles and space in the future there's going to be more trades between those.

Frankly, also the ability to eliminate certain back-office costs which we just don't need to have here going forward.

And we are at the point, I think you made an observation about the maturity of the integration.

We are at a point now where culturally and from a people standpoint, this makes sense and we can do this.

The other area which we're very excited about is the combination of our Mission Systems and our information technology sectors into the new information systems sector under Linda Mills, and this also will be about a $10 billion entity.

This is, again, a structure following strategy.

We found that over time the two businesses, while we had made some efforts to partition where they went, in fact did find themselves in the marketplace having to work together and in a way which was awkward, and we found that we could bring greater critical mass to our customers by actually realigning and putting us all under one common management, under one roof, if you will.

Again, the opportunity for significant synergies, these two businesses are largely located in northern Virginia, although they have multiple sites there, and also an opportunity, in addition to agile deployment of people and talent and massing for major bids, the ability to take some costs out as well.

So this just seemed the right sort of things to do.

And I might also mention, Joe, that through the other sectors that are unaffected, and also the corporation as a whole, we're continuing to look at how to streamline to become more agile and more competitive.

We think the environment demands it.

Frankly, we're getting ahead of it, and we think it's the right thing to do.

Ron, just one other question, and I don't mean this in a mean spirited way in any way, but Northrop is the only company that had these impairment charges.

Is there something different about either the amount of goodwill or the growth rates for ships that somehow led Northrop to be unique in taking the big impairment?

There was a ton of M&A, but we haven't seen anybody else do it, and it just sort of strikes me that it's sort of another example of Northrop being a little different.

Let my buddy here, Jim Palmer, answer that question.

I think he can give you a pretty precise answer, Joe.

A couple observations, Joe.

We are not the only ones who have taken goodwill impairment charge.

There are others in our industry, although smaller, who have taken goodwill impairment charges, Harris, for one, for an example.

Other observations, as we mentioned at our investor conference last year, when we talked about goodwill and RONA and its impact on goodwill and its impact on RONA, our acquisitions largely were completed towards the end of the cycle of defense industry acquisitions, largely completed after the adoption of 142, the new standard which did not allow the amortization of goodwill that some of our other competitors who had purchased transactions amortized goodwill.

Some of them had pooling transactions, if we go further back, where there really wasn't any goodwill associated or recorded with those transactions.

We did end up with proportionally more goodwill than many of our competitors, due to the timing of our acquisitions, and we did not have the opportunity to amortize any of the goodwill or much of the goodwill unlike many of our competitors.

So those are two historical factors that are important and then as I mentioned, it really is our view of market multiples for each of our businesses that drove the actual impairment charge this year.

Just a follow-up.

With regard to the way you measure yourself on RONA and the returns, do you think that you were previously being sort of penalized relative to the industry benchmarks because of these things you've gone through or because you have now taken these charges will you, for purposes of rewarding -- compensation and so on, based on return type metrics, adjust it back up as if you hadn't written it off because, of course, if you write enough assets down, the RONA will [vary greatly].

Our intention on a go-forward basis, Joe is to revise the baseline for the RONA portion of our long-term goal to reflect the lower base, if you will, so the bar will be increased as we go through time.

RONA is just one of the two long-term measures of our long-term plan.

The other is operating margin, dollars accumulative over the three-year period.

There may be a benefit on one side.

There's a cost on the other side.

Terrific.

Thanks for the answers.

I appreciate it.

Thanks, Joe.

Your next question comes from the line of Ronald Epstein with Bank of America.

Please proceed.

Good morning, guys.

Good morning.

Ron, just a follow-up on some of your initial remarks.

You mentioned the opportunity in cyber security.

Do you mind to elaborate on that.

Potentially how big a market is it, and what do you guys bring to the space?

Well, at this point in time, Ron, it's hard to really quantify it for a lot of reasons.

First of all, it's huge.

A lot of it is something that's visible, a lot of it that may, in fact, not be as visible as we look at our understanding of where the Department of Defense and the intelligence agencies are putting future money on their plans.

We've seen increasing part of it being in cyber security, which relates to not only protection against cyber threats but also dealing with the broader issues of cyber warfare going forward.

So certainly this is a multi-billion dollar sort of opportunity at large.

It has ramifications frankly for not just defense purposes but also for other civilian agencies who to have deal with security of their own networks.

