諾斯洛普·格拉曼 (NOC) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Northrop Grumman third quarter 2009 earnings conference call.

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

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

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

(Operator Instructions).

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

Paul Gregory, Vice President of Investor Relations.

Please proceed, sir.

Great.

Thank you, Lacey.

Good morning, everyone and welcome to Northrop Grumman's third quarter 2009 conference call.

In support of today's call, we provided supplemental information in the form of a PowerPoint presentation you can you can access at www.NorthropGrumman.com.

Before we start, please understand that the matters discussed today constitute forward-looking statements pursuant to Safe Harbor provisions and federal security laws.

The forward-looking statements involve risks and uncertainties, which are detailed in today's press release, as well as our SEC filings, and may cause actual company results to differ materially.

During today's call, we will discuss third quarter 2009 results and guidance for the year.

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

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

At this point, please go to slide three, and I would like to turn the call over to Ron.

Ron?

Thanks, Paul, and good morning everyone.

And thanks for joining us today.

We are very pleased with this quarter's performance, which was driven by a 4% sales growth, a solid 9% segment operating margin rate, strong cash flow, and continued share repurchases.

Earnings per share from continuing operations are slightly higher than last year, despite our pension head wind.

Adjusting for pension, underlying EPS growth was approximately 22%.

As a result of improved operating performance and lower tax rate, we are raising our 2009 EPS guidance from a range of $4.65 to $4.90 a share to $5.00 to $5.15 a share.

Third quarter new awards were quite strong at $10 billion, or a book to bill ratio of 115%.

Based on the strength of new awards, our backlog increased to $71.5 billion, which does not include the substantial backlog represented by our many ID/IQ awards.

Third quarter cash from operations and free cash flow were also robust, and based on that, we continued to execute our balance cash deployment strategy during the quarter.

Cash deployment actions included discretionary pension contributions totaling $586 million, and share repurchases of $227 million.

During the third quarter, we repurchased another 4.7 million shares of our common stock, bringing year-to-date repurchases to nearly 15 million shares.

At the end of the third quarter we had approximately $280 million remaining on the authorization.

I want to spend a moment on sales, which grew by more than 4% in the quarter, and for the year-to-date, by more than 5%.

These trends continued to reinforce our confidence in the strength of our program portfolio, and our strategic alignment with our customers' needs.

We continue to see solid market demand in areas like unmanned aircraft, C4ISR, the F-35 program, Cyber Warfare, restricted programs, and logistics and sustainment programs.

One of the best examples of the strength in our C4ISR positioning is our Battlefield Airborne Communications Node, or [BACN], capability for the Air Force.

This new revolutionary beta gateway was created, demonstrated, and fielded as a rapid response to challenges faced by the war fighter in theater.

The BACN capability will be integrated on to our Global Hawk platform to provide around the clock critical communications capability to our troops on the ground.

Theater commanders in Afghanistan and Iraq have identified BACN as an urgent operational need.

This is a game-changing technology for our war fighters, and we are working closely with the Air Force to rapidly deploy this capability as quickly as possible.

As I mentioned earlier, third quarter new business awards total about $10 billion, and included a contract for the refueling and overhaul of CVN 71, the USS Theodore Roosevelt.

This contract is valued of up to $2.4 billion.

We were awarded $300 million for continued development of the Army's distributed common ground system, and $150 million for lightning, targeting, and sensor systems.

Year-to-date, we have booked more than $24 billion in new awards.

We also won several significant ID/IQ awards that were substantial both in dollar and strategic importance, but won't show up in the backlog until individual task orders are received.

For example, the Air Force raised the ceiling of our ID/IQ contract for B2 modernization and sustainment activities by more than $3 billion.

The Army selected us to supply lightweight laser designator range finders under a five-year ID/IQ contract with an estimated value of $600 million.

We also received an ID/IQ contract from the Army for laser target locator modules.

This award has an estimated value of $400 million over five years if all the contract options are exercised.

And just after the close of the third quarter, we won the competition to provide contract logistics support for the Air Force's fleet of KC-10 extender refueling tanker aircraft.

The capture of this nine-year ID/IQ contract with a $3.8 billion ceiling further solidifies Northrop Grumman's position as a premier provider of air mobility solutions.

We also have near-term competitive opportunities upcoming like the Navy's Consolidated Afloat Network Enterprise System, or CANES.

The Air Force's GPS OCX contract and, of course, the aerial refueling tanker.

As you know.

the Air Force released the draft RFP last month.

Our team is evaluating the RFP, and we are in the process of providing our comments to the customer.

Looking ahead, the fiscal 2010 appropriations contracts, the conference is well underway, the Quadrennial Defense Review, or QDR, is progressing, and the 2011 budget process has also begun.

I believe our portfolio will continue to be positively aligned with national security needs.

So in summary, at Northrop Grumman, we continue to focus on managing risks, improving operating performance, and positioning the Company for growth.

We just completed a strong quarter, which allowed us to raise our 2009 EPS guidance.

Our balance sheet is solid.

We have an exceptionally strong management team in place.

We have a program portfolio correctly aligned with future defense needs.

And as we drive operating margin improvements, we have the opportunity to create substantial future shareholder value.

Finally, and on a personal note, as all of you know, I will be retiring as Northrop's Chairman and CEO at the end of this year.

So this will be my final conference call.

It has been a privilege to lead this remarkable Company since 2003, and I have thoroughly enjoyed by interactions with each of you in the investment community along the way.

Wes Bush will take the reins of Northrop in January, and there is no one more capable or fully prepared to do so.

I expect this Company will reach new heights under his able leadership.

