Northrop Grumman Corp. (Electronic Systems sector)

1580-A West Nursery Rd., Linthicum, MD 21090

TEL: (410) 993-2463

Chairman & CEO: Kent Kresa

　

TO OUR SHAREHOLDERS

　

For Litton, 2000 was a year of accelerating change both in our markets and our operations. In this environment, we strengthened our management team and made substantial headway in refocusing and investing in our businesses. Progress will continue in 2001, with Litton emerging stronger, more effective and better positioned to generate sustainable and profitable growth going forward.

　

We strengthened our balance sheet, making significant progress toward reaching our goal of 45 percent debt to total capital, an important benchmark in support of our investment grade rating and access to capital markets. Once we reach our goal, we will have greater flexibility to pursue growth opportunities or repurchase Litton stock.

　

In many areas, we achieved solid performance during fiscal year 2000. We continued to bolster our technology leadership in our key markets of ship systems, information systems, advanced electronics and telecommunications. Fiscal year 2000 revenue increased 16% to $5.6 billion. Net earnings and diluted earnings per share were $218.4 million and $4.74, including a charge for the cumulative effect of a one-time accounting change ($.06 per share) compared with $120.6 million and $2.58 for fiscal 1999. We ended fiscal year 2000 with a total backlog of $10.4 billion.

　

Throughout FY2000, we demonstrated our willingness to strengthen our business through strategic acquisitions and divestitures of non-core business units. We completed the largest ever Litton acquisition, of Avondale Industries, for $529 million. With Avondale and our Ingalls Shipbuilding businesses, we created the Ship Systems reporting segment which has combined revenues of about $2.0 billion and the capability of producing any class of non-nuclear ship for military or commercial customers. For FY2000, Ship Systems revenue increased 83% and operating profit grew 74% as a result of the Avondale acquisition and double-digit revenue growth at Ingalls.

　

The sale of WSI, our real-time weather data and forecasting business, generated pretax proceeds of $120 million, which were used to pay down debt. We also divested Emerge, our agricultural imaging business, and selected assets and liabilities of Litton Enterprise Solutions. We believed these businesses would be of greater strategic value to the acquiring companies as we continued to sharpen our focus on those segments that offer more substantial long-term returns.

　

To enhance our leadership position in the non-nuclear shipbuilding industry, we invested heavily to improve manufacturing efficiency and increase productivity. We also created a Litton Ship Systems Full Service Center business unit to provide customers with a complete range of research and development, design and life-cycle support services. Strengthening our Ship Systems business gives us a strong position in a market that offers good returns and long-term growth prospects.

　

We made capital investments to ensure continued growth in our Electronic Components and Materials business, an area where we see outstanding opportunities. These investments -- in capacity, productivity and technology -- have provided rapid growth in sales to the exploding telecommunications industry where our high-tech materials and components are enabling products in wireless broadband communications, the Internet and data storage. More important, we will increase investments in FY2001 in new product development and capacity expansion for high-growth product lines such as Gallium Arsenide wafers, backplanes and optical connectors and components.

　

In our Advanced Electronics business, we have for the last three years engaged in an aggressive productivity program that has enabled Litton to improve cash flow. We also have won many key development programs such as in the integrated systems segment of the defense electronics market. We see the integrated systems market continuing to grow. Certainly, there are challenges that lie ahead and we are working diligently to reduce risks and position this business for the best value in the future.

　

With the sale of non-core businesses and the transfer of Data Systems Division to the Advanced Electronics segment, we focused our Information Systems business on core information technology(IT) units, PRC and TASC. During 2000, our PRC subsidiary won significant contract awards, including a role in a potential $1.5 billion program to provide a "smart card" system to all federal agencies and leadership in a U.S. Department of Treasury enterprise resources planning system that has a potential value of $110 million. Our TASC subsidiary, which exceeded revenue and operating profit plans for the year, had a strong win rate, including receiving one of multiple contracts on the Defense Information Systems Agency's $1.5 billion Information Assurance program. With continued growth at TASC and improved fundamentals at PRC, we will strengthen our position as a top-10 federal IT services prime contractor with core competencies in defense, intelligence, public safety, health and outsourcing services.

