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Northrop Grumman Corporation (NYSE:NOC)

Q1 2010 Earnings Call

April 28, 2010; 10:30am ET

Executives

Wes Bush - Chief Executive Officer & President

Jim Palmer - Chief Financial Officer

Paul Gregory - Vice President of Investor Relations

Analysts

Robert Spingarn - Credit Suisse

Doug Harned - Sanford Bernstein

Sam Pearlstein - Wells Fargo Security

David Strauss - UBS

Howard Rubel - Jefferies & Company.

Heidi Wood - Morgan Stanley

Cai von Rumohr - Cowen & Company

Joseph Nadol - JPMorgan

Robert Stallard - Macquarie

George Shapiro - Access 342

Noah Poponak - Goldman Sachs

Troy Lahr - Stifel Nicolaus & Co.

Operator

Good day ladies and gentleman and welcome to the Northrop Grumman first quarter earnings conference call. My name is Michael and I will be your coordinator for today. At this time all participants are in 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 conference Mr. Paul Gregory, Vice President of Investor Relations; please proceed sir.

Paul Gregory

Very good, thank you Michael. Good morning everyone and welcome to the Northrop Grumman first quarter 2010 conference call. We’ve provided supplemental information in the form of a PowerPoint presentation that you can access at www.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 Security 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 today’s call we will discuss first quarter results and our guidance for 2010. We will refer to non-GAAP measures, which are defined and reconciled in our earnings release. I also want to point out that results for all periods reported reflect the tax divestiture, which was completed in December of 2009. On the income statement task sales, operating income, and the net gain on sale are accounted for a discontinued operations for the first quarter of 2009 and for all periods presented.

On the call today, are our CEO and President Wes Bush; and Chief Financial Officer Jim Palmer. With that, I think we are ready to go to slide three and at this point I would like to turn the call over to Wes.

Wesley Bush

Thank you, Paul. Good morning everyone and thanks for joining us. This morning we will discuss our first quarter results, operational highlights and Northrop Grumman’s outlook for 2010.

Overall we are pleased with the quarter; EPS grew 37% to $1.51 of higher sales, higher operating income and lower shares outstanding. We now expect 2010 earnings from continuing operations of $5.75 to $6 per share, due to operational improvements. Cash flow for the quarter was impacted by some timing issues, but as we look at the year, we are comfortable that we will meet our cash guidance.

During the quarter we repurchased $8.3 million shares of our stock for approximately $500 million, and approximately $440 million remains on our current authorization. Combined with last year’s fourth quarter repurchases of 8.4 million shares, we have now essentially offset the task divestitures impact to 2010 earnings per share. As a result we expect share repurchases to moderate from the phase of the last two quarters.

First quarter new business awards totaled $6.9 billion, bringing total backlog to $67.5 billion or approximately two years of sales. The decline from year-end is almost entirely due to a $1.4 billion decline in ship building backlog, where order flow is more lumpy due to the size and duration of contract awards.

Looking ahead, we have many exciting new business opportunities. At the company level E-Mars is a key competitive ISR opportunity to develop under aerial common center requirements. Northrop Grumman can bring an unparalleled set of capabilities to this pursuit from across our sectors and E-Mars announcement is expected sometime in the fall.

For aerospace in the unmanned domain we are pursuing several major new programs including UCLASS. This is a multibillion dollar Navy opportunity that builds in our UCLASS work and leverages our industry leading unmanned technology.

We are also pursuing NATO AGS, a $2 billion program to deploy Global Hawk’s for NATO and other promising international targets. We continue to make good progress on BAMS, our Global Hawk derivative for the Navy. This program is currently in development, and the Navy has plans to procure multiple systems in the future, and this represents a terrific opportunity for us down the road when the program goes into production.

On the manned side, we have major international opportunities on advanced Hawk Eye and the FA18. In space we have opportunities for additional Advanced EHF payload builds and upgrade and we are pursuing the precision tracking space system, which builds on the recently launched STSS missile-tracking program.

We continue to be excited about our broad array of differentiation sensor products and electronics, such as VADER, our Vehicle and Dismount Exploitation Radar, which is capable or tracking vehicles and foot traffic over a wide area, and SABR our Scalable Agile Beam Radar, which will provide state-of-the art radar performance for the F16.

Our information systems sector continues to pursue a robust set of target, including the joint space operations center mission systems, which we expect to be awarded later this year. We are also excited about being BAEs teammate on the Ground Combat Vehicle, which over the long term could be a major program for the company.

In shipbuilding, we are working with the Navy on follow on awards of the DDG, LPD and LHA classes. Finally technical services also has a number of new opportunities primary in the logistics and maintenance area including longer term opportunities like the C21, and C9, CLS programs. So although we expect top line budgets to remain under pressure in the coming years, we continue to address a very robust new business pipeline.

Now I’d like to touch on a few of the operating highlights. As I said on our last call, our number one priority is to achieve sustainable operating performance improvement. Our sector results this quarter supported chief and of our performance objectives for the year.

Aerospace systems had a strong quarter in which they expanded their operating margin rate to 11%. We continue to see growth in our manned and unmanned programs as development programs like Global Hawk and advanced Hawkeye move into production, complementing strong performance and legacy programs such as the FA18 and B2.