So there is a lot of work to be done here.

And the company is remarkably positioned with the skills we bring in this area.

This is an area we have been working on for a long time and have a very, very strong market position, and we see this improving.

I will give you an example of one area where we've been able to expand this, that we can talk about, and that is our acquisition of Essex.

Essex was a company that was focused on this area and since our acquisition, we have seen that business dramatically increase in demand for that they're doing.

I think that's just representative of what we see.

So, Ron, the short answer is I can't give you a precise dollar number but I can tell you it is billions and billions.

How do you think about -- there's also commercial contractors who work that in space.

Are they competitors?

Are they potential folks you could team up with?

Are they potential M&A candidates?

I think more people we can team up with, Ron, you think about where we would be addressing our attention would be largely to the defense and intelligence space.

Those markets which we understand extremely well and where we can partner with a commercial competitor to do that better, that's great.

In general, we do have some special and unique skills as a result of our deep understanding of intelligence and defense that many of the other commercial players do not have.

And frankly, we're also not primarily interested in addressing the commercial market for our services.

That is, helping other companies with their internal security threats.

So I think more an opportunity for collaboration, Ron, than competition.

Okay, great.

Finally, when we think about the opportunity set in maybe the more near term, what could happen in say the next six to nine months, what is that laundry list of things we should keep an eye on?

I think Wes gave you a set of those targets that we're pursuing.

I think we'll look for the restart of tanker at some point, although we don't expect that will be a 2009 event.

As Wes talked about, the F-16 radar work could be significant.

We have work on E-2, which we might be able to bring in internationally, CANES, EPX, ACS, the TSAT competition is a big one for us and our partner Lockheed that should be able to get -- we think will get off the dime here later in the year and, of course, the down select process on GPS OCX.

Those are kind of the trigger points we're looking.

In addition, a whole raft of follow-ons of our franchise program work which would go into future backlog.

Great, thank you very much.

For further questioners, we only after few minutes left.

Appreciate if you would limit yourself to one question.

Thanks.

Next question comes from the line of Robert Spingarn with Credit Suisse.

Please proceed.

Good morning.

Good morning.

Could you talk a little bit about the nice changes we saw in unfunded backlog in the quarter, particularly in space, and I think in tech services as well?

Robert, it's Wes.

Let me just say a few words across the board.

Much of that growth in unfunded backlog comes from our success in building on follow-on activities to long-standing programs that we have in the Company.

Ron talked a little bit about it for ships, space was similar, tech services has a little bit of that.

But when you combine that success in building on those franchise programs with the successes that we've that I described on the competitive front, together those generated a record year of backlog growth for us.

So it was really the combination of those two things, both competitive and the benefit of having large scale franchise programs that we can continue to build on.

And then in contrast to some commentary on the wider aspect of your '09 revenue guidance, perhaps in ships and a couple other spots, ES looks real strong there.

Can you talk about that?

Ron, could you talk about any major opportunities perhaps that can enhance any of the segments in this fiscal year?

Well, obviously electronics went through a couple years of flattening a few years ago and we put a real press along with Jim Pitts on improving our competitiveness there.

They have been knocking the lights out in that area and they have been adding backlog, and you can see that their sales are growing accordingly.

And as you know it's an extraordinarily well performing business with good margins.

We see a few opportunities we go through, we've outlined most of the individual ones already and we'll just sort of watch and see.

When we build a plan, we have to make some assumptions about what -- how funding gets metered out.

We also are not unmindful of the fact that some of the programs that we have in our plans could have some stretches associated with them.

Others could potentially be accelerated, and what we've given you here is guidance which reflects kind of our integrated view of how that will all play out for the year.

If it turns out that there's no stretches or slips or no reductions in guidance we could have some -- funding, rather, we could have some up side.

If we were to see a program or two significantly delayed or an award put off, that could have an impact on the other side, but I think the numbers we've guided to, the $34.5 billion, about our best guess at this point in time.

Well, that's very helpful, and I would like echo Joe's thanks to Gaston as well.

Thanks, Rob.

Your next question comes from the line of Richard Safran with Goldman Sachs.

Please proceed.

Good morning.

Good morning, Rich.

Just -- you mentioned substantial opportunities in the restricted area in your opening remarks.

In 2008, good classified bookings.

