This week, the U.S. Air Force announced that it has begun reducing the number of bases at which it plans to eventually house the new F-35. This is being done in an effort to reduce the estimated life-cycle cost of the single-engine stealthy fighter.

Last year, the Pentagon disclosed an estimated more than $1 trillion to operate the fighter for the next 50 years, raising significant concern from customers, including the U.S. Navy and Air Force. Since then, the services have been working to refine their plans to operate the jet in hopes of curbing operations and sustainment (O&S) cost.

Air Force Chief of Staff Gen. Norton Schwartz says the original cost estimate contained more than 40 operating locations for the F-35A, and “We are pressing down on that. We are in the low 30s now.” Schwartz adds that the initial cost estimate is “of limited value” because it projected so far out into the future – 50 years. Typical cost estimates of this type span fewer years, he notes. Fewer operating locations could dovetail with the service’s request to conduct new rounds of base closures with a hope of reducing as much as 20% of excess infrastructure being operated by the Air Force.

Big Movers

OSI Systems, Inc. (Up 10.2%) – Shares rose this week after the company announced that Mexico’s tax and customs authority has exercised options under its pact that bring the total value of the six-year turnkey screening services agreement to about $900 million. The specialized electronics and services provider had previously announced the minimum obligated value of $400 million for the program.

VSE Corp. (Down 11.4%) – Shares fell this week after the company fourth-quarter revenue of $148.9 million, down 29.9% from $212.4 million in the same quarter a year ago. For the year, revenue was down 28.6% to $618.6 million, while earnings fell 13.2% to $20.6 million. VSE blames lower fourth-quarter and full-year revenue on the expiration of a large U.S. Army contract, delays in other government contract awards and delays caused by protests of contract awards.

DigitalGlobe, Inc. (Down 21.3%) – Shares fell this week after the company reported a fourth quarter net loss of $27 million, or 58 cents per diluted share. The loss compares to a $600,000 profit the company reported in the fourth quarter of 2010. During the past fiscal year, which ended December 31, DigitalGlobe reported a net loss of $28.1 million, or 61 cents per diluted share. In 2010, the company reported a net income of $2.5 million, or 5 cents per diluted share.

Relevant Transactions

RLJ Equity Partners acquired LAI International, a portfolio company of Spell Capital Partners. LAI International is a contract manufacturer, offering precision-engineered finished parts, components, and subassemblies for aerospace, power generation, defense, medical, electronics, and other technology industries. The deal was funded by a $37.1 million unitranche facility and an equity co-investment provided by Monroe Capital.

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This week President Obama released the Budget for Fiscal Year 2013. In it the Department of Defense has requested a total of $613.9 billion – $525.4 billion for base discretionary spending and $88.5 billion for Overseas Contingency Operation (“OCO”) spending. In all, the Pentagon’s 2013 budget outlines the elimination of $259 billion over the next five years, which is in line with the Budget Control Act of 2011’s requirement of $487 billion in defense cuts over the next decade.

According to the budget proposal, the Pentagon has stated that $75 billion will be saved over the next five years by reorganizing its investment strategy. A large portion of these cuts, $15.1 billion, will come from reorganizing the Joint Strike Fighter program, with another $13.1 billion from reducing the Navy’s shipbuilding plans. Overall the Pentagon has requested $179 billion in 2013 to buy and develop aircraft, ships, vehicles, missiles, and satellites.

Specifically, the 2013 budget requests breakdown for military services are:

• $136.6 billion for the Army – about $700 million more than appropriated in 2012
• $155.9 billion for the Navy – about $900 million less than appropriated in 2012
• $140.1 billion for the Air Force – about $4.8 billion less than appropriated in 2012
• $94.9 billion for defense-wide issues – about that same as was appropriated in 2012

Big Movers

Finmeccanica SpA (Up 17.7%) – Shares are up this week amid investor speculation that euro-area officials are nearing an agreement on a Greek bailout deal, as well as the announcement that the company’s subsidiary Telespazio signed contracts worth about €112 million ($147 million). All of the contracts signed support various space operations.

Mine Safety Appliances Co. (Up 6.1%) – Shares rose this week after the company announced record net sales in the fourth quarter and full year. MSA earned $0.46 a share on net sales of $303.7 million, compared to $0.32 a share on $285 million a year ago.

Ceradyne, Inc. (Down 4.3%) – Shares declined this week after the company reported 4Q2011 earnings per share of $0.56, $0.05 below analysts’ estimates of $0.61. Revenue for the quarter also came in below estimates at $128.5 million, versus the consensus of $131.9 million.

