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Despite Budget Worries Programs Continue

The U.S. Congress and the Obama Administration may have pushed off the decision on sequestration and dealing with the planned budget cuts for the Defense Department but that does not mean development and new programs don’t continue. Using available funding the work goes on to advance these efforts 2 recent press releases illustrate this activity.

General Dynamics and Alenia Aermacchi Join Forces for U.S. Air Force T-X Trainer Competition — “General Dynamics (NYSE: GD) and Alenia Aermacchi, a Finmeccanica company, announced today the signing of a Letter of Intent (LOI) to join forces and compete for the U.S. Air Force’s T-X trainer program, which will replace aging T-38 trainer jets and related training systems.” The American defense contractor will team up with Italy’s Alenia Aermacchi to propose a variant of the M-346 military aircraft trainer designated the T-100. The T-X program will replace the U.S. Air Force’s T-38 fleet. THe M-346 was recently selected by Israel to be their primary training aircraft.

Lockheed Martin JLTV Undergoes Successful Design Review — ” Lockheed Martin’s (NYSE: LMT) family of Joint Light Tactical Vehicles successfully completed a top-to-bottom government design review in late December, well ahead of the first Engineering and Manufacturing Development (EMD) JLTVs that will begin rolling off the assembly line this spring.” The JLTV is the planned replacement for the HUMVEE in use by the U.S. military and potentially its Allies. It will be a large program if fully executed as there will be a requirement for thousands of the vehicles. The U.S. is utilizing a process where multiple designs are being developed independently by contractors and then one or more may eventually be selected to go into Engineering, Manufacturing and Development (EMD) and then production.

The hard decisions facing U.S. defense budget decision makers is whether to cut back funding for these types of programs and make do with existing systems that may cost more in the long run to operate and maintain due to their age and capabilities. In the past it has been tempting to reduce investment in new systems beyond basic development to manage the size of the budget. If these types of programs continue it may mean cuts to current operations and force sizes to fee up the necessary investment requirements. The types of cuts required by sequestration will be hard to implement in the current budget but could be easier in future ones as more specific cuts may be made.

In the end if the cuts are carried out the U.S. will lose capability and may see new programs like these executed.

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ATK Keeps Major Contract for Lake City Plant

Alliant Techsystems (ATK) is a mid-sized defense contractor. It primarily manufactures ammunition, pyrotechnics and rocket motors. The company is experiencing some struggles due to the ending of the fighting in Iraq and Afghanistan and the potential defense budget cuts. It has made several changes recently to adjust to these new market conditions but key to the company’s near term success was retention of the contract from the U.S. Army to manage the Lake City ammunition plant operations.

Last year the company lost the contract for the Radford Plant in Virginia to BAE Systems (BAE:LSE). BAE was also aggressively targeting the Lake City contract as well. ATK had run these plants responsible for large amounts of ammunition and explosives for the U.S. military for several years and they were a core part of their revenue and earnings. Short term the loss of the Lake City contract would have been a blow to the company.

Yesterday it as announced that the Army had decided to award the contract to ATK again. The initial contract is for seven years but it has options for a further three. No value has been reported yet.

To indicate the size of the production at Lake City in September the company and Army celebrated the delivery of 2 billion 7.62mm rounds from the plant. Due to the demands of the last ten years of combat ATK had expanded the plant to produce over 1.5 billion rounds annually of 5.56mm as well as other sizes.

The winning of this contract gives ATK more time to continue its adjustments and reorganization to address the changing market it finds itself in and establish a good foundation for future performance.

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F-35 Money Keeps Rolling In for Lockheed Martin

The F-35 Joint Strike Fighter (JSF) is the largest acquisition program in history headed up by prime, Lockheed Martin (LMT). The program has suffered delays due to testing and technical issues but now is in steady low rate production with the U.S. buying 30 or more a year for itself and allies. The F-35 will be used by the U.S. Air Force, Navy and Marine Corps. It also has countries like the u.K., Australia, the Netherlands, Norway and Canada as partners as well as already having Foreign Military Sales (FMS) to Japan and Israel.

