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GeoEye and DigitalGlobe Receive Antitrust Clearance in Connection with Pending Combination — Press Release

HERNDON, Va., Jan. 9, 2013 /PRNewswire/ — GeoEye, Inc. (NASDAQ: GEOY), a leading source of geospatial information and insight, announced that it has received antitrust clearance from the U.S. Department of Justice in connection with its pending combination with DigitalGlobe, Inc. (NYSE: DGI).

As previously announced, on July 23, 2012, the boards of directors of both GeoEye and DigitalGlobe unanimously approved a definitive merger agreement under which the companies will combine. Completion of the transaction is subject to satisfaction of other customary closing conditions, including obtaining regulatory approval from the Federal Communications Commission (FCC) and the National Oceanic and Atmospheric Administration (NOAA). GeoEye is working cooperatively with the FCC and NOAA, and the transaction is expected to close by January 31, 2013. Shareowners of both GeoEye and DigitalGlobe have previously voted overwhelmingly in favor of the combination. Simultaneous with the closing of the transaction, the company expects to complete a $1.2 billion refinancing, which is expected to include a combination of senior notes and senior secured credit facilities.

Pursuant to the Agreement and Plan of Merger between the parties and the anticipated closing date of January 31, 2013, all stockholder election forms with respect to the consideration to be received in the merger by GeoEye stockholders must be received by the Exchange Agent, American Stock Transfer & Trust Company, LLC (AST) by no later than 5:00 p.m., New York City time, on January 29, 2013. Further information regarding the stockholder election form may be obtained by contacting AST toll free at (877) 825 – 8619.

About GeoEye

GeoEye is a leading source of geospatial information and insight for decision makers and analysts, who need a clear understanding of our changing world to protect lives, manage risk and optimize resources. Each day, organizations in defense and intelligence, public safety, critical infrastructure, energy and online media rely on GeoEye’s imagery, tools and expertise to support important missions around the globe. Widely recognized as a pioneer in high-resolution satellite imagery, GeoEye has evolved into a complete provider of geospatial intelligence solutions. GeoEye’s ability to collect, process and analyze massive amounts of geospatial data allows our customers to quickly see precise changes on the ground and anticipate where events may occur in the future. GeoEye is a public company listed on NASDAQ as GEOY and is headquartered in Herndon, Virginia with more than 700 employees worldwide. Learn more at www.geoeye.com.

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

This release includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Without limitation, the words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “will” and similar expressions are intended to identify forward-looking statements. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future, including statements relating to growth, expected levels of expenditures and statements expressing general optimism about future operating results, are forward-looking statements. Similarly, statements that describe our business strategy, outlook, objectives, plans, intentions or goals also are forward-looking statements. All such forward-looking statements and those presented elsewhere by our management from time to time are subject to certain risks and uncertainties that could cause actual results to differ materially from those in forward-looking statements. These risks and uncertainties include, but are not limited to, those described in “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2011, which we filed with the Securities and Exchange Commission (“SEC”) on March 13, 2012, as updated in our Quarterly Reports on Form 10-Q for the periods ended March 31, 2012, June 30, 2012, and September 30, 2012, which we filed with the SEC on May 4, 2012, August 7, 2012, and November 6, 2012, respectively. Copies of all SEC filings may be obtained from the SEC’s EDGAR Web site, http://www.sec.gov or by contacting: William L. Warren, Executive Vice President, General Counsel and Secretary, at 703-480-5672.

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Final Conference Defense Spending Bill from Congress Kills MEADS

Despite threats of a veto from the Obama White House the current conference version of the 2013 Defense Authorization Bill will end the MEADS program. The final version of the law cuts the last planned $400 million expenditure on the new, joint air defense system.

The Medium Extended Air Defense System (MEADS) was being developed by the U.S., Italy and Germany as a replacement for the PATRIOT system made by Raytheon (RTN). Lockheed Martin (LMT) is the lead contractor for the MEADS system. The Administration and Congress have already agreed that newer versions of the PATRIOT will suffice and work on MEADS would end. The dispute is that Congress decided that there was no reason for funding in FY13 rather then completing that year of work.

Italy and Germany had wanted to continue the program having provided several hundred million dollars of funding over its life stretching back to the Nineties. Not only will there be fall out internationally from this decision it is estimated that paying out contract termination fees and close out costs would probably be close to the planned $400 million in funding.

The program had been in its test phase and had recently had some successes.

Unfortunately in the potential fiscal situation new programs that are yet to enter service are the ones that face the biggest cuts as it is possible to utilize some of the things developed but by avoiding production and deployment large amounts of funding are saved. While the Administration wanted that last year of funding it seems clear that Congress intends to not provide it in the FY13 bill.

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Discussion of Sequestration Effects Heats Up

As part of the Budget Control Act last year that emerged after a failed consensus between President Obama and Congress to deal with the U.S. government’s budget issues a plan was put in place for automatic cuts to spending. This sequestration of funds requires about $1 Trillion in cuts over the next 10 years. In FY13 this would amount to just under $100 billion with half coming out of the defense budget.

The way the Pentagon is approaching this is to apply the cuts evenly across all appropriations and spending which amounts to a 9.4% reduction in spending. This may be adjusted as they get closer to the actual implementation to fully fund some critical items such as personnel and medical costs which would mean some investment programs may see bigger cuts.