During the quarter we continue to build on our base of franchise programs with new business awards for advanced Hawkeye, Global Hawk, Restricted Work, ICBM, Joint STARS and the FA18 program. Our industry leading unmanned systems continue to deliver mission enameling capabilities to our customers.

Global Hawk is providing unparalleled and theatre service. It also recently demonstrated its utility in civil mission with an AgroScience flights for NASA and in supportive earthquake relief efforts in Haiti, and Fire Scout deployed aboard the USS McInerney successfully supported its first drug interdiction mission.

Electronic systems also had solid results for the quarter, with a 12% operating margin rate. The lower margin rate this quarter principally reflects lower performance on a flat sequencing system program, which resulted from higher integration, test and deployment cost.

We expect ES will meet our guidance of a mid-to-high 12% margin rate for the year despite the slow start in the first quarter. Operational highlights for the included a $143 million order for more than 500 Lightweight Laser Designator Rangefinders for the army. To-date more than 1300 of these systems had been delivered and fielded in Iraq and Afghanistan.

We delivered our 500 Directional Infrared Countermeasures, aircraft self-protection systems and our STARTLite program completed all of its testing. STARTLite is a lightweight multifunction radar that can support a variety of manned and unmanned platforms for tactical reconnaissance surveillance and target detection, and shortly after the end of the first quarter our F-35 radar successfully flew its first mission systems flight.

Information system sales were slightly lower than last year primarily due to the plan decline in Civil Systems volume related to lower state and local government volume. We view improving performance in IS as one of our best opportunities, so we are particularly pleased with the 8.9% margin rate for the quarter.

We continue to move along a path of sustainable performance improvement at IS. We had important positive developments this quarter on our VADER program. The Common Wealth of Virginia announced a comprehensive set of changes to the VADER contract. We believe the new agreement is an important forward in both parties. Upon completion of its review period in late June, the modified agreement will significantly improve the clarity of program scope and performance expectations.

Another positive was the 7% increase in IS new business awards. We were one of two contractors selected for the development phase of the Navy’s consolidated afloat networks and enterprise services program or CANES. This will lead to a down select of the contract to improve interoperability and affordability at shipyard networks systems across the fleet.

We also continue to capture restricted business in our intelligence division, and defense systems was awarded additional work for our battle field air borne communications node or BACN, which is providing in theatre war fighters with critical real time battle field information.

For shipbuilding, first quarter sales increased 25%, which reflects to the extra working days this year, and revenue step backs in last years first quarter. We continue to focus on improving performance in the gulf and our 6.2% margin rate this quarter reflects that progress. The four LPD ships in the gulf remain our biggest challenge going forward.

As we said last quarter our improved operating system provides enhanced visibility that a name was asked to continually assess performance. Last week we redelivered the USS Enterprise to the Navy. The recent redeliveries of the enterprise, the Karl Vincent, and George H. W. Bush will result in lower carrier volume going forward and will contribute to more ratable ship building sales for the balance of the year.

Technical services had a very strong quarter with margin rate expansion is at 6.4%. This reflects our strategy of focusing on higher margin opportunities, especially in the life cycle optimization and engineering business area.

In summary, we are refining our sales estimate for the year to approximately $34.5 billion and raising our EPS guidance to reflect this quarters strong operational performance. The new range is $5.75 to $6 per share. Our focus for the reminder of the year and our number one priority across the entire organization will continue to be achieving sustainable performance improvement.

Improving performance and disciplined cash deployment intend to be Northrop Grumman’s greatest share holder value drivers. As a management team we are firmly committed to realizing positive performance improvements in all of our businesses, and we demonstrated some of that improvement with our first quarter results.

So now I’d like to turn the call over to Jim for a more detailed discussion of our quarter and our 2010 outlook.

James Palmer

Thanks Wes, and good morning ladies and gentleman. During my comments this morning I’ll give you my perspective on the quarter, the sector results and our guidance for the sectors, as well as cash flow performance and guidance for the year.

As Wes said, it was a good solid quarter, and a good start for the year. EPS growth was 37%, with sales operating improvement and a lower share count being the biggest growth drivers. Due largely to cost caps implemented in 2006, we do not have a charge related to the recent legislative changes impacting the Medicare Part-D subsidies. You all might remember that we indicated in our 10-K that Medicare Part-D subsidies were not significant.

Let’s look at the quarter; starting with sales, a growth rate of 8.5%, which including the impact of more working days in this year’s first quarter. Excluding that impact we estimate that sales growth was consistent with our guidance for the low single digit growth rate.

Operating income increased 24% due to lower net pension expense, higher segment operating income, and lower cooperate allocated expenses. Then the third driver of EPS growth was nearly 8% reduction in our weighted average share count, as a result of our share repurchase program. So let me start with sales then again, and try to put it into a little bit of perspective sue to the additional working days.

Depending on the sector of the impacts, and impacts like the snow on the East Coast that we saw in the first quarter, the additional days ranged anywhere from two to five days, and obviously the impact was not uniform across the five sectors, but I estimated it accounted for about $400 million of this quarter’s year-over-year growth.

Then another $100 million growth reflects the first quarter 2009 step back in sales that we recorded in shipbuilding due to the negative contract adjustments on the LPD and DDG programs last year in the first quarter. So adjusting for those two items sales growth was between 2% and 3%, and as I said, consistent with our updated guidance for the year.

