UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

FORM 10-Q

 

 

 

 

 

Commission File Number 1-16411

 

 

NORTHROP GRUMMAN CORPORATION
(Exact name of registrant as specified in its charter)

 

 

 

 

1840 Century Park East, Los Angeles, California 90067
www.northropgrumman.com
(Address of principal executive offices and internet site)

 

 

(310) 553-6262
(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

As of April 20, 2007, 345,110,288 shares of common stock were outstanding.

 

 

NORTHROP GRUMMAN CORPORATION

 

Table of Contents

 

NORTHROP GRUMMAN CORPORATION

 

 

 

 

 

NORTHROP GRUMMAN CORPORATION

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

NORTHROP GRUMMAN CORPORATION

 

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

NORTHROP GRUMMAN CORPORATION

 

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

NORTHROP GRUMMAN CORPORATION

 

 

NORTHROP GRUMMAN CORPORATION

 

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

NORTHROP GRUMMAN CORPORATION

 

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

NORTHROP GRUMMAN CORPORATION

 

Principles of Consolidation – The unaudited consolidated condensed financial statements include the accounts of Northrop Grumman Corporation and its subsidiaries (the company). All material intercompany accounts, transactions, and profits are eliminated in consolidation.

 

The accompanying unaudited consolidated condensed financial statements of the company have been prepared by management in accordance with the instructions to Form 10-Q of the Securities and Exchange Commission. These statements include all adjustments considered necessary by management to present a fair statement of the consolidated financial position, results of operations, and cash flows. The results reported in these financial statements should not be regarded as necessarily indicative of results that may be expected for the entire year. These financial statements should be read in conjunction with the Notes to Consolidated Financial Statements contained in the company’s 2006 Annual Report on Form 10-K.

 

The quarterly information is labeled using a calendar convention; that is, first quarter is consistently labeled as ending on March 31, second quarter as ending on June 30, and third quarter as ending on September 30. It is management’s long-standing practice to establish actual interim closing dates using a “fiscal” calendar, which requires our businesses to close their books on the Friday nearest these quarter-end dates in order to normalize the potentially disruptive effects of quarterly closings on business processes. The effects of this practice only exist within a reporting year.

 

Accounting Estimates – The company’s financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The preparation of the financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best available information and actual results could differ materially from those estimates.

 

Financial Statement Reclassifications – Certain amounts in the prior period financial statements and related notes have been reclassified to conform to the 2007 presentation, primarily due to the shutdown of the Enterprise Information Technology (EIT) business (Note 5) and business operation realignments (Note 6).

 

The disclosure requirements and cumulative effect of adoption of the Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 48 – Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 are presented in Note 13.

 

Other new pronouncements issued but not effective until after March 31, 2007 are not expected to have a significant effect on the company’s consolidated financial position or results of operations, with the possible exception of the following, which are currently being evaluated by management:

 

In February 2007, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 159 – The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115.  SFAS No. 159 permits entities to choose to measure eligible items at fair value at specified election dates and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Management is currently evaluating the effect that adoption of this statement will have on the company’s consolidated financial position and results of operations when it becomes effective in 2008.

 

In September 2006, the FASB issued SFAS No. 157 – Fair Value Measurements, which defines fair value, establishes a framework for consistently measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective for the company beginning

 

NORTHROP GRUMMAN CORPORATION

January 1, 2008, and the provisions of SFAS No. 157 will be applied prospectively as of that date. Management is currently evaluating the effect that adoption of this statement will have on the company’s consolidated financial position and results of operations.

 

Common Stock Dividend – On February 21, 2007, the company’s board of directors approved a 23 percent increase to the quarterly common stock dividend, from $.30 per share to $.37 per share, effective with the first quarter 2007 dividend.

 

Essex – On January 25, 2007, the company acquired Essex Corporation (Essex) for approximately $600 million, including the assumption of debt totaling $23 million and estimated transaction costs of $14 million. Essex provides signal processing services and products, and advanced optoelectronic imaging for U.S. government intelligence and defense customers. The operating results of Essex are included as part of the Mission Systems segment. The assets, liabilities, and results of operations of Essex were not material and thus pro-forma information is not presented. The financial statements reflect preliminary estimates of the fair value of the assets acquired and liabilities assumed and the related allocation of the purchase price for Essex. During the quarter, approximately $66 million of the purchase price was allocated to purchased intangibles (Note 8). The company is currently reviewing preliminary fair value adjustments associated with purchased intangibles. The ultimate allocation of the purchase price may differ from the amounts included in these financial statements. Adjustments to the purchase price allocations, if any, are expected to be finalized by the first quarter of 2008, and will be reflected in future filings. Management does not expect these adjustments, if any, to have a material effect on the company’s financial position or results of operations.

 

Interconnect – On February 24, 2006, the company sold the assembly business of Interconnect Technologies (Interconnect) for net cash proceeds of $26 million and recognized an after-tax gain of $4 million in discontinued operations.

 

Enterprise Information Technology – In the first quarter of 2006, management announced its decision to exit the EIT business reported within the Information Technology segment. The shutdown of this business was completed during the second quarter of 2006 and costs associated with the exit activities were not material. The results of operations of this business are reported as discontinued operations in the consolidated condensed statements of income, net of applicable income taxes.

 

Effective January 1, 2007, the company realigned businesses among its operating segments that possess similar customers, expertise, and capabilities. The realignment more fully leverages existing capabilities and enhances development and delivery of highly integrated services. The realignment primarily involved the Radio Systems business being transferred from the Space Technology segment to the Mission Systems segment and the UK AWACS program being transferred from the Information Technology segment to the Technical Services segment. On July 1, 2006, certain logistics, services and technical support programs from Electronics, Integrated Systems, Mission Systems, and Space Technology were transferred to Technical Services. The sales and segment operating

 

NORTHROP GRUMMAN CORPORATION

margin in the following tables have been revised, where applicable, to reflect these realignments for all periods presented.

 

The following table presents segment sales and service revenues for the three months ended March 31, 2007, and 2006.

 

 

NORTHROP GRUMMAN CORPORATION

The following table presents segment operating margin reconciled to total operating margin for the three months ended March 31, 2007, and 2006.

