On Wednesday, March 9, 2005, Mike Petters, corporate vice president and president of Northrop Grumman Newport News, addressed the National Press Club in Washington, D.C. His comments focused on designing, building and maintaining aircraft carriers and submarines amid an ever-changing defense environment. Below is an edited transcript of his remarks.

An Overview of Northrop Grumman's Newport News Sector

Thank you. We're going to cover a few things today. First of all, I'm going to talk to you a little bit about Northrop Grumman Newport News. Then I'll talk a little bit about the projects that we have underway. Then I have planned a discussion of some of the challenges, not only facing the shipyard, but more broadly than that, facing the industry. And I'll talk a little bit about what we're trying to do to overcome some of those challenges.

I'd like to show you what we do at the shipyard. And this is just sort of a smorgasbord of the kinds of things that we participate in at the shipyard.

(Audio-visual presentation.)

As you can see, we have a lot going on there and we challenge our employees to have the opportunity to grow in what they're doing every day, and also we challenge them to be part of something bigger than just their job. And when we send a ship down the river on a delivery or we take it out on sea trials, our employees take a lot of satisfaction in what they've done to help advance the cause of freedom and democracy for the United States.

Let me give you some background on the sector itself. Newport News Shipbuilding became part of Northrop Grumman about three years ago. We were acquired in late 2001 and today we are one of seven operating sectors in Northrop Grumman. Northrop Grumman, by the acquisition of Newport News, became the largest supplier to the Navy of all the Navy suppliers, and the Navy became Northrop Grumman's biggest customer. And so just by that single act, we completely changed the relationship between Northrop Grumman and the Navy. We are the sole designer, builder and refueler of U.S. Navy aircraft carriers, and we're one of the two companies that build the nuclear submarines for the U.S. Navy.

We are a leading provider of engineering and design services. Not only are we doing the CVN-21 design today, but we also participate with some submarine design activities with our partner, Electric Boat. We have a workforce now of about 4,000 engineers and designers at the shipyard. And overall, we have about 19,000 people. We also have about anywhere from 300 to 500 people at our Continental Maritime shipyard in San Diego, California, and that fluctuates a little bit based on the workload that they have there.

Newport News has two miles of waterfront and 550 acres of land. The company has the largest Gantry crane and dry-dock in the Western hemisphere. That crane is capable of making lifts on the order of 900 tons. We have seven dry-docks throughout the shipyard plus we have one floating dry-dock that we use in our submarine program. Actually, we build the ships on land and then we'll take them and put them in the dry-dock and submerge the dock. That's how we launch these ships today. We have two outfitting berths where we will pull the ships – primarily carriers, but we can pull other ships into those berths as well, and continue to do maintenance and work on those ships. And we have four major piers.

The enterprise itself goes back to 1886 and upon the acquisition of 2001, we immediately became the oldest sector in Northrop Grumman; we are 119 years old. We were founded by Collis P. Huntington. Many of you may know that he was a railroad magnate. He was involved in building a transcontinental railroad and what happened is he found – on the peninsula – a place to build a shipping station and he felt like, if he was going to have ships coming to the peninsula to match up with his railroads, then he needed to have a place there that could take care of ships. In the course of our 119 years, we've built more than 800 Navy and commercial ships.

And you can see, in the history, we go back to the Simon Lake submarines, the passenger liners like the S.S. United States. We have built the Enterprise, one of the most famous ships in history, and it is the first nuclear-powered aircraft carrier – and in fact, I'll talk in a little bit about how the Enterprise is back in the shipyard today. We are building Nimitz-class aircraft carriers, we built the Los Angeles-class submarines and we are building Virginia-class submarines.

Which leads to about what work we have in the shipyard today. And first of all, I'll talk about the George Bush. TheGeorge H.W. Bush is under construction – this picture actually is a little dated, because just yesterday, we put the bow section on the ship. And if you go to our Web site, northropgrumman.com, you'll see not only a picture of that event, but there's a Web video of that event. It was a very wet morning and it was a very windy morning, but we got it in place and I think you might find that of interest. It's an example of what we do. It's a 700-ton lift that we put down and when we match it up to the forward end of this ship, the precision is in fractions of inches. The George H.W. Bush will be launched in the fall of 2006 and our plan is to deliver that ship in the fall of 2008.

