President and Chief Executive
Boeing Integrated Defense Systems
"Presentation to Bear Stearns 12th Annual Commercial Aerospace & Defense Conference"
New York, NY
May 03, 2005
Steve: I want to introduce the management of the Boeing Company. I'm pleased to have Jim Albaugh, EVP, and the Boeing Company's President and CEO of the IDS business. We have Randy Simons here as well who is the CFO of IDS, and Dave Dohnalek who is the Investor Relations contact at Boeing. Jim, I guess, joined Rockwell 30 years ago? And he ran Rocketdyne at one time -- which is a business that is being sold to United Technologies -- and steadily moved up the ranks at the Boeing Company to eventually run the IDS business. So I think, Jim, you're going to provide a brief overview and then we're going to open up for Q&A. Thank you.
Jim Albaugh: Thank you, Steve. And thank you for putting Secretary DuBois on first. I do appreciate that. Never want to get up and contradict the customer. Before I get started, our SEC police want to have me give you a short disclaimer. Let me just read it to you if I could. I refer you to the forward-looking statement at the back of this presentation which lays out risks and uncertainties in our forecasts. We also discuss these items in our SEC filings.
Now with that, what I'd like to do is talk a little bit about the Boeing Company and then spend most of the time talking about IDS and then we'll open it up to any questions that you might have. I think if you go back to the early 1990s and take a look at the Boeing Company, there's no question that we were a commercial airplane business. And one of the things that our leadership wanted to do was diversify and become more of an aerospace business and also be an organization that could ride out some of the swings that we have often seen in the commercial airplane marketplace. I think that this restructure certainly has paid off. When you look at what happened in 1999, we delivered 620 commercial airplanes and last year it was only 280. Despite that slump, we grew and grew significantly and you can see from 1994 to 2004 we grew from $22 billion in revenues up to $52 billion in revenues and you can see also that the mix changed as our defense business now accounts for close to 60% of the revenues.
Going forward, we see a pretty significant shift in the commercial airplane cycle, and over time what we'd like to have is a balanced portfolio about 50% defense and space and about 50% coming from the commercial business that we have. Please take a look at the guidance that we've given you. If you listened in to James Bell's earnings broadcast last Wednesday, these are the numbers that he showed you. We're predicting revenues of about $58 billion this year growing to between $62 and $63 billion in 2006. We're forecasting earnings from $2.40 to $2.60 this year and certainly a very solid cash performance continuing. Last year, even after our pension contributions, we contributed $3.7 billion worth of cash and it was $8 billion before the pension contribution. This year, greater than $5 billion and next year greater than $5.5 billion. So we have good performance by the core businesses generating a lot of cash for reinvestment.
Let me talk a little bit about the IDS business. We feel pretty good about the organization that we have in place. It's one that really brings together the best of McDonnell Douglas, Rockwell, Hughes, and heritage Boeing. We're organized into customer-facing organizations to support the various customers that we have. The strategy that we have put in place over the last several years has focused on the whole concept of network-centric operations and not being a vertically integrated company, but bringing the best of industry and bringing some of those key innovative technologies that were talked about by Secretary DuBois that come from some of these small entrepreneurial companies that are out there.
In terms of growth, we have grown our revenue base on the defense side by 50% from the year 2000 through 2004. For the most part, it's been organic in nature with compounded annual growth rate of over 11% and generating strong margins. I'll discuss those margins in just a couple of minutes. We think with some of the recent things we've done in commercial space and yesterday's announcement on the formation of the United Launch Alliance, we have and will continue to diminish some of the exposure we've had in the commercial space area.
Last year we brought in about $30.5 billion in revenues, we're moving to $32.5 billion this year. Last year we had operating earnings of $2.9 billion, operating margins of 9.6 and that was despite the fact that we wrote down about $80 billion on the tanker development program and we also lost a couple hundred million dollars in commercial space. Other than that, the engine performed very, very well last year. I think also of note is that with the strategies that we have put in place over the last two years, we've been able to generate $82 billion worth of orders and we currently have a backlog of about $86 billion and I think that's probably the best in the industry right now.