 

 

Unallocated Expenses – This reconciling item includes the portion of corporate expenses such as management and administration, legal, environmental, certain compensation and retiree benefits, and other expenses not considered allowable or allocable under applicable United States (U.S.) Government Cost Accounting Standards (CAS) regulations and the Federal Acquisition Regulation, and therefore not allocated to the segments.

 

Net Pension Adjustment – Net pension adjustment reflects the difference between pension expense determined in accordance with GAAP and pension expense allocated to the operating segments determined in accordance with CAS. For the three months ended March 31, 2007, and 2006, pension expense determined in accordance with GAAP was $87 million and $112 million, respectively, offset by pension expense determined in accordance with CAS of $120 million and $102 million, respectively.

 

Reversal of Royalty Income – Royalty income is included in segment operating margin for internal reporting purposes. This amount is reversed in the table above to arrive at the operating margin as determined in accordance with GAAP as royalty income is included in the “Other, net” line item in the Consolidated Condensed Statements of Income.

 

Basic Earnings Per Share – Basic earnings per share are calculated by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during each period.

 

Diluted Earnings Per Share – Diluted earnings per share include the dilutive effect of stock options and other stock awards granted to employees under stock-based compensation plans, and the company’s mandatorily redeemable convertible series B preferred stock. The dilutive effect of these potential common stock instruments totaled

 

NORTHROP GRUMMAN CORPORATION

13 million shares (including 6.4 million shares for the preferred stock) and 7.5 million shares for the three months ended March 31, 2007 and 2006, respectively. The related dividends on the preferred shares are added back to the numerator to arrive at income available to common shareholders from continuing operations. The dividends and shares related to the preferred stock were not included in the diluted per share calculations for the three months ended March 31, 2006, because their effect was not dilutive to earnings per share. The weighted-average diluted shares outstanding for the three months ended March 31, 2007 and 2006, exclude stock options to purchase approximately 74,000 and 700,000 shares, respectively, since such options have an exercise price in excess of the average market price of the company’s common stock during the period.

 

Diluted earnings per share from continuing operations are calculated as follows:

 

 

Share Repurchases – On December 14, 2006, the company’s board of directors authorized a share repurchase program of up to $1 billion of its outstanding common stock. This new authorization is in addition to $176 million remaining on the company’s previous share repurchase authorization which commenced in November 2005. As of March 31, 2007, the company has $576 million authorized for share repurchases.

 

Since November 2005 the company has entered into three separate accelerated share repurchase agreements with Credit Suisse, New York Branch (Credit Suisse) to repurchase shares of common stock. Credit Suisse in each case immediately borrowed shares that were sold to and canceled by the company. Subsequently, Credit Suisse purchases shares in the open market to settle its share borrowings. The cost of the company’s share repurchases are subject to adjustment based on the actual cost of the shares subsequently purchased by Credit Suisse. If additional cost is owed by the company upon settlement, the price adjustment can be settled, at the company’s option, in cash or in shares of common stock.

 

The table below summarizes the accelerated share repurchase transactions:

 

 

As of March 31, 2007, Credit Suisse had purchased 3.6 million shares, or 45 percent of the shares, under the latest agreement, at an average price per share of $72.91, net of commissions and other items. Assuming Credit Suisse purchases the remaining shares at a price per share equal to the closing price of the company’s common stock on March 30, 2007 ($74.22), Credit Suisse would be required to reimburse approximately $13.2 million to the company to complete the transaction. The settlement amount may increase or decrease depending upon the

 

NORTHROP GRUMMAN CORPORATION

average price paid for the shares under the program. Settlement is expected to occur in the second quarter of 2007, depending upon the timing and pace of the purchases, and would result in an adjustment to shareholders’ equity.

 

With the exception of the accelerated share repurchase agreements with Credit Suisse noted above, share repurchases take place at management’s discretion and under pre-established, non-discretionary programs from time to time, depending on market conditions, in the open market, and in privately negotiated transactions. The company retires its common stock upon repurchase and has not made any purchases of common stock other than in connection with these publicly announced repurchase programs.

 

Goodwill

The changes in the carrying amounts of goodwill for the three months ended March 31, 2007, were as follows:

 

 

Purchased Intangible Assets

The table below summarizes the company’s aggregate purchased intangible assets:

 

 

During the quarter ended March 31, 2007, approximately $66 million of the Essex purchase price was allocated to purchased intangible assets with a weighted average life of 6 years.

 

The company’s purchased intangible assets are subject to amortization and are being amortized on a straight-line basis over an aggregate weighted-average period of 21 years. Aggregate amortization expense for the three months ended March 31, 2007, was $33 million.

 

NORTHROP GRUMMAN CORPORATION

 

The table below shows expected amortization for purchased intangibles for the remainder of 2007 and for the next five years:

 

 

U.S. Government Investigations and Claims – Departments and agencies of the U.S. Government have the authority to investigate various transactions and operations of the company, and the results of such investigations may lead to administrative, civil, or criminal proceedings, the ultimate outcome of which could be fines, penalties, repayments or compensatory or treble damages. U.S. Government regulations provide that certain findings against a contractor may lead to suspension or debarment from future U.S. Government contracts or the loss of export privileges for a company or an operating division or subdivision. Suspension or debarment could have a material adverse effect on the company because of its reliance on government contracts.

 

As previously disclosed, in October 2005, the U.S. Department of Justice and a classified U.S. Government customer apprised the company of potential substantial claims relating to certain microelectronic parts produced by the Space and Electronics Sector of former TRW Inc., now a component of the company. The relationship, if any, between the potential claims and a civil False Claims Act case that remains under seal in the U.S. District Court for the Central District of California remains unclear to the company. In the third quarter of 2006, the parties commenced settlement discussions. While the company continues to believe that it did not breach the contracts in question and that it acted appropriately in this matter, the company proposed to settle the claims and any associated matters and recognized a pre-tax charge of $112.5 million in the third quarter of 2006 to cover the cost of the settlement proposal and associated investigative costs. The charge has been recorded within “General and administrative expenses” in the consolidated statements of income. The company extended the offer in an effort to avoid litigation and in recognition of the value of the relationship with this customer. The U.S. Government has advised the company that if settlement is not reached it will pursue its claims through litigation. Because of the highly technical nature of the issues involved and their classified status and because of the significant disagreement between the company and the U.S. Government as to the U.S. Government’s theories of liability and damages (including a material difference between the U.S. Government’s damage theories and the company’s offer), final resolution of this matter could take a considerable amount of time, particularly if litigation should ensue. If the U.S. Government were to pursue litigation and were to be ultimately successful on its theories of liability and damages, which could be trebled under the Federal False Claims Act, the effect upon the company’s consolidated financial position, results of operations, and cash flows would materially exceed the amount provided by the company. Based upon the information available to the company to date, the company believes that it has substantive defenses but can give no assurance that its views will prevail. Accordingly, the ultimate disposition of this matter cannot presently be determined.

