“The history of progress is a history of evolution of men’s ideas.”
“The search for ideas is a never ending adventure.”
“The incessant winds of change shift the sands, arranging the same uncounted grains into ever-new combinations.”
Tex asserted that over half of his company’s products did not exist five years before this annual report. In 1966, Litton introduced more new products and services than in any other year in its history.
Thornton flipped back, again, to lead with the income statement.
Litton changed its capitalization structure too. It added a convertible preferred share. 80% of the common shares eligible for this trade made the voluntary exchange for the new “Preference Stock” cumulative offering.
I think of Litton’s 1966 operations as marketing ideas.
Business Equipment
Litton entered the copying machine market with the Royfax 7 because it expected the “dynamic” copying machine market to expand at 20% per year. The Royfax made an immediate impact on sales due to the repeat orders it generated, but Tex attributed part of that performance to a marketing ploy:
“Its metering system permits the customer to pay only for the size and number of copies made. He is not required to purchase or pay rent for the machine itself.”
Here we have an inverse capital-light business model. Litton bore the responsibility of manufacturing the copying machine and its maintenance capital expenditure requirements over the product’s lifetime. It feels like Litton lost an invisible negotiation with the market.
The Epic 3000 calculator, which could solve quadratic equations, was introduced. An investor in the mid-60s might have believed scientific and business professionals to purchase each new calculator released for their increasingly complex calculating abilities.
The Epic 2000 had its first full year of sales and “exceeded expectations” —note, no numerical target was given to shareholders, in 1965. The high sales were attributed to its unique features: namely that the machine operated unattended with no control keys.
The Monroe PC 1421 was released in Japan and Australia and Litton’s global market share increased. Again, that statement wasn’t quantified or verified. The increased sales were reported to be due to faster answer delivery and data entry during the calculator’s computations.
Royal (acquired in 1965) released a new typewriter called the 660. It had various features not available on the market at the time (larger, contoured keys, automatic functions, lighter activating pressure, noise-free drive systems and a floating mount).
The release of the Ultronic machine marked its entry into the personal electronic typewriting market. 60 per cent of sales were for home usage and 40 per cent were for business use. Royal released the manual typewriter called the 440 and three new portable models (the Royalite, Lark, and Custom).
Litton attributed the success of Dataregister to its “successful marketing campaigns” that resulted in increased small and medium business uptake.
Sweda released the Mark II — a new accounts receivable system that printed retailers’ invoices. Paper tape was punched with all information required for accounting purposes before it was transmitted to Litton’s Automated Business Services’ data processing center.
“The system enables thousands of small stores to offer efficient charge account services to customers at a competitive cost.”
Kimball’s Source Marketing program placed punch-marked tags onto retailers’ production-line inventory. The coded tags manually carried data that was sent (like above) to a Litton data processing center. The data was converted and returned to the customer in the form of reports.
Technology begot technology:
“Greatly increasing the processing speed of the coded tags is a new Litton machine, the Krome, which converts the data to magnetic tape fed into a computer.”
Time-saving was cited, again.
McBee offered data processing services primarily to hospitals, schools, and manufacturers. Data was collected with cards, transferred to tapes, and sent to Litton’s Service Center computers (customer-owned or not). The McBee Keysort Card unit automatically converted cards to magnetic tapes. A new McBee card processor was expected to be introduced in 1967.
The Streater division, responsible for designing and consulting retail store layouts and displays, broadened its activities to include refrigerator design and manufacturing through the McCray line. Tex predicted refrigerators to be a significant growth market for retailers.
Five out of forty-nine stations in the Illinois Central Railroad commuter system were delivered whilst the automatic collection of money through magnetically coded cards was applied to the London bus system for single-fares.
Eureka-Carlisle was the largest stamp-producing company in the world. It expanded its facilities for quantity printing of magnetically encoded checks. Five-color presses were installed in two of their plants.
The Data-log MC 4000 ultra-high speed printer nearly doubled its sales in the second half of 1966. It was a solid-sate, cathode ray tube, and fiber optic printer. The Datalog MC 8800 was released after the close of the fiscal year.
Litton inaugurated its Business Equipment Centers marketing plan first shared in its 1965 annual report. The first center was placed in Springfield, Massachusetts and another was opened in Anaheim, California. Litton envisioned a nationwide network of these centers. For example, a new Crestwood Series of quality wood furniture line was sold in these centers, in 1966.
