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Cubic Reports Financial Results for the Quarter Ended December 31, 2012 — Press Release

February 11, 2013 by · Comment
Filed under: Business Line, Companies, Cubic, Earnings, Events, Press Releases 

SAN DIEGO, CA–(Marketwire – February 11, 2013) – Cubic Corporation (NYSE: CUB) today reported its financial results for the quarter ended December 31, 2012. Net income attributable to Cubic shareholders for the first quarter of fiscal 2013 was $12.4 million, or 47 cents per share this year compared to $20.7 million, or 77 cents per share last year. Sales for the quarter decreased from $316.8 million to $313.4 million, a decrease of 1 percent. Operating income was $18.2 million in this year’s first quarter compared to $27.8 million last year, a decrease of 34 percent. Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization (Adjusted EBITDA), a non-GAAP measure (as described below), for the first quarter this year was $23.0 million, compared to $33.6 million last year.

“While our first quarter reflected some unusual cost items and lower profitability, we continue to make progress on major long-term transit projects and have completed two acquisitions that will provide growth opportunities in our defense and transportation segments in key strategic focus areas,” said William W. Boyle, Chief Executive Officer of Cubic Corporation. “I believe our diversification and strategic focus will differentiate Cubic over the long term.”

Transportation Systems

Cubic Transportation Systems (CTS) develops and delivers innovative fare collection systems and services for public transit authorities worldwide. In the first quarter of this year, CTS sales decreased 6 percent to $118.6 million compared to $125.8 million in the same period last year, primarily due to reduced work on a contract to design and build a system in Vancouver. Last year’s first quarter revenues were higher on the project as we were producing a significant amount of the hardware for the system, while this year we are in the latter stages of system delivery. This decrease was partially offset by higher sales from a contract to design and build a system in Sydney, Australia. CTS is currently in the design and build phase for three major projects to design, build and operate transit fare systems in Sydney, Vancouver and Chicago.

Operating income from CTS decreased 26 percent in the first quarter this year to $13.2 million, compared to $17.9 million in the first quarter of last year. In addition to the impact on operating income caused by the decrease in sales, we are currently incurring costs in excess of revenues on our contract in Sydney, Australia due to the transition of portions of the system into full operations. We anticipate improved profitability on the Sydney contract as the systems complete the transition phase and move into full operations.

Mission Support Services

Mission Support Services (MSS) is a leading provider of highly specialized support services to the U.S. government and allied nations. Sales from MSS increased 5 percent to $113.4 million in the first quarter this year, from $107.5 million in the first quarter of last year. Sales growth was driven by an increase in activity during the first quarter at the Joint Readiness Training Center (JRTC) in Fort Polk, Louisiana and by higher sales from Abraxas, a company Cubic acquired in fiscal year 2011.

MSS operating income decreased 7 percent to $4.2 million in the first quarter this year from $4.5 million in the first quarter of last year. NEK, a Special Operations Forces Training company we acquired in December 2012, had an operating loss of $0.5 million in the first quarter of fiscal 2013 primarily due to the incurrence of $0.4 million of acquisition-related costs.

Defense Systems

Cubic Defense Systems (CDS) is focused on two primary lines of business: training systems and secure communications. Training systems sales increased 1 percent in the first quarter this year to $65.6 million while operating income decreased 48 percent for the quarter from $4.8 million last year to $2.5 million this year. Although total training systems sales increased, the sales of higher margin small arms training systems and air combat training systems to a customer in the Far East decreased, which decreased operating income.

Secure communications sales decreased 23 percent in the first quarter this year to $11.6 million compared to $15.0 million in the first quarter of last year. Secure communications operating income decreased to $0.3 million in the first quarter this year from $3.2 million in the first quarter of last year. Decreased profitability on lower data link sales, including the impact of a $1.2 million cost increase on a U.S. government contract, contributed to the decrease in operating income.
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Article on Defense Earnings at Seeking Alpha

Here is an article I wrote for Seeking Alpha on recent defense earnings reports and how companies are addressing the difficult 2013 situation.

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CSC and CACI Analysis – Seeking Alpha

This is an article I wrote for Seeking Alpha discussing trends in CSC and CACI earnings and stock price.