On an earnings per share basis, the additional working days represents about $0.08 per share. So looking ahead, the fourth quarter of 2010 will have fewer working days then last year’s fourth quarter, with the second and third quarter’s having the same number of work days as in 2009.

So, let’s spend a few minutes and talk about each of the sectors. Aerospace sales reflect the impact of the extra working days with some modest growth beyond that. For the year we continue to expect stable revenues with some variability depending on the timing of the imposed restructuring. Until that program is restructured we continue to work under our current contract with 2010 first quarter revenues for IMPOSE being comparable to last year.

Aerospace sales performance reflects the overall strength of its portfolio, especially in light of last year’s KEI termination, which represented about $60 million in sales in last years first quarter, that were not repeated this year. Solid sales results were accompanied by the strong 11% operating margin, 50 basis points better than last year, due to improved performance across a number of different programs. For the year we continue to expect a mid 10% operating margin rate, but I think we could essentially do slightly better as well.

Electronic sales grew 5%, reflecting the extra days with a 12% operating margin. The lower margin rate this quarter reflects the lower performance on our flat sequencing system program, as well as lower royalty income than in the prior year, and a small provision for work force reduction at some selected sites at ES. They recently announced a small reduction in work force to rebalance the skill mix required for the existing backlog and anticipated new awards. For the year we continue to expect ES operating margin rates in the mid-to-high 12% range.

For information systems, the additional days were not a significant benefit in the quarter, due to the snow days in the East Cost. The decline in stable revenues, which were anticipated or planned, were partially offset by about a 4% increase for our intelligence programs, where we continue to see growth opportunities.

In our defense systems division, revenue was down slightly this quarter, due to the higher volume of in-theater hardware deliveries during the first quarter of 2009. This included programs like the command force platform, trailer mounted support system, counter artillery and motors, and integrated base defense security system.

Looking forward, we continue to see good demand in our core chief ISR areas and intelligence, particularly in a number of restricted areas. We do see some pressure on IS sales for the year, but we are also increasing our margin rate guidance for information systems to the mid 8% from lower to mid 8%.

Shipbuilding sales increased 25%. This increase needs to be good in context in terms of what I expect for the balance of the year. $346 million sales growth for the quarter was driven by several factors. First the additional days accounted for about $115 million of growth. Secondly, last quarter’s first quarter sales were reduced by about $100 million step back in revenues for the LPD, DDG, EAC adjustments, and thirdly we experienced some cost growth in LPDs this quarter as we work towards ensuring that we are producing and delivering quality ships.

Looking ahead, shipbuilding sales will be more ratable for the rest of the year due to the redelivery of the enterprise, which contributed about $55 million of revenues in the first quarter that obviously won’t continue for the balance of the year. As Wes said, we expect shipbuilding sales will be approximately $6.2 billion for the year, and are comparable to the 2009 sales level, with margin rate between 5% and 6%.

Technical services had a 21% sales growth and their operating income increased 32% to 6.4%. First quarter sales benefited from the additional days and included higher volume for existing programs like the Counter Narco-Terrorism program, as well as new programs like KC-10 and C-20, which were competitive captures in 2009.

Higher operating income and higher operating rate reflect the volume increases, as well as the more favorable contract mix towards the higher margin life cycle optimization engineering programs. We continue to expect a lower-to-mid 6% margin rate, and sales could be stronger than our original guidance at 2% to 4%, depending upon IDIQ task order levels over the balance of the year.

Turning to cash for the quarter, operations used $571 million of cash and free cash flow. Outflow totaled $669 million for the quarter. As many of you know, the first quarter is typically our lowest quarter, but in addition to the seasonality issues there were several timing issues that impacted our results.

The first was a delay in information systems billings, and collections, which was related to the task divestiture. This along with a decrease in payables negatively impacted working capital by about $425 million. These were timing issues. We are already in process of recovering those issues in the second quarter.

The first quarter also included an additional payroll payment sue to the additional days in the quarter, as well as the higher federal tax payments. These two items represented about $150 million, and so when I consider each of those items, as Wes said, we are comfortable with our guidance for cash flow. We continue to expect cash flow from operations at $2.5 billion to $3 billion for the year, and free cash flow in the range of $1.7 to $2.2 billion before the discretionary pension contributions.

Also as Wes mentioned, based on first quarter results we no expect earnings per share from continuing operations to be $5.75 to $6 per share, a new increase of $0.05 for the year, driven by higher sales at shipbuilding, say potentially higher sales in aerospace systems and technical services, with higher margin rates for information systems and potentially slight increase in aerospace systems, I see as the drivers for the increase.

So I would say in summary, a good solid quarter, one that supports our improved operational outlook for the year, and demonstrates to focus that Wes talked about in driving sustainable performance improvement, and that performance improvement yielding results.

So Paul, I think with that we are ready to turn it over for question-and-answer session.

Paul Gregory

Very good. Thanks Jim. Michael I think we are ready to go Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Robert Spingarn of Credit Suisse. You may proceed.

Robert Spingarn - Credit Suisse

Good morning.

Wesley Bush

Good morning Rob.

Robert Spingarn - Credit Suisse

Wes this topic has been talked about so much, so I thought perhaps you could quickly just walk through your current position on getting back in the tankers as a subcontract, would you be interested?