For some programs a 9.4% reduction would not be that significant. You buy less of an item, you maybe drive, fly or sail it less, you don’t have as much training supplies as in the past. For others it might be much worse. A 10% cut in R&D for a program could cause multi-year delays in completing development or testing meaning the system wouldn’t get into service as soon. It may be that a program would be cancelled as it wouldn’t be executable without that level of funding.

There are concerns with some of the big acquisition programs that utilize multi-year production contracts. These rely on a 5 year deal with the OEM providing for a specific number of items to be delivered each year. If the 9.4% cut happens and this number is reduced below the minimum the contract may have to be renegotiated leading to cost increases. The KC-46A tanker contract also faces some issues as it is a Firm Fixed Price (FFP) contract and the cut may reduce its funding below what was negotiated with Boeing (BA) when the contract was awarded which also could lead to a need to renegotiate.

As expected pretty much every one is against sequestration and have lately spoken up about dealing with it. Primarily by transferring the spending reductions from the Pentagon to other parts of the Federal government. This includes legislators, Pentagon officials, industry, local governments and employees. All would expect to see some hardship as the spending cuts are implemented.

The media is full of articles such as this, Sequestration threatens Portsmouth Naval Shipyard jobs, workload, from Seacoastonline.com.

Congressman Connelly (D-VA), who has a lot of defense contractors and civil servants in his district, wants Congress to stop campaigning and stay in DC to work out a resolution.

Studies are being done to calculate how many jobs will be lost due to the budget cuts and what industries will be affected the most.

There is also discussion of the effect beyond defense as the rest of the government would lose $50 billion in funding which would cause programs to be cut, eliminated and people laid off.

Overall the issue will continue to be there through the November elections. Most likely no attempt will be made to deal with this until after that when the lame duck Congress will have to also deal with the expiration of the Bush tax cuts and other budget issues. There probably will be a big omnibus bill that addresses all of this.

Will sequestration actually happen for defense? It is hard to say right now. Everyone should be planning for it and calculating how to implement it. This includes the Services, acquisition program managers, and contractors. The U.s. should be expecting reduced defense spending as the fighting in Afghanistan and Iraq winds down and wartime requirements are eliminated. It would be better if it was done in a more planned fashion.

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Netherlands Looks At Leaving F-35 Program

The Joint Strike Fighter (JSF) program led by prime contractor Lockheed Martin (LMT) was designed similar to the successful earlier F-16 aircraft. Different NATO and other allied nations would contribute towards the development and also the production to spread the costs and benefits of the advanced fighter. The Netherlands was one of those countries that did this with a commitment of R&D funding and ultimately having a plant that would support their and Italian aircraft deliveries.

Now driven by austerity and cuts to the budget the Netherlands’ Parliament voted on leaving the program. New elections will be held later this fall and by then the plan is to report on the costs to the country of abandoning participation.

For several years some representatives have expressed concerns with the growth of the unit cost of the aircraft and the delays to the schedule making it hard for the Dutch to buy the necessary amount of aircraft with the funding available. This vote just formalizes those concerns.

Even with the vote the program continues to move along. The Japanese military has gone ahead with their order. The U.S. has placed orders related to Lot VI and VII of the production while continuing to negotiate Lot V.

At the same time the cost growth experienced by the overall program is making all purchasers re-evaluate how many they may buy. Cuts to production orders will only further increase unit costs as there will be less aircraft to spread development funds over as well as reduce economies of scale. The situation where a program is stretched out and annual buys reduced is a common one in defense acquisition leading to higher unit and overall costs.

While the JSF has shown a great deal of improvement over the last four years it still has a long way to go and its final numbers will most likely be much lower then originally planned.

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Australia to Stretch Out F-35 Deliveries

One of the key components of the F-35 Joint Strike Fighter (JSF) program was the early participation by U.S. allied countries. Unlike traditional Foreign Military Sales (FMS) these countries provided some of the development costs and committed early to buy the the aircraft rather then wait for the establishment of production and get it after the aircraft entered U.S. service. These included Great Britain, Australia, Canada and The Netherlands.

These countries planned to buy different amounts of the three types of the F-35. Britain to operate from their new carriers and replace the Harrier Jump Jet, Canada to retire their CF-18 fleet and the other two to upgrade from the aging F-16. In fact the F-35 would be similar to the F-16 program with parts and components made by the buying countries. Norway, Japan and Israel have also decided to buy the F-35 over other potential aircraft.

The F-35 has seen serious delays and cost growth due to testing and development issues. It is currently in Low Rate Initial Production (LRIP) as well as continuing testing. The U.S. in their latest budget proposal have decided to stretch production out to save money in the near term. Australia has now decided to do the same thing.

That country’s budget plans now call for delays of accepting the majority of their aircraft to mirror current U.S. plans. The goal is to save over $1.6 billion in the next few eyars. The first two Australian aircraft are in production and should be delivered in 2014-15 to start training but their first squadron will not stand up now for a few years after that.

The problem with stretching out production buys is that while it does save money in the near term the same number of systems will have to be bought over a longer time. Due to inflation alone as well as the loss of production efficiencies the average price per aircraft will increase causing the whole program to get more expensive. One potential problem that may arise is that the total number to be bought will be reduced.

