On Tuesday, May 9, 2006, Philip A. Teel, president of Northrop Grumman Ship Systems, briefed the media on the regeneration of the company's Gulf Coast shipyards following Hurricane Katrina. Below are remarks from the briefing.

Good morning. I appreciate everybody coming today. We’ll cover a range of topics. Some of the topics will relate to Katrina – I’ll talk a little bit about that. But I think before we get into that we’ll give you a little bit of an update of Northrop Grumman. I know you all know the company, but I’ll just put us in perspective a little bit.

And then also talk a little bit about the shipbuilding issues that are on the table today, a little bit about the cost issues, how we see that, and what we’re doing about that issue, and in general where we’re headed with costs and cost improvement.

I would like to make this as interactive as we can. I think we’ve got about an hour, maybe a little bit more, but about an hour. I think the briefing, depending on how quickly I talk, is about 30 to 40 minutes. In the course of that, if there are questions or issues that either in something I say that doesn’t seem to make sense to you, or if there’s something that’s topical that you’d like to interrupt, let’s do that because I think then it will make the communication go a little more effectively. So feel free to ask questions.

If we start down a path that gets us too far off the topic at hand, we’ll move back to the briefing and then cover that question at the end. But I’d like you to just interject the questions as we go along.

First of all, you all are very familiar with the company. I won’t spend a lot of time describing the different operating sectors. I might point out that, as I think most of you know, we’ve added a new Technical Services sector the first of the year. That will focus our services business that each of our different operating units had, and get us in a more focused position to pursue the technical services and after-market service business. You can see the other parts of our business. Each of those sectors are significant in their own right. The company itself is, as you all know, $30 billion plus in sales and 125,000 people.

For Ship Systems specifically, we have three major sites on the Gulf coast, a combination of what used to be called Ingalls, a Litton operation; Avondale, also a Litton operation when acquired by Northrop Grumman; and then the Gulfport facility, and we’ll talk some about that facility and some of the changes that have taken place there. We today have 12 ships in production. I hope within the next few weeks we’ll have a couple more. And we have five different classes of ships that we are building or designing at this stage. So we’re not a one-ship or small shipyard building one type of ship. We build many different types of ships, one of the largest defense shipbuilders in the world.

Production facilities – we have three facilities, as we talked about. Here is a brief summary of those facilities. We’re the largest manufacturing employer in both Mississippi and Louisiana. We today have about 16,800 people at all of those facilities.

Unless there are any questions about the facility piece, I want to move directly into a topic that I know is something important to all of us. It’s certainly important to us, and I know that you all have been covering this topic pretty significantly over the course of the last few years.

Shipbuilding costs. You know, we talk a lot about the cost of shipbuilding. Certainly I talk a lot about it. I hear a lot about it, and as a result I see a lot written about it because that’s usually what I’m reading about. Today what I’d like to do is talk a little bit about some of the cost drivers, offer some suggestions about what is being done to deal with those cost drivers, both within the Navy/Department of Defense and within Northrop Grumman, and I believe in other shipbuilders. But I’ll let them speak for themselves.

This breakdown is really a compilation, as it says at the bottom, of several studies, studies by Congressional Research Service, RAND, some of our own internal sourcing, our own internal analysis. So I won’t attribute it to any single source, but I think what’s important about it is that there is significant consensus that if you look at what are driving shipbuilding costs today, and I would say today is probably the last 5 to 10 years. Complexity – we’ll talk a little about that. And build rates and programmatic churn are some of the significant drivers. Those drivers are not difficult to describe with a one-liner. System complexity relates to the complexity of the whole mechanical and electrical portions of the ship. They also apply to the combat and weapons systems of the ship. Obviously the build-rate issues have gotten a lot of discussion. Numbers of ships in total and the number of ships of any one class have significant implications.

And our Navy customer, certainly over the last year, has begun to focus pretty significantly on those cost drivers. Stable acquisition plan – a lot’s been written about that, as we all know. A lot’s been written about how that can be achieved in the fiscal constrained budget environment. But stability is certainly a big issue.

