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Northrop Grumman Corporation(NYSE:NOC) is the world’s fourth largest defense contractor; it manufactures aircraft carriers, submarines, space craft systems, mission-critical computer systems, and wireless communications infrastructure; about 90% of its revenue comes from the U.S. Department of Defense (DoD). It operates four business segments: Information & Services (38% of fiscal 2007 revenue), Aerospace (24%), Electronic Systems (21%), and Ships (17%).^[1] Its revenues increased by 6 percent from $30.1B in 2006 to a record $32B in 2007, thanks in part to a 7% increase in the Department of Defense budget.^[2]

With its success based primarily on American military spending, the country's political climate is the primary driver of Northrop Grumman's growth. Historically, defense spending has been inversely correlated with non-defense spending, as both compete for limited dollars in the Budget. The imminent retiring of 78 million of America's citizens and their future demands for Medicaid and Social Security payment does not bode well for the defense industry as a whole. The 2008 elections will also be instrumental in determining U.S. military spending for the next few years; Democratic Presidential Candidate Barack Obama has promised to end the Iraq War, which would greatly reduce defense spending, while Republican Candidate John McCain has vowed to push to victory, a stance which is certain to pump military spending up. Since NOC is one of the government's most important defense contractors, the company receives some benefits that civilian industrial manufacturers don't; for example, the company has contracts with the government to mitigate the risks associated with steel prices, so despite higher input costs, NOC's margins are not harshly affected. Northrop Grumman's main competitors include Raytheon Company, Boeing Company, and Lockheed Martin.

Contents 1 Business Financials 1.1 Information & Services 1.2 Aerospace 1.3 Acquisitions 1.4 Electronics 1.5 Ships 2 Trends and Forces 2.1 The Vast Majority of Northrop Grumman’s Revenue Stems from the U.S. Government 2.2 Defense Spending Competes for Room with Non-Defense Spending in the Budget; Baby Boomers Have the Potential to Pressure Government Spending in Favor of Non-Defense Spending 2.3 The Outcome of the 2008 Elections Will Determine Whether Defense Spending Rises or Falls in the Next Few Years 2.4 The Cutting-Edge Nature of Many of NOC's Contracts Creates Unpredictable Risk 2.5 Rising Raw Materials Prices Put Pressure on NOC's Margins 2.6 Key Products 3 Competition 4 References

[edit] Business Financials

Northrop Grumman operates four segments: Information & Services (38% revenue fiscal 2007), Aerospace (24%), Electronics (21%), and Ships (17%).^[3] Its revenue increased by 6 percent from $30.1B in 2006 to a record $32B in 2007, due to increases in defense spending by the U.S. Government.^[4]

^{[5] [6]}

NOC Backlog

in millions	Funded 2007	Unfunded 2007	Total Backlog 2007	Funded 2006	Unfunded 2006	Total Backlog 2006
Information & Services	$7,272	$14,446	$21,718	$7,161	$14,301	$21,462
Aerospace	$5,464	$12,791	$18,255	$5,908	$12,072	$17,980
Electronics	$8,446	$2,062	$10,508	$6,576	$1,583	$8,159
Ships	$10,348	$3,230	$13,578	$10,854	$2,566	$13,420
Total			$64,059			$61,021

^[7]

Backlog orders increased 5% in 2007 to $64B. Both total funded backlog (orders for which funding has been agreed to by a customer) and total unfunded backlog (orders for which funding has not yet been agreed to) increased in 2007. Backlog was comprised of 89% of U.S. Government orders, 6% foreign customer orders, and 5% domestic commercial orders.^[8]