Canada is also re-considering their F-35 buy due to issues with how the contract was awarded last year. These decisions will be a blow to Lockheed Martin (LMT) as they reduce near term revenue and earnings.

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House Begins Markup of 2014 Budget with Add of Submarine

The House and Senate are in the process of considering the President’s 2014 budget request. As often different committees will review it and make changes sometimes based on their own priorities which means adding things or removing items from the original request. The budget has to go through two committees in each the House and Senate. Then it is voted on and a Conference Committee held. This means that often the final budget is not necessarily similar to what was submitted in February.

Not only do different companies lobby Congress for inclusion of their products and projects but sometimes the Services will indirectly. There exist lists of “unfunded priorities” and needs that Congress may address even though they are not part of the budget request.

The House Armed Services Committee as part of its review has reportedly increased the Navy’s buy of U.S.S. Virginia class attack submarines by 1 more then requested. The Navy had originally planned to buy two a year but in order to meet budget cut goals and reduce spending only 1 was asked for in 2014. The HASC has bumped that back up to 2.

Congress also wants the Navy to consider signing a multi-year contract for 10 submarines. Multi-year contracts are normally for five years and done for systems, especially aircraft, in steady state production. This allows efficiencies and better pricing due to stable quantities and funding. Virginia submarines are currently built by two companies – Huntington Ingalls Industries (HII) in Virgina and General Dynamics (GD) Electric Boat in Connecticut and Rhode Island.

One of the problems that the Pentagon will face as it tries to cut money required to meet budget goals is that Congress is loathe to reduce programs. There are 435 House members and 100 Senators who see defense spending as a way to bring money and jobs into their districts. The idea of keeping one more submarine in the current budget will do so. It will also require the Navy to cut less money or take it from other budget priorities.

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Canadian F-35 Controversy Continues

The fall out from the controversial decision by the Canadian government to commit to the F-35 Joint Strike Fighter without conducting a competition continues. The execution of the contract with Lockheed Martin (LMT) and the U.S. has been placed on hold as a new group outside the traditional defense procurement organization re-examines the contracting process.

The latest fall out from the Auditor report released earlier this year is that the Government underestimated the total cost of the program by $10 billion. Rather then then fixed costs being in the $15 billion range they are actually close to $25 billion. This is because ten years of operational costs (training, personnel, fuel, etc) were not included in the original estimate.

With the current issues it is not inconceivable that Canada could re-start their procurement process. This may lead to a new competition for the contract to replace the current CF-18 fighters that could include multiple competitors like the Eurofighter Typhoon, the Dassault Rafale and American aircraft like Boeing’s (BA) F/A-18.

The loss of 65 aircraft to the F-35 program is a small part of its over 2,000 planned deliveries but the loss of Canada’s participation would be a blow to the whole concept of the program with its shared development, production and operational cost. If Canada reconsiders then other nations who have hinted they could might follow. This could include Japan and the Netherlands both of whom have questions about the cost increases and schedule delays facing the program as a whole.

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Joint Air to Ground Missile (JAGM) to Remain in Development

With the expected reductions in U.S. planned defense spending there have been different discussions and rumors of programs being cancelled or ended. One of these is the new Joint Air to Ground Missile (JAGM) which is a replacement for the Hellfire and Maverick missiles. These are launched from a variety of helicopters and fixed wing aircraft and had an original mission of destroying enemy armor. Over the last several years different warheads have been developed to attack personnel and buildings.

The JAGM itself was a new program that replaced the earlier Joint Common Missile (JCM) which was cancelled itself a few years ago. The JCM was being developed by Lockheed Martin (LMT). They and a team of Raytheon (RTN) and Boeing (BA) were competing for the JAGM contract.

The Army had demonstrations of the two competing design and last summer received bids for the next phase of the program which was to be Engineering, Manufacturing and Development (EMD). One of the two designs would have been selected to enter this phase and then move on into production. Those proposals were received in June.

The production contract would be worth several billion dollars due to the amount of missiles that needed to be procured.

Now it is being reported that rather then moving out with this phase or cancelling the program the Army will continue to pay for a small amount of continued development and risk reduction. Available R&D funds would be used for this program. This would allow further refinement of the concept and designs and allow a decision to enter the EMD phase at a later date.

Those contracts would be awarded at the end of this summer.

The U.S. is going to be facing a number of situations like this. If there need to be severe cuts to investment programs it makes sense to cancel whole ones before they enter production. This saves the most money. It also means that the technology developed is still available for use if needed. It also continues to support some of the industrial base that might go away if whole sale cuts were made.

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Changes in Guam’s Plans Lead to Contract Cancellations

For several years the U.S. and Japanese governments have been working on moving a majority of the U.S. military based on Okinawa to Guam. This is to reduce their presence and potentially provide better training facilities. The move was going to be jointly funded by the two countries. One sticking point has been relocating the main Marine air base on the island which under the current plans will stay.

The Navy has been issuing contracts to build the new facilities on Guam which will include not only barracks but support capability such as a hospital, larger port, and the myriad things needed to support thousands of Marines, Sailors and Airmen and their families. The estimated cost of the move is close to $12 billion.

