THE SECRET BOMBER BUGGING NORTHROP Having bungled the MX missile guidance system, the company says it is doing better with the hush-hush Stealth. The Air Force agrees. Critics aren't so sure.
(FORTUNE Magazine) – EXECUTIVES OF Northrop Corp. have been taking a lot of flak lately. The defense contractor botched production of the guidance system of the MX missile, bringing Northrop reams of bad publicity, congressional hearings last summer, financial penalties from the Pentagon, and a possible federal grand jury investigation for criminal fraud. When Thomas Jones, Northrop's veteran chairman, tried to answer the charges on television's 60 Minutes last November, he wound up looking like a bumbler. In December, Northrop lost out on an estimated $40 billion project to build the Advanced Tactical Aircraft, the Navy's new medium-size bomber. Northrop does have what you might call a hidden asset -- the contract for the Stealth bomber. Designed to appear on a radar screen as an object about the size of a sparrow rather than a nuclear attacker, the bomber would greatly increase America's ability to sneak past Soviet defenses in war. Rockwell's B- 1B bomber has some ability to evade radar through electronic devices, but Stealth would be better at it. The Air Force's ancient B-52, which shows up like a huge barn door on radar screens, would be phased out as an attack bomber. The Stealth project is so secret that even the bomber's current pricetag is anyone's guess. Security analysts say it could exceed $53 billion for 132 planes, or $400 million each. Stealth accounted for half Northrop's $6.1 billion in revenue last year and a large portion of its $94.2 million in profit. Recommending Northrop stock as a buy, analysts say the Stealth program is so important to national security that the next President, Republican or Democrat, will find it virtually impossible to cancel. For its part, Northrop says it won't repeat the MX mistakes in the bomber project. What if Northrop hasn't learned its lesson? To some present and former employees of Northrop, the troubled past is prologue to an even more troubling future. They say Northrop is so mismanaging development and production of the bomber that it won't fly on schedule this year, the seventh year of the ; program. Robert Kilborne, a Claremont, California, lawyer representing these Northrop whistle blowers, plans a lawsuit against Northrop. The suit will claim that the company has overcharged the government by between $400 million and $1 billion. Northrop can't respond to the allegations because of the Stealth bomber's top-secret classification, but presumably would deny them. The Air Force does deny them. Les Aspin, chairman of the House Armed Services Committee, is ''examining a number of acquisition issues related to the Stealth program, some involving business procedures,'' says a staffer, declining further comment because of the security classification. The Northrop employees, in their lawsuit and in any testimony to Congress, would most likely be stopped by the same clearance problems. Documents provided to FORTUNE to support the employees' charges are not classified. THE CHARGES ABOUT Stealth seem at first glance odd. The plane is the pride and joy of one of the most experienced chiefs in the aerospace industry. Tom Jones, 67, is a Stanford-educated aeronautical engineer who has run the company for 28 years. President Kent Kresa, 49, is also an aeronautical engineer, from MIT. Before joining Northrop he was with the Pentagon's Defense Advanced Research Projects Agency, a sort of venture capital firm for high- tech projects. Bear in mind, however, that the Los Angeles-based company hasn't built a big airplane in nearly 40 years. Though it produces fuselages for the Boeing 747, the company's experience is mainly with small jet fighters. Northrop turns out about 40% of the Navy's F/A-18 Hornets under subcontract to McDonnell Douglas. It is the prime contractor on the relatively unsophisticated F-5 jet fighter, which is sold mainly to foreign countries (''Tinkertoys for sheiks,'' an analyst says). Northrop won its reputation for innovation mainly as a subcontractor. The company builds guidance systems for Harpoon and Tomahawk missiles and sensor systems for Navy F-14 Tomcat jets and Army Scout helicopters. It is the nation's largest supplier of airborne electronic countermeasures equipment, or ECM, providing radar-jamming gear for the B-1B and B-52 bombers. In 1975 this knack for electronic innovation won Northrop the ill-starred prime contract, worth $2 billion, to build the brains of the MX missile. Called an