So with that, Wes, now over to you.

Thanks very much, Ron.

Good morning, everyone.

My comments today will briefly touch on the operational highlights for the five businesses.

Beginning with Aerospace Systems on slide four, we had a particularly strong quarter with 5% sales growth, and a 10.5% margin rate.

Year-to-date sales in operating margin are on track with our expectations.

Growth continues to be driven by restricted programs, unmanned aircraft systems like Global Hawk, BAMS, and Navy UCAS, and manned aircraft programs like the E-2D Advanced Hawkeye, B-2 and the EA-18G.

Aerospace highlights during the quarter included the launch of two Northrop Grumman built demonstrator satellites for the Missile Defense Agency Space Tracking and Surveillance System.

These satellites will demonstrate the inherent advantages space sensors bring to persistent missile tracking and engagement.

This quarter we also completed a series of tests that validated the design and structural integrity of the X-47B Navy UCAS.

The test confirmed that X-47B meets the Navy's requirements for a jet-powered, fighter-sized aircraft, to demonstrate carrier-based autonomous launches and recoveries.

This is a major milestone in preparation for first flight later this year.

Aerospace systems ended the quarter with a $25 billion total backlog, about the same as the end of the second quarter.

New business in the quarter included low rate initial production awards for the F-35 and Global Hawk, new awards for restricted programs, and several follow on awards for space and manned aircraft programs.

On slide five, Electronic Systems sales grew by 2%.

You will recall that last quarter we indicated their double digit growth pace would not continue in the third and fourth quarters.

So this quarter's sale growth is on track with our expectations.

This quarter's lower operating income and rate reflects the $40 million patent infringement settlement we had in the third quarter of 2008 and lower performance for government systems programs this quarter.

Electronic Systems remains on track to achieve a mid to high 12% margin rate for 2009.

Ron mentioned some of Electronic Systems third quarter program awards and at the end of the third quarter ES had a total backlog of nearly $11 billion.

Information Systems, on slide six, had a solid quarter.

Sales increased 4%, operating income increased by 32%, and operating margin rate improved to 8.2%.

Sales growth for Information Systems continues to be driven by growth in our intelligence and defense businesses.

On a combined basis, intelligence and defense grew by approximately 7% this quarter, and are up by more than 10% year-to-date.

During the quarter, our Cyber Security team was awarded the Army information operation contract at Fort Belvoir, Virginia, to provide secure and efficient network operations and assure information superiority.

This contract has a ceiling of $430 million.

We were also one of five companies the Army selected to provide automatic identification technology hardware, software, and engineering services.

This contract has a maximum value of $419 million.

Information Systems total backlog stood at more than $10 billion at the end of the third quarter.

In our state and local business, we have made progress on the [VETA] program, and we are on our way to putting the program back on track.

In the third quarter, we provided a corrective action plan to the Commonwealth of Virginia.

We are working to that plan.

For example, more than 80% of the transformation activity and more than 90% of contract milestones are now complete.

In addition, we have instituted a number of improved processes for open and frequent communication between the partners.

Northrop Grumman, VETA, and the various agencies of the Commonwealth to insure rapid and effective resolution of issues.

Our plan calls for completion of transformation activities by June 30th of 2010.

We are confident that the corrective action plan is the path to success.

Moving to Shipbuilding on slide seven, sales increased 14%, and operating margin declined 4%, representing an operating margin rate of 6.8% for the quarter.

Last quarter, I outlined the components of the performance improvement plan that we are implementing on the gulf coast.

We are making progress in the implementation of this plan, and while we still have work in front of us to fully implement it, we believe this approach will drive consistent sustained improvement on these large multiyear programs.

Margin improvement in Shipbuilding remains one of our largest opportunities to create value.

Third quarter operating highlights in Shipbuilding included the redelivery of CVN 70, the USS Carl Vincent, after a successful 3.5 year refueling and complex overhaul.

We delivered two ships out of the Gulf Coast, the DDG 105, or [Dewey] and the LPD 21, the New York.

And our second national security cutter, the [Washey], successfully completed acceptance trials in October, marking the final test before delivery in November, and at the end of the quarter Shipbuilding's backlog stood at more than $21 billion.

So all in all it was a pretty solid quarter for Shipbuilding, with stable performance.

Moving to slide eight, Technical Services had another strong quarter.

Sales increased 4%, and operating income increased 5%.

However, as Ron mentioned, the real highlight for Technical Services occurred just after the quarter ended when it was announced that we had won the KC-10 contract for logistic support program.

Coming on the heels of the key A-10 and C-20 wins, this nine-year $3.8 billion KC-10 competitive win demonstrates our progress in expanding our presence in the key logistics and sustainment market.

We are very proud of the Technical Services team and their success in capturing and executing new business.

In summary, we remain intensely focused on managing risks, improving performance, and driving growth.

This quarter's solid performance demonstrates we are making progress on all three fronts.

With that, I will turn the call over to Jim.

Thanks, Wes.

Good morning, ladies and gentlemen.

My comments begin on slide nine, and will focus on third quarter performance, the expectations for the rest of 2009, and some thoughts on value creation on a go-forward basis.

Overall, it was a good solid quarter with mid-single digit sales growth, and a 9% segment operating margin rate.

Although not in our long-term objective, we view this rate as satisfactory at this point, considering where we are in the improvement program, at Shipbuilding that Wes outlined.

Earnings per share of $1.52 were slightly higher than last year, despite the negative year-over-year pension impact, and quite a bit better than what you may have been expecting based on a consensus.

The third quarter did include a $75 million tax benefit, which improved earnings by $0.23 per share.