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Some Evaluation of Smaller Defense Contractor Earnings – Seeking Alpha

Here is a post I wrote for Seeking Alpha discussing ATK and Rockwell Collins recent earning reports.

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Defense Industrials Continue 2012 Trends, Preparing For Rocky 2013 — Seeking Alpha

Here is a post I wrote for Seeking Alpha about the latest quarterly earnings of the 5 big defense contractors.

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UTC Reports Third Quarter EPS From Continuing Operations of $1.37; Affirms 2012 EPS Outlook of $5.25 to $5.35 and Increases Restructuring to $600 Million — Press Release

HARTFORD, Conn., Oct. 23, 2012 /PRNewswire/ — United Technologies Corp. (NYSE: UTX) today reported third quarter 2012 results. All results in this release reflect continuing operations unless otherwise noted.

Earnings per share of $1.37 and net income attributable to common shareowners of $1.2 billion were down 4 percent and 3 percent, respectively, over the year ago quarter. Results for the current quarter include $0.09 per share of restructuring costs, offset by $0.09 of favorable one-time items. Earnings per share in the year ago quarter included $0.06 of restructuring costs, partially offset by $0.04 per share of net favorable one-time items. Before these items, earnings per share decreased 6 percent year over year. The effective tax rate for the quarter was 26.6 percent. Foreign currency translation, and hedges at Pratt & Whitney Canada, had an adverse impact of $0.07.

The acquisition of Rolls-Royce’s share of the International Aero Engines joint venture closed on June 29 and provided $0.03 of EPS accretion in the quarter. Net of transaction and financing costs, the acquisition of Goodrich Corporation, which closed on July 26, did not have an impact on EPS.

“The integration of Goodrich and IAE is off to a good start with solid underlying performance at both businesses,” said Louis Chenevert, UTC Chairman & Chief Executive Officer. “We now expect just $0.10 of EPS dilution from the Goodrich acquisition in 2012 versus our prior estimate of $0.20.”

Sales for the quarter of $15.0 billion were 6 percent above prior year. Net acquisitions provided 11 points of growth. Organic sales decreased 2 percent over the year ago quarter and foreign currency translation also had an adverse impact of 3 points. Third quarter segment operating margin at 14.2 percent was 160 basis points lower than prior year. Adjusted for restructuring costs and net one-time items, segment operating margin at 15.0 percent was 100 basis points lower than prior year, including the impact from the Goodrich acquisition. Research and development costs increased $125 million in the quarter to $590 million, including $101 million at Goodrich. Cash flow from operations was $1.6 billion and, less capital expenditures of $317 million, exceeded net income attributable to common shareowners.

“We expect earnings per share of $5.25 to $5.35 for 2012. Faced with a challenging economic environment, we are increasing our investment in restructuring this year to $600 million, up from our prior plan of $500 million, and continue to expect net one-time gains of $600 million,” Chenevert added. “Strong cash flow is a hallmark of UTC, and we now expect free cash flow to exceed net income for the full year.”

New equipment orders at Otis were up 7 percent over the year ago third quarter, including unfavorable foreign exchange of 4 percentage points. North American Residential HVAC new equipment orders at UTC Climate, Controls & Security grew 3 percent. Commercial spares orders were up 14 percent at Pratt & Whitney’s large engine business including the impact from the incremental IAE share. Organically, commercial spares orders were down 21 percent at Pratt & Whitney and down 6 percent at UTC Aerospace Systems.

“Due to the lack of recovery in the commercial aerospace aftermarket and continued uncertainty in the global economy, we now expect 2012 sales of $58 billion,” Chenevert added. “The portfolio transformation is substantially complete, and we are focused on integration and execution.”

As previously announced, the company does not anticipate share repurchase in 2012 due to the Goodrich transaction. UTC expects a full year effective tax rate of 29 percent excluding one-time items, down from the prior estimate of 29.5 percent.

Earnings per share from discontinued operations were $0.19 in the quarter. Results included $127 million of positive income tax adjustments associated with the legacy Hamilton Sundstrand Industrials businesses.
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ATK Changes Paying Off? — Seeking Alpha

Here is an article I wrote at Seeking Alpha discussing Alliant Techsystems (ATK) latest earnings.