The classified area is something that we've been able to grow in recent years and last year we had $5 billion in orders in the classified area and we see some great opportunities as we go forward. Let's talk about this year. In the first quarter, revenues of $7.5 billion, that was only 2% revenue growth. We had some timing issues in our aircraft and weapons area. We think for the year the growth rate will be about 6.6% for the business. Operating earnings $800 million with 15% improvement from last year at this time and we had margins of 11.2% from an operating standpoint. Now there were a couple of one-time events. If you peel out those one-time events, the margins were still over 10% -- they were 10.1% -- so the machine is working very, very well. All the segments were profitable and I think of note is our Launch and Orbital Systems business return to profitability. This has been an area that we have suffered through some real difficult times over the last several years. So a good job by the people.
Let me move on and talk about the environment and the strategy. We'll talk about the business performance then and we'll close with a couple of comments. I'm sure you've had a lot of discussions over the last two days from both the customer as well as people from the defense industry talking about where the budgets are going. We've enjoyed a terrific buildup in spending since 2001. To go 2001 to 2005, the compound annual growth rate in the investment accounts has been about 9%. From '05 to '06, it's going to be flat and my guess is it's not going to be nearly as robust from '06 to '09 as people are projecting. People are saying it's going to be 6.6%. My guess is the best we can hope for is probably 2 to 3%.
Despite all that, defense spending is at an all time high, but there's budget deficit pressure. We have a more conservative Congress. I think balancing the budget will be one of its concerns. There are other social programs competing for the dollars. We've got the re-prioritization that will come out of the QDR which I know has been talked about. The Iraq operation is consuming about $1 billion a week. There will be a requirement to eventually reset all the equipment that's being worn out in place. So a lot of things competing for our customers' dollars. International procurements: there are some great opportunities out there in the fighter area but we're also seeing many of those procurements being delayed. The civil space vision is one that we certainly can all embrace going back to the moon and going on to Mars, but is there going to be the support for that on Capitol Hill? Will there be the resources necessary to do that? And of course the commercial space market remains pretty much commodity based.
If I take a look at what's going to happen and my view is that there are four types of programs that are going to come under a lot of scrutiny. All big programs. They'll be looked at just because they're big. All programs that aren't transformational will be looked at and looked at very hard. You can see programs going the way of Comanche and getting cancelled because they don't support transformation. New starts: we're seeing them pushed to the right and I think they'll be continued to push to the right. Last year we saw the transformational communications architecture program pushed to the right. We saw SBR (Space Based Radar) pushed to the right. I think that will continue because we cannot afford the new large programs that I just mentioned. And then programs that are in trouble from a performance standpoint will be looked at very, very hard.
I think the things we're working on are probably the same things that other defense contractors are working on. We need to keep our programs healthy. That means we have to execute. We need to keep the programs relevant and that's relevant to the warfighters that are deployed today. And then we need to make sure the programs are politically viable which means working the support on Capitol Hill.
In looking at the customers, we are a customer driven organization. We like to think that we try to anticipate where our customer wants to go. You heard the secretary talk about transformation and the needs of the warfighter in the 21 st century. We like to boil it down to the following four capabilities: mobility, precision engagement, global situational awareness, and integrated command and control. We have tried to develop a company that can really address these four capabilities that our customers are demanding. And certainly we recognize that eventually we will get to an integrated battlespace where all the platforms, all the soldiers, all the airmen, all the seamen are connected together through a system-of-systems network where they can transfer information and knowledge and transfer capabilities across various platforms.
We talk about the competitive discriminators that we have in place -- market- and customer-needs driven. I'm sure that's one that everybody would say that they have. Our view is that the wins we have had, wins like Future Combat Systems, like MMA (Multi-mission Maritime Aircraft), like GMD (Ground-based Midcourse Defense) and others, really demonstrate the fact that we have been able to shape some of the markets and we have been able to come up with the kinds of innovative solutions our customers are demanding.