Before that our earnings per share would have be $1.29, a very strong performance considering the pension headwind we faced in the quarter.

Net pension costs reduced third quarter EPS by $0.15 per share, compared to a benefit of $0.13 in last year's third quarter.

So on a pension-adjusted basis, our third quarter earnings per share increased by 22%.

Based on year-to-date results, we are raising our EPS guidance to a range of $5.00 to $5.15 from the prior guidance range of $4.65 to $4.90.

The reduction in third quarter segment operating income to 9% from 9.2% last year is principally due to the lower operating income for electronics, and the primary driver for lower electronics margin was the $40 million of royalty income associated with the patent infringement settlement that occurred in last year's third quarter.

We generally had solid or expected performance in the four other businesses.

There were also some items below the segment operating income line that are worth noting.

Unallocated expenses increased by $35 million, and that increase principally relates to higher environmental accruals.

This reduction was essentially offset by $41 million in other income.

Now, other income typically includes a number of reoccurring items such as interest, gain or loss on assets sold, reoccurring royalties, and returns on assets held to fund our non-qualified plans, in excess of the non-qualified plan expense.

However, for the third quarter, the largest item in other income relates to a gain of $18 million from an operating joint venture whose performance improved resulting in a recovery of a loan that we had previously reserved for.

Turning to slide 10, third quarter 2009 cash performance was strong.

Through the nine months, before discretionary pension contributions, we generated $1.8 billion in cash from operations, and $1.3 billion in free cash flow, which keeps us on track for our guidance for the year.

On a year-to-date basis, both cash provided by operations and free cash flow are slightly lower than in 2008, which principally reflects higher working capital needs.

As you all remember, we just had an outstanding working capital performance last year.

So that really is the change in working capital.

Year-to-date, we have made discretionary pension contributions of $800 million, which has turned out to be a very strategic use of capital.

Through the end of the third quarter investment returns on our pension plans are about 13%, and at this point I don't anticipate any more discretionary contributions this year.

Now I know all of you are anxious for 2010 guidance regarding the financial accounting or FAS and cost accounting, CAS, pension expense.

But as you know, we really won't have Fidelity on this until the books are closed at the end of the year in that the 2010 costs will be based on actual plan returns for 2009, the discount rate as of the end of the year, as well as demographic and other assumptions.

However, to help you think about trends for next year, our FAS expense sensitivities are about $35 million for every 100 basis points change above or below the 8.5% long-term expected investment rate of return.

And then $75 million for every 25 basis points change in the discount rate.

Based on what I see today, our pension position is relatively strong going into to 2010, but it is too early to quantify our net FAS/CAS pension adjustment with any degree of certainty.

At this point it does look like investment returns, relative to assumptions, will be positive.

However, the discount rate could turn out to be a major driver for 2010 FAS expense for everyone with large pension liabilities.

But again, I believe our relative position is quite good.

As you know, we have been very focused on managing our pension liabilities.

I'm especially mindful of the potential growth in required funding that may occur in future years due to the magnitude of plan losses in 2008.

Our goal in making voluntary contributions is to reduce that volatility of those future funding requirements that would otherwise be associated with our plans and to better match the reimbursement for pension costs under our contracts, over a multiyear basis to our funding requirements.

All done in a tax efficient matter while improving our cost competitiveness.

So even though the vast majority of our pension expense is recoverable through our contracts, we are striving to be as competitive as possible in an environment where the customer is becoming increasingly price sensitive.

In addition to making pension contributions, we used cash to purchase [4.

million] shares for approximately $227 million, which leaves us, as Ron mentioned, with about $280 million remaining on our current authorization.

Year-to-date we have bought about 15 million shares, and since the beginning of 2007, we reduced our shares outstanding by about 9%.

Turning to the quarter, or during the quarter, we also took advantage of favorable conditions in the corporate debt market and raised $850 million of long-term debt, and we used about $400 million of that on October 15th to retire the 8% senior notes that matured at that point.

So in summary, a good solid quarter.

One in which we continue to focus on proactively managing risks and improving performance.

Looking ahead, as you know, we will provide specific 2010 guidance on our year-end earnings call, as is our customary practice.

But I so want to make the point today that we have a substantial opportunity to create shareholder value.

Even in a constrained budget environment, where top line growth will likely slow, we have a tremendous opportunity to improve profitability principally in Shipbuilding and in parts of our Information Systems business.

Relative to our peers we should be in a good position regarding the net pension costs.

We continue to expect at that we will generate robust cash flows that should allow us to effectively manage our liabilities, fund share repurchases, increase the dividends, and invest in the business.

So, Paul, with that I think we are ready to turn it over to questions and answers.

Terrific.

Lacey, if we could go to the Q&A session, that would be great.

(Operator Instructions).

Our first question will come from the line of Sam Pearlstein with Wells Fargo.

Please proceed.

Good morning.

I guess the first question I just to confirm -- you didn't mention anything about revenue or cash flow guidance for this year.

I want to make sure nothing has changed on that front.

Sam, on cash flow, nothing has changed.

As I said, I think we are on track for that.

In terms of revenue at this point I would probably be looking maybe at 34.9 versus 34.5.

And in terms of how that might be reflected in the segments, I would think Aerospace at this point is on the top end of the range, maybe even $100 million better.

Electronics is probably mid range in terms of the guidance.

The Information Systems is probably on the low end.

Shipbuilding is probably on the high end, maybe even a little better, and Technical Service I would say is in the mid range.

Okay.

Can you just talk specifically about Electronics Systems?

