SEC Filing - Northrop Grumman

FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 29549 (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 or ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________________ to _____________________ Commission File Number 1-3229 NORTHROP GRUMMAN CORPORATION (Exact name of registrant as specified in its charter) DELAWARE No. 95-1055798 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1840 Century Park East, Los Angeles, California 90067 (address of principal executive offices) (310) 553-6262 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock outstanding as of October 19, 1998 68,817,686 shares Northrop Grumman Corporation and Subsidiaries Part I. Financial Information Item 1. Financial Statements CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL POSITION September 30, December 31, Dollars in millions 1998 1997 - ---------------------------------------------------------------------- Assets Cash and cash equivalents $ 80 $ 63 Accounts receivable, net of progress payments of $2,716 in 1998 and $2,999 in 1997 1,418 1,441 Inventoried costs, net of progress payments of $551 in 1998 and $495 in 1997 1,580 1,283 Deferred income taxes 81 82 Prepaid expenses 65 67 - ----------------------------------------------------------------------- Total current assets 3,224 2,936 - ----------------------------------------------------------------------- Property, plant and equipment 3,115 3,109 Accumulated depreciation (1,807) (1,763) - ----------------------------------------------------------------------- 1,308 1,346 - ----------------------------------------------------------------------- Goodwill, net of accumulated amortization of $313 in 1998 and $244 in 1997 3,401 3,421 Other purchased intangibles, net of accumulated amortization of $278 in 1998 and $208 in 1997 826 896 Deferred income taxes 396 485 Prepaid pension cost, intangible pension asset and benefit trust funds 705 452 Investments in and advances to affiliates and sundry assets 112 141 - ----------------------------------------------------------------------- 5,440 5,395 - ----------------------------------------------------------------------- $9,972 $9,677 ======================================================================= I-1 Northrop Grumman Corporation and Subsidiaries September 30, December 31, Dollars in millions 1998 1997 - ----------------------------------------------------------------------- Liabilities and Shareholders' Equity Notes payable to banks $ 26 $ 91 Current portion of long-term debt 200 200 Trade accounts payable 400 463 Accrued employees' compensation 372 366 Advances on contracts 391 410 Income taxes payable, including deferred income taxes of $686 in 1998 and $717 in 1997 740 733 Other current liabilities 446 452 - ----------------------------------------------------------------------- Total current liabilities 2,575 2,715 - ----------------------------------------------------------------------- Long-term debt 2,710 2,500 Accrued retiree benefits 1,671 1,716 Other long-term liabilities 42 48 Deferred income taxes 88 75 Paid-in capital Preferred stock, 10,000,000 shares authorized; none issued Common stock, 200,000,000 shares authorized; issued and outstanding: 1998 -- 68,816,077; 1997 -- 67,278,876 986 838 Retained earnings 1,922 1,807 Unfunded pension losses, net of taxes (22) (22) - ----------------------------------------------------------------------- 2,886 2,623 - ----------------------------------------------------------------------- $9,972 $9,677 ======================================================================= The accompanying notes are an integral part of these consolidated financial statements. I-2 Northrop Grumman Corporation and Subsidiaries CONSOLIDATED CONDENSED STATEMENTS OF INCOME Three months ended Nine months ended September 30, September 30, Dollars in millions, except per share 1998 1997 1998 1997 - ------------------------------------------------------------------------------ Net sales $2,213 $2,297 $6,366 $6,643 Cost of sales Operating costs 1,769 1,878 5,097 5,329 Administrative and general expenses 206 214 616 680 - ------------------------------------------------------------------------------ Operating margin 238 205 653 634 Merger costs (16) (186) (18) Interest expense (59) (68) (173) (197) Other, net 5 41 18 48 - ------------------------------------------------------------------------------ Income before income taxes 184 162 312 467 Federal and foreign income taxes 68 64 115 177 - ------------------------------------------------------------------------------ Net income $ 116 $ 98 $ 197 $ 290 ============================================================================== Weighted average shares outstanding, in millions 68.9 66.9 68.4 66.7 Basic earnings per share $1.68 $1.46 $2.88 $4.35 Diluted earnings per share $1.67 $1.44 $2.83 $4.27 Dividends per share $ .40 $ .40 $1.20 $1.20 ============================================================================== The accompanying notes are an integral part of these consolidated financial statements. I-3 CONSOLIDATED CONDENSED Northrop Grumman Corporation and Subsidiaries STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY Nine months ended September 30, Dollars in millions 1998 1997 - ---------------------------------------------------------------------- Paid-in Capital At beginning of year $ 838 $ 784 Treasury stock transactions (5) Employee stock awards and options exercised 148 10 - ---------------------------------------------------------------------- 986 789 - ---------------------------------------------------------------------- Retained Earnings At beginning of year 1,807 1,502 Net income 197 290 Cash dividends (82) (74) - ---------------------------------------------------------------------- 1,922 1,718 - ---------------------------------------------------------------------- Unfunded Pension Losses, Net of Taxes (22) (4) - ---------------------------------------------------------------------- Total shareholders' equity $2,886 $2,503 ====================================================================== The accompanying notes are an integral part of these consolidated financial statements. I-4 Northrop Grumman Corporation and Subsidiaries CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS Nine months ended September 30, Dollars in millions 1998 1997 - ---------------------------------------------------------------------------- Operating Activities Sources of Cash Cash received from customers Progress payments $1,419 $1,646 Other collections 4,980 4,909 Income tax refunds received 23 1 Interest received 12 4 Other cash receipts 7 4 - ---------------------------------------------------------------------------- Cash provided by operating activities 6,441 6,564 - ---------------------------------------------------------------------------- Uses of Cash Cash paid to suppliers and employees 6,156 6,039 Interest paid 144 189 Income taxes paid 38 47 Other cash disbursements 31 19 - ---------------------------------------------------------------------------- Cash used in operating activities 6,369 6,294 - ---------------------------------------------------------------------------- Net cash provided by operating activities 72 270 - ---------------------------------------------------------------------------- Investing Activities Additions to property, plant and equipment (145) (141) Payment for business purchased, net of cash acquired (51) Proceeds from sale of property, plant and equipment 50 48 Proceeds from sale of affiliates/operations 19 Other investing activities (7) (8) - ---------------------------------------------------------------------------- Net cash used in investing activities (153) (82) - ---------------------------------------------------------------------------- Financing Activities Borrowings under lines of credit 295 421 Repayment of borrowings under lines of credit (462) Principal payments of long-term debt (150) (150) Proceeds from issuance of stock 35 8 Dividends paid (82) (74) Other financing activities (6) - ---------------------------------------------------------------------------- Net cash provided by (used in) financing activities 98 (263) - ---------------------------------------------------------------------------- Increase(decrease) in cash and cash equivalents 17 (75) Cash and cash equivalents balance at beginning of period 63 123 - ---------------------------------------------------------------------------- Cash and cash equivalents balance at end of period $ 80 $ 48 ============================================================================ I-5 Northrop Grumman Corporation and Subsidiaries Nine months ended September 30, Dollars in millions 1998 1997 - ---------------------------------------------------------------------- Reconciliation of Net Income to Net Cash Provided by Operating Activities Net income $ 197 $ 290 Adjustments to reconcile net income to net cash provided Depreciation 150 164 Amortization of intangible assets 139 139 Common stock issued to employees 88 1 Loss on disposals of property, plant and equipment 5 3 Retiree benefits income (146) (35) Decrease(increase) in Accounts receivable 285 (524) Inventoried costs (354) (189) Prepaid expenses 2 (10) Increase(decrease) in Progress payments (228) 368 Accounts payable and accruals (116) 40 Provisions for contract losses 36 14 Income taxes 110 134 Retiree benefits (129) (134) Other transactions 33 9 - ---------------------------------------------------------------------- Net cash provided by operating activities $ 72 $ 270 ====================================================================== Noncash Investing Activities: Purchase of business Fair value of assets acquired $ 67 Cash paid (56) - ---------------------------------------------------------------------- Liabilities assumed $ 11 ====================================================================== The accompanying notes are an integral part of these consolidated financial statements. I-6 Northrop Grumman Corporation and Subsidiaries SELECTED INDUSTRY SEGMENT INFORMATION Three months ended Nine months ended September 30, September 30, Dollars in millions 1998 1997 1998 1997 - ----------------------------------------------------------------------------- Net Sales Aircraft $ 1,021 $ 1,186 $ 2,980 $ 3,243 Electronics 1,042 966 2,913 2,927 Information Technology and Services 258 238 781 744 Intersegment sales (108) (93) (308) (271) - ----------------------------------------------------------------------------- $ 2,213 $ 2,297 $ 6,366 $ 6,643 ============================================================================= Operating Profit Aircraft $ 179 $ 183 $ 488 $ 460 Electronics 95 46 230 223 Information Technology and Services 24 22 79 69 - ----------------------------------------------------------------------------- Total operating profit 298 251 797 752 Adjustments to reconcile operating profit to operating margin: Other income included above (3) (3) (2) (7) State and local