Answers to 10 Key USAF Questions about Industry. Alex Miller, PhD Founder, Aerospace Defense Executive MBA University of Tennessee

Transcription

1 Answers to 10 Key USAF Questions about Industry Alex Miller, PhD Founder, Aerospace Defense Executive MBA University of Tennessee

2 Overview of Questions 1. What are the legal responsibilities of corporate officers? 2. Outside combat, what are the key differences between USAF Officer and Corporate Officer goals and mindsets? 3. How do corporations measure their performance? 4. What drives corporate shareholder returns from stock? 5. How does industry think about time in making investment decisions? 6. What are the implications of the drumbeat of quarterly earnings reports? 7. How do corporations structure management compensation and incentives? 8. Just how profitable is the defense industry?. 9. If contractors don t invest in defense opportunities, what do they do with those funds? 10. What are the keys to successfully negotiating with industry? 1

3 1. What are the legal responsibilities of corporate officers? 2

4 The Extreme View 3

5 A level higher than that trodden by the crowd Ancient basis in English common law Three types of duty 1. Duty of loyalty agent places interests of principal before self-interests 2. Duty of care agent responsible for being well informed 3. Duty of good faith agent responsible for acting with prudence and in good faith Remedies under the law 1. Gains returned to principals 2. Compensatory damages 3. Incarceration 4

6 Do Executives Really go to Jail? 5

7 A Sampler of CEOs Recently Imprisoned CEO/Corporation Crime Imprisonment DeCoster/Quality Egg Unknowingly allowing unsafe products 3 months Stewart/Martha Stewart Living Insider trading/perjury 5 months Nacchio/Qwest Misrepresented sales 6 years Scrushy/Healthsouth Various 6 years Kumar/Computer Associates Misrepresenting books 12 years Forbes/Cendant Misrepresented financials 12 years Rigas/Adelphia Various, including personal use of funds 15 years Kozlowski/Tyco Theft of corporate funds 8-25 years Skilling/Enron Fraud to inflate profits 24 years Ebbers/WorldCom Fraud to hide losses 25 years Stanford/Stanford Financial Investor Fraud 110 years Madoff/Bernie Madoff Securities Investor Fraud 150 years 6

8 2. Outside combat, what are the key differences between USAF Officer and Corporate Officer goals and mindsets? 7

9 Examples of Different Perspectives Principal Served Issue Military Perspective Industry Perspective Combatants, Congress, Taxpayers Shareholders Working to Budgets Spend appropriated funds Deliver forecasted profits Cost of Capital No Charge WACC ( ~ 9% in A/D) Time Horizon Annual spend Quarterly earnings Major Legal Frameworks Promotion Process Compensation Laws of War, Uniform Military Code, Federal Regulations (FAR, etc.) Fixed schedule; up or out of uniform Based on grade; federally established rates Corporate Law, Securities and Exchange Commission, Uniform Commercial Code, Contractual Law, Tax Law, Bankruptcy Law, Product Regulation, Antitrust Law, Industry-specific Law Flexible schedule; stay, up, sideways, or new company Based on performance; market established rates 8

10 3. How do corporations measure their performance? 9

11 Ask yourself what you want out of your investments? 10

12 Creating Wealth: Outperforming Investors Options 11

13 Destroying Wealth: Underperforming Investors Options 12

14 Minimum Expectation 13

15 Frequency of Occurrence Consider The Normal Distribution of Shareholder Returns* Average Return Shareholder Returns *To simplify discussion, assume risks are the same across all options being considered. 14

16 Frequency of Occurrence The Goal: Above Average Total Returns to Shareholders Objective Average Return Shareholder Returns Everybody has the same Goal. Only 50% can achieve it. 15

17 4. What drives corporate shareholder returns from stock? 16

18 Shareholders Seek Total Returns Changes in Stock Price Total Shareholder Returns Dividends Paid Total Shareholder Returns Beginning Ending ( - ) Price Price + Dividend s = Beginning Price 17

