On October 2nd, the Brent Scowcroft Center on International Security launched the Atlantic Council Captains of Industry series, a forum for leaders of major defense contractors to discuss their plans for navigating the new realities facing their businesses. The first speaker was David Melcher, CEO and president of Excelis, a $5.5 billion global aerospace, defense, and information solutions company. The event was moderated by Steven Grundman, the MA and George Lund Fellow at the Scowcroft Center.

Welcome and Moderator:
Steve Grundman
M. A. and George Lund Fellow for Emerging Defense Challenges
Atlantic Council

Lieutenant General David Melcher (Ret.)
CEO and President

Location: Atlantic Council,
Washington, D.C.

Transcript by
Federal News Service
Washington, D.C.

STEVE GRUNDMAN:  Good morning, and welcome to the Atlantic Council.  I’m Steve Grundman, the M.A. and George Lund Fellow for Emerging Defense Challenges here at the council. 

Our purpose today is to launch a new speaker series, Captains of Industry, by which we aim to create the pre-eminent platform from which senior executives whose businesses contribute to national security can address the public interests their companies serve and the public policies that shape their markets.  And to that end we are privileged today to have the chief executive of Excelis, Dave Melcher, here to address the very first address in this series.

In a moment I will ask my colleague Barry Pavel, director of the Brent Scowcroft Center on International Security, to introduce Dave.   But before I do that, I want to take a moment to summarize the particular impetus for this series and, not least, to say a word about the catchy title we’ve chosen to give to it.

The impetus for the series is twofold.  First, there is the recognition that the business or marketplace of defense, as expressed on the demand side within defense ministries and on the supply side in commercial firms, is a vital thread in the overall fabric of U.S. national security of its allies in the Atlantic Alliance and partners around the globe.  Indeed, it can be said that this proposition was also central to the establishment here at the council of the very fellowship I hold – whose namesake, George Lund – (chuckles) – happens just to have walked in the room.  I’m especially pleased to have George and his partner Steve Kappes, both directors of the council, here this morning.  Thanks, George.  Well-timed.

The second impetus for this series is the recognition that that marketplace is at an inflection, an inflection formed by the confluence of several factors which together mark, in my view, the end of what I think historians will come to call – if they don’t already – the post-Cold War era, and indeed the beginning of something new. 

Chief among those factors for the defense industry marking this inflection, of course, are the fiscal crises that are reducing investments in national defense by nearly every national capital represented in today’s audience, a crisis which in this country could not be more plainly on display, of course, than in the government shutdown that ensued from yesterday.  But in addition, there is the fact that allied militaries are receding from more than a decade of counterinsurgency wars despite the fact that many of the sources and expressions of those conflicts continue to percolate throughout the Middle East and South Asia. 

I would add to this list of factors forming the markets’ inflection the advance of commercial technologies in, most especially, computing, sensing, communications, biotechnology, to name just four disciplines that are rapidly advancing on the commercial side of the world and not on the defense side of the world, the reverse of the orientation of spin-on and spin-off that we variously enjoyed or endured during the Cold War.

Finally, it must be said that the particular growth story that inspired the capital markets’ support of the post-Cold War restructuring of the defense industry is at an end.  The sequel is not yet written, but I think that particular growth story that was a big part of the way the defense industry restructured over the last 20 years has reached its final chapter. 

All of that having been said, to set the stage let me turn your attention to the agenda we will follow over the next hour or so before Barry and Dave take the stage.  Barry will presently introduce Dave Melcher.  Dave will make his address, which we would expect to run for about a half-hour.  Following his address, he and I will sit down here, have a short discussion and then take your questions.  At 11:40, I will give Dave the opportunity of having a last word, and then we will conclude.

Let me say just one word about the catchy title.  Since I will admit to a couple of decades of uncritically using this term, “captains of industry,” I thought I ought to – I ought to look up the etymology before affixing it to this series.  And, fortunately, I think it works.  Indeed, I think it’s especially apropos for what we have in mind in this series.

I’m not unaware – as some of you in the audience may be who look down on my choice of this title – I’m not unaware of its origins from the 19th century pen of the Scottish historian Thomas Carlyle, “captains of industry,” to commend the subjection of laborers to the yoke of men with better breeding, frankly.  I’m not unaware of that origin of it. 

However, when the term came across the Atlantic, it took on the sense that I have more in mind to underscore our purpose.  The sense I’m deliberately trying to invoke here is a more modern and American usage, which is one reformers of the early 20th century employed to contrast “captains of industry” with “robber barons” by the contribution that the former, those captains, make both by their managerial acumen and philanthropy to economic growth, social advancement and the public good.

Indeed, the idea, or the association, of that sense of the term “captains of industry” with chief executives in the defense industry I think could not be more appropriate.  These are businesses that, more than most – although I think it would be true of all – are in business to serve the interests of constituents well beyond their shareholders.  It could not be more true of the defense industry, and that realization indeed is one of the points that we want to give these chief executives an opportunity here at this Atlantic Council platform to talk about.  I know that’s all a little highbrow for the Atlantic Council but I thought I would try it. 

I’m very grateful to Barry Pavel for agreeing to be here this morning to introduce the CEO of Excelis, and not least because they know one another from their respective and distinguished service in government.  Indeed, before joining the Atlantic Council a couple years ago to become its director of the Scowcroft Center, Barry was a senior executive who held a succession of key assignments in the Office of the Undersecretary of Defense for Policy.  He culminated his government career at the White House on the National Security Council, where he was the special assistant to the president and senior director for defense policy and strategy. 

Barry, thanks for coming to introduce Dave.

BARRY PAVEL:  Thank you.  Thank you, Steve.  And welcome, everyone.  And Steve’s reminding me of my White House title, defense policy and strategy, on a day like today – we wish we were talking more about defense policy and strategy instead of furloughs, sequestration and continuing resolutions.  I’ll just very briefly give some context for this event. 

This is a Scowcroft Center event.  General Scowcroft’s mandate to me was to address all of the changes that are going on in the world, big changes – what we call global challenges – in a strategic context.  And so a few of the ones that we’re spending a lot of time on and applying to all of our work across regional and functional challenges are the massive shift of economic power to Asia that’s going on.  That sort of covers most of our conversations. 

And that will be followed by security capabilities as well as political.  And we’re seeing some of that playing out now:  a very significant new shift of power to individuals and small groups, partly enabled by a growing middle class but also by some of the technologies that Steve mentioned – biotech, three-dimensional printing, computing power, and a range of other technologies that are really changing the operating environment in which governments are now acting, because whereas before they could really focus at the state level, now there certainly are state-to-state issues that remain critical but there are also sort of state-to-individual and group issues that require a lot of attention. 

So we’re increasingly calling this not a post-Westphalian world but a Westphalian-plus world, because there’s a new set of actors on the international stage that really mandate the attention and planning of our – of our – of our efforts.  And so these changes that we’re discussing at the Atlantic Council really provide the strategic context for all of our work, and it certainly applies to defense. 