income taxes (11) (2) (31) (7) General corporate expenses (46) (41) (111) (104) - ----------------------------------------------------------------------------- Operating margin $ 238 $ 205 $ 653 $ 634 ============================================================================= Contract Acquisitions Aircraft $ 1,123 $ 751 $ 2,766 $ 2,657 Electronics 766 467 2,152 2,812 Information Technology and Services 197 156 707 586 Intersegment acquisitions (106) (83) (300) (272) - ----------------------------------------------------------------------------- $ 1,980 $ 1,291 $ 5,325 $ 5,783 ============================================================================= Funded Order Backlog Aircraft $ 5,779 $ 6,459 Electronics 4,701 5,043 Information Technology and Services 373 353 Intersegment backlog (32) (48) - ----------------------------------------------------------------------------- $10,821 $11,807 ============================================================================= I-7 Northrop Grumman Corporation and Subsidiaries NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS Basis of Presentation The accompanying unaudited consolidated condensed financial statements have been prepared by management in accordance with the instructions to Form 10-Q of the Securities and Exchange Commission. They do not include all information and notes necessary for a complete presentation of financial position, results of operations, changes in shareholders' equity, and cash flows in conformity with generally accepted accounting principles. They do, however, in the opinion of management, include all adjustments necessary for a fair statement of the results for the periods presented. The financial statements should be read in conjunction with the Notes and Independent Auditors' Report contained in the company's 1997 Annual Report on Form 10-K. Merger Agreement On July 3, 1997, the company announced that it had entered into a definitive agreement with Lockheed Martin Corporation to combine the companies. On February 26, 1998, shareholders of Northrop Grumman approved the merger. On March 23, 1998, the U. S. Government filed suit to block the combination. On July 16, 1998, Lockheed Martin notified the company that it was terminating its merger agreement with the company pursuant to the terms of the merger agreement. The company recorded a charge of $186 million through September 30, 1998, for costs related to the proposed merger. The charge covers vesting of restricted stock which became issuable following shareholder approval of the merger and other costs associated with the proposed merger, such as investment banking fees, legal and accounting fees, and costs related to responding to the Government's request for information. Comprehensive Income The company has adopted Statement of Financial Accounting Standards No. 130 - Reporting Comprehensive Income. This standard establishes new standards for the presentation and disclosure of other comprehensive income. There were no material items of other comprehensive income for the first nine months of 1998 or 1997. Earnings per Share Basic earnings per share are calculated using the weighted average number of shares of common stock outstanding during each period, after giving recognition to stock splits and stock dividends. Diluted earnings per share reflect the dilutive effect of stock options and other stock awards granted to employees under stock-based compensation plans. I-8 Northrop Grumman Corporation and Subsidiaries Basic and diluted earnings per share are calculated as follows: Earnings Three months ended September 30, Net Income Shares per Share ---------- ------- --------- (millions) (millions) 1998 Basic earnings per share $116 68.9 $1.68 ==== ===== Dilutive effect of stock options and awards .7 ---- Diluted earnings per share $116 69.6 $1.67 ==== ==== ===== 1997 Basic earnings per share $ 98 66.9 $1.46 ==== ===== Dilutive effect of stock options and awards 1.2 ---- Diluted earnings per share $ 98 68.1 $1.44 ==== ==== ===== Nine months ended September 30, 1998 Basic earnings per share $197 68.4 $2.88 ==== ===== Dilutive effect of stock options and awards 1.1 ---- Diluted earnings per share $197 69.5 $2.83 ==== ==== ===== 1997 Basic earnings per share $290 66.7 $4.35 ==== ===== Dilutive effect of stock options and awards 1.2 ---- Diluted earnings per share $290 67.9 $4.27 ==== ==== ===== I-9 Northrop Grumman Corporation and Subsidiaries Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE COMPANY'S FINANCIAL CONDITION AND THE RESULTS OF ITS OPERATIONS Sales were 4 percent lower in both the third quarter and first nine months of 1998 versus the same periods of 1997. Aircraft segment sales decreased in the quarter and nine month periods of 1998 versus comparable periods of 1997 principally due to lower B-2 volume and the sale in 1997 of the company's Grumman Allied Industries subsidiary. These declines were partially offset by increased Boeing jetliner shipset deliveries. Electronics segment sales for the third quarter increased by 8 percent over the same quarter last year, reflecting increases in surveillance aircraft and airspace management sales. Sales for the first nine months of 1998 are essentially unchanged from the level achieved in the same period of 1997. Increases in surveillance aircraft and airspace management sales were partially offset by lower volume in the marine systems and other electronics business areas. Sales by major program/business area and units delivered were: Three