Bloomberg News

Pentagon Cuts Hit Accounts That Pay Lockheed to Raytheon

March 04, 2013

Pentagon Cuts Hit Funds Paying Lockheed to General Dynamics

An employee descends scaffolding surrounding a U.S. Navy Littoral Combat Ship (LCS) under construction at Marinette Marine Corp., in Marinette, Wisconsin, on Feb. 11, 2013. Marinette Marine Corp. makes one version of the Littoral Combat Ship in partnership with Lockheed Martin Corp. Photographer: Daniel Acker/Bloomberg

The Pentagon has offered little guidance to contractors that may be hurt by $46 billion in defense-spending cutbacks over the next seven months, even as a budget document showed the effect on procurement accounts that pay companies from Lockheed Martin Corp. (LMT:US) to Raytheon Co. (RTN:US)

Pentagon Comptroller Robert Hale urged defense contractors to be patient and “stay with us” as the military imposes across-the-board cuts under the process called sequestration that took effect on March 1.

“I can’t sit here and tell you you will be unaffected,” Hale said, addressing contractors in an interview with Bloomberg Television’s Peter Cook for “Capitol Gains” that aired yesterday. “You will. We will try to communicate with you as best we can.”

With the exception of military pay, which is exempted, every Pentagon account will be cut by 7.8 percent from planned full-year levels, the White House’s Office of Management and Budget said in a report to Congress as sequestration began. The defense cuts are effectively 13 percent because they are being squeezed into the seven months remaining in the fiscal year, according to the budget office.

The cuts apply to funds from this fiscal year that aren’t yet obligated under a contract as well as unspent money from previous years. Defense programs would be reduced by about $500 billion over nine years from planned levels if sequestration stays in place.

Directly Affected

Contractors will be “affected very directly,” Deputy Defense Secretary Ashton Carter told reporters at the Pentagon on March 1, because the cuts may result in “fewer weapons systems in a contract than we anticipated were going to be put in a contract.”

Hale said signed contracts would be affected only in rare cases “because we would experience heavy cancellation charges.”

“If there are options in the contract, they may not get picked up” or would be extended at lower levels, he said. “Certainly, new contracts would have to be reconsidered.”

This fiscal year, the Pentagon had planned to buy 29 F-35 jets built by Bethesda, Maryland-based Lockheed. “Under the current circumstances, we would probably end up reducing the buy size by several,” Hale said. The F-35 is the costliest U.S. weapons system.

Huntington, Austal

The Navy will begin negotiating contract modifications that may scale back funding for Virginia-class attack submarines, nuclear reactors and Joint High-Speed Vessels, according to a March 2 memo from Navy Secretary Ray Mabus posted on Navy Live, the Navy’s blog.

The reductions would hit the Navy’s two submarine builders, Huntington Ingalls Industries Inc. (HII:US) and General Dynamics Corp. (GD:US) Babcock & Wilcox Co. based in Charlotte, North Carolina, which makes nuclear reactors, and Austal Ltd. (ASB) based in Henderson, Australia, which makes the Joint High-Speed Vessel, also would be affected.

Among specifics in the budget office’s report relevant to defense contractors, the Navy’s aircraft account has $20.8 billion, including $2.91 billion in unobligated funds from prior years. A 7.8 percent reduction equals $1.62 billion from the account that pays for aircraft made by Boeing Co. (BA:US), Northrop Grumman Corp. (NOC:US) and Lockheed.

General Dynamics, Raytheon

Similarly, the Navy’s $22.5 billion shipbuilding and conversion account, including $7.5 billion in unobligated dollars, would be reduced by $1.75 billion. The dollars go to ships and systems built by Huntington Ingalls, Falls Church, Virginia-based General Dynamics, Lockheed, Raytheon and Austal.

The Air Force’s aircraft procurement fund holds $22.8 billion, including $9.75 billion from prior years. The account bankrolls Lockheed and Boeing jets and drones built by General Atomics based in San Diego and Falls Church, Virginia-based Northrop Grumman. This account will take a $1.78 billion reduction.

The Air Force’s $6.6 billion missile account, which pays for air-to-air missiles made by Waltham, Massachusetts-based Raytheon, as well as satellite-guidance kits for bombs from Chicago-based Boeing and Lockheed Martin cruise missiles, is reduced by $514 million.

Boeing, United Technologies

The Army’s $7.4 billion aircraft account, which primarily pays for helicopters built by Boeing and United Technologies Corp. (UTX:US)’s Sikorsky Aircraft unit, is reduced by $576 million.

The Pentagon may get more leeway in apportioning the cuts. The Republican-led House may begin consideration on March 6 of legislation to fund the government for the remainder of the fiscal year. A provision would ease the requirement to apply equally steep cuts to every Pentagon account.

It’s “not going to undo sequestration, but it is going to add flexibility and it is going to update the categories,” Representative Mac Thornberry of Texas, a Republican member of the House Armed Services Committee, said at a news conference on March 1.

For now, the Pentagon has taken few immediate steps to reduce procurement spending. In fact, the Defense Department and Lockheed reached agreement the day before sequestration began on a $333.7 million downpayment to buy initial parts, components and materials for an eighth batch of F-35 jets.

F-35 Sheltered

The contract obligated those funds, sheltering them from sequestration. The move underscored the Pentagon’s commitment to Lockheed and the F-35 even after the estimated cost for a fleet of the planes has ballooned to $395.7 billion, a 70 percent increase since 2001.

In one cost-cutting action, the Navy has delayed indefinitely a $3.3 billion refueling and overhaul of the aircraft carrier USS Abraham Lincoln. The move may cost jobs at Newport News, Virginia-based Huntington Ingalls, the only U.S. builder of carriers.

The Defense Department has warned that sequestration will undercut the readiness of U.S. forces, and new Defense Secretary Chuck Hagel said March 1 that the Air Force would immediately reduce flying hours and that “the Army will curtail training for all units except those deploying to Afghanistan.”

Making Adjustments

Hagel stopped short of the dire language used by his predecessor, Leon Panetta, who had talked of an approaching fiscal “doomsday.”

“We will manage these issues,” Hagel said. “These are adjustments. We anticipated these kinds of realities, and we will do what we need to do to ensure the capabilities of our forces.”

He expressed confidence that Obama and lawmakers will reach consensus “at some point to avert tremendous damage” to the U.S. military.

Defense analysts such as Todd Harrison of the Center for Strategic and Budgetary Assessments say the Pentagon has exaggerated the effect of the cuts.

“This is relatively mild compared to some previous drawdowns in defense spending,” Harrison said March 1 on a conference call with reporters. “This is bad policy, this is not a way to run your government, but this is not going to make us a second-rate power by any means.”

To contact the reporters on this story: David Lerman in Washington at dlerman1@bloomberg.net; Tony Capaccio in Washington at acapaccio@bloomberg.net

To contact the editor responsible for this story: John Walcott at jwalcott9@bloomberg.net


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Companies Mentioned

  • LMT
    (Lockheed Martin Corp)
    • $169.33 USD
    • -0.67
    • -0.4%
  • RTN
    (Raytheon Co)
    • $92.49 USD
    • -0.79
    • -0.85%
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