Northrop Grumman Business Organization

Information & Services	Aerospace	Electronics	Ships
Mission Systems	Integrated Systems	Aerospace Systems	Aircraft Carriers
Command, Control and Communications (C3)	Integrated Systems Western Region (ISWR)	Defensive Systems	Expeditionary Warfare
Intelligence, Surveullance and Reconnaissance (ISR)	Integrated Systems Eastern Region (ISER)	Government Systems	Surface Combatants
Missile Systems	Airborne Early Warning and Battle Management Command & Control-Navy	Naval & Marine Systems	Submarines
Information Technology	Intelligence, Surveillance, Reconnaissance & Battle Management Command & Control-Air Force	Navigation Systems	Coast Guard & Coastal Defense
Civilian Agencies	Electronic Support & Attack Solutiions		Fleet Support
Commercial, State & Local	Maritime & Tactical Systems		Services, Commercial & Other
Defense	Space technology
Technical Services	Civil Systems
Systems Support	Military Systems
Trainning and Simulation	National Systems
Life Cycle Optimization and Engineering	Technology & Emerging Systems

[edit] Information & Services

The Information & Services business had a 6 percent increase from 1Q fiscal 2008 compared to 1Q of fiscal 2007. It is composed of three segments: Mission Systems (47% of fiscal 2007), Information Technology (36%), and Technical Services (17%).^[9]

The Mission Systems segment is a global integrator of mission-enabling systems in the following programs: Command, Control and Communications (C3), Intelligence, Surveillance, and Reconnaissance (ISR), and Missile Systems. Revenue for 1Q fiscal 2008 increased $150 million, or 11 percent, as compared with the same period in 2007.^[10] The increase was primarily due to $67 million in higher sales in C3, $61 million in higher sales in ISR, and $31 million in higher sales in Missile Systems.^[11]

The Information Technology provides information technology services to the following segments: Intelligence, Civilian Agencies, Commercial, State & Local, and Defense. Information Technology revenue for the 1Q 2008 increased $47 million, or 5 percent, as compared with the same period in 2007.^[12] The increase was primarily due to $26 million in higher sales in State & Local, and $22 million in higher sales in Defense.^[13]

The Technical Services business has three segments: Systems Support (SSG), Life Cycle Optimization and Engineering (LCOE), and Training and Simulation. It provides infrastructure management and maintenance to its customers. Revenue for the 1Q 2008 decreased $15 million, or 3 percent, as compared with the same period in 2007.^[14] The decrease was primarily due to lower sales volume in SSG driven by 2007 decreases in spending on government operations that used the service.^[15]

Sales and Services Revenues ($ in millions)	2007	2006	2005
Information & Services
Missions Systems	$5,931	$5,494	$5,494
Information Technology	$4,486	$3,962	$3,736
Technical Services	$2,177	$1,858	$1,617
Total	$12,594	$11,314	$10,847

^[16]

Operatin Margin ($ in millions)	2007	2006	2005
Information & Services
Missions Systems	$566	$519	$424
Information Technology	$329	$342	$322
Technical Services	$120	$120	$100
Total	$1,015	$981	$846

^[17]

[edit] Aerospace

The Aerospace business had a 4 percent sales revenue increase in 1Q fiscal 2008, when compared to 1Q of fiscal 2007. It is composed of two segments: Integrated Systems (62 %) and Space Technology (38%).^[18]

Integrated Systems’ products and services are grouped into the Integrated Systems Western Region (ISWR) and Integrated Systems Eastern Region (ISER); both design, develop, and produce missionized integrated systems for battlefield monitoring and airborne ground surveillance. Revenue for the 1Q 2008 increased $59 million, or 5 percent, as compared with the same period in 2007.^[19]The increase was primarily due to $48 million in higher sales in ISWR and $13 million in higher sales in ISER.^[20]

Space Technology’s products and services are grouped into Civil Systems, Military Systems, National Systems, and Technology & Emerging Systems (Technology). Revenue for the 1Q 2008 increased $21 million, or 3 percent, as compared with the same period in 2007.^[21] The increase was primarily due to $54 million in higher sales in National Systems and $16 million in higher sales in Civil Systems, partially offset by $61 million in lower sales in Military Systems.^[22]