inertial measurement unit (IMU), the device is a kind of compass and speedometer that steers the missile's ten warheads to individual targets. One of the most complex devices in a complex field, it crams some 12,000 parts -- nearly as many as a jet fighter's -- into a sphere the size of a basketball. The parts have to be built to exasperatingly fine tolerances. Some circuits undergo more than 11,000 tests. Northrop's big problems can be traced not so much to complexity as to congressional indecision. Congress got into a long debate on whether the new missiles should be put into traditional silos or moved around, perhaps on railroad cars, to make them less vulnerable to increasingly accurate Soviet missiles. Eventually Congress settled on silos, but the delay cut production time from about 44 months to 29. Northrop accepted the shortened timetable. President Kresa recalls that the company was ''very gung ho,'' but adds that the decision to charge ahead ''was the seed of our undoing.'' Says Jones bitterly: ''We should have rejected that schedule!'' What followed was a production disaster. The MX went from a small research project employing about 200 to a full-scale manufacturing operation with 2,200 employees. Wolfgang Demisch, director of research at UBS Securities, describes the change as the difference between ''Swiss watchmakers and a bunch of guys in Grateful Dead T-shirts.'' To save time, some managers began bypassing Northrop's complicated ordering system. Because of voluminous paperwork related to government contracts, Northrop's purchasing department fell weeks behind in getting parts from outside suppliers. By setting up mail drops at fictitious companies, managers could avoid the Northrop system and sometimes get what they needed in a matter of days. When the shortcut scheme came to light, congressional critics immediately raised questions about the reliability of the guidance system. Top Northrop executives blame themselves for relying on inexperienced managers. ''These guys were great at the 200-employee level, but some of them just buckled at the seams when we moved them to bigger jobs,'' says John Campbell, vice president and controller. CEO Jones adds, ''We should have had our mature people in there holding their hands and working with them. That was our mistake.'' THOUGH Northrop's critics -- chief among them House Armed Services Committee chairman Aspin -- continue to raise questions about the IMU, an independent review board last October found that it performs better than expected. Northrop's customer, the Air Force, says it is satisfied. Moreover, the part ; that's been the most troublesome, a device for measuring acceleration, was made by Honeywell. The Air Force startled the defense industry in 1981 when it awarded Stealth to Northrop, a medium-size aerospace company with $1.7 billion in revenue the previous year. Northrop's last big aircraft was the B-49 Flying Wing, built after World War II. Aerospace experts not connected with the project assume that the Stealth bomber resembles a flying wing because a plane without a fuselage is harder to detect. While Northrop's work on the B-49 may have played a role in winning the contract, the clincher was probably Northrop's research into ''low observables,'' dating back to work with the Snark missile in the 1950s. The technical challenges of the contract are formidable. Bill Sweetman, author of Stealth Aircraft: Secrets of Future Airpower, explains how the plane could be virtually invisible: Radar is like a flashlight searching a darkened room. If the flashlight hits a mirror, the reflection from the mirror's shiny flat surface is like that from a plane with a large radar ''signature.'' Now imagine a dull-black bowling ball in the same dark room. When the flashlight hits the bowling ball, very little of the beam is reflected back from the round contours, and the ball's black finish tends to absorb light. The ball will be hard to see. In the same way, a Stealth bomber, with rounded contours, and a radar- absorbent black finish similar to the ferromagnetic coating on audio tape, will be hard to detect. Make the plane a flying wing, shield the turbulent air intakes, find a way to cool the jet exhaust (hot gases show up against a cold sky), and fill the plane with electronic countermeasures, such as ghost- imaging, and you have a Stealth bomber. Making a plane like that is tricky. Graphite-based composite materials can be sculptured into rounded contours, but aircraft tools are designed for metal. Holes drilled into composites often come out misshapen. And integrating the complex electronics