months Nine months $ in millions 1998 1997 1998 1997 - ---------------------------------------------------------------------- B-2 $ 325 $ 430 $ 966 $1,190 Surveillance Aircraft (E-8 Joint Stars, E-2) 274 222 851 745 Boeing Jetliners 267 211 749 636 Airborne Radar 166 195 481 491 Marine Systems 119 154 361 426 F/A-18 137 144 418 396 Electronic Countermeasures 109 95 310 288 Space 65 63 214 227 Airspace Management 138 65 276 194 C-17 83 73 191 215 Information Technology and Services 252 233 766 733 All Other 278 412 783 1,102 - ---------------------------------------------------------------------- $2,213 $2,297 $6,366 $6,643 ====================================================================== Three months Nine months Units 1998 1997 1998 1997 - ---------------------------------------------------------------------- B-2 2 2 4 2 747 13 10 39 32 F/A-18 C/D 8 8 25 26 C-17 4 2 6 6 I-10 Northrop Grumman Corporation and Subsidiaries Operating margin includes pension income, net of deferred state taxes, of $60 million for the third quarter and $181 million for the first nine months of 1998 as compared with $29 million and $87 million for the same periods of 1997. Substantially all of the pension income is attributable to the aircraft segment. Operating margin in the third quarter of 1998 was reduced $16 million for costs related to activities to realign operating units, consolidate facilities and laboratories, and exit certain business areas. The rate of operating profit earned on sales increased in the aircraft segment in the third quarter and first nine months of 1998 as compared with the same periods of 1997, reflecting increased pension income. This benefit was offset by lower operating margin rates on commercial aerostructures work and decreases in B-2 production and other aircraft business area sales. Two B-2 bombers were delivered in the third quarter of 1998 as well as in the third quarter of 1997. The first nine month period of 1998 benefited from four B-2 bomber deliveries as compared to two deliveries for the same period of 1997. The amount and rate of operating profit earned on sales increased in the electronics segment in the third quarter and first nine month periods as compared with the same periods of 1997. Electronics business segment operating profit for the third quarter of last year was reduced $53 million by a cumulative margin rate adjustment on the E-8 Joint STARS. The charge was related principally to an increase in the number of hours required to remanufacture Boeing 707 jetliners, used as the Joint STARS platform. The charge was partially offset by settlement of a claim involving work performed in the 1980s on the MX missile Interface Test Adapter, which resulted in an $8 million increase in operating margin and $12 million in interest income for the third quarter of 1997. Electronics business segment operating profit in the first nine months of 1998 increased slightly on flat sales as compared to the same period a year ago. Last year's first nine month results included the $53 million downward cumulative margin rate adjustment on the E-8 Joint STARS and a $13 million pretax charge related to an increase in the cost estimate to complete the company's work on the Directional Infrared Countermeasures (DIRCM) program. In the second quarter of this year, the company recorded an $8 million charge for plant closures and $25 million downward cumulative margin rate adjustments on the E-8 Joint STARS and E-2C programs. An increase in the cost to complete the remanufacture of the 707 jetliner for production aircraft No. 4 was the primary cause of the Joint STARS adjustment. This aircraft was delivered in the third quarter of 1998. The company has reached an agreement with the Air Force that will reduce the extensive remanufacturing work required for the Joint STARS. In addition, the company and the Air Force have established the framework to discuss further contractual adjustments on the program. The company has not included any operating margin from the Joint STARS production program in its financial results for this year. The financial impact, if any, of these discussions is not expected to be known until sometime in the first half of 1999. I-11 Northrop Grumman Corporation and Subsidiaries The information technology and services business segment reported improved operating profit rates on increased sales for both the third quarter and first nine month periods of 1998 as compared with the same periods of 1997. In the first nine months of 1998, the company recorded pretax charges of $186 million ($1.73 per share after tax) for merger costs related to the company's proposed combination with Lockheed Martin Corporation. The charges cover vesting of restricted stock that became issuable following the February 1998 shareholder approval of the merger as well as other costs associated with the proposed combination such as investment banking fees, legal and accounting fees, and costs related to responding to the Government's request for information. On July 16, 1998, Lockheed Martin Corporation notified the company that it was terminating its merger agreement with the company pursuant to the terms of the merger agreement. Merger costs reported in 1997 are associated with the Logicon merger. Other income for the third quarter of last year benefited by $24 million from the recovery of a portion of a charge recorded in 1996 related to the sale of the company's Perry, Georgia facility, and by $12 million in interest income