Lockheed is not only getting contracts for the production but also for items such as training, simulators and of course spare parts. They were just awarded a contract for spares for the U.S. Navy and international aircraft worth about $200 million. As the aircraft are fielded they will also require the establishment of stocks of parts at bases and depots to support them.

The current production of F-35 is pretty much all going to the different training sites to support pilot conversion. They are also being used to continue testing and development of the system.

If the F-35 in its current plan survives potential budget cuts and restructuring between 3 and 4,000 aircraft will be made. They will fly for 30 plus years and be the main equipment of Western tactical air forces for most of that time.

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Despite Recent Progress Lockheed Martin Faces Some Challenges

Lockheed Martin (LMT) remains the largest defense contractor in the United States as well as globally. It is responsible for the biggest military acquisition program in the history of the world – the F-35 Joint Strike Fighter (JSF) as well as several other major aircraft and hardware systems. The company has consistently done well with its earnings and maintained a high dividend.

The Lockheed stock seems attractive right now. Price as of 29 June was $87.08. It has outperformed the market by 6 percent over the last year, its P/E is a little above 10 and it pays a dividend of $4.00 a year. The major defense contractors like LMT or Northrop Grumman (NOC), Raytheon (RTN) and General Dynamics (GD) have consistently increased their dividend over time. The companies have also focused on reducing their costs to boost profit margins as well as make them more competitive with the Pentagon when it comes to price meaning as long as defense spending remains fairly consistent there should be increases in earnings and profit as these trends continue.

Lockheed has moved to reduce its workforce especially those in the middle management or overhead positions. It has also when possible adjusted its pension plans and negotiated new contracts with its unionized workers to lower personnel costs when possible. It’s most recent quarter set it apart from its competitors as the company had both growth in earnings and revenue. Most others had seen earnings up but on a revenue drop as their efforts to reduce overhead and cost of providing their products helped.

As the Pentagon continues to execute its Fiscal Year (FY) 12 budget plans new contracts are competed and awarded with Lockheed winning their fair share of them. Yet the future of defense spending is clouded with uncertainty due to the plans for FY13 spending caused by sequestration. Sequestration is automatic budget cuts of up to $100 billion a year in defense spending due to the failure of the Obama Administration and Congress to reach a budget deal last year. All acknowledge that these cuts would have a severe effect on the military, its contractors and the U.S. economy in general yet without changing the current law they will occur.

Lockheed just finally settled a major strike by its Dallas-Fort Worth aircraft assembly workers. This lasted over two months and was driven by Lockheed’s request for them to cut their pension plans. These workers make the F-35 and the F-16 fighters which are a large portion of Lockheed’s portfolio. The key part of the new contract as stated in the press release is “The agreement compensates union members fairly while allowing Lockheed Martin Aeronautics to be competitive for new contracts and respond to customer demands for greater affordability in defense products.” The settlement of this action will allow Lockheed to focus on delivery of the aircraft.

Other then the potential budgetary issues facing the industry as a whole Lockheed does raise some concerns. It has a large debt and pension obligation due to a large workforce and a more traditional defined benefit plan. The Pentagon recently announced that due to concerns with Lockheed Earned Value Management System (EVMS), which tracks cost and schedule data, it will now withhold up to 5 percent of payments. This is the maximum penalty that may be applied. The EVMS for the F-35 is the major concern which is a program that faces scrutiny of its costs and schedule from Congress. If Lockheed cannot get its system into compliance then it faces a potential hit to its earnings and profits as the F-35 program is so large.

Congress has already made some moves to keep parts of the budget recommended for cuts by the Obama Administration. (http://seekingalpha.com/article/566861-defense-contractors-aided-by-congress-keeping-money-in-defense-budget) It may be expected that these will continue. Sequestration is designed to prevent Congress from doing this which is why all are focused on ways to prevent it or minimize the effect on defense spending. Too many jobs, and votes, are affected by it. That does not mean that there will be success in preventing the reduced spending. The U.S. deficits are recognized as too high and something must be done.