Right now though the move is under discussion and potential revision. This meant in the FY12 budget the Navy was specifically prevented from obligating anymore of the money from Japan. This meant that it has had to cancel two large contracts that were intended to be funded with that money.

The largest contract was an omnibus one, Mamizu Multiple Award Construction Contract, which would have allowed the Navy to issue orders to build facilities where the Marine headquarters were going to be. The other was for construction of a clinic.

The two governments have been working on this moved for several years. The fact that it remains unresolved despite much of the planning and work done in the last decade is not surprising. The presence of the U.S. on Okinawa has been a burden in the mind of the islanders and they would like all of it to leave. The relocation of the airbase has become a key sticking point and has not shown signs of resolution.

Even so eventually the U.S. will move a great deal of their infrastructure and personnel from Okinawa. The work on Guam will eventually get done and contracts issued and completed.

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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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U.S Army Exploring Renewable Energy Contract

On Friday the U.S. Army released a draft RFP related to the purchase of renewable energy for facilities. The potential contract could be for up to 30 years and involve $7 billion.

The contract is not for generating capacity or for equipment related to electricity but actually just to buy power from different sources. The caveat is that it needs to be renewable generated electricity which normally implies solar, wind or geothermal rather then traditional means such as natural gas, oil or coal.

The Department of Defense is one of the biggest users of not only gasoline but also electricity to power their large number of facilities across the U.S. and the world. They have been aggressively exploring ways to reduce this demand not only through economizing but through use of other sources. This includes investments in biofuels such as algae and vegetation based. The goals are to reduce reliance on traditional fuels as well as save money.

The issuance of a draft RFP does not necessarily mean a contract will be awarded or that the final one will look like this but it will get industry thinking and figuring out how to respond. The issuance of this contract could provide some more jump start to the renewable power industry by creating massive demand. The Defense Department could also through pricing make it more financially viable.

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Oshkosh (OSK) and the FY13 Defense Budget — Seeking Alpha

This is an exclusive post I made for Seeking Alpha about cuts to the FMTV program in the FY13 budget and its effect on Oshkosh’s bottom line.

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FY13 Defense Budget Hits Aircraft Procurement

The Obama Administration submitted its FY13 budget to the Congress today and as expected the defense budget took some hits. Trying to keep spending flat compared to the 2012 budget the Administration has proposed some cuts to investment, personnel programs and benefits. Chief among these were cuts to the most expensive program in the budget: the F-35 Joint Strike Fighter (JSF) as well as some other aircraft and Unmanned Aerial Vehicle (UAV) programs.

Even though the F-35 saw production reduced from only 31 to 29 this saved an estimated $1.6 billion. Over the next five year budget plan 179 less F-35 would be purchased then planned. Lockheed Martin (LMT) is the prime contractor on the advanced aircraft.

The V-22 which has gone into use with the U.S.M.C. and Air Force as a transport and search-and-resuce aircraft saw its planned production cut to 21 from 27. This should save about $500 million. The V-22 made by Boeing (BA) and Bell Helicopter, part of Textron (TXT), was on the downslope of the current multi-year production contract with the second in negotiation. This possibly could see reduced quantities.

All of this adds up to reduced revenues for Lockheed, Boeing and Textron although Congress does not need to accept the proposed cuts. It is expected though that a great deal of them will make it through the budget cycle as the need to reduce the deficit and government spending as a whole will require some reductions in defense spending.

Photo from Secretary of Defense’s flickr photostream.

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Insourcing, Outsourcing: SAIC Wins OSD Support Contract

As the debate about eliminating contractor jobs in the Defense Department and insourcing those positions continues the Defense Department and Services continue to award support contracts. SAIC (SAI) the latest contractor to benefit by winning a large award to support the Assistant Secretary of Defense for Nuclear, Chemical and Biological Defense (OASD(NCB)).

The contract has one base year and four options years and could be worth up to $95 million if all options are exercised. SAIC, one of the largest defense contractors in the U.S., will provide professional, technical, analytical and executive services through the contract.

The OASD(NCB)’s office is chartered with “Drive the capability to prevent, protect against, and respond to weapons of mass destruction threats” and provide “A world safe from nuclear, chemical, and biological threats” as part of the Office of Secretary of Defense. Under it are offices for Chemical and Biological Defense, the Defense Threat Reduction Agency, Nuclear Matters and Threat Reduction and Arms Control. The current office was created in 2011.

As with all such offices throughout DoD and the different Services and Agencies they still rely on contractor support in different areas. These include direct office and mission support. The goal of insourcing was to reduce these positions by making sure that any “inherently government work” was being done by a civil servant and not a contractor. There have been disputes among the government, unions and contractors as what jobs should be insourced and how much work is being taken away from private industry. There have also been arguments about who is cheaper, civil servants or contractors, and various politicians weighing in on both sides.

The fact that these types of contracts are still being awarded is a good sign for the industry and SAIC especially. SAIC is one of the larger defense contractors with projected revenues of $10 billion or more in 2012 and it does this primarily by providing services rather then manufacturing large, defense systems. As the Defense Department reduces contracts and positions it might hit SAIC hard although they have shown the ability to win some major contracts.

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Despite Concerns About Lockheed’s Future Earnings Company Wins JIEDDO Contract

On the same day that the Standard & Poor’s (S&P) lowered its outlook on U.S. defense contractor Lockheed Martin (LMT) to negative the company also announced a large contract to support the U.S. Defense Department’s anti-Improvised Explosive Device (IED) efforts.