We have worked very hard to be a horizontally integrated organization. If one looks at the kinds of large systems integration programs that we do, we cannot do them in any one location. We have to be able to bring together multiple locations of Boeing and also multiple partner locations to do the kind of work necessary to execute these large complex programs that we have won. Our strategy has been one also of bringing the best of industry and not being a vertically integrated organization. I would submit that any company that brings the best of its company only to the marketplace is one that will always have a sub-optimal solution. Because no company can be the best in the world at everything it does. So we've worked very hard to bring the best of industry to the various teams that we've proposed and our strategy is one that has been effective for us.
A common architecture across all the systems, a common information and communications architecture that we apply to all of the programs so we aren't uniquely developing approaches for our various customers. The fact we have a large legacy-installed base is allowing us to bring a transformational perspective to many of the modification and repair programs that we have. And then, of course, the fact that in the larger scope of the Boeing Company, we have access to the commercial airplanes that will allow us to do the commercial derivative airplanes for programs like tankers, MMA, AWACS and others. We think these strategies and these competitive discriminators have served us well and we've been able to leverage these things in the marketplace. Again, growing the business by 50% over the last four years.
In terms of military transformation, these are some of the programs that we've captured. But along with transformation, certainly there is a need to upgrade many of the existing programs that are out there, the existing platforms, and I'm not sure that people realize how many airplane programs we have ongoing right now. This next chart shows just a few. The Airborne Laser program where we had first flight and first light last year. The first KC-767 tanker for Italy which was rolled out in February. We rolled out the F/A-18E/F Block II last week in St. Louis. We are actively flying the X-45A out of Edwards Air Force Base. The first 737 AEW&C Wedgetail airplane visited Australia several weeks ago and toured several RAAF bases. In addition to the F/A-18E/F, we're building EA-18G for the U.S. Navy today, and we inducted our first C-130 into our mod facility down in San Antonio last week to start doing some of the avionics modernization activities. And we will deliver the first two F-15K to Korea later this fall. So a lot of activity going on and if one looks at the dollars associated with this chart, it's well over $100 billion over the next 10 years and the product chart is over $100 billion as well.
We think we've got a pretty robust portfolio and we have a good mix between production programs and development programs. You can see the production programs listed here. The majority of those programs are well into double digits. We have very good performance on fixed price programs. In the support area, we're making good double digit margins. Those are some of the larger programs that we have. In development, you can see a long shopping list and there's no reason on the majority of these programs that you can't make low double digits and on average, I think, make high single digit margins on these programs, and you can see some of the near term competitions that we have and some of the concept studies that we are involved in.
So a lot of activity going on right now. Margins certainly are a reflection of how well you're performing on your various programs. We have worked very hard to reduce our cost basis, to lean out our manufacturing, to get more robust program management best practices in place, to do a better job of developing software the first time. And I think our margins reflect the improvement that we've been able to make and our guidance for this year on margins is 9.8%, which is a little under what we performed at in the first quarter.
Let's talk about business performance if I could. Looking at 2005, you can see $32.5 billion is what we're forecasting. The revenue growth this year will be about 6.6% over last year. And for next year, 7% growth. You can see the margin is 9.8% and you can see next year we're projecting close to double digit across the entire enterprise. You can see the four different reporting segments here and you can see the different contribution of each as a percentage of the $30.5 billion in revenue from last year. Let me just make a comment on network systems. You go back five or six years and this segment was worth about $2 billion. And we've been able to develop a large network-centric operations series of programs that go into this segment. We've been able to grow our intelligence business from next to nothing to over $3 billion and we've also been able to grow in some of the other areas. So we've really been able to develop this area from around $2 billion to about $12 billion of revenues.
Let's go through the different segments if we could. First let's talk about Network Systems and let me just spend a little time on Future Combat Systems. Secretary DuBois touched on it just a little bit. There have only been two major changes to the program over the last six months. Last fall we did a restructure of the program. The program had been criticized about some of the technology being immature. There were some comments that we were only going to be fielding 14 out of the 18 different platforms in 2012. There was some concern about the revenues or the funding that was going to be available over the development phase of this program. And there was also some criticism about the fact that Future Combat Systems was not going to be relevant to current forces.