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Seeking Alpha – Survey of Defense Earnings for Last Quarter

I wrote an article at Seeking Alpha on this week’s earnings reports.

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Lockheed Martin Earnings — Seeking Alpha

This is an exclusive article I wrote for Seeking Alpha about Lockheed Martin’s latest quarterly earnings and the rest of 2012.

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Expectations for Defense Earnings This Quarter — Seeking Alpha

This is an exclusive post I wrote for Seeking Alpha looking at the upcoming earning reports from defense contractors.

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An Update on GD’s Recent Moves – Seeking Alpha

Here is an exclusive article I wrote for Seeking Alpha on some moves General Dynamics (GD) has made to adjust to current market conditions. The post may be found here.

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Update on ITT Since the Break Up – Seeking Alpha

Here is an exclusive article I wrote for Seeking Alpha on the status of ITT’s components after their first earning reports. It may be found here.

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Defense Industrials as Dividend Stocks – Seeking Alpha

Here is an exclusive post I wrote at Seeking Alpha on defense industrials as dividend stocks.

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L-3 Expands Electro Optical Business with Acquisition of Kollmorgen

L-3 Communications (LLL) expanded its electro optical business by completing the acquisition of Kollmorgen from Danaher Corporation. The transaction closed for a price of about $210 million. Kollmorgan primarily makes optical systems for U.S. and other nation’s submarines.

L-3 already has a growing electro-optical sensor business and the addition of Kollmorgen will only add to that growth. In their most recent quarterly report the company reported earnings of $2.72 a share on net sales of $4 billion. This was an increase of earnings of twenty-eight cents over the previous year. Interestingly the Electronics Systems division of the company where Kollmorgen will fall had a decline in net sales of $110 million in 2011 primarily due to less demand for night vision products, power devices and the lack of revenue from technology licenses. The division did, though, sell $43 million more in Electro-Optical / Infra-Red (EO/IR) products.

Kollmorgen is estimated to add sales of $160 to $170 million and earnings of up to $30 million for L-3. This additional revenue will help offset any further drops in sales by the Electronics Systems part of the company.

The addition of the company to L-3 allows them to expand their overall market share of the EO/IR business. With the expected reductions in U.S. defense spending the more diverse product line and markets should help L-3 maintain its sales and earnings. For 2012 the company is predicting $14.4 to $14.6 billion in sales and earnings per share (EPS) of between $8.35 and $8.55. This compares to sales of $15.17 billion in 2011 and EPS of $8.77. Clearly L-3 is expecting some contraction in the defense business in the coming year. This estimate does not include Kollmorgen.

As will all of the defense industry L-3 will have to adjust to the changing market in 2012 and one way of doing this is through M&A. The addition of Kollmorgen not only adds revenue and earnings but also increases their exposure in the EO/IR market while reducing potential competitors. There should be more moves of this type by defense contractors as they make moves to cushion the changes in spending.

Photo from Daniel Garcia Neto’s flickr photostream

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Curtiss-Wright: A Lot of Eyes Looking At It

I wrote a premium article at Seeking Alpha about Curtiss-Wright’s (CW) upcoming earnings report next week. It may be found here.

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Lockheed and Raytheon Earnings Reports

I wrote an exclusive post for Seeking Alpha discussing Lockheed Martin’s (LMT) and Raytheon’s (RTN) most recent earnings report. It may be found here.

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Boeing and United Technologies Earning Reports

January 27, 2012 by · Comment
Filed under: Boeing, Business Line, Companies, Earnings, Events, UTC 

I wrote an exclusive post on Boeing’s (BA) and United Technologies (UTX) recent earnings report for Seeking Alpha which may be found here.

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Alliant Techsystems Faces Double Dose of Bad News

24 January – Updated to reflect the loss of the Lake City contract would be a blow to the company instead of “will be”.

Over the last ten years the U.S. military has consumed large amounts of ammunition. This includes not only small arms and support weapons like machine guns and mortars but also larger and more sophisticated weapons such as tank rounds, artillery shells, aerial bombs and guided missiles. Alliant Techsystems (ATK) has become one of the largest suppliers of ammunition and other pyrotechnics to the U.S. military during this time.

