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3 August 2016 · 3 min read

Lockheed Martin names and shames the US DoD

Funding for the F-35 is "insufficient"

Lockheed Martin depends on the US Department of Defense (DoD) for c.80% of its revenues. Therefore for Lockheed Martin’s CEO Marillyn Hewson to name and shame the DoD as having overdue bills at Q2 results last week is not a decision she would have taken lightly. It caused me to wonder, what was Hewson trying to achieve?

Low-rate initial production (LRIP) contracts 9 and 10 are still in negotiation between the Pentagon and Lockheed and are not expected to be concluded before the end of the year, despite the fact that Lockheed is now well into production of these aircraft. The company claims that the US Government is withholding appropriated funds and so Lockheed has made the decision to temporarily fund the program from its own balance sheet in order not to disrupt production. However, with the F-35 ramp up requiring $400-500m cash every month this is not a sustainable solution and Lockheed continues to ask the DoD for recovery funding. CFO Bruce Tanner said “the Pentagon clearly knows the situation and I am optimistic we are going to get the cash soon.” However, in the presentation slides, Lockheed stated explicitly it has $3bn of termination liability exposure.

The F-35 is the largest ever single military procurement programme and the next generation fighter is due to reach initial operating capacity (IOC) with the US Air Force (USAF) later this year. So far 180 aircraft have been delivered to numerous customers and the jet has clocked up 65,000 flying hours. The programme is therefore relatively mature, but has a very troubled history due to its cost overruns and lengthy delays. In 2010 the then Secretary of Defense Robert Gates withheld $614m in fees as a penalty and none of the 36 aircraft delivered in 2014 had war-fighting capabilities.

Relations between the DoD and Lockheed Martin are well known to be tense. The publication of the termination costs the company would incur raises the question of whether Lockheed is suggesting to the DoD that it is willing to walk away if negotiations do not go its way? Some press reports say this is Lockheed making a statement of intent. However, I find it incredulous that Lockheed Martin (and its industrial partners) could walk away from the largest ever procurement programme, particularly at this late stage. It would be the end of the company as its reputation would be damaged beyond repair, and thousands of jobs would be lost, which in the months before a US Election would be untenable for the politicians.

I believe that this public naming and shaming is a reflection of Hewson’s despair with the calamitous budget and procurement processes in the DoD, and is her attempt to shock officials into action.

It is well known that the defence industry operates in a way that seems perverse to outsiders. Usual laws of economics and competition often seem irrelevant, with politics, national pride and job preservation playing a far more important role. The question is how long can it remain this way? Successive US Defense Secretaries have pushed to make the DoD audit ready, but none have succeeded. The UK has just appointed a new Defence Procurement Minister, Harriett Baldwin. It is hoped that her private sector experience at JP Morgan will help bring some business sense to decisions made by the Ministry of Defence (MOD). Hewson’s comments last week imply that industry is reaching the end of its tether with the DoD and that real change may well be forced upon it. The problem is though, the industry is totally reliant on the DoD as its number one customer by some way, and therefore the DoD will always have the upper hand in negotiations.

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