Sales and Services Revenues ($ in millions)	2007	2006	2005
Aerospace
Integrated Systems	$5,067	$5,500	$5,489
Space Technology	$3,133	$2,923	$2,866
Total	$8,200	$8,423	$8,355

^[23]

Operating Margin ($ in millions)	2007	2006	2005
Aerospace
Integrated Systems	$591	$551	$499
Space Technology	$261	$245	$219
Total	$852	$796	$718

^[24]

[edit] Acquisitions

In January 2007 Essex Corporation was acquired for $590M. Essex produces signal processing services, products, and operating optoelectronic imaging. In July 2007 there was reorganization in the joint venture of AMSEC LLC with Science Applications International Corporation (SAIC), dividing AMSEC which was treated as an acquisition. NOC retained the ship engineering, logistics and technical service business. Additionally in 3Q 2007 Xinetics Inc. was acquired along with Scaled Composites LLC for about $100M.^[25] During 2006 there were no significant acquisitions. NOC has become more conservative in business acquisitions.

[edit] Electronics

The Electronics business produces sensors and navigation systems that operate in all environments; sales revenue increased about 2 percent during the 1Q of fiscal 2008.^[26] Its products and services are grouped into Aerospace Systems, Government Systems, Naval & Marine Systems (NMS), Defensive Systems, Land Forces, Navigation Systems, Space Sensors & ISR Systems, and Defense Other. Revenue for the 1Q 2008 increased $27 million, or 2 percent, as compared with the same period in 2007.^[27] The increase was primarily due to $89 million in higher sales in Land Forces and $35 million in higher sales in Navigation Systems, partially offset by $47 million in lower sales in Naval & Marine Systems and $22 million in lower sales in Government Systems.^[28]

Sales and Services Revenues ($ in millions)	2007	2006	2005
Electronics	$6,906	$6,543	$6,513

^[29]

Operating Margins ($ in millions)	2007	2006	2005
Electronics	$813	$754	$709

^[30]

[edit] Ships

The ships segment builds naval craft; its revenues increased about 9 percent during the 1Q of fiscal 2008.^[31] Its products and services are grouped into Aircraft Carriers, Expeditionary Warfare, Surface Combatants, Submarines, Coast Guard & Coastal Defense (CG&CD), Fleet Support, Services, and Commercial & Other. Revenue for the 1Q 2008 increased $108 million, or 9 percent, as compared with the same period in 2007.^[32] The increase was primarily due to $77 million in higher sales in Surface Combatants, $48 million in higher sales in Fleet Support and $41 million in higher sales in Services, partially offset by $107 million of lower sales in Expeditionary Warfare.^[33] This segment should see significant growth in the coming years. On September 11, Northrop announced that they had received a $5.1 billion contract to construct the first aircraft carrier in the Gerald Ford Class. The USS Gerald R. Ford, CVN-78, is expected to launch in 2015.^[34]

Sales and Services Revenues ($ in millions)	2007	2006	2005
Ships	$5,788	$5,321	$5,786

^[35]

Operating Margin ($ in millions)	2007	2006	2005
Ships	$538	$393	$249

^[36]

[edit] Trends and Forces

[edit] The Vast Majority of Northrop Grumman’s Revenue Stems from the U.S. Government

Northrop Grumman depends heavily on Department of Defense (DoD) spending by the U.S Government; n fiscal 2007 about 90 percent of NOC’s revenue came from products and services sold to the U.S. Government. Changes in the U.S. federal budget, in particular spending on defense, can have adverse affects on Northrop Grumman. The 2007 federal budget saw a 7 percent increase in DoD spending, from 410.8 B to 439.3B; subsequently, NOC's revenue increased by 6 percent, from $30.1B in 2006 to a record $32B in 2007.^[37][38] Estimates of future federal defense budgets are 479.5B for 2008 and 515.4B for 2009, indicating that NOC will have significant growth opportunities in the next few years.^[39]

