“A free society reflects in every facet the dedication, the sense of responsibility, and the moral conviction of the men and women who direct its endeavors.”
“From the standpoint of financial strength, the company is in a better position than ever to continue implementing its long-term plan for growth.”
“During the year we made a highly beneficial change in our capital structure through the creation of a new class of preferred stock.”
Litton’s Second Phase, “Rapid Expansion Through Acquisitions and Internal Growth During the ‘60s,” 1 was in flux.
Tex changed tact, again, and led with the balance sheet, in 1964.
Charles “Tex” Thornton’s Operational Highlights:
Acquisitions:
“Acquisitions have been of continuing importance in Litton’s growth. They have been used as an expedient in saving time and money and protecting markets, but they have never carried a priority over internal growth.”2
Merger with Clifton Precision Products, Inc. (manufacturer of flight synchronizers, computing resolvers, synchros, and subminiature motors).
Acquisition of Bruder and Co. (infra-red food heating equipment).
Acquisition of Advance Data Systems Corp. (automatic revenue control technology).
Acquisition of Fitchburg Paper Co. (quality paper for office, commercial and general use).
Some additional M&A activity completed after year-end:
Streater Industries, Inc., (display equipment for retail stores, and merchandise control centers).
Profexray, Inc., (medical diagnostic X-ray equipment).
Mellonics Systems Development, Inc., (design and implementation of command and control systems for data processing and satellites).
Preliminary agreement with Royal McBee Corp., (electric and manual typewriters, and electromechanical data processing systems).
Negotiations to purchase Universal Controls, Inc.
“In our acquisition activities, we do not, as a policy, engage in raids or hostile takeovers. We believe that the benefits expected from an acquisition would be totally negated by the existence of an adversarial relationship between the parties.”3
The Art of Preferreds:
“Subsequently, we issued 428,141 shares of the new preferred to our stockholders in return for common stock on a share-for-share exchange offer… [it] gives us an additional tool for use in making acquisitions.”
For an investor, non-convertible preferred shares are weak. They rank above junior issues and are entitled to (often higher) dividend payments before the common shareholders. However, the preferred dividend still depends on the enterprise’s ability to pay it. If it can’t, the dividend disappears. In some cases (noncumulative preferred shares) that dividend will never be recouped. So the conventional assumption of investors is that preferred shares are safer and guarantee higher dividends than common shares. Both are questionable. In addition, a preferred shareholder, if they can’t convert into the common, cannot participate in the enterprise’s future expansion.
In the words of Graham and Dodd:
“It may be said that preferred stocks combine the limitations of creditorship (bonds) with the hazards of partnership (common stocks).”4
From a capital allocation perspective, preferreds are a useful tool in the acquirer’s arsenal. A serial acquirer can issue preferreds to ensure new shareholders still receive a dividend that they were accustomed to at the acquired company. In doing that, the dividend policy on the acquirer’s common stock can stay the same.
“Andrew Wyeth has achieved greatness through an intellectual independence to record on canvas his individual conviction about the human soul and the wonders of nature. His deep sense of responsibility would not permit him to be swept up in the artistic clichés of the time.”
I believe business and investing are scientific arts. An annual report and its communications reveal the management’s arrangement of their human, financial, and technological resources. Contracting artists to design the annual report seems a step too far.
Data Processing and Computation (31% of sales):
This segment was not the largest contributor to Litton’s sales, in 1964. Why was it discussed first?
Litton was on the cusp of introducing the Monrobot XII, a solid-state, special-purpose computer designed to replace electromechanical billing and invoicing equipment.
In 1964, Monroe Business Machines added a Data/Log high-speed printer — a newer version of a previous model. Sales and production doubled, as a result.
Observe Thornton’s affinity for sales organization planning…
Sales capacity expansion:
“To keep pace with the heavy demand for Monroe products, the company increased the sales staff in this division by 10 per cent in fiscal 1964.”