 

Based upon the available information regarding matters that are subject to U.S. Government investigations, other than as set out above, the company believes, but can give no assurance, that the outcome of any such matters would not have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

 

Litigation – Various claims and legal proceedings arise in the ordinary course of business and are pending against the company and its properties. Based upon the information available, the company believes that the resolution

 

NORTHROP GRUMMAN CORPORATION

of any of these various claims and legal proceedings will not have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

 

As previously disclosed, the company is a defendant in litigation brought by Cogent Systems, Inc. (Cogent) in Los Angeles Superior Court in California on April 20, 2005, for unspecified damages for alleged unauthorized use of Cogent technology relating to fingerprint recognition. Cogent has asserted entitlement to damages totaling in excess of $160 million, loss of goodwill and enterprise value in an amount not yet specified by the plaintiff, and other amounts, including, without limitation, exemplary damages and attorneys’ fees and interest. The trial date has been set for May 22, 2007, with a mediation scheduled for May 3, 2007. The company believes, but can give no assurance, that the outcome of this matter would not have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

 

On March 27, 2007, the U.S. District Court, Central District of California, consolidated two separately filed ERISA class actions (Grabek v. Northrop Grumman Corporation, et al., previously styled Waldbuesser v. Northrop Grumman Corporation, et al., and Heidecker v. Northrop Grumman Corporation, et al.) into the In Re Northrop Grumman Corporation ERISA Litigation for discovery and other purposes, as each allege similar issues of law and fact. As previously reported, plaintiffs in Grabek allege breaches of fiduciary duty by the company, certain of its administrative and Board committees, all members of the company’s Board of Directors, and certain company officers and employees with respect to alleged excessive, hidden and/or otherwise improper fee and expense charges to the Northrop Grumman Savings Plan and the Northrop Grumman Financial Security and Savings Plan (both of which are 401(k) plans). Heidecker asserts similar claims, but has dismissed the company’s Board of Directors. Each lawsuit seeks unspecified damages, removal of individuals acting as fiduciaries to such plans, payment of attorney fees and costs, and an accounting. The company believes, but can give no assurance, that the outcome of these matters would not have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

 

Insurance Recovery – Property damage from Hurricane Katrina is covered by the company’s comprehensive property insurance program. The insurance provider for coverage of property damage losses over $500 million has advised management of a disagreement regarding coverage for certain losses above $500 million. As a result, the company has taken legal action against the insurance provider as the company believes that its insurance policies are enforceable and intends to pursue all of its available rights and remedies. However, based on the current status of the assessment and claim process, no assurances can be made as to the ultimate outcome of this matter.

 

Accelerated Share Repurchase – On February 21, 2007, the company entered into an accelerated share repurchase agreement with Credit Suisse. Settlement is expected to occur in the second quarter of 2007, depending upon the timing and pace of open market purchases by Credit Suisse, and would result in an adjustment to shareholders’ equity. The settlement amount depends upon the average price paid for the shares under the program (Note 7).

 

Contract Performance Contingencies – Contract profit margins may include estimates of costs not contractually agreed to between the customer and the company for matters such as contract changes, negotiated settlements, claims and requests for equitable adjustment for previously unanticipated contract costs. These estimates are based upon management’s best assessment of the underlying causal events and circumstances, and are included in determining contract profit margins to the extent of expected recovery based on contractual entitlements and the probability of successful negotiation with the customer. As of March 31, 2007, the amounts recorded are not material individually or in the aggregate.

 

In April 2007, the company was notified by the prime contractor on the Wedgetail contract that it anticipates that the prime contractor’s delivery dates will be late and this could subject the prime contractor to liquidated damages from the customer. Should liquidated damages be assessed, the company would share in a proportionate

 

NORTHROP GRUMMAN CORPORATION

amount of those damages to a maximum of approximately $40 million. Until such time as liquidated damages are assessed by the customer, it is not possible to determine the operating margin impact, if any, that such charges would have to the company.

 

Environmental Matters – In accordance with company policy on environmental remediation, the estimated cost to complete remediation has been accrued where it is probable that the company will incur such costs in the future to address environmental impacts at currently or formerly owned or leased operating facilities, or at sites where it has been named a Potentially Responsible Party (PRP) by the Environmental Protection Agency, or similarly designated by other environmental agencies. To assess the potential impact on the company’s consolidated financial statements, management estimates the total reasonably possible remediation costs that could be incurred by the company, taking into account currently available facts on each site as well as the current state of technology and prior experience in remediating contaminated sites. These estimates are reviewed periodically and adjusted to reflect changes in facts and technical and legal circumstances. Management estimates that as of March 31, 2007, the range of reasonably possible future costs for environmental remediation sites was $228 million to $322 million, of which $253 million is accrued in other current liabilities. Factors that could result in changes to the company’s estimates include: modification of planned remedial actions, increase or decrease in the estimated time required to remediate, discovery of more extensive contamination than anticipated, changes in laws and regulations affecting remediation requirements, and improvements in remediation technology. Should other PRPs not pay their allocable share of remediation costs, the company may have to incur costs in addition to those already estimated and accrued. Although management cannot predict whether new information gained as projects progress will materially affect the estimated liability accrued, management does not anticipate that future remediation expenditures will have a material adverse effect on the company’s consolidated financial position, results of operations, or cash flows.

