Contractors seeking coping mechanisms for budget cuts

April 28, 2013

Even though sequestration is not yet taking a serious toll on the balance sheets of defense contractors, companies spent plenty of time last week talking about their diversification plans.

The pressure is on to find new sources of revenue, as contractors brace for tougher times. For some of the largest defense contractors — which last week reported slightly declining sales in the first quarter — that meant talking up their plans to sell more weapons to foreign countries.

“We do know that our core domestic defense business will flatten [and] potentially decline,” said Marillyn A. Hewson, Lockheed Martin’s president and chief executive, in a call with analysts last week. “What we’re focused on is growing our international business.”

She said about 17 percent of Lockheed’s sales were international last year; the company plans to grow that to 20 percent in the coming years.

At contracting rival General Dynamics, executives also saw opportunities for growth in international work.

Phebe N. Novakovic, the defense contractor’s chairman and chief executive, said international sales would help the company’s combat systems unit handle domestic spending cuts. The unit builds military vehicles and tanks, a booming business during the war that has suffered as the military moved out of Iraq and Afghanistan.

“We have very, very nice and robust international orders that ought to bridge [the business] until the [U.S.] Army begins to recapitalize,” she said.

Christian Mayes, an industrial analyst with Edward Jones, said international work is becoming an increasing focus for U.S. defense companies.

“International sales are smaller than U.S. sales, but they’re growing,” he said. “You may have some slowdown in Europe, but places like the Middle East and Asia are seeing increased demand.”

At the same time, companies are taking on more commercial ventures. Bethesda-based Lockheed, for instance, has announced plans to build a renewable energy power plant off the coast of China and is moving forward with a water purification technology known as Perforene.

Still, Hewson downplayed these ventures’ short-term impact.

“These are not needle movers in the near-term,” she said. “Our top-line growth will be on our core and near adjacencies, both domestically and internationally.”

Executives at Falls Church-based Northrop Grumman were less optimistic about moving into new areas — which companies typically describe as “adjacent markets.”

“The experience of our industry suggests that the longer you have to stretch out your tape measure to measure how adjacent it is, the less likely it is that you’re going to really create value,” said Wes Bush, Northrop’s chairman, chief executive and president. “You have to be very thoughtful both around the practical application of the technology and a company’s ability to understand and navigate the channels to market.”

Both he and Hewson said partnerships may be a promising approach; Lockheed, for instance, is teaming up with a Chinese company on its power plant and is looking for a partner to help it commercialize Perforene.

For contractors determined to improve profits despite spending cuts, the contracts they don’t pursue are as important as the ones they do.

Novakovic said General Dynamics is seeing more competitions based on price, and is choosing not to participate in some of those.

“We [are] not going to participate in a race to the bottom,” she said. “In those instances where we don’t believe there is sufficient price permitted in a particular bid or contract, we’re going to walk away.”

Northrop, too, has vowed to stay away from contracts that don’t provide enough profit.

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April 28, 2013

Even though sequestration is not yet taking a serious toll on the balance sheets of defense contractors, companies spent plenty of time last week talking about their diversification plans.

The pressure is on to find new sources of revenue, as contractors brace for tougher times. For some of the largest defense contractors — which last week reported slightly declining sales in the first quarter — that meant talking up their plans to sell more weapons to foreign countries.

“We do know that our core domestic defense business will flatten [and] potentially decline,” said Marillyn A. Hewson, Lockheed Martin’s president and chief executive, in a call with analysts last week. “What we’re focused on is growing our international business.”

She said about 17 percent of Lockheed’s sales were international last year; the company plans to grow that to 20 percent in the coming years.

At contracting rival General Dynamics, executives also saw opportunities for growth in international work.

Phebe N. Novakovic, the defense contractor’s chairman and chief executive, said international sales would help the company’s combat systems unit handle domestic spending cuts. The unit builds military vehicles and tanks, a booming business during the war that has suffered as the military moved out of Iraq and Afghanistan.

“We have very, very nice and robust international orders that ought to bridge [the business] until the [U.S.] Army begins to recapitalize,” she said.

Christian Mayes, an industrial analyst with Edward Jones, said international work is becoming an increasing focus for U.S. defense companies.

“International sales are smaller than U.S. sales, but they’re growing,” he said. “You may have some slowdown in Europe, but places like the Middle East and Asia are seeing increased demand.”

At the same time, companies are taking on more commercial ventures. Bethesda-based Lockheed, for instance, has announced plans to build a renewable energy power plant off the coast of China and is moving forward with a water purification technology known as Perforene.

Still, Hewson downplayed these ventures’ short-term impact.

“These are not needle movers in the near-term,” she said. “Our top-line growth will be on our core and near adjacencies, both domestically and internationally.”

Executives at Falls Church-based Northrop Grumman were less optimistic about moving into new areas — which companies typically describe as “adjacent markets.”

“The experience of our industry suggests that the longer you have to stretch out your tape measure to measure how adjacent it is, the less likely it is that you’re going to really create value,” said Wes Bush, Northrop’s chairman, chief executive and president. “You have to be very thoughtful both around the practical application of the technology and a company’s ability to understand and navigate the channels to market.”

Both he and Hewson said partnerships may be a promising approach; Lockheed, for instance, is teaming up with a Chinese company on its power plant and is looking for a partner to help it commercialize Perforene.

For contractors determined to improve profits despite spending cuts, the contracts they don’t pursue are as important as the ones they do.

Novakovic said General Dynamics is seeing more competitions based on price, and is choosing not to participate in some of those.

“We [are] not going to participate in a race to the bottom,” she said. “In those instances where we don’t believe there is sufficient price permitted in a particular bid or contract, we’re going to walk away.”

Northrop, too, has vowed to stay away from contracts that don’t provide enough profit.

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