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General Dynamics blames $2 billion loss on defense cuts

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One of the nation’s largest federal contractors reported a $2 billion loss Wednesday and blamed it on defense cuts, a sign that the government spending that provided the rocket fuel for the metro area’s decade-long economic expansion is now dissipating.

General Dynamics, based in Falls Church, said it was devaluing its information technology business by $2 billion amid falling government demand. The announcement was particularly worrisome because IT contracting is the key ingredient to the metro area’s government-powered growth.

Information technology appears to be one of the first segments of the private sector to sustain tangible damage from federal budget cuts — because it’s easier for the government to stop rewiring offices than it is to stop building a ship or a tank.

The region’s dependence on government IT, and contracting in general, makes it particularly vulnerable to the spending reductions put in place by President Obama and Congress over the past two years. Government procurement spending in the area grew by double digits from 2000 to 2010. In 2012, it shrank by 5.5 percent.

There’s a certain symmetry to the timing: All that federal spending pushed the Washington region to the top of the list of major U.S. metropolitan areas for job creation after the Great Recession, and it helped fill office parks along the Dulles Toll Road and elsewhere with well-paid white-collar workers.

Now, as growth is slowly picking up in many other cities, federal budget-tightening is dampening the economic outlook here.

Rapid government expansion “was dragging everything else along with it” in the local economy, said Stephen Fuller, director of George MasonUniversity’s Center for Regional Analysis. The sudden contraction “was like hitting a wall,” he said, adding: “This is a new way of life that we have to get used to.”

New, but not unexpected.

Economists have warned regional leaders that a shift in federal spending was coming. Defense contractors have been preparing for a military budget that’s expected to shrink as the wars in Iraq and Afghanistan wind down. The Pentagon budget is facing a reduction of $487 billion in projected spending over 10 years, the result of an agreement reached by Congress and the White House in 2011.

Local contractors are already feeling the hit.

The size of the loss at General Dynamics stunned some analysts who have grown accustomed to years of steady profits at the company.

Over the past year, the luster of providing basic services to the federal government, in particular, has been wearing off. Profits shrank. Some firms began to seek an exit.

At Northrop Grumman, a major rival of General Dynamics, some IT contracts now provide such little profit that executives are refusing to bid on them. Northrop Grumman and Lockheed Martin, another leading contractor, will report their earnings in the coming days.

General Dynamics went in a different direction, buying up a slew of smaller IT contractors. Wednesday, the company’s new chief executive, Phebe Novakovic, was highly critical of the approach.

“We are not pleased with the considerable decline in margins in this group,” Novakovic said. “The performance was disappointing at best.” She added that she would not have allowed the company to go through with some of the acquisitions.

Without the loss in the IT division, the company would have had fourth-quarter earnings of $491 million. A year ago, the company reported $603 million in fourth-quarter profits.

Overall, Fuller calculates that defense procurement in the Washington metro area dropped from $39.5 billion in 2011 to $36.9 billion last year, a nearly 7 percent drop.

Next year looks worse, particularly in IT. The Pentagon plans to spend $32 billion on IT contracts across the entire country in fiscal 2013. That’s down from $37 billion in 2012.

The drop reflects a shift from large-scale IT modernization programs that can take several years complete to shorter-term projects, such as implementing a Web-based e- mail system. The government also is trying to save money by combining computer systems — for payroll, budgets and other functions — among agencies.

All those changes hurt metro area contractors, giving them less certainty about future work.

Among contracting firms specializing in larger projects such as weapons manufacturing, “you’re probably two years out before you start to see the impact” of budget cuts, said William Loomis, managing director at the financial services firm Stifel Nicolaus. “The shorter-cycle businesses see the impact earlier.”

Economists don’t expect the budget cuts currently coming into effect to drag the metro area into recession, unless the federal fiscal situation deteriorates considerably. That’s partly because government largess has built a foundation of prosperity in the area. The local housing market, for instance, remained relatively calm even as real estate in other regions melted down during the financial crisis. Washington’s regional unemployment rate is at 5 percent, nearly three percentage points below the national rate.

Even with the cuts now hurting contractors, “we’re going to still look pretty good here, because we have such a strong base,” Fuller said. “We still have $170 billion in federal money in the local economy. It’s not that they’ve taken it all away. It just isn’t growing as much.”

What could really damage the area — what Fuller calls “the end-of-the-world kind of hit” — would be if lawmakers allow $85 billion in “sequester” cuts, split between defense and non-defense programs, to go through in March as planned. Those cuts would reduce federal spending — and procurement — at a much faster clip than the current reductions.

Fuller estimated last July that the sequester cuts would destroy some 450,000 jobs across Virginia, Maryland and the District of Columbia.

Lisa Rein contributed to this report.

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