I give General Schoomaker a lot of credit for going in and restructuring the program around a series of spirals where we will be making technology available to the existing troops starting in 2008. We also pushed the program out two years and rather than fielding 14 of the 18 platforms, all of them will be fielded at the same time in 2014. By pushing it out, we were also able to manage some of the risks associated with the technologies and smooth the funding profile. So that was one of the big changes on the program. Then the other change was going from the OTA type contract to a Far Type 15 contract. Now I think it's entirely appropriate to make that change. Here's a program worth $22 billion with the potential to be worth $120 billion and I think to provide the taxpayer and the U.S. Government full cost visibility of what we do is certainly appropriate. We are working right now to change our contract to be in compliance with Far Type 15. In terms of the cost of doing that, we think the costs will be very marginal if at all and we're trying to flush out what that number is going to be.
Just a comment on the Joint Tactical Radio System program. We did get a show cause letter on that last week. The issue is the technical basis for the wave form and the radio adequate for that technology to be portable to some of the other phases of JTRS. We feel confident that the technology is mature enough and it is portable and we'll be working with our customer over the next 30 days to demonstrate that to them. So to wrap up Network Systems, if you look at the revenues you can see the pretty significant and robust growth year-to-year and you can also see what the margins are. The margins are 8% and this includes for the most part development programs.
Aircraft and Weapons, pretty flat from last year to this year. Good margins last year. They were 14.4%. This year, 12.5% is what we're projecting. Obviously we're going to try to work that to bring it up to where it was last year, but I'm not ready to come off the 12.5% quite yet. On the F/A-18, we'll continue to deliver 42 of those per year. On the F-15, we've got a number of international competitions that are ongoing today and we're supporting Lockheed Martin on the F/A-22. On Apache, we just got under contract to remanufacture some 501 Apaches and convert them to D models. JDAM, we're knocking out about 35,000 of those per year. The Small Diameter Bomb just went into low rate initial production and it's performing well. We continue to deliver about 15 C-17s a year and V-22 is in Opeval (Operational Evaluation ) right now. So a lot of activity in the Aircraft and Weapons Systems area and pretty good performance across the board.
Support Systems: if you look at the maintenance and operations accounts and the DoD budget, it's growing. We want to grow as that account grows. As our guidance shows, we expect growth in this area and very, very strong margin performance. There are over 10,000 different contracts that we have in the aerospace support area and you can see some of the larger ones listed here.
In Launch and Orbital Systems, it's about $3 billion a year. About $1 billion of that is launch and about $1 billion is commercial satellites and $1 billion is the work that we do with NASA. We returned to profitability this quarter after being absent for a couple of years. I'm not going to stand up here and tell you without question we've solved all the problems in our satellite factory, but we've had two pretty solid quarters and I'm starting to gain some confidence that the team has its arms around the issues.
You probably saw yesterday that we made an announcement with Lockheed Martin to take our government launch business and combine it with its. Our customer has really demanded three things in the government launch area. It wants to have lower cost, it wants to have assured access which means two different kinds of launch vehicles, and it wants to have improved reliability. We believe that this construct that we have put together and announced yesterday will give that to our customer. There might be some that say this limits competition, but as I think you know, the government policy is to have two suppliers for the near term and eventually going to one. If one looks at the current strategy that the Air Force has for Buy III which is the next block buy of expendable launch vehicles, it was not going to be a competition. It was going to be an allocation. We believe this Joint Venture is an approach where they can allocate their launches and get their launches at a lower cost than they would have if we'd stayed in two separate companies. So we think what we've done here is moderate a lot of the risk that we had and we continue to think that we can make this into a good business.
Okay, let me just wrap up real quickly by talking about the makeup of the portfolio. You can see here the revenues we generate from the different customers that we have. In terms of international, it's about 7% of our business. We think there are some opportunities to grow here, but export restrictions continue to be a concern for us. It makes it difficult to compete but we think we've got some products that are attractive to the international marketplace.
Just looking at our customers, where they've been and where they're going, in years past they bought things. They're starting to purchase systems today and we think eventually it's going to be all about how you can integrate all these systems together and we're trying to position our company to support all three of these types of acquisition by our customer.