The company was awarded one of five contracts to provide Operations Support to the Joint Improvised Explosive Device Defeat Organization (JIEDDO). The contract is an Indefinite Delivery / Indefinite Quantity (ID/IQ)one that could have a value of up to $900 million depending how the tasks area awarded. The initial contract is for two years with three option years.

The JIEDDO was established by DoD to focus efforts on defeating the mine and IED threat in Iraq and Afghanistan which became the primary method of attack and caused a great deal of casualties. The JIEDDO has focused on technical means to detect and disable IED’s including advanced detection and jamming.

The contract with Lockheed is focused on the operational part of JIEDDO mission with operations, analysis, combat and IT support for JIEDDO’s analytical team.

There has been concern expressed by many in the financial community that the stocks of the large defense contractors will suffer with the proposed reduction in U.S. spending. This will have a negative effect on their revenue and earnings. Of course the cuts may not happen or be as large as discussed. Also major acquisition programs like the F-35 JSF or ship construction will most likely see reductions in quantity rather then outright cancellation. This should cushion the blow to defense contractors.

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Seeking Alpha: Potential Areas For Defense M&A

I published an exclusive article at Seeking Alpha on future M&A activity among defense contractors. It may be found here.

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Reports that Next V-22 Production Contract Will See Reduced Quantities

The V-22 Osprey tilt rotor aircraft is a unique capability to the U.S. armed forces. Built by Boeing (BA) and Bell, part of Textron (TXT), in a joint venture the twin engined aircraft have seen a great deal of use in Iraq and Afghanistan since entering service in 2006 with the U.S. Air Force and Marine Corps. The system had a lengthy development timeline being cancelled more then once and then revived.

The first five year production contract saw 174 aircraft ordered and late last summer the government and contractor began entering into negotiations for the second one. That would be for a further 122 Ospreys at an estimated cost of close to $8 billion.

Now there is word that as part of the planned reductions to the defense budget over the next five years the U.S. Defense Department will cut 24 of the next batch of V-22. This would reduce the next five year contract to 98 aircraft at a cost of roughly $6.5 billion. The reports indicate that the hope is to save $1.75 billion but if 122 cost $8 billion the back of the envelope calculation would show only about $1.5 billion in savings.

Normally reducing the quantity bought over the same time period would lead to higher unit costs as there would be the loss of savings reduced with buying larger numbers of parts but it seems the Pentagon is hoping to not only cut aircraft but to negotiate a better price with Boeing-Bell. If that is possible remains to be seen. The delay in retiring the CH-46 and other aircraft the V-22 is replacing may also lead to higher operational costs for those as some will have to remain in service for a longer then originally planned timeline.

At least for the companies the program is not being eliminated or delayed. That means there will still be some revenue and earnings off of the program.

The cut will also illustrate how hard it is to reduce the budget just by slicing programs. There are enough sunk and recurring costs that savings are not directly tied to the amount of items being purchased. It is easier to eliminate whole programs which is reportedly being done with the Joint Air-to-Ground Missile (JAGM, C-27 JCA transport and the C-130 Avionics Modernization Program.

Photo from Beige Alert’s flickr photostream.

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Panetta Lays Out Initial Defense Budget Spending Plans

Yesterday the Pentagon made a series of presentations and media events to lay out the initial numbers for future spending. The goal of the Secretary Leon Panetta’s Defense Department is to cut $487 billion in ten years with the current Five Year Defense Plan (FYDP) containing over half the reductions. As part of this DoD released a 15 page document and a one page budget summary that provides top level guidance on the plans.

Many of the planned cut backs are based on the idea that with the disengagement of forces in Iraq and Afghanistan cuts may be made in those areas. This means that money for the “Global War on Terror (GWOT)” or “Overseas Contingency Operations (OCO)” as that support was called will see significant cuts. In FY10 it was $163 billion, in FY11 $159 billion with $115 billion planned for FY12 and only $88 billion in FY13. This adds up to a 54 percent reduction and saves $75 billion in those three years.

Since personnel costs both for the current Active members, their dependents,the reserve force and retirees make up about thirty percent of the defense budget there will be reductions and adjustments to their size and benefits. 100,000 Soldiers and Marines will be eliminated from the active military with the Army losing approximately 8 brigades of troops. Even though the Marine Corps has grown substantially since 9/11 it maintains the same force structure of 3 active divisions and 1 reserve so there will be cuts to the size of individual units and support forces. The Pentagon states that even with these cuts the size of the ground forces will be bigger then on 9/11. There will also be increases in medical costs to the individuals and a commission to revamp military retirement benefits.

The Air Force and Navy will too see reductions in their force structure. The Navy will retire some ships early while delaying the construction of others. This means that it won’t grow as fast as currently planned. The Air Force will lose some tactical aircraft, cut transports and reduce planned buys of some F-35 Joint Strike Fighter.

Only a few programs are targeted for elimination so far. These include the C-27 Joint Cargo Aircraft used primarily by the Air National Guard. It is planned the C-130 will provide needed capability there. The new Joint Air-to-Ground Missile (JAGM) which is to replace the Maverick and Hellfire missiles will be scaled back. It was about to select its prime contractor. The Global Hawk Block 30 will finish production and there will be some other nibbling around the edges.