And so the reason for this series, and sort of its main motivation, is that commercial firms such as Excelis, they design and build innovative products and services that are an important part of our country’s response, of our allies’ response, to this really changing world that many of us are calling an inflection point.  And so we’re just thrilled to be hosting this speaker series, and I’m personally thrilled to be hosting the first one with General Melcher. 

A few people in the audience that I wanted to recognize – again, George Lund, Steve Kappes, Ambassador Jolevski of Macedonia, and several council members with distinguished careers in government service and the defense industry.  I’m afraid if I start that list I will inevitably leave someone off, so I will not make that mistake.  (Laughs.)  So let me just turn to introducing Dave Melcher, the chief executive officer of Excelis. 

Dave is ideally suited to launch this series because of the rare combination of experiences he has had in the military, in government, and now in the defense business with a thriving company amidst this very changing time.  And for those of you who don’t remember this still new brand, Excelis is the now-independent company formed by the spinout in 2011 of the defense business of ITT.  It’s a company approaching $6 billion in sales across four continents.  They specialize in products and services that animate the C4ISR functions.  And I was just in Italy, and I can’t tell you how hard it is to translate C4ISR – (laughter) – into Italian, but I tried.  They tried yesterday and it caused some problems.

But prior to joining ITT Corporation in 2008, Dave served a 32-year career in the U.S. Army, from which he retired as a lieutenant general.  His Army career included a series of commands as well as leading the Army staff officers responsible for program and budget development.  His military career included a tour as a White House fellow in which capacity he had served as the executive assistant to the director of the Office of Management and Budget – no doubt a very trying position today.

It’s also worth noting that Dave holds two master’s degrees, one in public administration and another in business from Harvard.  I know Dave from our time in the Pentagon together when Dave was doing strategy for the Army and I was doing strategy for the secretary of defense.  So please join me in welcoming Dave Melcher, CEO of Excelis.  (Applause.) 

LIEUTENANT GENERAL DAVID MELCHER:  I can drag that mic around all day.  (Laughter.)  Thanks so much.

First of all, I want to say thanks to Steve and Barry for inviting me over today.  I really appreciate the opportunity to address all the folks in the room here.  And as I look around, there are many people that I know from some past experience, whether a colleague or a friend or customer or somebody else that we’ve run into – media.  There’s some media folks in the room here that we’ve had a chance to interact.  And I just want to say it’s a pleasure to be able to talk to all of you this morning.  And congratulations to the Atlantic Council on your new digs.  This is a very nice facility, and I know you’re sort of easing into it but it’s nice to be able to present here. 

I will say I used to be captain.  I was a captain for about seven years, from 1980 to 1987, so I’ll claim that title.  I don’t know about captain of industry, with all the ramifications that that entails. but it has really been my pleasure and honor to be associated with ITT Corporation and then Excelis for five years now.  I left service in 2008 out of the Pentagon.  And, you know, as we’ll see on some of the charts that I’ll show you this morning, that was sort of the peak of defense spending, from which now we’ve gone into a little bit of a decline – and we’ll see how much of a trough – complicated by factors like debt ceiling and, you know, shutting down the government, and other things that we’re all facing these days.  So it’s a pretty interesting environment. 

So I’ll start with a chart that I think many of you have seen.  And I apologize to those in the rear of the room if it’s hard to see but you’ll get the drift.  What this portrays is defense spending over the course of about the last 50 years or so.  World War II is just off to the left of the chart, but if you saw it, it sort of looked like the Washington Monument – a big peak up and then another big decline after World War II – followed by the Korean War – or, excuse me, Korean War, Vietnam War, Reagan buildup, and then the current buildup, which we’re coming off of, whether you call it global war on terror or whatever name you ascribe to it.

I like to think about this chart in a couple ways.  One, you can see the cyclic nature of it, right?  It sort of goes up and it goes down.  It has a relatively common low point, at least over the last several declines, that ends up in real terms today to be about the $400 billion level, and in all of the previous downturns we tended to return to that level.  I like to think about this whole period in terms of maybe some capabilities and maybe a couple stories. 

I had a dad who was of the World War II generation.  He participated in World War II.  And, oh, by the way, God bless the World War II veterans who stormed the barricades yesterday to go see their memorial.  (Applause.)  I thought that was – you know, for the people who stormed Omaha Beach and defended, you know, other places, at Bastogne and so forth, that was a task not too difficult. 

But my dad was of that generation.  He was a combat medic in World War II – you know, a humble guy – like most of that generation, never talked about their experiences afterwards.  I only found out when I was a teenager he’d won a Silver Star and a Bronze Star for action in World War II.  But what he had as a combat medic was a 45-caliber pistol.  He had a pistol belt.  He had a canteen.  He had an entrenching tool, an ammo pouch, maybe a first aid kit, because he was a medic.   And that’s all he had.  It might have cost a hundred bucks to outfit him in World War II, and we tended to try and seize the initiative with mass more than anything else. 

You know, fast-forward to where we are today, right?  It’s probably somewhere – last time I saw a figure – in the 120(,000 dollars), (1)30(,000 dollars), (1)40(,000 dollars) figure to outfit a soldier or Marine with all the capabilities they have today, to include body armor, night vision, GPS capability and all the other things that are part of the kit today – modern weapons systems.  And so we have, in fact, come a long way from the way we were equipping people then to the way we’re equipping people now. 

Let me tell you a story about the troughs.  I happened to come in the Army in 1976.  That’s that trough after the Vietnam War.  And this was not a good time in the United States Army.  There were drug problems.  There were racial problems.  There was inadequate dollars to train.  And so therefore units were not ready and equipped to go do the things they had to do.  We still had Korean War vintage equipment and Vietnam-era jeeps and a couple of Hueys, you know, that were bought during the Vietnam era.  This was not a great time.  And my favorite story – let me tell you my favorite story about this era. 

It was the dawn of the all-volunteer Army, as you may recall, and I had a friend who was a captain – a company commander of an infantry company at Fort Ord, California.  And he had a soldier that basically was sort of certifiably insane – you know, not ha-ha funny but funny enough.  He used to dress up as a general, and he thought he was a general.  And my classmate had tried to get rid of him a couple times, you know, but then you couldn’t get rid of people because the all-volunteer Army had to work, and so we weren’t going to allow people to leave.  Well, so one day this soldier shows up at the division headquarters demanding to see the commanding general because he had a few things he wanted to talk about.  And of course everybody goes into a big tizzy.  He’s dressed in a uniform as a brigadier general with cavalry brass.

They finally figure out this isn’t real and they figure out where this soldier came from.  And the assistant division commander rushes down to my friend’s office, bursts in and said:  Do you know where your soldier is this morning?  He calmly reached into his desk, pulled out a piece of paper and said:  Sir, I would imagine he’s up at the commanding general’s office right now.  And he says:  What?  You knew that he was going to be up there talking to the commanding general?  He said:  I’ve been trying to get rid of this soldier for months, so essentially I’ve just given up and all I do is ask him for his itinerary every morning.  (Laughter.)  True story.  True story.  That was sort of how the ‘70s were in many respects.  (Laughter.) 