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This week Republican senators introduced a bill aimed at delaying the spending cuts required under sequestration by one year. Senator John McCain, R-Arizona, introduced the legislation entitled, the “Down Payment to Protect National Security Act of 2012,” aimed towards reducing federal spending by $127 billion over the next ten years. Republicans hope to realize these savings through an extension of the federal pay freeze, including members of Congress, by an additional year and a reduction in the federal workforce through attrition. According to John McCain, roughly $110 billion is required to cover the first year of cuts under sequestration; however, President Obama has formerly stated that he would veto any plan that would undo the Budget Control Act of 2011’s sequestration provision because he believes it could still force Congress to come together on a much broader solution to reduce the country’s deficit.

As budget cuts are pushed throughout the military, reductions in the Air Force are expected to be met through a heavier reliance on multirole aircraft. According to Dan Goure, an analyst at the Lexington Institute, the service cannot afford to maintain fleets of specialized aircraft anymore, even though it might mean the Air Force ends up with planes capable of performing many missions, but none particularly well. Given the delays on the F-35, however, the Air Force is currently modifying roughly 350 F-16s to add capabilities and extend the aircrafts’ service life.

Big Movers

Northstar Aerospace Inc. (Down 62.3%) – Shares plunged this week after the company received a notice from a major customer claiming breach of obligations under certain contracts. The aircraft parts maker said that it expects to violate its financial covenants as of January 31.

Cubic Corporation (Up 10.6%) – Shares rose this week after the company released Q12012 sales and operating income of $318.7 million and $28.2 million, compared to $284.4 million and $27.2 million the same quarter last year, an increase of 12% and 4%, respectively. The company also announced a record backlog of $3.2 billion.

BE Aerospace Inc. (Up 10.4%) – Shares are up this week after the company announced fiscal 2012 estimated revenue and earnings per share (“EPS”) to be approximately $2.95 billion and $2.75 per diluted share, respectively. Analysts had expected revenue of $2.86 billion and EPS of $2.74 for fiscal 2012.

Recent Acquisitions

ICF International Inc. to acquire GHK Holdings Limited, a multidisciplinary consultancy serving government and commercial clients on government, health, and international development issues. The acquisition is expected to strengthen ICF’s European presence and create critical mass for ICF in high-growth Asian markets. Terms of the deal were not disclosed.

Wynnchurch Capital, Ltd. acquired the assets of Burtek, Inc., a manufacturer of ground-based mobile military equipment, such as radar systems, ground vehicles, and shelters, for nine million dollars. Wynnchurch originally offered $14 million two months ago, but reduced its offer after Burtek lost two contracts while the deal was still pending. The deal closed late Thursday after a U.S. District Court approved the sale.

Berger Group Holdings, Inc. Acquired Ranger International Services Group, Inc., a provider of aviation, logistics, and engineering services both domestically and internationally, for an undisclosed amount. The acquisition is expected to increase Berger’s capabilities in government operations contracting, operations and maintenance, airfield operations, and specialized technical services. Ranger International Services Group, Inc., will now do business under the Louis Berger Services, Inc. name.

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This week, U.S. Defense Secretary Leon Panetta removed the F-35B short take-off-and-vertical-landing (“STOVL) from probation. The F-35B had been placed on probation last year after it was troubled by schedule delays and cost overruns. Though there may not be significant production ramp-ups, the F-35B variant has caught up with the Air Force and Navy versions of the aircraft.

The Pentagon released a list of 30 priority capabilities it needs in order to conduct war anywhere on the globe in the future. The document, officially called the Joint Operational Access Concept (JOAC), outlines a more flexible integration of space and cyberspace operations into the traditional air-sea-land battle space. The 30 capabilities listed in the document are focused on command and control, intelligence, fires, movement and maneuver, protection, protection, sustainment, information and engagement. The document calls for more integration between the services at lower levels

Big Movers

Finmeccanica SpA (Up 16.8%) – Shares rose this week as subsidiaries of the company received positive news. Avions de Transport Regional (turbo props) announced its highest order intake in its 30-year history of 157 planes last year; AgustaWestland (helicopters) signed a EUR90 million (roughly $117 million) deal to supply 5 helicopters and 14 upgrades to the polish defense Ministry; and DRS Technologies announced award of a one year $48.4 million option.

OSI Systems Inc. (Up 11.1%) – Shares rose this week after the company announced that its security division, Rapiscan Systems, was awarded a six year authorization to provide inspection services throughout Mexico. The company is the sole provider for this agreement valued at approximately $400 million.

