Aerospace & Defense Update

While the United Nations Assembly was meeting in New York, Airbus and Boeing announced that each company has received permission from the U.S. government to sell commercial aircraft to Iran.  Boeing plans to sell 80 new aircraft and lease an additional 29 Boeing 737s to Iran for ~$25 billion.  Airbus, on the other hand, only received approval from the U.S. Treasury on one of the two licenses it requested, allowing it to sell 17 aircraft to Iran for ~$1.8 billion, rather than the 112 aircraft requested.  Airbus is hoping to receive approval for the second license making the total agreement with Airbus and Boeing worth ~$50 billion.  Even though Airbus is internationally based, it was required to seek approval from the U.S. Treasury because at least 10% of the plane’s components will be manufactured in America.  Many believe that the upcoming U.S. presidential election may affect the execution of the proposed sales agreement, since Republican Presidential candidate Donald Trump has threatened to revoke the recent nuclear deal with Iran which allowed for these sales to be made.

U.S. Defense Secretary Ash Carter believes the lack of cohesiveness and stability among Congressional members when negotiating budget deals are the most prominent threats to the Department of Defense (“DoD”).  Last week, Carter encouraged lawmakers to work together on a defense budget deal stating that it is a national security risk not to fund the DoD requests.  He stated that the inability to conduct stable planning results is an inefficient use of taxpayers’ dollars and creates inefficiencies for our defense industry partners.  Senator McCain emphasized that the military is being forced to confront a myriad of global threats with insufficient budgets, equipment and readiness.  Many Republicans expressed frustration over Democrats strategically blocking DoD appropriations in an attempt to force Republicans to pass non-defense spending bills.  If a budget is not agreed upon by September 30^th, the government is expected to institute a stopgap measure to continue operating.  If the stopgap measure extends into 2017, the U.S. will not be able to fund the European Defense Initiative, which helps NATO allies deter Russian aggression.  Carter also expressed concern about the inability of Congress to fund military research programs saying that it is not prudent to starve new and future oriented defense investments in a rapidly changing and competitive world.

Government Technology Solutions Update

Last Friday, two joint venture (“JV”) organizations filed motions in court with the intention of shutting down Leidos’ protest of the National Nuclear Security Administration’s (“NNSA”) decision to rescind a 10-year, $5 billion contract for the management and operation of the Nevada National Security Site.  The contract was originally taken from Nevada Site Science Support and Technologies Corp. (“NVS3T”) due to NVS3T’s failure to disclose the fact that its ownership would change as a result of Leidos’ acquisition of Lockheed Martin’s Information Systems and Global Solutions business.  Leidos lodged a protest on September 9th, with CEO Roger Krone stating that a clause in the NVS3T contract made a potential change of ownership known to NNSA.  However, “the protest was filed under seal, shielding Leidos’ grounds for protest from the eyes of the public.”  The two JVs which protested, the Northrop Grumman-led Nuclear Security and Technology LLC and the Honeywell-led Mission Support and Technologies Corp., did so in attempt to discover Leidos’ legal rationale for their protest and therefore determine their ability to pursue further legal action.

Representative Martha McSally introduced the IDENT Fingerprint Digitalization Completion Act of 2016 on Tuesday as a result of a September 16th report which revealed that the United States Customs and Immigration Service (“USCIS”) mistakenly granted citizenship to over 800 people who had actually been ordered to be deported.  The mistake occurred because fingerprint databases hosted by the Department of Homeland Security (“DHS”) and the Federal Bureau of Investigation (“FBI”) were incomplete.  As a result, the two systems could not be correctly matched, which resulted in people with deportation orders and fraudulent identities to successfully apply for naturalization. The report also found that close to 150,000 fingerprints of people who have been ordered to be deported have not yet been added to any digital database.  The act proposed by Ms. McSally would require the DHS to create a fully digitized fingerprint record within three months if the bill were to become law.

