Companies in the US aerospace and defense (A&D) industry have enjoyed a decade of record-breaking revenues and profits. In 2012, the industry reported its best year on the strength of a surging commercial aviation market. But while the commercial sector is thriving, the outlook for the US defense sector is shifting in the wake of budget cuts to defense and space programs at home and in much of Europe. The most challenging of these cuts came on March 1, 2013, when the word sequestration entered the daily American vernacular.
Through the sequestration process, the US government reduced spending on federal programs across the board, including a cut of roughly $43 billion from the defense budget in 2013 and an estimated $500 billion over the next decade. Even if the cuts are temporary— which is how they were originally conceived—the US defense budget is likely to get leaner in coming years as the government grapples with lower revenues, the evolving nature of global security and increased competition for federal dollars.
PwC reported in A&D Insights, an annual publication examining the state of the A&D sector, that as a result of these and other challenges, A&D companies are “experiencing more pressures from more directions than ever before.” To stay competitive, A&D companies must manage variables like price constraints, supply chain risk and broad economic uncertainty, all while continuing to develop and market new innovations to help their customers adapt to the evolving global threat environment. Keyword recently spoke with three PwC alumni—Dave Wajsgras, Rajeev Bhalla and Tom Crimmins—to gain their insight into industry trends and learn how they are positioning their companies to succeed in this economic climate.
Dave Wajsgras has been the CFO of Raytheon Company, the world’s fifth largest defense contractor, since 2006. With 2012 sales of $24 billion and 68,000 employees worldwide, Raytheon is a global leader in defense, security and civil markets spanning a range of fields including missile defense, communications and intelligence systems, cybersecurity and electronic warfare. The company is perhaps best known for the Patriot air and missile defense system now in 12 nations, and today benefits from a broad portfolio and focus on international business.
Rajeev Bhalla took over as CFO of Sikorsky Aircraft Corporation in 2012 after serving as CFO of aerospace manufacturer Pratt & Whitney. All five branches of the US Armed Forces use Sikorsky helicopters, including the BLACK HAWK by the US Army and the SEAHAWK® by the US Navy. Sikorsky also produces helicopters for commercial applications like oil and gas exploration, and search and rescue. The company posted revenues of $6.8 billion in 2012.
Tom Crimmins assumed the role of CFO at DRS Technologies in 2012 after 13 years with the company in other financial roles. DRS, which grossed $2.8 billion in 2012, is among the market leaders in electrooptical/ infrared (EO/IR) technology, combat display workstations, electronic sensor systems air combat training systems, and a host of other mission-critical systems and sustainment solutions.
Senior Vice President and CFO
By improving efficiencies at every level, maintaining a broad portfolio of products and services and keeping a relentless focus on innovation and customer support, CFO Dave Wajsgras believes Raytheon will find itself in an even stronger competitive position.
Dave Wajsgras describes Raytheon as “platform agnostic.” In other words, the company’s core product lines of electronic systems and subsystems enable the missions of a variety of planes, ships, satellites, ground vehicles or even weapons systems provided by other companies.
This flexibility gives Raytheon a competitive advantage in today’s defense budget environment, Wajsgras says, by allowing customers to affordably improve performance without having to invest in all-new equipment. “For example, we provide replacement radar systems as well as cockpit technology modules for fighter jets,” he explains. “These systems take existing planes to new levels of performance without requiring our customers to buy additional aircraft, allowing them to efficiently manage their increasingly scarce resources.”
Wajsgras believes it’s this approach—proactively seeking opportunities especially in a challenging operating environment—that has made Raytheon successful. The company has streamlined and consolidated operations without losing sight of the big picture. It balances the delivery of innovative solutions with the achievement of efficiency gains throughout its operations, allowing the company to effectively respond to customer needs. With more than 30 years of experience in industry, Wajsgras is well suited to help Raytheon operate in just that way.
Wajsgras credits his years at PwC with preparing him to succeed in a variety of roles. “Your first few years in public accounting, you’re doing a lot of routine audit work, and sometimes you don’t understand how it all fits together,” says Wajsgras, who joined Coopers & Lybrand in 1982. “I was fortunate to work with a lot of managers and partners early on who helped me connect the dots from a business perspective. That’s an approach to communicating that I still use today in my work with younger professionals.”
