Lockheed warns on costs of further US defense cuts

Wed Jun 20, 2012 2:49am IST

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* Lockheed sees possible claims worth hundreds of millions of dollars

* Says thousands of contracts would need to be renegotiated

* Uncertainty chills M&A activity in defense sector

By Andrea Shalal-Esa

WASHINGTON, June 19 (Reuters) - Lockheed Martin Corp , the Pentagon's largest supplier, said on Tuesday it could face hundreds of millions of dollars in business claims from suppliers if $500 billion in additional defense spending cuts take effect in January, as currently mandated.

Lockheed Chief Executive Bob Stevens said further cuts required under the process called "sequestration" would cause massive disruption across the defense industry, resulting in extensive layoffs, facilities closures and an erosion of quality.

"From an industry perspective, the near-term horizon is completely obscured by a fog of uncertainty," Stevens told reporters on Tuesday, calling it a "fiction" that the U.S. defense industry was robust enough to survive additional cuts.

Lockheed officials say they expect to complete within the next few weeks their own assessment of the impact of the additional budget cuts, which come on top of $487 billion in cuts already slated to take effect over the next decade.

U.S. lawmakers are considering various ways to avert the additional slashes, but no one has any clear answers for Lockheed and other major U.S. defense contractors.

The additional defense cuts are part of $1.2 trillion in U.S. budget cuts triggered after a congressional committee failed to reach agreement on other ways to reduce the cavernous federal deficit.

Republicans want to slash federal spending on education and other programs to trim the deficit, while Democrats have said some tax reforms are needed. Lawmakers on both sides have said they hope to avoid the mandatory defense cuts.

Stevens said the sequestration cuts could trim 10 percent of programs across the board in just the first year, which would carve about $3.8 billion from its annual total of $38 billion in government contracts, potentially triggering thousands of claims from its 43,000 suppliers.

Many of those smaller companies have signed fixed-price contracts with Lockheed that would need to be restructured or renegotiated if spending cuts took effect, he said. Lockheed would then bundle those claims and bring them to the Pentagon, he said.

"We're talking about very substantial amounts of money in claims and requests for equitable adjustment for business disruption," he told Reuters in an interview after delivering a speech to reporters. Asked if the claims could total tens of millions of dollars, Stevens said, "I think it's greater than that."

BLUNT FORCE

Stevens said the process would deliver a "blunt force trauma" to the overall industry, hitting small businesses especially hard and setting back the Obama administration's drive to rebuild the U.S. high-tech manufacturing base.

"How much real savings is there going to be?" he asked, noting that the government would ultimately have to bear the cost of breaking thousands of contracts.

Additional budget cuts could also force Lockheed to lay off about 10 percent of its current workforce of 123,000, Stevens said, noting that current law requires the company to give employees 60 to 90 days' notice of possible job cuts.

He said Lockheed had already reduced its workforce by about 18 percent over the past three years.

Given the current lack of information about which weapons programs would be affected, the company could have to notify every single one of its employees as early as October or November - just before the U.S. presidential election - about possible layoffs, he said.

Bruce Tanner, Lockheed's chief financial officer, said the cuts could result in a total of 500,000 job losses next year alone, including about half from the federal government and 100,000 to 200,000 across the defense industry.

Stevens said Lockheed was continuing to attack its overhead costs, cut capital spending, reduce outlays for research and development and consolidate facilities to prepare for leaner times.

Tanner told Reuters that Lockheed had in the past spent its own money to maintain suppliers, when defense budgets were tied up in Congress, but it would be increasingly difficult to justify such spending given the uncertainty of sequestration.

He said the prospect of sequestration was also having a chilling effect on mergers and acquisitions activity in the sector, since companies were unwilling to make commitments to buy or sell assets until it was clear whether the automatic budget cuts could be averted.

"No one in their right mind should be doing a defense deal between now and January 2," when the further budget cuts are due to take effect, Tanner said. He added that he could not imagine lawmakers allowing the cuts to take effect.

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