Here's a picture of the Texas as she gets ready for launch; we'll be launching her in the next couple of months. We are finishing up the construction of the program now, heading for launch, and then we'll go through a systems test and checkout with the delivery sometime in the spring of 2006. You may recall that we did have a christening event and the sponsor of the ship is our first lady, Laura Bush.

The Eisenhower was the second Nimitz-class ship to be refueled at the shipyard and she finished her refueling at the beginning of this year. She is in Norfolk today and will be – at some point in the near future – going out on her sea trials and then returning to service and the fleet. We have come back into the submarine repair business; the Hyman Rickover is in for an intermediate dry-docking availability and things are going well on that opportunity.

The Enterprise, as I said, is the first nuclear-powered carrier, and we get a chance to work on the Enterprise every two years or so. The ship is now forty years old and we have some very interesting challenges there. In some cases, we have to go work on equipment where the vendors no longer exist and some of the suppliers that provided originally to the ship are not there anymore. So we have to come up with new approaches to solving some of those technical issues. The Enterprise has a very special place in our shipyard history and lore, as it was the first nuclear-powered carrier.

Several years ago, when I was responsible for the carrier program, the Enterprise was in and we had a little discussion going on between the CO of the ship and our testers. They wanted to run a test and the CO wasn't sure that he wanted to run the test today, he wanted to run it tomorrow. And my test team is pretty – let's say, they're pretty aggressive – and they wanted to go ahead and run it tonight. Finally, the captain called me and he said, listen, you need to tell your test guys that we're going to run it first thing in the morning. That's when the crew is going to be ready. So I called up our director of tests and I said, “Look, you need to understand, he's the captain of a U.S. Navy ship. He's responsible for this ship. He owns this ship.” And my test director said, “No, Mike, you need to understand something. I was here when we built this ship. We loaned this ship to the Navy and we want to make sure they take good care of it, but it's still ours.” And so you know, that's kind of the way we feel about the Enterprise, in a nutshell. It's a very special ship, it's been involved in many acts of diplomacy in the last 40 years, and we look forward to continuing to work with her.

The George Washington is in the shipyard now for a docking availability. This is an interesting job because this job came into the shipyard as part of the Navy's plan to help us – some of you may recall the Vinson refueling was delayed for a year, and when the Vinson was delayed, the Navy helped us work through restructuring our workload. And so they brought the Washington in to put in our dry-dock and this helps us keep our skilled folks who had worked on theEisenhower refueling, keep them in place and ready to go when the Vinson comes in at the end of the year. This is an interesting job for us because, while we have done dry-docking jobs on carriers before, this is really the first time that we have done what they call a planned incremental dry-docking. And so, the Navy yards do these fairly regularly and we've learned a lot of lessons working with the Navy yards to make this a success. And she'll be delivered back to the Navy by the end of the year.

CVN-21 – you probably have seen a lot and heard a lot about the carrier of the future. Let me just say that when you're setting out to design a new ship, it's the one chance that you have to really redesign the way you build that ship so not only are you able to take advantage of the new technologies that are out there – we're talking about replacing a 40 year-old design, because he Nimitz-class was done in the late '60s and the early '70s when the first Nimitz went to sea. Now, you're talking about taking advantage of all the advances in technology, but it's really your best chance to take advantage of the advances in manufacturing capability, as well. And what we have found is, if you can marry the design-to-build process up with the plan for manufacturing, you have a great opportunity to drive some efficiencies into the process.

It's always a question of starting a new design of a ship or keeping going, and I'm going to talk about that a little bit later in the brief. But in this case, as a result of our design, we're going to be able to take 1,200 people off of that ship. And our estimate of what the cost of those 1,200 people is – on one ship, we're actually going to recover the cost of those 1,200 people – we'll recover the cost of the design in the savings afforded by those 1,200 people. And that's before you ever go into the other savings that come along with workforce efficiencies and production efficiencies that you can get inside the shipyard.

Let me talk to you a little bit about the challenges we face. I really have three areas that I'm going to talk about, but all of these are going to relate to each other. You might call this the perfect storm for shipbuilding, because all of these things are coming to bear at the same time.