Big Movers

DigitalGlobe (Up 9.8%) – Shares were up this week after DigitalGlobe announced its delivery program under the EnhancedView contract was renewed.

Oshkosh (Down 9.0%) – Shares were down this week after Oshkosh lowered its earnings expectations for 2017.

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Aerospace & Defense Update

According to Breaking Defense, Under Secretary of Defense for Acquisition, Frank Kendall, firmly believes Congress will be unable to implement a new defense funding bill before October 1^st.  With the Senate failing to pass the bill for the third time earlier this week, the real question has changed to whether the Continuing Resolution (“CR”) will last for three or six months.  Todd Harrison, from the Center for Strategic & International Studies, believes a three-month CR is more probable because President Obama will not want a budgetary decision to span administrations.  However, much of the process is out of President Obama’s hands as the House and the Senate’s bills still need to be reconciled.  In an act Kendall has condemned, the House seeks to shift $18 billion from current combat readiness to administrative operations.

With General Electric’s (“GE”) pending $1.4 billion aggregate purchase of Arcam AB and SLM Solutions Group, the company seeks to combine 3-D printing capabilities with its jet engine production and power turbine businesses.  According to David Joyce, CEO of GE Aviation, the technology will allow engines to be built cheaper and with hundreds of fewer parts, saving weight.  The company expected to purchase ~1,000 new 3-D printing machines in the next 12 years, but now hopes to realize cost synergies totaling $3 – 5 billion.  In addition to these cost benefits, GE hopes to expand the two company’s current $140M aggregate revenue by over $1 billion before 2020.  Even in light of these proposed synergies, analysts believe GE paid a substantial premium; when news of these two acquisitions become public, Arcam and SLM shares rose by 54% and 38%, respectively.

Government Technology Solutions Update

Members of the House Committee on Oversight and Government Reform (“HCOGR”) released a report on Wednesday harshly criticizing the Office of Personnel Management’s (“OPM”) cybersecurity habits, placing blame on OPM’s leadership and culture for a series of major data breaches.  These breaches led to the hacking of more than 20 million U.S. citizens’ personal information records.  According to the report, OPM leadership ignored early warnings about critical infrastructure vulnerabilities.  Furthermore, the agency failed to detect system breaches or the presence of malware in a timely manner.  Democrats on the HCOGR want to hold contractors, such as KeyPoint, partially responsible for these incidents due to what they claim were poor practices contributing to the data breaches, while HCOGR Republicans want to push legislation requiring the certification of websites containing sensitive information.

The Defense Information Systems Agency (“DISA”) released a revised request for proposal (“RFP”) for the 10-year, $17.5 billion ENCORE-III indefinite delivery / indefinite quantity (“IDIQ”) contract, roughly one month after the Government Accountability Office (“GAO”) found that DISA’s original contracting process was flawed.  DISA still plans to award the contract on a lowest price technically acceptable (“LPTA”) basis, despite that point being a major component of the bid protests made by CACI and Booz Allen Hamilton. However, the revised RFP has been amended to address GAO’s main concerns that bidders must now propose rates for both the fixed-price and cost-plus portions of the contract, whereas the previous iteration of the bids only required rates for the fixed-price portion of the contract.  DISA will make 40 total awards – with 20 being awarded full and open (“F&O”) and 20 awarded to small businesses (“SB”).

Big Movers

Bombardier (Down 5.2%) – Shares were down this week after Bombardier lowered its CSeries delivery guidance.

Rolls Royce (Down 7.6%) – Shares were down this week after reports surfaced of ANA’s plans to claim compensation for replacement of all turbine blades across its 787 fleet.

Transactions

Aviation Technical Services has acquired Texas Pneumatics, a provider of repair and overhaul services for commercial airlines.  Terms of the deal were not disclosed.

Broadcast Microwave Services has acquired Data911, a provider of modular information systems for military and law enforcement agencies.  Terms of the deal were not disclosed.