Now, one thing to think about:  All the current Joint Chiefs of Staff came into service during that period – Marty Dempsey, ’74; Ray Odierno, my classmate, ’76; Jon Greenert, ’75; Jim Amos, ’70; Mark Welsh, ’76 – so I bet you every one of them has a story like that about what was life like in the ‘70s during that trough, which is why when you see them go up on the Hill and testify, they’re testifying with passion and feeling about why you never want to return down to those historic lows and that lack of ability to train and equip forces.

Of course we’re much better now, and we went to a higher peak than we’ve ever been before, and we will come down probably to what’s shown as the red line, the sequestration line, which is still about $100 billion above the historic lows, but, as you have heard, represent certainly some challenge for all of us in the defense industry.  And so we have better gear today.  We filled a lot of the holes that were in the unit.  My job when I was in the Pentagon, honestly, was to help fill the equipping holes that we had for forces that were deploying into combat.  And that’s what I did from 2002 to 2008.  So we have some challenges with respect to funding.

Here’s the problem.  And this is a chart that just sort of shows the world.  It shows some of the kind of things that have happened in terms of instability, war, nuclear proliferation, terrorism, civil unrest, cyberattacks, piracy, drug wars or natural disasters.  And what you see is this is not necessarily a more stable and secure environment today than we might have enjoyed in the early ‘90s during the last drawdown, or even in ones prior to that.  In the early ‘90s we talked about the peace dividend and we talked about procurement holidays because we felt we had the luxury of skipping a generation of modernization in order to – because there was no real threat out there post-Cold War. 

And so this is the problem.  This is a very unstable environment.  There’s a complex array of security concerns.  Things like Syria and Kenya, which have come onto the screen here recently, represent the kind of challenge that’s out there, not to mention our own challenges at home.  And these complex security concerns are going to persist, which represents a bit of a problem for those in government who want to try and plan for the future.  You know, if you look at this chart – I was just thinking the other day, the only three places that sort of look like safe havens are Canada, Brazil and Australia.  And that’s probably true but for the occasional hockey riot, soccer riot or rugby riot, which happened in some of those places.  But the rest of the world is pretty uncertain.

You know, I want to – actually, I saw a quote this morning that I thought was worth mentioning.  You all know Secretary Hagel is over – was over in South Korea.  He may be returning now but he was in South Korea.  And this was a quote off the DOD website this morning where he was commenting that he has been asked repeatedly by South Korean officials why the shutdown occurred.  Hagel this week called the action “irresponsible,” and he said today it affects our relationships around the world.  He added, “It cuts straight to the obvious question, can you rely on the United States to fulfill its commitments to its allies?”  OK, so those are the kind of questions that are being asked, and I think they’re fair questions of our allies.  And I know the Atlantic Council thinks a lot about those relationships.  That is why what I’ve talked about is very problematic. 

And so, what are some of the reactions?  This is a chart that tries to portray some of the adaptations that have occurred in government here over time as some of this current environment has evolved.  I would say in terms of concept development – and, you know, each of the services has their own way of developing concepts and thinking about the future.  For the last decade or so they had really devolved to more of a focus on current needs instead of future needs.  And I think that there were obvious reasons why that happened.  We were fighting in Iraq and Afghanistan; we had other complications around the world; we were trying very hard to make sure that we were – we were bringing forth the capabilities needed to be successful in those environments.

I think the thinking is now turning more to the future – you know, this thought about a shift, Asia-Pacific shift.  The question is, you know, can you escape the gravitational pull of the Middle East and Africa as you begin to think about some of the new challenges that are emerging?  But I think people are trying to get back to more future-oriented thinking.  The problem is future-oriented thinking normally implies modernization, new ways of doing business, and that’s going to be very difficult in the resource environment we’re in. 

Budgets, as you know, are evolving a bit from being more land-centric almost by definition in the last decade to being more commons-centric.  And when we talk about commons I’m talking about air, sea, space and the cyber domain, right, which has its own set of commands that are oriented on that capability now.  In terms of programs, we’ve had typically, in the past, multiple programs of record.  And during the last decade we became very facile at, you know, rapid ad hoc adaptation of capabilities through things like the rapid equipping force and JIEDDO, the Joint IED Defeat Organization, and so forth.

I think in the future you’re seeing very selective, now, programs of record – much reduced numbers of programs of record because you’ve seen many of the big programs already leave the system.  There will be more.  And you’ve seen some more emphasis on affordable upgrades.  We happen to like that as a business because we have a very large installed base of radios and night vision and jamming capabilities and electronic warfare and so forth, but we’re going to all have to figure out how to bring affordable solutions forward.  And there have been some experimental pilot things, like the Army’s Network Integration Evaluation exercises, that have been trying to bring forth capabilities that are more ready now.  And that’s sort of in its infancy.  It really hasn’t had a chance to play out completely. 

Contracts – new starts and more extensions of contracts as we go forward.  And you’re also seeing, of course, more protest activity.  Why?  Because the competitive environment is becoming ever-tougher.  You’re also seeing more use of indefinite delivery, indefinite quantity contracts, IDIQs, which really had their origin in disaster relief.  I think the Corps of Engineers were the first ones to use big IDIQ contracts so that when a hurricane happened you could rapidly have power and shelter and ice and other things available when needed. 

Well, now IDIQs are making their way into sort of the whole of government contracting, but here’s the problem:  If you have a large service contract that used to be serviced by maybe one, two, three companies, now on many of these big IDIQs there are 40 large businesses that are given a hunting license.  There are 40 small businesses.  And every time they’re doing a task order, which is essentially splitting the contract up into smaller pieces, now you have 40 companies that are responding for large and 40 that are responding for small; yet, you know, the question is, is the government contracting mechanism able to handle that kind of volume of bidding?  And I think the answer is no.  I don’t think they are able to handle that volume of bidding.

And so what does that force things to devolve to?  More low-priced technically acceptable contracts where we’re not really looking for the capabilities as much as we are the price, and we’ll take the lowest price that we think minimally can meet the standard. 

That’s not necessarily good.  And I think that pendulum has swung very far to that side, and it’ll swing back some as we go forward, as the customers see that they’re not getting the value that they thought they wanted out of the contracts.

And investment drivers typically have been requirements in the military domain and in DOD.  That’s still always going to be there to some extent, but resource – the resource tail is going to wag the requirements dog, I think, a lot more over the course of the next several years.

And then competition – we do want it to be robust.  I would characterize it more as relentless in this environment, and it’s going to get worse as we go forward.  And I think that’s just – that’s just a state of what’s going to be true in this environment.