19 4. What drives corporate shareholder returns from stock?(simplified Answer) Three Main Drivers We Will Consider: Dividends Price The Market as a Whole News on an Individual Stock 18

20 Dividends Set by Policy 19

21 The Market as a Whole Boeing Stock Vs SP500, Dow, and Nasdaq for past 10 years 20

22 4. What drives corporate shareholder returns from stock?(simplified Answer) Three Main Drivers We Will Consider: Dividends Price The Market as a Whole News on an Individual Stock Set by Board Policy Beyond Control of Corporation Focus Here 21

23 Surprisingly Good News 22

24 Surprisingly Bad News 23

25 Continually Delivering Surprisingly Good News 24

26 Most Common Good or Bad News is Beating or Missing Expectations of Economic Profit % Economic Profit WACC ROIC WACC Weighted average cost of capital how much it costs the corporation to rent the money it has in use (debt + opportunity cost incurred by investors) ROIC Return on invested capital the profits generated by the money the corporation has in use Economic Profit ROIC-WACC returns in excess of the cost of capital Scale 25

27 What s WACC? Balance Sheet Calculating Weighted Average Assets what corporation has invested in Debt what corporation owes Equity what stockholders have invested + earnings reinvested in the business Debt cost is measured as interest expense Cost of equity is measured as shareholder s opportunity cost 33% 6% + 67% 12% =.33(.06)+.67(.12) = =.10 WACC 26