Wesley Bush

No we have withdrawn completely from the tanker competition. We were I think very clear, very transparent around how we made that decision, and I think we gained to a very timely notification of the defense department, and broadly to the community of our position on tanker after the final RFP was released. So we are no longer participating in the tanker competition.

Robert Spingarn - Credit Suisse

Anyway, I guess what I am getting at is, would being the sub de-risk it enough to make sense.

Wesley Bush

No we concluded we were not interested in participating.

Robert Spingarn - Credit Suisse

Okay and then for Jim on the shipbuilding revenue flow throughout the rest of year, you just talked about why it's front ended, the extra work days so forth and the delivery of the enterprise. How should we think about the Q2 through Q4 run rate, because it sounds like Q4 will be the lowest or should they be more even than the rest of the business?

Wesley Bush

I see it as more even over the next three quarters.

Robert Spingarn – Credit Suisse

With the margins similar?

Wesley Bush

Well our guidance is 5% to 6% for the year.

Robert Spingarn – Credit Suisse

Understood. So you are going to be lower than this quarter, but will the margins be even throughout as well?

Wesley Bush

We look the margins every quarter and as I said a number of times, I look at this business as a very long-term business and so I don’t pay attention that much to the quarterly margin. I look more at the long-term margin rate.

Robert Spingarn – Credit Suisse

Okay, and then finally, how did the insurance recovery affect the factor?

Wesley Bush

Essentially, as we said we had cost growth and LPDs and then the insurance recovery was essentially a recovery of some of the cost growth that we had previously recognized on LPD. So those items taken together contributed a small or single digit type number to the quarter.

Robert Spingarn – Credit Suisse

In terms of margin and/or cash flow, how should we think about?

Wesley Bush

Positive cash flow from the insurance recovery negative from the cost growth.

Robert Spingarn – Credit Suisse

Okay. Thanks very much.

Wesley Bush

Thanks Rob.

Operator

Your next question comes from the line of Doug Harned of Sanford Bernstein. You may proceed.

Doug Harned – Sanford Bernstein

On information systems three years ago there has been a strong focus on growing the top line there, and that lead to the state and local programs that have been pretty difficult, and today when we look at the environment ahead, and I’d say it’s a little bit more challenging, and you’ve shifted away from pursuing state and local outsourcing deals, can you describe what your top line growth aspirations are for information systems; and which business area is you really see offering the most potential for growth?

Wes Bush

Thanks Doug. This is Wes, let me address that. We have been I think very clear when you referenced it that we have taken a very careful look over the last few years of state and local, just determined that that is not really a very attractive marketplace for us, given the way that we typically bring ultimate value to customers, and so we’ve been backing away from that, and as we said in your remarks, our sales and our civil systems part of IS have been on a plan to decline as a result of those decisions that we made.

At the same time, the defense business and the intelligence business had information systems, which together represent right around 75% of our total sales of IS, are strong healthy businesses, and when I went through my earlier remarks and opportunities you probably noticed that there were quite a few of the opportunities that I discussed associated with information systems.

We bring a number of what we see as truly discriminating capabilities to defense and intelligence, ranging from the work that we do in command and control, the work of course that we do ISR where we have some just absolutely permanent positions, and the work that we do in cyber security, which we see continuing to grow quite robustly.

So we are optimistic about the outlook at IS, and both intel and defense. We see sort of a little bit of a longer cycle for civil, largely driven by bringing the expertise that we have in cyber security form intel and defense, into many of our civil applications where we are beginning to see the cyber capabilities as an enabler to go after some of the more sophisticated requirements of other federal agencies.

So, we like this business. We think it’s a good business for our future, and we are looking forward to getting to the right place in our balance of the portfolio on civil, and continuing to grow the rest of the business. Let me also give a perspective of how we are thinking about that growth.

There are various layers in the information systems market. We are really focusing our attention on the layers where we can bring real value through engineering content, where we have truly differentiated offerings, and where the margin opportunities are consistent with our margin expansion objectives in the company.

So we will not be going after opportunities in this space simply because of top line revenue opportunities. We are looking very carefully at the opportunities as to whether or not they support our margin rate objectives.

Doug Harned – Sanford Bernstein

Okay, and then just switching gears for a moment. You recently described your UAV business as generating about $2 billion in revenues. What fraction of that is try to HALE systems, and when you look at other parts of your systems, you mentioned a couple in your opening remarks, how do you see growth proceeding there?

Wesley Bush

Well hour HALE systems represent the preponderance of our sales in UAV. The HALE systems are large platforms, each individually large, and they are large programs such as Global Hawk and BAMS. So naturally they do represent a substantial fraction.

As we look at the emerging requirements, we see a very healthy continuing future for HALE. The idea that you can have an asset at an altitude that affords it an enormous amount of visibility and collection capability and availability over many, many long hour of duration of focus is just a very, very useful tool for the military.

With that said, while we are really focused on growing HALE, we are also focused on some of the other applications and there is a long list I could point out, but one in particular is UCAS. The concept of having unmanned operations off of a carrier, will transform a lot of the fundamental concept of operations for force deployment, and we see that as another groundbreaking opportunity in the application of unmanned.

We have a lot of other great actions going on unmanned; whether its Fire Scout or even smaller unmanned vehicles, we continue to apply a lot of engineering and innovation to this field. We want to stay differentiated technologically and capability wise, because we see this as a business area that’s got a great future.