So what are some of the trends that have resulted in thinking in industry and perspectives, given everything that we’ve discussed?  Certainly, you know, I think industry understands, looking at the top part of the chart, you know, that the big war era is drawing to a close with withdrawal from Iraq and eventual withdrawal from Afghanistan.  I think industry has accepted that sequestration is a reality, it’s going to happen, you know, one way or another, over the course of the next several years.  And of course, you know, the political cycle and the things that will happen attendant to the midterm elections and ultimately the next presidential election will have an influence.  And I think all of us in industry are sort of looking at like the ’15 and ’16 budget submissions as a way of getting a gauge on what will be the priorities and what will the emphasis from the Department of Defense and other agencies going forward. 

Industry has responded in a number of ways.  Cost take-out – I think, virtually – listen to any earnings call of a prime or a midtier or a smaller business – everybody is focusing on their cost structure.  That is footprint, shared services, headcount reductions, global sourcing, you know, doing the things that can make a business more efficient and competitive.

You’ve seen some rationalization of portfolios.  Some companies have spun off certain parts of their portfolio.  Three examples are the Huntington Ingalls spinoff from Northrop, the Engility spinoff from L-3, and Leidos, which just spun off from SAIC.  So there have been some examples of rationalization of portfolio. 

And largely you’ve seen M&A activity on hold.  And I think that’s really a result of the uncertainty in this environment.  People have not been willing to commit to doing something that would engender perhaps some consolidation or realignment in the industry. 

But I do think that will happen over time.  I can’t tell you exactly how that will play out or in what part of the industry or what arraignment, but – or arena – there will be some industry realignment, because I think there has to be.

Some companies have gone to a return value strategy to shareholders.  Now let’s face it; if you’re a public company, the reason you exist is to return value to your shareholders and your investors.  And so some companies have gone into very large share buyback, you know, allocation of their cash.  Others have put that money into dividends.  You see a lot of that right now.  In part, it’s because there’s really not much M&A going on, and so this is the best use of cash in the eyes of the shareholders and the management teams right now.  But I think that that will lose a little steam as we begin to see this whole era play out, and you’ll see more companies begin to invest in the things they think are required for the future.

With respect to Wall Street, I – you know, a year ago I probably would have told you that I thought that the market declines and sequestration had been priced in to aerospace and defense valuations.  I think, though, they have been increasing, as you’ve seen, over the course of the last year, and I noticed at least one article that said, hey, the government shut down yesterday and defense properties went up .7 percent.  So there wasn’t as much concern from the Wall Street angle about that.

I think there’s a couple reasons why you’re seeing defense valuations increased.  Some of them, you know, I think is – sequestration has been factored in a bit in the minds of some.  They think that industry, you know, understands what’s going to happen and is accommodating it in cost structures.

Interest rates, believe it not – big factor for a company like ours that has a large pension liability.  When interest rates go down, our future liabilities go up.  When interest rates go up, our future liabilities come down.  And the increase in interest rates over the course of the last year or so have vastly decreased some of the pension liabilities are out there, resulting, I think, in higher valuations.

And I think some companies have been sort of squeezing out the reserves that they have, you know, as they’ve done estimates to completion on many of their programs, and thus, you know, increased valuation, plus the high dividend yields and share buybacks. 

As we go forward, I think, you know, you’re going to see some differentiated performance that will drive valuation among defense companies.

Just as an aside, right now the valuation of defense companies is about where it was in 1993.  And for those who have ever looked at those curves, ’93 was just sort of moving back up past the low point of the last defense downturn, and then they eventually – they’re at about 12 times earnings today.   They eventually got as high as 20 times earnings.  No, I’m not predicting that.  I’m just saying we’re about at that part in the curve.

OK.  So what are some of the choices that a company like ours, a midtier, has in the environment?  Certainly we can stay the course.  “Stay the course” implies a little bit of hunkering down, you know, trying to weather some of the environmental considerations that are out there, working on cost control, trying to return value to shareholders, things that companies would normally do.

A second is to reposition.  You’ve seen that in some of the examples that I cited.

For our part, we have tried to reposition our company a bit and focus on what we’ve called strategic growth platforms, which I’ll show you in just a minute, which we believe represented for us the best opportunity to match the DOD priorities, the priorities of our other customers in the FAA and NASA, international customers and so forth.  We worked hard on developing those.

The third is to scale up.  You’ve seen some attempts to scale up in this industry, particularly in information and cybersecurity a few years back, right.  Lot of companies bought a lot of those businesses, I think with mixed success.  You know, in some cases, it gave them new markets to move into.  In other cases, it was like air.  It was people with clearances that dissipated after, you know, a period of a year or two.  So you know, everybody has to figure out what they want to do to scale up.

We have tried in our own way to scale up with six small acquisitions over the course of the last two years that were focused on our strategic growth platforms.

Diversifying is also an option.  I think you’ve seen some of that.  For example, in Rockwell’s recent acquisition of ARINC, right – in fact, Carlyle – somebody from Carlyle – Frank’s in the room here – you know, that was, I think, an attempt for them to diversify a bit in their business and also to reposition a bit in their business more towards the commercial side.

For our part, air structure composites has been an attempt to diversify our portfolio.  We have parts on military aircraft, like F-35 and CH-53, but also commercial parts, and have invested in the business to try and really develop the commercial opportunities that match the secular trends that you see out there for air travel and airline production and so forth in the next couple years.

And of course exit.  Exit’s always an option, not so much for the big primes – I don’t think the big primes have the choice of necessarily exiting – but my own example is ITT Corporation.  ITT two years ago chose to exit the defense business.  And ITT Corporation today is a $2 billion industrial products company on the New York Stock Exchange, and its two children, a water company and Exelis, in the defense base, are now out as separate public companies.  And so they exited and of course we’re all in.  We have always been all in on defense.

But these are some of the options available to us. 

Just a bit, because, you know, our company is maybe a little bit unique in some respects – we’re fairly well-diversified for the size that we are – but we focused on these strategic growth platforms.  Electronic warfare, in the bottom left, which really is about airborne and ground jamming and sensors, radars, acoustic sensors, mine clearing and defense equipment, you know, those all have applicability going forward, right, with a shift to the Pacific, an emphasis on the air and sea lines of communication.  We felt that was important. 

Critical networks, for us, is represented by our work for the FAA, where we’re, you know, the prime contractor for their ADS-B GPS-based global surveillance network that’s going to roll out here.  The network will be completed by the end of this year, and then equipage will happen between now and 2020, so that everybody is eventually on it.  And we do about 60 percent of NASA’s networks.

But critical networks will remain important, right?  One example I have is, you know, when you talk to some Army folks, they used to talk about the “Big Five.”  Now they’re talking about the “Big One,” the network, you know.  So the network is going to have increasing importance in all domains.

ISR and analytics, you know, we talked about it a little bit.  You know, that is, how do you take sensors – and we make them – space payloads for GPS and weather and imagery – and take that – those volumes – petabytes of data and make it into usable, actionable intelligence.  We and others have been thinking a lot about that, and we’ve been working to make sure that we’re bringing forth things that are needed that really use the benefit of all the sensors we’ve bought.  And then I mentioned the composite air structures.