28 Cost of Capital Data from NYU Stern School of Business Industry Name Number of Firms Beta Cost of Equity E/(D+E) Std Dev in Stock Cost of Debt Tax Rate After-tax Cost of Debt D/(D+E) Cost of Capital Tobacco % 83.45% 48.90% 3.52% 11.64% 2.11% 16.55% 11.82% Retail (Online) % 92.17% 50.54% 4.02% 11.14% 2.41% 7.83% 10.99% Oil/Gas (Integrated) % 85.84% 50.24% 4.02% 8.14% 2.41% 14.16% 10.20% Software (Entertainment) % 90.72% 54.18% 4.02% 1.56% 2.41% 9.28% 10.00% Software (Internet) % 95.76% 64.71% 4.02% 3.80% 2.41% 4.24% 9.97% Oilfield Svcs/Equip % 71.90% 69.62% 4.52% 9.56% 2.71% 28.10% 9.91% Retail (Building Supply) % 84.22% 50.34% 4.02% 23.18% 2.41% 15.78% 9.73% Semiconductor % 88.83% 51.24% 4.02% 9.51% 2.41% 11.17% 9.68% Software (System & Application) % 89.14% 59.22% 4.02% 6.34% 2.41% 10.86% 9.39% Drugs (Biotechnology) % 87.50% 88.89% 6.52% 1.80% 3.91% 12.50% 9.20% Computers/Peripherals % 84.28% 63.91% 4.02% 5.48% 2.41% 15.72% 9.01% Office Equipment & Services % 62.28% 41.58% 3.52% 19.14% 2.11% 37.72% 8.99% Machinery % 78.39% 46.07% 3.52% 15.24% 2.11% 21.61% 8.99% Chemical (Diversified) % 72.32% 40.56% 3.52% 18.35% 2.11% 27.68% 8.97% Aerospace/Defense % 82.99% 46.90% 3.52% 13.51% 2.11% 17.01% 8.86% Electronics (Consumer & Office) % 87.10% 63.42% 4.02% 9.71% 2.41% 12.90% 8.72% Telecom. Equipment % 82.84% 57.78% 4.02% 8.86% 2.41% 17.16% 8.71% Transportation % 76.27% 40.03% 3.52% 18.82% 2.11% 23.73% 8.69% Construction Supplies % 62.86% 42.41% 3.52% 17.00% 2.11% 37.14% 8.43% Semiconductor Equip % 72.69% 54.21% 4.02% 11.25% 2.41% 27.31% 8.41% Metals & Mining % 53.83% 91.02% 7.77% 1.42% 4.66% 46.17% 8.40% Oil/Gas (Production and Exploration) % 54.80% 80.22% 6.52% 2.91% 3.91% 45.20% 8.37% Precious Metals % 66.65% 93.13% 7.77% 1.60% 4.66% 33.35% 8.24% Rubber& Tires % 60.51% 38.00% 3.52% 9.60% 2.11% 39.49% 8.23% Publshing & Newspapers % 66.86% 51.60% 4.02% 13.67% 2.41% 33.14% 8.12% Auto Parts % 75.24% 55.06% 4.02% 9.64% 2.41% 24.76% 8.11% Real Estate (General/Diversified) % 79.70% 40.76% 3.52% 9.64% 2.11% 20.30% 8.05% Electrical Equipment % 82.03% 71.04% 4.52% 6.58% 2.71% 17.97% 8.01% Chemical (Specialty) % 76.12% 50.43% 4.02% 8.45% 2.41% 23.88% 8.00% Healthcare I&T % 84.96% 60.52% 4.02% 6.96% 2.41% 15.04% 7.95% Beverage (Soft) % 81.32% 54.55% 4.02% 5.97% 2.41% 18.68% 7.92% Entertainment % 76.96% 63.16% 4.02% 3.25% 2.41% 23.04% 7.90% Engineering/Construction % 70.47% 57.02% 4.02% 11.63% 2.41% 29.53% 7.88% Furn/Home Furnishings % 76.37% 44.49% 3.52% 15.53% 2.11% 23.63% 7.87% Computer Services % 77.60% 51.74% 4.02% 12.84% 2.41% 22.40% 7.75% Drugs (Pharmaceutical) % 88.49% 77.30% 4.52% 3.90% 2.71% 11.51% 7.72% Real Estate (Operations & Services) % 60.78% 43.44% 3.52% 11.19% 2.11% 39.22% 7.66% Business & Consumer Services % 73.89% 50.13% 4.02% 13.76% 2.41% 26.11% 7.58% Building Materials % 75.10% 44.27% 3.52% 22.43% 2.11% 24.90% 7.54% Transportation (Railroads) % 76.63% 31.20% 3.52% 15.11% 2.11% 23.37% 7.53% Household Products % 83.32% 62.02% 4.02% 8.86% 2.41% 16.68% 7.53% Healthcare Products % 83.68% 62.16% 4.02% 6.42% 2.41% 16.32% 7.45% Information Services % 86.56% 40.74% 3.52% 16.46% 2.11% 13.44% 7.44% Electronics (General) % 83.48% 59.34% 4.02% 9.47% 2.41% 16.52% 7.43% Real Estate (Development) % 61.39% 36.15% 3.52% 1.06% 2.11% 38.61% 7.39% Apparel % 78.21% 60.62% 4.02% 13.84% 2.41% 21.79% 7.26% Trucking % 49.70% 43.08% 3.52% 31.25% 2.11% 50.30% 7.22% Retail (General) % 71.69% 46.87% 3.52% 24.75% 2.11% 28.31% 7.22% Healthcare Support Services % 77.75% 54.32% 4.02% 13.84% 2.41% 22.25% 7.20% Environmental & Waste Services % 72.04% 65.51% 4.52% 7.49% 2.71% 27.96% 7.17% Cable TV % 66.84% 41.58% 3.52% 17.19% 2.11% 33.16% 7.16% Packaging & Container % 64.63% 32.10% 3.52% 21.41% 2.11% 35.37% 7.12% Shipbuilding & Marine % 63.72% 60.89% 4.02% 11.82% 2.41% 36.28% 7.07% Beverage (Alcoholic) % 84.56% 58.51% 4.02% 11.28% 2.41% 15.44% 7.05% Paper/Forest Products % 52.89% 38.53% 3.52% 15.88% 2.11% 47.11% 7.01% Retail (Distributors) % 62.37% 52.36% 4.02% 16.42% 2.41% 37.63% 6.89% Shoe % 93.64% 39.02% 3.52% 18.12% 2.11% 6.36% 6.87% Air Transport % 58.90% 51.95% 4.02% 18.34% 2.41% 41.10% 6.81% Steel % 52.15% 51.52% 4.02% 11.49% 2.41% 47.85% 6.80% Retail (Special Lines) % 68.17% 50.69% 4.02% 19.95% 2.41% 31.83% 6.71% Chemical (Basic) % 61.75% 54.20% 4.02% 8.24% 2.41% 38.25% 6.65% Reinsurance % 71.70% 29.15% 3.52% 20.37% 2.11% 28.30% 6.65% Education % 68.38% 59.62% 4.02% 12.05% 2.41% 31.62% 6.63% Insurance (General) % 70.05% 33.57% 3.52% 21.73% 2.11% 29.95% 6.60% Advertising % 64.00% 71.03% 4.52% 3.90% 2.71% 36.00% 6.57% Retail (Grocery and Food) % 68.08% 51.57% 4.02% 23.56% 2.41% 31.92% 6.56% Green & Renewable Energy % 42.93% 62.36% 4.02% 0.77% 2.41% 57.07% 6.53% 27