Just if I look at Q2 to Q3, you had a sequential down tick in terms of sales and pretty, I guess big change in terms of margin.

Is that some benefits you had in Q2, or is there something else in terms of mix in Q3?

In terms of sales, it really is just the timing of contracts and revenue recognition.

As you might remember, in Electronics, that is the part of our business that has the majority of -- a large percentage of contracts accounted for on a units of delivery basis.

We traditionally find in the third quarter, lower deliveries in that business.

So that is one of the revenue impacts.

In terms of margins, it really comes down to individual programs.

As Wes mentioned, we did -- as our normal practice look at EACs on a number of our major programs.

We did have one program that had some cost growth.

So we have also decided to add some additional time to the implementation systems for the systems, so we reflected that in our cost assumption, and adjusted earnings on that.

Now, I think that part of those costs should be recovered from our customer, but since we are on the very front end of those kind of conversations, we reflected the costs in our assumptions, but we haven't reflected any recovery in our EAC assumptions.

How big was that cost?

We don't really talk about individual programs, but essentially as we said in the press release, again, on a year-over-year basis, the largest change in Electronics was the royalty payment -- one-time royalty payment that we had last year.

When you adjust for that you had 11.7% margins versus 12.4% last year.

Not really that significant, I think in an overall margin trend.

We are continuing to support the (inaudible) the projection for electronics for the year for the mid to high 12%.

On a year-to-date basis, in terms of earnings this year versus last year, the margin rate in Electronics began adjusting for the one-time royalties that were in last year is exactly right on top of each other at 12.4%.

Okay.

Thank you.

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

Please proceed.

Good morning.

Doug, how are you?

Good.

I am interested in Shipbuilding.

My understanding has been in the Gulf, that you are basically adding to the management team, you have been bringing people over from [Newport News] and also putting operational metrics in place that perhaps are more rigorous than were there before.

Could you talk about how that process is proceeding, where you stand now, and when you think you will be where you want to be in terms of having that organization, and the management processes all set?

Yes.

Doug, it's Wes.

Let me just take you through that a little bit.

And if you reflect back on some of my comments from the last quarterly call, I would say things are on track relative to what I delineated then.

But if you kind of turn clock back a little bit, it was the beginning of last year, the beginning of 2008, we announced that we were going to be integrating the two previously separate Shipbuilding business into our new Shipbuilding sector with Mike Petters as our Sector President.

Mike and his team went through a very thorough organizational process last year, during the year of 2008, to identify the right structure, organizational structure, and then the right people to populate that structure.

It did include moving select individuals from Newport News down to the Gulf to take some of the key positions.

It also included identifying many of the very, very capable leaders we already in the Gulf for important positions in the new organizational structure.

We largely went through that process last year.

And at the end of the year, if you look back on the senior leadership positions, about three-quarters of the senior leaders were in different roles.

So that was really our focus last year, making sure we had the right people, in the right roles, and we continue of course, as in any business, to continue to fine tune that.

But I feel good about the leadership profile in the Gulf Coast operations.

Getting that leadership team in place was critical, because as we have worked to define and now implement the new operating system, with what you mentioned, the metrics, but as, or perhaps more importantly a different focus on how we are actually managing the progress in construction.

We wanted ownership.

We didn't want this just to be something that was invented at some senior level and then new folks brought in to try and figure out if they could implement it.

Instead we used the team we had worked to establish last year, to together, build, design and build this operating system and really begin, I would say the aggressive implementation of that operating system over the course of this year.

As we did that, it reflected in changing the profiles for how we were getting ships done.

We talked a little bit about that last quarter and those changes rippled through the schedules and costs and showed up in our earnings in the first two quarters.

That operating system -- and I went through it in some detail on the call last quarter in terms of the work we are doing with phased implementation plans, where we are breaking things down into finer gated decision boxes for each of the ships.

It is taking hold and I would say even though we are very early in the implementation of a very substantial change to the way we are driving operations, so far, the results indicate that it is doing what we intended.

The nice thing, the better thing I would say, about this approach to running the business there is it really gives us earlier visibility of costs and schedule variations.

And that gives us time to get out in front of those things, when inevitable execution issues rise.

I think probably the most important thing is the rigid adherence to this build sequence we have defined in the Gulf really drives problem resolution to the left in the process, instead of letting things slip to the right and then aggregate and become bigger problems downstream.

We are also adhering to the class build plans that I talked a little about last quarter.

We are beginning to seeing that they really should drive substantial benefits in zero production.

So I would give us the grade of in process right now.

It -- as I indicated -- as we have been indicating, now for some time, we need to get some run time on this operating system.

We need to iron out the bugs, that inevitably arise as you better connect the planning process with the program execution process, with the labor management process, all of those different processes operating together in a system.

Takes a little bit of time to [ring] that out and it is my expectation, as we get into the early part of next year, we will be able to really give you some indication of the stability of what we have been able to accomplish with the operating system.

So that might be more of an answer than you wanted, but I thought it was important to take you through it since we are doing a lot of work down there.

No, that is helpful.

As a follow up, on the State of Virginia, you talked about going to June 30th, 2010 now as the target for this transition date.

Let's say that happens.

Will you be able to basically work through that point, go into operation and feel that you are not going have to take a charge given that you have essentially added a year to the entire development period for this?

Jim, do you want to --

Yes, let me -- Doug, let me walk through [VETA] a little bit.

And as you know, these large IT outsourcing programs, such as VETA, are essentially characterized by two types of risks.

The first is the cost of transition from the old legacy computing environment to the new environment, and then once you have completed that transition, it is the future revenue stream and the cost to provide that future revenue stream.