All of this ads up to some significant reduction in business for defense contractors. The JAGM was a large contract that either Raytheon (RTN) or Lockheed Martin (LMT) were hoping to win. The cuts in ship production will affect Huntington Ingalls Industries (HII) and General Dynamics (GD). Reduction in JSF will certainly affect Lockheed and its support contractors.

The contractors who provide support in Afghanistan and at bases across the U.S. will see cuts as there are smaller, less troops to support. Logistics needs will also be cut back so those making things like battle armor, uniforms, and small arms will also be affected.

Overall it will will remove about 9% of planned spending in FY13-17 from the defense budget. That will cause some companies severe pain depending on how broad their product line and customer base is.

Of course Congress is the final say and they could easily keep some of the funding for some of the programs cushioning the cuts and blows to the defense industry. The elections this year will also have a key affect.

A lot more to come as yesterday was just a starting point.

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

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Global Hawk Rumored to be Cut

Update – The Defense Department released their Budget Priorities and Choices today and that included cancelling the remaining Block 30 Global Hawk production. The rationale given was that it provided the “same capability as the U-­‐2 manned aircraft for significantly less money to both buy and operate. As the program has matured, these cost savings have not materialized and, at best, we project the future cost of Global Hawk Block 30 operations to be comparable with the U-2.” Northrop Grumman responded this afternoon and said in their press release that “Northrop Grumman is disappointed with the Pentagon’s decision, and plans to work with the Pentagon to assess alternatives to program termination.” They also said that:

“The Global Hawk program has demonstrated its utility in U.S. military operations in Iraq, Afghanistan and Libya, as well as its utility in humanitarian operations in Japan and Haiti. Just a few months ago, the Pentagon published an acquisition decision memorandum regarding Global Hawk Block 30 that stated: ‘The continuation of the program is essential to the national security… there are no alternatives to the program which will provide acceptable capability to meet the joint military requirement at less cost.’

Today the Pentagon will begin to present its plans to reduce the U.S. defense budget by close to $500 billion over the next ten years. There have already been reports of programs being ended or reduced but so far none have been confirmed. As the plans are revealed it will be seen if these reports are true.

Yesterday it came out that the U.S. Air Force is considering reducing its planned purchase of Northrop Grumman’s (NOC) Global Hawk strategic reconnaissance Unmanned Aerial Vehicle (UAV). The Global Hawk has been in development since before 2000 and early versions went into use right after 9/11 supporting collection and targeting efforts across Afghanistan and Iraq. The Global Hawk was planned to replace the manned high altitude reconnaissance U-2 aircraft.

The Air Force has been steadily improving the system and buying different versions. The current production model is the RQ-4 Block 30 and the plan was to buy about 28 of them. Now there are reports that 10 of the systems will not be purchased and the U-2 will continue flying for several more years.

The Air Force would buy 3 more of the Block 40 version and the naval version to fulfill the Broad Area Maritime Surveillance (BAMS) requirement would continue so Northrop would not be losing all of its Global Hawk business but the loss of the ten systems would significantly reduce near term revenue.

In order to save that kind of money the Pentagon will have to cancel entire programs preferably before they go into production such as the Army’s Joint Air-to-Ground Missile (JAGM) program which has been a potential cut or reduce the amount of procurement items significantly such as with the Global Hawk. You cannot cut a slice of the budget proportionally without seriously affecting readiness, training and effectiveness of the armed forces overall. It is better to kill off whole programs and continue to utilize existing systems.

With these kind of reductions in planned spending there may be a time of flat or little growth for defense contractors. These decisions will force defense contractors to lose development and production programs they will still be able to keep their business of maintaining and supporting existing, older programs and equipment. The decisions may also force contraction in the industry as a whole.

Photo from ewen and donabel’s flickr photostream.

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Rumors of Program Cuts Starting to Swirl Affecting Boeing

If the Pentagon is really going to cut tens of billions of spending a year from its budget then it will not be able to nibble around the edges. What it will need to do is cancel whole programs. These will include ones in development as well as those in production and may also include ones that have yet to start yet. Already rumors of what will be cut are starting to come out in advance of any announcements by the Department of Defense.

Earlier this month it had been mooted that the C-27 Joint Cargo Aircraft (JCA) program would be eliminated. This is a light transport originally intended for the Army but now will be fielded to the U.S. Air Force Guard across the U.S. It was a program not really supported by the Air Force and now it is coming out that it might be on the block.

Another Air Force program that is now rumored to be on the chopping block is the C-130 Avionics Modernization Program (AMP). The C-130 made by Lockheed Martin (LMT) is a four engined transport used by the Air Force and Marine Corps. It has been in use since the 1950′s and the current C-130J is still being built today in Georgia.

The AMP adds a new glass cockpit along with the capability to meet the Global Air Traffic Control Management (GATM) requirements that all aircraft will be required to met by the end of this decade.

So far under the program Boeing (BA) has received a contract to modify 26 C-130 of which 6 have begun the AMP retrofit. The contract for the remaining 195 aircraft was supposed to be competed next year.

Ending the AMP would save about $2 billion over the next several years. Cutting it now makes sense as the follow-on contract has not been awarded.