29 Estimating WACC for Aerospace/Defense Industry Firms Beta Aerospace /Defense Cost of Equity E/(D+E) Cost of Debt D/(D+E) WACC % 83% 3.5% 17% 8.9% 28

30 Thought Experiment: Apply the Model to Suds % Economic Profit WACC ROIC Scale 29

31 Corporate Approach to Investing % A B C D Economic Profit WACC ROIC Where Should the Corporation Stop Investing? Scale 30

32 WACC Becomes the Hurdle Rate % Economic Profit WACC ROIC Value-creating investments that cover cost of capital and produce economic profits Value-destroying investments that don t cover the cost of capital 31

33 WACC Becomes the Hurdle Rate % Economic Profit WACC ROIC Planting a Seed: What should corporation s do with its money at this point? Value-creating investments that cover cost of capital and produce economic profits Value-destroying investments that don t cover the cost of capital 32

34 Goal is to Grow Area Under the Curve Economic Profit WACC Economic Profit WACC ROIC ROIC Make Existing Programs More Profitable Finding New Programs that are Profitable 33

35 Frequency of Occurrence Putting it all together The best strategy for delivering better than average shareholder returns is to drive stock prices up Objective Average Return Shareholder Returns % Economic Profit By consistently delivering suprisingly good news on ability to invest in projects that will generate a return greater than the cost of capital required. Scale Job of Corporate Leadership Team is to Deliver Surprisingly Good News Every Quarter. 34

36 5. How does industry think about time in making investment decisions? 35

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40 Applying Time Value of Money to Your Personal Finances Assume you can get a 7% return on retirement funds. What is the implication of investing $5K per year starting at 20 years old vs 30? 39

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42 Time Really is Money 41

43 Reminder: WACC in Aerospace Defense Industry Firms Beta Aerospace /Defense Cost of Equity E/(D+E) Cost of Debt D/(D+E) WACC % 83% 3.5% 17% 8.9% 42

44 What is DOD s Cost of Capital? 43

45 Pay Early and Pay Less (or Get More) Assume Contractor has WACC= 9% and must spend $100 in year 1, all of which is allowable costs. Government s Annual Payments Pay Late Scenario Pay Early Scenario Year 1 $0 $50 Year 2 $25 $25 Year 3 $25 $25 Year 4 $25 $25 Year 5 $75 $0 Total Government Payments $150 $125 Government View of Profits $50 $25 Contractor s Rate of Return 10.9% 11% Questions: 1. Based on these projections, will the contractor make an economic profit? 2. Which option should the government prefer, and why? 44