Somewhat related was the expansion of the industrial supply outlets. Sixteen outlets covered the Northeast, Mid-Atlantic, South, and Far West. This was the roll-out of the “Order-Mation” service.
Defense and Space
“As the world’s leading producer of inertial navigation equipment, Litton produced its 5000th inertial system.”
Litton received a contract to apply SIDS to long-range aircraft navigation and the company received a contract for the research, development, test, evaluation and production of the stellar navigator for the FB-111 strategic bomber.
In 1966, Litton was producing LN-14 inertial navigation systems for the Air Force F111A attack aircraft and the Navy F-111B carrier-based fleet air defense fighter.
The LN-15, first mentioned in 1965, was being developed for commercial usage. Demonstrations of the LTN-50 for major airlines and aircraft manufacturers were scheduled for 1967.
A truck-mounted and computer-based inertial guidance system was developed for the Army.
During conflicts at the time, Litton’s airborne inertial systems were employed by military powers — for example, in Southeast Asia the F-4, A-6A, P-3A and E-2A aircraft were active. Litton provided advisory services for training and maintenance of the inertial guidance systems during the Vietnam War.
After the close of the financial year, Litton submitted an extensive proposal for the development and production of advanced, tactical command and control systems for the Air Force. It was named the 407L. Litton was one of two companies competing for this contract and the decision was to be made in December 1966. I find it odd that a company would report reaching the final stage of a selection process as an achievement without knowing who won the final contract…
The ATDS was successfully implemented in Navy and Air Force strikes over hostile territory. It was also used in the Navy’s E-2A “Hawkeye” early warning aircraft.
In 1966, the first operational unit of the MTDS was delivered. It controlled air weapons and was transportable by aircraft.
Litton recorded its first sales of L-300 and L-3000 microelectronic and general-purpose computers, in 1966. Five prototypes of the L-304 model were being tested for the U.S. Navy’s ATDS. Litton’s microminiature power supplies, used in the L-300 and L-3000 computers received additional contracts.
Litton Systems Ltd (Canada) developed the first microelectronic shipboard control system for the Royal Canadian Navy. Critical to that system was the L-304 microminiature computer.
Four microelectronic data processing units were delivered under contract to the Army Missile Command. Each unit incorporates 1,685 integrated circuits in 3.4 cubic feet that could be placed inside missile batteries. To understand the change in size and space, previous units were transported by trucks and kept in separate buildings. That was another example of Litton’s involvement in integrated circuits and advanced semiconductor technology — the main reason given for Teledyne’s exceptional success — inside complex guidance systems.
Litton released a new Digital Message Entry Device (DMED): it accelerated communication with command and control centers and reduced the risk of interception or enemy jamming.
Hewitt-Robins’ transmission and gearing helicopter systems saw increased demand due to the Vietnam conflict. Litton produced the transmissions for the Army’s CH47A Chinook helicopter. In total, five transmissions were built which meant more than 900 ultra-precise parts. Transmissions were supplied for the tri-service XC-142A also.
The Navy selected Litton for the Fast Deployment Logistic Ship (FDLS) program which was the largest peacetime shipbuilding project in US history. There were two other contractors selected and the winner was to be announced in June 1967. The Navy’s procurement strategy for that program was different to its past approaches. Typically, the Navy specified what it wanted and took bids from the lowest contractors on a year-to-year basis. Instead, this program was to be managed by a singular contractor.
USS Tripoli — which could carry personnel, cargo, and helicopters simultaneously — was delivered. Litton had 8 other military ships under construction at its Pascagoula, Mississippi facility (four nuclear submarines and four amphibious surface ships).
A new oceanographic data collecting system (Model 1001) was developed and four prototypes were purchased by the US coastguard. The system gathered data on salination, depth, and temperature. Litton produced elements of the AN/SQA-13 such as a sonar mounted on the stern of a destroyer escort.
The Navy’s first Combat Information Center Trainer-Simulator System was completed during the year too.
Airtron’s research laboratory expanded its research goals. In 1966, Litton was testing the quality and reproducibility of the large yttrium crystals it had produced in previous years. Ruby and yttrium aluminium crystals controlled laser energy and sapphire crystals were used as integrated circuit substrates.