At this point in time, the costs associated with transition are being deferred and then amortized against both current and future revenue streams.

So, at this point, as Wes said in his comments, we are about 80% complete with the transition, so a big part of it is behind us.

We do have some agencies to complete that will take us into mid next year.

But we have made substantial progress on the transition.

We have been working diligently not only to complete the transition, but also to drive down the cost of providing the services that we perform currently as well as in the future.

We've made good progress on both of those, and for certain, we do have to complete the transition, but at this point, from my perspective I see the largest variable in this equation to be the future net revenue stream particularly in a budget-constrained economic environment as we are now experiencing.

The key will be whether that future net revenue stream is sufficient to fully offset the unamortized transition costs, which frankly at this point, I think is probably at the high point.

Clearly, we have more costs to incur on transition, but we will also have some amortization.

So I am really looking at this point being the high water mark in terms of those unamortized costs.

And so the key will, as I said, be that future revenue stream and whether it is sufficient to allow us to recover those unamortized costs.

And if it is not, we could have some impairment of that unamortized costs, but it is -- the good news, if you will, is that it is a non-cash item at that point.

But you won't have much visibility into that it sounds like, until you get well into next year.

We clearly have a future revenue projection and a cost projection.

It's based on what we see as the requirements, and the need based on the two years we have been already providing services, but I think any of us in our own businesses only have to look at what happens to the appetite for IT services over time.

They tend to grow as opposed to shrink.

So the key will be, as I said, that future revenue stream in total over the remaining seven or eight years of the program.

Okay.

At this point, we feel pretty good about our forecast for future revenues and future costs, but it is, as I said, a variable.

Okay.

Great.

Thank you.

Your next question will come from the line of Myles Walton with Oppenheimer & Company.

Hello, Myles.

Thanks.

Good morning, and Ron, it has been a pleasure working with you over the last couple of -- few years, five years now.

Wes, you are getting handed the keys just as the spending cycle is running out of gas and there's a few ways you can manage this business in a constrained or maybe even declining revenue environment out in the future.

I'm curious.

As you look out, do you anticipate shifting the Company in terms of the way you'll manage Northrop, whether that's through acquisition divestiture strategy, overall capital deployment, or your thoughts if there will be a change and where on the margin you anticipate that happening?

Yes.

Thanks, Myles.

When we looked at the environment, clearly, at a national level there are different pressures today than there have been over the last few years.

On the flip side of that, we all know national security spending is more responsive to what's going on in the world around us than it necessarily is to individual annual budget cycles.

So we continue to see a lot of issues in a broad sense, when you think about global security, that the nation is simply going to have to address.

We have architected this Company, to be in an absolutely stellar position, I believe, to address that global security challenges, and more simply need to navigate our way through the budget issues over the next few years as we continue to expand our way of thinking about addressing those global security challenges.

This is a great Company.

It has a tremendous set of capabilities, and I give, of course, Ron, enormous amount of credit for what he has done in assembling the capability that we have today.

So I am excited about the future, and now is not the time I would choose to go into lots of thoughts about all of the things that might be on our mind for the future.

But I would say that we believe we are incredibly well positioned, and it is really up to us to take advantage of what we have in the Corporation to fully address the emerging environment we see in front of us.

Jim, I guess on the 2010 outlook, I know you don't want to talk too much about it.

But given the moving parts of the portfolio, would you expect sales growth in 2010 to be above or below what you are seeing in 2009?

Miles, I am going to wait until January as is our traditional plan on guidance.

We will just leave it at that.

Okay.

I tried.

(Laughter).

Thanks, Myles.

Your next question will come from the line of [George Shapiro] with [Access 342].

Please Proceed.

Hello, George.

Hey.

How are you doing, Jim?

Good.

Lots of luck to you, Ron after all of these years and good luck to you, Wes.

Thank you, George.

Thanks, George.

In Shipbuilding, you said that you might be a little bit above the high end, but the reality is even if you did 59 you would see a substantial drop in Shipbuilding revenues in the fourth quarter.

And usually the fourth quarter is your strongest revenue quarter.

Can you kind of explain what is going on there, or are you really going to be very conservative in terms of what sales are going to be?

George, the variables always in these big contracts, is the cost input at the end of the year.

As you know, we use percentage of completion, it is based on costs, and so how much costs are you going to get from various suppliers is a key in determining your revenue forecast.

So that's the big variable at this point in time.

It is -- we have a good handle obviously on how much labor we are think we are going to expend, but the variable is always that cost input from the supply community, and it is -- I wish it were easier to forecast than it is.

But, Jim, if you go back to like the last three or four years, the fourth quarter revenues have been traditionally the highest of the year.

So I was just wondering what -- in the mix of business might be substantially different this year that would cause this year's fourth quarter to be a lot less than the highest of the year.

It really is just that that cost input, that as I said it occurs in the quarter, and when I look at the fourth quarter, you are right.

This quarter is above that forecast, but the fourth quarter, for example, is above the first quarter.

So there are quarterly variations in the revenue dependent upon that cost input variability that goes with the various programs.

Okay.

And then, one quick follow up, have you seen any difference in terms of the F-35 sales projection that you are looking at over the next several years?

No, not, not from what we can see at this point, George.

Okay.

We make our own assessments of that in our long-range planning, and we obviously take into account what we believe are the budget plans and, also frankly, the realities we have seen over the years of the inevitable changes in the production quantities and what have you.

But we are not seeing any changes from our planning standpoint.

Okay.

Thanks very much.

Thank you, George.

Our next question will come from Joe Campbell with Barclays Capital.

Please proceed.

Hey, Joe.

