Cspan2. Navy secretary Richard Spencer and technology and financial Industry Leaders discuss the Defense Forum at the Reagan Library and california in california. Hello everyone. Good morning. Its great to be here. Its a beautiful place at a very important time for many, many reasons. We are here today to talk about the challenges that the Defense Industry, and our government faces, as a result of the pressure from wall street. How does that Quarterly Earnings report affect the ability of our government to innovate and protect us . Its a big question, its an important question with lots of ramifications for years to come. Here to discuss this and attack the problem, we have mr. Michae mr. Michael, executive director of aerospace j. P. Morgan, he is the wall street guy that is basically demanding all these things but he will have some good insight. We have mr. Ron, managing director of ui asked. He is part of the entity, in Silicon Valley to go out and acquire new technologies and find the neatest, coolest things on the horizon that can really help us. We have the secretary of the navy, honorable Richard Spencer next to me and we have chairman and ceo of l3 technology. They are looking at what it is that can best protect us in terms of new technologies. I want to remind you all to jump into the conversation. You can do that online through the mobile app and anyone at home, if you have questions, submit them to us on twitter. We will watch those questions. Lets kick it off, first tell us about what it is you want for an investor stand point for these companies, what is it that you want, what you need . First i want yo i want to thank you for being here. Its a privilege to be with this esteemed group. The topic of putting more money into the business is something is, its not at a level that makes the department happy. With the investor, there are tradeoffs. I can ask for it evidence or a buyback where companies can invest in the business. For me too want to allocate my shareholders money to those who are investing, i need to see three things. I need to see stable budgets, thats not necessarily ten or 20 higher but its stable budgets i can be planned on. China has a fiveyear plan. You can plan with five years and companies can invest with five years. I need to see that. The need to see companies being rewarded for taking risk. That should be a lower fee if theyre not taking risk. I would rather see dividend buyback and incentive for investment. From the department standpoint, you want to see companies rewarded for past performance and vice versa. If you are on a tanker or an Aircraft Program and you did not deliver on time and on budget, that should have an impact on how likely you are to win the next program. When i look at how programs are awarded for that doesnt happen today. Those are the three pieces i would focus on. Mr. Secretary, when you hear this and you know there is this pressure from investors like michael and all of wall street, they want the most out of these companies, how do you think about it in terms of making sure youre getting the most Innovative Technology out there for our youth . Its fascinating, having come from wall street, everyone is saying whats it like to work inside the pentagon. If you look at the job of the secretary of the navy, they man, equipped, train and deliver, the hat that i wear is running a business. I have a budget, i deploy the funds, i get the equipment, i painted and deliver it to the combat commanders. It is imperative for me to be a responsible consumer or client. The word that we are putting out right now, and this starts from the top on down through our lor lord, we want to erase the whiteboard and get away from transactional relationships in the general sense and really Welcome Partnership with the Industrial Base. What i mean . I mean shared risk, shared benefits. We want to make sure that we are taking risks and that risks are being shared. The government shouldnt take 90 of the risk and leave 10 . It has to be distributed. Its incumbent on us to send that signal out to the Industrial Base. Norm augustine told me once, stop ranting about the Industrial Base, they are simply mirroring the system that you have and its human nature. Its true. We have to change that and we are looking forward to opening the doors for this relationship concept, its out there and i know it will come. Just to strengthen them because i dont have the amount of funds that i need for the requirements that are being heaped on me. I need to increase my capabilities and every single aspect were i do business. The only way i can do that is by working in partnership with the Industrial Base and in that lin line, that sends the trickle down to michael who will make the investments appropriate because capital is the universal lubricant for my business, in order for my suppliers and my supply chain to function correctly. Your kind of caught in the middle because youve got michael who is demanding those Quarterly Earnings. You have a client who wants the best technology for the future so how are you thinking about it. Theres the dilemma. We are Public Companies subject to competitive pressures, we have our customers that we care about that need technology and investment, we have our shareholders, we are not the only industry that you can invest in. Theres industries on the west coast that produce returns way greater than the the Defense Industry but we are known for being predictable and generating reasonably good returns. However, as a result of the past decade of shrinking and flat budgets, its been very difficult for many of the companies in the industry to make Investment Decisions that were for the longterm because of the lack of certainty of whether there would be a program, how long it will take, if the get the money