So based on what opportunities you are watching, and I'm assuming you are doing some type of internal expected value calculation, can you comment directionally on what you think 2009 classified bookings might be like?

I also ask this in the context of your comments pertaining to a more stringent bid criteria.

Well, Richard, I really cannot give you any more color on that for obvious reasons.

I will emphasize Wes' comments about more stringent bid criteria.

It turns out in our restricted business we often find that to be our business that gives us the greatest opportunities to bid the kind of ways we want to bid.

It's some of the other programs that we need to put additional attention on in terms of bid criteria, and we are going to use them across the whole spectrum of what we bid, but I wouldn't single out restricted as an example there.

Okay.

Thank you very much.

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

Please proceed.

Good morning.

Morning, David.

Just to clarify on your EPS guidance I think, Ron, you had talked about that on a pension adjusted basis it implies high single digit, low double digit kind of growth.

But just to be clear, if you adjust for the ship building charge last year, it looks like flat to just slightly higher EPS growth.

Is that correct?

David, the way I think about it, and this is Jim, '08 did have some unusual items in it.

You can't just take the first quarter ship building charge because we had some offsets or some reversals of that charge in the third and fourth quarter and we also had the roughly $60 million of royalty or patent infringement settlement, so when I net all that down, that is about a $200 million impact to segment margin rate.

So the way I think about it essentially is I have part of that operational improvement that is the absence of all of that net item and then margin improvement and sales growth associated with the balance.

Okay.

So, Jim, just so I am clear, so you're saying it is roughly $350 million in charges you took in ships and you're netting, you have got about $150 million of positive that nets out to the negative 200?

Let me go through the exact numbers with you.

$326 million in the first quarter offset by $69 -- $63 million of pickup in --- or reversals in the third and fourth quarter on LHD-8 for a net of $263 on LHD-8 for the year and then $59 million or $60 million of patent infringement settlements that again kind of a one-time impact that nets the $200 million.

Okay.

Great.

That's very helpful.

Thanks, David.

Your next question comes from the line of Troy Lahr with Stifel Nicolaus.

Please proceed.

Thanks.

Just wondering if you guys could talk a little bit about your international sales, some of the other companies have done a pretty good job of just breaking that out and kind of talking about some of the opportunities in growth there.

Could you do the same?

Well, as you know, we have probably 7% or 8% of our sales in international.

This is probably lower than some of the other players.

At one time Northrop historically had almost half of its sales internationally.

This was quite a number of years before my time.

We do have a number of opportunities.

A lot of our opportunities are in the electronics area which is our largest international participant.

We do see opportunities for programs such as E-2 perhaps in the Middle East.

We have some new opportunities there.

We have some discussions in India.

The F-16 Saber radar, which is a new modernization upgrade to the radars of F-16s for the fleet which is deployed around the world is very significant for us, and while there wouldn't necessarily be sales of new aircraft, there would be total replacement of radars and that could be a significant opportunity for our electronics focus as well.

Okay.

Do you see that 7% to 8% growing?

Is there a certain target that you have out there?

Do you think you can get up to 10%?

We've said for several years that we have not set -- I have not set a specific target that says we need to achieve a certain fraction of our portfolio.

We have got to go where the market is for what we can do well and make money at and my guess is that our proportion will probably remain about there for the next year or two.

Okay.

Thanks you guys.

Good, all right.

What I'd like to do now is a couple of closing remarks and I would basically like to reiterate as mentioned at the beginning, Paul Gregory will be taking the investor relations role from Gaston.

Paul has been the chief financial officer at our space technology sector to this point in time and a long-term Northrop executive.

I do want to thank Gaston.

This completes his 64th quarterly conference call over the last 16 years and I think one or two of you said he has some battle scars and deserves some medals and we would certainly agree with that.

We very much want to thank you, Gaston, for your service to the company and to the Wall Street community as well.

You've been a fixture.

You are probably the longest serving investor relations guy at least in our industry, maybe in the universe for all we know.

Gaston will not be disappearing.

We are going to use Gaston's perspective and his market focus to help us in the next couple of years as we think through how we can focus on some competitive initiatives across the corporation and Gaston will bring his knowledge and a sharp scalpel with him as we go forward in that effort.

So we very much appreciate Gaston, your help.

That, ladies and gentlemen, completes our call.

Thank you for your interest, and we will talk to you next quarter.

Bye bye.