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Defense budget cuts: preparing for the worst

Smaller contractors adjust, prepare for sequestration cuts

Lemon Grove-based JCI Metal Products is in freeze mode until it figures out how much the impending budget cuts will affect its business.

The planned federal cuts will reduce overall defense spending by $487 billion, or at least 9 percent, starting next year.

A 2011 law requires “sequestration,” or cutting another $500 billion over the next 10 years, or at least 18 percent when combined with the $487 billion cuts.

But for defense businesses like JCI, they are not just sitting around until Jan. 2 — when sequestration would kick in — to make a move. They are already preparing for the worst by making adjustments to their businesses.

“The impact already began and has for some time,” said Marcel Becker, CEO of JCI. “The uncertainty of what is going to happen has compelled me and my partners to not make any capital expenditures whatsoever until we figure out where the dust is going to settle on this.”

His company has done Navy shipboard repair throughout the Pacific and East Coast for more than two decades.

“Contractors I would have engaged … are not getting those contracts right now. They are already feeling the impact of me tightening up discretionary spending,” he said.

San Diego County’s defense contractors could see their contract revenues drop $2.12 billion a year over the next decade as a result of sequestration, estimates the Washington, D.C.-based Center for Security Policy.

Employment is also at stake. Becker is not training his work force at the level he would be if the market were stable, he said. Some jobs could be in jeopardy at JCI, which employs several hundred people in California and Hawaii.

Sequestration threatens to crush at least 125,789 jobs in California, and the state economy stands to lose $7.41 billion in lost earnings, according to a 2011 nationwide economic impact study from the Center for Regional Analysis at George Mason University.

“This could potentially cut my work force in half. It could potentially put me out of business in its entirety. I just don’t know what’s going to happen,” he said.

He does realize that automatic cuts mean every program that’s funded by the DoD will get hit.

“You can’t build 90 percent of a ship, so if you cut 10 percent off that shipbuilding budget … the whole project gets cut,” he said.

As the potential sequestration nightmare approaches, local small businesses are finding ways to make adjustments to their expenses and lower their operating costs. One solution is relocating outside the San Diego region, and in some cases, the state of California.

“That’s because of the challenging business environment inside our own state, so businesses are going to look at everything. Everything is on the table at this point,” said Sean Barr, vice president of economic development for San Diego Regional Economic Development Corp. “If our small businesses are looking at other markets, the operating environment in California needs to improve.”

Contractors and small businesses are actively pursuing projects in areas outside of defense.

They are figuring out where alternative opportunities lie within the San Diego community, redirecting resources towards consumer-related projects and health care markets.

Carlsbad-based ViaSat Inc. (Nasdaq: VSAT), which started out as a defense contractor, has become diversified in the past few years and now splits its revenue streams between the defense and communications industries.

“It understood the benefits of being in both markets and the challenge of being solely focused on one market,” said Barr.

San Diego-based Epsilon Systems Solutions Inc. does defense work but is also propped up by a number of products in the renewable energy market.

Other contractors are trying to nab a piece of the pie in red hot industries like cyber security and unmanned systems capabilities.

San Diego-based General Atomics Aeronautical Systems Inc. has emerged as a leader in that space with its Predator unmanned aerial vehicle (UAV).

The company pulled in a whopping $1.67 billion in contracts in 2011 and calls the U.S. Air Force and CIA customers.

“Companies in San Diego with those strengths are looking at opportunities in those areas,” said Barr.

Companies are also scouring for business outside the domestic marketplace, trying to sell some of their products and services to overseas trading partners, like the United Kingdom.

That method is working for San Diego-based Cubic Global Tracking Solutions, which has created diverse revenue streams to stay afloat in uncertain times.

“Half of our work is outside the U.S.,” said Brad Feldmann, president, during a SPAWAR Industry Executive Network (SIEN) roundtable in April. “So while Washington is doing whatever it’s doing, we plow ahead and try to win work overseas.”

Barr explains that some markets outside the U.S. have a regulatory climate that is much more conducive to doing business.

“With that comes some concern,” said Barr.

That’s because existing International Traffic in Arms Regulations (ITAR) present challenges for companies that are trying to pursue international markets, he said.

“We are going to be asking elected officials to look at those regulations that limit the ability to access global markets,” he said.

Some businesses aren’t making many changes to their operations, opting to face the budget cuts head on.

“Some businesses see these cuts as opportunities,” said Barr.

One of those is El Cajon-based GET Engineering Corp. Dave Grundies, vice president, thinks his company’s services will be desirable once cuts hit. That’s because the 30-year-old firm works with aging legacy equipment and bridges it with new technology. In other words, it keeps the old systems running.

“If these cuts come the way we think, there will be not a whole lot of new stuff bought. Legacy stuff that works will have to be sustained and maintained,” he said.

The 24-person company is actually in hiring mode, looking for a new employee specialized in software.

“I am a half-full kind of guy. I see opportunity in tough times,” said Grundies.

The reality is, however, that California’s small businesses could be the first ones on the chopping block when sequestration arrives.

Of the 467 small defense businesses in the state last year, their combined $1.32 billion in revenues would shrink by $237.3 million if sequestration occurs, according to the Center for Security Policy.

“A lot of those companies operate on 2 to 5-percent margins. So it would be hard for them to stay in business at that point,” said Christine Brim, chief operating officer of the nonpartisan, nonprofit center.

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