Doug Harned – Sanford Bernstein

Very good. Thank you.

Operator

Your next question comes from the line of Sam Pearlstein of Wells Fargo. You may proceed.

Sam Pearlstein – Wells Fargo Security

Hi, good morning. Can you talk a little bit more about Aerospace. I think you had said in the past that we should see the year fairly stable in revenue. In light of this strong growth this quarter I know that extra days were in there, and so I am just wondering as you think about the remainder of the year, is there anything that should be weakening, that would take the current margin of 11% back down to the mid nines and growth rate a little bit lower?

Wesley Bush

Sam in terms of revenues as I said in my comments, the biggest variable at this point in time is the IMPOSE program and how its going to be restructured and what work we’ve going to retain on a go forward basis.

So we continue to work with that the customers on that potential restructuring, but at this point its unknown exactly what’s going to happen there, and so I guess maybe I’m a little cautious as to what the future revenue outlook is for that program on a go forward basis. In terms of performance margin rate, absolutely wonderful quarter out of those guys this quarter. 11% margins and as I said the, guidance for the year is still to mid tens with some opportunity I think to increase margins as we go through the year, but probably too early to call at this point in time.

Sam Pearlstein – Wells Fargo Security

Okay. Can you frame in terms of how large IMPOSE was in 2009.

Wesley Bush

I think what we said in the first quarter call in January, year-end call, was that IMPOSE was kind of about $520 million kind of number for the year, and its pretty ratable over the year.

Sam Pearlstein – Wells Fargo Security

Okay. Thank you, and then actually Jim, can you just talk about some of the below the operating line numbers as we look forward to the year. Interest is certainly higher in the first quarter than I would have expected. How do you think that plays out for the year in the tax rate as well?

Jim Palmer

Interest; essentially we sold and I guess it was second quarter of last year, $850 million of debt, so that contributed to the additional interest cost of share, as well as some capitalized leases added some interest costs for the quarter.

In terms of tax rate, on a regular basis I would say the kind of the 34.5% is what I would expect on a go forward basis. We do have the potential or the resolution of the 2004 to 2006 IRS exam, which could be favorable to tax rate for the year if resolved in our favor, which frankly that’s our expectation.

Sam Pearlstein – Wells Fargo Security

Okay great. Thank you.

Operator

Your next question comes from the line of David Strauss of UBS. You may proceed.

David Strauss – UBS

Good morning.

Jim Palmer

Good morning.

David Strauss – UBS

Wes, can you talk about where you are in VITA. It looks like you complete negotiations with Virginia in the quarter. Obviously you took up the IT margin expectation for the quarter. Did resolution on VITA have anything to do with that?

Wes Bush

All right, it helped a little bit. I think the main perspective on VITA is more forward-looking in terms of where we are going on a contract. We spent a lot of time together with the VITA organization in the commonwealth, and with the administration of commonwealth, really working to get the parties together and focused on how we move the program forward as you know.

The program involves many, many different agencies across the commonwealth, and we were very pleased with the modified agreement, because we do think it brings a lot more clarity into the actual scope and the specific performance expectations, so that we get better alignment between the customer and ourselves around where we are applying the energy to get to the outcomes.

So we see it as good stuff forward, but we think the goodness of that manifests in the future as we go forward, largely in the future. So that’s the way I would characterize VITA.

David Strauss – UBS

Okay and Jim, was there any pension contribution in the quarter, and can you give us an update if there any CAS harmonization?

Jim Palmer

On pension contributions, we had our normal required contributions, and frankly I don’t recall how much that was for the quarter. We did have a voluntary contribution of $30 million related to some of our foreign pension plans. So that was the only unusual item if you want to characterize it that way in the quarter.

On CAS organization, we’re waiting just like all of you are for some indication of how and when it’s going to proceed. I really don’t have any new or more current information David.

David Strauss – UBS

Okay and timing on the $300 million that you’re looking to contribute this year to the country plan voluntarily.

Jim Palmer

Second quarter.

David Strauss – UBS

Thank you.

Operator

Your next question comes from the line of Howard Rubel of Jefferies. You may proceed.

Howard Rubel - Jefferies & Company.

Thank you very much. To return to the shipyard Wes, there is obviously a restart that’s going to proceed with the DDG 51. What are you doing to bring this ship into the yard, so that it performs -- the work just gets done a lot better and more efficiently and so on, the planning you are undertaking there?

Wes Bush

Yes Howard, thanks for asking. The DDG restart program is a really important program for our company. It represents as you know, an opportunity to continue a line of ship class that over the years we have demonstrated very, very good performance on. The last few years as we went through some of the struggles in the gulf, that performance declined, but we expect that with the new class of ships we will be able to return to the level of performance demonstrated in the past.

A big part of that is the operating system that we put in place in the gulf, that’s up and running. That’s giving us the type of transparency and the degree to end up understanding that we need to not only better plan the execution, but in real time really see how it’s going. In a shipyard that it’s managing multiple classes of ships compared to the past back in the 90s, when it really was primarily just the DDG program that it was going through. So we feel good about the progress that we’ve made operationally in being able to get that under way.

The other thing I would say though is, we are not yet under contract fully for those DDGs. So we are in a process of working through the contracting of the navy, and we are very focused on making sure that those contracts support our opportunity to perform well. So, we are looking at it both operationally and contracting to make sure that we end up in the right place.