46 6. What are the implications of the drumbeat of quarterly earnings reports? 45

47 Do Quarterly Earnings Call Make a Long-term View More Difficult? 46

48 Earnings Management 47

49 Predictable Patterns in Short-term Cost Cutting 48

50 1. Cut Training 49

51 2. Cut R&D 50

52 3. Cut Maintenance 51

53 Quarterly Drumbeat s Impact on Risk Taking 52

54 Incentives for Taking Risks 53

55 7. How do corporations structure management compensation and incentives? 54

56 What Carrots Are Available? 55

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66 Government Contract Data Source: m 65

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69 8. Just how profitable is the defense industry?. 68

70 Accounting-based Profitability by Sector, NYU Stern School of Business Industry Name Number of firms Net Margin Tobacco % Bank (Money Center) % Banks (Regional) % Shipbuilding & Marine % Financial Svcs. (Non-bank & Insurance) % R.E.I.T % Transportation (Railroads) % Investments & Asset Management % Drugs (Biotechnology) % Drugs (Pharmaceutical) % Rubber& Tires % Utility (Water) % Entertainment % Beverage (Alcoholic) % Semiconductor % Information Services % Computers/Peripherals % Software (Entertainment) % Hotel/Gaming % Telecom. Equipment % Software (Internet) % Software (System & Application) % Air Transport % Beverage (Soft) % Chemical (Specialty) % Shoe % Brokerage & Investment Banking % Healthcare I&T % Insurance (Prop/Cas.) % Restaurant/Dining % Cable TV % Healthcare Products % Utility (General) % Homebuilding % Power % Insurance (Life) % Chemical (Diversified) % Aerospace/Defense % Broadcasting % Electrical Equipment % Food Processing % Electronics (General) % Household Products % Retail (Building Supply) % Machinery % Reinsurance % Total Market % Apparel % Insurance (General) % Computer Services % 69

71 Accounting Profitability in Aerospace Defense Industry Firms Net Margin Aerospace/Defense % 70

72 Accounting-based Profitability by Sector, NYU Stern School of Business Industry Name Number of firms Net Margin Tobacco % Bank (Money Center) % Banks (Regional) % Shipbuilding & Marine % Financial Svcs. (Non-bank & Insurance) % R.E.I.T % Transportation (Railroads) % Investments & Asset Management % Drugs (Biotechnology) % Drugs (Pharmaceutical) % Rubber& Tires % Utility (Water) % Entertainment % Beverage (Alcoholic) % Semiconductor % Information Services % Computers/Peripherals % Software (Entertainment) % Hotel/Gaming % Telecom. Equipment % Software (Internet) % Software (System & Application) % Air Transport % Beverage (Soft) % Chemical (Specialty) % Shoe % Brokerage & Investment Banking % Healthcare I&T % Insurance (Prop/Cas.) % Restaurant/Dining % Cable TV % Healthcare Products % Utility (General) % Homebuilding % Power % Insurance (Life) % Chemical (Diversified) % Aerospace/Defense % Broadcasting % Electrical Equipment % Food Processing % Electronics (General) % Household Products % Retail (Building Supply) % Machinery % Reinsurance % Total Market % Apparel % Insurance (General) % Computer Services % 71