Disciplined acquisition process. Again, the Navy and the Department of Defense have taken a pretty strong position on maintaining control of requirements. And control maybe is the wrong word, but certainly understanding the implications of requirements on cost, and working to keep change down, both change in the acquisition strategy and the plan, but also change in the baseline of ships and the weapons systems that drive the weapons of those ships.

We obviously, I think you know, strongly support that stable approach to both aspects of that, and it will certainly go very strongly toward both the system complexity issue, but probably more importantly toward the programmatic churn and the build rate issues.

From industry’s perspective, and certainly our perspective, over the course of the last several years, and certainly over the course of the last couple of years, we all recognize that some of these issues aren’t going to change. We aren’t likely to have large production runs of any ship class, certainly not in the foreseeable future. We’re not likely to see return to the pre-‘90s construction quantities of 19 ships a year. Likely we’ll be in the six and we hope eight to nine ships a year. So there are some realities associated with it.

The ships will be no less complex than their predecessors. We certainly understand that as well. In that constrained environment, and with a commitment by the Navy to increase the top line, to increase the numbers of ships – maybe not to pre-90’s situation, certainly not likely – and to control change and program variation, we’ve looked at what we can do as an industry and have embarked on that path. And I’m going to talk a little bit about some of the things that we have done because I don’t think we’ve talked much about that story.

Obviously capital investment, we’ve heard a lot about that. Our secretary of the Navy certainly has encouraged us to do that. I understand that. And our industry understands it. We are a capital intensive industry, and we know that it requires capital to do our job. I’ll talk some about that.

Process focus, as I believe the secretary intended, and still intends, to make the point that process focus doesn’t necessarily – although there’s investment to be made – have the same cost investment of capital. It can have significant leverage on the outcome of what we do, and I’ll talk some about that. I think that’s an area that we in American shipbuilding have got to focus on.

And then the last point, much has been discussed about how much capacity American shipbuilding has, especially if American shipbuilding is only going to support Navy and Coast Guard ships. Clearly reduced infrastructure on standing shipyard basis is something that we have to look at, and I’ll talk about that in a little bit more detail as well.

So we feel very positive about the direction the Navy’s taken. We think that within the constraints that they have to live – and being a shipbuilder I’d like to see some of those constraints removed, and that is the number of ships that are bought – but within the fiscal realities of it, a stable plan is certainly a step in the right direction. And certainly an acquisition process that doesn’t move that number of ships and type of ships around on a constant basis, and controls the configuration of those ships, will go a long way to help us. Then we in return can do those things that I mentioned there. I’ll talk a little bit about those.

First I’d like to talk about some of the things that we at Northrop Grumman, and specifically Ship Systems, have been doing to address some of those issues back really starting in 2000. Because those issues aren’t new. There’s a crescendo of discussion about them today, but they’re not new. And I won’t go through each one of those, but one of the things I do want to point out is that over the course of the 2000-2001 time period, that was the period where we were actually putting together one sector from multiple different shipyards and trying to focus – I would call it an internal consolidation. The beginnings of the planning for the internal consolidation to address the capacity issues on an internal basis. And also then to stabilize the manpower.

Much has been discussed about having a trained workforce and the impacts and implications of that. I’ll talk some more about that a little later. We also recognize that with too much steel capacity, we probably did not have any composite capacity. We believed and still believe strongly in shipbuilding it would help, as it has in the aircraft industry, to change some of the paradigms of cost to produce ships. And so the composite facility was a focus for us at Gulfport, and we also took that facility offline as a metal-manufacturing facility, and then began to leverage the buying across the sector and get gains associated with, again, multiple yards combined into one single sector.

The next step was really to embark on a capital investment program that would both invest in the capability – not capacity, although I’ll talk some about that – but in the capability of those yards to operate in this century in shipbuilding. We also had to facilitize for the future. DD(X), now DDG-1000, required additional investment to facilitize to be able to produce that ship. I’ll talk about that a little bit more on the next slide. And again, the composite manufacturing was a large piece of that, as well as the heavy lift capability that was required because that ship will be much more modular and built in a modular way, much more so than ships have been built certainly in our yard, and most American yards in the past. So a heavy lift capability was necessary, which improves our efficiency.