Again, just to close, 2005, $32.5 billion. We think we've got the right organization in place, the right strategies. We have been growing the revenues and we think we can continue to do that. We expect the margins to continue to improve, but improve incrementally because you're never going to run more than 10, 11, 12% on a government business and we think we have been able to manage the risk pretty well over the last couple of years. With that, I'd like to open it up to questions.
Steve: I've done a really poor job yesterday and today in asking companies the question which programs do you currently operate and perform on where the customer is unhappy? I'll ask you that question because I don't want to push back unless you do.
Jim Albaugh: Well, I wish I'd been here the last couple of days to find out what the customers said, but I'll take a shot at it, Steve. Certainly the JTRS program where we received a show cause letter is one. When we have a customer that's not totally pleased with your performance, we know that. And JTRS is one where we're going to have to demonstrate the technical basis for that program. The Airborne Laser is a difficult program and it's one that I think was in jeopardy of being cancelled last year until we were able to achieve first flight and first light. On the Ground-base Midcourse Defense program, as probably most of you know, we've had two failed intercepts in a row. In fact, we failed to get the interceptor out of the silo, so I think clearly we have customer issues there that we need to address. Those are the three big ones, Steve, that I'm focusing a lot on right now. We have a lot of development programs, a lot of challenging programs. I think the margins reflect for the most part, though, the fact that our customers are generally pleased with what we're doing.
Steve: What do you think needs to be done different organizationally to handle these program issues today or do you think it's really more of a cumulative reflection of what's been going on for quite some time?
Jim Albaugh: Are you talking about our programs, Steve?
Jim Albaugh: I think the organization is okay. I think if one goes back four or five years, we became so focused on IPTs that we lost some of our systems engineering focus. We think we've been able to bring that back. Two years ago, if you'd asked me what the biggest performance issues we had were, I would have said subcontract management and software development. Today I'd say to a large degree we've fixed the software development issue, but subcontract management continues to be a big issue. We've tried to move up the value chain. We've tried to outsource much more and put a lot of the work with some of our partners that have better capabilities than we do, and not managing those partnerships to the extent we should, not flowing down good solid baselines has been a problem for us. But we work very hard at program management best practices, at sharing lessons learned across the enterprise, trying to be horizontally integrated and I think the organizations are A1.
Steve: If you look at employment, what kind of growth curve are you still at in 2005? It that an issue at all? Is that a challenge?
Jim Albaugh: Our need for engineers continues. In fact, I think we've got requisitions out for a couple of thousand engineers and certainly especially in the Washington, D.C., area and the Southern California area, there is a lot of spirited competition for resources and I think that's a problem across the enterprise. I worry about the defense industry though. The average age of an aerospace worker is 53 years old. We're graduating about 30,000 engineers a year. Eighty-percent of the aerospace workers would not recommend to their children to go into the business we're in. I do worry about intellectual disarmament of the defense community. It's an issue for us.
Steve: Do you concur with Jim Roche's view that I touched on earlier today? He basically drew an analogy that the major primes are going down the same path as the U.S. automotive manufacturers that essentially they're blocking innovation and they're unionized. They're having foreign threats, smaller companies.
Jim Albaugh: I think I generally agree with what Jim said. If I looked at the aerospace industry, there have been four defining moments so far. They are Kitty Hawk, WWII, the jet age and going to the moon. The last one was in 1969 and I think to a large degree we are an industry that evolves what's allowed us to be successful as opposed to being very innovative in scope. You look at the real entrepreneurs in the aerospace industry, you know, people like Northrop and Kindelberger and Douglas and others and where are those innovators today? I don't think they're working in the aerospace business, I think they're working someplace else.
I think a lot of it stems from how we have traditionally hired and promoted people. We still promote people based on years of service too much and not nearly enough on capability, innovation and ability, but we are trying to improve in this area. So, I do think Jim is right. At the same time, I think what we're doing is trying not to create all the innovation within the company, but trying to team with people that have been innovative. But I will also tell you that I've seen an awful lot of small innovative companies get bought by large defense contractors who quickly stifle that innovation. So I guess in general I'd agree with some of the comments that Jim made.
