Defense And Aerospace: Real Value For Investors And The Nation

| About: Exelis Inc. (XLS)

by David Melcher, President and Chief Executive Officer, ITT Exelis

We live in a complex and unpredictable world. America and its allies face hostile threats every day. Navigating the endless and evolving challenges needed to keep our country safe and maintain global security requires experienced leadership, operational agility, substantial expertise and a well-developed understanding of what works, what is possible and what is necessary.

As we begin our first day as a standalone publicly-traded company, ITT Exelis (NYSE:XLS), a leading defense contractor with more than 20,000 employees, is well prepared for today’s new environment, providing a diverse range of products and services to military, government and commercial customers around the world.

Having spent 32 years in the Army before becoming a CEO, and as a parent of two children who have served in the military, I’m only too aware the state of global security today is characterized by threats that are numerous, asymmetric and unlikely to abate. That makes ensuring access for U.S. forces (with ships, aircraft and unmanned vehicles) and denying access to adversaries (through electronic warfare, ISR, missile defense and cyber technologies) top priorities. These are all areas where ITT Exelis has leadership positions and unique technical capabilities.

The Landscape
Of course, there will be challenges for a new defense company going public during a downturn. As we begin our new venture, post-9/11 growth in U.S. defense spending is slowing and we are preparing for defense cuts that could be in the hundreds of billions of dollars over the coming years. Due to the country’s economic and fiscal difficulties, as well as the draw-downs underway in Iraq and Afghanistan, defense companies must adjust to constrained spending and smarter procurement while still meeting the challenges and the needs of government customers like the Department of Defense (DoD).

The nation’s leaders, the Pentagon and the public readily acknowledge these downward pressures. Nevertheless, they remain strongly committed to maintaining force readiness. This broad consensus is absolutely essential if we are to successfully respond to both existing and future threats, whether from global terrorism, cyber attacks or hostile states. Only in this way can we do what is necessary to protect our country, our allies and our interests.

Since we fully expect that these threats to global security will persist and evolve, the U.S. will continue to fund the world’s largest defense budget and will still count on the defense and aerospace industry for innovation, research & development and answers to increasingly complex scenarios. Moreover, militaries around the globe will also modernize programs and update capabilities to meet emerging needs in electronic warfare, intelligence-surveillance-reconnaissance (ISR), navigation and information exploitation.

Adapting with Ingenuity
Just as military forces have adapted to meet new and more asymmetric threats, the industry must adapt to ensure that the ever-evolving needs of its customers are anticipated and addressed -- and the health of individual companies will be based on whether they are well-positioned to meet these new and evolving requirements, here and abroad.

This development underscores a fundamental shift underway in U.S. military strategy. Going forward, we anticipate greater reliance on technology, air and sea assets, as opposed to boots on the ground. Consequently, customers’ appetites for expensive and “exquisite” solutions have diminished, especially when smarter and leaner options are available. Many of the massive platforms and costly concepts of yesterday just are not an option for many buyers navigating a constrained fiscal environment. Customers are looking for products and services that meet pressing realities and can be rapidly utilized in the field of combat.

In this environment, companies that can quickly turn concepts into deployable solutions will have a significant advantage. For instance, in a matter of weeks, our company has delivered a breakthrough technology that sends drone-captured imagery and video to users in command centers and on the battlefield. Anticipating customer needs and responding rapidly are guiding principles for establishing leadership positions in enduring and emerging markets.

Shifting Priorities
ITT Exelis’ products, services and investments in new technologies are geared towards enabling customers to adopt this advanced breed of capabilities for today’s conflicts. There is no set term for these next-generation technologies, but we refer to them under our C4ISR product category – military terminology that stands for Command, Control, Communications, Computers, Intelligence, Surveillance and Reconnaissance – a major priority area for the DoD. From our smartphones for soldiers on the front lines to our sensing technologies onboard unmanned systems that capture imagery and video of areas of interest, our C4ISR segment accounts for approximately 50 percent of our combined revenue.

Another factor that needs to be considered is the importance of being “platform agnostic.” For ITT Exelis, this means that many of our products can be fitted across multiple platforms and can be used to upgrade existing systems. No single program currently accounts for more than 7 percent of our revenues, allowing us to avoid becoming overly dependent on legacy systems and large-scale projects increasingly subject to budget scrutiny.

A great example of this concept in action centers on the ongoing debate over continuing the F-35 Joint Strike Fighter program or upgrading the current series of F-18s. Regardless of outcome, ITT Exelis is confident in our position because our systems factor into both options.

New Markets
Beyond adapting to meet the demands of military customers, success in the industry will rely on taking technologies to new markets and continually looking for opportunities to diversify the portfolio. Through active portfolio management and diversification, we feel well-equipped to navigate the current period of industry uncertainty.

Over the last two years, our organization achieved 40 percent growth in non-DoD revenue and now approximately 30 percent of our customers are outside the Department. Our expansion beyond the Pentagon includes serving as the Federal Aviation Administration’s (FAA) leading partner in modernizing the U.S. air traffic management system from a radar-based to satellite-based operation.

ITT Exelis is now taking many of our leading positions to international markets – an arena that constitutes approximately 11 percent of total revenues and continues to expand. For example, we are working to replicate our success helping the FAA modernize the U.S. air traffic management system in several other countries.

Beyond our global work, we will pursue opportunities to enter more nontraditional markets, particularly on the commercial side. For instance, we recently expanded our manufacturing presence in Utah to develop our role as one of the most advanced designers and producers of lightweight composite structures, supplying composites to major aerospace prime contractors and commercial aircraft manufacturers. We are even taking our technologies into new fields such as health care. We recently partnered with the oncology company Novocure to adapt one of our technologies to a device that fights one of the deadliest forms of brain cancer.

While military and government institutions will remain core customers for defense companies like ITT Exelis, we believe that our 50-year track record of success is directly tied to our ability to transform smart ideas into solutions that can be re-engineered for new markets and new customers.

Moving Forward
By focusing on new technologies, diversifying our portfolio and demonstrating agility in the way we approach tough challenges, we believe that we are well-situated in the competitive defense marketplace to create long-term value for taxpayers, customers and shareholders. For current ITT shareholders who now hold ITT Exelis stock and value investors who are potential shareholders, we are excited about the steps we have taken to adapt to change and even more excited about advancing our enduring and emerging positions.

At ITT Exelis, we believe the question facing policymakers, appropriators, customers and even investors is less “how much defense we can afford?” and more “how much and what kind of risk can we afford to take?”

Disclaimer: I am the CEO of ITT Exelis.

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