Encoder developments resulted due to discoveries in material science. The utilization of gallium arsenide diodes (light source) made optical encoding possible. The encoders precisely measured the position of the electromechanical rotating devices (radar antennas, tracking equipment).
Litton’s synchros and resolvers market doubled in a single year. These components link electrical and mechanical elements of aerospace systems such as the F-111 and A7A aircraft.
Voice communication systems were installed at Cape Kennedy.
Litton’s Mellonics division increased its activities fourfold in the design and development of computer programs for real-time command and control of satellites.
Another broad statement that was hard for shareholders to verify:
“Every major space vehicle launched by the United States has carried Litton components.”
Industrial Products
Hewitt-Robbins had a record performance, in 1966. Increased sales of high-tension steel cable belting that exceeded 6,000 pounds per inch of conveyor width, compared with the former industry maximum of 2,000 pounds.
New contracts included:
Conveyor complex for a steel company (Canada)
Largest ore-handling system for a steel company in the world (India)
Eight portable processing plants for road, railroad, harbor and dock construction (Turkey)
Floating marine supply lines for ship loading (Brazil & Philippines)
Litton participated in cargo transportation at the Travis Air Force Base (California) and reduced the loading time of a jet to 30 minutes (down from hours). It processed an average of 10,000 tons of military freight per month.
Moore-McCormack Lines contracted four new and completely different automated cargo ships (over 600 feet in length, designated C-5 cargo vessels and capable of carrying bulk as well as containers, and cargo). The ships were to be built with a dual-loading facility where the cargo would be lifted or rolled aboard. Fabrication began in 1966 and the contract was to run until 1967.
The American President Lines and Delta Steamship Lines had their keels laid. One McLean cargo ship was delivered and one other was in construction.
Construction of 16 major vessels under contract. Ingalls was building the Oregon II. It was a special-purpose ship for exploratory fishing and ocean research. It was fabricated under a contract from the Department of Interior’s Bureau of Commercial Fisheries.
Litton initiated the airborne gradiometer avionics system. It was an electromagnetic system that gathered data on subterranean domes up to a depth of 30,000 feet. It rendered magnetic surveys obsolete.
1966 saw a geographical office expansion of the Western Geophysical division:
The Shreveport, Louisiana fully operational
Houston, Texas addition (Gulf exploration area)
London opened (five new high-speed computers)
Perth, Australia marine data processing unit opened
Litton favoured truck-mounted vibrator energy sources because they were more effective in producing seismic data for analysis than customary explosive charges.
Litton was commissioned to search for water in Niger. The nation-state in its current form began in 1958. The US Agency for International Development wanted a geological analysis of the country.
The introduction of the Model 500 microwaves resulted in an increase of 250% vs 1965 in sales for Litton’s microwave division. Both personal self-service and commercial-sized ovens were supplied whilst Litton expanded internationally into countries such as Canada, Mexico, Australia, and various European nation-states. Some level of vertical integration was afforded by Litton’s historical proficiency (since WWII) in producing magnetrons and electron tubes.
250 pulse klystrons were delivered to the Stanford Linear Accelerator Center. Another 450 were expected to be delivered by 1971. The National Bureau of Standards’ new linear accelerator at Gaithersburg, Maryland conducted research into nuclear and matter. Litton was producing all of the 5 million watt klystrons that would generate the power bursts.
The pendulum transducer (replacing expensive gyroscopes for references in aerospace applications) was released and supplied accurate vertical and horizontal position measurements.
Litton was a leading manufacturer of deflection yokes that were important in TV colour sets. The company tripled production of these yokes in an expanded plant during the year to claim more than 15 per cent of the total yoke market.
Litton expanded its Latin American manufacturing facilities. It established an advanced core memory facility for computers in Mexico City as well as a transformer production facility in Mexico.
Tex believed there was a trend for the US Federal Government to request industry solutions to socioeconomic problems and expected other nations to follow. Litton would plan development programs, obtain financing, and supervise the projects.
Litton was interested in establishing a private venture capital bank for the Middle East. The United Banking and Investment Corporation would include Litton and American, Lebanese, and European banks together with Middle Eastern businessmen.