Good morning, and I would like to echo everybody else's sentiments.

Ron we are going miss you.

Good luck in whatever you choose to do, and Wes, I don't know about an MIT guy running a California company, but best of luck.

Well, I can thank you, Joe.

He may not.

I have a kind of bean counter question about cost accounting standard outlook.

I know the FAS is pretty volatile with all these discount rates and lots of variables, but what is the outlook for the way the ability to build the Pentagon is going to go under the cost accounting standard, and if you have any update on what it is that the Government is doing under the PPA mandated harmonization of CAS and FAS, that would be great as well.

Okay.

Good questions, Joe.

The -- on CAS harmonization -- let me back up.

First of all, PPA is a funding mechanism which really drives how much we have to fund into our plans.

It has nothing to do with FAS or CAS.

Except that there's the PPA mandates, the cost accounting board to harmonize the PPA minimums in CAS.

So what's -- we have essentially, as I said, three requirements or three regulations, FAS, CAS, and funding.

You are correct, that there is a move under foot to try to harmonize CAS to PPA.

It is unclear exactly what that will mean.

I don't expect that it will mean they will be exactly the same.

We, industry, saw a draft of CAS, proposed CAS harmonization about a year ago.

We made some comments to that and we haven't seen anything since then.

So at this point we, as I said, we saw a draft a year ago.

That draft, as I said, partly closes the gap between what PPA would require you to fund, and what you are reimbursed under your contracts for under cost accounting standards, but it does not entirely close the funding or the difference in funding in CAS.

Exactly where it will end up is kind of anyone's guess at this point in time until we again see the next version of the proposed regulations.

I do think it is fair to say, George, or Joe, that the CAS harmonization should result in an acceleration of the recovery of costs under the cost accounting rules, but again, I don't expect it will be fully on top of the funding requirements.

Okay.

What about what's going to happen to CAS in say, 2010, 2011, 2012.

A lot of variables but I think probably the best way to talk about it is to hold all of the variables constant.

So if I hold investment returns at 8.5% to discount rate constant, all the other assumption, essentially I will talk about what I see for FAS, for CAS, for the net FAS/CAS difference, and then for funding.

Okay.

If I look at 2010 and 2011 for example I would expect that FAS expense stays relatively constant, some fluctuation, around an $850 million number essentially where we are for 2009.

But with some fluctuation around that, maybe $20 million type number.

The net number, the net FAS/CAS number I think in 2010, under that set of assumptions, improves maybe $50 million.

And improves more in 2011, significantly more, and that is without a cash harmonization assumption.

When I look at my funding going forward, under that set of assumptions, I am fairly confident that my recoveries under CAS would exceed all of my required funding amounts for 2010 and 2011, and if I chose to do voluntary contributions, let's say at the same combined level as I did in 2009, I still ought to be somewhat cash positive from total recoveries versus total funding.

So that's kind of how I see that landscape at this point in time but as I said in my prepared comments, there's a whole lot of variables at this point in time, and I only have to point to last year, at these calls last year, where some of us in the industry were projecting kind of a 7.5% discount rate, and we got the year-end and it was back down in the low 6%s.

So there can be a lot of variability between now and the end of the year, frankly both in discount rates, and potentially in investment returns although we've had a good market so far this year.

It sounds like under most circumstances, your CAS is going be big enough so you will recover everything you have to put in.

And CAS is rising.

So, whatever, when FAS feels like it is staying the same, it could also rise.

But in any event, whatever pension short falls they are, it feels like in your case at least the Government will be providing, sounds like all of the funding and on an improving and accelerated basis, without harmonization, and with harmonization it would be even better.

I think that is a fair [similar].

For today's assumption.

Yes, for today's assumption.

Yes.

Well, I know you can't know what the discount rate's going to be.

So, terrific.

Thanks very much.

Good luck to everybody.

Thank you, Joe.

Our next question will come from the line of Howard Rubel with Jefferies.

Please proceed.

Hi, how are you doing, Howard?

Yes.

Good afternoon, gentlemen.

You've been pretty straightforward with your share repurchase program, and you continue to have a fairly conservative balance sheet.

Is there an effort here to change the debt to capital ratio now that you have completed some of your near-term funding requirements on the debt side?

I don't think so, Howard.

We're continuing to manage balance cash deployment.

What you see is what you get, and these days it is not a terrible thing to be a little conservative.

I appreciate that, Ron.

And then just to follow up a little bit on the conservative side.

It appears two of the more highlightable contracts that have now been put into the marketplace, the LCS rebid, and the tanker both have fixed price elements to it.

Could you explain how you are going to run the business or operate it so that the risk isn't unmanageable?

Let me take a first cut, and probably more important here, what Wes has to say.

But LCS, we aren't directly playing in that at the moment.

Tanker obviously on that one, we have a competition underway, we have an RFP in hand, we are evaluating the draft RFP, which has certain conditions in it.

And we are in the process of having our discussions with the government.

It would be premature for us to say much about that.

I will say overall though, as we look going forward, we have to be extraordinarily mindful of the risk reward for all contract bids, and if we see conditions and terms that don't make a lot of sense for us, on some future opportunities, we will look at those very carefully before we would actually bid them.

Or we bid them on conditions we thought would be sensible for our shareholders.

I think that's the way we are approaching it, and frankly, I can't speak for the whole industry but I am certain that other folks have similar views.

Howard, it is Wes.

The thing I would add and just amplify really what Ron was saying.

We certainly intend to be very disciplined and our approach to this marketplace -- all of us have lived through the other side of this experience on fixed price contracting and so -- some major investments were made, and we hope to learn from those investments, if you will.