The aircraft though will still ultimately need to be upgraded for GATM reasons but this could be done cheaper without the addition of the glass cockpit and other modifications.

It can be expected that further “rumors” of this sort will be floated as the next budget is developed that should include the first wave of cuts. As always in this situation Congress will have to weigh in with their blessing or changes to these types of decisions so politics will also play a role.

Photo from Nellis Air Force Base’s Flickr photostream.

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The New Obama Doctrine: Doing Less with Less

The Obama Administration announced its new strategy for the U.S. armed forces yesterday that will reflect future budget reality for the Defense Department. While no nation ever wants to state that its military size and missions are backed into a total budget number rather they claim to be buying the necessary capability at a certain price. The Obama defense team stood there yesterday and made that claim.

It really is though a combination of the two. The U.S. is under severe budgetary pressure. The Supercommittee failed which mandates a series of cuts to all spending including defense over the next several years. The DoD and Armed Services will have less money to buy things so our capability will be reduced. Similar to the Nineties with the ending of the Cold War but worse due to the current economic state and the overall size of the military.

The core change enunciated is the ending of the “Two War” plan which supposedly drove U.S. strategy since WW II. The U.S. had to have the ability to deal with a major war in Europe and a regional one. The new plan limits our ability to fighting one war and containing another. Conventional forces especially will be reduced to mean troops, aircraft, ships and heavy equipment.

That does not mean there are not opportunities as the hope is to use new systems such as UAV’s and better intelligence to make up for the lack of firepower. Special Forces will be used for regional conflicts rather then heavy brigades deploying such as they did to Iraq and Afghanistan. They will need equipment and force multipliers from across the spectrum.

The defense industry will also have to contract and adjust. There may not be any new heavy programs for several years. Aircraft will be limited to the F-35, the KC-46A and a new bomber of some sort. Carriers, destroyers and submarines along with amphibious ships will be cut and construction of new ones reduced. The Army and Marines will lose boots on the ground and the need to train, equip and support them. Big contracts will be fewer and competition for them much greater until the industry right sizes.

We will probably see many companies exiting the business. Either through M&A or just testing other markets to just disappearing. This will be hardware and support contractors. The DoD workforce will also shrink. Some communities will be hit hard as Wichita, KS is learning this week.

Congress will fight for some programs with each other and the Administration. The budget may not shrink as fast as planned and individual efforts may be saved.

All-in-all the next ten years will see a major adjustment to what the U.S. invests in its military and to the defense economy as a whole. Long term a path similar to the United Kingdom where conventional forces have shrunk precipitously over the last thirty years may be the best case. No matter what the U.S. defense budget will go down for a few years with a magnifying effect on the U.S. economy.

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Joint Cargo Aircraft (JCA) Facing Uncertain Future

The C-27J Spartan is a twin engined light transport aircraft purchased for the U.S. Air Force from a team made up of L-3 Communications (LLL) and Alenia North America, part of the Italian defence and industrial group Finmeccanica. The C-27 is not only used by the U.S. but other countries across the world.

The C-27 was the result of a program originally called the Joint Cargo Aircraft (JCA) which was conceived by the Army as part of their plans caused by the decision to cancel the RH-66 Comanche helicopter in 2004. The Comanche was going to be a new attack and reconnaissance helicopter utilizing many new technologies to maximize its stealth and performance. In development for almost twenty years it finally had begun serious testing when it was cancelled. The money freed up was used to by systems like the UH-60M, the AH-64D Block III, CH-47F and UH-72A helicopters.

The Army suffered from a lack of internal heavy lift for intra-theater missions unlike the Marine Corps who possessed their own C-130 transports. The JCA was meant to add this capability and relieve the pressure on the rotary wing fleet primarily being used to carry cargo in Afghanistan and Iraq. Fixed wing assets would be more efficient and economical.

In 2007 the Army and Air Force selected the C-27 from L-3 and Alenia over bids by Raytheon (RTN), who had teamed with EADS North America, offering a Spanish made C-295 and Lockheed Martin (LMT) who proposed a C-130 version. An initial contract worth about $2 billion for 78 aircraft was awarded to the winners.

The JCA was made a joint program and it was originally planned to issue it to Army and Air Force National Guard units to operate. In 2010 the Obama administration decided to transfer the program wholly to the Air Force to manage and operate. The number of aircraft was potentially reduced and only the Air Force Guard would receive it.

The first unit stood up in 2011 in Ohio where four aircraft will be based at Mansfield. In 2013 the Connecticut and the North Dakota Guard are supposed to received the aircraft.

There are now concerns that the C-27 program may be on the chopping block due to budgetary pressures. The Connecticut unit may be the first to feel this pain although the 2012 budget as submitted does contain the funding for the aircraft it may not make it into the final budget.

The C-27 is not a priority for the Air Force and new equipment for the Guard also sometimes takes hits. If the Air Force leadership is forced to sacrifice some of their funding it may be the C-27 is what is given up. It is also a small program and is primarily oriented towards non-combat missions at this time further making it easier to give up.

As the budget goes through these machinations over the next few years other programs similar to the C-27 may be on the chopping block. That does not mean they will be eliminated but they could see cuts, delays and changes to their size, missions and deployment plans. These programs will have to rely on the Congressmen and Senators who represent the states where they are made or based to protect them through trading of priorities and support.

