Finance on the Front Line

Defense contractors are benefiting from new controls their CFOs have installed.

The system has worked well for L-3, which has built itself into a company with $4 billion in annual sales, about eight times the size it started at in 1997. And sometimes, L-3 finds a gem among the operations that others have put on the market.

Take the Link Simulation and Training business bought by L-3 from Raytheon in 2000 for $160 million. The deal gave L-3 the world’s leading flight-simulator business, with $300 million in annual sales, though losses ran about $50 million. “Here, not only the vice president of finance went, but also the controller, president, and program management,” says LaPenta. “Within 60 days of acquiring the company, we cut it back to $250 million, and became more selective about bidding for business.” Last year, Link contributed $35 million in operating to L-3, and LaPenta projects more than $40 million from Link this year.

Political Wars

The government has been granting the industry some breaks in contracting terms in recent years, which have been good for cash flow. Early last year, the rate of government progress payments on programs was boosted to 80 percent from 75 percent. Other restrictions were loosened on performance-based payments, allowing contractors to get paid earlier as specific program milestones are reached. And in 2000, the so-called paid-cost rule — forbidding contractors from billing the United States until the company paid its subcontractors — was eliminated.

Replacing the paid-cost rule was especially beneficial, says Lockheed Martin’s Kubasik. “When I first came on board we were paying our invoices in seven days on average,” he explains. “Basic cash management would suggest you stretch that out.” (Lockheed has done so, realizing a nearly $100 million one-time benefit in the third quarter of 2000, after the rule was changed.)

Of course, politics still plays a powerful defense-industry role largely outside the influence of its finance chiefs. And that certainly won’t change — unless it increases.

In the case of Lockheed Martin’s enormous JSF program, for example, development is being handled in an international arrangement that is a break from past policy, which called for warplanes first to be designed and built in the United States, then marketed abroad. The company has already won commitments from the United Kingdom, Canada, Denmark, the Netherlands, Norway, Turkey, and Italy to participate in development. The global venturing spreads developmental risk while potentially doubling the total market compared with U.S. sales alone.

But Lockheed’s rivals suggest that unmanned aircraft now being designed — planes that don’t expose a pilot to enemy fire — may well replace large numbers of manned JSF planes in future budgets. And these rivals see the JSF’s global marketing as largely a political ploy.

“With so many of our allies signed up for the JSF,” notes analyst Nisbet, “it would be a very hard plane for the U.S. to kill,” even if the fighters were no longer needed.

Roy Harris is a senior editor at CFO.

No Place Like Home

Like an alarm in the night, the 9/11 terrorist attacks woke one defense-industry market that had been sleepy for years: homeland security.

The new cabinet-level department with that name would have a $38 billion first-year budget, and encompass 22 existing federal entities, including the Customs Service, Secret Service, Federal Emergency Management Agency, and Coast Guard. Companies that already have contracts in those areas — and other fields classified as homeland defense, from fingerprint identification to creating missile shields — are analyzing ways to expand that business at a time of greatly heightened national interest.

The Boeing Co. won a contract to produce Transportation Security Administration airport bomb-detection machinery, while Lockheed Martin Corp. will work on passenger-screening systems, beating out Raytheon Co. and Northrop Grumman Corp. for the business. But there will be plenty to go around. A recent contract to Northrop and Lockheed to manage the Coast Guard’s $11 billion modernization, for example, is likely to be an open door to more antiterrorist business. And Raytheon is developing a “first responder” vehicle for emergency command and communication.

“That $38 billion is a starting point, just accumulating the costs of all the agencies right now. That will go way up,” says Robert LaPenta, president and CFO of L-3 Communications Corp., which itself is active in numerous homeland-security areas, including bomb detection.

But he expects a greater challenge in the bidding for contracts against defense companies that have become financially better-conditioned. Says LaPenta: “Certainly, the industry will be more competitive now in trying to win them.” —R.H.

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