Wajsgras says PwC is also a great training ground for professionals who want to become more self-reliant. “They gave me a lot of confidence in my ability to multitask in a business environment,” he recalls. “It also really validated my ability as a self-starter.”
Wajsgras’s post-PwC experience included stints as director of operations for a conglomerate eventually acquired by General Electric, as vice president and corporate controller of Engelhard Corporation, and as CFO and executive vice president of Lear Corporation.
It has always been about laying a solid foundation and building on it with each new opportunity.
“It has always been about laying a solid foundation and building on it with each new opportunity,” he says. “For instance, my earlier operational roles gave me the foundation to be successful at Lear, where I helped oversee both the financial function and the manufacturing sector of the business. That led to where I am today and was the cornerstone for what I’ve been able to achieve at Raytheon.”
That said, Wajsgras says the defense industry is more complex than he originally anticipated. “Frankly, it’s more complicated than most purely commercial industries, and just as competitive,” he says. “You’re dealing not only with the traditional ground rules any enterprise faces, but with a whole other set of rules and regulations. And these regulations can have an impact on some of the business decisions we need to make from a shareholder perspective.”
Nonetheless, Wajsgras and Raytheon are standouts in the industry. In 2012, The Wall Street Journal named him to its inaugural list of 25 Best CFOs among larger companies in the S&P 500. Wajsgras deflects much of the credit—“Raytheon has a world-class finance team that I am fortunate to lead on behalf of the company” —but the fact remains that Wajsgras’s financial leadership has helped advance Raytheon’s position as a world leader in defense systems. Since joining Raytheon, he has overseen more than 13 acquisitions; orchestrated the sale of the company’s commercial aircraft business in 2007; and guided the transformation of Raytheon’s supply chain, reducing the supplier base from 30,000 to 12,000—all in an effort to provide the financial basis for the company’s businesses and core product activities to succeed in an increasingly challenging marketplace.
He cites the leadership of Chairman and CEO William H. Swanson for building a team capable of executing strategies that address the future needs of the company’s customers. “This alignment has made us stronger and more agile in the market, and together with my colleagues on the senior team we are delivering for customers and shareholders,” Wajsgras says.
Total return for company shareholders was 23.1% in 2012, outperforming the S&P 500 and representing the highest performance among US large cap defense prime contractors.
“Our approach is to address efficiencies in every part of the company,” Wajsgras says. On the operations side, Raytheon has led the A&D industry in leveraging common IT systems across the company to standardize processes, reduce complexity and achieve competitive advantage. Raytheon is also consolidating office and manufacturing locations to bring talent together and ensure facilities are fully utilized. And by streamlining its supplier base, Raytheon has lowered its procurement costs on key subcontracts and commodities— savings the company is able to pass along to customers.
It’s all about an intense, sustained focus on programs and operational performance.
Combined, these efforts help Raytheon develop agility and speed in its business processes—a strategy PwC’s A&D Insights identified as a priority for defense contractors who want to respond faster to new market opportunities. “It’s all about an intense, sustained focus on programs and operational performance,” Wajsgras says.
While these efforts make good business sense at any time, Wajsgras says they’re especially helpful during periods of pressure on defense budgets. In fact, he says Raytheon has spent the past several years preparing for today’s defense environment, which increasingly requires customers to become more productive while spending less. Even the US Department of Defense now lists affordability among its procurement requirements, a change from just a few years ago.
“We know from past experience that this industry operates in 5- to 10-year cycles,” Wajsgras says, adding that Raytheon—like every company—has to be prepared to operate effectively in any environment. “We weren’t going to be one of the companies caught behind the eight ball.”
In order to emerge from the current cycle on even stronger footing, Raytheon is continuing to invest in the process of innovation, spending nearly $80 million more in 2012 on R&D than it did in 2011.
A market that continues to show promise for defense contractors is overseas exports. In a recent A&D forecast, PwC estimated that annual defense export agreements more than doubled from 2006 to 2010, leading to a record backlog of $327 billion at mid-year 2011. Wajsgras believes that the continued strength of these markets could prove a boon to the defense industry.
“We anticipate continued growth in international markets, with Middle East and Pacific Rim countries offering the greatest near-term opportunities,” he says, while noting that Raytheon achieved 26% of its total 2012 sales from international business, the highest percentage in its peer group. “We also expect the US government to continue to improve the export process for US companies.”