Litton executed its pioneer education program with Oakland Community College, Union Lakes, Michigan. About one-half of US typewriters were manufactured by Royal. Litton introduced students to Key-Punch Training Tandem which was an Electress typewriter with a simulated plug-in keypunch.
New government programs made medical care available to larger segments of the population.
Litton opened manufacturing facilities in Des Plaines (Illinois) bringing its total office locations to 49.
Ratio Analysis for Conglomerates:
“Over the long term it is hard for a stock to earn a much better return than the business that underlies its earnings… …. if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive-looking price, you'll end up with one hell of a result.” ~ Charlie Munger.
As conglomerates attain more companies — with different products and services — under their umbrella, analyzing efficiency ratios becomes less meaningful as the financial statements are a mesh of different product cycles, supply chains, and cash conversion cycles.
In a different but similar sense, analyzing the profitability ratios, such as return on equity, becomes less meaningful as a conglomerate grows through acquisitions wherein serious changes to the capitalization structure occur. This can be in the form of common or senior issuance to finance acquisitions, preferred shares to enable one-for-one exchanges, or repurchase programs.
To make that idea more concrete, let’s think about ABC Corp which has a perfectly round 100,000 shares outstanding and no senior issues ahead of the common. If a business is earning $10mm in net income (excluding one-time items) on shareholder’s equity of $100mm the ROE is (clearly) 10%.
Granted, such a company is small in size but let’s, for this thought experiment, consider that it is publicly traded. Rumours spread in the media that a pension liability from 12 years ago was mishandled: the auditors are reviewing the accounting policies at company HQ and the publication of ABC Corp’s annual report is delayed. The share price plummets by 20% on the day the first headline breaks.
Despite all-time high profitability, net income, and free cash flow, the company is trading at a 6-year low price. For the first time in its 20-year history, ABC Corp has authorized a $15mm share buyback program over the next three years. Management doesn’t hang around and repurchases $15mm of shares outstanding over the next 6 months.
If no growth occurs during that period, ABC Corp would earn $10mm of net income on shareholder’s equity of $85mm (ROE of 11.76%).
Alternatively, if net income grew at its 10-year historical CAGR of 5% then ABC would earn $10.5mm of net income on the $85mm of shareholder’s equity (ROE of 12.4%).
In a different scenario, consider ABC Corp acquires XYZ Inc. and earns $5mm of net income for a purchase price of $35mm. This was financed with $10mm of free cash flow and $25mm of new notes and debentures with varying maturities over the next 5-10 years. Even though the earning power of ABC is now $15mm (or 50% higher than before the acquisition), its shareholder’s equity is $125mm. Those facts give an ROE of 12% which was lower than the no growth with buybacks scenario.
A long-term investor would find ABC more attractive with XYZ if they believed there existed a runway for both companies, even though ABC Corp’s ROE was lower than the buyback route. The point is that ROE can be depressed for a long time despite rapid improvements to the quality of a conglomerate. Comparing ROEs on a like-to-like basis for competitors is first-level thinking with less informational value than the second-order calculation of what ROE would become if management were rational in their longer-term capital allocation policies.
Litton included the capital base of its finance subsidiaries in its consolidated balance sheet.
See its Investments line below:
Of which c. $20mm were attributed to equity in the finance subsidiaries:
But the first notes to the statements show that only the equity of the financial subsidiaries was included in Litton’s consolidated statements:
Therefore, I’ve deducted the net assets (c. $20.7mm) of the finance subsidiaries from the consolidated shareholders’ equity figure (c. $309mm) to get c. $288mm in shareholders’ equity after removing the finance subsidiaries.
That gives Litton a return on capital of 12.84% for 1966. Such a standalone figure is meaningless. Especially considering that average figures should be used and not just the period-end ones.
A more interesting figure is Litton’s 10-year (1956 to 1966) return on capital.
1956 NOPAT was c. $1mm (assuming a 50% corp tax rate). 1966 NOPAT was c. $55.1mm (assuming a 48% corp tax rate).
1956 invested capital (shareholders’ equity + total debt + debentures - cash - goodwill) was $5.8mm in 1956 and $429mm in 1966.
Incidentally, the 10-year return on capital figure is 12.76% (similar to 1966). It will be interesting to see how this compares with Teledyne over its first six years...
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