Cybraics, Inc. has acquired Caerus Analytics, a provider of big data analytics and cybersecurity for intelligence fusion, campaign assessments, systems analysis, and monitoring and evaluation.  Terms of the deal were not disclosed.

ESCO Technologies has acquired Westland Technologies, a provider of custom-molded rubber parts for vibration and sound dampening, thermal insulation, and shock absorption in industrial and defense applications.  Terms of the deal were not disclosed.

GE Aviation has agreed to acquire SLM solutions, a provider of metal-based additive manufacturing technology solutions.  The deal is worth an estimated $761.4 million.

GE Aviation has agreed to acquire Arcam AB, a provider of additive manufacturing solutions for the production of metal components.  The deal is worth an estimated $697.5 million.

InfoTek Corp., has acquired SilverRhino LLC, a provider of cybersecurity and IT services for Federal agencies such as the Department of Defense (“DoD”), Transportation Security Administration (“TSA”), and the Department of Homeland Security (“DHS”).  Terms of the deal were not disclosed.

L-3 Communications Corp. has agreed to acquire Micreo, Ltd., a provider of solutions for high-performance microwave, millimeter wave and photonic technology.  Terms of the deal were not disclosed.

MAG Aerospace Corp. has agreed to acquire Discovery Air Fire Services, Inc., a provider of forest fire detection, aerial infrared detection, birddog, and aerial transportation services. The deal is worth an estimated $15.4 million.

TransDigm Group, Inc. has acquired Young & Franklin, a provider for turbine controls for the energy, oil and gas, and aerospace markets.  The deal is worth an estimated $260.0 million.

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Aerospace & Defense Update

The Department of Defense (“DoD”) announced Lockheed Martin has been awarded an indefinite delivery / indefinite quantity (“IDIQ”) contract with the U.S. Air Force for the production of the Super Hercules C-130J transport plane.  The decade long contract covers production of an estimated 100 aircraft for domestic and foreign military sales through August 2026 and has a ceiling value of $10 billion.  The C-130 is a versatile four-engine aircraft which has transported troops and cargo of up to 44,000 pounds for over 60 years.  The U.S. Air Force has purchased over 150 C-130s since 2003 and ~15 countries currently use the C-130 to provide military transport as well as aeromedical evacuation and firefighting.  The flexible aircraft continues to evolve to meet new operational requirements and the growing worldwide need for airlift.

Reports have revealed that Boeing has revised its internal sales forecast and plans to sell 535 jetliners this year, a target well below its initial forecast of 740 – 745 aircraft.  Wide-body aircraft sales have been hit the hardest this year, with current net orders of less than 20% of its revised FY16 sales goal of 215.  Of the wide-body aircraft, the 747 has struggled significantly with only four new orders this year, signaling a possible end to production unless there is an increase in new orders during 4Q16.  Additionally, the Company aims to book 88 orders each for its 777 and 787 aircraft, yet has only sold 19 and 8 aircraft so far this year.  Boeing maintains that it will not lower prices in order to win orders and instead is focusing on securing orders through active sales campaigns around the world.  The slowdown in demand for new aircraft has been caused by weak global growth and low oil prices causing some airlines to choose to fly older planes longer rather than upgrading to new fuel-efficient models.

Government Technology Solutions Update

According to recent research released on Tuesday, government contract spending is likely to see an increase in fiscal 2017 after having declined for the past seven years.  The Federal government has typically directed 60% of its spending towards services, a trend that is believed to continue in the near-term. The “knowledge-based services,” such as professional, engineering, and administrative support, are the leading sub-category with $69.8 billion in annual spending.  The Department of Defense (“DoD”) continues to be a major catalyst for spending in that sector; the Army, Navy, and Air Force combined for over 40% of all Federal spending on knowledge-based services with the large defense primes, such as Boeing, Raytheon, Lockheed Martin, and Northrop Grumman receiving the largest portion of those contract dollars.  Another large, and growing, portion of the Federal budget is funding for technology services and technological equipment, which combine for over $60 billion in annual procurements, and grew at a rate of over 1.5% in 2015 despite the overall decline in spending.