The nature of global threats largely dictates which technologies offer the most potential for companies like Raytheon, Wajsgras explains. Although it can be difficult to project too far, Wajsgras says some trends have become clear. “We see domestic and international customers investing in the very segments we have established as priorities: air and missile defense systems, C4I systems, electronic warfare, and cybersecurity. A secure nation and a secure economy begin with secure infrastructures that can be effectively defended against cyberattacks.”
Cybersecurity is a well-established, core capability of Raytheon, “yet our approach is unique in many ways,” Wajsgras explains. The company leverages a comprehensive, end-to-end approach to resilient cyber protection based on multilayered defenses. Raytheon has supplemented three decades of experience in cyber technologies and network security with several related acquisitions since 2007. “Our customers understand that cyberattacks are a persistent threat,” he says. “We see additional growth opportunities in this market for the future.”
One strategy that Raytheon has not pursued in recent years is initiatives targeting commercial markets. “Over the last decade our markets have been sufficiently robust that moving too far away from our core competencies did not merit the investment,” Wajsgras says. The company remains resolutely committed to innovation, and believes it is well served by focusing on operational excellence and developing gamechanging technologies.
“We work closely with our customers, we make adjustments as necessary, and we remain flexible in our approach to the markets we serve,” Wajsgras says. “Our success has been made possible through strong leadership—both internally in terms of how we run the company, and externally in terms of how we shape the market and deliver for our customers. None of this happened by accident. We’ve spent years preparing the company for today and the future.”
Sikorsky Aircraft Corporation, a subsidiary of United Technologies
Vice President of Finance and Strategy and CFO
A thriving commercial business and a clear vision of how to incorporate new innovations into its military products give Sikorsky Aircraft CFO Rajeev Bhalla confidence for the future.
In its 2012 thought leadership and forecast for the A&D industry, PwC noted that once the F-35 Joint Strike Fighter is completed, “There will be no military fighter aircraft in development [in the US] for the first time since the innovation of flight.” For an industry that’s historically at the leading edge of innovation— having developed technologies that eventually led to the creation of the Internet, GPS and commercial satellite communications—this is big news. And it shows just how cautious the US Department of Defense is acting in the midst of changing budget priorities.
Rajeev Bhalla has seen the caution firsthand. The CFO of Sikorsky Aircraft says it’s especially obvious when you attend both commercial and defense industry trade shows. “We attended the HELI-EXPO in Las Vegas this year, and the mood was very upbeat,” he says. “Most of the commercial helicopter markets are growing, like search and rescue, offshore oil transportation, and medical. But the military shows are different. In the US, we’re operating under some pressure and uncertainty, and it’s not just sequestration, but also changing priorities.”
Fortunately for Sikorsky, demand for the company’s military helicopters remains strong. Sikorsky’s UH-60 BLACK HAWK utility helicopter, for example, is still a fixture in military operations around the world, including the US Special Forces raid on the Osama bin Laden compound in 2011.
Bhalla’s history with PwC traces all the way to his family’s farm in Kenya, where his parents also ran an insurance business and travel agency. “We used the services of Price Waterhouse quite a bit,” he says. “They actually helped me research a paper on the Financial Accounting Standards Board. I’m pretty sure I got an A.” After graduating from the University of Massachusetts Amherst, he joined PwC full time and stayed with the firm from 1986 to 2001.
At PwC, Bhalla joined the team working on the Pratt & Whitney account in 1997, which spurred his interest in the A&D industry as a whole. “I liked jet engines, and I liked the breadth of the industry— both military and commercial,” he says. “But just as important, I really enjoyed working with United Technologies, the owner of Pratt & Whitney, because they were a good, strong, confident client.” Bhalla left PwC and worked at Lockheed Martin from 2001 to 2005 before joining Pratt & Whitney full time as the company’s vice president of finance and CFO. When the CFO position opened in 2012 at Sikorsky— also a United Technologies company—Bhalla welcomed the new challenge.
No matter what’s going on in the industry, you can’t take a sabbatical on innovation.
In Bhalla’s opinion, one of the biggest mistakes a defense contractor can make in tough times is to get too conservative. “It’s easy to start focusing a little more inward than you do outward, and that’s a real danger,” he explains. “No matter what’s going on in the industry, you can’t take a sabbatical on innovation. You just have to make it more affordable.”
That’s easier said than done, of course, especially when companies are in cost-cutting mode. But Bhalla says it’s critical because the markets are fickle. When you’re not innovating, you might as well not exist. “They basically act like you’re exiting the business,” he says, “and there are plenty of competitors who are ready to take your place.”