back, whether it will be terminated and you start missing earnings and you run into problems or even worst you have an activist show up and ive had the personal pleasure of dealing with that and fortunately we are still here and they arent and im happy to say that, but its the dacey environment. We want to keep our customers in our war fighters, the best fighting force the world has ever seen. The u. S. Military has always had a stencil Technology Advantage and i think we have a bit of a deficit that the occurred and we need to be competitive within the Capital Markets so that we are viewed as an attractive place to invest. Its a balancing act. I want to circle back to that because activist investors are very much a new phenomenon, certainly in the past five, ten years, at least the extent of which their operating and that makes it challenging for any business, but it adds on a whole other layer when youre talking about the Defense Industry because its so relevant to you mr. Secretary, and to all of us keeping us safe. Before i do that, you are part of what the government is trying to do to discover these new technologies before l3 or before wall street. Hows about your process. Thank you for this well opportunity to be here as the department of defense representative. Its great to be on the wall street panel. The nature of warfare is changing. It is being driven by technologies being led in the pilot sector. The pentagon used to be a monopoly buyer in buying stuff for ourselves. That world is changing and it has a lot of implications for us. One, these companies are gonna build these technologies whether we participate or not. I think about Artificial Intelligence and our economy, how its disrupting the Financial Market and technology companies, its embedded in all the phones that you have in your pocket now, you realtime translation of any language that didnt exist five years ago. The world of self driving cars are on the way. All these things have military implications. Because two things, one is that technology is moving so fast and we dont have exclusive rights to this. Whats most important is not necessarily just the protection of that technology, its how fast we can incorporate that into the hands of the men and women on the battlefield. I think we are seeing a slew of things that are interesting, we are seeing. We have to think about our approach. There was a question about how much data we collect, how much we release. We can talk more about that but the good news is Capital Market, even the earlystage Capital Markets are beginning to look to department problems as once they want to solve and invest in. How has investment changed . When you think about the military you think theres a time in history where we were pouring all kinds of resources into defense and we backed off that because much of this is outsourced. That may be far more efficient, but walk us through the change and the current state of things now. If you look back at the days when tarp but was new and you had them leading innovation, literally between nasa and dod, they were probably the biggest innovators. You look at what happened on a budgeting cycle from the dod specifically, and the requirements and tasks that weve received to do our job, we no longer had the money to make those investments. It naturally trickled away. The fire to look back over the last ten years and the responsibility i had to be a good client to my suppliers and supply chain, we obviously , i wont say weve sent a failed signal, weve sent a signal that were not investing because they dont find any opportunity to invest on the business basis. That on us, for not having a sustainable source of resources to signal to the marketplace that we are in this for the long run so they can afford to invest the dollars to make the return so michael will invest in their companies. It is a true relationship. But enough is truly understood in the building. The responsible of being a good client, to be frank with you. Michael, at l3, you want the best, most Cutting Edge Technology to show your clients, but how do you do that when its driven by a bottom line when the products that youre investing in in terms of your overall portfolio. Will the Congress Fund this. Like all companies in this industry we invested a certain level and we run into the problem where theres an urgent requirement because of deployment or whatever the case may be and you invest in new technology or new system that can keep our men and women in uniform safe, and making those decisions. We dont make anything at the pentagon, as you know, theres not tanks and ships flowing out the back door. We need confidence to move forward and not run into problems with our investors. I can bring up a point on that, i dont know how many of you have really paid attention to this but the budget control act, the sequestration, i was asked by some of my board of directors on the hill to ask what that has cost the navy. The last nine crs have cost the navy around 4 billion. That is not opportunity lost, that is putting 4 billion in the trashcan, putting lighter fluid on it, and burning it. Thats exactly the relationship we have to have for the Industrial Base, its a tough environment to work in. When we think we can turn a switch on and off too. [inaudible] and let alone what happens to the cost of dollars, it trickles down to our suppliers in a magnified manner. The returns in the Defense Industry are very good. This is a great business. Its not a question of not investing in it because of the current returns, its a question of if i invest today, will it drive more revenue and sequestration. Thats a hesitancy to invest. You said mike is kind of in the middle between the customer and the investor and thats not exactly true. If i see Revenue Growth i will support