Howard Rubel - Jefferies & Company.

Just to follow, one more item on the shipyard in general. I mean at one point, there was either skill shortages or just other things that just weren’t right. How would you characterize what you’ve done to sort of give you the confidence that when you wake up in the morning you are not going to find something bad happen.

Wes Bush

Well, I would characterize it on just about every front of the operational perspective of our shipyard involved. As you know, we integrated, we brought together the Newport News operations, the Gulf operations under common leadership of Mike Petters at the beginning of 2008. So we are more than two years into that process. By doing that, we have been able to bring a lot of things from Newport News to the gulf and quite frankly vice versa.

We have I think done a very good job under Mike’s leadership. Mike and his team’s leadership of figuring out how to best optimize where we are going, and that means looking at every single aspect. We talked a lot about the operating system and how we actually manage the flow of the work through the yard and the gulf.

Quality was another area where we just put an extraordinary focus on changing the way that we’ve addressed that opportunity. Leadership development, talent development, training of the workforce, you name it, just about every aspect of the operational capacity in the gulf, and then translating a lot that back into Newport News.

So I think while we are clearly not out of the woods, we have a margin rate that we are forecasting in ship building this year. That’s not a margin rate that we would be happy with in the long term, but it does represent a good step up over last year. We still have several programs, primarily the LPDs in the gulf that are operating at low or no margin rate, that will pull us down for awhile on our margin rate improvements curve, but I see us making the solid incremental steps forward to make the ship building business a business that is doing the right things for both our customers and for our shareholders.

Howard Rubel - Jefferies & Company.

Thank you Wes.

Wes Bush

Thanks Howard.

Operator

Your next question comes from the line of Heidi Wood of Morgan Stanley. You may proceed.

Heidi Wood - Morgan Stanley

Yes, thank you. Chairman, a question for you. Can you talk about the F-35, what kind of revenue growth that you have seen year-over-year and what kind of bookings margins that you recognizing now?

Wes Bush

Heidi, I’m not going to get into individual booking rates on the program. We did say in the fourth quarter that we adjusted our margin rates on the STD program at Aerospace to reflect our expectation for the change in award fee, and to our milestone and cost scheduled perspective. So we basically did most of that adjustment in the fourth quarter.

We continue to perform on across the company, on outlook programs as well as some small amounts still remaining on STD, principally in the information systems area on the CNI suite, but a little bit remaining on the Aerospace on the fuselage program as well. But most of our effort today on F-35 is albeit related, and revenues have an increase over 2009, but I wouldn’t characterize it as that significant at this point in time.

Heidi Wood - Morgan Stanley

Alright, thank you. Then maybe a bigger question. Wes you guys have started strong out of the gate this year with a number of bold initiatives. Can you give us some nail about you thinking about potential or further strategic initiatives or changes ahead that we might be anticipating?

Wes Bush

Well, as we go forward and we understand the environment, we are constantly looking at what it might cost strategic initiatives, but I guess Heidi I would continue to focus your attention on the performance activities that we have underway.

Given the portfolio we have, which we think is very, very well aligned with what our customers need, I think our biggest opportunity for shareholder value creation goes to performance improvement; things like margin, rate expansion, and think smart about how we declare our cash. Those are the two things that we are really focused on and driving on as the most near term opportunities for shareholder value expansion.

Now that being said, we of course are looking very carefully at our portfolio, we are looking downstream, but our media focus is on performance, and deploying our cash wisely.

Heidi Wood - Morgan Stanley

Alright, thanks a lot Wes.

Wes Bush

Thank you Heidi.

Operator

Your next question comes from the line of Cai Von Rumohr of Cowen & Company. You may proceed.

Cai von Rumohr – Cowen & Company

Yes thank you very much. On the insurance claim you mentioned a single digit net difference. How much was the claim recovery in the quarter and how much could you still recover because your Q indicates you still have some claims outstanding.

Jim Palmer

The recovery on related to Hurricane Ike, this was the last piece of what we would have expected to get. It was $17 million, and the Q essentially refers to the ongoing litigation with FM Global related to Katrina.

Cai von Rumohr – Cowen & Company

Got it, thank you. Then I noticed your cash flow indicates amortization of assets of $39 million, but the Q suggests you will do $65 million over the remainder of the year, which would suggest a big step down and then $57 million next year. Refresh my memory now, why are we seeing that. I mean are those two items correct and why are we seeing that short fall off.

Jim Palmer

I’m sure they are correct. The fall off next year is due to purchase of intangibles, some of the amortization being completed this year. Why 69 versus 39, I’d have to get it through the details. I will ask Paul to give you a call on that one.

Cai von Rumohr – Cowen And Company

Okay, terrific. Thanks so much.

Jim Palmer

Okay.

Operator

Your next question comes from the line of Jo Nadol of JPMorgan. You may proceed.

Joseph Nadol – JPMorgan

Thanks, good morning. Wes on the share purchases, you indicated that it’s going to come off after this quarter, after the past two quarters were at a higher level. If you just look at where your volume in the last couple quarters were relative to where you were before you sold cash, its about $200 million or $300 million per quarter higher, so that gets you around 500 of excess share purchase. Your proceeds are $1.1 billion. Just can you help put into context a little bit, how you are thinking about share purchase the rest of the year and what is kind of the normalized level here.