And you can see investment in panel lines, investment in safety and environmental. Total over that period of time was about $463 million. About $200 million of that is Northrop Grumman capital. The remainder of it is from the states of Louisiana and Mississippi, who partner with us to invest in our shipyard and invest in their people and the jobs in their states. They’ve been great partners for us across the course of the last several years. So [these are] some of the things that we were doing prior to Katrina – and really prior to this debate being as vocal and as open as it is today about what needs to be done to get shipbuilding costs under control.

Talking a little bit about the centers of excellence, and the combination of restructuring within single yards and bringing capability and capacity down in those yards. Over the course of the period of time that we described in combining Pascagoula, Gulfport and New Orleans, we reduced overcapacity significantly. Basically shut parts of the yard down, consolidated functions and capabilities, and the outcome of that, along with the leveraged buying, has been over $95 million a year in annual savings to the cost of our sector – of the things that we deliver. So our customers have seen that kind of savings.

I put Newport News up here. As you know, during this time Northrop Grumman bought Newport News. And our first step at having the Ship Systems sector and Newport News working together was to combine buying. That was step one. Since that time we’ve continued to look at ways that would bring those two shipyards together, and I’ll talk a little bit more about that in the post-Katrina era as we begin to rebuild, or not, facilities at our yard. We have capability at Newport News that we can take advantage of. [This is] another one of those areas where we can bring capacity down within our own existing yards as we try to deal with both the overcapacity issue as it is described, and the realities of how many ships we actually have in production today. If I look across my yard today, I’m hard-pressed to find overcapacity, and I don’t just mean at Pascagoula. I mean in Avondale and at Newport News, to get the jobs done that we’ve got to do.

I mentioned the expansion for DD(X). The yellow dotted area there is a new addition to the – to the quay area and the area that we needed for DD(X). That large crane you see is also part of that process. And then you see dotted phase two, which is the next phase required to complete so that we can bring the large deckhouse-assembled unit from our Gulfport facility, load it on, and the large units that Bath will build, (because we’ll share the building of these ships) that Bath will build that will be brought down and loaded on. So we need this extra area for large lift capability and bringing large blocks on.

And importantly, down on the right-hand side you see, that’s the national security cutter, NSC-1. And if we hadn’t built that expansion area, frankly we’d be hard-pressed to find a place to put her together. So she and her sister ships will be built there as we work up to DDG-1000.

Process and process improvement. This area across our industry really gets a lot of discussion. Maybe less attention but a lot of discussion. We have embarked on a process-improvement path that would look across our entire value stream. We have brought in people from other parts of our sector and outside experts over the course of the last couple of years, and certainly focused on it in the last year, to begin to look at exactly how we do what we do, and how we document and then train our employees on what we do and how we do it.

Shipbuilding, as I think all of you know – many of you visited our shipyard and many others – has always been described as different. In many respects it is, and it’s certainly one of the few industries in this country that still brings raw material in one end, and out the other end goes a completed, and, in most cases, a phenomenally huge and complex warship. That’s an important capability for America to retain.

On the other hand, there are many things that we in the shipbuilding business need to and are learning about process documentation and about process change that has and in the future will significantly help us to address the cost issues. In this regard I certainly agree with the secretary of the Navy, in his push in urging us to get more process focused. We’ve been attempting to do that, and in fact we’ve made some real gains with real savings to come from it. But expect much more from us in this area. This is an area we’ve turned the gain up significantly. I’ll talk a little about that some more, but it’s a little like promising things in the future. I’ll wait to talk more about it until after we’ve shown you the savings and our customer savings we expect to get from it. But we have made progress, even already to date.