investment all day long and the same point i would make is on development, on new programs, if returns are commensurate with the risk taken, i will encourage more speculative investing, and that means, if youre spending money five years early to develop new technology, when it comes to fruition it has to be higher than something you will turn around and 60 or 90 days. Right now the acquisition rules dont allow that or its not utilized to the extent it should be. What does that mean for a company like l3 if the acquisition rules, are you in competition with roche was out there trying to find these new technologies in silk on valley . You have got to find them and acquire them because it would be cheaper to acquire them then to put five years capital expense and not know if its going to pay out or not. Thats true. We dont know if we will compete yet, it doesnt really serve either of our interest to make things more expensive, but i would say, lets just follow the money over the last several years. This industry has plowed. We had a certain return. Its not a lot to think about, if you want to sustain your company and operate in this competitive market. Thats what weve seen. We are just coming at the end of that cycle. We have shifted back from predominantly purchases to an acquisition to r d. We have made investments in areas that are not quite funded yet. We have enough confidence that our clients will get there. Michael hits the nail on the head paired one of the things we have to do, we been nibbling around the edge for reform of the acquisition policy. In fact, funny story, when i was spooling up for confirmation i got a briefing on the acquisition instruction, instruction 5000 and had two generals and two admirals briefing me and at the end of the table was marine corps captain and Navy Lieutenant and i was loved speaking to the junior officers. I said what do you think about our acquisition program, instruction 5000 and the Navy Lieutenant chins it over to the marina and the marine looks down and says well, sir, if it was up to me i would leave it on the Chinese Embassy steps. They adopted and we win. [laughter] that kind of sums it up. We have to get after this. We are doing great things, ellen ward is leading some great reformation, we have cells, we have to make sure it impregnates the whole organization. We are our own worst enemies in some cases. We sit here and, from my point of view, we need this, we do, but we also need to do some work inside the building, make sure that we spend your treasures the best way that we can and that we have to have the tools to do that. Industry is ready. As i referenced earlier, if we change the process, industry will adapt that process. I would actually like to address that and touch on the commercial sector and industry. It underpins both the hard and soft power. I dont think theres any daylight or shouldnt be any daylight between the innovation, the economy that weve seen crop up over the last decade or so. You have Young Companies that take high levels of risk that are backed by Venture Capital and understand that risk. They want to bring it to scale, the department has 3 million people. The Largest Organization in the world. If you want to bring it to scale, this is where our Industrial Partners are absolutely vital. They understand the process. They have the relationships. They know how to work in classified locations. What weve seen from our Vantage Point is the most successful effort are taking our best Young Companies and merging technologies infusing them with our Industrial Partners to say, lets bring the strength of both together and we can do it in a timeline thats much much faster. Michael, in terms of where these companies are treating, i think in part they caused a lot of upsize and it wasnt really builtin. The sector is doing extremely well. Where do you see it heading over the next 6 12 months. The pe ratio for the sector, what the evaluation is and where it goes or where it can go. The sectors valued at the top five percentile of where its been historically so to see it expand from here is tough. To see a contract is unlikely as well. The budgets have turned. In the returns, thats a nice set up in a relatively slow growth world. I would like to see the customers, if that occurs than the differentiato differential will common i think thats exactly what the others would like to see. At the commercial analog. I think the dod could adopt it, and that is, on key programs, legacy programs. What boeing has come up with is partnering for success. We know can contractually you can charge ask for this piece of landing gear. Its very similar to what we see with the prime in many cases in dod. If you work with us on this program, then when you come out with the next variance, you are going to get more business because you are partnering with us. That requires Program Managers to work across programs and i think that is low hanging fruit for the department to do. Here is where we have to change our acquisition parameters. One of the most fascinating things that i have had to do so far is the pa program which is the 737, and if you look at what goes on with the 737 on the commercial side and now we are military buyer, you almost think its commercial off the shelf, its not quite there but its pretty close. You look at exactly what michael is talking about and boeing has a service, boeing commercial services where 24 hours the plane doesnt remain on the ground and they dispatch the parts, et cetera. I was saying why cant we take the mindset that we are buying readiness. I dont care, i dont actually want to own parts, i want to buy readiness. I am buying 99 up, how does supply chain get it there . Thats the value they provide me and thats what we provide for. There was no way for us to validate what