But what we also are working very hard – and I think all midtiers like us are working hard – to integrate these capabilities better within a company, so that we don’t have pockets or stovepipes of capability that are not linked to the others, because all of these things come together eventually as capability.

In terms of capital deployment – I think I’ve talked a little bit about this – some of the things that influence capital deployment are shown on the outside of this chart, things like market dynamics, stock price, interest rates, pension liability.  But once you’ve paid your workforce and you’ve paid your supply chain and you’ve invested in your business and you’ve allocated capital, you basically got four choices as a company.  You know, you can do M&A, an increase to your portfolio – not much of that so far in the defense base.  You can do share repurchases – a lot of that going on in the defense base.  You can have a dividend policy that’s shareholder-friendly.  You’ve seen a lot of that in the defense base.  In fact some of the defense companies are sort of leading – they’re not quite as high as utilities, maybe, but they’re getting pretty close.  In terms of the dividends that are being paid to shareholders now, you know, one big prime is paying 55 percent of their cash payout for dividends.  You know, that’s a pretty remarkable statement.  And then of course for us, you can pay your pension.

And you know, this was – I always referred to it as “The Gift of the Magi,” right?  When we split up, every company got some liability.  Our happened to be the old ITT pension liability, which in our – prior to our first year in spinoff, had grown from a $1 billion to a $2 billion liability.  And so what we have been doing over the course of the last two years is a number of things:  managing the portfolio, working to get legislation that gave us some interest rate smoothing capability, doing a lump sum buyout of certain members in the pension plan.  We did a voluntary retirement, and two or three months ago we froze it, as of 2016.  So you know, it’s not like this isn’t an active issue for us and other companies in the industry, and of course we’ve been making contributions to pension.

So I think we’re going to do all of these as a company, but you’re going to find some companies doing more of one or another.  But those are basically the choices.

I think the agility in managing your capital allocation in order to stay in tune with your shareholders and also stay in tune with the needs of your government customers – in other words, investing in the right things, buying the right things – is the balance that all of us have to achieve.

Partnerships are important, and having engagement among different groups that must collaborate together in order to help us all be successful is really, I think, the key to the future.  We certainly work hard to stay in tune with our government customers, shown at the top right.  Our commercial customers, media and influencer groups, many of – actually, all of whom who are shown in the circle there we’ve talked to and we’ve had engagements and interactions with.  And I just want Barry and Steve to notice we gave Atlantic Council top billing in that circle there.

MR.     :  (Off mic.)

GEN. MELCHER:  Industry groups are important to companies in the midtier and to the primes as well. 

There’s always a good debate about, you know, is the individual voice more powerful than the collective voice?  Well, for our company our size, the collective voice really counts.  And so we belong to industry associations like National Defense Industrial Association, Aerospace Industries Association and even Business Roundtable to try and stay in touch with the issues that are important to companies like ours.  BRT is a little bit more on a national level, and they address issues like tax reform and trade reform and education and pension and retirement, and that’s a good thing, because all those things are part of corporate life as well.

Our “competimates,” some of whom are in the room here – every company that’s shown in that circle on the left, from EADS to Boeing to GD, Lockheed, to BAE, Raytheon and so forth – L-3 – we partner with every single one of those companies somewhere.  We also compete with every single one of those companies somewhere.  That’s the nature of life, I think, in the defense industry for a company our size.  Sometimes we can be the prime.  Sometimes we’re going to be the sub.  But having those relationships and, I think, smart partnering going forward is going to be absolutely critical to this industry, you know, weathering the downturn that’s going to occur in defense spending.  And so you can’t be too prideful.  You got to pick your – pick your targets, pick your battles and figure out when is it a smart time to partner with a company where your collective strength is going to be the best.

And then of course Congress – we spend time up on the Hill, working not only to protect programs that we care about but to try and make sure that we’re giving members of Congress opinions of industry about things that are happening.  And you know, I, like all of you on the room, are concerned about the polarization that’s occurred there, the fact that the shutdown is emblematic of that, and the fact that we really do need people to work together and collaborate, you know, to come to a consensus that we all can live with.  I mean, that’s just important, right?  And so many manifestations of that are already out and discussed in today’s media, so I don’t have to belabor that point.

And I’ll close with just a couple industry concerns.  Certainly we’re concerned about the funding levels, but I think we actually have a pretty good understanding of what is happening to the funding levels, and I think, you know, the biggest opportunity for all of us to address funding levels as it relates to deficits is to figure out how to grow the economy, all right?  You know, when the economy is growing, tax revenues are up, a lot of these issues begin to go away.  So fiscal, monetary, tax reform – those are all issues that matter to the defense industry.

Industrial base durability is something that I worry about.  I can – I can tell you with pretty good certainty, in virtually every case where we have problems that crop up on programs, it’s mostly all related to the supply chain, either the fact that we have narrowed the supply chain so much that there are only one or two producers of a given capability – and given the level of, you know, technology that we’re trying to advance, we’re really pushing some of the boundaries of what folks in the supply chain and us are able to deliver.  And so that’s something to worry about. 

And in our case, I would only cite two technologies that I really think are of, you know, critical national importance that I’m worried about.  One is night vision.  And my friends from L-3, who are really the only other competitor in the marketplace today who are providing night vision capabilities know this is an issue.  You have to continue to develop that capability or at some point you lose it. 

The other for us is payloads.  If there’s not enough payloads going through the pipeline, you begin to lose the critical technologies and the critical capabilities that are required to, you know, bring this exquisite capability forward.

We’ve gone internationally, with some success, which gets to the – sort of the – one of the points below, as we’ve had some relief on trade and ITAR considerations to be able to sell some of our capabilities internationally to maintain the viability of that industrial base.  But it’s something that we watch closely.

I won’t mention more about trade and ITAR reform, except to say that there are really some good pieces of progress being made on revisiting the munitions list, moving some of the items on that over to the commerce list.  But the engagement of our ambassadors and our country teams and our president to help us begin to make inroads internationally is extremely important for all of us in this industry, because other countries do it, and that’s who we compete with.

With respect to government assumptions regarding industry investment, I think there was a bit of a macro-assumption made on the part of the government as they faced the downturn that we could simply begin to cut some of the R&D and expect industry to pick up the – you know, pick up the slack.  That’s true to some extent.  It is not true absolutely.  And so an expectation that industry will bring in products at high technology readiness levels and, you know, compete them in an environment where we will select somebody to bring it forth is viable if you select and if you produce.  But at the end of the day, I know our board and our shareholders will not want us to keep investing in something that doesn’t have a return on the invested capital.  And so that’s something to worry about and are we putting enough money into investment.

And then the clarity of customer requirements, I think, is always an issue, but particularly now, as we people try and sort out their own priorities.  And you know, believe me, I think our customers in some ways are as – you know, as confused and in a chaotic environment as we are, as they’re trying to work their way through all these different, you know, budget drills and ramifications.  And so we got to worry about can we give clarity to industry, so that we’re investing in the right things. 

We do put IRAD into our businesses every year.  Picking the right targets is the real challenge, which is why you want to have a good dialogue.