The challenge is that budgeting is a short-term analysis, while innovation, by its nature, requires a longterm outlook. And as PwC observes in the January 2013 issue of Gaining Altitude, a thought-leadership series focused on the A&D industry, innovation is extremely tough to evaluate: “We are more adept at measuring financial and compliance risks, including operational risks that have financial consequences. But in looking at innovation risk, we need to evaluate opportunity risk—and that is much more difficult.”
Complicating matters is the Defense Department’s evolving approach to innovation. Whereas the government used to invest heavily in private companies that were developing new technologies, it’s now transitioning to more of a procurement role. That leaves innovation—and its associated risks—almost entirely on the defense contractor’s shoulders.
Bhalla says that given these circumstances, maintaining financial discipline is crucial. “You have to properly evaluate risk, yes, but you also have to learn how to make the business case for innovation,” he explains. “It has to be ingrained into every one of your actions. The more disciplined you are on this front, the more likely you’ll make the right decisions.”
Bhalla suggests that defense companies seek partnerships with like-minded companies to share the risks and costs of innovation. Sikorsky recently announced a deal with Boeing to develop a new breed of military helicopters intended to eventually replace the Sikorsky BLACK HAWK utility and Boeing Apache attack helicopters. By joining their resources and expertise, Bhalla says the two companies are in a much better position to create a meaningful solution for the customer—and to reduce their own risk exposure. “It’s a very significant strategic move,” he says.
The partnership also points out the challenges companies face trying to develop new innovations in a longcycle industry. “Our work with Boeing is on a 2030 time frame,” Bhalla says. “Right now, we’re bidding on a technology demonstrator and will hopefully fly a prototype around 2017. We’ll use that to decide whether to enter what’s called a ‘future vertical lift competition’ around 2019. And if we win, we’ll put it into production hopefully around 2034.”
Plus, defense contractors must assume these risks without a clear picture of what the global threat environment will look like in 20 to 30 years. From where conflicts are centered to the evolving threats that governments, economies and populations face, circumstances could be dramatically different by the time new products finally come to market.
Thanks largely to these factors, Bhalla says partnerships between companies like Sikorsky and Boeing are likely to become more common.
PwC analysts believe one of the smartest moves defense contractors can make is to commercialize their product innovations and strategies and look to enter new markets. This approach isn’t new for Sikorsky, which already operates in the commercial aerospace sector. Bhalla says the strength of the commercial marketplace validates this strategy.
“Our commercial side is growing substantially,” he says. “A number of trends are favorable for us—especially what we’re seeing with offshore oil, where companies are not only digging more wells overall, but also digging them deeper and farther offshore. That’s perfect for our S-92® helicopter, which is selling like hotcakes.”
Bhalla says commercial trends are far easier to forecast right now, including growth opportunities in developing countries, many of which are looking to expand their energy infrastructures. He also says many defense contractors are looking at revenue opportunities for their military products in overseas markets.
“We see growth opportunities in Brazil, India, Turkey, Poland, Saudi Arabia and Indonesia for our BLACK HAWK utility aircraft, for example,” he says. Bhalla says these are exactly the types of opportunities defense contractors need to seize. “I see declining spend into the foreseeable future,” he says. “That said, there will still be opportunities to win new business. Even in this environment, you need to replace aged equipment—and a lot of military equipment is pretty aged.”
In addition, Bhalla points out that new threats will continue to emerge: “You can’t take a holiday on innovation, because the rest of the world isn’t doing that. The last thing you want to do is come across a bad guy that has better technology than you.”
DRS Technologies, a Finmeccanica company
Executive Vice President and CFO
To CFO Tom Crimmins, staying nimble while continuing to invest in R&D will give DRS Technologies the advantage it’s looking for.
Tom Crimmins says the defense industry has never felt more competitive. The CFO of DRS Technologies— which produces defense-oriented electronics like EO/ IR devices, sensor systems and combat display workstations— says the US government is putting programs up for competitive bid that used to be the domain of one or two companies. And he’s seeing bids from contractors he never would have expected.
“We’re all fighting for a limited number of dollars,” Crimmins says. “And we’re all competing against each other, submitting bids at profitability levels I’ve never seen in my 14 years in the industry. It’s a very challenging market.”