[edit] Defense Spending Competes for Room with Non-Defense Spending in the Budget; Baby Boomers Have the Potential to Pressure Government Spending in Favor of Non-Defense Spending

With the U.S. Budget experiencing increases in defense spending, there is competition for non-defense (entitlements) spending. Non-defense spending includes programs such as Social Security, Medicare, Medicaid, etc. that eligible people are entitled to. Two-thirds of the U.S. Budget for 2008 comprised non-defense spending; Thanks to the baby-boomers, spending for this part of the budget has increased rapidly over the years, rising 759% from 1965 to 2007, from $169 B to $1.45 T.^[40] As the baby boomers retire, non-defense spending will continue to increase and put pressure on other government expenditures, such as defense spending, as this large demographic of about 78 million people starts to retire.^[41] As a percentage of federal outlays, defense spending has decreased from 37.5% to 36%, from 2005 to 2007, while non-defense spending has increase from 62.5% to 64% during the same time lapse of two years.^[42]

^{[43] [44]}

[edit] The Outcome of the 2008 Elections Will Determine Whether Defense Spending Rises or Falls in the Next Few Years

The budget is set by Congress, and therefore is affected by the party dominating congress. The result of the 2008 elections will determine the direction of the defense budget. Democrats are more likely to promote spending for social programs, national healthcare for example, that will compete with defense spending. They are also more willing to end existing wars and less likely to enter into other conflicts which will reduce defense spending. Furthermore, the two candidates in the 2008 Presidential Election, Barack Obama for the Democrats and John McCain for the Republicans, each have different views on the Iraq War. If Obama is elected, he has pledged to pull out of the country, a move which will certainly result in reduced defense spending. McCain, on the other hand, has pledged to stay in Iraq for "as long as it takes", which would certainly result in increased defense spending as the government puts its considerable resources into winning the war.

[edit] The Cutting-Edge Nature of Many of NOC's Contracts Creates Unpredictable Risk

Many of Northrop Grumman’s contracts contain performance obligations which require innovation and sometimes unproven technologies. In addition, NOC’s products cannot be tested and proven in all situations, and therefore can run into unforeseen problems, like spacecraft launch failure, problems with subcontractor components or services, or a product simply not working the way it's supposed to in a real-life situation.^[45] NOC is responsible for cost overrun if a project malfunctions, which has a higher rate of occurring given the cutting-edge nature of the company's technology. The U.S. Coast Guard, for example, pursued a $96.1 M refund for faulty ships made by Northrop Grumman and Lockheed Martin; Northrop Grumman will also lose $360 M for delaying the completion of an amphibious assault ship because of wiring problems and other defects.^[46][47]

[edit] Rising Raw Materials Prices Put Pressure on NOC's Margins

Northrop Grumman uses a substantial amount of steel, primarily for shipbuilding. Also, its subsidiary, Northrop Grumman Ship Systems Avondale Operations, is a supplier of carbon steel plates and shapes in the Gulf Coast area, providing steel products to the marine, oil field construction, and industrial sector.^[48] Steel prices have been rising and continue to increase, from $.38/lb in April 2007 to $.55/lb in April 2008, cutting into NOC’s profit margin.^[49] The company has negotiated long-term agreements with steel suppliers to mitigate the possibility of a steel shortage, though the risk associated with such contracts is that a long-term fall in steel prices would lead Northrop Grumman to pay more for steel from the contract than it would for steel from the market. Fortunately, NOC also has contracts with the U.S. Government to mitigate price risk related to its steel purchases, putting its margins in a better position than industrial manufacturers operating in the commercial sector.

