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Thursday, October 14, 1999

Defense malaise catches up with Raytheon
Contractor, blaming competition, follows trend in reporting lower-than-expected earnings
By Leslie Miller
Associated Press

BOSTON - Until Raytheon Co. first indicated to investors last month that its earnings would be lower than expected, it was considered one of the best-managed defense contractors in the country.
   Now, despite Pentagon assurances that Raytheon is not in trouble, analysts and investors are trying to figure out what happened.
   The company's chief executive and chief financial officers were sticking to their story Wednesday as they hit the road to meet with key investors.
   On Tuesday, they said earnings would be worse than had been previously indicated: tough competition and delayed orders were responsible for projected earnings per share of $2.70 to $2.80 without special charges, well below Wall Street expectations of $3.56 per share.
   The company's Class B stock, which plunged more than 43 percent Tuesday on the New York Stock Exchange on news of the second earnings warning, fell $1.62 Wednesday to close at $22.62.
   The company took write-downs in connection with its missile plant in Lewisville and plants in Greenville and Garland, all in Texas, where Boeing jets are modified for business travel.
   Analysts said they were surprised by the continuing bad news, as Raytheon had so far seemingly managed to stay away from the troubles that have beset the rest of the defense industry, which has been hurt by declining military spending.
   Defense procurement peaked in 1985 at $97 billion and bottomed out in 1996 at $42.4 billion, a long, long starving trend," said Charles Gabriel, senior vice president at Prudential Securities.
   Industry troubles
   Big defense contractors boosted revenues by acquiring other companies and cutting costs. In four years, Raytheon bought defense businesses from Texas Instruments, General Motors and Chrysler Corp., as well as E-Systems, a defense electronics company.
   One by one, however, defense contractors began to run into trouble.
   Bethesda, Md.-based Lockheed Martin Corp. lost $128 million during the first half of 1999 after four satellite launch failures, then announced a major restructuring in September.
   Boeing Co. struggled with production line snarls, delayed deliveries and the Asian financial crisis during the past two years. The Seattle-based company reported losing $178 million in 1997 and had relatively low earnings of $1.1 billion last year.
   'Water was poisoned'
   Northrop Grumman, a major supplier of components for the 747, suffered a blow when Boeing cut commercial airplane production. Northrop, based in Los Angeles, announced last year it would lay off more than 10,000 workers to reduce its operating expenses by $300 million because of dwindling military work and competition.
   "The water was poisoned by prior blowups at Lockheed, Boeing and Northrop Grumman," said Pierre Chao, senior aerospace defense analyst at Credit Suisse First Boston.
   So when Raytheon first announced in September that its quarterly earnings would be lower than predicted, its shares began to slide. Trading at around $61 when the Lexington, Mass.-based company issued its first warning last month, shares have fallen nearly 63 percent.
   Positive outlook
   Analysts say the outlook is improving for defense contractors, however. The Pentagon will spend between $55 billion to $56 billion this fiscal year on procurement, and is expected to spend $61 billion next year, Gabriel said.
   "We're heading toward the first upturn in defense spending in 13 years," Chao said. "That's a powerful, positive event for the defense industry."
   But some analysts said they are less concerned about external problems than they were about the strength of Raytheon's management team.
   "It's one thing if someone down the street tries to kamikaze underbid them," said Martin Knoblowitz, an analyst at Standard & Poor's. But it's quite another if a defense contractor can't restructure itself internally after making major acquisitions, he said.
   "Always the answer (from Raytheon) has been 'Yes, yes, yes we have strong internal controls, a rigorous budget and planning process,' " Knoblowitz said. "Clearly that's going to be part of the line of questioning: How could things have gotten to that state?"
   Losing perspective
   Raytheon chairman and chief executive officer Daniel Burnham acknowledged Tuesday its acquisition spree may have been too much for its managers, and that the company should have been aware of the lowered expectations for margins and revenues.
   "We have had a lot of change," he said, noting the acquired companies were restructured around products. "That created an opportunity to lose perspective on what was going on."
   The company announced James Schuster has been named general manager of aircraft integration systems, succeeding the retiring Glen Hood. Raytheon spokeswoman Toni Simonetti would not comment on whether the change had anything to do with the earnings warning.

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