Complicating matters is that it’s not yet obvious which programs the sequestration budget cuts will affect most. “That’s what’s so tough about the current environment— we have some sense of where the cuts may hit, but we could be blinded-sided in this unpredictable market,” he continues. “It makes it very difficult to plan your requirements from a head count and facilities perspective. We’re trying to get ahead of it by making some very difficult decisions now, so we’re not caught flat-footed when we have a better idea of exactly how the cuts will be structured.”
As a finance professional, there’s probably no better training than to be on the ground auditing a public company’s financial statements.
Crimmins joined Price Waterhouse in 1992 and worked at the company for seven years. He credits PwC with giving him the background to make smart financial decisions. “As a finance professional, there’s probably no better training than to be on the ground auditing a public company’s financial statements,” Crimmins says. “You’re learning balance sheet P&L analytics and audit processes, and you’re being exposed to very senior people at public companies at a young age.”
Since he started with DRS as a manager of financial reporting, Crimmins has seen it grow from a $265 million company in 1999 to a multibillion-dollar company today. “We acquired roughly 20 defense companies in that time frame,” he says, “and we now have 25 individual operating units across the country, as well as in Canada and the UK.” Crimmins took over as CFO in 2012.
With so many defense contractors increasingly competing on price, PwC advises companies in A&D Insights to “become adept at combining cost-reduction strategies with ‘innovation-ready’ derivative platforms.”
Crimmins sees a number of ways for companies like DRS to become leaner while still looking to the future. “You have to look across the entire cost spectrum of the enterprise, but it’s largely general and administrative expenses and overhead,” he explains. DRS is made up of several individual companies and uses a number of data centers sprinkled across the US—all of which can be consolidated to streamline operations.
“We have been leaning out our manufacturing processes and reducing overhead very aggressively for several years. Now we are focusing on the next level of cost savings initiatives so we can get ahead of the sequestration impact curve to maintain profitability in the short term and improve it in the long term,” Crimmins says.
The goal is to make DRS extremely nimble, so the company can respond quickly to market opportunities. “We’re flexible partly because of our size, but also by design,” Crimmins says. “We’re sort of a mid-tier defense player, and we don’t have multiple layers of management making every call. I can walk down the hall and grab the CEO and COO at any time and make real-time business decisions.”
Supply chains are another area that defense contractors are eyeing in their attempts to become more efficient. “We still have too many separate, independent supply chains,” Crimmins says. “But we’ve made tremendous strides. Maybe three years ago, our 25 DRS units were buying from probably 300 different circuit board manufacturers. I think we’ve reduced that number down to three or four. We’ve saved a significant amount of money, particularly when it comes to buying commodities.”
While DRS’s primary customer remains the US Department of Defense, its technologies are broad enough to appeal to customers in other government markets, including the Department of Homeland Security and emergency service providers across the country. For instance, DRS is currently selling small infrared cameras—technology that the company originally developed for the military—to the New York City Fire Department.
DRS is also actively pursuing opportunities in the commercial market. “We have world-class technology in power electronics and in infrared systems,” Crimmins says. “Many of these technologies have very viable commercial applications.” While he prefers not to get into specifics, Crimmins says the key is to be cautious and smart—and not cast a wide net just because of tight defense budgets. “We’re focusing on some very targeted ventures. We’re not out there pursuing 50 different opportunities.” He adds: “One thing we will not do is reduce our investment in R&D. The money we’re spending today could yield products 3, 5 or even 10 years from now.”
Acquired by Italian conglomerate Finmeccanica in 2008, DRS is now able to leverage its parent company’s global network to pursue international business. Conversely, Finmeccanica now has a better opportunity to market its helicopters, cargo craft and military training aircraft to the US market.
He cautions, however, that the pace of international orders is often glacial. “Getting an order booked internationally can take significantly longer than it does in the US,” Crimmins explains. He says it’s not uncommon for him to hear about a DRS broker-dealer chasing an international booking that he expects to get almost immediately, only to have it take weeks, months or even years to complete.
Like Wajsgras and Bhalla, Crimmins believes defense contractors will be on much better footing once the US defense budget stabilizes. It’s the uncertainty that’s difficult to manage.
But Crimmins remains optimistic. “I doubt this is the new norm,” he says. “At some point, we’ll stop having to make educated guesses and will know program by program what the impact is going to be. The companies that will survive and thrive are the ones doing the smart and aggressive things now.”