Steve: The joint venture with Lockheed Martin, is it more of a profit answer in the '07 timeframe or do you see much improvement in the '06?
Jim Albaugh: '05, '06 really doesn't have much of an impact. We'll start to see some improvement in '07 and the out years. What it really does though is it reduces the risk to both companies as we go forward and it provides our customer with exactly what it wants and that is lower cost, better reliability, and two launch capabilities.
Steve: Have you calibrated roughly to be about a $75 million benefit to earnings?
Jim Albaugh: I tell you what, I think it's probably a little early for us to assess that. We're going to have our investor conference out in Seattle in May and we'll give you some more information on how this organization split comes together. We need to sit down with Lockheed Martin and agree on the charts. But we'll give you more insights on how this joint venture is going to come together and what the benefits to both companies will be.
Steve: Okay. Do you have any questions in the audience here?
Jim Albaugh: I feel like I'm having a conversation with Steve up here.
Speaker: Jim, on the idea of some of the gaps that you might want to fill, on the network-centric side or Network Systems side, thinking maybe two years out, are there other areas of the market, either by sort of the end product group, perhaps the Army or slices of the market as far as technology like IT that are big gaps that you'd like to fill?
Jim Albaugh: We're not going to go into the shipbuilding business, I can tell you that. And we're not going to go into the tank business, I can assure you of that. We took a hard look at the IT area because that's going to be an increasing need and we decided there were really three options. To buy somebody, to form an alliance or try to develop the capability internally. And we put together an alliance with IBM which we think will fill some of the IT needs that we have. Right now, the kinds of acquisitions that we're looking at are small ones to support our ability to penetrate some of the Intelligence markets that we're currently not in. Those would be acquisitions less than $100 million or so. We also are looking in the service area. Are there are some acquisitions that we might make there in order to better address that growing marketplace.
Steve: Other questions?
Speaker: Jim, can you expand a little bit on the international opportunity?
Jim Albaugh: Sure.
Speaker: Bill Swanson yesterday talked about the fact that he's seen the Asian market being stronger than he originally projected for this year so they've got their bookings forecast. You've got some competition and you're kind of handicapped obviously on some of those competitions.
Jim Albaugh: We've got a number of them in Asia. I think the one that the people are looking at right now and it's been in the paper recently is the fighter competition that we have ongoing in Singapore and we're competing against the French airplane with the F-15. I think they're going to come in with a very good price and I think we're going to come in with a very capable vehicle. I think those things will make up the balanced capabilities against price. I'd say we're 50/50 on that one. There's an airborne early warning and command competition in Korea. It's one where they are going to come out with a new RFP here shortly and we'll be competing against an Israeli radar over there. That down select ought to be towards the end of the year. Malaysia - we continue to talk to Malaysia about F-18s, but I don't see that one happening anytime soon. To the extent that the JSF may slip, we think there could be some gap filler opportunities in Australia and other locations for F-18s. Certainly in Japan and India, we see the potential for about 200 airplanes in those two markets and we need to better understand the customer requirements before we decide if the F-18 or the F-15 is the right way to address what those opportunities are. And certainly in the missile defense area, you're seeing a lot of interest in Japan and opportunities for us and Lockheed and Raytheon over in that market.
Steve: How about the C-17?
Jim Albaugh: Everybody likes the C-17, but they don't like the price tag. And while we might sell a couple more, I don't really see a lot of market internationally for that airplane. I will say that there is a good market for C-130AMP upgrades internationally around the world though.
Steve: Long term, without quantifying or projecting out for '05 or '06, but long term, how high can your defense margins go? What is the opportunity there? Not to say you're going to project it that you're going to get there.
Jim Albaugh: Well, as I think everybody knows, with a fixed price contract you can make margins of north of 15% and we've demonstrated we can do that. But every time we go back and renegotiate the contract, you're going to have to give some of that money back. And on the development programs that we have that are cost plus, you execute perfectly and you can't make any more than 15%. I think to say a range of 10 to 12% for a government business is probably the top end. I would be very surprised if we could do any better than that.
Steve: Other questions? Okay, thank you very much, Jim.
Jim Albaugh: Okay. Thanks, Steve.