All of those numbers don’t mean anything unless they get to the actual cost of delivered product. That’s what our customer is expecting us to do. And frankly, as you know, we’ve had mixed results over the course of the last several years, but in those areas where we do have process maturity, and in those areas where we are at the place where we’ve built more than one ship, we have been doing really quite well. And I believe the same can be said for our “competi-mates” at Bath because I know that they’ve been doing some of these same things, and both of us are seeing some real gains in the DDG program in particular.

I won’t go through these numbers in detail, but I want you to just look at the percent trends. And those are real numbers, documentable with our customers. They’re not numbers made up for this briefing. They’re numbers that are very much a part of what we do every day. At the top it’s labor reduction. The bottom is what we call cost of quality, the impact of good first-time quality, not having to re-do or re-make. And you can see we’ve made improvements really across the board. You can see LPD-18, then how the improvements on 19, 20 and 21 were significantly improved beyond that. As goes first-time quality, so goes cost.

Now first-of-class. A lot’s been made, and rightly so, in our industry. You all have written a lot about it and we’ve said a lot about it about how difficult it is to build a first-of-class new ship. And we oftentimes try to give ourselves a mulligan on that first ship. We try to say, well, that first ship, well, first time. It’s going to cost a lot. It’s going to take a long time. That’s true to some extent, but we can’t avoid the fact that we should not miss the estimates for that first ship to the extent that I believe we have, and certainly I believe it’s an industry issue.

So we’ve taken it as a direct challenge to work on what we can do to improve the – again, processes, but also the focus on those first-of-class ships. I’ve taken an example here of our newest first-of-class ship and the one that really has gotten a lot of attention from us, and that’s the National Security Cutter Number One. Across the top you’ll see hours per ton of that first-of-class ship compared to other first-of-class ships at our facility. You can see it’s significantly better. There are differences in that ship. It’s not the same ship that a DDG or a 963, but I will tell you it’s a very complex ship in its own way and it certainly has a Coast Guard flavor to it, which is a very different ship and therefore adds first time complexity that the others don’t.

Some of the things that we have done to focus on those first-of-class issues, and sort of the bottom line, the ship that we proposed was 10 percent more cost per ton than the ship that we are building, which I think is a significant achievement for our workforce. And first-time quality compared to the 21st DDG and the very first NSC, we’re doing better in first time quality for that ship. So I think we’re making progress on the first-of-class ships.

One other thing that I want us to think about, and I think this is another one of those issues of focusing the national debate. I talked very early in the discussion about cost of a total weapons system, a thing called a ship. Over the course of the last many years, and I think this trend we’ve all recognized but maybe haven’t focused on to the extent we should; we’ve started doing that. If you look at the controllable costs that the shipbuilder deals with, and the cost of the mission system and armaments system, combat system, weapons system, however you want to describe it, and how that percentage has changed over the course of time, I think it’s pretty illuminating. And I also believe it tells us that we need to address all the aspects of the cost challenge.

DDG-1000, as you can see, is percentage-wise cost perspective more combat system and weapons system than it is HM&E. DDG-51 class, the Arleigh Burkes, are about 50-50, and then you can see how it goes back to the time period of the 963s. So I don’t want us to lose that in our debate about how we control shipbuilding costs.

Much has been said about the DDX, the cost of DDX, the capability of DDX. Back to that complexity factor that we talked about on the chart that drives the different costs. DDG-1000 will be designed – and actually is designed, because we’re in the early stages of the detail design, but certainly much of the design has proven itself through phase three – this ship’s designed for producability. We and Bath have an integrated design team. Each of us has 50-50 share of the design responsibility. We have linked design tools, design teams and common design objectives to build this ship in a way that will set the stage for future complex shipbuilding in both of our yards, not only for this platform but all platforms that are to be built after that.

You’ll notice that these relate to probably a million hours of reduction in production cost over what classic production techniques would require for the building of this ship. Design for modularity is huge. That’s part of what we talked about, about facilitizing at our yard. Being able to design and integrate a deck house. In this case it’s all composite, that will integrate all the elements of that deck house – read combat weapons system – together before, and test it, before it ever is delivered to the ship. The modular gun system, which again will be tested and delivered in modules and then installed in the ship. The modular sonar, something that was put together, as we call it, in stick figure in the past, now comes together in a modular capability that’s been pre-tested and bolts in.