　

Although we accomplished much in FY2000, we are far from satisfied. We announced in September that targeted earnings per share growth in FY2001 will not match the double-digit rate we have posted over the last several years. Our efforts are now focused on building a foundation to achieve growth in sales, earnings and cash flow. To do that, we must accelerate the pace of change throughout the organization to seize the enormous growth opportunities in existing and evolving markets.

　

We continually evaluate our business and market positions to assure that Litton is positioned to enhance shareholder value. We have the technology to compete in the markets we serve. Moreover, we have institutionalized our cash-flow-return-on-investment metric companywide, making it a key element in our incentive compensation program to link business performance more directly to increased shareholder value. The application of these technologies and metrics -- with appropriate pace -- will continue to improve our market positions and provide superior return on investment.

　

To prosper in today's rapidly changing business environment, we continued our strengthening of operational management. Late in FY2000, Ronald D. Sugar was appointed president and chief operating officer. Ron brings outstanding managerial depth and breadth from both commercial and government markets and a proven record of success. We have new senior managers in Electronic Components and Materials, Ship Systems, Information Systems and Corporate Human Resources who will provide the leadership needed to achieve our increased level of expectations.

　

Finally, it is important to us that we salute the outstanding contributions of Litton's 40,000 employees worldwide. Because of their continued achievement of tough and challenging goals and dedication to innovation and customer service, the long-term value to our shareholders will constantly build. We are proud of who they are and what they have done.

　

When trouble breaks out in hot spots around the globe, the U.S. Navy and Marine Corps deploy peace keeping forces via Wasp LHD Class amphibious assault ships. The largest private employer in Mississippi, Ship Systems is the sole source on this program and has delivered six of these large-deck ships designed to carry 2,000 Marines into action, and is currently working on two more. Among the many other mission critical programs at Ship Systems is the Arleigh Burke DDG 51 Class Aegis guided missile destroyer, considered one of the most important shipbuilding programs in America today, the advanced technology LPD-17, the Navy's newest class of amphibious assault ship, and the Strategic Sealift program, featuring ships that are among the largest in the Navy's fleet.

　

Litton is building three of the world's new environmentally safe tankers. The first double-hulled tankers to be built in the United States, these ships will transport critical crude oil supplies between Alaska and ports on the U.S. west coast. Cutting edge Litton technology will help ensure that environmental safety is a priority for the program.

　

Litton's inertial navigation systems and integrated electronic systems keep military and commercial planes and ships safe and on course. The Company's on-board oxygen generating systems supply 80% of the market to enable military aviators to breathe easy and fly higher. And Litton provides specialized information technology (IT) services to the National Reconnaissance Office and other defense intelligence customers. Litton is applying its expertise in the design and development of air and missile defense systems to the Theater High Altitude Area Defense program, providing battle management command, control and communications for this critical defense system.

　

FBI, state and local law enforcement officials are gaining access to faster and more reliable fingerprint identification of criminals thanks to Litton's state-of-the-art integrated network storage and workflow management systems. In the largest contract of its kind, the U.S. Department of Treasury awarded Litton$110 million in FY2000 to provide program management and systems integration services for its enterprise resources planning (ERP) system, which will provide human resources and payroll processes for 14 agencies. The Company is also developing a technology framework for a government healthcare information system as well as IT systems for medical supplies and patient information.

　

Litton plays a key role in the wireless technology fueling today's communications revolution. The Company's Electronic Components and Materials business produces and processes the Gallium Arsenide-based wafers used in hand-sets along with the complex backplanes essential to network telecommunication base station equipment, large network servers and data storage systems. Litton also supplies fiber optic switches, couplers, optical crystals, microelectronic attachment materials and other electronic and optical components to this rapidly growing market.

　

Clockwise from upper left: Gallium Arsenide wafer for telecommunications market; navigation systems for Eurofighter; shipbuilding at Litton Ingalls shipyard; laser gyro inertial navigation units for Apache Longbow helicopter; command, control and communications systems; advanced antenna system.

　

In information technology, Litton is a top-10 systems integrator for the federal government as a whole and is the largest system engineering contractor to the National Reconnaissance Office. In the civil sector today, nine out of the 11 largest U.S. cities use Litton's highly advanced 911 emergency response systems.