73 Economic Profit by Industry as Estimated by NYU Stern School of Business Industry Name Number of Firms Beta ROE Cost of Equity (ROE - COE) BV of Equity Equity EVA ROC WACC (ROC - WACC) Tobacco % 13.75% % $ $(204.07) 77.34% 11.82% 65.51% Advertising % 8.74% 17.21% $4, $ % 6.57% 53.11% Healthcare Support Services % 8.57% 6.01% $162, $9, % 7.20% 34.30% Information Services % 8.27% 15.51% $85, $13, % 7.44% 30.17% Computers/Peripherals % 10.24% 17.28% $228, $39, % 9.01% 26.69% Entertainment % 9.55% 12.37% $99, $12, % 7.90% 25.10% Computer Services % 9.30% 22.93% $59, $13, % 7.75% 22.35% Household Products % 8.55% 4.91% $92, $4, % 7.53% 21.48% Aerospace/Defense % 10.25% 9.94% $158, $15, % 8.86% 21.29% Food Processing % 7.59% 9.98% $94, $9, % 6.45% 16.68% Electrical Equipment % 9.17% 6.27% $29, $1, % 8.01% 16.34% Shoe % 7.20% 18.76% $16, $3, % 6.87% 15.54% Business & Consumer Services % 9.40% 0.60% $48, $ % 7.58% 14.83% Software (Entertainment) % 10.77% 1.53% $12, $ % 10.00% 14.52% Beverage (Soft) % 9.19% 12.80% $62, $8, % 7.92% 14.50% Office Equipment & Services % 13.16% 16.20% $4, $ % 8.99% 14.03% Machinery % 10.88% 1.88% $69, $1, % 8.99% 13.55% Broadcasting % 10.02% 1.71% $31, $ % 6.17% 13.21% Chemical (Specialty) % 9.75% 12.03% $66, $7, % 8.00% 12.20% Food Wholesalers % 6.65% 4.49% $8, $ % 5.80% 12.14% Retail (Building Supply) % 11.10% 34.54% $21, $7, % 9.73% 11.89% Rubber& Tires % 12.23% % $2, $(324.16) 20.05% 8.23% 11.81% Air Transport % 9.88% 34.25% $40, $14, % 6.81% 11.76% Electronics (Consumer & Office) % 9.65% 8.09% $3, $ % 8.72% 11.46% Transportation % 10.74% 9.58% $29, $2, % 8.69% 11.45% Environmental & Waste Services % 8.90% -0.69% $23, $(165.63) 18.31% 7.17% 11.14% Drugs (Biotechnology) % 9.96% 12.39% $95, $11, % 9.20% 11.13% Auto Parts % 9.98% 11.83% $29, $3, % 8.11% 10.27% Restaurant/Dining % 6.83% 25.09% $36, $9, % 5.86% 10.01% Packaging & Container % 9.85% 7.14% $19, $1, % 7.12% 9.98% Retail (Online) % 11.72% 4.24% $26, $1, % 10.99% 9.82% Transportation (Railroads) % 9.18% 9.37% $51, $4, % 7.53% 9.66% Software (System & Application) % 10.23% 1.49% $213, $3, % 9.39% 9.57% Healthcare Products % 8.43% 1.90% $103, $1, % 7.45% 9.30% Cable TV % 9.66% 9.92% $63, $6, % 7.16% 8.88% Beverage (Alcoholic) % 7.90% 5.13% $16, $ % 7.05% 8.80% Apparel % 8.61% 5.90% $27, $1, % 7.26% 8.73% Recreation % 7.76% 3.45% $14, $ % 6.40% 8.40% Building Materials % 9.33% 3.30% $15, $ % 7.54% 8.37% Drugs (Pharmaceutical) % 8.37% 6.84% $240, $16, % 7.72% 7.47% Engineering/Construction % 10.17% -8.43% $30, $(2,595.29) 15.20% 7.88% 7.32% Telecom. Services % 7.94% 4.27% $135, $5, % 5.52% 7.30% Furn/Home Furnishings % 9.65% 3.91% $14, $ % 7.87% 7.20% Retail (Distributors) % 9.60% 5.36% $34, $1, % 6.89% 6.84% Heathcare Information and Technology % 8.93% 2.86% $49, $1, % 7.95% 6.40% Oilfield Svcs/Equip % 12.72% -4.46% $183, $(8,166.12) 16.19% 9.91% 6.28% Retail (Automotive) % 8.63% 25.27% $14, $3, % 6.37% 6.20% 72

74 Economic Profits in Aerospace-Defense Industry Firms Return on Capital WACC ROC-WACC Aerospace/De fense % 8.9% 21.3% 73