The annual Lowering the Cost of Government with IT Summit was held Thursday, during which industry insiders commented on what they felt were constraints placed on cybersecurity planning by the Federal budgeting process.  According to Thomas McDermott, acting deputy assistant secretary for cyber policy at the Department of Homeland Security (“DHS”), the current one-year budgeting process makes it difficult to plan and acquire upgrades to legacy technology, forcing agencies “to patch old, sometimes indefensible IT systems.”  As a result, there have been recent efforts to address these concerns.  The Obama administration is trying to set up a $3.1 billion revolving fund “outside the appropriations process to help agencies upgrade their legacy IT.”  Additionally, DHS has created the Continuous Diagnostics and Mitigation (“CDM”) program, which has saved at least $46 million by allowing agencies to take better advantage of bulk savings.  With these efforts, the government is making a more concerted attempt to maximize the efficiency of the procurement process, as well as increase the flexibility of government agencies’ ability to plan long-term improvements to critical IT infrastructure.

Big Movers

Boeing (Down 1.6%) – Shares were down this week after there were reports that Boeing revised its internal sales forecast negatively; however, the Company rebounded after Qantas Airways announced it may add more of Boeing’s 787 in 2017

Thales (Down 2.7%) – Shares were down this week after DCNS (Thales owns a 35% stake) was investigated by India for a submarine data leak

Transactions

Brixey & Meyer Capital has acquired Stillwater Technologies, Inc., a provider of precision machining and resistance welding solutions for the aerospace, defense, and energy sectors.  Terms of the deal were not disclosed.

J.F. Lehman & Co. has agreed to acquire Oldenburg Group, Inc.’s Heavy Equipment Group, a provider of heavy equipment systems that meet mission critical requirements in harsh operating environments.  The new company, which consists of the defensive and mining business units, will be named Lake Shore Systems, Inc.  Terms of the deal were not disclosed.

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Aerospace & Defense Update

With the looming Continuing Resolution (“CR”), Air Force Secretary, Deborah Lee James, warned congressional members that up to 60 program budgets would be impacted.  The potential long-term CR would underfund the Air Force by an estimated $1.3 billion compared to its requested FY2017 budget.  Many new upgrade programs such as the MQ-9 Reaper unmanned system, C-130 cargo transport, and the B-52 and B-2 bomber fleets will be underfunded.  Other key programs such as the B-21 bomber and the KC-46A tanker would be capped and potentially experience timing delays.  While the CR is likely, the Air Force may be able to request additional Overseas Contingency Operation (“OCO”) funding for munitions programs.

Boeing expects to decide whether to cut its current 777 production rate of 8.3 jets per month in the next two months.  The Company has only received eight orders this year for the current 777 wide body, and must garner 40 – 50 orders per year in order to maintain its current production rate.  Other factors in this decision include Boeing’s current development of the 777-X, Airbus’ recent release of the A-350, and the current glut of wide body aircraft in the market.  Boeing executives have hinted they would rather cut production of the 777 than sell more at lower margins.

During its 2Q16 earnings call, Orbital ATK announced it will restate earnings due to accounting errors that buried operating losses of up to $450 million and overstated revenue by ~$100 million.  The losses stem from Orbital’s ten-year, $2.3 billion contract to supply small caliber ammunition to the U.S. Army.  Orbital management believes most of the financial impact will apply to FY2015 earnings, estimating operating income to change from a profit of $232 million to a loss of ~$200 million.  In reaction to this news, Orbital’s shares dropped 20.2% for the day, but have since rebounded slightly to be down 15.7% for the week.