Cross-selling strategy promoted:
“the company developed an integrated sales approach for Monroe Data Processing, utilizing the sales staff of our Monroe, Monroe/Sweda, and Kimball Systems divisions.” As a result, Litton offered retailers data recording and processing systems (Kimball punched tags), Monroe/Sweda point-of-sale recorders to record all transactions, and analysis by Monroe Data Processing.
1964 saw record sales of Monroe/Sweda sales registers and point-of-sale recorders.
Aero Service created a new line of business called Data Bank that controlled city mapping and inventory services for regional planners. It stored the data collected from analyzing photographs and sold it to planners.
The Advance Data Systems division built a revenue control system and placed it in the London Underground transport system. Magnetically coded tickets tracked a passenger’s train journey via a machine terminal.
Data was utilized to reduce response times in weapons systems. For example, the Marine Tactical Data System (MTDS) earned Litton a $51mm follow-on contract in 1964.
A similar system, the Airborne Tactical Data System (ATDS) was used in the Navy’s E2A carrier-based aircraft. It surveilled large areas, detected enemy aircraft, and tracked their direction of travel. The ATDS could be used as a live air traffic control system on board or simply as a system to relay real-time data to the ground.
Thornton believed the F-111 aircraft would become the standard fighter jet for the Navy and Air Force. Litton’s Guidance and Control Systems division produced an element of the computer required for the F-111’s Phoenix missile system.
In 1964, Litton developed the L-300 computer series using integrated circuits. This was four years after Teledyne was founded to pursue semiconductor technology.
That was one reason why George Roberts felt Teledyne Inc. was exceptional:
“Henry had three great ideas in creating and growing Teledyne. His first was to recognize the future importance of digital semiconductor electronics when this technology was in its infancy and by selective acquisitions to create a strong base in this growing field on which to diversify his company.”5
A different electronic device growing in popularity in the 1960s was the calculator. Litton entered this market in 1962 and its sales continued to grow:
“Our Monroe division began marketing a new printing calculator which represents a major advance in its field of technology. This product, designated the Monro-Matic PC 1421, performs more functions automatically than any other calculator on the market today… The PC 1421 has an automatic decimal placement capability and processes computations involving results expressed in up to 21 digits.”
To summarize, Litton developed many new products related to collecting, storing, and using data, in 1964. This was broadly applicable to various markets, from office equipment to missile systems.
Communications and Transmission (11% of sales):
This segment contributed the second lowest to sales. Why did Tex choose to discuss these operations before other, higher contributors?
Tropospheric scatter communications take advantage of an interesting phenomenon. When microwaves approach the limit of the earth’s lowest level of atmosphere (the troposphere), some of the waves, at certain frequencies, are distributed in random directions.
To that phenomenon, Bell Labs scientists applied the principle of firing concentrated microwaves at high frequencies into the atmosphere to convey information over long distances: a small sample of the scattered waves is amplified and transmitted by a highly sensitive receiver somewhere else in the world. Think of it like an invisible mirror reflecting microwaves to Earth. Remember, not all microwaves are redirected, some may continue their journey to higher levels of the atmosphere.
Airtron received a contract to upgrade a series of commercial telephone troposcatter sites, installing every element from the tube output to the antenna feeds and receivers for complete wave-guide runs.
Litton built a new research laboratory, with X-ray diffraction studies, interferometry, spectrophotometry, laser output measurements, and special-purpose crystal processing and preparation equipment, to continue its investigation of large single crystals for laser and microwave applications. “Litton is now seeking to increase crystal size and yield.”
The physical infrastructure of the Airtron Division started to produce the long-term results it was designed to, in 1964. Solid-state devices with preselector filters (operating between 250 to 500 megacycles) were successfully developed. Litton was working on these filters covering bands from 125 to 18,000 megacycles and expected “broad commercial and military markets [to] soon develop these devices.”
Claude Shannon’s observation that Singleton rarely revealed his strategies, as discussed in Litton’s 1963 Annual Report, contrasts with Tex’s desire to share his plans:
“This program has as its goal the creation of whole new classes of optical maser devices for communications, range-finding, navigation and related commercial and military applications.”
