Defense technology executives discussed supply chain and labor challenges recently during their second-quarter earnings calls.
These businesses aren’t simply trying to get past the short-term challenges. They are also strategizing and investing in long-term solutions. Expectations of greater defense spending are giving the executives confidence to make such investments and position for the future.
Four themes emerged from the earnings calls, transcripts of which were provided by Bloomberg:
Labor shortages: Expanding the talent pool
Executives have commented on the tightness of the labor market for some time. This focus continued in the second quarter with an emphasis on the need for skilled workers, particularly those with security clearances. According to Eric Demarco, chief executive of Kratos Defense & Security Solutions, hiring cleared talent is a far greater challenge than winning new business.
Gregory Hayes, chief executive of Raytheon, illustrated the issue with some estimated figures from Raytheon’s hiring plan. He noted how challenging it is to hire engineers when the unemployment rate for engineering talent in the United States is less than 2%.
The company started the year planning to hire nearly 2,000 engineers, a goal that continues to increase. For Hayes, engineers working on programs generate revenue. Talent is his ticket to growth.
Extended labor shortages can call for creative solutions and a reassessment of strategy. Some organizations, like Northrup Grumman, are implementing structural changes to their workforce.
Kathy Warden, Northrup’s chief executive, said that Northrup uses a training facility to quickly onboard lesser-skilled labor to in-demand programs. This opens the labor pool from which Northrup can recruit, and gets new employees up to speed quickly.
Supply chains: Back to the drawing board
Many defense technology companies are also looking to rethink their supply chain strategy. Robert Mehrabian, chief executives of Teledyne Technologies, quantified a $60 million impact on second-quarter sales because of shortages of electronic components and other materials. Broker purchases were far more expensive than expected and signaled continued shortfalls for the remainder of the year.
Many are moving away from just-in-time inventory and global supply chain strategies. Christopher Kubasik of L3Harris called this the “new norm” in supply chain management.
Others are looking to emphasize local distribution, partnerships with local government agencies, and trade school apprenticeships to minimize future supply chain disruptions and labor shortages. To reduce short-term constraints, Northrup Grumman is embedding employees with suppliers, Warden said.
Defense technology companies are also taking this opportunity to invest in design changes that would offer alternate parts and suppliers.
Defense spending: Up and to the right
The long-term solutions for both labor and supply chain shortages are imperative to meet the increasing demand.
Jason Aiken, chief financial officer of General Dynamics, emphasized the significant amount of support from Congress for increasing the defense budget.
Mark Aslett, chief executive of Mercury Systems, mirrored Aiken’s sentiment, citing bipartisan support for increasing fiscal year 2023 defense spending compared to President Biden’s request from earlier in the year.
Rex Geveden, chief executive of BWXT Technologies, noted that the firm’s outlook for defense spending over the coming years helps to validate his company’s growth expectations.
He was also particularly encouraged by support for increased shipbuilding, national security, the Department of Energy and the National Nuclear Security Administration, specifically given BWXT’s nuclear focus.
International demand
The opportunity to also help meet demand from NATO allies increases the market opportunity for defense technology businesses amid heightened geopolitical conflict.
Hayes of Raytheon reminded listeners that many NATO countries reaffirmed their commitment to spending at least 2% of gross domestic product on national defense, with many countries recently announcing even higher spending targets.
He cited Poland’s request for an accelerated delivery of Patriot missile systems batteries, and Germany’s and Finland’s selection of the F-35.
Warden also noted a fundamental shift in the global commitment of resources for defense and national security, particularly in Europe.
The Russia-Ukraine war has also helped the general public better understand the importance of geospatial data and precision satellite imagery, according to Daniel Jablonsky, chief executive of Maxar Technologies. He noted stronger product adoption with international defense and intelligence customers, providing high-margin opportunities and customer diversification for the business.
The takeaway
Industry executives are creating different approaches to solving extended labor and supply chain challenges. Their success is critical to meeting growing domestic and international demand.
We expect next quarter’s earnings calls to dive deeper into the annual government fourth quarter procurement push, which ends Sept. 30; expectations around the duration of a likely continuing resolution; and more specifics related to how defense budget bills are shaping up for the new fiscal year.