 

Income Tax Matters – The company has exposure related to income tax filings in the ordinary course of business, including matters related to pre-acquisition periods of acquired businesses or indemnifications of businesses divested. The company periodically assesses these exposures for all tax years that are open under the applicable statute of limitations and records a liability, including related interest charges, where it has determined that a liability has been incurred and the amount of the loss can be reasonably estimated. Liabilities under indemnification agreements for businesses divested are recorded at fair value at the inception of the indemnification and presented within income taxes payable. These primarily relate to indemnifications of foreign taxes as a result of the divestiture of TRW Auto in 2003 and total approximately $140 million at March 31, 2007, and December 31, 2006. Management does not believe that the resolution of any of these income tax exposures will have a material adverse effect on the company’s consolidated financial position or results of operations.

 

Co-Operative Agreements – In 2003, Ships executed agreements with the states of Mississippi and Louisiana whereby Ships leases facility improvements and equipment from Mississippi and from a non-profit economic development corporation in Louisiana in exchange for certain commitments by Ships to these states.

 

As of March 31, 2007, Ships has met its obligations under the Mississippi agreement and remains obligated under the Louisiana agreement to maintain a minimum average of 5,200 full-time employees at the end of any four-year period occurring between January 1, 2003, and December 31, 2010.

 

Failure by Ships to meet the Louisiana commitment would result in reimbursement by Ships to Louisiana in accordance with the agreement. As of March 31, 2007, Ships expects that all future commitments under the Louisiana agreement will be met based on its most recent business plan.

 

Impact from Hurricane Katrina – As of March 31, 2007, management estimates that the costs to clean-up and restore its operations will total approximately $850 million, which includes $590 million to repair or replace assets damaged by the storm. As of March 31, 2007, the company has received $353 million in insurance proceeds. Through March 31, 2007, the company has expended $416 million in cash to clean-up and restore its facilities, including $209 million in capital expenditures. During the three months ended March 31, 2007, and 2006, the company incurred clean-up and restoration costs of $6 million and $17 million and capital

 

NORTHROP GRUMMAN CORPORATION

expenditures of $17 million and $54 million, respectively. As of March 31, 2007, the company has written off $98 million in assets that were completely destroyed by the storm, all of which were written off during 2005 and 2006.

 

The company has submitted estimated expenditures for recovery to its insurance carriers that are substantially in excess of the insurance proceeds received to date, and is awaiting resolution of its submissions. The company is continuing to assess its damage estimates as the process of repairing its operations is performed. The company estimates this process will continue through 2008.

 

Management believes that substantially all of the estimated cost will be recovered through the company’s comprehensive property damage insurance. However, the matter of insurance recovery is being litigated as discussed in Note 9. The company believes that its insurance policies are enforceable and intends to pursue all of its available rights and remedies. However, based on the current status of the litigation between the company and its insurance provider, no assurances can be made as to the ultimate outcome of this matter.

 

The company’s comprehensive property insurance includes coverage for business interruption effects caused by the storm, however, the company is unable to currently estimate the amount of any recovery or the period in which its claims related to business interruption will be resolved. Accordingly, no such amounts have been recognized by the company in the accompanying consolidated condensed financial statements. To the extent that its insurance recoveries are inadequate to fund the repair and restoration costs that the company deems necessary, the company will pursue other means for funding the shortfall, including funding from its current operations.

 

In accordance with cost accounting regulations relating to U.S. Government contractors, recovery of property damages in excess of the net book value of the damaged assets as well as losses on property damage that are not recovered through insurance are required to be included in the company’s overhead pools and allocated to current contracts under a systematic process. The company is currently in discussions with its government customers regarding the allocation methodology to be used to account for these differences. Depending upon the outcome of these discussions and the ultimate resolution of the company’s damage claims with its insurance providers, the company may be required to recognize additional cost growth on its contracts and cumulative downward adjustment to its contract profit rates at a future date.

 

Due to the complexity of the regulatory issues relating to the treatment of insurance recoveries on government contracts, the overall magnitude of the company’s insurance claims, the extended period of time that has ensued in the discussions with the company’s government customers, and the uncertainties surrounding the resolution of the damage claims with our insurance provider, the company is not able to estimate the effects of any potential incremental costs that could result in further reduction of margin on contracts in process or the ultimate resolution of the insurance litigation at this time.

 

Financial Arrangements – In the ordinary course of business, the company utilizes standby letters of credit and guarantees issued by commercial banks and surety bonds issued by insurance companies principally to guarantee the performance on certain contracts and to support the company’s self-insured workers’ compensation plans. At March 31, 2007, there were $419 million of unused stand-by letters of credit, $140 million of bank guarantees, and $615 million of surety bonds outstanding.

 

In December 2006, Ships entered into a loan agreement with the Mississippi Business Finance Corporation (MBFC) under which Ships received access to $200 million from the issuance of Gulf Opportunity Zone Industrial Development Revenue Bonds by the MBFC. The loan accrues interest payable semi-annually at a fixed rate of 4.55 percent per annum. The bonds are subject to redemption at the company’s discretion on or after December 1, 2016, and mature on December 1, 2028. The bond issuance proceeds must be used to finance the construction, reconstruction, and renovation of the company’s interest in certain ship manufacturing and repair facilities, or portions thereof, located in the state of Mississippi. As of March 31, 2007, approximately $90 million was used by Ships and the remaining $110 million was recorded in miscellaneous other assets as

 

NORTHROP GRUMMAN CORPORATION

restricted cash in the consolidated statement of financial position. Repayment of the bonds is guaranteed by the company.

 

Indemnifications – The company has retained certain warranty, environmental, and other liabilities in connection with certain divestitures. Except as discussed in the following paragraph, the settlement of these liabilities is not expected to have a material effect on the company’s consolidated financial position, results of operations, or cash flows.