Lockheed stock due to its current price, dividend and their large contracts should probably continue outperform the market over the next few months. Until the full effects of sequestration or efforts by Congress to minimize cuts to defense spending are identified there should be no major movement of the price. If the worst case happens and the U.S. faces cuts to defense spending in the range of $50-100 billion a year Lockheed should at least see some short term pain. If the plan is changed and defense spending is protected then this stock along with the other defense industrial stocks should see some increase. This, though, won’t occur until 2013 and the stock like most of its competitors really remains a dividend buy only.

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Lockheed Martin (LMT) Wins GIG Contracts, SAIC (SAIC) Protests

The U.S. Department of Defense operates the Global Information Grid (GIG) as a way to link its various communications and sensor systems together to ensure that information is processed and distributed as necessary. Most of the different systems the Services buy interface with the GIG one way or another either through radios, data links or networks. The goal of the GIG is to get the right information to the right person in order to support decision making and actions.

The GIG is managed by DoD and relies on a large contract to carry out these functions. Recently Lockheed Martin (LMT) was awarded this contract. It has an initial value of about $1.9 billion but the potential to grow to $4.6 billion if all options are exercised over its seven year life. The contract is an Indefinite Delivery/Indefinite Quantity (ID/IQ) type which means that the government places orders for products as needed. Normally ID/IQ contracts do not necessarily guarantee any work will be done but it can be expected with the size and importance of this contract Lockheed will get a great deal of orders from it.

SAIC (SAIC) was the losing bidder and they have moved to protest the award to Lockheed. SAIC is the incumbent for the contract and the loss of a contract this size is an issue for the company especially considering the potential budgetary issues facing the Defense Department next year.

If budget cuts do materialize and companies see much less contracts protests based on history will only increase. The different defense contractors will be fighting over a smaller pool of work so competition will be even more contentious. Normally protests have to be resolved in 100 days and contracts are placed on hold while this is being done. This means that SAIC will keep their current contract until the protest is over. Potential results could be a new competition, a reaffirmation of Lockheed or on rare cases a decision to award the contract to the protester.

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ITT Exelis (nee Defense) Enters Brave New World of Defense Contracting

ITT Exelis (XLS) is what used to be ITT Defense, one of the component parts of the former ITT Corporation (ITT). That company decided to break itself into three separate parts spinning its defense, water and electronic components into separately traded companies. Reportedly the flat performance of its defense business had been one of the prime factors driving the decision.

In the early Nineties ITT Corporation itself was formed as ITT broke itself apart into ITT Industries; Starwood Resorts, which managed hotels and casinos; and Hartford which sold insurance. ITT Industries changed its name to ITT Corporation in the last decade.

ITT Exelis will now have all of the defense related industries which includes electronic warfare systems, radars, command & control systems, intelligence and surveillance as well as defense services and sensor and networks.

The new company is estimated to have earnings of about $800 million for this year and there are already rumors of the defense component being the target of acquisitions by other larger defense contractors.

ITT follows Northrop Grumman (NOC) which earlier this year separated its shipbuilding piece into a separate company entirely, Huntington Ingalls Industries (HII). Northrop was concerned that with budget cuts and the U.S. Navy’s shipbuilding plans that growth in this area would be very limited. This allows them to separate that sector from other more successful parts of the parent company.

How long ITT Exelis makes its as a unique company depends on how quickly the U.S. defense spending decreases and decisions about what the U.S. and Western Europe buys. If there are smaller amounts of budget available for new electronic systems ITT Exelis could be facing a very limited market. This might make it attractive to someone looking at buying capability and access to specific parts of the ITT Exelis portfolio and would see chunks of the company wither away.

The other question will be if similar moves are made by defense contractors splitting their military and commercial arms or jettisoning pieces that in the view of management and shareholders do not have much upside in the future. Exelis could be the start of a trend.

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More Defense Layoffs in Orlando Area

The U.S. defense industry is a complex group of companies large and small that constantly win and lose contracts. This leads to turn over in hiring and firing as sometimes work moves across the country as the Department of Defense seeks the best supplier at the best price. Most defense contracts have fixed times of five years or less which means contractors must plan to recompete their work and winning the same contract adds some consistency to their business.