related to the MX missile ITA claim settlement. Interest expense was $59 million for the third quarter of 1998 and $173 million for the first nine months of 1998, down $9 million and $24 million, respectively, from the same periods last year. The decreases resulted principally from a lower average level of borrowings in the first nine months of 1998 as compared with the same period of 1997. During the first nine months of 1998, $72 million of cash was generated by operations versus the $270 million generated in the first nine months of 1997. The decline in the amount generated from operating activities is primarily due to the increase in working capital for commercial aerostructures to support increased production levels. In the last quarter of this year, cash generated from operating activities is expected to be more than sufficient to finance capital expenditures and dividends. The company's liquidity and financial flexibility is expected to continue to be provided by cash flow generated by operating activities, supplemented by the unused borrowing capacity available under the company's credit agreement and other short- term credit facilities. Year 2000 Issues The company continues to implement its program to address the Year 2000 issue. The program, which was begun in 1996, consists of the following phases: assessing, planning, remediating, and testing-validating. The project encompasses the entire company and all aspects of Year 2000 compliance including software applications, mainframe environment, desktop equipment, networks, telecommunications, department supported systems, facilities systems, and embedded systems in product deliverables. The company also is working with its customers and suppliers to assess their Year 2000 readiness, reviewing contracts for Year 2000 liability, and developing remediation and contingency plans where appropriate. I-12 Northrop Grumman Corporation and Subsidiaries The assessment and planning phases are substantially complete. The company is on track to complete the remediation and testing-validating phases in all critical areas by the end of 1998. Activities scheduled to be completed in 1999 include low risk upgrades which will be addressed by normal maintenance activities and various vendor supplied software upgrades that will become available in late 1998 and early 1999. The company has a formal planning, measurement and reporting process for the Year 2000 project. This process includes regular progress briefings to senior management and to the audit committee of the Board of Directors. The company separately identifies the costs of Year 2000 remedial efforts only for internal information services personnel, principally as a planning and control tool. The total costs of these efforts incurred during the years 1996 through 1999 are expected to be approximately $40 million, most of which will be expended in 1998. Year 2000 costs are allowable costs under applicable government contracting regulations. Accordingly, the portion of Year 2000 costs allocable to contracts is being so charged as part of normal overhead pursuant to approved methods established for the purpose. Based on information available to date, management does not anticipate that future expenditures for required modifications and conversions will have a material adverse effect on the company's financial position, results of operations, or cash flows. Northrop Grumman cannot predict the eventual outcome associated with the innumerable possible situations that could result from whatever computer failures might occur, internally or among its customers and suppliers, and the impact that such failures might have on Northrop Grumman's ability to perform its day to day operations. If required modifications and conversions are not made as planned, serious adverse impact to the operations of the company could result. In addition, Year 2000 problems could adversely affect the ability of customers and critical suppliers to meet their contractual commitments to the company. Some of these developments, should they occur, could have a material adverse impact on the financial position, results of operations, or cash flows of Northrop Grumman. As stated above, management plans to complete a substantial portion of remediation and testing-validating in 1998, with a minor number of activities to be addressed in 1999. Contingency and resumption planning will be required to address potential computer failures that either are 1) of greatest risk for potential failure or 2) might impact mission critical systems. Assessment of Year 2000 progress is a critical input to the development of contingency plans and the formulation of such plans is expected to commence in the fourth quarter of 1998 and continue into 1999. I-13 Northrop Grumman Corporation and Subsidiaries Forward-Looking Information This quarterly report on Form 10-Q, and, not by way of limitation, certain statements and assumptions in Management's Discussion and Analysis, contain or are based on "forward-looking" statements and information (as defined in the Private Securities Litigation and Reform Act of 1995) that involve risk and uncertainties, including statements and assumptions that reflect the company's views with respect to future revenues, program performance and cash flows, the outcome of contingencies including litigation and environmental remediation, and anticipated costs of capital investments and planned dispositions. The company's operations are necessarily subject to