Northrop Grumman Economic Climate Northrop

Northrop Grumman

Economic Climate

Northrop Grumman (NOC, NYSE) is in an excellent position within the next two years to continually manage topline revenue growth in the key business sectors of Information and Services, Technical Services, Information technology, Electronics, and Ships. Information and Services specifically is expected to deliver an 8% to 10% increase in FY 2007 topline revenue growth with Technical Services being the biggest contributor due to large logistics deals in the pipeline including those from LOGCAP, Linguist and CFT. Margins in technical Services however lag other sectors of the company yet have the greatest topline revenue growth potential within the Information & Services overall sector of their business. The Electronics sector, which is the largest and historically the most profitable for the company, is expected to deliver a modest 5% topline revenue growth performance level for the company, gated only by the periodic charges taken from competing on fixed-price development programs including ASPIS II, f016 Block 60 electronics and Project Wedgetail.

Despite all these promising aspects of sector performance for Northrop Grumman, the stock continually underperforms its peers in the large-cap defense sector by 12%, delivering an 8% return YTD vs. The industry average of 20%. The losses of very high profile projects in the Aerospace and Defense sector coupled with the impact of Hurricane Katrina on the company's ability to sustain its relatively high growth shipbuilding operation have continued to challenge the company's ability to deliver valuations consistent with the norms of its industry averages. The fact that the contracts in place today are solid through the election year also is cause for optimism in Northrop-Grumman's ability to increase its stock performance relative to peers. Finally on November 1 oth, 2006 Northrop Grumman chose their annual investors' conference in New York City to announce the acquisition of Essex Corporation. Northrop Grumman paid $24/share for Essex, which represented a 20$ premium over their closing price on Thursday November 9th, 2006. The total value of the transaction is $580M, and the 1,000 member company has roughly 67% of its workforce enabled with security clearances, in addition to having sizeable contracts with the Defense Department and Transportation Security Administration (TSA).

Essex is best known as the maker of SIGINT systems and services.

Northrop Grumman Operations

The four dominant sectors of Northrop-Grumman's business are Information & Services, Aerospace, Electronics, and Ships. The company chooses to financially report subsectors of their business that have significant revenue and net income, as is shown in the following table, Analysis of Key Business Segments.

Information & Services is comprised of Mission Systems, Information technology, and Technical Services. Taken together, this sector of operations is expected to grow between 8% to 10% based on increased intelligence spending by the U.S. government, state and local spending on IT services throughout the U.S. Of these sectors, Northrop Grumman manager is staffing up Information Technology the most aggressively, quadrupling its size over the last four years, and has a sizeable pipeline of deals specifically from state and local governments needing assistance with IT integration projects.

Aerospace as a sector was done in FY06 and beginning FY07 yet the recent big win of the U.S. Navy BAMS and UCAS Programs, in conjunction with electronics for the USAF 767 Tanker Program and the EuroHawk win in FY06. This sector continues to be the most volatile and cyclical of the entire company. The Aerospace sector itself is comprised of the Integrated Systems and Space Tech subsectors. Space tech has shown strong gains in gross margins as this division focuses on space-based defenses and monitoring as intelligence weapons on the global war on terror.

Electronics and Ships are the last two sectors Northrop Grumman participates in. The biggest challenge for the Electronics sector is in creating a greater market for its airborne radar expertise both from a ground forces support and naval operations strategic perspective. This sector has had initial success with the USMC G/ATOR radar program and numerous projects throughout South Korea, Jordan, the United Arab Emirates, and Israel.

The Ships sector is in recovery mode from the impact to production caused by Hurricane Katrina. Fortunately for this sector the main opportunities for ships are in fulfilling existing contracts and the delivery of two Virginia-class submarines in the 2012 timeframe which are on schedule for delivery. As post-Katrina efforts to get production back on schedule continue it's believed the company can generate 8% margin in this specific sector going into FY 2007.

In summary, the table Analysis of Key Business Segments shows the success the company has had in distributing revenue over more segments, thereby alleviating risk while being able to position itself to take advantage of greater market opportunities in the process. The growth Mission Systems and Space technology, while much of the product development is confidential, show strong revenue and income growth which will continue given budgeting for space-based monitoring and defense systems.

Analysis of Key Business Segments

Revenues 12/31/2005 (%) 12/31/2004 (%) 12/31/2003 (%) 12/31/2002 (%) 12/31/2001 (%) Electronic Systems 6,042,000 20% 6,417,000 21% 6,039,000 22% 5,339,000 30% 4,719,000 34% Information Technology 4,999,000 16% 5,051,000 16% 4,754,000 18% 4,237,000 24% 3,783,000 27% Integrated Systems 5,550,000 18% 4,742,000 15% 3,800,000 14% 3,273,000 19% 3,001,000 22% Ships 5,784,000 19% 6,252,000 20% 5,451,000 20% 4,712,000 27% 1,880,000 14% Mission Systems 4,959,000 16% 4,947,000 16% 4,115,000 15% -- Space Technology 3,345,000 11% 3,269,000 11% 2,823,000 10% -- Component Technologies -- 427,000 3% Totals 30,679,000 100% 30,678,000 100% 26,982,000 100% 17,561,000 100% 13,810,000 100% Operating Income 12/31/2005 (%) 12/31/2004 (%) 12/31/2003 (%) 12/31/2002 (%) 12/31/2001 (%) Electronic Systems 710,000 29% 670,000 29% 590,000 30% 435,000 33% 359,000 47% Information Technology 355,000 15% 301,000 13% 281,000 14% 249,000 19% 170,000 22% Integrated Systems 474,000 20% 412,000 18% 380,000 19% 331,000 25% 258,000 34% Ships 241,000 10% 389,000 17% 295,000 15% 306,000 23% 19,000 2% Mission Systems 381,000 16% 321,000 14% 258,000 13% -- Space Technology 255,000 11% 222,000 10% 193,000 10% -- Component Technologies -- -38,000 -5% Totals 2,416,000 100% 2,315,000 100% 1,997,000 100% 1,321,000 100% 768,000 100%

Five Year Performance Analysis

In terms of overall financial performance the company has been able to stabilize and slightly grow corporate wide net profit margins, while greatly increasing overall Return on Equity (ROE) through the use of better project management and the aggressive growth of the Information & Services sector. Additionally, Northrop-Grumman has successfully branched into more sectors than ever before, relying on same-account sales to accomplish a higher lifetime value per customer, often at the agency or state government level. The bottom line is that the company is well-positioned to attain its guidance of $31B in Sales with an operating margin of 7%, which is what the company delivered at the close of last year.

Northrop Grumman Corp Ratio Analysis

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