 

In May 2006, Goodrich Corporation (Goodrich) notified the company of its claims under indemnities assumed by the company in its December 2002 acquisition of TRW that related to the sale by TRW of its Aeronautical Systems business in October 2002. Goodrich seeks relief from increased costs and other damages of approximately $118 million. The parties are engaged in discussions to enable the company to evaluate the merits of the claims as well as to assess the amounts being claimed. If the parties are unable to reach a negotiated resolution of the claims, Goodrich will have the right to commence litigation and may seek significant additional damages relating to allegations of other incurred costs and lost profits. The ultimate disposition of any litigation could take an extended period of time due to the nature of the claims. The company does not have sufficient information to assess the probable outcome of the disposition of this matter. If Goodrich were to pursue litigation and ultimately be successful on its claims, the effect upon the company’s consolidated financial position, results of operations, and cash flows could be material.

 

U.S. Government Claims – During the second quarter of 2006, the U.S. Government advised the company of claims and penalties concerning certain potential disallowed costs. The parties are engaged in discussions to enable the company to evaluate the merits of these claims as well as to assess the amounts being claimed. The company believes, but can give no assurance, that the outcome of any such matters would not have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

 

Related Party Transactions – The company had no material related party transactions for any period presented.

 

The cost of the company’s pension plans and medical and life benefits plans is shown in the following table:

 

 

Employer Contributions – The company expects to contribute approximately $155 million to its pension plans and approximately $217 million to its medical and life benefit plans in 2007. As of March 31, 2007, contributions of $33 million and $31 million have been made to the company’s pension plans and its medical and life benefit plans, respectively.

 

NORTHROP GRUMMAN CORPORATION

 

At March 31, 2007, the company had stock-based awards outstanding under the following plans: the 2001 Long-Term Incentive Stock Plan, the 1993 Long-Term Incentive Stock Plan, both applicable to employees, and the 1993 Stock Plan for Non-Employee Directors and the 1995 Stock Option Plan for Non-Employee Directors. All of these plans were approved by the company’s shareholders. Share-based awards under the employee plans consist of stock option awards (Stock Options) and restricted stock awards (Stock Awards).

 

Compensation Expense – Total pre-tax stock-based compensation for the three months ended March 31, 2007, and 2006, was $38 million and $48 million, respectively, of which $4 million and $3 million related to Stock Options and $34 million and $45 million related to Stock Awards, respectively. Tax benefits recognized in the consolidated condensed statements of income for stock-based compensation during the three months ended March 31, 2007, and 2006, were $15 million and $17 million, respectively. In addition, the company realized excess tax benefits of $30 million and $34 million from the exercise of Stock Options and $22 million and $5 million from the vesting of Stock Awards in the three months ended March 31, 2007, and 2006, respectively.

 

Stock Options – The fair value of each of the company’s Stock Option awards is estimated on the date of grant using a Black-Scholes option-pricing model that uses the assumptions noted in the table below. The fair value of the company’s Stock Option awards is expensed on a straight-line basis over the vesting period of the options, which is generally four years. Expected volatility is based on an average of (1) historical volatility of the company’s stock and (2) implied volatility from traded options on the company’s stock. The risk-free rate for periods within the contractual life of the Stock Option award is based on the yield curve of a zero-coupon U.S. Treasury bond on the date the award is granted with a maturity equal to the expected term of the award. The company uses historical data to estimate forfeitures within its valuation model. The expected term of awards granted is derived from historical experience under the company’s stock-based compensation plans and represents the period of time that awards granted are expected to be outstanding.

 

The significant weighted average assumptions relating to the valuation of the company’s Stock Options for the three months ended March 31, 2007, and 2006, were as follows:

 

 

The weighted average grant date fair value of Stock Options granted during the three months ended March 31, 2007, and 2006, was $15 and $18 per share, respectively.

 

NORTHROP GRUMMAN CORPORATION

 

Stock Option activity for the three months ended March 31, 2007, was as follows:

 

 

The total intrinsic value of options exercised during the three months ended March 31, 2007, and 2006, was $77 million and $112 million, respectively. Intrinsic value is measured using the fair market value at the date of exercise (for options exercised) or at March 31, 2007 (for outstanding options), less the applicable exercise price.

 

Stock Awards – The fair value of Stock Awards is determined based on the closing market price of the company’s common stock on the grant date. Compensation expense for Stock Awards is measured at the grant date and recognized over the vesting period. For purposes of measuring compensation expense, the amount of shares ultimately expected to vest is estimated at each reporting date based on management’s expectations regarding the relevant performance criteria. In the table below, the share adjustment resulting from the final performance measure is considered granted in the period that the related grant is vested. There were 2.4 million Stock Awards that vested and were issued in the three months ended March 31, 2006, with a total fair value of $153.7 million. There were 3.4 million Stock Awards granted in the three months ended March 31, 2006, with a weighted average grant date fair value of $65 per share.

 

Stock Award activity for the three months ended March 31, 2007, was as follows:

 

 

Unrecognized Compensation Expense – At March 31, 2007, there was $333 million of unrecognized compensation expense related to unvested awards granted under the company’s stock-based compensation plans, of which $24 million relates to Stock Options and $309 million relates to Stock Awards. These amounts are expected to be charged to expense over a weighted-average period of 2 years.

 

NORTHROP GRUMMAN CORPORATION

 

The company adopted the provisions of FIN 48 – Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109, on January 1, 2007. As a result of the implementation of FIN 48, the company made a comprehensive review of its portfolio of uncertain tax positions in accordance with recognition standards established by FIN 48. In this regard, an uncertain tax position represents the company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. As a result of this review, the company adjusted the estimated value of its uncertain tax positions by recognizing additional liabilities totaling $66 million through a charge to retained earnings, and reduced the carrying value of uncertain tax positions resulting from prior acquisitions by $63 million through a reduction of goodwill. Upon the adoption of FIN 48, the estimated value of the company’s uncertain tax positions is a liability of $514 million resulting from unrecognized net tax benefits. The liability for uncertain tax positions is carried in other liabilities in the consolidated condensed statement of financial position as of March 31, 2007, and approximately $447 million is reported as long-term. If the company’s positions are sustained by the taxing authority in favor of the company, approximately $331 million would be treated as a reduction of goodwill, and the balance of $183 million would reduce the company’s effective tax rate. The company does not expect any reasonably possible material changes to the estimated amount of liability associated with its uncertain tax positions through January 1, 2008.

 

The company recognizes accrued interest and penalties related to uncertain tax positions in federal and foreign income tax expense. As of January 1, 2007, the company had accrued approximately $45 million for the payment of tax-related interest and penalties.