The U.S. military also often buys a fixed amount of a system. This means that contracts providing logistical and maintenance support for an aircraft, helicopter or vehicle are often more valuable in the long run then actually making the system. This work too does not have to be done by the OEM but also can be awarded to another company or government depot. What all this means is that one company could be hiring people to work on a new contract while another will be laying them off due to the lost work.

With the potential for budget cuts in the future the situation of losing work and workers may become more common. The Orlando, FL area has already seen Northrop Grumman (NOC) make some strategic workforce decisions which led to shedding employees. Now one of their smaller defense contractors, DSE Fuzing LLC, has decided to end operations in that area which has led to the loss of over 100 jobs.

DSE makes fuzes for different weapon systems. They have opened a new factory in South Carolina and plan to consolidate operations there. As with all of these moves the goal is to reduce costs and increase revenue and profit. The company made clear that they are expecting future reductions in business from the military and this is part of the equation in their move.

DSE made news last year when some of the detonators it was making proved faulty and an employee was injured. This led to a fine and audit that found issues with its production practices. The company says that those issues have been resolved.

The company has been making military munitions in Orlando since after World War II when it was originally part of Martin Marietta. It has been sold and transferred a few times since.

If predicted trends in defense spending continue then there will be more stories like this as companies seek out the best place to do business in terms of cost. Unfortunately this means that other parts of the U.S. will face a negative economic effect as the work ends or moves.

Photo from Official U.S. Navy Imagery’s flickr photostream.

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2012 Budget Due Today to Congress

Even though the Congress failed to pass a 2011 budget the Obama Administration will submit its 2012 spending plan today. Even that is late as it is supposed to be sent up to the Hill the first Tuesday in February. The President’s plan reportedly includes some budget cuts with a goal of reducing the total deficit by up to $1.1 trillion over ten years. Of course for the first three years of this Administration the annual deficit has been over $1 trillion so this plan barely puts a dent in spending.

Congress generally adopts the President’s plan overall but because the House really is in control of Federal spending it normally makes changes that track more to its priorities then necessarily the executive branch. This year will be Obama’s first with a hostile House and there may be significant changes to his proposed spending. It is expected that the new Republican leadership will cut much more from total annual spending then the President is proposing.

The Defense Budget will actually be larger then last year but the rate of growth will almost be flat. This reflects the winding down of operations in Iraq as well as the new budget realities the U.S. must face. Secretary of Defense Robert Gates had already announced $100 billion in reinvestment opportunities as well as cuts of up to $78 billion.

Part of this was generated by Defense recommending cancellation of the U.S. Marines new amphibious assault vehicle, the Expeditionary Fighting Vehicle (EFV). This program to replace the existing LVTP-7 vehicles used to move troops from ship to shore and then support their operations inland is being managed by General Dynamics (GD) and has had budget and schedule issues. Of course there has already been push back from Congress especially from those states who will lose significant jobs and business when the program ends.

This reduction of one program illustrates the problems both the Administration and Congress will have as they try to balance the Federal budget. Every program that is facing cuts will have some sort of advocate in Congress who will attempt to keep it funded. That is why the President is freezing most spending but that will not be enough to bring the budget back from multi-billion dollar deficits.

The defense budget is the largest part of the discretionary spending and as long as the U.S. is fighting overseas there will be a lot of pressure to keep its size up. At the same time money must be invested into new weapons as well as replacing and recapitalizing those damaged or lost in the last ten years of combat.

There will be no easy choices with the total budget.

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End of Fighting and Budget Cuts Mean Hard Times Ahead for Military Depots

This weekend the Obama Administration made clear that it will start winding down the U.S. and its Allies commitment to Afghanistan next year with a goal of total withdrawal by 2014. Along with the planned movement of most U.S. troops from Iraq over the next few years combat operations by U.S forces will gradually decline. This means that the defense budget will reconfigure itself to buy less of the things being consumed in daily combat to investing in new equipment and rebuilding stocks.

