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As sequestration nears, companies hold on

While most companies are gearing up for their festive holiday parties this time of year, defense contractors are prepping for a Scrooge-worthy event.

Sequestration, the nightmarish concept that was never expected to occur, now appears to be coming to life. This week, the Pentagon got the green light from the Office of Management and Budget (OMB) to start planning for the automatic cuts that are set to kick in Jan. 2.

Sequestration means $1.2 trillion will be axed from federal spending over the next decade, and the defense community stands to feel the sharpest edge of that cut, or $500 billion.

Under the process, the Department of Defense will receive information from OMB about how to implement sequestration at the program, project and activity (PPA) level.

New obligations for DOD procurements are expected to take a 9.4 percent hit.

The San Diego Military Advisory Council (SDMAC), which has been a fierce opponent of sequestration since day one, hopes the DOD will get the ability to manage the cuts, rather than sustain an arbitrary across-the-board slice.

“That method treats the funding to mow the grass at Naval Base San Diego in the same manner as the funding to build the F-35. Which is pretty ridiculous,” said Larry Blumberg, executive director of SDMAC.

The membership organization, which holds monthly breakfasts with speeches from high-ranking military officials, held an unconventional “emergency” meeting in October to hash out what sequestration could mean for San Diego, where one out of four jobs is tied to the defense sector.

"Everyone thinks sequestration would be a disaster,” said Jim Schweiter, a partner at McKenna Long & Aldridge LLP in Washington, D.C., in an interview last month. “Everyone would like to avoid it. Unfortunately, so far no concrete steps have been taken to avoid it."

San Diego's defense community, however, has done its part over the past few months to speak up and warn others about sequestration.

Local military proponents traveled to Sacramento to spell out the cuts to state leaders, Rep. Duncan D. Hunter hosted a conference to brainstorm ways to beat the budget and the San Diego North Chamber of Commerce commissioned an unmanned aerial vehicle (UAV) study to quantify the immense impact of the industry on the county. In addition, a Washington, D.C.-based consulting firm was hired to lobby in the nation's capital on behalf of San Diego.

The 2011 Budget Control Act’s sequestration mandate means cuts will kick in across the government starting next year unless Congress and the administration agree on a solution.

“Congress and the president need to solve it because it is not only bad for the economy, but it also puts the national defense strategy in jeopardy,” said Blumberg.

Semantic Research, an 80-person software development company, hopes the nature of its service – helping the DOD make intelligent decisions based on large data sets – will save it from the chopping block.

“We are fortunate with our company that the products we make are very valuable to the intelligence community, and I’m glad we are not making bombers or big hardware,” said president and chief operating officer Charles Gillespie.

What keeps Gillespie up at night, however, is the uncertainty about what government spending will look like in the new year.

“We have lined up the customers, programs and agencies within the DOD who want to buy our products and services but they are sort of waiting to see," he said.

That stalled action affects his revenue projections, he said.

“It’s a constant dance and challenge a company like ours has to face,” he said.

Larger defense contractors have already prepped for the uncertain defense environment by laying off local employees at Lockheed Martin Corp. (NYSE: LMT) and Computer Sciences Corp. (NYSE: CSC), to name a few.

Semantic is taking advantage of that downsizing by scooping up qualified candidates who have landed on the street.

“We’ve snapped them all up,” said Gillespie.

Tapestry Solutions, a subsidiary of defense giant Boeing Co. (NYSE: BA), can’t be as candid about the topic.

“I’ve been told corporately we don’t comment on sequestration," said Mark Young, chief financial officer and executive vice president of Tapestry Solutions.

He did, however, open up about the "fiscal cliff" in general, calling it “a serious tipping point.”

“It’s a significant emotional and financial event for Boeing as a whole. They will spend a fair amount of effort reinvesting in IP, technology and growth, but this concern is across the board," Young said.

There’s a lot of internal pressure to push for efficiency across the business.

“That means you are working with less and not hiring as many people," Young said.

Frustration about the fiscal environment is compounded by onerous reporting requirements and oversight coming from the state and national level.

“It feels that the switch has been 'business, bad; government, good,' even more so. It’s like contractors are bad people,” Young said. “Bureaucracy takes the focus away from creating jobs and value.”

It’s getting more difficult to find cheap ways to build products and support applications to appease the government’s request for low-cost services.

“We are somewhat limited because of security requirements … we are not outsourcing work to India to do software development,” Young said.

Sequestration means contractors may have to do things differently, but it doesn't mean the government will automatically terminate or modify a contract.

The government may find money elsewhere to keep a desired contract afloat, for example, according to McKenna Long's Schweiter.

Some contractors are preparing for the worst and diversifying their portfolios in case some of their defense contracts get cut.

Semantic, which has been in business 11 years, is looking outside of the government to see where else its technology can be applied.

“We are starting to dip our toes in the water of health care and legal discovery and see if there can be applications for things we’ve perfected in our current domain in commercial sectors,” Gillespie said.

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San Diego Military Advisory Council

Company Website

7710 Hazard Center Dr. Ste., E-335
San Diego, CA 92108

San Diego Military Advisory Council Executive(s):

John Nersesian

  • President

Larry Blumberg

  • Executive Director

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