various risks and uncertainties; actual outcomes are dependent upon many factors, including, without limitation, 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; the ability of the company, its customers and suppliers to become Year 2000 compliant; continued development and acceptance of new products; performance issues with key suppliers and subcontractors; government import and export policies; termination of government contracts; the outcome of political and legal 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, including risks detailed in the company's filings with the Securities and Exchange Commission, including, not by way of limitation, any Form 10-K, Form 10-Q and proxy statements, among others. Item 3. Quantitative and Qualitative Disclosures About Market Risks The company has fixed-rate long-term debt obligations, most of which are not callable until maturity. The company also has financial instruments that are subject to interest rate risk, principally variable-rate short-term debt outstanding under the Credit Agreement. The company may enter into interest rate swap agreements to offset the variable-rate characteristics of these loans. At September 30, 1998, no interest rate swap agreements were in effect. Only a small portion of the company's transactions are contracted in foreign currencies. The company does not consider the market risk exposure relating to foreign currency exchange to be material. I-14 Northrop Grumman Corporation and Subsidiaries Part II. OTHER INFORMATION Item 1. Legal Proceedings Zabielski and related cases In July and August 1998, three shareholder derivative lawsuits, respectively encaptioned Zabielski v. Kent Kresa, et al., Harbor Finance Partners v. Kent Kresa et al., and Clarren v. Kent Kresa, et al., were filed in the Superior Court of California for the County of Los Angeles. These lawsuits each contain similar allegations that the directors of the Company and certain of its officers breached their fiduciary duties in connection with the shareholder vote approving the proposed acquisition of the Company by Lockheed Martin Corporation, and that certain defendants engaged in stock trades in violation of federal and state securities laws. The lawsuits are purportedly brought on the Company's behalf and do not seek relief against the Company. Defendants have filed demurrers based on plaintiffs' failure to make a pre-suit demand on the Board of Directors, and also have moved to stay discovery pending the resolution of the demurrers. The defendants deny the allegations made in these actions and intend to defend the actions vigorously. Fanni and related cases Five shareholder class action lawsuits, making similar allegations, were filed in the United States District Court for the Central District of California against the Company, its directors, and certain of its officers. Three of these lawsuits, respectively encaptioned Fanni v. Northrop Grumman Corp., et al., Schnee v. Northrop Grumman Corp., et al, and Florida State Board of Admin. v. Northrop Grumman Corp., et al., allege that defendants issued misleading proxy materials in connection with the proposed acquisition of the Company by Lockheed Martin Corporation, in violation of the federal securities laws. Two of these lawsuits, respectively encaptioned Burroughs v. Northrop Grumman Corp., et al., and Miller, et al. v. Northrop Grumman Corp., et al., allege that defendants disseminated misleading information in connection with the proposed acquisition, in violation of the federal securities laws, thereby artificially inflating the market price of the Company's common stock. Plaintiffs have moved to consolidate Fanni, Schnee and Florida State Board of Admin. into one action, and Burroughs and Miller into another action, and to have a lead plaintiff and lead counsel appointed in each consolidated case. The Company and the individual defendants deny the allegations made in these actions and intend to defend the actions vigorously. U.S. ex rel. McMorrough v. Northrop Grumman Corporation In October 1998, the United States, acting through the Department of Justice, intervened in a portion of this civil action filed in the U.S. District Court for the Western District of Louisiana. The government intervened in the portion of the complaint that alleges the Company knowingly supplied improperly heat treated parts for JSTARS aircraft in 1994 and 1995, in violation of the False Claims Act; the government seeks unspecified damages in connection with the alleged violations. The Company intends to defend this matter vigorously and does not expect this matter to have a material adverse effect on its financial condition. II-1 Northrop Grumman Corporation and Subsidiaries Item 2. Changes in Securities and Use of Proceeds Rights Agreement On September 16, 1998, the Board of Directors of the Corporation declared a dividend distribution of one preferred share purchase right (a "Right") for each outstanding share of Common Stock, par value $1.00 per share (the "Common Shares"), of the Corporation. The dividend is payable to the stockholders of record on October 2, 1998 (the "Record Date"), and with respect to Common Shares issued thereafter until the Distribution Date (as defined below) and, in certain circumstances, with respect to Common Shares issued after the Distribution Date. Except as set forth below, each Right, when it becomes exercisable, entitles the registered holder to purchase from the Corporation one one-thousandth of a share of Series