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The U.S. economy unexpectedly dipped into the red in the fourth quarter of 2012, as the defense department, with Fiscal Cliff II looming, cut spending by 22 percent.
Without a new budget deal, the federal government once again faces $1.2 trillion in automatic spending cuts. With half of that ticketed for defense, the Pentagon last month ordered the armed services “to begin implementing prudent measures to help mitigate the department’s budget execution risks.”
Memo to Long Island defense contractors: Don’t panic, but get ready for another rocky ride.
“Panic was the first time,” said Michael Polimeni, chairman of a defense advocacy committee run by the Association for a Better Long Island, a developer group. “I don’t know that we’ve recovered enough to suffer the emotion of panic again. It’s been a general malaise since the last cliff.”
While Polimeni butters his bread in the real estate trade, his committee role requires him to keep a close eye on federal wheeling and dealing, and he knows “all that toxic debt is still out there.”
“We don’t think the defense budget is going to miraculously receive an influx of capital by March,” he said. “We’re going to run into more cost-cutting and belt-tightening.”
Vincent Palazzolo, CFO at Edgewood-based CPI Aerostructures, said his company – which provides structural aircraft assemblies for Defense Department cornerstones like Sikorsky and Northrop Grumman – is already experiencing a slowdown in “expected contract awards.”
“We’ve been getting a lot of ‘you guys are the winning bidder,’ but the actual contract doesn’t come through,” Palazzolo said. “Boeing and Sikorsky have work they’d like to subcontract out, but they’re holding off on formal agreements to start the work because they’re waiting to see what happens.”
After CPI shifted focus five years ago from direct government work to subcontracting under bigger government suppliers, second-tier Defense Department orders peaked at 70 percent of its business. But that percentage “slid a bit in 2012,” Palazzolo said, and now the Edgewood manufacturer is “definitely looking to increase its commercial customers.”
In 2012, CPI signed new deals with Kansas-based Cessna Aircraft Co. and Brazilian conglomerate Embraer, a producer of corporate and commercial jets. Diversifying its customer base has strengthened CPI – “We have not had any layoffs and we’re not anticipating any,” Palazzolo noted – but if its bigger defense-industry cousins lose work to sequestration, that could change.
“If there are automatic across-the-board cuts, eventually that would trickle down to us,” Palazzolo said. “We would possibly have to consider cutbacks in our staff.”
Diversity shield
Short-term stability is also the rallying cry at Farmingdale-based surveillance specialist Telephonics, another second-tier supplier to firms like Boeing and Northrop Grumman. CEO Joseph Battaglia estimates that 60 percent of his business is defense-related, but said his company’s clientele is diversified enough that Telephonics can withstand whatever happens in the coming fiscal fight.
“We’re well-positioned to bear the brunt,” Battaglia said. “Unless we get the rug pulled out completely with all kinds of cancelations, I can maintain the level of employment that I have. We’re in good shape for the remainder of fiscal year 2013.”
Telephonics is further insulated by an international client base that represents 35 percent of sales.
“If I sell Sikorsky radar for a helicopter, they might sell it to an international customer or they might sell it domestically,” Battaglia noted. “All governments want to ensure the integrity of their borders.”
Still, Polimeni worries about the close “symbiotic relationship” of local manufacturers, “from guidance chips to the people who actually pound the steel.”
“On Long Island, if you’re in the defense-industry pool, that’s your game,” Polimeni said. “There are conglomerates out there that can retool and reallocate their brainpower and funds, but for these local companies, defense contracts are their mainstay. That’s what they do.”
Many Long Island manufacturers also service other government sectors, meaning diversifying won’t be much of a shield against across-the-board government cuts. Paul Scardino, vice president of sales at Hauppauge communications company Globecomm Systems, estimates that “government work in general” accounts for 50 percent of his company’s business.
Scardino puts the Pentagon’s fourth-quarter cutbacks in perspective, noting that defense spending typically dips between October and December, the start of the government fiscal year.
“So yes, defense spending is down,” Scardino said. “But government spending typically comes later in their fiscal year.”
Cautious optimism
Also buoying Island defense contractors is the likelihood that lawmakers will forestall the cliff once again. Like Palazzolo and Battaglia, Scardino doesn’t believe Congress will concoct a “grandiose scheme to fix any problems” before March, and instead predicts the federal government will seek as little economic disruption as possible.
Noting “the new Congress is really new,” Palazzolo agreed that another short-term deal is likely; Battaglia also said there will be some kind of an agreement before sequestration hits. Polimeni concurred, noting that “kicking the can down the road is the name of the game in politics these days.”
But too many delaying tactics won’t do the Island’s defense industry any good.
“Without any firm standing as to where and when any of these questions are going to be answered, it’s like trying to map a course without a compass,” Polimeni said. “It’s devastating.”