One area that may see significant decline is the production of ammunition. The U.S. has increased greatly its sources for small arm rounds as well as those used by key systems such as Apache attack helicopters and mortars which are providing the majority of fire support in Afghanistan. This has mainly been done by using the Army depots as a traditional source but by leasing out space and equipment to private companies. ATK for example operates facilities at different depots to make small arms ammunition and pyrotechnics.

The Services have also tried to get private companies to use the resources of the depots including their workforce for other means. This contracting out has helped pay for support services and investment in the physical plant of the depots aiding them in their basic mission of supporting the military.

Blue Grass Army Depot in Kentucky for example has been “attempting to market itself to defense contractors and non-defense manufacturers to bring in more funds.” The depot hopes that any partnership it may establish with a defense contractor or other company to help it stay in business. Right now the depot primarily manufactures parts for 81 mm mortar rounds. It also is about to start up a chemical demilitarization and destruction operation to remove its stocks of chemical weapons from the cold war.

The problem that may face Blue Grass and the other depots is that once fighting ends the Army will rebuild its stocks of 81 mm mortar rounds but then only replace those used in training or reaching their service life. Most of the older rounds will have been expended already as traditionally the military uses up those first in combat.

Like the situation where the U.S. Army completed buys of the ubiquitous HUMVEE a year earlier then planned due to combat losses not being what was predicted and the total quantity needed had been reached the depots making ammunition could see the same happening. This means their work and workforce will be reduced and as in the last major downturn the depots closed or realigned.

The ultimate effect of cuts in the defense budget will be jobs lost across the country. Ending a program without starting up a replacement or new one means those jobs won’t be replaced even in another location. The economic affect of that will be lasting.

Photo from The U.S. Army Flickr photostream.

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Editorial: Comment on the Guardian article, "Carriers without Harriers: budget cuts leave MoD with jump jet-shaped hole"

October 19, 2010 by · Comment
Filed under: Editorial, Syndicated Industry News 
Editorial: Comment on the Guardian newspaper article, "Carriers without Harriers: budget cuts leave MoD with jump jet-shaped hole"
October 19th, 2010

The construction costs of a 3billion GBP aircraft carrier over 50 years = 60 million GBP per annum = approx. 1GBP per head of population.

Are we not at risk of getting this out of proportion HMG ? Is this more about 'squaring away' the Scottish Labour class by wounding a programme who final integration is due to occur in the past Prime Minister's constituency. Clearly the new Administration is not playing politics with defence...

Suggestions for employment of the CVF;

1. Launch helicopters to protect British Nationals abroad - does anyone remember the rescue of Brits in Lebanon the other year ? The vessel is three times bigger...

2. Disaster relief in the Commonwealth - imagine the capability to support an isolated community post hurricane / tsunami and so forth.

3. Pursue limited conflicts in support of British interests - Sierra Leone involved an auxiliary tanker as the sole ship on station - what difference the CVF could make...

4. Providing a deck for use by other coalition partners in support of operations in the national interest - far from home base partners will appreciate any 'flat-top' space for running missions from. At sea, invulnerable (except in all-out war with a substantial submarine equipped opponent).

5. A re-run of the Falkland islands campaign no-one would question the utility...

Additionally, what if the Government is being shrewd in its calculations - if the economy picks up will the second vessel still be sold or retained ? The CVA-01 programme was cancelled in the mid-1960s eliminating aircraft carriers - only for the RN to keep the programme going in the shape of the 'through-deck cruiser' which only now is being decommissioned.

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Decline in Federal spending may reduce business for contractors

This article in FederalTimes.com states that due to cutbacks in spending in the President’s 2009 budget the Federal government will reduce what it spends on contractors a substantial percentage. This is not only in DoD but also in Homeland Security and the State Department as well. Part of this is budget cuts to the various programs but also the predicted removal of US troops from Iraq. Whether this will really pan out will have to be seen. The final 2009 budget won’t be out until October-December, and there also may be various supplementals to support the war in Iraq and Afghanistan. At some point the wars will be winding down and this will have a significant effect on Defense’s spending. Historically the US budget for these activities have gone from boom to bust very quickly.

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