Human engineering issues inside the ship, the deck house, or the deck heights are slightly higher, that allow us more freedom in cable runs, also as a nicer ship from a habitation perspective, will also allow us to be able to put enclosures in that are large enclosures that will allow commercial equipment because those enclosures themselves will be shock-tested, shock-mounted so that commercial equipment can be brought in, which brings the cost down.

So the focus on produce-ability, and that ties closely with process, is major in our shipyard and other shipyards to begin to bring the cost of these ships down. It’s certainly something that you’ll see on DD(X).

I talked a little bit now about sort of what we and we think others view to be the impacts of the cost drivers and some of the things we’re doing about it. We are on a journey, I’ll talk about that later, on addressing those cost issues, but I wanted you to know we have started that journey.

I’ll talk a little bit now about Katrina. I really did want to emphasize the word unprecedented. I think it’s important for all of us to recognize, and I know you do, that Katrina was unprecedented, and there’s been much that you’ve written and you’ve been told about the unprecedented nature of some of the things that people have asked about, and asked for as a result of the impact of Katrina, and have asked our Congress for. And those too are titled as unprecedented – unprecedented events requiring unprecedented actions, I would submit.

Several of you have seen this slide. I won’t stay here long, but one of the things I want to point out is you can see the eye of the storm that went just to the west of Gulfport. That was where she entered. So the storm split our shipyards, literally and figuratively. And part of the display of the rubble fields and so forth around gives some indication of how significant the impact was, even inland as far as Hattiesburg.

So the region that was impacted that we now have – and are in fact recovering in – is fairly extensive, both along the coast and inland in terms of the disruption to the infrastructure and to our people. Again, some of you have seen this slide. I won’t belabor it.

Pascagoula and Gulfport were significantly impacted by wind-driven water and storm winds. Our New Orleans facility was much less impacted. It was on the west side of the river in New Orleans, and on the west side of the storm, which was the more kind side of the storm. And we’re very fortunate, and Navy shipbuilding is very fortunate, that was the case. Had we had significant damage there as well, we wouldn’t have been able to come back to production as quickly as we were because we’re using the Avondale facility for all of our shopwork that we don’t offload to some other local provider or manufacturer or Newport News. So that’s been a significant gain for us, and we’re really pleased that we had already combined the shipyards together.

Impact to labor. You’re looking at representation of the production labor, production resources pre-storm, equivalent head count. The impact of the storm, and then the build-back. At this stage I want to make a quick plug for the Gulf coast shipbuilding workers. We had never anticipated that the recovery of that valley would happen as quickly as it did. We had about 7,000 workers back by two weeks after the storm. We were back building ships two weeks after the storm, and we could have never done that if people hadn’t come back. And many of them were – were there and didn’t have homes. Quite incredible. And they’re still there and they continue to come back.

As some of us talked about earlier, we find that while the workforce came back quickly, we didn’t – they obviously had a lot of distractions and they’re still working on their homes. Homes will take some time to rebuild, and in many cases maybe years, and so the equivalent head count is lower than the actual total head count because people aren’t working the full 40-hour week still. But they’re there, and that’s what’s important, and each day it gets a little better in that regard.

Cost impacts. Impact to ships, the damage repair, the delay, the disruption, the impact of that lost 8 million hours of labor, about $1.5 billion. Infrastructure impacts, facilities, equipment, the clean-up, things that are the company’s costs to pay, about $850 million. So our impact and the impact to Navy shipbuilding on the coast is in the billions of dollars.

Now what are we doing to regenerate? I won’t go through those numbers, but you can see we’re significantly back, especially if you look at numbers, numbers, percentages. The critical issues are about the third line down on the Pascagoula line – 40% of our shops are operational. So the front end part of our business is still significantly impacted. And as I mentioned earlier, we’re using the New Orleans facility offloads some of that shop work. We’re using out-sourcing to offload that, and we’re using Newport News to offload work to. But I think the important part is 12 ships are in production.