Amecom produced a long-range communication system called Transcom and delivered the Redwood telephone system to the US Air Force, which could double as an air traffic control center. Fourteen of these units, which could receive more than three telephone and sixteen teletype channels simultaneously, were delivered.
The Electron Tube division received large orders for M-type backward wave oscillators in the US’s new countermeasures systems. New magnetron applications were discovered for airborne weather and navigation radar. New contracts for klystrons and power supplies for the Stanford Linear Accelerator Center Program were sponsored by the Atomic Energy Commission.
The first electrostatically focused klystron (first mentioned in 1963) — a 32-ounce device which would provide 20 watts of continuous wave power for the Apollo space vehicle’s voyage — was delivered.
Litton entered the Educational Television market when the Federal Communications Commission reserved a block of 31 television channels in the 2,500-megacycle frequency range for instructional broadcasts by public and private schools, colleges, and universities.
Ships and Marine Vessels (12% of sales):
“For as long as the earth’s oceans and waterways have been a factor in commerce and defense, skill in shipbuilding has been a prized capability. This is no less true today than it was two hundred or two thousand years ago; the need for faster and more efficient vessels of many types poses a continuing challenge to shipbuilders throughout the world.”
Litton’s metalworking process transformed, in 1964. Before installation of the new push button system, all cutting, cleaning, scaling, printing, repainting, drying, and delivery was completed manually. Tex believed this operational transformation would be completed in 1965 and provide “Litton with an important competitive advantage as a shipbuilder.”
(I always get a little nervous when a management team or CEO uses the term competitive advantage).
Ingalls completed the SS Mormacargo, one of six vessels ordered by Moore-McCormack Lines. This was the first vessel to be centrally controlled via an electronic console in the engine room. Manpower requirements on the ship were reduced by 20%.
Ingalls was the lowest bidder for the US Maritime Administration and American President Lines, a leading West Coast shipping company. That sounds wrong but is right. The lowest bidder is the company that offers the most amount of work at the lowest price. That is most desirable for the company procuring a contractor. That bid was for four 572-foot-long, 21,000-ton displacement automated cargo ships, with an option to extend to a fifth. It extended the company’s backlog to 1968.
There was an interesting leasing arrangement created for Mclean Industries of Alabama, in 1964. A newly formed Litton Industries Leasing Corporation would purchase six C-4 cargo ships from Mclean’s subsidiary. Litton would then convert the cargo ships into container vessels at the Ingalls facility and lease them to Mclean.
Conversion of the first ship was expected in January 1965 and the remaining five were to be converted in two-month intervals. The second phase was to involve building new ships for Sea Land. The first deliveries of this phase were expected in 1967. Tex asserted that this was the first time an American shipbuilder had provided the type and quantity without a Federal Government subsidy or federal loan guarantee. I can’t comment on the veracity of that claim and it will be interesting to see if management kept to these schedules.
Ingalls continued work from previous years too. One example was the production of aluminium rings and the delivery of nuclear-powered submarines. Another was the construction of the USS Canopus, a sister ship to USS Holland.
Tex believed that nuclear power was economically viable and preferable on all ships in the future. “We expect to be among the leading contenders for the construction of new vessels employing nuclear power.”
Litton began construction on an ambitious Amphibious assault ship (LPH-10) project: it was the first of their class to be constructed by a private shipbuilding facility. They were 600-foot-long vessels capable of carrying 30 helicopters, 2,000 combat-ready marines and a 900-person Navy crew. LPH would make it possible to engage an enemy behind its lines.
Business Equipment and Supplies (9% of sales):
A new executive furniture line at Cole Office Equipment broadened its offering beyond moderately priced ranges.
The two themes of Litton’s operational analysis that stand out in 1964 are:
An emphasis on expanding the quantity of land and manufacturing capacity.
The pursuit of international growth.
