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"United States and Europe Need to Share Defense Technology"

"United States and Europe Need to Share Defense Technology"

Source: Speech As Delivered by Kent Kresa, Chairman, President and Chief Executive Officer at Northrop Grumman Shareholder's Meeting 2000. Fairmont Miramar Hotel, Santa Monica, California, May 17, 2000.

Today marks the first Northrop Grumman shareholders’ meeting of the new decade and the new century—which promises to be a dynamic and exciting era for our company. The future begins today, and for Northrop Grumman it has never been more promising.

This past year was definitely a turning point for our company. At this time last year, many were questioning whether Northrop Grumman was large enough to remain independent and compete in an industry made up of fewer players than ever before. The results of the past year have provided an emphatic "yes" to those questions. Clearly our fortunes have changed.

Nineteen ninety-nine and the first quarter of 2000 have been outstanding—from a financial perspective and indeed by nearly every measure. We have proven that our ability to compete is not necessarily a function of our size, but more importantly about our people and our management—and our demonstrated ability to be innovative, agile, and capable of rapidly adapting to our customers' emerging requirements.

Let me add that I am proud to lead this team of dedicated and talented employees who are truly focused on customer performance and shareholder value.

I should also add that, unlike some others in our industry, Northrop Grumman has most of our restructuring and operational issues well behind us. We have become a stronger and more innovative competitor. We are focused on our main engines of growth—defense electronics and information technology, as well as systems integration, including military aircraft design and development. These are core competencies for the Northrop Grumman of the future, and we are realizing the benefits and synergies that come from these business segments.

Those benefits over the past year have been considerable—and are testimony to the fact that our operational machine is in great shape. We achieved record net income in 1999, with significantly improved operating results. Our first quarter results for 2000 were also marked by continued strong performance, with net income increasing 66 percent over the comparable period a year ago.

Northrop Grumman's 1999 results also included record cash generation—some $1.2 billion. In the first quarter of 2000, we again generated solid cash flow, adding to an already strong balance sheet. In addition to paying down our debt, we are actively evaluating all of our other strategic options, including possible acquisitions and other initiatives to further enhance value for you, our shareholders. Today, Northrop Grumman is a complete and balanced company, and we are in control of our own destiny and do not need to make acquisitions to be competitive or successful. However, we continually evaluate and when appropriate, aggressively pursue acquisitions that are a good strategic fit and enhance shareholder value.

You may have read that one of the strategic alternatives we are pursuing concerns our commercial aerostructures business area. While commercial aerostructures is a solid business and has been, and can be, very profitable, it is not where we are focusing our growth right now. Our growth is focused on defense electronics and information technology sectors, as well as our systems integration business area. Since this is an active issue, I have nothing further to add on this subject at this time, but we will keep you posted on significant developments.

One of the key reasons for Northrop Grumman's strong financial performance has been our ability to achieve major turnarounds in some challenging programs. Last year, we resolved our Accurate Fuselage Assembly claim with Boeing, negotiated a settlement with the Air Force on our Joint Stars claim, and resolved issues with our Directional Infrared Countermeasures system.

In fact, Northrop Grumman is presently enjoying solid operating performance in every business area of the company.

And it is especially gratifying that all of these outstanding performance milestones have not gone unnoticed. Both the media and Wall Street have finally begun to recognize our efforts. Our stock price is up 40 percent from the beginning of the year and has significantly outperformed the S&P Aerospace and Defense Index.

And there is other encouraging news as well. The proposed Fiscal Year 2001 U.S. defense budget has fully funded Northrop Grumman's programs at the levels we projected in our strategic plan, including production dollars for the 15th Joint STARS aircraft.

While the proposed budget represents the first increase in DoD spending in more than a decade, many feel it is not enough. Not only do we need more defense dollars but we need to optimize those dollars in terms of how they are allocated to support our future needs.

