With no guarantees that Congress will block deep new defense spending cuts scheduled to kick in early next year, major defense contractors and their suppliers are bracing for the worst.
- Lockheed Martin Corp., the Defense Department’s largest supplier, said this week that it may have to shut down at least 10 percent of its weapons production next year, forcing massive layoffs and wreaking havoc with suppliers who could miss out on hundreds of millions of dollars of business.
- Boeing Co. says it has begun paring its workforce, consolidating manufacturing facilities and cutting overhead. The company’s defense division already shed about 8,000 of 60,000 jobs during the past 18 months.
- General Dynamics says it fears substantial losses in its Information Science and Technology products division, especially if the government cuts corners or puts off purchasing Internet software and cyber protection programs, which now seems the case.
These warnings are part of a sophisticated industry campaign to force Congress and the Obama administration to grant the Pentagon and its contractors a reprieve from the more than $500 billion of automatic cuts in the defense budget that are looming on the horizon.
Industry executives are talking among themselves about pressuring the president and lawmakers by announcing plans for layoffs shortly before the November election. The federal Worker Adjustment and Retraining Notification Act (WARN) requires major employers to provide notice 60 days in advance of plant closings and mass layoffs.
“We are at a point in time when the fog of uncertainty is as deep as it ever has been,” said Fred Downey of the Aerospace Industries Association, representing 350 defense and aerospace contractors and businesses. “Presumably the Pentagon is going to have to slow down, spread out or even cancel programs.”
Some critics say industry executives are exaggerating the short term adverse effect of sequestration, and that there are many ways that companies like Lockheed and Boeing can blunt the impact of the cuts.
Yet virtually every defense program and project other than those directly related to overseas combat could be cut by 15 percent next year, resulting in potential widespread industry layoffs and declining revenues. Moreover, CEOs of major defense contractors will be obliged by Securities and Exchange Commission regulations to begin disclosing as early as next month projected business losses or significant downturns.
Dennis Muilenburg, president and CEO of Boeing, said earlier this month that Boeing’s military business would be in serious jeopardy if the automatic cuts take effect. “We have thousands of suppliers in our global network that support our defense and commercial business, and the ripple effect to second- and third-tier suppliers would be very significant,” Muilenburg said during a news conference in Singapore.
DRIVING TOWARD THE FISCAL CLIFF
Lawmakers and fiscal policy experts are voicing deep concern that the nation is headed for a cataclysmic fiscal cliff by the end of the year when more than $1 trillion of automatic spending cuts – equally divided between defense and domestic programs – are scheduled to begin. At the same time, Bush era tax cuts and other tax breaks are set to expire. The Congressional Budget Office, Federal Reserve Chairman Ben Bernanke and other policy experts warn that the combination of the deep spending cuts and the sudden surge in taxes could spur another recession.
The automatic, across the board spending cuts – known as sequestration – were approved by Congress and the Obama administration last July as part of major legislation to raise the debt ceiling while reducing the long term deficit. The Budget Control Act requires $1.2 trillion in automatic cuts over the next decade, with the first $109 billion taking effect January 2, 2013.
But since then, many Republican and Democratic lawmakers, Defense Department officials and budget experts have come to regret the action – fearing that it will lead to a hollow military force and pose hardships for members of the military and their families. Last month, the GOP-dominated House passed legislation that would spare the Pentagon the additional cuts while shifting the burden of savings completely to domestic social programs.
The Bipartisan Policy Center warned in a recent report that the deep savings would greatly add to the country’s economic woes by slowing growth and wiping out more than a million jobs – without putting a dent in the federal debt.
Moreover, the study cautioned that all of the uncertainty about how the sequester will impact the defense industry will have “a paralytic effect.” Unsure of how much in funds they will have available in the coming years, the report said, “program managers at the Pentagon are already delaying signing contracts and slowing the procurement process.”
INTERNAL RESTRUCTURING IS NOT ENOUGH
Lockheed Martin is a case in point. Bob Stevens, the chief executive, said earlier this week that further cuts required under sequestration – on top of the $487 billion of cuts already slated to take effect over the next decade – would cause massive disruption across the defense industry, leading to extensive layoffs, shuttering of plants and an erosion of quality.
Stevens also warned that Lockheed Martin could face hundreds of millions of dollars in business claims from suppliers if the company is forced to cancel orders or renegotiate contracts with its vast array of suppliers. Many of those smaller companies have signed fixed-price contracts with Lockheed, and would demand that the company make good on its promises. “We’re talking about very substantial amounts of money in claims and requests for equitable adjustment for business disruption,” Stevens told Reuters.
At the same time, Lockheed Martin executives said they were trying hard to reduce the cost of the F-35 Joint Strike Fighter program, the Pentagon's biggest weapons program, but ultimately needed bigger order volumes to make the program affordable.
Boeing spends about $40 billion annually in purchasing materials and products from more than 18,500 businesses and vendors throughout the country. The company estimates that it supports 1.3 million supplier-related jobs. Muilenburg told reporters that Boeing’s defense business has been able to offset cuts in the military budgets of the U.S. and European countries by increasing sales to militaries in Asia and the Middle East.
Last April, General Dynamics chairman and chief executive officer Jay Johnson told analysts and reporters, “We are doing everything in our control to position our defense businesses for the declining budget headwind, including continuous improvement initiatives, restructuring, divesting non-core businesses, and headcount reductions.”
While those measures have enabled General Dynamics to maintain defense earnings last year despite declining sales, the company is facing a rocky road with its information science and technology products because of the threat of sequestration.
For example, the government has delayed orders of encryptors – electronic devices that protect classified information as it is transmitted through networks, according to the company. General Dynamics supplies about 85 percent of all encryptors purchased by the Pentagon, and the volume of purchases on that product line has declined this year from previous years’ levels, according to Rob Doolittle, a spokesman for Boeing.
STILL, THERE’S FAT
Some defense budget experts believe there is still plenty of fat in the defense budget, and that industry officials are exaggerating the extent of the problem – especially since the first installment of the defense cut in January will total $50 billion in a $520 billion overall defense budget.
“I think they are basically using the kind of the scare tactics that many lobbying groups unfortunately use in terms of trying to get a point across,” said Lawrence Korb, a veteran defense analyst and senior fellow at the Center for American Progress. “If you take the $50 billion in cuts for next year, it brings you back to where you were in 2007, the next to the last year of the Bush Administration. Also, they can play some games” with the supplemental funds for the Afghanistan and Iraq war effort to blunt the impact of the cuts.
What’s more, the cuts will be made in budget authority for future procurements and project, not immediate outlays of federal funds – meaning there should be a substantial backlog of government projects for defense contractors to turn to. “Money that already has been authorized you can spend, and particularly in procurement money, it’s very rarely ever spent the first year,” Korb said. “So they have a pretty good backlog of things that they can spend the money on.”
A senior executive of a manufacturing company that does substantial business with the Pentagon agreed that his company would suffer little if any short term harm from the sequestration, largely because his company has a substantial backlog of work and can cut back on overtime if necessary to respond to declining work orders.
“Our backlog takes us well into 2013,” said the executive, who declined to be identified in order to speak candidly. “So for us, to put a warn notice out in November would be disingenuous.