75 Economic Profit by Industry as Estimated by NYU Stern School of Business Industry Name Number of Firms Beta ROE Cost of Equity (ROE - COE) BV of Equity Equity EVA ROC WACC (ROC - WACC) Tobacco % 13.75% % $ $(204.07) 77.34% 11.82% 65.51% Advertising % 8.74% 17.21% $4, $ % 6.57% 53.11% Healthcare Support Services % 8.57% 6.01% $162, $9, % 7.20% 34.30% Information Services % 8.27% 15.51% $85, $13, % 7.44% 30.17% Computers/Peripherals % 10.24% 17.28% $228, $39, % 9.01% 26.69% Entertainment % 9.55% 12.37% $99, $12, % 7.90% 25.10% Computer Services % 9.30% 22.93% $59, $13, % 7.75% 22.35% Household Products % 8.55% 4.91% $92, $4, % 7.53% 21.48% Aerospace/Defense % 10.25% 9.94% $158, $15, % 8.86% 21.29% Food Processing % 7.59% 9.98% $94, $9, % 6.45% 16.68% Electrical Equipment % 9.17% 6.27% $29, $1, % 8.01% 16.34% Shoe % 7.20% 18.76% $16, $3, % 6.87% 15.54% Business & Consumer Services % 9.40% 0.60% $48, $ % 7.58% 14.83% Software (Entertainment) % 10.77% 1.53% $12, $ % 10.00% 14.52% Beverage (Soft) % 9.19% 12.80% $62, $8, % 7.92% 14.50% Office Equipment & Services % 13.16% 16.20% $4, $ % 8.99% 14.03% Machinery % 10.88% 1.88% $69, $1, % 8.99% 13.55% Broadcasting % 10.02% 1.71% $31, $ % 6.17% 13.21% Chemical (Specialty) % 9.75% 12.03% $66, $7, % 8.00% 12.20% Food Wholesalers % 6.65% 4.49% $8, $ % 5.80% 12.14% Retail (Building Supply) % 11.10% 34.54% $21, $7, % 9.73% 11.89% Rubber& Tires % 12.23% % $2, $(324.16) 20.05% 8.23% 11.81% Air Transport % 9.88% 34.25% $40, $14, % 6.81% 11.76% Electronics (Consumer & Office) % 9.65% 8.09% $3, $ % 8.72% 11.46% Transportation % 10.74% 9.58% $29, $2, % 8.69% 11.45% Environmental & Waste Services % 8.90% -0.69% $23, $(165.63) 18.31% 7.17% 11.14% Drugs (Biotechnology) % 9.96% 12.39% $95, $11, % 9.20% 11.13% Auto Parts % 9.98% 11.83% $29, $3, % 8.11% 10.27% Restaurant/Dining % 6.83% 25.09% $36, $9, % 5.86% 10.01% Packaging & Container % 9.85% 7.14% $19, $1, % 7.12% 9.98% Retail (Online) % 11.72% 4.24% $26, $1, % 10.99% 9.82% Transportation (Railroads) % 9.18% 9.37% $51, $4, % 7.53% 9.66% Software (System & Application) % 10.23% 1.49% $213, $3, % 9.39% 9.57% Healthcare Products % 8.43% 1.90% $103, $1, % 7.45% 9.30% Cable TV % 9.66% 9.92% $63, $6, % 7.16% 8.88% Beverage (Alcoholic) % 7.90% 5.13% $16, $ % 7.05% 8.80% Apparel % 8.61% 5.90% $27, $1, % 7.26% 8.73% Recreation % 7.76% 3.45% $14, $ % 6.40% 8.40% Building Materials % 9.33% 3.30% $15, $ % 7.54% 8.37% Drugs (Pharmaceutical) % 8.37% 6.84% $240, $16, % 7.72% 7.47% Engineering/Construction % 10.17% -8.43% $30, $(2,595.29) 15.20% 7.88% 7.32% Telecom. Services % 7.94% 4.27% $135, $5, % 5.52% 7.30% Furn/Home Furnishings % 9.65% 3.91% $14, $ % 7.87% 7.20% Retail (Distributors) % 9.60% 5.36% $34, $1, % 6.89% 6.84% Heathcare Information and Technology % 8.93% 2.86% $49, $1, % 7.95% 6.40% Oilfield Svcs/Equip % 12.72% -4.46% $183, $(8,166.12) 16.19% 9.91% 6.28% Retail (Automotive) % 8.63% 25.27% $14, $3, % 6.37% 6.20% 74