In addition, a Defense Science Board study on the overall health of the industry is expected to be released soon, and we certainly hope that the DoD adopts various initiatives of this study, which we expect will include: increasing R&D spending, encouraging more multi-year contracts, and increasing progress payments—all of which should improve the long-term financial health of our industry and ensure that we can continue to provide our customers with the most innovative solutions possible.

Even though American defense spending remains below what many believe is necessary, it still greatly exceeds that of our European allies. And NATO's campaign in the Balkans last year dramatized the capability gap that exists between American and European forces; a gap that is both unhealthy and unnecessary.

So what can be done to assist in closing this gap? First, they need to significantly increase defense spending. And secondly, the United States and Europe need to share defense technology.

I continue to believe that equity mergers among major defense firms across the Atlantic will be difficult to achieve, at least in the near- to mid-term. Cross-border business combinations may happen, but they are more complex and more difficult than domestic combinations.

Recent history shows American companies have been most successful with their international business partners in various teaming relationships. And this is where I believe our industry should continue to focus its efforts and energy.

In fact, last month Northrop Grumman announced that we have signed an exploratory agreement with DaimlerChrysler Aerospace, soon to become a major component of EADS, the European Aeronautic Defense and Space company. Together, we will evaluate business opportunities across several key defense electronic and platform areas, specifically in surveillance and reconnaissance.

Next month at the Berlin Air Show we expect to discuss with key German and other European companies how we can collectively meet NATO's requirement for an alliance-owned airborne ground surveillance system. This type of teaming approach should serve the interests of governments on both sides of the Atlantic by preserving competition and producing innovative solutions to emerging military requirements.

Many of these emerging technologies, such as airborne surveillance, mission planning and precision strike, are part of the cyberspace revolution that I discussed in my letter to you in this year's Annual Report. The Kosovo conflict provided the first glimpse of this fundamental change in military strategy—one that enables systems to assimilate and distribute vast amounts of information on a real-time basis.

With all the potential benefits of this cyberspace revolution, there are also some very real concerns.

We're all painfully familiar with the recent "I love you" virus that infiltrated government and business computers throughout the world. This cyber attack immobilized communications systems, destroyed files and inflicted an estimated $15 billion in damage to both commercial and government systems. The virus penetrated 14 federal agencies, including the CIA, NASA, INS and the Department of Defense. Unfortunately, in this era of increasing reliance on computers, and particularly on links between computers, there are more and more opportunities for conspirators to invade and corrupt systems.

Such cyber attacks, especially on computer-networked battle management systems, offer a glimpse into how future information battles, or cyber wars, may be fought. Just imagine the impact of an invader who could infiltrate our military systems to alter target information on bombing missions, change surveillance imagery and disrupt entire communications systems. Such cyber battles will be won not only by the smartest and most capable aircraft, but also by the smartest and most robust software.

At Northrop Grumman, we are on the leading edge of this cyberspace revolution. Our information technology subsidiary, Logicon, provides our military customers with a number of technologies that help to ensure that our country's infrastructure becomes ever more secure from a cyber attack. These applications, which are also being used by commercial enterprises, help detect and contain cyber attacks while restoring the corrupted data with correct information. Today, we are developing new software applications that can forecast the timing and nature of an attack and help operators prepare to counter it.

Logicon and our Electronic Sensors and Systems Sector are working with our customers on military systems that embody the new concept of "information resiliency." Rather than trusting in conventional access control systems to prevent intrusion, we want to detect intrusions and recover critical data—automatically and in real-time.

Finally, as the military gradually shifts from traditional battlefield tactics to information-rich warfare approaches, the Department of Defense should allocate more resources toward this area.

Another important element of this cyberspace revolution is the emergence of unmanned aeronautical vehicles. UAVs offer the most promising new approaches to reconnaissance, battle management, and weapon delivery capabilities without risking pilot lives—and they are rapidly gaining attention and support in the Pentagon and on Capitol Hill. Northrop Grumman's acquisition of Ryan Aeronautical last July positioned our company as a leader in this growing market.

Ryan’s state-of-the-art UAV, the Global Hawk, continues to set world records for unmanned aircraft, and has just successfully completed its first trans-Atlantic mission, in military exercises over Portugal.