 

The company files income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. The Internal Revenue Service (IRS) is currently examining the company’s U.S. income tax returns for 1999 – 2003, including pre-acquisition activities of acquired companies, and commenced an examination of the company’s U.S. income tax returns for 2004 – 2005 in the first quarter of 2007. In addition, open tax years related to state and foreign jurisdictions remain subject to examination but are not considered material.

 

As of March 31, 2007, there have been no material changes to the liability for uncertain tax positions.

 

The components of accumulated other comprehensive loss were as follows:

 

 

NORTHROP GRUMMAN CORPORATION

 

To the Board of Directors and Shareholders of
Northrop Grumman Corporation
Los Angeles, California

 

We have reviewed the accompanying consolidated condensed statement of financial position of Northrop Grumman Corporation and subsidiaries as of March 31, 2007, and the related consolidated condensed statements of income, comprehensive income, cash flows and changes in shareholders’ equity for the three-month periods ended March 31, 2007 and 2006. These interim financial statements are the responsibility of the Corporation’s management.

 

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to such consolidated condensed interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial position of Northrop Grumman Corporation and subsidiaries as of December 31, 2006, and the related consolidated statements of income, comprehensive income, cash flows, and changes in shareholders’ equity for the year then ended (not presented herein); and in our report dated February 20, 2007, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated condensed statement of financial position as of December 31, 2006 is fairly stated, in all material respects, in relation to the consolidated statement of financial position from which it has been derived.

 

Los Angeles, California

April 23, 2007

 

NORTHROP GRUMMAN CORPORATION

 

The following discussion should be read along with the unaudited consolidated condensed financial statements included in this Form 10-Q, as well as the company’s 2006 Annual Report on Form 10-K filed with the Securities and Exchange Commission, which provides a more thorough discussion of the company’s products and services, industry outlook, and business trends.

 

Northrop Grumman provides technologically advanced, innovative products, services, and solutions in information and services, aerospace, electronics, and shipbuilding. As a prime contractor, principal subcontractor, partner, or preferred supplier, Northrop Grumman participates in many high-priority defense and commercial technology programs in the United States (U.S.) and abroad. Northrop Grumman conducts most of its business with the U.S. Government, principally the Department of Defense. The company also conducts business with foreign governments and makes domestic and international commercial sales.

 

Operating performance for the three months ended March 31, 2007, compared to the same period in 2006 improved in almost every consolidated financial measure. Sales, operating margin, net income, cash from operations, and funded backlog all increased over the same period in 2006. A discussion of results on a consolidated basis and by reportable segment is included below. Notable non-contract events during the three months ended March 31, 2007, affecting the company’s results included the following:

 

 

The company manages and assesses the performance of its businesses based on individual performance on individual contracts and programs obtained generally from government organizations using the financial measures described on page I-27, with consideration given to the Critical Accounting Policies, Estimates and Judgments referred to below. Based on this approach and the nature of the company’s operations, the discussion of results of operations generally focuses around the company’s seven reportable segments versus distinguishing between products and services. Product sales are predominantly generated in the Electronics, Integrated Systems, Space Technology and Ships segments, while the majority of the company’s service revenues are generated by the Information Technology, Mission Systems and Technical Services segments.

 

There were no significant changes to the company’s products and services, industry outlook, or business trends from those disclosed in the company’s 2006 Annual Report on Form 10-K.

 

For convenience, a brief description of certain programs discussed in this Form 10-Q are included in the “Glossary of Programs” beginning on page I-36.

 

Changes in Critical Accounting Policies – There have been no changes in the company’s critical accounting policies during the three months ended March 31, 2007, except for the treatment of tax contingency accruals.

 

Effective January 1, 2007, the company began to measure and record tax contingency accruals in accordance with FIN 48 – Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109. The expanded disclosure requirements of FIN 48 are presented in Note 13 to the Consolidated Condensed Financial Statements in Part I, Item I.

 

NORTHROP GRUMMAN CORPORATION

 

FIN 48 prescribes a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Only tax positions meeting the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized upon adoption of this Interpretation. FIN 48 also provides guidance on accounting for derecognition, interest and penalties, and classification and disclosure of matters related to uncertainty in income taxes. As in the past, changes in accruals associated with uncertainties arising from pre-acquisition years for acquired businesses are charged or credited to goodwill. Adjustments to other tax accruals are generally recorded in earnings in the period they are determined.

 

Prior to January 1, 2007, the company recorded accruals for tax contingencies and related interest when it was probable that a liability had been incurred and the amount of the contingency could be reasonably estimated based on specific events such as an audit or inquiry by a taxing authority.

 

Use of Estimates – The company’s financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The preparation of the financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best available information. Actual results could differ materially from those estimates.

 

Selected financial highlights are presented in the table below.

 

 

Sales and Service Revenues

Sales and service revenues for the three months ended March 31, 2007, increased $251 million, or 4 percent, as compared with the same period in 2006, reflecting increased revenues in all operating segments except the Integrated Systems segment.

 

Operating Margin

Operating margin as a percentage of total sales and service revenues for the three months ended March 31, 2007, was 9.3 percent, as compared to 8.5 percent for the same period in 2006. The increase was primarily due to a favorable net pension adjustment of $33 million in 2007 compared to an unfavorable net pension adjustment of $10 million in 2006 and lower unallocated expenses of $3 million. Total segment operating margin was 9.3 percent and 9.2 percent for the three months ended March 31, 2007, and 2006, respectively.

 

NORTHROP GRUMMAN CORPORATION

 

Operating margin consists of the following:

 

 

Unallocated Expenses – Unallocated expenses for the three months ended March 31, 2007, decreased $3 million, or 9 percent, as compared with the same period in 2006. The decrease was primarily due to lower post-retirement benefit costs determined under GAAP as a result of a plan design change in 2006.