Wes Bush

Well, we have been careful never to give an exact forecast when we are in the market of how much we are buying or when we are buying. So I wouldn’t want to stare down that path.

The thing I would just point out is when we divested task, we were very clear about our intent to offset the dilution to earnings per share resulting from that divestiture, through the use of the net proceeds you pointed about $1.1 billion, to repurchase shares, so we increased our rate rather substantially there for awhile.

My comments this morning was simply intended to say we essentially achieved that offset, so we are going to go back to what we might view as a more typical level. I think that’s about all the flavor I would give to it.

We do have a fair amount left in our outstanding authorization, and we continually look at what the level of authorization should be that we seek from our board, and I think you can see from our history, we got a pretty good track record of what we call balance cash deployment in our company.

Joseph Nadol – JPMorgan

Is there any color you can provide on how you are thinking about the M&A?

Wes Bush

We are always looking. We participate in that part of the market place very actively. I would say we will continue to be very disciplined in how we look at it. Given that we are quite pleased with the portfolio we have today, I don’t feel a burning need to fill some gaping hole, but that being said, we do look if there are good value opportunities, and we will look at it even more seriously, but right now I would say that we like the way that we have been looking at cash deployment.

Joseph Nadol – JPMorgan

Okay and then just one more for you Wes. On the bookings, you were above 0.8 I guess in Q1 in terms of book-to-bill, and you read about the whole bunch of pursuits this year. I’m wondering if you can put it into context and provide what your bookings target is, or even arrange for the year, where you expect to end the year in terms of backlog?

Wes Bush

No, we typically don’t guide in terms of backlog. The one thing I would say Jo in that regard when we look at our backlog, first off we don’t report in our backlog on the unfunded side, either unexercised contract options or unfunded IDIQ orders, and as time has gone by, we are finding more and more things are getting handled through the IDIQ channel.

So if you look interestingly at our funded backlog for the quarter, which is in the release that we put out, every single one of our sectors grew their funded backlog year-over-year, and that is I think a good place for us to be. We are satisfied with where we are right now in backlog. Of course I’d like to expand it, and we are working hard to expand it. So, directionally I would say our objective is up, but I would shy away from being very quantitative with respect to an outcome for the year.

Joseph Nadol – JPMorgan

Okay, thanks.

Wes Bush

Thank you.

Operator

Your next question comes from the line of Robert Stallard of Macquarie. You may proceed.

Robert Stallard – Macquarie

Good morning.

Wes Bush

Hi Rob.

Robert Stallard – Macquarie

Just a couple of quick ship questions. First of all on LPD, you said there was some cost creep in the quarter. Is that just reality protruding out with your estimate cost to complete or is there any new issues here?

Wes Bush

I wouldn’t characterize it as new issues. As we have said, the operating systems and processes that we have put in place gives us greater visibility on a more current basis, and so every quarter we look at the performance in those and other ships and make some small adjustments, and that’s really what we saw this quarter.

Robert Stallard – Macquarie

Then on the submarine front, as you mentioned that so far, what do you think the impact will be on Northrop Grumman as the Virginia class submarine moves to two year, looking at both your revenues on your operative margin.

Wes Bush

That’s out in the 2012, ’13 timeframe Rob.

Robert Stallard – Macquarie

You’ll be getting some long lead items I would have thought and …

Wes Bush

We are getting some growth in Virginia class between now and then, when it really starts to make a difference is

Jim Palmer

And it’s a really good program. The program that’s performing very well, so we look forward to that opportunity to increase production.

Robert Stallard – Macquarie

You have at this stage not prepared to scale how big an impact that could be?

Wes Bush

No.

Robert Stallard – Macquarie

Okay.

Wes Bush

Thank you Rob.

Operator

Your next question comes from the line of George Shapiro of Access 342. You may proceed.

George Shapiro – Access 342

I wanted to ask a couple of things. The first quarter revenues you commented were about $400 million higher because of the additional days. I assume that that means the fourth quarter will be about $400 million lower.

Wes Bush

Yes, you got it.

George Shapiro – Access 342

Okay, and then normally though from the first to the fourth quarter, the revenue is anywhere from a higher by $1 billion to $1.4 billion. Would that still hold this year or it's only going to be $400 million or $800 million from the first to the fourth quarter, as opposed to being normally a $1 billion to $1.4 billion difference.

Jim Palmer

George, as I look at my crystal ball I would characterize revenue this year as much more ratable over the four quarters. So what you see in the first quarter is kind of my expectations for quarterly revenues on a go-forward basis.

George Shapiro – Access 342

Okay, and then just Jim if you could provide a little more details. You had three provisions in electron, or three comments in electronics that caused the weaker margin. Could you break out how much was like the workforce provision verses the other provision.

Jim Palmer

So the three items are the flat sequencing sewing program, it's operational issues, the lower royalty. Last year royalty income was like $4 million, and then the provision for the work force reduction, which is single digit type numbers.

The way I look at it George is, if I adjust both 2010 and 2009 for the royalty and the workforce reduction, the 80 basis point decline in margin becomes about 30 basis points. So that then says that essentially 90 basis points was due to the flat sequencing sorting program and the others were these two small items.

