Defense Spending in Virginia: How Deep Will Cuts Be?
February 6, 2011
War has been good to Hampton Roads. Last year, more than $12 billion in contracts fed the region and helped make Virginia the No. 2 state for defense spending. But defense cuts loom, and contractors and economists are concerned about what that could mean for Hampton Roads.
A block south of the busy auto dealerships and fast-food franchises on Military Highway in Chesapeake, an 80,000-square-foot building sits on a side street in an industrial park.
Most people looking for a new car or a burger, a minute away, would never suspect it’s there, much less what goes on inside.
Small Navy patrol boats, Humvees and black, armor-laden SUVs, like those in movies, are brought by tractor-trailer into the hangar-like facility. There, BAE Systems Inc. installs and tests prototype communications devices in them for U.S. special operations forces, the Navy and an array of other government agencies.
Since Sept. 11, 2001, the facility has grown from a handful of employees to nearly 250.
Many are former military personnel who may have once used equipment similar to what they now help perfect. Others are engineers or programmers, busy at work stations adorned with coils of wire and assorted electronics gear.
BAE Systems, one of the world’s largest defense contractors, is one of thousands of such firms operating in Hampton Roads. The region is so thick with contractors it’s known by some as “Pentagon South.” They’re vying for contracts that are part of a requested Pentagon budget worth $708 billion . Virginia – along with California and Texas – is one of the Big Three states for Department of Defense expenditures. In 2009, it was No. 1 in the nation in total defense spending, surpassing even California.
In terms of defense-contracting dollars, Virginia ranked second only to California. Quite naturally, Hampton Roads gets its share.
The four congressional districts that represent South Hampton Roads were awarded more than $12.5 billion in defense contracts in 2009, federal figures show. But the defense landscape is shifting.
In a speech last spring, Defense Secretary Robert Gates laid out his case for why business-as-usual at the Pentagon must end.
“The attacks of Sept. 11 , 2001, opened a gusher of defense spending that nearly doubled the base budget over the last decade ,” he said. “… Given America’s difficult economic circumstances and parlous fiscal condition, military spending on things large and small can and should expect closer, harsher scrutiny. The gusher has been turned off, and will stay off for a good period of time.”
In early January, Gates called for $78 billion in defense cuts; later the same day, President Barack Obama signed off on the closure of the Norfolk-based Joint Forces Command, which will mean a loss of roughly 1,900 jobs.
“The canary has died,” said E. Dana Dickens III, president and CEO of the Hampton Roads Partnership, a regional economic development organization.
When the partnership was founded in 1996, military/federal spending accounted for roughly 26 percent of the local economy. Today, he said, it’s “north of 45 percent.”
“There’s a wake-up call, that the region needs to diversify our economy,” Dickens said.
Defense contractors and their facilities are so much a part of the local landscape as to seem virtually invisible.
“It’s like the layers of an onion,” said Chris Philbrick, vice president of marketing at ADS Inc., or Atlantic Diving Supply Inc., a roughly $1 billion-a-year defense-contracting firm based in Virginia Beach. “For every large defense contractor, there are hundreds of small ones.”
They range in size and service from huge, well-known companies such as Northrop Grumman Corp. and Lockheed Martin Corp. to a Norfolk-based unit of Flowers Foods Inc., which makes bakery and cereal products, and Jo-Kell Inc. of Chesapeake, which supplies shipboard electrical systems. Even Landmark Media Enterprises LLC, owner of The Virginian-Pilot, publishes base newspapers under a defense contract.
Together, defense contractors pack an economic wallop.
Procurement contracts in the region totaled more than $8.3 billion in fiscal year 2009, according to the Hampton Roads Planning District Commission. Toss in other defense spending in the area, including salaries/wages as well as retirement/disability payments, and the Pentagon’s contribution to the local economy came to nearly $14.5 billion.
Of course, not all that money stays in Hampton Roads. When a contractor such as Northrop Grumman, for example, gets a large award for work on an aircraft carrier, its expenditures will be spread across a number of years and will include purchases of services and materials from companies outside of the region and the state.
