Executives in the defense technology industry are grappling with a host of challenges including labor shortages, inflation, supply chain delays and an extended continuing resolution from Congress. But even as they work through these challenges, the executives remain energized about opportunities—particularly those involving hypersonics.
The executives shared their perspectives recently in earnings calls that discussed their companies’ fourth-quarter results. The companies represented were L3Harris Technologies (LHX); Teledyne Technologies (TDY); BWX Technologies (BWXT); Maxar Technologies (MAXR); Mercury Systems (MRCY); Kratos Defense and Security Solutions (KTOS); General Dynamics (GD); Raytheon (RTX); and Lockheed Martin (LMT).
While each company told its own story, five key themes emerged from the calls, according to transcripts provided by Bloomberg:
The labor shortage is not going away. Mark Aslett of Mercury Systems called the labor market “challenging,” Gregory Hayes of Raytheon talked about the difficulty of finding skilled workers, and Phebe Novakovic of General Dynamics noted some pockets of wage increases.
But executives expressed confidence in their ability to hire, train and retain employees thanks to significant investments in their workforces.
Novakovic emphasized the importance of efficient training programs to support accelerated hiring at General Dynamics. She noted that General Dynamics has had elevated levels of hiring before and has proven its ability to effectively equip and train new employees.
According to Christopher Kubasik of L3Harris Technologies, his company hired 8,000 people last year and may hire another 8,000. He cited some wage inflation at the entry level but noted that with a large portion of the company’s workforce in the fast-growing states of Florida and Texas, geography has so far worked to their advantage.
Mark Aslett was sure to note Mercury Systems’ efforts to “evaluate and influence initiatives aimed at attracting top talent.”
While most executives expressed confidence that they were employers of choice, this confidence appears to be the result of significant time, attention and investment from leadership.
Prices continue to increase. Robert Mehrabian of Teledyne Technologies expects price increases from suppliers roughly in the 2% to 3% range. Hayes also expects inflationary pressure across Raytheon’s business units with the hope of partially offsetting it through productivity improvements.
Executives expect inflationary pressures to continue.
Kubasik similarly emphasized L3Harris’ attempt to offset inflation pressures through productivity enhancements like “factory optimization, engineering excellence, and supply chain and overhead management.”
In addition to productivity enhancements, executives also mentioned passing increased costs along to their government customers when able and by leaning on long-term supplier contracts that are already in place.
Rex Geveden explained the visibility that BWXT Technologies has into raw materials pricing thanks to pricing agreements that extend for multiple quarters. The company continues to monitor pricing and inventory needs closely so that it is prepared to negotiate adequate protection when the time comes to sign new agreements. Hayes also noted that with Raytheon, a “significant portion” of its material spending is under long-term agreements.
The domino effect of long lead times
Supply chain issues from prior quarters are starting to sort out. But long lead times for certain component parts are creating a domino effect.
Eric DeMarco, chief executive of Kratos, cited aluminum in particular during his earnings call on Feb. 22. He said that the five aluminum smelters in the United States are booked out for two to three years. He went on to say that, even worse, some suppliers have not notified Kratos of multi-month delays until the week they were originally scheduled to get their deliveries.
Hayes’ team is monitoring the 13,000 suppliers in Raytheon’s supply chain daily. He went on to say that fewer than 100 suppliers are a real concern but added that it “only takes one” to miss a shipment.
To combat this, L3Harris is investing in tools that provide more visibility into the second and third tiers of its supply chains, Kubasik said. Others have buyers positioned around the world and purchasing teams that can anticipate the next hiccup.
The continuing resolution…continues
While the United States has grown accustomed to continuing resolutions from Congress, or stopgap funding of the government, this year’s extended continuing resolution is beginning to cause heartburn. If Congress cannot pass an omnibus spending bill for this fiscal year, delays in new program starts will hurt top- and bottom-line results.
DeMarco reminded Kratos’ shareholders that under a continuing resolution, “there are no new start program awards for new programs of record, no increases in production on existing programs and no transition from existing development programs to production.”
Many are expecting the resolution to be resolved by the March deadline but are managing shareholder expectations if a spending bill isn’t passed, suggesting that revenue targets could slip a quarter or two.
Moving at Mach 5
While there are plenty of headwinds to navigate, the federal government continues to provide significant long-term opportunity—particularly through highly technical services and innovative products needed to address evolving threats.
DeMarco referred to hypersonics as one of the “best funded, highest priority national security areas of the United States today and for the foreseeable future.” He went on to cite China’s and Russia’s progress developing hypersonics as a catalyst.
Contractors with the required capability and clearances are placing a big bet on these highly maneuverable Mach 5 missiles.
Lockheed Martin recently opened its intelligent advanced hypersonic strike production facility in Courtland, Ala., to support the company’s hypersonic programs. Its chief executive, James Taiclet, said that this investment represents Lockheed’s “long-term investment in this critical technology.”
Hayes reminded listeners on Raytheon’s earnings call of the classified nature of most hypersonics programs but noted that hypersonics defense will most likely be a layered strategy involving ground-based effectors, ship-based effectors and possibly directed energy.
These complex missile systems remain an early-stage venture, but one with significant upside if proven to be accurate and feasible. Opportunities exist for contractors relating to hypersonic offensive systems, defensive systems, test and evaluation systems, and more.
Executives in the sector remain resilient and energetic, anticipating government spending trends and investing in rapidly advancing technologies. We expect the first quarter earnings calls to touch on continued supply chain monitoring, the federal budget, inflation and geopolitical risk.