Up to last year they had contracts to run two of the largest government owned plants involved in this process — the one in Radford, VA that manufactures nitrocellulose used as the basis for ammunition as well as the one in Lake City, MO which makes small arms ammunition.

Last year the Army awarded the contract for Radford to BAE Systems (BAE:LSE) in the spring. Alliant protested that decision and the Army agreed to revise the competition and conduct another source selection. In October the new contract bids were received and again BAE won. Alliant protested that decision too.

Unfortunately the Government Accountability Office (GAO) announced today that it had denied that protest upholding the award to BAE. Alliant will lose a key contract that it had had since 1995. BAE’s 10 year initial contract also has multiple five year options that could make the contract last until 2036. The value could be well over a billion dollars if all options are exercised and production at Radford remains fairly steady.

Alliant will also face a challenge this year for the Lake City contract as BAE announced it will team with ammunition manufacturer Olin (OLN) to form a team to bid on that one. The Lake City contract could be worth up to $200 million a year to the winner. With the knowledge used for their successful Radford contract proposal BAE and Olin should have a good chance of winning the Lake City one as well.

The loss of these two contracts would be a hard blow to Alliant as they form a decent portion of their revenue each year. They have already seen declines in revenues the last few quarters and this would continue that negative trend. In 2011 their total sales to the U.S. Government, primarily ammunition and explosives, was about $3.3 billion. In their annual report the company stated that they “derived approximately 15% of our total fiscal
sales from the military small-caliber ammunition contract at Lake City”. The loss could be made up if their were other contracts to win or demand for their other products would increase. Unfortunately with the fighting winding down in Afghanistan and budget cuts predicted this might be hard.

Alliant may have recognized that the future might get tough as they moved their headquarters from Minnesota to the Washington D.C. area. In this they followed Northrop Grumman (NOC) which left California. It places them nearer Congress and the Pentagon and will facilitate engagement. This should aid them in keeping work and perhaps gaining new efforts.

All defense contractors no matter what the size are facing the same problems that Alliant is. Cost pressure on the Defense Department will make them look at new providers who may offer the best price meaning contracts will be harder to keep. There will also be less contracts due to the retrenchment from the recent fighting and budget cuts. If the 1990′s when a similar decline in defense spending is a guide then some contractors will have to adjust or face converting to new markets or just merging with other companies.

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Good and Bad News for Huntington Ingalls Industries (HII)

An F-35B Lightning II makes the first vertical landing on a flight deck at sea aboard the amphibious assault ship USS Wasp (LHD 1).

Late last year after Northrop Grumman (NOC) separated their ship building components from the main corporation. Rather then selling these to another defense contractor they decided to set up a new company with its own stock. This was Huntington Ingalls Shipyard(HII). HII owns yards in Louisiana, Mississippi, and the Hampton Roads area of Virginia. It builds carriers, destroyers, and amphibious warships.

Northrop Grumman along with General Dynamics (GD) were the two major naval ship builders in the United States. They were concerned that the long term ship construction plans for the Navy were so limited in the future due to budgetary pressures and requirements that they decided it was better to get out of the business. The U.S. Navy currently really doesn’t have enough funds to build the number of ships in their plans. They also restructured their plans by limiting the new destroyer, DDG-1000, to only three and continuing production of the previous Arliegh Burke class.

HII has continued to received contracts from the Navy and deliver ships although it is planning a restructuring of its capabilities and workforce most importantly by closing their yard at Avondale, LA. In its last quarter the company reported a loss of $248 million but adjusting for a charge it actually had a profit of over $1 a share. This was better then analysts expectations and the stock went up quite a bit last week. The company increased its backlog and is predicting by 2013 that the financial should show much improvement as it works off contracts from the Northrop era.

At the same time though word came the Navy penalized the company several million dollars on a recent destroyer contract due to failures in its accounting and management system. The Department of Defense utilizes Earned Value Management System (EVMS) to help understand the cost and schedule of contracts. In this case the audit found deficiencies in 19 of 32 guidelines. The DoD qualifies company’s EVMS and if it fails then they can withhold funds or limit future contract awards until the system passes.