Tracking defense contracting isn’t easy. An array of sources offer information , and their numbers don’t always align .
Since its launch in 2007, however, USAspending.gov has become the government’s showcase for user-friendly, publicly accessible federal spending data. It presents a good picture of how many defense-contracting dollars have been committed to the region and how that spending has grown in recent years. Defense contract awards for work performed in Congressional Districts 1, 2, 3 and 4 – which cover Hampton Roads but extend elsewhere in Virginia – grew 32-fold between fiscal years 2004 and 2008, from $421.7 million to more than $13.5 billion.
In the past two years, the totals began to slide – to $12.6 billion in 2009 and $11.8 billion in 2010.
ADS is one company whose revenues soared as defense-contracting dollars poured into the region.
Its roots go back to the 1980s, when it began as part of Lynnhaven Dive Center. “SEALs were coming in and buying their own stuff,” Philbrick said.
The company soon began to compete for – and win – defense contracts.
ADS was spun off as a separate company in 1997. Its CEO is Luke Hillier, whose father, Michael, founded Lynnhaven Dive Center. Its business has grown at a nearly incomprehensible rate, climbing from $18,380 in contract awards in 2005 to $1.08 billion in 2010, according to USAspending.gov data.
For the past four years, ADS has been the No. 1 defense contractor in the 2nd District – in terms of defense contract awards – eclipsing much larger and more nationally prominent contractors.
Some of ADS’ recent success is the result of a massive contract announced in January 2008. It lets
ADS and four other firms compete for work worth up to $4 billion over as many as five years.
Yet even before winning that contract, the kinds of products in which ADS specializes – such as boots, socks, scopes, night-vision and infrared equipment, cold-weather and flame-retardant gear – positioned it to capitalize on the wars the nation is fighting in Iraq and Afghanistan.
The Defense Department is moving away from large programs that focus on aviation or other expensive platforms, to equipment and technology to protect the individual soldier, Philbrick said. “That’s our core business.”
While ADS ships massive amounts of supplies to U.S. troops in Iraq and Afghanistan, it is not a manufacturer, but what Philbrick calls a “value- added distributor,” a kind of buyer for the Pentagon.
Years ago, if the Pentagon needed, for example, a flame-retardant glove, it would design and develop it itself, buy thousands of them and stockpile them in government warehouses, Philbrick said.
Today, it’s faster and more economical to buy “off-the-shelf” products on the commercial market.
ADS offers the Defense Department and government agencies one-stop-shopping for equipment and logistical support, buying the products that meet the necessary standards and then “kitting” – or assembling – them for shipping.
The company has an 85,000-square-foot kitting operation off London Bridge Road in Virginia Beach and employs more than 400 people. And, Philbrick said, it expects continued growth, so it’s building another kitting operation.
Not everyone is so optimistic, especially with the budget-cutting ax already falling in Hampton Roads.
“These are not easy decisions,” said Charles A. Schue III, president and CEO of UrsaNav Inc. in Chesapeake. “No matter what they decide, somebody in the United States is going to get hurt.”
Among other tasks, UrsaNav helps maintain and service the workhorse navigational radar systems used on most ships in the Navy and Coast Guard.
Schue and another Coast Guard vet established UrsaNav about seven years ago when they bought the East Coast operations of a California company.
Now with about 100 employees and annual revenues in the $20 million to $30 million range, UrsaNav has positioned itself in the defense sector as a product and service provider focused on maintaining and modernizing existing systems, sometimes referred to as “legacy systems,” Schue said. Its employees travel to vessels around the world to do repairs, make adjustments and train crew members.
Losing any contract would have a dramatic effect on UrsaNav.
“Large defense contractors have the ability to recover from losing 500, 1,000 or 1,500 people; as public corporations, they’re big enough to absorb that,” Schue said. “Small, typically privately held businesses don’t have that big a footprint; there’s much more of a drastic effect. The impact on small businesses is significant.”