Government Technology Solutions Update

According to a recent report, worldwide demand for cybersecurity services and solutions will continue to experience rapid growth in the near-term.  The cybersecurity services and solutions market is expected to increase from $122.45 billion in 2016 to $202.36 billion in 2021, representing a 10.6% compound annual growth rate (“CAGR”).  While the financial sector is likely to see the fastest growth rates, both the Federal government and government contractors are generating significant growth for the sector as well.  The Federal cybersecurity market has expanded 66% since 2011 to $5.5 billion in 2015.  Rapid growth in the sector, as well as an increasing push to both modernize and protect Federal technology infrastructure, has led to a string of acquisitions in the cybersecurity sector.  There have been 38 M&A transactions since the beginning of 2015 involving selling companies engaged in cybersecurity, including the recent noteworthy $4.65 billion acquisition of Blue Coat by Symantec, which closed on August 1^st of this year.

On Monday, the Office of Management and Budget (“OMB”) released a memo advising Federal agencies on how they should properly go about obtaining software solutions for their departments.  The policy set forth by the OMB lists a three-step process for software procurement, which states that agencies should first seek software solutions within the Federal government, then in the commercial market, before considering developing an internal solution.   Additionally, the OMB will require that the agencies release a minimum of 20% of proprietary code to the public in an effort to encourage collaboration between public and private sectors, and that doing so might enable “the best and brightest minds inside and outside government” to “work together to ensure that the code is reliable and effective.”  The Federal government spends approximately $6 billion on 42,000 transactions annually. The OMB hopes that, in addition to promoting transparency and interoperability between government agencies, this initiative will help reduce the amount of money spent on software.

Big Movers

Orbital ATK (Down 15.7%) – Shares were down this week after the company reported a restatement of their financials due an accounting error that obscured operating losses of ~$400 million

Smiths Group (Up 4.6%) – Shares were up this week after the company raised guidance on FY2016 revenue and operating profit

Transactions

Exchange Income Corp. has acquired CarteNav Solutions, Inc., a provider of Intelligence, Surveillance, and Reconnaissance (“ISR”) and situational awareness software solutions for the maritime, land, and air environments to defense, security, and commercial clients.  The deal is worth an estimated $12 million.

KBR, Inc. has acquired Honeywell Technology Solutions, Inc., a provider of satellite mission lifecycle support services, military equipment prepositioning and logistics services, and cybersecurity solutions primarily to Federal government clients.  The deal is worth an estimated $266 million, after adjustments worth $34 million for acquired tax benefits.

LightPath Technologies has agreed to acquire ISP Optics Corporation, a manufacturer and provider of advanced infrared optical components, coatings and subsystems.  The deal is worth an estimated $18 million. KippsDeSanto & Co. served as the exclusive financial advisor to ISP Optics.

PlanetRisk, Inc. has acquired Analytic Strategies LLC, a provider of data analytics solutions and consulting services for commercial and government clients.  Terms of the deal were not disclosed.

Tribalco, LLC has acquired Intelligent Decisions, Inc.’s U.S. Army Communications and Transmissions Systems business, a provider of a wide range of transmissions and communications solutions as well as ancillary support services.  Terms of the deal were not disclosed.

Trident Maritime Systems has agreed to acquire Callenburg Technology, a designer and supplier for heating, ventilation, and air-conditioning to the passenger, offshore and navy markets.  The net sale price was approximately $ 64 million.

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Aerospace & Defense Update

Boeing announced it may end production of its 747 aircraft if it continues to experience a decline in orders and an increase in pricing pressure.  For the time being, Boeing has decided to continue with the plan of halving the production rate to 6 aircraft per year starting in September. That being said, Boeing’s CEO, Dennis Muilenburg, still believes there is tremendous value for the 747 over the long run despite challenges in the current air cargo market.  Boeing had strong performances in its passenger jet and defense businesses this past quarter, which helped offset troubles with the 747 program.