into such a plane is always daunting. EVEN BEFORE the recent allegations, hints of problems had surfaced. In the past two years, Northrop wrote off $214 million in unanticipated Stealth development costs. The Air Force has yet to approve the purchasing procedures Northrop uses in its advanced systems division, the unit that builds the secret plane, and Northrop has voluntarily reduced its billings by several million dollars. A prototype flight scheduled for April has reportedly been ; delayed until August. According to the Los Angeles Times, Northrop has begun laying off workers from the Stealth program at a time when a contractor normally hires workers to gear up for production. But sources inside the Pico Rivera plant, where Stealth parts are being built, say the program's problems go beyond the chaos and technical difficulties of trying to build a breakthrough aircraft. A financial employee says that among other things, Northrop is mischarging the government by manipulating so-called ''earned value.'' Designed as a way to give early warning of cost overruns, this method measures the completion of certain tasks and isn't directly related to what Northrop bills the government. But by representing tasks as substantially completed when in fact they are not, Northrop employees allege, the company is painting a false picture of satisfactory progress. A. Ernest Fitzgerald, an Air Force systems analyst who became famous in the 1960s as a Pentagon whistle blower, agrees that the earned value method, which his consulting group developed, can be manipulated in this way. While professing no knowledge of the Stealth bomber program, Fitzgerald says, ''Changing the earned value reports just delays the day of reckoning. You may find out you've spent all the money the government's given you and the work's half done.'' A Northrop engineer says development of the plane has been as chaotic as the bookkeeping. By constantly changing designs, Northrop is confusing both its own employees and those of its subcontractors -- Boeing, LTV, and General Electric. The engineer claims that recent layoffs resulted from Northrop's loss of ''configuration control,'' which means making sure all the parts fit together. He claims that production is so disorganized that workers and managers are idle for lack of assignments. The Air Force issued a statement emphatically denying both overcharging and control problems: ''We see no way in which this alleged manipulation of Northrop's earned value system could result in overcharging the government. Although we review this data closely, we pay on the basis of actual cost, not the earned value system. As to the allegation that Northrop has lost configuration control, we maintain full cognizance of the design and development efforts throughout, and see no basis for this allegation.'' The Stealth bomber is crucial to Northrop's future at a time when revenue from projects like the F-5 and the F/A-18 jets are leveling off or winding ) down. Paul Nisbet, a defense-industry analyst with Prudential-Bache Securities, thinks Stealth could help boost Northrop's annual revenue nearly 50% to $9 billion and quadruple profits to $365 million in 1992, the first full year of scheduled production. What's more, Northrop is in the running in the 1991 competition to build a Stealth fighter. That could be a project as lucrative as the Stealth bomber. But if Northrop bungles the bomber, presumably it would be out of the running for the smaller craft. IN ANY CASE, if a major Stealth scandal breaks, cost overruns and ensuing penalties from the Pentagon could hammer Northrop's profits and prestige. The company could be vulnerable to a takeover. MX problems reduced the Northrop electronics segment's 1987 operating profits by more than a third from the year earlier to $23.6 million. The Defense Department might frown on a raider. When T. Boone Pickens made a pass at Boeing last year, the Pentagon seemed ready to growl about national security since Boeing is a major defense contractor. But if another defense contractor proposed taking over Northrop, would the Pentagon turn a blind eye? Perhaps. In any case, Northrop will need to make Stealth technology work, if only for itself. There's hostile radar ahead.
CHART: INVESTOR'S SNAPSHOT NORTHROP SALES (latest four quarters) $6.1 BILLION CHANGE FROM YEAR EARLIER UP 8%
NET PROFIT $94.2 MILLION CHANGE UP 129%
RETURN ON COMMON STOCKHOLDERS' EQUITY 10% FIVE-YEAR AVERAGE 16%
STOCK PRICE RANGE (last 12 months) $52.63-$24.75
RECENT SHARE PRICE $29.88
PRICE/EARNINGS MULTIPLE 20
TOTAL RETURN TO INVESTORS (12 months to 2/12) -30%