.^[50]

[edit] Key Products

B2 Bomber

Its low-observable technology, “stealth”, and high aerodynamic efficiency gives the B-2 important advantages over existing bombers. Its “stealth” ability gives it a unique ability to penetrate an enemy’s most sophisticated defense and threaten its most valued targets.^[51] It is capable of delivering both conventional and nuclear munitions. Valued at about $1.5 B a unit, the US Government is limited to purchasing only a few.^[52] As the principal contractor and manufacturer, Northrop Grumman's income increases considerably as the quantity of B-2 bombers sold to the U.S. Government increases. Northrop is not able to profit from selling this product to foreign governments because the U.S. Government has ownership over the B-2.

KC-45

The KC-45 will provide better air refueling capabilities and will replace the KC-135 Stratotankers. Before take off, the KC-135 has to be set to refuel either Air Force or Navy aircrafts due to their different refueling systems. The KC-45 improves this drawback as it is equipped for both systems; additionally, it can be refueled in flight by other tankers.^[53] What sells the product is its defensive system that allows it to enter into dangerous environments which would otherwise have to avoid, like all exisiting tankers must do. Additionally, it can carry cargo, passengers, and medical patients as a secondary role. The initial contract consists of four test aircrafts for $1.5B which can increase up to 179 tanker aircrafts for approximately $35B.^[54] The total amount of KC-45 tankers ordered are solely determined by the U.S. Government. Several economic reasons why the U.S. Government favors purchasing this product is that: it will support about 48,000 jobs in the U.S., since no jobs will be sent abroad, and more than 230 companies in 49 states will see benefits.^[55].

Nimitz-class Supercarriers (CVN)

The Nimitz-class Supercarriers are 1,092 feet long powered by nuclear reactors that operate for more than 20 years without having to be refueled, and exceeding speeds of 30 knots (56+ km/h). It carries more than 80 combat aircrafts and is built with three eight-cell missile launchers along with other weapon and combat systems.^[56][57] It also includes decoys for countermeasures and electronic systems which identifies threats and their directions. The U.S. Government spends about $4.5B for each unit. The U.S. owns only 10 ships to date (CVN68-CVN77). Northrop Grumman does not make too many sales and depends on the U.S. Government to spend on such high profile projects.

Many products that Northrop Grumman develops for the U.S. become property of the U.S. Government. Northrop is not legally allowed to sell any of those products to any other customers, including foreign governments. Therefore, government spending on National Defense and on high profile projects has vast affects on Northrop Grumman. Increases in National Defense spending is highly correlated with the Republican party, while large cuts are correlated with the Democratic party. The party that holds the majority in Congress and the Presidential seat is of paramount importance to Northrop Grumman’s profit margins.

[edit] Competition

Northrop Grumman is one of the largest defense contractors. It competes with Lockheed Martin Corporation, The Boeing Company, Raytheon Company, and General Dynamics Corporation, which are among the largest companies in the U.S. defense industry. Its success in the competitive defense industry depends upon its ability to develop and market its products and services, and its ability to gather the resources needed to deliver those products and services with maximum efficiency. NOC is the only U.S. designer and builder of nuclear-powered aircraft carriers and one of two producers of nuclear-powered submarines, the other is the Electric Boat Corporation a a dividion of General Dynamics Corporation. However, it has to compete for most contracts.The U.S. Air Force found NOC’s more advantageous cost/price proposal bid to build the next generation of aerial refueling tankers KC-45 superior to Boeing's in four of the five most important selection criteria.^[58] NOC also beat out Motorola for New York City’s contract in building a broadband wireless network.^[59]

LEADING GLOBAL DEFENSE CONTRACTORS

Revenues 2006

(Ranked by defense revenues, in millions of dollars)