The first thing I want to talk about is people. The workforce that builds these ships is the critical element in the building of the ship. And what I'd like to do is I'd like to show you a chart. If you look across the bottom, it talks about years of experience in the shipyard and if you look up the left-hand side, it tells you what the age of the workers are. We've gone through a period of time since the early '90s – in 1990 we had about 30,000 people in the shipyard and today we have 19,000 people. And as the workforce has gone down, the nature of our business is that we usually take that down – we do that in a couple of ways. Early on in the '90s, we did that by reductions in force, by layoffs. Later, we managed that by attrition and retirement. But those early '90s layoffs were done by seniority.

And so what you end up with is this situation, where you have a very experienced workforce with more than 20 years of experience and in the 45-to-65 range. That is a very experienced workforce and very capable workforce. And now, as we are hiring to manage our level of employment, we're bringing in a whole lot of new folks, down in the less-than-five-years-of-experience range, and we have to bring those folks up to speed. And one of our biggest challenges is making sure that we capture what our senior folks know, what our most experienced shipbuilders know – capturing what they know and then translating that to these new folks.

It's our estimate that it takes about five years before you are fully proficient as a craftsman or as a shipbuilder. We can't go to a local community college and ask them to give us somebody who has an associate's degree in shipbuilding. You can't do that; they don't offer that. And we work very hard with our local community college to make sure that they train them in some of the key skills that they need, but there is no substitute for just spending time on the ship and doing the work that we have to do.

One of the things that happened to us during the '90s is that the workforce that we had was very experienced – probably the most experienced workforce we'd ever had in our history – because we were coming down in a point of time when budgets were coming down and projects were coming along. So now we are moving into an environment where our workforce is going to be less experienced.

The number of folks that had less than five years – if you think about the number of people when we delivered theRonald Reagan that had less than five years of experience, just think about what that number is. When we deliver the 77, the George H.W. Bush, that level is going to be twice what it was on the 76. What that means is I'm going to have twice as many inexperienced shipbuilders building the George H.W. Bush as I had that delivered the Ronald Reagan. And, let's go one ship further – if we go out to the CVN-21, if you stay on the plan that the Navy presented to the Congress in 2005, just to deliver that ship, our expectation is that we will have three times the level of inexperience on that ship as we had on the ship when we delivered the Ronald Reagan. If a ship is delayed by a year, it would be worse than that. And so that's one of the issues that we have that we are trying to work our way through.

And I would tell you that if you got to the end of the '90s, as we looked at that, that was one of those things that as management and leadership of the organization, we probably didn't anticipate the effect of that as well as we could have. And so that's part of what has laid on our table when I talk about the perfect storm.

Now the second thing that's happened is, as the budgets have changed, there's been a whole lot of instability brought into our workload. I'm going to show you a chart that just talks about aircraft carriers scheduled. And this is just symptomatic of – or emblematic of -- the kinds of things that we are fighting our way through. On this chart, what we've done is we've laid out the span for building a ship – say, the Truman – from this point to this point, that's how long it takes to build the ship. But what we did is we marked on here where we laid the keel for that ship and then where we launched the ship.

I want to point at the Truman because the Truman is a very interesting case study. The Truman was the second ship of a two-ship contract and it was the second two-ship contract that we had. So in a sense, it was the fourth ship in a production line. And as the fourth ship, we had a supplier base intact; we had our manufacturing facilities synchronized, so that we could optimize the production of that ship. And I want you to look at the gap between the launch of theStennis and the laying of the keel of the Truman because that's in the same dock and we are able to – if we're able to launch the ship, now the dock is empty, but we've optimized our flow, so that within a month, we were able to put the keel for the Truman into that dock behind the launch of the Stennis.

Now I draw your attention to what happened after that because when the Truman launched, the Reagan was the next ship. Had we been able to optimize our facilities and our manufacturing flow, it would have been only one month from the time that we launched the Truman to the point in time where we laid the keel for the Reagan. But in point of fact, it was 18 months.