　

In advanced electronics, Litton has forged strong leadership positions worldwide in inertial navigation, electronic warfare systems, laser targeting devices and night vision systems. In addition, Litton is widely sought after for voice communications systems and has pioneered oxygen separation technology for both defense and commercial applications.

　

In electronic components and materials, Litton is a worldwide leader in laser crystals used in medical and industrial markets, in semi-insulating Gallium Arsenide wafers used in telecommunications applications, oxygen/nitrogen generators, backplanes, slip rings and microelectronic bonding materials for the semiconductor and telecommunications market.

　

In ship building for the U.S. Navy, Litton is a leading designer and producer of surface combatant ships and is assured participation in the next generation DD-21 destroyer/cruiser program. Litton is also leading the way in commercial markets by constructing double-hulled tankers and the first cruise ships to be built in the United States in 40 years.

　

Litton's continuous improvement efforts extend to every corner of the organization. The Company is committed to exceeding customer expectations by raising the bar on quality and service. Litton made progress in this area in FY2000 when its Information Systems subsidiary, PRC, attained the Software Engineering Institute's highest level designation (the SEI Level 5 rating). Only 1.4 percent of U.S. companies serving government agencies have achieved this goal. As part of Litton's ongoing effort to improve operations and reduce costs, the Company has developed a centralized purchasing procedure for certain subsidiaries and continues to promote synergies between divisions.

　

To fortify its leadership position in highly competitive worldwide technology markets, Litton must attract, retain and develop the most talented work force in the industry. To that end, in FY2000 Litton established a program for sharing best practices within and across divisions and invested in the future by sending 300 managers to a customized executive education program at the Harvard University Graduate School of Business. One of the goals of the program is to reinforce the value metrics developed to ensure that shareholders achieve superior return on investment.

　

Clockwise from upper left: Ring laser gyro inertial reference system for navigation and flight control; information systems for"911" dispatch center; integrated bridge system for latest U.S. Navy ships; Gallium Arsenide wafers for cell phone hand-sets; ship construction underway at Litton Avondale shipyard.

　

　

In FY2000 Litton made substantial progress toward its goal of reaching a debt-to-total Capitalization ratio of 45 percent. By year-end, the ratio was 48 percent, down from 55 percent at the beginning of the year, following the acquisition of Avondale. The goal is to increase free cash flow to give Litton the ability to repurchase shares, create debt capacity and invest in growth opportunities, building long-term value for shareholders.

　

As part of a commitment to improve shareholder returns, Litton acted to strengthen its core competencies. Actions taken during fiscal 2000 included putting new management in place in key units, investing in productivity improvements and strengthening technological competencies. In addition, the Company completed divestitures of its weather information systems, agricultural imaging and commercial mainframe data outsourcing businesses. By selling these businesses to more strategic partners, Litton was able to sharpen its focus on its core federal information technology systems and services, commercial electronics and shipbuilding markets.

　

Aggressive capital spending programs in Ship Systems and Electronic Components and Materials (EC&M) will assure continued competitive advantage in the markets Litton serves. The major capital spending program begun at Ingalls Shipbuilding this year is scheduled for completion in fiscal year 2001. These expenditures will increase productivity and assure Ingalls' competitiveness as it pursues new opportunities in military and commercial shipbuilding. Investments in EC&M will be focused on serving the rapidly growing telecommunications, Internet and data storage markets by investing in new product development. Litton will also expand production capacity in existing high-growth product lines such as high density connectors, optical switches and components, large complex, multi-layer printed circuit boards, and backplane assembly and integration.

　

Internal growth in shipbuilding, information technology and commercial electronics, combined with selective acquisitions, can support Litton's long-term goals of doubledigit earnings growth and cash returns substantially in excess of cost of capital. As it pursues these long-term financial goals, the Company continually evaluates its portfolio of businesses, assesses its market positions and allocates managerial and capital resources to position the company for success. Litton is confident that these businesses can support accelerating growth in sales and earnings beyond fiscal year 2001.

　

Clockwise from upper left: Laser crystals; voice switching technology for air traffic control systems; capital expansion program at Litton Ingalls shipyard; integrated voice communication system; microelectronic attachment material for integrated circuit board; ship construction at Litton Avondale.