 

Net Pension Adjustment – Net pension adjustment reflects the difference between pension expense determined in accordance with GAAP and pension expense allocated to the operating segments determined in accordance with U.S. Government Cost Accounting Standards (CAS). For the three months ended March 31, 2007, and 2006, pension expense determined in accordance with GAAP was $87 million and $112 million, respectively, offset by pension expense determined in accordance with CAS of $120 million and $102 million, respectively. The improvement in GAAP pension cost primarily relates to higher returns on plan assets and a voluntary pre-funding in the fourth quarter of 2006.

 

Reversal of Royalty Income – Royalty income is included in segment operating margin for internal reporting purposes. This amount is reversed in the table above to arrive at the operating margin as determined in accordance with GAAP as royalty income is included in the “Other, net” line item discussed below.

 

General and Administrative Expenses – In accordance with industry practice and the regulations that govern the cost accounting requirements for government contracts, most general corporate expenses incurred at both the segment and corporate locations are considered allowable and allocable costs on government contracts and such costs are allocated to contracts in progress on a systematic basis and contract performance factors include this cost component as an element of cost.

 

General and administrative expenses for the three months ended March 31, 2007, increased $38 million, or 6 percent, as compared with the same period in 2006. The increase is primarily due to higher sales volume, increased property and casualty insurance costs as a result of hurricane Katrina and the acquisition of Essex.

 

Interest Expense, Net

Interest expense, net for the three months ended March 31, 2007, increased $5 million, or 6 percent, as compared with the same period in 2006. The increase was primarily due to a lower amount of interest-bearing cash deposits.

 

Federal and Foreign Income Taxes

The company’s effective tax rate on income from continuing operations for the three months ended March 31, 2007, was 34.4 percent compared with 31.2 percent for the same period in 2006. During the three months ended March 31, 2006, the company recognized a net tax benefit of $18 million with respect to tax credits associated with qualified wages paid to employees affected by hurricane Katrina.

 

Diluted Earnings Per Share

Diluted earnings per share for the three months ended March 31, 2007, were $1.10, as compared with $1.02 per share in the same period in 2006. Earnings per share are based on weighted average diluted shares outstanding of

 

NORTHROP GRUMMAN CORPORATION

358.3 million for the three months ended March 31, 2007, and 350.8 million for the same period in 2006. See Note 7 to the Consolidated Condensed Financial Statements in Part I, Item 1.

 

Net Cash Provided by (Used in) Operating Activities

For the three months ended March 31, 2007, the company provided cash from operating activities of $400 million compared with cash used in operating activities of $115 million for the same period in 2006. The increase was primarily due to higher net collections on programs in progress and less cash expended for discontinued operations.

 

Effective January 1, 2007, the company realigned businesses among its operating segments that possess similar customers, expertise, and capabilities. The realignment more fully leverages existing capabilities and enhances development and delivery of highly integrated services. The realignment primarily involved the Radio Systems business being transferred from the Space Technology segment to the Mission Systems segment and the UK AWACS program being transferred from the Information Technology segment to the Technical Services segment. On July 1, 2006, certain logistics, services and technical support programs from Electronics, Integrated Systems, Mission Systems, and Space Technology were transferred to Technical Services. The sales and segment operating margin in the following tables have been revised, where applicable, to reflect these realignments for all periods presented.

 

For presentation purposes, the company’s seven reportable segments are categorized into four primary businesses. The Mission Systems, Information Technology and Technical Services reportable segments are presented as Information & Services. The Integrated Systems and Space Technology reportable segments are presented as Aerospace. The Electronics and Ships reportable segments are presented as separate businesses. The Ships reportable segment includes the aggregated results of the Newport News and Ship Systems operating segments.

 

NORTHROP GRUMMAN CORPORATION

 

Segment operating results are discussed below with respect to the following financial measures:

 

Funded Contract Acquisitions – Funded contract acquisitions represent amounts funded during the period on customer contractually obligated orders. Funded contract acquisitions tend to fluctuate from period to period and are determined by the size and timing of new and follow-on orders and by appropriations of funding on previously awarded unfunded orders. In the period that a business is purchased, its existing funded order backlog as of the date of purchase is reported as funded contract acquisitions. In the period that a business is sold, its existing funded order backlog as of the divestiture date is deducted from funded contract acquisitions.

 

Sales and Service Revenues – Period-to-period sales generally vary less than funded contract acquisitions and reflect performance under new and ongoing contracts. Changes in sales and service revenues are typically expressed in

 

NORTHROP GRUMMAN CORPORATION

terms of volume. Volume generally refers to increases (or decreases) in revenues incurred due to varying production activity levels, delivery rates, or service levels on individual contracts. Volume changes will typically carry a corresponding margin change based on the margin rate for a particular contract.

 

Segment Operating Margin – Segment operating margin reflects the performance of segment contracts and programs. Excluded from this measure are certain costs not directly associated with contract performance, including the portion of corporate expenses such as management and administration, legal, environmental, certain compensation and other retiree benefits, and other expenses not considered allowable or allocable under applicable CAS regulations and the Federal Acquisition Regulation, and therefore not allocated to the segments. Changes in segment operating margin are typically expressed in terms of volume, as discussed above, or performance. Performance refers to changes in contract margin rates. These changes typically relate to profit recognition associated with revisions to total estimated costs at completion of the contract (EAC) that reflect improved (or deteriorated) operating performance on a particular contract. Operating margin changes are accounted for on a cumulative basis at the time an EAC change is recorded.

 

Funded contract acquisitions, sales and service revenues, and segment operating margin in the tables within this section include intercompany amounts that are eliminated in the Consolidated Condensed Financial Statements in Part I, Item 1.

 

INFORMATION & SERVICES

 

Mission Systems

Mission Systems is a leading global system integrator of complex, mission-enabling systems for government, military, and commercial customers. Products and services are grouped into the following business areas: Command, Control and Communications (C3); Intelligence, Surveillance and Reconnaissance (ISR); and Missile Systems.

 

 

Funded Contract Acquisitions

Mission Systems funded contract acquisitions for the three months ended March 31, 2007, decreased $129 million, or 7 percent, as compared with the same period in 2006, partially due to higher 2006 funded contract acquisitions as a result of delayed funding upon approval of the fiscal year 2006 defense budget. Significant acquisitions in 2007 included $307 million for the Intercontinental Ballistic Missile (ICBM) program, $157 million of funded backlog from the acquisition of Essex, $89 million for the Joint National Integration Center Research & Development (JRDC) program, and $47 million for the Ground-Based Midcourse Fire Control and Communications program.