The last thing I’m going to do is pick this microphone up and – no, I’d like to give a coin to Steve and Barry, you know, just as a way of saying thanks for inviting me here today.  But the coin isn’t so important as what’s on it.  So these coins were minted in 2011, when we became a public company.

MR.     :  Very nice.  (Inaudible.)

MR.     :  Thank you.

GEN. MELCHER:  For an old Army guy, giving out coins is a hard habit to break.  (Laughter.)

MR.     :  Fantastic.  Thank you.

GEN. MELCHER:   But what’s on the coins that I think is important is on the back.  And those are the values of the company – of respect, responsibility and integrity.  We talk a lot about values in our company.  We really try and emphasize the fact that we got to live those values each and every day.  Everybody in the room here can relate to these, and every company has their own expression of values.  But in this environment, with all the tough problems we have to tackle and all the challenges that are out there, we all need to live by values that allow us to get to a conclusion that’s best for America.  And so that is what that coin symbolizes to me and, I hope, will to you.

So that’s all I have formally.  I’d be happy to answer any questions you have.  (Applause.)

MR. GRUNDMAN:  Let me ask our AV guy just to make a final adjustment to Dave’s microphone there.  Ooh.  Maybe mine.  These things are vexing us both.

Thank you very, very much, Dave.  That sets a really high standard for this series, which I appreciate – oh – appreciate very much.

MR.     :  That’s (push-ups ?).  (Laughter.)

MR. GRUNDMAN:  Yeah, you’re right. Oh, yes.

There are some very distinguished guests in the audience, as you’ve already acknowledged.  At the same time, I’m going to exercise the prerogative of getting the first question in.


MR. GRUNDMAN:  We indeed are running on schedule, will have about 20 minutes for Q-and-A. 

I posited the idea that the trends in the development of commercial technologies is part of the inflection that the defense industry is trying to grapple with.  And I’m interested in your response to that.  You are a very high technology company, but at the same time I wonder if you feel like you need a strategy for accessing commercial technologies or maybe in some sense providing that service to the customer.

GEN. MELCHER:  In fact we are trying to do that, and it is an important area of focus for us.  We have about 4 or 5 percent of our revenues you could cite as being commercial revenues today.  It certainly is a place we’d like to grow.  And for us, it’s in the commercial air structure composites, right?  As you move from military applications to commercial ones, the machines and people don’t know the difference between a, you know, commercial and a military part, because they’re mostly built to relatively similar tolerances.

So we’re trying to grow there.  We’re trying to grow a lot on the capabilities relatives to the ISR and the data analytics that allow you to take information and use them in a commercial sense.  And we’ve partnered with a big company called Esri that has, you know, sort of a global network of that kind of capability, and you know, they’ve invested in us and we’ve partnered with them, to some extent, to do that.

We’ve been looking at some medical applications to the – there aren’t many, but there are a few medical applications for some of the technologies that we have.  One quick example is a product called Novocure. It actually derives from the piezoelectric discs that are produced for large sonar rays, but as it just happens to turn out, those discs produce, you know, a constant and reliable pulse that is good in brain cancer treatment.  And so these discs have been manufactured and used in a treatment for glioblastoma, and then they’re now looking at lung.  And so it’s a small piece of the business, but it came from a military heritage and now has made its way into the medical arena.  We’re doing some similar things with some of the technologies we have for, you know, night vision and so forth, as applies to, you know, medical applications.

So we are consciously trying to invest in some things that give us some potential.  Other companies are doing it in a larger scale.  I mean, you’ve seen some examples of primes buying some pieces of business that you would have not classically thought would be part of their domain, but they’re trying to make inroads.  And health and IT is also a big area, I know, for a lot of companies.

MR. GRUNDMAN:  I appreciate you underscoring that you’re trying to address commercial markets.  I’m also trying to draw out whether or not you need to keep pace, you need access to or exposure to commercial markets to keep pace with computing, communications, stuff that really is core to your business, or, alternatively, should we think, no, defense – investment in military R&D’s going to keep us ahead?

GEN. MELCHER:  Well, you know, I think investment in military R&D has kept us ahead in some respects.  The difference is the tolerances to which things are built, right, you know, and it’s – that’s why the old story about there’s – the road is, you know, a lot of ruined defense company opportunities to try and move into commercial markets because it was such a different market with different expectations on price and not the same requirements that we were bringing to military products.

We’re very mindful of that, and we look for, you know, opportunity and access where it makes sense.  But we’re going to stay pretty close to our core competencies, I think.

MR. GRUNDMAN:  OK.  Questions here?  Harlan Ullman, please.  There is a microphone, so please introduce yourself before you ask your question.  And just to reiterate what might be obvious, this entire conversation is on the record.

Q:  I’m Harlan Ullman.  Dave, thanks for your comments.  They were very comprehensive.  I have an observation that I’d like you to respond to and may cause Steve to change the name of the series to corporals of industry.  I think that both sides of the Potomac have failed to understand and appreciate the magnitude of the decline that’s coming. 

Even if you assume that sequestration somehow is overridden, the inherent cost growth in people, medical services, pensions, weapon systems, et cetera, et cetera, mean that best case, unless something happens otherwise, by the end of this decade and sooner, the buying power of defense will probably be cut at least in half, which means there are going to be huge, huge changes, and not for the better.  And if interest rates go up, that may help your liability situation, but it’s going to put a huge squeeze on discretionary spending. 

Are you doing anything in terms of red team or plan B, thinking about something that is going to be a much, much worse situation?  And have you any sense whether or not somebody inside the Pentagon close to Chuck Hagel is even envisioning this because when I talk to very, very senior members in the White House and in the Pentagon, they seem to be largely oblivious to what I think is coming at much larger than a huge train wreck or a collision with an iceberg?

GEN. MELCHER:  Well, you know, speaking from an industry perspective – and I imagine every company has some version of this – you know, we have taken a look at a variety of scenarios that could emerge as a result of this, some even worse than sequestration, right, because there is a – there is a plausible theory that, you know, you go down to that line and then you keep trending down a bit past that.

So we’ve tried to look at all the worst-case scenarios, which is why we and others I think have so aggressively been trying to go after costs structure, because we can’t control the top line, you know, and what’s going to happen to the top line.  We can help try and mitigate some of the impacts on the bottom line for each of our companies.  So every company, I think, is thinking that way.

The department, as you know, still to this day has not submitted a sequester budget up to the Hill, you know, basically saying we took it to the Budget Control Act now over to you, Congress, you know, and tell us what you think.  And that resulted in, you know, the $37 billion of additional sequester cuts last year.  And we’ll see what it results in this year if they’re not able to pass any legislation.  But in a way it’s a bit of a state of denial, you know, about the realities of what’s really coming and making the hard choices that are applicable to them. 

Cutting people is important.  I mean, as a former programmer, resource person, you know, people were 55 percent of the Army’s budget and probably 35 to 40 percent of the DOD budget when you looked at – across all of it.  And unless you can bring down some of those health care costs, unless you can bring down, you know, some of the – just the cost of having that infrastructure, the benefits, you’re going to have to address that, I think, to get to a level that you have forces that are sustainable and can be modernized.

