The defense industry is financial healthy and its financial performance improved from 2010 to 2019 versus the prior decade despite worsening budgetary restrictions such as longer continuing resolutions, sequestration and decreased use of performance payments, according to a comprehensive study initiated by the Defense Department and released on Monday.
The study also shows that internal research and development spending and capital expenditures fell from 6.2 percent of revenue to 5.9 percent from the 10-year period beginning in 2000 to the following decade ending in 2019. During those same two decades, the amount spent by publicly traded defense companies on dividends and stock repurchases climbed to 6.4 percent of sales from 3.7 percent.
Citing one defense industry association’s comments made during the data collection portion of the study, the Defense Contract Finance Study says: “In its comments regarding capital investments, one defense industry association specifically stated: ‘In most cases the profitability for government customers is insufficient to finance the investments.’ However, this assertion did not appear to be demonstrated by the data.”
The study began in 2019 at the behest of the Government Accountability Office (GAO) and was the first comprehensive review of defense contract financing since 1985. The DoD contracted out various areas of the study to three universities, Virginia, Tennessee and George Mason, and the Institute for Defense Analyses, and conducted its own analysis in addition to reaching out for public comments.
The study says “The most extensive comments” came from the Aerospace Industries Association, the National Defense Industrial Association, and the Professional Services Council.
Two budgetary challenges cited by the defense associations include continuing resolutions, which lengthened on average from 129 days in the first decade of the 21st Century to 177 days in the second decade, and sequestration, which began in April 2019 and ended in 2021. Sequestration was aimed a reducing the federal deficit by across-the-board spending cuts.
In addition to the continuing resolutions, which limit federal spending to prior fiscal year rates until a budget is enacted and prevent new program starts, and sequestration, the report cites an industry association mentioning the decline in performance-based payments to defense contractors from 76 percent in 2010 to 36 percent in 2016.
“Based on these industry comments, financial performance should have degraded in the 2010-2019 timeframe but the financial statements for defense contractors showed a significant improvement over the prior ten years (2000-2009),” the study says.
Some of the financial metrics of the defense industry in the study include operating margin, which improved from 8.9 percent to 10.8 percent during the two respective decades, and free cash flow, which increased to 6.4 percent of sales from 5.9 percent over the 20 years.
“Although defense contractors operate under the same procurement laws and regulations, individual company performance varies widely within every market segment,” the study says. “This applies in commercial segments as well.” Quoting from the Univ. of Virginia study, the final DoD study says: “’How well you are run is more important than in which market segment you participate.’”
The study says that DoD’s contract financing policies benefit the major defense contractors in the area of cash flow but that this benefit doesn’t typically flow to suppliers to the same extent.
“This is a crucial finding, as GAO has noted estimates of 60 to 70% of defense work being performed by subcontractors,” the study says. “Improvements can be made in this area, which would not only aid in the financial health of defense subcontractors but could assist in attracting new entrants into the DIB at the supply chain level.”
The study also says that small businesses struggle with having cash to cover operating expenses and lack the same opportunities as larger companies to get working capital. It says the DoD is working to improve the financial health of small businesses and help get new entrants into the market.
AIA President and CEO Eric Fanning released a statement about the DoD saying “Cash flow drives our companies investments in talent and innovation and is the lifeblood of small businesses and specialized suppliers that support both military and civil aviation manufacturing. We are initially encouraged by the report’s recommendations for incentives for strong contract performance and improved training for DOD’s acquisition workforce, and we will continue to work with DOD leaders and Congress to improve our nation’s ability to put the very best capabilities into the hands of our warfighters.”