HII is in a situation where things like this are not helpful in the long run. It is not uncommon for EVMS to fail at times and the DoD and Lockheed Martin (LMT) had a long running argument over that company’s system a few years ago. Eventually they get resolved and work continues. It can just effect earnings and revenue in the short run.

The U.S. shipbuilding industry is in for a rough time in the next decade or so as the U.S. works out its budget issues. If the mandatory cuts do come into force there would be significant reduction in new ships which would affect GD and HII very negatively. While ships take several years to complete they need a steady stream of orders to maintain their entire workforce and to use them effectively. If there is a time when no new ship is on the horizon then there will be layoffs and contractions.

HII latest results were a positive but it may be hard in the future to continue to maintain the level of orders and revenue.

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

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Raytheon Sees Slowing With Latest Earnings Report

Raytheon (RTN) also posted their third quarter results and did not do so well as some of its peers. Not only did earnings and profits fall from a year ago the company is more pessimistic about the whole of 2011. While several other defense contractors also saw reduced sales they all were able to increase profit due to cost cutting efforts and how their money was earned.

Raytheon on the other hand who specializes in radars and missiles reported profit of $1.43 a share which is well below last year’s $1.94. Sales were $6.13 billion only down a little. Analysts had expected lower earnings on more revenue.

Raytheon also lowered its predictions for the year from $25.5 – 26.3 billion to $25 to 25.3 billion. The company suffered as sales at its Integrated Defense Systems were lower due to reduced demand for its electronic systems and sales of the PATRIOT air defense missile. The Network Centric Systems vision also suffered. Other divisions did better but overall the company saw lower profit.

The company is hoping that foriegn sales of systems like the PATRIOTS and air launched missiles will help make up for any further reductions in U.S. defense spending. The company is bidding on the Army’s Joint Air-to-Ground (JAGM) missile system which will be used from helicopters and fixed wing aircraft and has the potential for several billion in sales. They are teamed with Boeing (BA) and competing against Lockheed Martin (LMT).

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Defense Contractor Earnings Continue to Be Steady

Several of the larger U.S. defense contractors released their quarterly statements this week and so far the trend has been to remain steady or show growth. As of now the planned reduction in U.S. defense spending has not yet seriously affected their performance but many expressed concerns with future plans and trends in the industry.

Lockheed Martin (LMT) saw an increase in profit compared to last year’s quarter of almost 25%. Profit was $700 million on revenues of $12.1 billion compared to the previous $560 million. The company though had a charge of almost $40 million related to cuts in its workforce.

Lockheed also expressed concerns with statements by the Pentagon that in the next batch of production F-35 Joint Strike Fighter that it should share in some of the costs caused by design changes related to testing results. This would be a major change in how defense procurements are normally done and could open up Lockheed for a large amount of liability and cost. The company and some in Congress have been meeting with Defense Department officials to push back on the idea of shared liability.

General Dynamics (GD) reported a slight increase in profits to $1.80 a share up ten cents from last year. This was on lower revenues of $7.85 billion compared to $8. GD expects for the year to deliver $7.15-$7.20 a share in earnings. The company like all of the other large contractors will continue plans to lower costs and shed employees over the next year to position itself for cuts in spending.

Northrop Grumman (NOC) also had an increase in profits. They were up 4.6% to $1.86 a share on slightly lower revenue of $6.61 billion. The growth was due to sales at their electronic systems segment as aerospace systems and information systems were lower. The company does expect overall earnings for the year to be higher then previously stated at $6.95-$7.05 a share. Northrop also saw pension impacts affect their earnings related to eliminating some jobs. Northrop had earlier this year spun off their naval systems business into Huntington Ingalls Industries (HII) which reduced revenue substantially.

Boeing (BA) also did well beating analyst estimates by 36 cents at $1.46 a share. Boeing’s net income was over a billion dollars an increase of almost $260 million compared to last quarter on sales of $17.7 billion. Boeing is different from other defense contractors in that 50% or more of their business is commercial aviation. This earnings report was dominated by discussion of the 787 airliner which has just started deliveries and service with airlines. Boeing delivered more jets this quarter then last and has sold out almost 8 years of 787 production. Boeing too will look at reducing overhead and cost structure on their defense side in order to compete in what is expected to be a tight market.

