Defense contractors report mixed results as they gird for ‘fiscal cliff’

October 24, 2012

The nation’s largest defense contractors reported mixed financial results Wednesday as the companies continue to take steps to safeguard against possible federal budget cuts associated with the “fiscal cliff.”

General Dynamics and Northrop Grumman said they are hanging on to more cash as part of a strategy to remain as flexible as possible in an unsteady business environment. Lockheed Martin, which has already pared back its payroll, had $4.6 billion in cash on its books at the end of the third quarter.

General Dynamics also said Wednesday that it did not execute any share buybacks this quarter, because of what chief executive Jay L. Johnson called the “fog bank” surrounding the federal budget.

“I would rather keep [the cash] in my quiver right now,” Johnson said in a conference call with investors.

All three companies reported largely solid third-quarter earnings, which analysts attributed to high profit margins on existing programs.

But at the core of their concerns is the process called “sequestration,” the series of automatic budget cuts looming at the first of the year that would hack about $55 billion out of Pentagon programs next year. The combination of government spending cuts and tax increases set to take effect in January have become known as the “fiscal cliff.”

“This would certainly impact sales and profits and cash flows, but we are all as concerned about what it would mean to the stability of the programs,” Wes Bush, chairman and chief executive of Northrop Grumman, said in a call with analysts and investors.

Bush said it was likely that his company’s services business would be the first to feel the effects of such cuts because those contracts tend to be for shorter terms compared with those for its aerospace and other businesses.

Bush said he is also worried about the time it would take for his government customers to sort out how to implement the cuts.

“Just the pure mechanics of that process would be daunting,” Bush said.

Northrop Grumman reported a decline in revenue in its third quarter, down to $6.3 billion from $6.6 billion last year. Its profit fell to $459 million from $520 million.

Johnson, of General Dynamics, told investors Wednesday that he is troubled by the “indiscriminate” nature of the planned spending cuts and that because of them his company is having difficulty planning for next year.

“Given the lack of planning to date, however, we are also extremely concerned about the profound disruption and paralysis that implementing these cuts will likely have on our [government] customer and thus our entire industry,” Johnson said.

Revenue was up at General Dynamics, from $7.85 billion to $7.93 billion, but the firm’s profit dipped to $600 million from $652 million. A bright spot for the company was its aerospace unit, which was boosted by strong demand for its Gulfstream aircraft.

In its earnings report, Lockheed Martin issued a corporate outlook for 2013 that was based on the premise that Congress would prevent sequestration from taking effect. Still, the company stressed that it was unsure whether that would be the outcome.

Robert J. Stevens, Lockheed’s chairman and chief executive, said he is not just worried about the effects of this policy on his own workforce; he is concerned about the potential fallout for smaller companies in his supply chain.

Though the company has already said it will not issue warning notices to its workers this year about the possibility of layoffs due to budget cuts, it said those notices still could be issued next year if conditions warrant.

Lockheed’s chief financial officer, Bruce J. Tanner, reiterated the company’s opposition to sequestration.

“Across-the-board cuts are really not an effective way to reduce spending,” Tanner said.

Lockheed had a relatively strong quarter, pulling in a profit of $727 million, up from $700 million last year. It posted $11.9 billion in revenue, a decline from $12.1 billion the previous year.

However, it projects that its sales will decline at “a low single digit rate” next year. This is mostly due to weakness in its information systems and global solutions unit.

So while the industry is clearly on edge about the fiscal cliff, the predicament has not yet taken a toll on the big defense contractors.

“I think the common thread here is that all of the companies continue to execute quite well on their programs,” said William R. Loomis, managing director at the Stifel Nicolaus investment firm. “There are no big, troubled programs that are hurting results.”

Richard L. Whittington, a senior equity research analyst with the investment firm Drexel Hamilton, said the strategy of sitting on cash is a smart one, even if sequestration is avoided.

“Government spending is going to go down significantly, regardless of what party resides in the White House,” Whittington said.

Sarah Halzack is a reporter and Web editor for Capital Business. She covers the local job market and the business of talent and hiring. She occasionally writes for other sections at the Post, most frequently in the form of dance reviews, dance features, book reviews and obituaries.
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