George Shapiro – Access 342

Okay, that’s helpful, thanks. Then just one last one; for the second quarter in a row we’ve seen lower cooperative on allocated. I mean is there something going on there or it just how it happens.

Jim Palmer

It's lumpy.

George Shapiro – Access 342

Okay, thanks a lot.

Wesley Bush

Thanks George.

Operator

Your next question comes from the like of Noah Poponak of Goldman Sachs. You may proceed.

Wesley Bush

Good morning, Noah.

Noah Poponak - Goldman Sachs

Hi, good morning guys. Back to IS, I think in your prepared remarks you said pressure on IS though the year. It's obviously lower because of TASC, but just want to clarify that you meant organically and if so can you kind of quantify that.

Jim Palmer

We didn’t change our guidance first of all for the sales in IS, but as we just look at our business, we do see good growth opportunity in intelligence and the defense business, and we expect that civil would be down. Then I look around the industry and I see other guys having concerns about the Information Systems, and so I’m factoring a little bit of that concern into the business that we still see as having growth in DSD and ISD.

So I’m just hedging a little bit based on what others are saying about there business, but on the other hand as Wes said, we see good opportunities in both the defense piece of our business and the intelligent piece of our business and the command control, C4ISR areas and obviously cyber as well.

Noah Poponak - Goldman Sachs

So you do still expect organic growth in the business for the full year.

Jim Palmer

Yes.

Noah Poponak - Goldman Sachs

A follow-up on taker; is there any reason you could potently have to take a charge for bid and proposal activity on that program at any point.

Wesley Bush

I don’t think so, not at all.

Noah Poponak - Goldman Sachs

Okay, and one last question. I think we got some more definitised OCI rules recently, and you know a company that obviously knows a lot there, I was just wondering if you can may be comment on whether or not there is anything in there that was surprising and what the impact might be to the rest of the industry that hasn’t already taken a strategic action that you guys did?

Wesley Bush

I do think it will cause the rest of the industry to talk another hard look at their OCI business. I think that the outcome that we saw out of the DOD confirmed our thinking and our divesture very strongly confirmed it.

The rule that came forward if you decompose it really had sort of three basic types of conflicts that it was worried about; cases were there where impaired objectivity. So if a contractor is giving technical advise on a procurement, and the contract also has some form of financial interest in that procurement, that conflict talked about unfair access to non-public information was kind of a broad statement around how you would look at access, and then the per category around the biased ground rules. That’s if the contract happens to be working on one contract, but you are in a position to help set the ground rules for some future acquisition that it might compete for.

These are pretty broad statements about the way that federal procurement officials need to think about OCI and interpret OCI, and our pretty well aligned with the frame work that we saw are largest customers in the TASK business using when they were alerting us last year that we will not be able to compete for the some of the business that we currently had.

So instead of standing by and watching that business dissipate we think we took a very appropriate action both for our customers, and our share holders, to diverts that business, put it in the hands of an organization that did not have these types of conflicts so that it can grow and thrive. I think with these rules it has a good opportunity to grow and thrive and looking at how its situated, relative to the businesses that remain within some of the other large contractors. So I do think it will cause others to stand back and think carefully about what they are doing.

Noah Poponak - Goldman Sachs

Now, that’s interesting. Thanks a lot, and good quarter.

Wesley Bush

Thank you very much.

Operator

Your next question comes from the line of Troy Lahr of Stifel Nicolaus. You may proceed.

Troy Lahr - Stifel Nicolaus & Co.

Thanks. I’m wondering if you guys can talk briefly about the competitive landscapes in the information systems area and technical services. Are you seeing more competitors out there as pricing pressure is starting to creep in.

Wesley Bush

I would say on information systems, there are two different answers for information systems and technical services. In information systems, we tend to participate in sort of the higher end of the market place, that’s largely engineering driven, and large-scale solutions driven.

While there is always pricing pressure in every single market that we participate in, there it is largely value determinations that we see in source selection. So, you got to support the customer’s budgets obviously, but I think the customers in those areas have a little bit broader view of value in terms of the solution that is being brought to the table, and how that satisfies their business case.

In technical services, that area has always been and I think will increasingly be much more price sensitive. We have sort of three major areas in technical services. We do a lot of base arrange in our systems support group. We do a lot of training work and of course we do a lot of operations and maintenance and logistics work in our lifecycle optimization business. All three of those have, I would say, intense price sensitivity, and I think we will continue to have that sensitivity. So, a little bit different flavor for the two different businesses.

Troy Lahr - Stifel Nicolaus & Co.

Okay and then as you ramp up on KC-10, is the profitability and is that program tracking in line with your expectations?

Wesley Bush

We are going through the ramp up phase, and we are working through what I would characterize as the typical transition issues in ramp up. We are satisfied with the trajectory that we see there, and see this as a really good program opportunity for the company.

Troy Lahr - Stifel Nicolaus & Co.

Alright, thanks guys.

Wesley Bush

Thank you.

Paul Gregory

Michael I think with that we are ready to end the call.

Wesley Bush

Yes, and so I just appreciate everyone’s interest in our call today. As we said, we think we are off to a good start for the year, a lot of work to be done. We are pleased that we could raise our EPS guidance, and look forward to discussing it with you again on our next quarter call. Thanks everyone.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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Source: Northrop Grumman Corporation Q1 2010 Earnings Call Transcript
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