President Obama was re-elected to a second term on Tuesday, providing some insight into the future of defense spending while leaving concerns over budgetary issues intact.  At a base line, defense spending under the Obama Administration will likely decline, though not to drastic levels.  The President’s 2012 – 2017 defense spending proposal had called for relatively flat defense spending, with a slight decline at a (0.9%) CAGR over the five years. 

However, concerns over the near-term effects of the “fiscal cliff” persist.  The Administration and Congress have until the end of the year to come to a budget agreement in order to avoid automatic, across-the-board cuts under sequestration.  Given the lame duck session and the split Congress, reaching an agreement is far from certain, and both the DoD and the defense industry are preparing for the potential reductions in spending.  In a speech on November 5^th, DoD acquisition chief Frank Kendall announced that the Pentagon had begun planning for sequestration.  However, leaders from both parties have indicated that the “fiscal cliff” negotiations are a priority and that both sides are open to a compromise.

In other news, the defense sector saw two major resignations on Friday, with CIA Director David Petraeus and incoming Lockheed Martin CEO Chris Kubasik both announcing they would leave their posts that afternoon.  Petraeus resigned in the wake of an extramarital affair.  Kubasik, who was slated to take over the defense contractor from current CEO Bob Stevens, was ousted following an investigation that determined his “close personal relationship” with a subordinate was against the company’s code of ethics.  The company announced that Marillyn Hewson will be taking over as CEO on January 1.

Big Movers

Computer Sciences Corporation (Up 13.2%) – Shares were up for the week after the company announced earnings and issued updated FY13 guidance on Tuesday.  It reported $0.58 EPS for the quarter, beating analyst expectations of $0.49.  CSC provided FY13 EPS guidance of $2.30 – $2.50 per share, compared to consensus estimates of $2.29.

Chemring Group Plc (Down 12.9%) – Shares were down for the week following Carlyle’s announcement that it will not be submitting an offer for the company.  The negotiations, originally announced on August 17^th and extended twice, were overshadowed by a series of profit warnings issued by Chemring as well as a management shakeup late last month.

Kratos Defense & Security Solutions (Down 17.3%) – Shares were down for the week following the company’s earnings announcement on Thursday, which met EPS estimates of $0.18, but fell short of Net Income from Continuing Operations estimates of a $2.9m loss with an announced loss of $4.4m.

Relevant Transactions

Thales Group has agreed to acquire Gentex Visionix, a provider of helmet mounted displays and motion tracking systems for defense and aerospace applications, for an undisclosed amount.  The acquisition gives Thales the ability to offer highly capable HMD technology within the market, enhancing its ability to support warfighters with increased situational awareness.

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Over the past week, the Department of Defense (“DoD”) has continued to support Federal Emergency Management Agency (“FEMA”) and other federal partners including U.S. Northern Command and the National Guard to relieve the effects of Hurricane Sandy.  As of Tuesday morning, there were approximately 7,400 National Guard members mobilized in 11 states.  Assistance included evacuation shelters, route clearance, search and rescue and delivery of essential equipment and supplies.  Twelve states and the District of Columbia declared a state of emergency due to the significant flooding and extensive power outages.

In other news, James Clapper, Director of National Intelligence, released a statement on Tuesday noting the FY2012 National Intelligence Programs budget is $53.9 billion, a 1% decrease from the previous year.  Earlier this year, Clapper announced the budget for FY2013 would drop further to $52.6 billion, an additional 2.4% decline.  Separately, the DoD stated the Military Intelligence Program FY2012 budget is $21.5 billion, a roughly 11% decrease over the previous year.

Big Movers

EDAC Technologies (Up 11.1%) – Shares were up this week after the company released strong 3Q12 results including record sales of $27.5 million.  The company reported EPS of $0.29, a 53% increase over 3Q11.

Intevac Inc. (Down 7.3%) – Shares were down this week after the company reported poor 3Q12 results including a net loss of $8.0 million and a $3.0 million bad debt write-off equivalent to $0.08 per share.  President and CEO Kevin Fairbairn noted “As expected, our Equipment business had a challenging quarter driven principally by the difficult economic environment and moderated demand for hard drives.”

Relevant Transactions

Creative Computing Solutions (“CCSi”) acquired a privately held company’s Military Health Solutions division, which held a prime contract position on MHS TRICARE Evaluation, Analysis, and Management Support (“TEAMS”) IDIQ vehicle.  The acquisition expands CCSi’s support to include Health Insurance Portability and Accountability Act (“HIPAA”) Electronic Standards Program Coordination and Analysis, adding to its current work on the Defense Centers of Excellence (“DCoE”) Program Management, Clinical and Program Policy, and Defense Health Board Support.