We also delivered two ships in December. So four months after the storm, we delivered San Antonio and the Forrest Sherman. Now those ships were nearly complete before the storm. Both got moderate storm damage. They were in the yard at the time. But we got those ships delivered and the Navy I think was very pleased to get those.

So the summary of this chart, significantly back but our shops are significantly still in disrepair and will take quite some time to get back online.

This is a summary of a little bit of what we just talked about and sort of the time period over which that recovery activity will have to take place. I want to speak just a minute about – and I know I’m probably running a little long, but I wanted to speak just a minute about what we’re doing to take advantage of – that’s a term I can use – use the opportunity that Katrina has provided us to continue the work of the capital investments, the process changes, and the activity to facilitize for the work that we have in the future.

One of the things that I think is important to highlight, and many of you have probably seen it, there’s a company called First Marine International, a consulting company out of England. FMI has done two benchmarking studies for the DoD over the course of the last several years. The benchmarking studies are looking at American shipbuilding versus international shipbuilding – compare and contrast and look at where those shipyards in this country can improve and build on what some of the foreign yards are doing.

They just completed their last update of that study last fall. We after the storm brought FMI in, told them we don’t have a greenfield here but we’ve certainly got opportunity as a result of what’s happened from Katrina, and they’ve been working with us fairly closely to identify areas that we can take advantage of, given what we’re recovering from and what happened during the storm. That’s been, I think, pretty valuable to us.

One of the key issues, and frankly maybe all of the key issues, really do relate to process as much as they do facilitization. I’ve talked about the idea of design for produce-ability and design of ships so that they are built in your yard. As many of you know, we’ve talked about the differences between large commercial shipbuilding in our organizations, and U.S. defense shipbuilding entities, and it’s frequently been understood as an excuse, but I’ll point it out one more time. In the case of commercial shipbuilding around the world, first of all, they build large quantities of ships – we’d frankly all like to do that. They also build ships that are less dense than and complex than the ships that we build. But I think as importantly as anything else, their ships are designed to be built by the yards that they have. They’re largely able to do that because of the lack of variation between the different ship types.

We design ships on the basis of the requirements that the Navy and the Coast Guard give us, and then design ways for those ships to be built in the yards that we have. One of the things that FMI is working with us on is how we do a better job of that front-end design for produce-ability activity so that we can join the Navy’s requirements, or the Coast Guard’s requirements with our shipyard capability to build, without creating inefficiencies that have been allowed to get into the system in the past that slowed down the front-end process of shipbuilding. So I think that will go a long way to help us.

The storm has also given us an opportunity to close another element of our shipyard. We’ll close the east bank of our yard, take more capacity out and move that capability to our west bank yard because we can support the capability and it’s more capacity than we would need to keep that yard open. We will add lift capability that will help us to build these mega-blocks that I mentioned earlier. The more blocks you put together, more outfitting you do in the yard before you turn them into an erected ship, the cheaper it is and the faster it will go.

We’ve proven to ourselves that we can do a thing called neat-cutting. We’ve increased our accuracy at building LPDs, and on LPD-21, for instance, we actually have gone through neat cuts that allow us to be able to cut the unit to the exact dimensions it needs to be before it’s ever lifted up as a mega-block and put on the ship. That saves a tremendous amount of time and allows additional outfitting to be done. [There are] several process changes that then drive investments in capital to be able to see them come true.

And, we’re completely changing our planning and scheduling system. We have begun that process, and we’re in fact now buying a tool that will allow us to be able to automate the system much more than it’s been in the past and to be able to plan down to the level of the worker within the work compartment as opposed to a section of the ship, which will make a big difference.

So several things are going on as a result of the opportunities that Katrina provided us to get at even more of those costs that we’ve talked about earlier. And our objective is to build back better than we were before.