And now look down to the next ship. When we launched the Reagan, it was over two years before we laid the keel for the Bush. One of the things that's true about shipbuilding as it is about most anything else – that if you can do things in a repetitive way, you can do them more efficiently and you can drive costs and you can become very good at it. When you break that line – when you break that sequence, you start to drive inefficiencies back into it. That gap from Trumanto Reagan of 18 months, and the gap from Reagan to Bush of two years and four months – I think it was – and now the gap from Bush to the CVN-21 – the gap between those ships is approaching four years.

This is another area where we had been through the course of the '90s, we were building these ships in a sequenced and synchronized way, and we probably failed to anticipate the effect – the full effect of breaking this gap. And so right up front in this perfect storm of what's happening in shipbuilding is we've got a demographic issue where our experienced shipbuilders are deciding that they want to go do something else, and we've been banking on that level of experience, and so now we have to go and replace that.

We have a case where we've been doing pretty good series production, and we've had a break in that production. No, the production line didn't just go cold, but we stretched it out at a point – to a point where we lost the ability to take advantage of those learning curves. So those are two factors – the people side and the stability side -- of the shipbuilding perfect storm.

The third factor is what I'm going to call return on investment. If you look at the corporate returns today for shipbuilding, if you were an investor and you pulled out the annual reports for Northrop Grumman or for General Dynamics, and you looked at what part of their sectors are performing, you would probably be less than impressed with the returns that you are seeing in the marine groups of those organizations. And as an investor you would say, “Why is that?” The second question you would ask is, “Is this a business worth investing in for whatever reason?”

I talked about the demographic issue that's in the industry today. I've talked about the lower rate of production and the efficiency piece that's in the industry today. I want to talk about one other change that has happened to the industry that I think has been a fundamental change. Prior to the current administration taking office in 2001, the way that we built ships – we'd contract with the government to build ships. The way those got funded – they were funded in such a way that we presumed that a lot of things would go right. We would sign a contract and we would set targets in those contracts. We would understand that there were risks out there, but we would presume that we would be able to manage those risks, and we would put contract structures in place that would allow adequate sharing or appropriate sharing of that risk between the government and the contractor.

Sometimes it took the form in contract type. You might have a cost-plus contract recognizing high levels of risk that needed to be shared with the government. Sometimes you would have share lines put in place. Sometimes, every contract you would take a look at the risks and then you would try to evaluate the best way to find the appropriate amount of sharing between the contractor and the government.

That was the way we'd been doing business since the early '80s, since before I came into the industry. And then when risks got retired, everybody was a hero. When risks did not get retired, if sometimes things would happen that we weren't able to control, then we would be in a situation where we would have to do a reprogramming of some kind – a budget reprogramming, or a prior-year adjustment, or a ship-cost adjustment, or something where we would have to go explain what had happened and why we weren't able to manage that risk, and then how we were going to go forward and resolve that.

This administration came in, and one of the very first things it did – and I think it's one of the most revolutionary things that has happened in this business, certainly in the 18 years that I've been here – is it said that no more was it going to do prior-year ship adjustments. No more was it going to try to account for those risks outside or in – on top of the contract that exists. It wanted to put the risk management – the cost of managing that risk - in the contract.

Now let me just say that I think that's a great thing. I think that was a great move on their part, and what you've seen in the last four years has been both the industry and the acquisition community have had to wrestle with how to do that because we basically had to train everyone in a new way of doing business. But today I'm able to go and sit down and negotiate with the government a contract that, when I get done with it, I can feel confident that I have a realistic chance of achieving the targets and managing the risks that are in that contract, and then I can take that and I can go to my workforce, and I can say, look, this is the deal. There's no out beyond this, and we can drive the workforce, and we can perform to that. And if you look at just my business, all of the contracts that I have signed since this administration came in place, I'm performing to schedule and budget. But that leaves outside that boundary those contracts that were signed in the old environment but are being managed in the new environment. And that's the challenge that we have today.

We've had challenges on the CVN-77, a contract that was signed at the beginning of 2001, at the very end of the previous administration, and we have challenges on the Virginia-class submarine, a contract that was signed in the '96 or '97 timeframe.

Now let's look at some of the assumptions that we put into those contracts, risks that were identified that needed to be managed. On the Virginia-class submarine, the original plan to go to two ships per year was 2002. We are now at 2012, so there's been a major change in the approach to that program, and you're trying to work through the original contract.