Many of the industry’s largest players reported earnings this week.  Both Raytheon and Textron reported positive 2Q16 earnings, while Airbus experienced financial charges on its A400M program.  Raytheon raised its full-year profit guidance as military budgets have increased in the U.S. and overseas. Additionally, military conflicts in the Middle East have increased the demand for more bombs, missiles, and intelligence services.  Textron profits and revenues also surpassed expectations in 2Q16.  The company’s aviation segment increased revenues 6.4% to $1.2 billion, driven by strong Citation jets deliveries.  However, Airbus reported $1.1 billion of additional financial charges for the A400M, adding on to the ~$5 billion of charges already incurred.   In the announcement, Airbus warned of potential future charges as it works on fixing technical problems on the fuselage and engine.

Government Technology Solutions Update

The Information Technology and Innovation Foundation (“ITIF”) released a report on Monday regarding adoption of the Internet of Things (“IoT”) by Federal agencies.  The ITIF identified several key obstacles preventing widespread usage of the technology.  Among these are issues with a lack of technical skills, leadership, funding, as well as procurement challenges and a low tolerance for risk.  In order to address these issues, the ITIF recommends that the Federal Chief Information Officer (“CIO”) set up an IoT taskforce, that agencies themselves prepare plans and goals for IoT implementation, and that the Federal government reach out to both the public and private sectors to “encourage improvements in privacy, security and interoperability.”  The Federal government spent $8.8 billion on IoT in 2015, a 20% year-over-year increase compared to 2014.  The technology is also one of the primary areas of focus in the $50 billion Alliant 2 Government-Wide Acquisition Contract (“GWAC”), for which proposals are due in August.

Industry leaders met at the ATARC Federal Cloud Computing Summit on Tuesday to discuss the Federal Data Center Optimization Initiative (“DCOI”).  Those in attendance were urged to think of the DCOI as an opportunity to replace or eliminate certain legacy data centers through the use of cloud computing technology.  The objectives of the DCOI are to streamline how the government addresses the data center marketplace, with the end goal of “cost reduction through efficiency gains, cost reduction through elimination of facilities, and sustainability.”  Currently, 75% of the Federal IT budget is earmarked for Operations and Maintenance (“O&M”) of legacy systems, representing over $63.1 billion in the 2017 budget.  Widespread adoption of the cloud – if achieved – by Federal agencies could facilitate the transfer of information and make steps towards a modernized, less maintenance-intensive Federal IT infrastructure.

Big Movers

Triumph Group (Down 21.8%) – Shares were down this week after the company reported a 20% decline in profits during its 1Q16 earnings announcement            .

Crane Co. (Up 6.3%) – Shares were up this week after the company announced it expects to reach ~$2.7 billion in revenue for 2016

Transactions

Belcan, LLC has acquired Intercom Consulting and Federal Systems Corp., a provider of secure, enterprise-level IT and cybersecurity solutions for commercial and government clients.  Terms of the deal were not disclosed.

Dynamis, Inc. has acquired Defense Group Inc.’s (DGI) Emergency and Security Management Solutions business, a provider of enterprise emergency and security management software solutions.  Terms of the deal were not disclosed.

Infinite RF Holdings has acquired L-com Inc., a provider of wireless components, cable assemblies, antennas, specialized military and aeronautics connectivity solutions, and wireless sensors.  Terms of the deal were not disclosed.

Odyssey Investment Partners has agreed to acquire Aero Precision Industries, LLC, DAC International, Inc., and NASAM, Inc. Aero Precision is a provider of aftermarket original equipment manufacturer (“OEM”) parts.  DAC International is a provider of avionics upgrade solutions for military and airlines.  NASAM is a provider of military / defense high tech electronics.  Terms of the deal were not disclosed.

Platte River Equity has acquired CTS Engines, a provider of full spectrum maintenance, repair, and overhaul (“MRO”) services for established engine platforms.  Terms of the deal were not disclosed.

Smith & Wesson Holding Corp. has agreed to acquire Crimson Trace Corp., a provider of laser sighting products and tactical lights for military, law enforcement, and civilian applications.  The deal is worth an estimated $95 million.

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