What I would also though say and I think it is an important part of the thought process here and as we work to engage with our Government customer, and I think there is a good understanding or an emerging understanding that fixed price doesn't really bound or appropriately manage risk for the Government in all cases particularly when you are talking about the development side of things.

When they ask the contractors to fix our pricing and there is a reasonable expectation of volatility requirements or of funding profile or other types of external input beyond what the contractor can control.

The contractor has to price that risk, and he has to price the risk in a more conservative way than the Government should be able to price that risk by managing the risk appropriately on their side.

So my outlook is that to the extent that we see the inappropriate use of fixed price activities like in development, where there is real true development to be done, the Government is going to find itself actually paying more to get things done.

Because, I believe as an industry, not just Northrop Grumman, I think as an industry, we are generally much more disciplined about our approach to pricing risks today than the industry may have been a decade or so ago.

And so I think -- hopefully we will be able to engender the discussion with our customers that really reflects that reality of how risk has to be priced.

If they try and put it all the way over on the shoulders of the contractors, who really don't control the majority of the sources of volatility.

And again, Howard, I think this differentiating of fixed price development is a different animal than fixed price production for something the Government we know exactly how to build.

Again fixed price production contracting has often turned out to be a win-win.

And is usually a win-win particularly with multiyear funding and we have been pleased with many of our multiyear fixed price production contracts.

They give us better margins, better predictability.

It's the development that is more problematic.

Ron, like F-18 is a great example on one on that end.

But I just am concerned that the Government doesn't understand that you don't repeal the law of physics by [insisting on it.] The two of you should know that better than anybody.

You run experiments until you show yourself that it doesn't work.

You said it well, Howard.

All right.

Thank you.

Thank you.

Next will come from the line of Cai von Rumohr with Cohen & Company.

Please proceed.

Yes, let me share the nice comments for Ron.

Thanks, Cai.

Jim, a question.

You gave us the sensitivity to cash to the P&L, but what is the sensitivity to the pension benefit obligation of a 25 [bip] swing approximately?

Cai, as I remember a 25 bips swing on the obligation side, on the discount rate is $700 million.

Okay.

Which would say, even if the discount rate is down 50 bips lower, it would look like your total pension benefit under funding at the end of the year, given a good performance, should be comparable to what you had going into the year, more or less.

Might be better if the discount rate is a little closer.

Is that a fair guess?

I would say today, being 930 with no change in assumptions, and then the actual performance, we essentially cut in half the underfunded situation in the plan at that point in time.

Now if discount rates move by 25 basis points, as you suggested, that affects that funded amount by roughly $700 million for every 7 -- 700 million for every 25 basis points.

But I think, as I said, given the performance in the plan as well as our funding situation this year, at the beginning of the year we had roughly $3.6 billion unfunded situations.

And at the end of September, it is probably a little bit under $2 billion.

So really good progress both from a contribution side as well as an earnings side.

To my point in terms of forgetting exactly when you are required to put the money in via (inaudible) or your harmonization, you are going to be in relative -- if you hit your 8.5%, you probably don't have to continue to fund at the level you did in 2009.

It looks like --

My required contributions are under the scenario that I talked about with Joe, 8.5% no change in discount rates.

My required contributions next year at this point are probably $100 million.

Right.

But forgetting you are required, if we think out over 4 to 5 years, your underfunding situation is really not that bad because at some point, I think, everyone expects the discount rate to move up.

So, it is not like you have a great big monster there.

Right.

I agree with you, and as you know, in our investor conference we had a chart in our presentation which essentially showed that our funded situation was the best of our major peers.

I think we have only added to that situation as we have gone through the year.

Terrific.

Thanks so much.

All right.

Thanks, Cai.

And our next question will come from the line of Robert Spingarn with Credit Suisse.

Please proceed.

Hello, Rob.

Hi, guys.

Ron, let me echo the comments.

Congrats on your retirement.

Thanks, Robert.

A couple of things.

Jim, you talked about segment guidance from a revenue perspective, and I think Wes talked about Electronic Systems.

Anything else you can add for us going to the final quarter, from a margin perspective along the segments?

Yes, Rob.

The best way for me to think about segment operating margins at this point is I am nine months into the year, I look at my nine month rate, and I think my year end rates are going be kind of 10 or 20 basis points around where I am at for nine months.

I think Aerospace has opportunity to do a little bit better.

I think Electronics as well.

Ships I'm expecting the 5% margin, but essentially from an individual segment, I look largely at where I am at today and then I am going to have a little fluctuation around that for each of the segments.

Okay.

More specifically a couple of things.

First of all on the KC-10 sustainment, no one has protested that at this point?

Right now we are not aware of any protest.

There was one other competitor.

We will wait and see as the period expires and deal with that when it comes.

Okay.

And then with the two satellite you delivered in the quarter, the STSS satellites you talked about earlier.

Does that present any kind of revenue headwind into next year in Aerospace?

Actually, this year was a fairly low burn rate on those satellites primarily because it was primarily ramping up for delivery and time spent at the launch site.

So no, we really don't see that as a headwind for us.

Then just the last thing on the Shipbuilding side, there has been talk about the submarine program and some issues there on the wells and so forth.

Where does that stand and are there any forward issues?

We really don't see those as forward issues for us.

I give a lot of credit to the team at Newport News, whenever there's any kind of quality issue, they jump on it very aggressively and very transparently, very open engagement with the customer.

We are making very good progress on repairing the issues that you have seen reported that have been found.