So far earnings by defense contractors have yet to see the effects of the end of fighting in Iraq, plans to draw down Afghanistan and expected cuts in defense spending. Although the 2012 budget has yet to be finished it is expected to be flat. The Government is already making decisions on ending programs such as radios, missiles and potentially vehicle systems. Next year may not be so good and 2013 might be much worse. All of the companies are looking at their costs and how to deal with a Defense Department that is pushing initiatives to reduce prices and risk in acquisition programs. As illustrated by the F-35 the contractors will only do so much to absorb this risk and the related costs.

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Army Decides to Recompete Radford Contract

In June the U.S. Army announced that it had awarded a contract with BAE Systems (BAE:LSE) to run the U.S. explosives production facility at the Radford, VA Army Ammunition Plant. The losing company, ATK (ATK), who had had contracts to run the facility for several years protested the award. Under normal processes the Government Accountability Office (GAO) which is responsible for deciding these matters would have made a decision no later then September.

The protest though is now not necessary as the Army has decided to recompete the contract which led to the GAO dismissing the protest. After a review by the GAO the Army will change some parts of the Request for Proposals (RFP) and allow bidders to submit new ones. This is good news for ATK as the Radford contract had a value of over $800 million over its ten year duration.

Because of this decision ATK, the incumbent, will continue to operate the plant and be paid by the Army until a new contract is awarded. Both BAE and ATK have indicated they will submit new proposals and there is always a potential for other companies to also try to win the work.

If the U.S. defense budget does decline for any company the key will be keeping their existing contracts and then attempting to win new ones. Having a core of existing work will cushion any lack of new work caused by the reduced opportunities available in the next decade or so as the U.S. reduces its investment in Iraq and Afghanistan as well as new development programs or building up stockpiles of weapons and munitions.

ATK recently had a rough quarter with sales down which led to a drop of about 4% in profits when compared to the similar quarter last year. One areas where revenue was down was sales of ammunition to U.S. allies like Afghanistan. The loss of the Radford contract would have reduced annual revenue $80 million or so or about 2%. A chance to win the work back will only help the company in the future.

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Better Price Does Not Lead to More Profit

The Department of Defense uses different source selection criteria for different programs depending on what phase they are at in the acquisition cycle or how stable a product they are. One factor that is constant though is they are looking for the best price and value for their dollar. This doesn’t mean that they will always accept the lowest bid but they will accept the most technical constant at the lowest bid.

This means that in some cases companies can win work by aggressively offering a low price by minimizing their overhead costs and factoring in a small amount for profit. This pricing strategy does have as an issue that while it may lead to the contractor winning the work it may mean little or even no profit on the contract. With the new focus by DoD on price this means that margins are going to be squeezed even more while budgetary pressures may reduce the amount of large contracts available for any contractor to win.

Two recent contracts illustrate this issue for different companies.

The first is the Family of Medium Tactical Vehicle (FMTV) truck production for the U.S. Army and U.S. Marine Corps. Oshkosh (OSK) aggressively bid on this work to win it away from BAE Systems (BAE:LSE). Oshkosh’s win was protested by the losers, including BAE and Navistar (NAV), with one of the concerns being the low price offered. The GAO denied the protest and Oshkosh has now built hundreds of the trucks and trailers for the U.S. military.

Oshkosh hoped to offset declines in its commercial specialty truck business with military work and was able to win this contract and another for Mine Resistant Ambush Protected (MRAP) vehicles. The two led to large amounts of revenue for the company but unfortunately the MRAP work is winding down and it turns out that Oshkosh’s price is so low on the FMTV that they are struggling to make money off of it. Their revenues and profit saw steep declines in the last quarter partially due to this issue.

Boeing (BA) recently won the new aerial tanker contract with their 767 derivative KC-46A. They bid $3.6 billion for the development and early production contract that the Air Force estimated would cost $3.9 billion. It was hard for the other bidder, EADS (EADS:P), to match this price. There were concerns raised that Boeing had deliberately bid low to make sure that they won since the contest would ultimately come down to price.