Let me now provide an update on events at each of our operating sectors.

First, in our Integrated Systems and Aerostructures sector:

Multi-year funding for the F-18E/F program has just been approved. This five-year contract to buy more than 200 advanced F-18 aircraft could be awarded to prime contractor Boeing as soon as late this month, adding greater stability and cash management to an already strong and profitable program. And the F-18E/F Super Hornet team was recently awarded the Collier Trophy, which represents the industry’s top aeronautical achievement of the year.

Production issues on the Joint STARS program have been resolved and we expect to continue to book margin on the program this year and beyond. The seventh production aircraft was delivered in March and we expect to deliver one more aircraft later this year. And, four additional Joint STARS are scheduled for delivery in 2001.

The B-2 Spirit stealth bomber will remain an important program for the company, providing a steady stream of revenue from upgrades and support work for many years to come.

The B-2 naming ceremony for the "Spirit of America"—the 21st—and last, for now, is scheduled for mid-July in Virginia.

Our position as a leader in the dynamic UAV market was further solidified with our recent contract award to provide a Vertical Takeoff and Landing UAV system for decks of small warships.

Our state-of-the art E-2C Hawkeye 2000 airborne early warning and control aircraft is under a multiyear Naval contract. The company has received additional awards to upgrade existing E-2C fleets in the United States, Egypt and Japan.

ISA and ES3 are key members of Lockheed Martin’s Joint Strike Fighter team competing to develop the military’s next-generation strike aircraft. This is a significant opportunity for ISA to showcase its stealth technologies and systems integration work and for ES3 to leverage its fire control radar and electro-optical expertise. A decision on the JSF competition is expected early next year.

And, in the commercial aerostructures arena, ISA is continuing to pursue additional business with Boeing, and has a multi-year contract on the C-17 military airlifter.

For 2000, we expect ISA’s sales to be down 12 to 15 percent, due to the generally low production levels of commercial aircraft orders from Boeing and the maturation of the B-2 program. Fortunately, strong growth in defense electronics and information technology will offset this decline.

In our Electronic Sensors and Systems Sector:

Lockheed Martin’s F-16 contract with the United Arab Emirates was signed in early March and should clear Congressional approval in a few weeks. This is a very important win for Northrop Grumman. Of particular note was our ability to not only secure the electronically scanned array radar and electro-optical segments, but also the electronic warfare component of this competition. We anticipate our contract for the UAE business to be signed early in the third quarter. All told, Northrop Grumman’s participation on the UAE F-16 Desert Falcon program is expected to exceed $1 billion and bodes well for additional international sales and upgrades.

The sector will provide upgraded radar systems for F-16s purchased by Israel, Greece and Egypt.

In addition, Project Wedgetail, which the sector was awarded last year as part of a Boeing-led team, is expected to be under contract later this summer. In this key program for Australia, ES3 will provide an advanced Airborne Early Warning surveillance radar in a seven-aircraft program that, overall, is worth another $1 billion. There is a similar competition under way in Turkey, which should be decided later this year.

Over the past year, the sector received two low-rate initial production contracts from Lockheed Martin to produce more than 900 BAT antiarmor submunitions. And under a separate contract, ES3 will develop a new multimode BAT terminal seeker that can detect, track and attack targets that are either hot or cold, moving or stationary. These are key wins for the sector’s Land Combat Systems division, another promising business area for the company.

Also, sales for the sector’s LITENING system—which is a multi-sensor laser target designating system—are picking up nicely.

The Directional Infrared Counter Measures program, or DIRCM, has turned around, and sales are expected to increase dramatically over the next five years.

Furthermore, the sector’s Advanced SEAL Delivery System has been delivered to Pearl Harbor and is heading for deep water testing this year. This system has been jointly developed with the U.S. Navy to provide a dry-submersible submarine for the Navy SEALS with greater range, speed, and comfort in extreme environments than ever before, and is a hallmark of ES3’s marine systems capabilities.