Service-contracting companies that provide engineering, maintenance and information-technology services are likely to be more vulnerable to defense cutbacks, said Cindy M. Walters, director of Old Dominion University’s Government Sponsored-Industry Assistance Programs.
The Pentagon already is working to bring back under its roof work that it “outsourced” to businesses over the past 15 years, so “you don’t have as many contracts,” said Walters, who helps local firms get federal contracting work.
“My biggest concern is that we have this somewhat of a perfect storm going on,” she said. “For me, the foregone conclusion would be a cut in defense spending that would impact dollars for programs and contracts, across the board, that would affect our area.”
The impending closure of the Joint Forces Command, which provides research and development, modeling and simulation, and training to the military, will slow one flow of defense contracts for firms large and small in the region.
“Everybody’s kind of breathing a sigh of relief,” said Tom Mastaglio, CEO of Mymic LLC, of news that roughly half of JFCOM’s functions will continue in Hampton Roads.
Yet Mastaglio – a West Point grad, 22-year Army veteran and founding director of the Virginia Modeling, Analysis and Simulation Center in Suffolk in the late 1990s – said he’s not sure how much to buy in to what he terms “spin.”
“We’re on the slippery slope here,” he said. “If we’re not careful, there are going to be some significant issues for small businesses.”
The Portsmouth-based company employs about 80 people and has about $20 million worth of defense contract work, about 90 percent of its portfolio. It’s now on a mission to diversify its product line, creating computer programs to help train emergency medical response teams, provide therapy for people with brain injuries, and improve security at U.S. ports. It’s already won a contract with the Virginia Port Authority.
“As a region, we’ve got to look beyond defense,” Mastaglio said. “If you don’t want to end up like Detroit, we better figure out what we have, what our organic capabilities are and how we can use them to meet other needs, rather than being largely dependent on a single customer .”
Others, however, believe that the region has such a well-established defense infrastructure, with facilities and a talent pool few other places can match, that it will continue to hold its own, at the very least, and even may see some growth.
“There’s a huge customer base there, and there’s a lot of talent,” said Dave Herr, president of BAE Systems’ Rockville, Md.-based Support Solutions sector. “It’s a good place to do business; it’s fairly diversified; I’d say it’s fairly well-positioned.”
BAE’s Support Solutions sector includes the Chesapeake communications facility, an office in Hampton and, most recognizable, its shipyard at the mouth of the Elizabeth River’s Southern Branch.
“The Hampton Roads area is actually fairly central to the BAE strategy,” Herr said.
Last summer, anticipating some of the shifts in the defense environment now under way, BAE reconfigured its businesses, shoring up the unit Herr heads, servicing and sustaining existing systems.
“We think there’s going to be rising demand to maintain and upgrade some of those older platforms,” Herr said.
The local shipbuilding and ship-repair industry, in which BAE is a player, contributes significantly to the region’s economy. Nearly one of every 11 jobs in Hampton Roads is directly or indirectly dependent upon the private-sector shipbuilding and repair industry, according to a 2007 study by Old Dominion University’s Economic Forecasting Project.
“Knock on wood, it’s not going to affect us very much,” said Malcolm Branch, president and CEO of the Norfolk-based trade group, of any defense-spending adjustments.
The port’s ship-repair facilities are virtually unparalleled, Branch said, and local firms have adapted to changes by the Navy that concentrate more work in one shipyard through “multi-ship, multi-option” contracts. The Navy’s 30-year plan calls for a minimum fleet of 313 ships. As long as they continue to be built and go to sea, Navy ships will require maintenance and periodic overhaul .
It’s that ongoing pace of operations that may secure continued defense contracting for businesses in Hampton Roads.
“When is that going to end?” asked Al White, an executive at BAE’s Chesapeake facility, pointing to a slide-show image of two camouflaged snipers in an Afghan-like setting, near a portable satellite dish. “When is the war on terror going to be over?”
Until that happens, he said, he’s not too worried.