The current estimate for this phase is now around $5.2 billion. It may end up being lower in the end but not by more then a few percent. This means that the Government and Boeing share the cost of the first billion increase and Boeing pays everything above $4.9 billion. If the current price is correct Boeing will lose $300 million. Boeing recently reported a good quarter with earnings up 20% and profits nineteen cents a share.

In Boeing’s case commercial sales as well as their diverse defense product line will offset the overruns in the KC-46A. Oshkosh does not necessarily have that luxury with the FMTV as their commercial vehicle sales are dependent on construction activity and government investment in equipment. Both have fallen off with the current economic situation in the U.S. and probably will be down for a few more years.

While the Government wants companies to make profits and stay in business they are not going to factor that in when they make awards. If a companies offer a low, best price they will take that. It is up to the bidder to calculate the price that offers the best chance of winning while generating revenue and profit. These examples show that is not always the easiest thing to do.

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L-3 Restructures in the Face of Budget Realities and Policy Changes

As part of their earnings announcement of the second quarter L-3 Communications Holdings (L3) announced that it would separate most of its government service unit into a stand alone company called Engility. L-3 is a diverse provider of services and hardware to the U.S. Defense Department. Management stated concerns with new rules on Organizational Conflicts of Interest (OCI) led them to this decision.

Interestingly the company has decided to keep the intelligence and cyber support parts of this business with L-3 while letting the more traditional Scientific, Engineering, Technical and Analytical (SETA) support go with the new company. The first two are potential high growth areas as illustrated by the moves of the larger defense contractors such as Boeing (BA) and General Dynamics (GD) buying up of smaller companies in that field. The use of SETA contractors who often work directly supporting new system development and acquisition is under pressure first through insourcing and now just through cuts to the size of the work force as the Pentagon moves to reduce its overhead and budget.

Overall the company reported a drop in sales due to the loss of one major contract but overall a rise in profits of about 32 cents a share. Revenue compared to the similar quarter last year fell to $3.77 billion or about fiver percent. The company followed other defense contractors reporting this week by increasing their guidance for the year raising it 15 cents a share from last quarter’s prediction.

The future defense budget remains in flux but different companies are positioning themselves for what is expected to be declines in business, more strict regulations and policies and pressure on pricing. This has been reflected in moves like ITT Corporation (ITT) which is spinning off its entire defense business into a separate company, to be called ITT Exelis or Lockheed Martin’s (LMT) plans to eliminate thousands of jobs to cut overhead and prices. L-3 is holding onto its business lines with the most potential while putting its services unit in a place where they will either sink, swim or end up being part of another company.

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Thales and French Government to Share in Fine for Taiwanese Bribes

A French court ruled this week that the French defense contractor, Thales (HO:PA), along with the French government must pay a fine in relation to charges that bribes had been paid to the Taiwanese government to secure a large naval ship order. The deal was originally signed with Thomson-CSF and the government owned shipyard DCN. Thomson-CSF is now part of Thales.

The fine of 630 million euros, which is almost a billion dollars, will be split roughly 70/30 between the government and Thales. As part of the agreement with the court the government will not appeal the decision allowing Thales to get on with business without facing any more potential penalties or bad publicity. Thales says that the money has already been accounted for in preparation for paying the fine. The money will be returned to Taiwan.

Thales stock price has been little affected by the news.

This is the largest corruption case in French history and rivals the payouts that BAE Systems (BAE:LSE) has had to give to the U.K. and U.S. governments over its deals with Saudi Arabia. These totaled almost $500 million to the U.S. and $450 million in the U.K. The U.S. has especially been harsh on companies that used bribes and corrupt acts to win contracts overseas.

Historically bribes and payments have been a part of the international arms trade. Many countries required these kind of payments or the use of middle men to facilitate deals. This practice has been accepted by governments more interested in winning the contract for their own domestic companies like this deal then in ethical practices. These kind of actions cheat the customer because they may not get the best system or deal for their money as well as the other potential bidders as they do not get a fair selection process.

Thales also illustrates the situation where mergers and acquisitions lead to a company inheriting the problems of another. Even though potentially no Thales employees were involved the company is responsible due to acquiring Thomson-CSF. Hopefully more decisions and cases like this will help eradicate this problem from the defense trade.

Photo from Lordcolus’ Flickr photostream.

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