You know, what that level is – I know it’s probably below where everybody’s saying it is right now, but the reality is, they’re going to have to take some significant cuts.  What everybody worries about is how does that relate to the strategy and, you know, are we going to fall off?  We used to have what we called the two MTW strategy – two major theaters of war.  You know, attend to one and make inroads on the other.  And then we’ve sort of softened that over time and where we’re going is we’ll only be able to go one place and do one thing at a time.

We have to decide as a nation, is that acceptable to us?  And then match the force structure and capabilities up to that.  But I accept your point.  There are some really tough conditions coming and everybody’s going to have own up to them – to include the Hill and the Department of Defense – in order to get to a solution that works.

MR. GRUNDMAN:  And indeed, as your own chart illustrates, sequestration is not the cyclical low.  It is a historic low.  We could back it down another $70 billion a year from there.

GEN. MELCHER:  No, it – yes. 

MR. GRUNDMAN:  Not that you were predicting that.  I’m just – I’m just pointing that out.  Tony Velocci, do you have a question?

Q:  Yes.  Steve, thank you.

MR. GRUNDMAN:  Hold one second, Tony.  Let’s get the microphone in front of you.

Q:  Thank you.  Tony Velocci, former editor in chief of Aviation Week and Space Technology magazine.  Great presentation, Dave. 

GEN. MELCHER:  Thanks.

Q:  I’d like to go back to the point that you – that you were making concerning IR&D.  Given the fact that IR&D, combined with government-funded R&D, is indeed the seed corn for the revenue generating products that you generate in the future – produce in the future, how do you know if a level – a given level of IR&D is the right level, whether it’s adequate?  To put it another way, how do you avoid falling into a trap that you’ve been underinvesting in IR&D, only to find out some years later that you’ve been shortchanging your future?

GEN. MELCHER:  No, I mean, it’s a – it’s a far-reaching question and it sort of gets to how do you do strategic plans and operational plans and eventually budgets for your business.  We try and benchmark.  For us, as a company, we try and benchmark how are we doing on our product side relative to industry peers?  You know, are we investing about the same, a little more, a little less? 

We certainly have to focus our investments because, you know, we don’t have the same deep pockets that the big primes have.  We have to focus the investments and target them appropriately, which is why these conversations about what do we need with customers are extremely important, so that I’m not wasting investment dollars in a place that has no logical outlet, you know, to be able to produce and satisfy the needs of the company and shareholders.  

So we watch that pretty closely.  My sense has been we are, you know, close to underinvesting.  And so a lot of the cost-reduction measures we did within our company were explicitly designed to create more headroom to invest more in IRAD (ph), which we intend to do over the next several years.  So in a way, it’s our way of trying to counter what we see as a little bit less government funding for research and development in our own way.  But you know, we’re struggling with exactly where to put it.

Now, each of our businesses have a number of ideas.  And they’ll come tell you, this is the best use of IRAD (ph) spending.  We want to make sure that’s validated with our customers so that they agree this is the place to put the dollars.  I worry about whether we have enough, and I know the government side of it is going to be going down.  So you know, collectively, corporately we all need to worry about are we, as a nation, investing enough in research and development for the capabilities we’ll need 10 or 20 years from now.

MR. GRUNDMAN:  I want to tack on a complementary question.  And that is – I’ll put it kind of sharply – does the government, does the Pentagon have a legitimate interest in your capital – on how you deploy capital – how you deploy your cash?

GEN. MELCHER:  I would say, as a CEO, you know, they have an ability to influence directions, but ultimately it’s the decision of the management team and the board of directors on how we allocate capital in the company.  And you know, the choice that we have is allocated against defense purposes, allocated against research and development for the FAA or NASA or some other agency, allocated against international customers or allocated against commercial.  And we – you know, naturally, we’re going to go to where we see the greatest return on that invested capital.  And it may not be in defense at the end of the day, depending on what we hear.

MR. GRUNDMAN:  Colin Clark.

Q:  Thanks.  Colin Clark, Breaking Defense.  You and everybody else seems to have factored in sequestration.  OK, we’ve got that.  The shutdown doesn’t seem to have really worried too many people in the defense business.  What about the debt limit negotiations?  Is that where you start to tremble and look at the government and go, good God, what are doing?  Or is that another chimera?

GEN. MELCHER:  Yeah.  First of all, I didn’t – I didn’t say I wasn’t worried about sequestration.  You know, I am worried about sequestration and how it eventually manifests itself.  I mean, that’s of concern to all of us.  I am worried about the shutdown because, you know, shutting down for a day or two is not going to be that much of an impact.  And we happen to be a business that has both products and services fixed-price contracts and cost-plus contracts.  We have a little bit of resiliency to keep the workforce engaged as we go forward.

But if the government shuts down for two or three weeks, well then a whole bunch of unintended consequences start to happen.  You know, contracts can’t be paid.  Cash flow begins to be affected.  Contracts maybe can’t get let.  Customers are not in their workspaces and therefore our employees who may work beside them are not going to our workspaces, particularly on cost-plus contracts.  I think there is a definite and real impact if this shutdown lasts, you know, more than a couple weeks for every company in this industry.

And then, you know, longer term I’m certainly worried about the debt ceiling, for all the reasons that people have enumerated, right?  I mean, it – you know, it is – it is going to be very symbolic, you know, with respect to this nation’s credibility.  It’s going to be symbolic, you know, in terms of – not symbolic but real in terms of the impact on the financial markets.  And I just am not a big fan of the brinksmanship that’s being used around that issue.

MR. GRUNDMAN:  There’s a question right here.  If you could hold for the mic a second.

Q:  Hi, Steve Mundt from EADS North America.  Steve, thanks for your moderation, but Dave, thanks for your comments.  I continue to learn from you.  I kind of want to parody (sic) off some of the questions that have been asked.  We talk about the speed and turn of technology and how fast it’s going.  We talk about a global market and how that technology is being developed and how we’re moving it.  And the move of technology from a military design base to the commercial market is much easier, but to take it from the commercial market, where most of our IRED (ph) is, and put it back inside the military faces tremendous certification requirements.  Do you see that there’s a need for reform on how we go about certifying the deltas between commercial certifying agencies and the military so that you can transition those technologies back and forth faster?

GEN. MELCHER:  Yeah, I mean, it’s an interesting question, and I do think that there are certainly complications and different sets of assumptions that are used for bringing these capabilities forward.

I don’t think it’s necessarily – I would have thought you said it maybe the other way, that it’s easier to take commercial technologies and try and bring them in and harder to take the defense ones the other way because, you know, you could probably find an example where that’s been true, you know, here or there.

But you know, clearly, if we have an intent to move more into commercial technologies, then we’re going to have to make sure that the rules accompanying that make sense.  And I don’t know that I can say much more than that, Steve.  I can’t give you a whole lot of examples, you know, because we have just, in a very small way, begun to move into commercial.

