During second-quarter earnings calls, defense technology executives highlighted an improved supply chain alongside easing labor constraints. Fixed-price development programs continue to give management teams headaches as estimating contract performance remains difficult. Executives remain diligent in facing these macroeconomic headwinds. Leaders look to remain agile by investing more in employees and technologies to address ongoing challenges and uncertainty.
Three themes emerged from the earnings calls, transcripts of which were provided by Bloomberg.
Labor conditions
Defense technology companies are finding relief from the historically tight labor conditions of the past few years. The labor market is not as tight as the previous two years have been, as shown by the payroll net change of 187,000 in July, leading to increases in available candidates. Jim Taiclet, chief executive of Lockheed Martin Corp., said his company’s “labor availability has improved significantly over the previous months, closing critical skill gaps, which has enabled sales growth.” He said Lockheed Martin is in a much better position than it was six months ago. Taiclet said the company had lower attrition and better hiring rates, and he was confident those trends would stick.
But highly skilled employees remain hard to come by. Eric DeMarco, CEO of Kratos Technologies Inc., said, “The market for the tactical employee continues to improve over the past several months … but it’s still expensive for people with very specialized capabilities.”
This viewpoint aligns with wider macroeconomic trends.
Supply chain concerns
L3Harris Technologies Inc. acquired Aerojet Rocketdyne in July. This comes after a long battle between L3Harris and the Federal Trade Commission (FTC), which centered on concerns about the company’s intentions to remain a true merchant supplier of rocket motors and engines.
Chris Kubasik, chief executive of L3Harris, said the company gave assurances to the Department of Defense that L3Harris would be a merchant supplier of rocket motors and rocket engines. Kubasik said, “I can assure you we are highly motivated to sell rocket engines and rocket motors to anyone who wants to buy them within the rules globally.”
To learn more about supply chain issues, download a copy of RSM’s supply chain report.
Other defense primes remain skeptical. Jesus Malave, chief financial officer of Lockheed Martin, said,
“The reliable access to propulsion, especially solid rocket motors is critical” and is of “critical importance for the entire aerospace and defense industry.” Malave said Aerojet Rocketdyne’s current structure is that of a merchant supplier of propulsion to the industry that treats all of the prime contractors equally. Malave said, “That’s what we feel we need to preserve even if Aerojet Rocketdyne goes into the ownership hands of another company.”
The impact of this acquisition, and its effects on the supply chain, remain uncertain.
Fixed-price development contracts
Defense technology companies continue to feel negative effects from long-standing fixed-price development contracts as companies struggle to estimate costs under this high-risk contract structure. Kubasik of L3Harris said, “We’re really going to be selective on bidding going forward, especially when the customer is asking for a fixed-price production or a low-rate production simultaneous with development.” Kubasik said that in those cases, L3Harris would push back and not bid “because it’s very hard to price something that you haven’t developed.”
Some companies have had success bidding cost-plus structures in design-and-development stages to mitigate contract risk. Kathy Warden, CEO of Northrop Grumman, said her company had worked with the government in a cost-plus structure through the preliminary design review. She said Northrop Grumman then transitioned into a fixed-price cost structure. Warden said, “We are being even more disciplined moving forward in ensuring that we work with the government to have the appropriate use of fixed-price contracts.”
In the second quarter, Mercury Systems ousted the company’s CEO, largely due to poor financial performance arising from estimation issues on development contracts. The company’s interim CEO, Bill Ballhaus, said, “Our engineering, our program management, and some of those other critical process areas and functions didn’t mature at a rate that we grew as we acquired these programs.” Ballhaus said Mercury Systems was working its way through the issue.
Companies will need to focus on both contracts and estimation systems to engage the government with contract types that align with business risk, especially as the supply chain remains dynamic as ever.
The takeaway
Defense technology companies are experiencing some relief from tight labor conditions, with improved availability of skilled employees, reduced attrition and better hiring rates. However, the supply chain continues to pose challenges and uncertainties, while fixed-price development contracts keep pressure on profitability. We expect defense technology companies to be more diligent in developing mature designs before moving to fixed-price contracts to mitigate the risk of declining profits.
Zach Phillips contributed to this article.