The size of the cuts the Defense Department must make dictate that whole programs whether in development of production will have to be cut. The C-27 might just be one of them.

Photo from Blyzz’s Flickr photostream.

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New AEGIS Weapon System Contract Attracting Interest

It is possible if a Service does not change a basic system or design for several decades for one company to dominate that program receiving the majority of the revenue and earnings from it. The U.S. Navy introduced anti-air warfare cruisers in the late 1970′s equipped with the new AEGIS weapon system as a major upgrade to its ship based air defense network. The AEGIS weapon system comprises the radars, software, command and control system as well as the missile and its launcher. The original version of the AEGIS was developed and produced by General Electric (GE).

In the early 1990′s Martin Marietta purchased that part of GE when the system had been in production and use for almost twenty years. By that time the Navy had completed production of the CG-47 class cruisers and was installing the system onto the DDG-51 destroyers. Martin Marietta was soon merged with Lockheed to form Lockheed Martin (LMT) who have been the prime contractor ever since. The U.S. Navy has purchased over 40 CG-47 and 50 DDG-51 although not all remain in use. The DDG-51 remains in production.

The AEGIS systems has also been sold to Japan and Spain.

The AEGIS weapon system has undergone incremental upgrades over the years most importantly to integrate Ballistic Missile Defense (BMD) capability and using the STANDARD Missile-3 designed to conduct exp-atmospheric intercepts of missiles. All of this has added up to years of funding worth tens of billions of dollars for Lockheed.

Now the Navy is considering opening up the core contract to competition so that Lockheed may lose its hold on the business. This of course is attracting a great deal of interest from other large defense contractors as the initial contract will be worth a decent amount but down the road the contract could be worth billions.

Boeing (BA) and Raytheon (RTN) reportedly are considering submitting bids for the contract. Both have expertise in radar and missiles from a variety of other programs although Raytheon makes the STANDARD Missile used by U.S. Navy and other countries for the air and ballistic missile defense program which is part of the AEGIS system. Boeing has experience designing, integrating and operating the Ground Based Missile Defense (GMD) system based in Alaska.

The Navy of course is hoping for a better price for its support believing that competition will aid them in getting this. In the time of projected massive defense cuts competition will help the military save money in the future.

This will be major win for the company that either keeps the contract or acquires the work from Lockheed. Competition if the other companies believe they can do the work and win it should be quite fierce.

Photo from Surface Forces Flickr photostream.

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ITT Exelis Lays Offs Workers As SINGCARS Production Ends

ITT Exelis (XLS) is the defense part of the former ITT Corporation (ITT) which at the beginning of this month broke into three parts. The other two parts deal with pumps and electronics. ITT Corporation itself was created by the division of the old ITT Industries into three parts twenty years ago severing the production company from Sheraton hotels and Hartford insurance.

ITT Corporation did a lot of different things for the U.S. and other nations defense establishments including making radars, airborne jammers and radios as well as providing maintenance and other services. One of their core products was the Single Channel Ground and Airborne Radio System (SINCGARS) which became the standard tactical radio for the U.S. military and many allies. ITT and other companies under license mad tens of thousands of the radios for almost three decades. Now the SINCGARS is ending its life as the new Joint Tactical Radio System (JTRS) comes into production as well as other new systems. In June ITT received a contract to provide engineering support for the system as it will remain in service for several more years.

Even with the decision last month to end the ground radio portion of the JTRS program headed up by Boeing (BA) does not mean more SINGCARS work. The Army is planning on developing a new series of radios to fulfill the JTRS requirement rather then continue buying the legacy ITT system.

What this means is that ITT Exelis will continue to restructure its work force especially that part supporting SINCGARS. Layoffs had already been announced in the past but this week a further 200 jobs at their Fort Wayne, IN facility will be eliminated. Many of these positions were short term ones created when the last contract was awarded to cover a surge in requirements. This will bring the total jobs eliminated to over 700.

That is one of the problems with defense contracts, especially production related ones, as the military usually has a fixed number of systems to buy and will always be working on an upgrade or replacement. If the current contractor does not win the new work they will reach a point where their product is no longer needed. Gone are the days like in WW II when the U.S. and other countries could afford to have multiple systems to meet a requirement. SINCGARS is ending, JTRS and other radios is starting adn ITT Exelis has less work. Unfortunately that means less jobs.

Another unfortunate thing is that often the new work takes place at a different plant in another part of the country or world. That can bring serious economic harm to a locale. Sealy, TX is going through this after BAE Systems (BAE:LSE) lost the U.S. Army truck contract to Oshkosh (OSK) who moved the production to their plant in Wisconsin. The Texas town’s major employer now had no work and it is slowly shutting down eliminating many jobs. Sealy will probably face economic hardship for several years. Its not Oshkosh’s, the Army or BAE Systems’ fault that production moved it is just how the system works.

ITT Exelis to maintain their workforce in Fort Wayne will need to find a new product to make at that plant or see its number of employees slowly wither away. With the coming cuts in U.S. defense spending there will be many communities across the U.S. that will see the same affect as programs are reduced or ended. The U.S. economy will take a significant hit as these jobs are eliminated along with the spending.

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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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