MR. GRUNDMAN:  OK, so we are into our lightning round now.  With five minutes remaining, I have at least three questions, Zach and Sandra and Marjorie, and then if we can fit any others, Michael, we’ll squeeze that in.

Zach Biggs.  So those with the microphones, be quick, please.

Q:  All right.  Quickly – Zach Biggs, Defense News – in one of the graphics that you displayed earlier, you had early 2015 as being the time when the cash redeployment strategy with share repurchases and dividend buys seemed to be diminishing.  Is that entirely because of M&A activity, or do you see something else driving a reduction of focus in that area?

GEN. MELCHER:  I think it’s mostly because of M&A activity, which I think is going to pick up.  And you know, while shareholders will tell you they like share buybacks because it’s constantly increasing EPS, there’s only so many shares to buy back, right?  And unless you’re going to go private, at some point you got to figure out how to have a better allocation of your capital to find ways to grow the business other than, you know, financially.

MR. GRUNDMAN:  Marjorie.

Q:  Marjorie Censer, Washington Post.  Just wanted to follow up on the M&A, kind of your predictions here.  It seems like we’ve seen more breakups.  Is this readying for a round of consolidation among some of the bigger ones, or you don’t think that’s going to happen?

GEN. MELCHER:  I think you – no, I think you can see some consolidation in different sectors within defense.  I mean, you know, some of the companies that have spun off their service businesses – now there are a number of smaller service businesses that are out there in the marketplace.  Since we have a business like that, I know that having, you know, large scale is an advantage, right, because you’re spreading the overhead of the business over a larger, you know, base of contracts.  So I think you could see some consolidation in that part perhaps first, and then we’ll see what happens in the other product-oriented parts of businesses.

MR. GRUNDMAN:  Sandra.

Q:  Thank you.  Sandra Erwin with National Defense magazine.  What we hear from industry – from the captains of industry a lot is that they want budget stability, predictability.  We hear that over and over and over.  It doesn’t seem realistic at this point to expect that.  So what is the thinking about maybe finding a new definition for stability, for budget stability, and what might that new definition be given what’s going on and what’s going to be going on for the near future?

GEN. MELCHER:  Well, I mean, budget stability would say that if you’re going to give a five-year projection, let’s make it the most realistic projection that we can have; let’s make the big decisions about the large programs that are going to stay and are going to go.  And believe me, businesses can and will adapt.  Businesses have already been adapting sort of in an anticipatory way by getting after cost structure and doing other things that all of us are working on.  But once we know where the programs are going, we can allocate our resources accordingly.

And I’d say businesses are much quicker on – you know, on the mark to make those changes than government is able to, right?  Look how long it takes a BRAC.  BRAC takes years and – of consensus-building until you finally have a – one big up-or-down vote, and then the whole thing goes whoosh.  All of us were reducing footprint as early as 2010 in anticipation of the trend that was coming.  So budget stability is important.

I’d say, you know, for those of us who are in industry, both in defense and in other sectors, we’re actually interested in the government solving some other problems as well, which is how do you invest appropriately in education and have enough science, technology, math, you know, training people in order to provide what we need as engineers in our industry.  We’re interested in corporate tax reform.  We have the highest corporate tax rate, I think, in the world, and we don’t allow our companies to bring money back from overseas, which means we’re investing overseas and not investing in the United States.  Trade reform and getting Pacific and Atlantic trade agreements that make sense make – is something that all of us who are CEOs would love to see happen.  So there are bigger issues than just the defense budget, and the fact is, you know, when I said, let’s get the economy moving, it is let’s tackle those issues, and let’s quit squabbling about some of the things we’re squabbling about.

MR. GRUNDMAN:  And Michael Bruno.

Q:  Hi, Michael Bruno with Aviation Week.  Do you see a tipping point at which the Pentagon lifts its formal ban on primes going through M&A, or do you see that staying no matter the consequences?

GEN. MELCHER:  You know, I think we should ask Brett Lambert (sp) –

MR.     :  I was going to say – (chuckles) –

GEN. MELCHER:  – who’s sitting in the back of the room, although he’s not – you know, he’s not the guy anymore.  But you know, Brett (sp) is –

MR.     :  He’s now at liberty to say anything at all, of course.

GEN. MELCHER:  Brett (sp) is a friend and somebody who’s thought a lot about that issue.  I mean, I think the initial position was, you know, we don’t see the big primes consolidating further because there was a lot of that that happened in the ’90s.  You know, the department, I think, has been largely silent below, you know, the prime level as to what kind of consolidation might happen.  It just – it hasn’t started yet because everybody’s so uncertain about where funding lines are going and what the future holds that I think everybody’s keeping their powder dry.

And it’s a safe thing now to pay dividends and do share buybacks.  You know, once the fog lifts a little bit and we know more about how sequestration is going to take hold, well, then, you know, you might see some different priorities.  And you know, unless Brett (sp) sees it differently, I don’t think the department’s going to stand in the way of consolidation, except perhaps in the case of critical technologies that are important to the national interest where you don’t want to go down to maybe one provider of those kind of technologies.

I don’t know.  Brett (sp), this wasn’t your day, but – (laughter) –

Q:  I don’t speak for the department.

MR.     :  Yes.  (Laughter.)

MR. GRUNDMAN:  I’ll spare you, Brett (sp), for now.  For now.

Thank you.  Thank you very much.  Dave, was there anything else you wanted to put a capstone on the event with?

GEN. MELCHER:  No, just I enjoyed being here this morning.  I hope y’all got something out of it.  If any of you want to follow up, I’m happy to follow up on any of these issues.  David Albritton here is with me, who’s our chief of communications.  And I hope you have some more good sessions with leaders of industry because it’s important to have this dialogue.  I really believe what I said about partnerships and exchange of ideas.  And so thanks for allowing us to be here.

MR. GRUNDMAN:  Thank you.  Let me put just a couple of final words on the morning.  Besides again thanking Dave and David Albritton, I also want to give a little credit to Jeff Ryder, your strategist, who has been instrumental to putting this together.  My colleague Alex Ward, who’s helped me put this together, has also been instrumental to it.  As I said before, I think this has set a very high standard for this series, which I have high expectations of.  You know, please stay tuned, and we’ll bring another CEO to this stage within six or eight weeks, I feel confident.

Well, the last thing I want to mention is that coincident with the launch of this series, we this week also are launching a blog dedicated to this very range of issues.  It’s called the Defense Industrialist.  It can be found at the Atlantic Council’s website, atlanticcouncil.org/blogs, and I would encourage – the curator of it is sitting here, Jim Hasik, senior fellow Jim Hasik.  I would encourage all of you to take a look at that, and I would also certainly mention that we would welcome guest contributors to our Defense Industrialist blog.

So thank you, Dave.

GEN. MELCHER:  You’re welcome.  (Inaudible.)  (Applause.)


Related Experts: Steven Grundman and Harlan Ullman