A Junior Participating Preferred Stock, $1.00 par value per share (the "Preferred Shares"), of the Corporation at a price of $250.00 per one one-thousandth of a Preferred Share (the "Purchase Price"), subject to adjustment. The description and terms of the Rights are set forth in a Rights Agreement (the "Rights Agreement") between the Corporation and ChaseMellon Shareholder Services, L.L.C., as Rights Agent (the "Rights Agent"), dated as of September 23, 1998. Initially, the Rights will be attached to all certificates representing Common Shares then outstanding, and no separate Right Certificates will be distributed. The Rights will separate from the Common Shares upon the earliest to occur of (i) a person or group of affiliated or associated persons having acquired beneficial ownership of 15% or more of the outstanding Common Shares (except pursuant to a Permitted Offer, as hereinafter defined); or (ii) 10 days (or such later date as the Board may determine) following the commencement of, or announcement of an intention to make, a tender offer or exchange offer the consummation of which would result in a person or group becoming an Acquiring Person (as hereinafter defined) (the earliest of such dates being called the "Distribution Date"). A person or group whose acquisition of Common Shares causes a Distribution Date pursuant to clause (i) above is an "Acquiring Person." The date that a person or group becomes an Acquiring Person is the "Shares Acquisition Date." The Rights Agreement provides that, until the Distribution Date, the Rights will be transferred with and only with the Common Shares. Until the Distribution Date (or earlier redemption or expiration of the Rights) new Common Share certificates issued after the Record Date upon transfer or new issuance of Common Shares will contain a notation incorporating the Rights Agreement by reference. Until the Distribution Date (or earlier redemption or expiration of the Rights), the surrender for transfer of any certificates for Common Shares outstanding as of the Record Date, even without such notation or a copy of this Summary of Rights being attached thereto, will also constitute the transfer of the Rights associated with the Common Shares represented by such certificate. As soon II-2 Northrop Grumman Corporation and Subsidiaries as practicable following the Distribution Date, separate certificates evidencing the Rights ("Right Certificates") will be mailed to holders of record of the Common Shares as of the close of business on the Distribution Date (and to each initial record holder of certain Common Shares issued after the Distribution Date), and such separate Right Certificates alone will evidence the Rights. The Rights are not exercisable until the Distribution Date and will expire at the close of business on October 31, 2008, unless earlier redeemed by the Corporation as described below. In the event that any person becomes as Acquiring Person (except pursuant to a tender or exchange offer which is for all outstanding Common Shares at a price and on terms which a majority of certain members of the Board of Directors determines to be adequate and in the best interests of the Corporation, its stockholders and other relevant constituencies, other than such Acquiring Person, its affiliates and associates ( a "Permitted Offer")), each holder of a Right will thereafter have the right (the "Flip-In Right") to receive upon exercise the number of Common Shares or of one one-thousandth of a share of Preferred Shares (or, in certain circumstances, other securities of the Corporation) having a value (immediately prior to such triggering event) equal to two times the exercise price of the Right. Notwithstanding the foregoing, following the occurrence of the event described above, all Rights that are, or (under certain circumstances specified in the Rights Agreement) were, beneficially owned by any Acquiring Person or any affiliate or associate thereof will be null and void. In the event that, at any time following the Shares Acquisition Date, (i) the Corporation is acquired in a merger or other business combination transaction in which the holders of all of the outstanding Common Shares immediately prior to the consummation of the transaction are not the holders of all of the surviving corporation's voting power, or (ii) more than 50% of the Corporation's assets or earning power is sold or transferred, in either case with or to an Acquiring Person or any affiliate or associate or any other person in which such Acquiring Person, affiliate or associate has an interest or any person acting on behalf of or in concert with such Acquiring Person, affiliate or associate, or, if in such transaction all holders of Common Shares are not treated alike, any other person, then each holder of a Right (except Rights which previously have been voided as set forth above) shall thereafter have the right (the "Flip-Over Right") to receive, upon exercise, common shares of the acquiring company having a value equal to two times the exercise price of the Right. The holder of a Right will continue to have the Flip-Over Right whether or not such holder exercises or surrenders the Flip-In Right. II-3 Northrop Grumman Corporation and Subsidiaries The Purchase Price payable, and the number of Preferred Shares, Common Shares or other securities issuable, upon exercise of the Rights are subject to adjustment from time to time to prevent dilution (i) in the event of a stock dividend on, or a