COMPANY	Country	Defense	Total Revenue	Defense as % of Total
Lockheed Martin (LMT)	US	36,090	39,620	91.1
Boeing Company (BA)	US	30,800	61,530	50.1
BAE Systems	UK	25,071	26,968	93
Northrop Grumman	US	23,649	30,148	78.4
Raytheon Company (RTN)	US	19,500	20,291	96.1
General Dynamics (GD)	US	18,769	24,063	78
EADS NV (EADSY)	Netherlands	13,203	52,019	25.4
L-3 Communications Holdings (LLL)	US	9,990	12,477	80.1
Finmeccanica	Italy	9,057	16,466	55
United Technologies (UTX)	US	7,653	47,829	16
Thales	France	6,997	13,599	51.5
KBR (KBR)	US	6,400	9,600	66.7
SAIC (SAI)	US	5,800	8,300	69.9
General Electric Company (GE)	US	4,600	15,400	29.9
Honeywell International (HON)	US	4,400	31,600	13.9
Rolls-Royce	UK	4,062	14,008	29
ITT Corporation (ITT)	US	3,659	7,808	46.9
DCNS	France	3,565	3,565	100
Computer Sciences (CSC)	US	3,530	14,616	24.2
Alliant Techsystems (ATK)	US	3,066	3,565	86
DRS Technologies (DRS)	US	2,732	2,821	97
SAFRAN Group	France	2,641	14,959	17.7
Saab Åke	Sweeden	2,462	3,078	80
Booz Allen Hamilton	US	2,449	4,000	61.2
Mitsubishi Heavy Industries	Japan	2,354	26,025	9

^[60]

[edit] References

1. ↑ NOC 2007 10-K, Pg 37
2. ↑ NOC 2007 10-K, Pg 79
3. ↑ NOC 2007 10-K, Pg 79-80
4. ↑ NOC 2007 10-K, Pg 79
5. ↑ NOC 2007 10-K, Pg 79-80
6. ↑ Income Statements by Yahoo Finance
7. ↑ NOC 2007 10-K, Pg 48
8. ↑ NOC 2007 10-K, Pg 48
9. ↑ NOC 2007 10-K, Pg 37
10. ↑ NOC 4/2008 10-Q, Pg 29
11. ↑ NOC 4/2008 10-Q, Pg 29
12. ↑ NOC 4/2008 10-Q, Pg 29
13. ↑ NOC 4/2008 10-Q, Pg 29
14. ↑ NOC 4/2008 10-Q, Pg 29
15. ↑ NOC 4/2008 10-Q, Pg 29
16. ↑ NOC 2007 10-K, Pg 79-80
17. ↑ NOC 2007 10-K, Pg 79-80
18. ↑ NOC 2007 10-K,Pg 37
19. ↑ NOC 4/2008 10-Q, Pg 30
20. ↑ NOC 4/2008 10-Q, Pg 30
21. ↑ NOC 4/2008 10-Q, Pg 30
22. ↑ NOC 4/2008 10-Q,Pg 30
23. ↑ NOC 2007 10-K, Pg 79-80
24. ↑ NOC 2007 10-K, Pg 79-80
25. ↑ NOC 2007 10-K, Pg 27
26. ↑ NOC 4/2008 10-Q, Pg 27
27. ↑ NOC 4/2008 10-Q, Pg 31
28. ↑ NOC 4/2008 10-Q, Pg 31
29. ↑ NOC 2007 10-K, Pg 79-80
30. ↑ NOC 2007 10-K, Pg 79-80
31. ↑ NOC 4/2008 10-Q,Pg 27
32. ↑ NOC 4/2008 10-Q, Pg 32
33. ↑ NOC 4/2008 10-Q, Pg 32
34. ↑ http://www.reuters.com/article/topNews/idUSN1134552420080911?feedType=RSS&feedName=topNews
35. ↑ NOC 2007 10-K,Pg 79-80
36. ↑ NOC 2007 10-K, Pg 79-80
37. ↑ NOC 2007 10-K, Pg 79
38. ↑ U.S. Federal Budget Pg 19
39. ↑ U.S. Federal Budget Pg 5
40. ↑ Outlays from FY 2009 Historical Tables, U.S. Budget, Table 8.1
41. ↑