Defense contractors buck expectations

July 24, 2013

General Dynamics and Northrop Grumman, two of the region’s largest defense contractors, reported Wednesday an uptick in profits during the past three months despite a decline in government spending.

Both of the Falls Church-based companies cautioned that the automatic spending cuts related to the sequester could take a greater toll on their bottom lines in the future, but they were upbeat about their performance so far and raised their profit expectations for the rest of the year.

General Dynamics’ profit grew about 1 percent during the second quarter to $640 million, while revenue was flat. Northrop Grumman’s profit increased 1.7 percent during the quarter, reaching $488 million, while revenue grew slightly to $6.3 billion.

Their results largely echoed those of Bethesda-based Lockheed Martin, the country’s largest defense contractor, which reported a 10 percent jump in quarterly profits Tuesday and raised its profit expectations for the year.

The defense industry had warned that sequestration would have dire consequences for the industry — and the economy overall. But, so far, the industry has weathered the budget cuts with far more ease than expected. Many, including Northrop and General Dynamics, have gradually shrunk their workforce in the past few years in anticipation of spending cuts, helping them manage the current budget woes.

“They just weren’t as bad as people feared,” said Christian Mayes, an analyst with the financial services firm Edward Jones. But, Mayes added, “2014 — that’s still a big question mark, and we won’t get much color on that until later this fall.”

General Dynamics is focused on staying on schedule with its various contracts, which include building ships and tanks for the military, Phebe Novakovic, the company’s chief executive, said in a conference call with analysts. That may be the best way to avoid becoming a target of budget cuts later on, she said.

“The best antidote to a budget cut is performance,” Novakovic said. “Bears eat the sick and the young first. So we are very focused on maintaining our good execution on each of our programs because without that execution, you become more vulnerable.”

The industry is not out of the woods, she said. “If sequestration’s impact this year becomes more draconian than we can currently envision or a [temporary budget] is implemented in a more rigid fashion than we can anticipate, we will revise our estimates,” Novakovic said.

Some parts of the contracting industry are beginning to see spending tightened.

At General Dynamics, growth in its aerospace unit, which includes commercial aircraft, helped offset losses in the company’s traditional defense units, including combat systems.

At Northrop, the company’s information technology unit saw a big drop in profits, while aerospace systems, which provides parts for fighter jets, continued to see profits rise. Contracts for services such as engineering support or administrative help generally are not booked as far in advance as contracts for weapons systems such as fighter jets and ships.

Wes Bush, chief executive of Northrop, said in a conference call with analysts that company executives “believe that sequestration . . . will increasingly harm the defense industrial base over time.”

In particular, he pointed to concerns about the government’s civilian workforce, which is facing furloughs.

“If anybody thinks that has no impact, they’re not thinking about it with a clear head,” Bush said. “Trying to predict exactly what the impact of these furloughs will be is a very difficult thing.”

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