On the George H.W. Bush – when we signed the contract for the George Bush, the production start date for the CVN-21 was in 2006. Today it's in 2007, and the plan that the administration sent to the Hill has it being moved to 2008 to start. In addition to that, the Vinson was delayed, and we were expecting that we would have two submarines per year before the end of this contract.

So all of those risks that were there were things that we needed to – you know, we identified – in that old approach to contracting. We identified risks that the Navy could cancel some work; we'll deal with that when it comes along. That's the way that was dealt with then. Sure, there's a risk that we may not go to two submarines per year; we'll deal with that when it comes along.

Well, if you step into the environment where you say we're not going to make any more adjustments for all of that, then you create a lot of tension in the business. And so, as a result, the industry is under fire. The industry is under fire in my view primarily for the work that was contracted prior to this administration and is playing through and playing out in this administration.

Again, I think that the industry itself is a solid industry and it's worth investing in, and I think it's that way because once you work through these kinds of processes, and you stick to the plan that we're going to manage that risk in the original contract, then I think that what you'll see is, over the next few years as these things work their way out of the system, you'll start to see the returns in the industry move back to a point where they warrant the investment.

We have a unique industry in that our investments are very large. We make very large capital investments. Our best opportunity to make returns on those investments is through production, and so when you see low rates of production, you see challenges to the opportunity, to the attractiveness of the investment, and that's a real challenge for the industry today. How much are shareholders willing to invest in the business given what we see as some of the issues – whether or not they can work their way through some of these challenges? And that's what we're working on, and we're working on that pretty hard.

So now let's talk about that perfect storm again. You've got a very experienced workforce, you've got a pretty solid production train that has only started to frazzle, but you haven't – we haven't recognized the effect of that – the breaking of that production yet, and now you have this change in the way you're going to do the contracting for ships. You put all of those together and you end up in the environment that we have today where returns don't look very good. There's a lot of unfortunate language about overruns on ships, and I would just emphasize I think that's unfortunate when the Navy decides that they want to move a carrier refueling out a year, and that adds cost to my programs and then they tell me that I'm the one who overran that. That's unfortunate language. But it is the language of the industry and that's what we have to deal with on a day-to-day basis.

You put all of those things together and you end up with contracts that have to be worked through, and we have to work our way all the way through those and get them out of our system so that we can get back to the point where we are making the returns on those investments that our shareholders are looking for.

So that's the storm; now, what are we doing about that? Well, the first thing is on the people side. We are investing. At Newport News, we are investing heavily in our people, in our leadership and in our training. We are looking today at tens of millions of dollars of investment in training the workforce so that they are capable in the next four to five years of continuing to build these ships that need to be built. That's a pretty significant investment. That's coming after what I would say is a drought. How much training do you need to do when your workforce is the most experienced, qualified workforce you've ever had in the history of the company? Not very much. We didn't do very much training during that period of time so now we're ramping back up our training to get our people back up to that level. We're trying to take that five-years-of-experience requirement and drive it down to something less than three. That's a major effort on our part.

We work very closely with the local high schools and with our local community colleges. At Thomas Nelson Community College in Hampton Roads, they actually use our software to do their design training, and that way we know that if we hire somebody right out of Thomas Nelson, we don't have to put them through the training for the software; they know how to do that. That's a big advantage for us.

We are also heavily involved in the state workforce development programs, collaborating with the state. In fact, the local chair of the Workforce Investment Board is a shipyard employee, and we do all of the things that workforce development efforts do with regard to making sure that people understand what the job is before they actually get into it.

And then inside the yard it's my view that the way you leverage all of this is with significant emphasis on leadership. I do have a personal view that corporations in general do not have an institutional view of leadership the way that some of the services do, and in my business I think that's a challenge for you when a lot of your work is done with 19,000 people. And so we are investing heavily in making leadership at Newport News a core competency of our business.

How about the rest of it? How do you get to the stability and the return on investment? Well, first of all, you do things like the Teaming Agreement on submarines. Again, the Teaming Agreement was put in place because we expected to be at two ships per year in 2002, but that doesn't mean it's a bad idea today because both partners are demonstrating the ability to come down on the learning curves that we've seen.