subdivision, combination or reclassification of, the Preferred Shares, (ii) upon the grant to holders of the Preferred Shares of certain rights or warrants to subscribe for or purchase Preferred Shares at a price, or securities convertible into Preferred Shares with a conversion price, less than the then current market price of the Preferred Shares or (iii) upon the distribution to holders of the Preferred Shares of evidences of indebtedness or assets (excluding regular quarterly cash dividends) or of subscription rights or warrants (other than those referred to above). The number of outstanding Rights and the number of one one-thousandths of a Preferred Share issuable upon exercise of each Right are also subject to adjustment in the event of a stock split of the Common Shares or a stock dividend on the Common Shares payable in Common Shares or subdivisions, consolidations or combinations of the Common Shares occurring, in any such case, prior to the Distribution Date. Preferred Shares purchasable upon exercise of the Rights will not be redeemable. Each Preferred Share will be entitled to a minimum preferential quarterly dividend payment of $10.00 per share but, if greater, will be entitled to an aggregate dividend per share of 1,000 times the dividend declared per Common Share. In the event of liquidation, the holders of the Preferred Shares will be entitled to a minimum preferential liquidation payment of $1,000 per share, provided that the holders will be entitled to an aggregate payment per share of at least 1,000 times the aggregate payment made per Common Share. These rights are protected by customary antidilution provisions. In the event that the amount of accrued and unpaid dividends on the Preferred Shares is equivalent to six full quarterly dividends or more, the holders of the Preferred Shares shall have the right, voting as a class, to elect two directors in addition to the directors elected by the holders of the Common Shares until all cumulative dividends on the Preferred Shares have been paid through the last quarterly dividend payment date or until non-cumulative dividends have been paid regularly for at least one year. With certain exceptions, no adjustment in the Purchase Price will be required until cumulative adjustments require an adjustment of at least 1% in such Purchase Price. No fractional Preferred Shares will be issued (other than fractions which are one one-thousandth or integral multiples of one one-thousandth of a Preferred Share, which may, at the election of the Corporation, be evidenced by depository receipts) and in lieu thereof, an adjustment in cash will be made based on the market price of the Preferred Shares on the last trading day prior to the date of exercise. II-4 Northrop Grumman Corporation and Subsidiaries At any time prior to the earlier to occur of (i) a person becoming an Acquiring Person or (ii) the expiration of the Rights, and under certain other circumstances, the Corporation may redeem the Rights in whole, but not in part, at a price of $.01 per Right (the "Redemption Price") which redemption shall be effective upon the action of the Board of Directors. Additionally, following the Shares Acquisition Date, the Corporation may redeem the then outstanding Rights in whole, but not in part, at the Redemption Price, provided that such redemption is in connection with a merger or other business combination transaction or series of transactions involving the Corporation in which all holders of Common Shares are treated alike but not involving an Acquiring Person or its affiliates or associates. All of the provisions of the Rights Agreement may be amended by the Board of Directors of the Corporation prior to the Distribution Date. After the Distribution Date, the provisions of the Rights Agreement may be amended by the Board in order to cure any ambiguity, defect or inconsistency, to make changes which do not adversely affect the interests of holders of Rights (excluding the interests of any Acquiring Person), or, subject to certain limitations, to shorten or lengthen any time period under the Rights Agreement. Until a Right is exercised, the holder thereof, as such, will have no rights as a stockholder of the Corporation, including, without limitation, the right to vote or to receive dividends. While the distribution of the Rights will not be taxable to stockholders of the Corporation, stockholders may, depending upon the circumstances, recognize taxable income should the Rights become exercisable or upon the occurrence of certain events thereafter. II-5 Northrop Grumman Corporation and Subsidiaries Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 4(a) Rights Agreement, dated as of September 23, 1998, between Northrop Grumman Corporation and ChaseMellon Shareholder Services, L.L.C., as Rights Agent (incorporated by reference to Forms 8-A12B and 8-A12B/A filed September 24, 1998). 27 Financial Data Schedule (b) Reports on Form 8-K No reports on Form 8-K were filed with the Securities and Exchange Commission during the quarter ended September 30, 1998. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Northrop Grumman Corporation (Registrant) Date: October 26, 1998 by/s/N. F. Gibbs Nelson F. Gibbs Corporate Vice President and Controller Date: October 26, 1998 by/s/J. H. Mullan John H. Mullan Acting Secretary II-6

5 9-MOS DEC-31-1998 SEP-30-1998 80 0 1,536 118 1,580 3,224 3,115 1,807 9,972 2,575 2,910 0 0 986 1,900 9,972 6,366 6,366 5,713 5,713 168 0 173 312 115 197 0 0 0 197 2.88 2.83