You don't see that impairing our ability to meet our delivery commitments, and more importantly, I think we feel the customer is pleased with the aggressive approach we are taking to both identify and resolve the issues, as well as our approach to continuous improvement to make sure our processes preclude future occurrence of similar issues.

So I see us making good progress there.

Okay.

One last one, Wes or Ron, is there anything coming up in the next quarter or two from an award perspective you would want us to focus on?

We did mention in my initial remarks the CANES, the OCX, are two examples of that.

Anything involving aerial refueling tankers is obviously way out probably into the latter part of the next year.

But what is interesting is that while we don't see that many competitive awards up for grabs in the next couple of quarters, we do have a very, very robust amount of follow-on business to existing contracts, and frankly, that's very good business for us because that's business we get from performing well.

And a good portion of our backlog, as you know, probably the overall majority of it for next year is pretty much in the $71 billion we have got now.

So nothing else that I can think of off the top of my head.

If you guys have any other ones.

Lots and lots of little ones, literally thousands of individual awards, but nothing that would kind of rise to a big earth shattering opportunity.

Okay.

Well, thanks very much.

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

Please proceed.

Hi, Joe.

Thanks.

Good morning.

Hey, Joe.

Congrats to both of you guys as well, from my end.

Thank you.

That's actually my first question.

Is -- during the transition process over the next two and change months, can you give us a view into what you guys are doing differently from last month or two months ago?

How are you handling the transition and any thoughts on the sustainability or the duration of the split CEO/Chairman role?

Is this like a one year thing, is that the anticipation here, or is it undetermined?

Joe, one thing that I think is pretty evident is that we take management succession very seriously here at Northrop.

We have been involved in this for quite a number of years and the board has obviously been very much involved in this.

I would say that what you are seeing is the combination of a gradual process in which management duties have been shared and expanded.

Wes and I, as I think has been obvious to most of you, have been running this place as a team.

So I wouldn't think for the last two and a half months you are going to see a whole lot different.

Obviously, with the future commitments we are talking about and some of the future issues, Wes needs to take the lead there because he owns them.

But the official change of command will be at the end of the year.

As far as the split Chairman/CEO roll, the Board has always at Northrop reserved the right to make the decision that is appropriate for the Company at the time.

In this particular case, it was the Board's decision that the split roll would probably be the right way to go and that's the way we will go until the Board makes a decision to change that.

Okay.

Second question, is for Jim, just on the cash flow, just to be specific, I know you said we are still on track.

The guidance you had given before was $1.9 to $2.4 free cash flow before pension.

That's now 800.

So am I direct in saying it is after pension we are talk about $1.1 to $1.6?

Some tax effect on that, the benefit of the contributions, but yes.

Okay.

And then on the working capital use, this year, is it $400 million it looks like to date, but where do you anticipate finishing the year on that, and how much of that is VETA or any other big specific pieces?

Almost as hard as projecting the supplier cost input at the end of the year is the cash collections.

You might remember Joe, at the beginning of the year, we talked about not having the working capital performance in 2009 that we had in 2008.

I did expect that it would be negative.

I still expect that it would be negative; however, I am also mindful of our organization's zeal for going out and collecting cash at the end of the year.

It is something, as I think you know, is part of our annual incentive, and so there is a clear incentive on the part of the management team to get as much cash as we can, and so at this point in time, my -- the guidance is, the best number I have, as you said, with $400 million down on working capital to date.

My guys, our guys are going to be really incentivized to bring that number down.

I don't think we will bring it totally down to 0.

Are you seeing, Jim, any changes in the collectability of these things?

Is it getting tougher?

It just seems the working capital maybe is going in the other direction for several companies than maybe it was last year, two years, three years ago.

It is getting tougher, Joe.

That we have -- the industry as a whole has had some issues, with electronic billing and DCAA, audit of electronic billing, which has resulted in some delays in collection.

Obviously, we still collect, it is just how soon.

The industry is dealing with that situation right now.

It is just a drag, has been a drag this year, on collections.

Okay.

Going forward you don't really have a sense of whether that's going into 2010 yet, is my guess?

We collectively -- the industry has an issue there has been a change in approach by the DCAA on electronic billing and we are trying to resolve it, but it is not resolved yet.

Okay.

Thank you, guys.

Congrats get, Ron.

Thanks, Joe.

Our next question will come from the line of Robert Stallard with Macquarie.

Please proceed.

Rob, this has to be our last question.

Thank you.

I'll keep it quick.

Jim, on Shipbuilding you had commented three months ago that -- you said there was a risk of further operating charges.

You haven't mentioned that today.

Has this situation changed any, is it now a lower risk of having to take further [accumulative capture of] adjustments there?

I would say, as Wes said, we are in the middle of this transitioning to the new way of managing the business, the metrics, we are in the midst of that.

I don't think I would say it is anymore or any less.

Okay.

Best of luck in the future, Ron.

Okay, thank you, Rob.

Ladies and gentlemen, This concludes our question and answer portion for today.

I would now like to turn call back over to Mr.

Wes Bush for any closing remarks.

Thank you, Lacey.

Before we wrap up the call, I want to thank you all for joining us on Ron's last conference call.

I know I speak for everyone at Northrop Grumman when I thank Ron for his leadership during an absolutely critical period of integration and growth for our Company.

Now on a personal note, I will tell you it is hard to express how much I have sincerely appreciated Ron's trust and his guidance.

I know many of our employees are listening in on today's call, and I certainly know I speak for all of them, in wishing Ron the very best.

So thank you, Ron.

And thanks everybody for joining our call today.

Thank you for your participation in today's conference.

This concludes your presentation.

You may now disconnect.

Good day, everyone.