In 1964, both themes were present in Litton’s discussion of its Cole Office Equipment Division:
First here…
“Major additions to the production capacity of this division… doubling the size of the 75,000-square-foot Cole plant in Toronto, Canada by the spring of 1965.”
And then here…
The Joint Venture of Cole Espana that would operate in Europe and Africa was the “first production of the Cole line outside North America.”
See both of those themes at play in Fitchburg Specialty Paper’s activities. The division opened a new plant in Belgium to grow in Europe and began penetrating the electrosensitive and heat-sensitive paper markets.
Similar to the calculator examples above, Litton was operating in technology essential to almost every human being alive on the planet at the time. However, both products (with the unfair benefit of hindsight) were commodities (fungible). Would an investor in 1964 imagine that consumers may purchase each calculator with new features? Though both calculators and paper are still important in the 21st Century, capturing the economic value of their importance was/is difficult.
The theme of capacity expansion also appeared in the Kimball Division:
“Anticipating further sales gains, the company acted in fiscal 1964 to increase its production capacity for pressure sensitive products… additional plants and expansion of existing plants is planned for increased production of pressure sensitive products by Kimball Systems.”
The Eureka Speciality Printing division developed a new method for perforating stamps, in 1964.
Instrumentation and Controls (37% of sales)
“A distinguishing characteristic of this age of unparalleled technological progress is the precision it demands.”
Why was the second largest segment as a percentage of sales, wherein many new products were launched in the year, the last to be discussed in 1964?
Litton developed a new gyro — a building block of inertial systems — and departed from the floating sphere technology. The new gyro was combined with a new accelerometer, using microcircuitry (another nod to integrated circuits).
Litton made volume deliveries of inertial systems for the U.S. Air Force’s F4C and RF4C tactical aircraft and operated at peak production for similar F-104 NATO fighters in German and Italian plants.
Production of inertial systems for the Air Force’s new F4D fighter and the Navy’s RF4B reconnaissance aircraft were to begin during fiscal 1965 under contract.
The Aero division acquired rights to use a rubidium vapour magnetometer. The resolution was ten times greater than that of any previously available instrument and benefitted Aero’s search for oil. The Persian Gulf and North Sea exploration projects were both completed. Consequently, 1964 was a record year for dollar volume for the Western Geophysical Division.
See the theme of physical expansion again:
“a significant enlargement of Western Geophysical’s data reduction facilities in Shreveport, Louisiana, was completed during the year.”
The newly-created Atherton division released the Heat-n-Eat infra-red ovens using a magnetron of the Electron Tube division.
The Fritz Hellige Division released the Erymat, an instrument for determining red blood cell count and haemoglobin content at a “competitive price.”
To summarize, many new products were released in this segment during 1964 but a significant portion of sales came from contracts or projects concluding in the same year.
Extra Stats:
Gross Margin 24.74%
EBIT Margin 9.08%
ROE 19.24%
ROA 7.06%
ROIC 13.47%
WC Turnover 4.3
Capital Turnover 4.4
Inventory Turnover 5.4, 67 days to sell
Dep. as % of Op. Prof 26.93%
Dep. as % of Net FA 16.03%
10 directors, 16 officers, 30% of directors are officers, 18.75% officers are directors.6
Dear Intelligent Investor,
Thank you for reading.
You can access this report and more due to the generosity of Adam Mead here:
Fred W. O’Green, Putting Technology to Work: The Story of Litton Industries (1988), Southern California Meeting of The Newcomen Society of the United States held in Los Angeles, pg. 12.
O’Green, Putting…, pg. 12.
O’Green, Putting…, pg. 13.
Benjamin Graham and David Dodd, Security Analysis (1934), pg. 153.
George Roberts, Distant Force (2007), pg, 17.
The board and executive team division looks like the principal-agent problem. A solution to that problem is owner-operators: the principal and agent are the same person. However, even if all officers were board members and vice versa, the principal-agent problem could persist due to differences in equity ownership.