An ES3-led team also continues to mature the development of an advanced radar for the U.S. Air Force F-22 Raptor, which will soon become America’s premier air dominance fighter.

Overall, ES3 is on track to post double-digit sales growth in 2000, and I expect contract acquisitions to approximate $4 billion by year-end. This momentum will carry forward, making ES3 a dynamic engine of growth for Northrop Grumman for many years to come.

Logicon, our information technology sector, is another key growth engine for Northrop Grumman:

The sector has continued to demonstrate outstanding performance, including record sales in 1999 and this past quarter, as well as improved margins.

Furthermore, Northrop Grumman also now ranks as the government’s third-largest supplier of Information Technology services. Logicon is capitalizing on this success by expanding its horizons to capture additional federal, commercial and international business opportunities.

They are applying their core capabilities, which were initially developed in the federal and commercial arenas, to the growing state and local IT markets.

And, most recently, the sector won key contracts with the U.S. Navy to provide C4ISR technology development, engineering and support. C4ISR is another suite of cutting-edge technologies that constitute a major component of Northrop Grumman’s future business strategy.

Currently, Logicon has a $5 billion funded and unfunded backlog and a robust pipeline of business opportunities ahead. While I do not anticipate that Logicon will match its outstanding 32 percent increase in revenues for 1999, I continue to look for double-digit sales growth for the sector this year and beyond.

While our corporation’s total sales for 2000 are expected to be relatively unchanged from last year, I look forward to solid growth in both sales and earnings in 2001 and beyond. And we continue to anticipate that we will grow internally to $12 billion in revenue by 2003.

Before I make my closing comments, I would like to offer one more piece of good news. As you may know, the company routinely reviews various economic figures to ensure that we offer competitive compensation and benefits to all of our hardworking employees, both past and present. As a result of a recently completed review and the subsequent board approval this morning, I am pleased to announce a $1,200 per year cost-of-living adjustment, effective October 1, 2000, for all members of the Northrop Grumman family who routinely receive a pension payment and who retired on or before December 1, 1994.

In the coming weeks, more information will be sent to all eligible retirees. I would like to take this opportunity to once again thank our retirees from all across the company, many of whom are joining us today, for their contributions to the company and their ongoing support as fellow shareholders.

Let me also extend my sincere gratitude and thanks to all current Northrop Grumman employees. Over the past two years we have all certainly been put to the test. Together, we have successfully weathered a difficult storm and are now standing on the decks with an exciting future on our horizon. While the storm may have cleared, significant challenges remain. And we must rely on the talent and dedication of our employees to help us chart and implement our strategic course.

Looking back on the past year, I am truly proud of our company’s ability to excel in virtually every aspect of our business. Thanks to the dedication and efforts of the men and women of Northrop Grumman, our future certainly remains bright as we continue to be a leader in defense, aerospace and cyberspace.

Thank you.

Note: the forward-looking statements contained in this speech concerning, among other things, future results of operations, deliveries, trends, cash flows, markets and programs are projections and are necessarily subject to various risks and uncertainties. Actual outcomes are dependent upon the company's successful performance of internal plans, government customers' budgetary restraints, customer changes in short range and long range plans, domestic and international competition in both the defense and commercial areas, product performance, continued development and acceptance of new products, performance issues with key suppliers and subcontractors, government import and export policies, termination of government contracts, political processes, legal, financial and governmental risks related to international transactions and global needs for military and commercial aircraft and electronic systems and support as well as other economic, political, and technological risks and uncertainties, and other risk factors set out in the company's filings from time to time with the securities and exchange commission, including, without limitation, the company's report on form 10-k.


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Directeur de la publication : Joël-François Dumont
Comité de rédaction : Jacques de Lestapis, Hugues Dumont, François de Vries (Bruxelles), Hans-Ulrich Helfer (Suisse), Michael Hellerforth (Allemagne).
Comité militaire : VAE Guy Labouérie (†), GAA François Mermet (2S), CF Patrice Théry (Asie).