76 What Does This Imply About Where the Industry as a Whole is On This Chart? % Economic Profit WACC ROIC Planting a Seed: What should corporation s do with its money at this point? Value-creating investments that cover cost of capital and produce economic profits Value-destroying investments that don t cover the cost of capital 75

77 9. If contractors don t invest in defense opportunities, what do they do with those funds? 76

78 Growing Trend of Pulling Cash out of Business and Returning it to Shareholders 77

79 10. What are the keys to successfully negotiating with industry? 78

80 Biggest Problems/Opportunities in USAF Negotiating with Industry Today 1. Adversarial approach 2. Lack of training 3. Lack of preparation 4. Staff acting as line 5. Crushingly bad processes 79

81 1. Adversarial Approach 80

82 Confrontational Negotiation is Instinctive Because it has Proven to Work. In Certain Settings. 81

83 Is USAF-Industry One of those Settings? Condition Single dimension? Once and done? Relationship unimportant? Yes or No No! No! No! 82

84 83 Maybe there is a better way.

85 From Adversarial to Joint Problem Solving From Me Against You To Us Against the Problem. 84

86 This is Not Soft 85

87 2. Lack of Training 86

88 Train on Basic Proven Tools: Search for Common Value 87

89 How to Discover Value Q A Q A Q You propel the conversation forward with open-ended questions. They steer the conversation with their answers. A Q A Q A Q A 88

90 Train on Basic Proven Tools: Position vs Interest 89

91 Thought Experiment on Position Vs Interest Your boss was just called on the carpet by her boss during her quarterly review. She got asked a lot of questions about costs she couldn t answer. Fact is, nobody can answer them because it would require working across three complex systems to integrate a huge amount of data. Your boss clearly heard she was to get this mess cleaned up or risk being replaced by somebody who can. You are head of information services and you ve been advocating for a new information system to integrate the three systems. It would be a huge undertaking - probably taking years and certainly many tens of millions of dollars - but you feel strongly it is would be worth the effort. Your boss calls you in and this is how the conversation goes: Your Boss: The old man went nuts! We ve got to get costs down and we ve got to do it fast. But I m flying blind - I don t know what my costs are! We are drowning in data, but starving for information!!! I m putting you in charge of implementing a new integrated information system to get this fixed. I ll give you 8 months. You: Eight months?!? 90

92 3. Lack of Preparation 91

93 Preparation Template 1 Question Me You Them Interests? Options? 92

94 Preparation Template 2 Values Mine Ours Yours 93

95 4. Staff Acting as Line Legal Counsel General Manager Director Director Director Line reporting Staff support 94

96 Staff Acting As Line 95

97 5. Crushingly Bad Processes Start Pure Waste Necessary Waste Essential Valueadding Work Finish 96

98 97

99 Review of Questions What are the legal responsibilities of corporate officers? Outside combat, what are the key differences between USAF Officer and Corporate Officer goals and mindsets? How do corporations measure their performance? What drives corporate shareholder returns from stock? What are the implications of the drumbeat of quarterly earnings reports? How does industry think about time in making investment decisions? How do corporations structure management compensation and incentives? Just how profitable is the defense industry?. If contractors don t invest in defense opportunities, what do they do with those funds? What are the keys to successfully negotiating with industry? 98

100 Closing Thoughts 99