Defense Industry Struggles With Uncertainty Over Looming Cuts

WASHINGTON—Sequestration: The mere mention of the word sends chills down the spine of America’s defense contractors. The $1.2 trillion of across-the-board spending cuts scheduled to go into effect Jan. 2, 2013, is looming large. With no alternative solution in sight, the defense industry is struggling to deal with the uncertainty.

“With just 167 days remaining until it is triggered, we have little insight as to how sequestration will be implemented … no insight into which programs will be curtailed, which sites will be closed, which technologies will be discontinued, or which contracts will be reformed,” Robert Stevens, chairman and CEO of Lockheed Martin, told the House Armed Services Committee at a hearing July 18.

Sequestration, or automatic cuts to discretionary spending, was planned as part of the Budget Control Act of 2011. It was the result of a political standoff in Congress over how to deal with the $17 trillion deficit.

The automatic cuts, so abhorrent to both Democrats and Republicans, were intended to force the two sides to compromise.

At the time the cuts were a distant threat, but the clock has been ticking and still a compromise has not been reached. Senate democrats indicated this week that they may be prepared to breach the fiscal cliff, Jan. 1, in order to force an agreement.

Until a decision is made, “companies are required to assess and plan according to the law—and sequestration is the law right now,” Howard “Buck” McKeon (R-Calif.), chairman of the Armed Services Committee, reminded the witnesses. But with no details about how the cuts will be put into effect, planning ahead is a real challenge for the industry.

Under sequestration, defense will be hit hard, with half a trillion dollars to be cut over 10 years. Secretary of Defense Leon Panetta described the process as taking a “meat axe” to the department. It is estimated that 1.5 million jobs will be lost and U.S. defense forces will shrink to the smallest ground force and navy in decades, and the smallest air force in history, McKeon said in his opening statement.

Based in nearby Maryland, Lockheed Martin is one of the largest defense contractors in the world, with around 80 percent of its revenues coming from military sales.

Stephens told the hearing that his company’s size and status would not immunize it against the effects of sequestration. With disruptions to programs and the company’s 120,000 employees worldwide to think of, Stephens said he had no idea how many people would lose their jobs or how many suppliers would be affected, but described the impact as potentially “devastating.”

“We fear our industry—which is a crown jewel of the American economy—will suffer a loss of learning, a depletion of talent, and erosion in quality,” he said.

While defense industries have received little guidance on the mechanics of the sequestration process, witnesses at the hearing said they did know that their obligations under the WARN Act requires them to give 60 days’ termination notice to their employees, in most states, and 90 days in New York.

“That establishes a framework where we’re compelled to start talking to our employees and our 40,000 suppliers, who want to know, “Am I going to have a job in January?” and “Am I going to have a contract in January?” Stephens said.

House committee members noted that employment termination notices would have to be given before the November general elections.

Sean O’Keefe, chairman and CEO of EADS North America, said the survival of subsidiary industries was also a concern.

EADS is a large multinational aerospace and defense company, makers of the Airbus and Eurocopter, they rely on a network of small-to-mid-cap businesses for parts, technology, and innovation.

“Small business suppliers tell us that they are already preparing to trim payrolls, that they are not creating new jobs because of the anticipation of sequestration, and that many are gearing up to leave the federal and defense market space all together,” O’Keefe told committee members.

David Hess, chairman of the Aerospace Industries Association (AIA), and president of military engine manufacturer, Pratt and Whitney, echoed O’Keefe’s fears.

Because of the complex nature of the aeronautics industry, companies need to makes plans and sign contracts with parts suppliers years before production is scheduled to begin. Critical investment in research and development is often put into place five or more years in advance. In this uncertain environment, companies are already limiting hiring and halting investments.

“At our sister division, Sikorsky, the leadership has already indicated that in this environment, if they had to choose right now how to invest internal R&D dollars between commercial and defense programs, they would choose commercial programs because of the uncertainty with the defense budget,” Hess said.

The industry leaders also expressed concerns about the legal ramifications if they were forced to renege on contracts as a result of the cut backs.

If triggered, sequestration is going to mean hard times for the defense industry, but with all the confusion and legal ramifications, it is going to be “great for attorneys,” O’Keefe said.

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