 

Sales and Service Revenues

Mission Systems revenue for the three months ended March 31, 2007, increased $22 million, or 2 percent, as compared with the same period in 2006. The increase was primarily due to $35 million in higher sales in ISR and $18 million in higher sales in Missile Systems, partially offset by $37 million in lower sales in C3. The increase in ISR is due to the acquisition of Essex. The increase in Missile Systems is primarily due to higher volume in the Kinetic Energy Interceptor (KEI) program. The lower sales in C3 is primarily due to lower volume in the F-35 development program and various other C3 programs.

 

NORTHROP GRUMMAN CORPORATION

 

Segment Operating Margin

Mission Systems operating margin for the three months ended March 31, 2007, decreased $6 million, or 5 percent, as compared with the same period in 2006. The decrease reflects net performance declines of $7 million primarily due to positive improvement in the ICBM program in the first quarter of 2006, and $2 million in higher amortization of purchased intangibles, offset by $3 million attributable to net sales volume increases.

 

Information Technology

Information Technology is a premier provider of advanced information technology (IT) solutions, engineering, and business services for government and commercial customers. Products and services are grouped into the following business areas: Intelligence; Civilian Agencies; Commercial, State & Local (CS&L); and Defense.

 

 

Funded Contract Acquisitions

Information Technology funded contract acquisitions for the three months ended March 31, 2007, decreased $228 million, or 19 percent, as compared with the same period in 2006. Significant non-restricted acquisitions in 2007 included $39 million for the Treasury Communication System program and $36 million for the Virginia IT outsourcing program.

 

Sales and Service Revenues

Information Technology revenue for the three months ended March 31, 2007, increased $109 million, or 12 percent, as compared with the same period in 2006. The increase was primarily due to $71 million in higher sales in CS&L and $52 million in higher sales in Intelligence, partially offset by $17 million in lower sales in Civilian Agencies. The higher sales in CS&L primarily reflect higher volume from programs awarded in 2006, including Virginia IT outsourcing, San Diego County IT outsourcing, and New York City Wireless. The increased sales in Intelligence primarily reflect new restricted program wins and the lower sales in Civilian Agencies reflects lower volume on a variety of programs.

 

Segment Operating Margin

Information Technology operating margin for the three months ended March 31, 2007, increased $6 million, or 8 percent, as compared with the same period in 2006 primarily attributable to the higher sales volume discussed above. The higher operating margin and lower operating margin rate reflect a higher percentage of newly commenced state and local programs.

 

NORTHROP GRUMMAN CORPORATION

 

Technical Services

Technical Services is a leading provider of logistics, infrastructure, and sustainment support, and also provides a wide-array of technical services including training and simulation. Services are grouped into the following business areas: Systems Support, Life Cycle Optimization and Engineering (LCOE), and Training and Simulation.

 

 

Funded Contract Acquisitions

Technical Services funded contract acquisitions for the three months ended March 31, 2007, decreased $83 million, or 15 percent, as compared with the same period in 2006. Significant acquisitions in 2007 included $105 million for the Joint Base Operations Support (JBOSC) program, $64 million for the Nevada Test Site (NTS) program, and $52 million for the Ft. Irwin program.

 

Sales and Service Revenues

Technical Services revenue for the three months ended March 31, 2007, increased $137 million, or 36 percent, as compared with the same period in 2006. The increase is primarily due to $115 million in higher sales in Systems Support due to increased volume in the NTS program and $28 million in higher sales in LCOE due to increased volume for F-15 repairs and other programs.

 

Segment Operating Margin

Technical Services operating margin for the three months ended March 31, 2007, increased $4 million, or 17 percent, as compared with the same period in 2006 primarily attributable to the higher sales volume as discussed above. The higher operating margin and lower operating margin rate are largely due to the impact of NTS.

 

AEROSPACE

 

Integrated Systems

Integrated Systems is a leader in the design, development, and production of airborne early warning, electronic warfare and surveillance, and battlefield management systems, as well as manned and unmanned tactical and strike systems. Products and services are grouped into the following business areas: Integrated Systems Western Region (ISWR); Integrated Systems Eastern Region (ISER); and International Programs.

 

 

Funded Contract Acquisitions

Integrated Systems funded contract acquisitions for the three months ended March 31, 2007, decreased $962 million, or 36 percent, as compared with the same period in 2006. Significant acquisitions in 2007 included $745 million for the F/A-18 program, $287 million for the B-2 program, $148 million for the E-2 program, and $133 million for the EuroHawk program.

 

NORTHROP GRUMMAN CORPORATION

 

Sales and Service Revenues

Integrated Systems revenue for the three months ended March 31, 2007, decreased $135 million, or 10 percent, as compared with the same period in 2006. The decrease was primarily due to $128 million in lower ISER sales due to lower sales volume in the E-2D Advanced Hawkeye and EA-18G programs, and $22 million in lower ISWR sales due to lower volume in the F-35 program, partially offset by higher sales in the F/A-18 program (due to delivery of one additional unit), Euro Hawk and B-2 Support programs.

 

Segment Operating Margin

Integrated Systems operating margin for the three months ended March 31, 2007, increased $12 million, or 8 percent, as compared with the same period in 2006. The increase includes net performance improvements totaling $17 million primarily from the F/A-18 and B-2 programs. The improvements in the F/A-18 program (due to completion of production lot 5 and improved performance on production lot 6) and the B-2 program more than offset the impact of lower sales.

 

Space Technology

Space Technology develops and integrates a broad range of systems at the leading edge of space, defense, and electronics technology. The segment supplies products primarily to the U.S. Government that are critical to maintaining the nation’s security and leadership in science and technology. Space Technology’s business areas focus on the design, development, manufacture, and integration of satellite systems and subsystems, electronic and communications payloads, and high energy laser systems and subsystems. Products and services are grouped into the following business areas: Intelligence, Surveillance and Reconnaissance (ISR); Civil Space; Satellite Communications (SatCom); Missile & Space Defense; and Technology.