NCI, Inc. (Down 30.7%) – Shares fell this week after the company reported poor FY2012 guidance. NCI’s current expected revenue range for FY2012 is $340 million – $360 million, compared to the company’s previous guidance for FY2011 of $556 million – $564 million.

Relevant Transactions

Symantec Corp. to acquire LiveOffice LLC, a provider of cloud-based email archiving, compliance, discovery, and continuity solutions for Fortune 500 companies in the U.S. for $115 million. The acquisition will allow Symantec to help organizations store, manage, and discover unstructured information including on-premise and cloud-based information sources such as email, instant message, social media and file sharing.

Lockheed Martin acquires Procerus Technologies, a company specializing in autopilot and other avionics for micro unmanned aerial systems. The acquisition expands Lockheed Martin’s capabilities into the small unmanned aerial vehicle market and helps the Company meet its customers’ strategic priorities. Terms of the deal were not disclosed.

Vishay Intertechnology to acquire HiRel Systems LLC, a provider of high reliability transformers, inductors, coils, and power conversion products for approximately $85 million. The acquisition further enhances Vishay’s inductor portfolio, particularly in the field of custom magnetics for medical, military, aerospace and aviation.

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This week, President Obama unveiled a new plan for defense spending and strategy officially titled: Sustaining Global Leadership: Priorities for 21^st Century Defense.  The plan outlines more than $487 billion in cuts and ultimately calls for a “leaner” and more “agile” military that uses smaller conventional ground forces amid cuts in federal spending.  With the shifting threat environment, the U.S. will no longer focus on the ability to fight two land wars at the same time, but rather strengthen new capabilities in special operations forces, C4ISR, unmanned systems, space and cybersecurity.  Furthermore, the military will shift its focus away from the Middle East and more towards the Asia Pacific region as growing threats and regional influence from China ensue.

The strategy also intends to reduce the U.S. nuclear stockpile, trim ground forces, and invest in weapons that can penetrate denied regions.  Though specific program cuts were not addressed, they are expected to be unveiled with the 2013 defense budget proposal, which the White House is scheduled to send to congress next month.

Big Movers

CPI Aerostructures Inc. (Up 9.7%) – Share rose this week after the company announced a purchase order from Boeing Defense, Space & Security valued at $12.7 million, as well as announcing that new business awards from all customers for 2011 was approximately $83.6 million compared to $61.7 million for all of 2010.

SPX Corporation (Up 8.5%) – Shares are up this week after the company announced a strategic joint venture with Shanghai Electric Group to supply products to the power sector in China. Shanghai Electric in one of China’s leading diversified heavy equipment manufacturers, with 2010 revenue of $9.5 billion. SPX aims to grow its presence in China through leveraging Shanghai Electric’s strong relationships among utilities, power plant builders, and engineering procurement companies.

Relevant Transactions

IBM Corporation to acquire Green Hat Software Limited, a provider of software quality and testing solutions for the cloud and other environments. The acquisition allows IBM to offer a complete software development and testing solution to its customers and capitalize on growing software testing markets. Terms of the deal were not disclosed.

Grey Mountain Partners acquires Global Security Glazing, a provider of security and architectural glazing solutions for correctional facilities, courthouses, and government security buildings. The acquisition demonstrates the heightened focus on safety and security for government buildings as well as the increasing demand for energy efficient glazing solutions. Terms of the deal were not disclosed.

Clearview Capital acquires Gregory C. Rigamer & Associates, Inc., a provider of consulting services and technology solutions for aviation, elections, energy, and public safety sectors. The acquisition will allow Clearview to provide consulting services for various growing industries. Terms of the deal were not disclosed.

Blue Wolf Capital Partners acquires Channel Technologies Group, a provider of piezo-electric ceramics, transducers and complex systems and services. The acquisition allows Blue Wolf Capital to take advantage of the increased requirements of the U.S. Government and other Channel Technologies customers. Terms of the deal were not disclosed.

Kratos Defense & Security Solutions acquires selected assets of an unnamed security and public safety system integration business, which designs, engineers, deploys, manages and maintains specialty security systems for the U.S. Government for $20 million. The acquisition is significant as Kratos essentially acquired one of its most formidable competitors. Furthermore, it will significantly expand its capabilities, qualifications, customer relationships, contract portfolio and geographic depth and breadth.

Electronic Consulting Services, Inc. (ECS) acquires Paradigm Technologies, Inc., a provider of product oriented management and technical services for federal government customers. The acquisition provides ECS with access to new customers, including the Missile Defense Agency, Navy PEO IWS 3.0, United States Marine Corps, and the US Marshal Service. Terms of the deal were not disclosed.

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