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Over the past week, Hawker Beechcraft announced that it plans to emerge from Chapter 11 protection as a standalone company.  The company is no longer pursuing a transaction with Superior Aviation Beijing Co., Ltd. as the parties could not reach a settlement on the terms of a Plan Sponsorship Agreement.  After Chapter 11, the company plans to rename itself Beechcraft Corporation and will focus on its turboprop, piston, special mission, and trainer / attach aircraft which are the company’s most profitable products.  It will also continue its high margin parts, maintenance, repairs, and refurbishment businesses.

Robert Miller, CEO of Hawker Beechcraft, Inc., said, “We made the decision to proceed with the standalone Plan of Reorganization after determining that, despite our best efforts, the proposed transaction with Superior could not be completed on terms acceptable to the company.  We are disappointed that the transaction did not come to fruition, but we protected ourselves by obtaining a $50 million deposit from Superior that is now fully non-refundable and property of the company.  The go-forward business plan we have developed with our creditors ensures that we will emerge from this process in a strong operational and financial position, with an enhanced ability to compete well into the future.”

Big Movers

Mercury Computer Systems Inc. (Up 6.3%) – Shares are up this week after the company announced that it received a 5-year sole source basic ordering agreement (“BOA”) from the U.S. Navy in support of the continued development of signaling architecture by producing a subset of its latest radar jammer equipment.  The BOA is valued at up to $58 million.

Relevant Transactions

Booz Allen Hamilton to acquire ARINC’s Defense Engineering Services Division, a provider of advanced aviation and maritime engineering, weapons modernization and sustainment, and systems engineering and integration for approximately $154 million.  The acquisition complements Booz Allen’s existing service base, which spans engineering and operations, technology, analytics, and strategy and organization.

Safran SA to acquire Goodrich Electric Power Systems, a provider of aircraft electrical generators and power distribution systems for roughly $401 million.  Goodrich Electric Power Systems is expected to have post sales of $200 million in 2012, with about half coming from spares and maintenance, repair, and overhaul.  The acquisition will also allow Safran to continue to develop new solutions for the electrification of aircraft equipment and closer integration of electrical systems with the aircraft engine.

Eurocopter to acquire Heuliez Aéronautique, a French provider of beating, sliding doors, and canopies for the aeronautical industry.  Heuliez Aéronautique will operate within Helicoptères Aérostructures Services, a subsidiary of Eurocopter.  Terms of the deal were not disclosed.

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September was a strong month for cybersecurity M&A and VC funding activity despite continuing industry headwinds and a sluggish economy. On the macro side, the OMB released its much-anticipated Sequestration Report, which covered the potential federal budget impact of sequestration. Despite the wealth of information provided, the report lacked program-level details, and as such, uncertainty remains a fundamental concern for industry participants. Additionally, the failed Cybersecurity Act of 2012 made headlines again as President Obama, the DHS, and the FBI began drafting an Executive Order to pass voluntary parts of the Act before year end.

As for M&A activity, General Dynamics, Novetta Solutions, and KeyW Corporation each made cyber / intel acquisitions in September, continuing their momentum from August. GD targeted mobile security in its acquisition of Open Kernel Labs, while Novetta focused on signals intelligence with its purchase of International Biometric Group. KeyW acquired systems and software engineering firm, Poole & Associates, after Poole won a $150 million contract to provide system engineering and program management support to an unnamed U.S. intelligence customer. Only three days later, KeyW announced it had acquired security information company, Sensage. Venture capital also saw impressive funding rounds for cyber companies, notably the $50 million Series A for Tenable Network Security. Shortly after that funding round, Tenable signed a formal strategic partnership and technology development agreement with In-Q-Tel.

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In its last act before adjourning last weekend, the Senate approved a continuing resolution which funds the federal government for the next six months, maintains defense funding at 2012 levels, and approves war funding at the Pentagon’s 2013 requested level. 

While this measure does avert a government shutdown, it still poses some challenges for the Department of Defense.  Pentagon Comptroller Robert Hale described the resolution as problematic due to the fact that it fails to authorize certain types of spending such as the assistance mission in Iraq or aircraft carrier overhaul projects.  Hale noted that the Pentagon would rely on temporary “work-arounds” to continue funding programs through December, but pointed out that its authority to do so diminishes significantly come January.  While the comptroller does not foresee mass contract cancellations on January 2^nd as a result of either the stop-gap spending bill or of sequestration, he did comment that the DoD may not be able to pick up new contract options, launch new programs, or increase production rates on existing programs.

Big Movers

QinetiQ Group plc (Up 9.5%) – Shares were up for the week after the company issued a business update ahead of its investor day in Farnborough, UK on September 26^th.  It reported that the company’s performance during the first half of the fiscal year was stronger than originally expected, with its Global Products and UK Services groups both performing well.

Wesco Aircraft Holdings (Down 8.6%) – Shares were down for the week after the company announced the pricing of a secondary offering of shares by certain employees and former employees at $13.65 a share.

Relevant Transactions

No relevant transactions for the week

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