Electric Boat did a magnificent job of getting the Virginia to sea -- the Virginia is a wonderful ship. We are working through our lead ship, the Texas, and we'll get her to the Navy next year. I actually think that there is a place in heaven reserved for those of us who have the chance to work on lead Navy ships. You walk into this place and you sit down and you say, “oh, yeah, I worked on a lead ship,” and all the other shipbuilders who worked on a lead ship will just look at their beer and shake their head because there is something different about a lead ship. When you say you don't know what you don't know, that's probably more true about a lead ship construction effort than it is about anything else you can think of. But we're working through our lead ship and by the middle of next year we will have come through that, and I think that Texas will be every bit the success that the Virginia was.

We've done some other things that are pretty creative. For instance, a couple of years ago we actually did an availability on the Enterprise, but we managed that availability while it was in the dry dock at Norfolk Naval Shipyard – quite a change in the way you do business in the harbor at Hampton Roads. It allows us to bring our expertise, it allows them to use the facility that they have, and that partnership was very effective. I mention the things that we've worked with the Navy on, for instance to bridge the gap in the refueling business, where the Eisenhower left at the beginning of this year and the Vinson does not arrive until the end of this year, and we've put the George Washington in there to fill that gap.

Another thing that we've done, though, is we've also formed the Aircraft Carrier Industrial Base Coalition because, for all of the things that I've talked about here about aircraft carriers, it's important to understand that these ships are national assets, and not only are they national assets, they're statements of national purpose. And, yes, they are assembled in Newport News but the equipment and the skill and the craftsmanship comes from all over the country. We have about 45 states or so that supply equipment to these ships. We have the privilege of assembling those ships, but reaching out and helping everyone understand the broad extent of an effect that we have, and support we have from across the country, is very important.

The other thing that we've been working on is we think that if you look at the budget, whenever an aircraft carrier comes through the budget, it is the largest single item in the budget. It's the largest single item in the Navy's budget and they have trouble dealing with that. It's the largest single item in the president's budget and then Congress has a challenge dealing with that. We think that there probably are other ways to more gracefully finance that. Northrop Grumman has been proposing a financing arrangement that we call advanced appropriations that more gracefully lays in, not just for aircraft carriers but for all shipbuilding, a funding scheme that would allow – We frankly think it would be more efficient for the shipbuilders and in the end could save the Navy some money.

At the end of the day, though, what it comes down to is what I am doing inside my shipyard. The very first thing I did on November 1 when I was appointed to this job was I appointed a vice president of process excellence. If you think about the shipyard of 19,000 people and you think about how many processes there are inside that shipyard, and you think about how many of them have been formalized and how many of them have just been passed down from one generation to the next, you realize that there's an awful lot of opportunity there to standardize those processes, streamline them, take advantage of the tools that are out there like Lean and Six Sigma and really drive some efficiency in your organization.

So I appointed Jennifer Boykin to be the vice president of process excellence on the first day of the first morning, and the challenge is to go look at the whole value stream for putting together an aircraft carrier and how can we make that more efficient. And included in that value stream is our customer, and included in that value stream are our suppliers, and we have had some success already – we're four-and-a-half months into it – but we have some pretty aggressive targets that we're going to be chasing, and we think that will have a dramatic effect on the way these ships go together.

And, finally, as I said, these are platforms of national purpose. What this requires more than virtually anything else is close collaboration with our customers. If our customer is involved in an eight-year project to build an aircraft carrier, or the five to six years that it takes to build a submarine, they're involved every step of the way. And being closely partnered with them to understand, number one, what decisions they need to make, and, number two, the impacts of those decisions. And, helping them understand in a timely way that, yes, it's an eight-year project, but you need to make this decision by Friday because you don't have eight years to make that decision. Helping them to understand that is critical and so we are emphasizing collaboration, partnering up with the Navy to make sure that what we give them is what they want, and helping them to understand what the decisions are that they need to go make.

So, that's our approach to this perfect storm. We've got a lot of work to do. We've got a lot of challenges in front of us, but in the end, I'm very excited about the opportunity to do this. After 18 years in the shipyard, it's a great place with great shipbuilders and I think it has a very bright future.

But we have to go take care of some business.