UPDATE 1-Pentagon says cost cuts not aimed at profits

* Pentagon says it is not aiming at profits

* Officials want incentives for productivity gains

* Industry officials see pressure on profit margins
(Adds comment from Air Force official, analyst)

By Andrea Shalal-Esa

NEW YORK, Dec 1 (BestGrowthStock) – The Pentagon’s chief arms buyer
underscored on Wednesday the Defense Department’s determination
to cut costs, but sought to reassure investors the initiative
was not aimed at cutting industry profits.

“A profitable defense industry is in the national interest
and we recognize that,” Ashton Carter, defense undersecretary
for acquisition, technology and logistics, told an investment
conference hosted by Credit Suisse and Aviation Week.

“The idea that you save money by cutting profit is not only
illogical, it’s backwards,” he said, noting that defense
acquisition officials were looking for ways to give defense
companies incentives to improve productivity and cut costs.

The Pentagon is setting up a “superior supplier” program to
reward companies with good performance on weapons programs and
also wants to do more to support independent research efforts
funding by companies themselves, he said.

“Profit is the way to incentivize productivity. That’s the
way we’re thinking about it,” he said.

Recent analyst reports have portrayed defense stocks as
less promising investments given tightening margins.

Michael Strianese, chief executive of L-3 Communications
Holdings Inc (LLL.N: ), said the defense industry welcomed and
supported the Pentagon’s increased focus on productivity and
appreciated the department’s collaborative approach.

He told the conference the current defense budget
environment was challenging, but “not going off a cliff.”

At the same time, he expressed concern that the efficiency
drive was putting pressure on industry profit margins, and said
his company would skip bidding for some contracts — including
a big linguist services contract — if margins got too low.

“There are areas where the margins have contracted to the
point where we are reacting to it with no bids,” he said. “If
we don’t think the margins aren’t worth it, we won’t do it.”

He said the result would be that some contracts would shift
to smaller firms that might not be able to handle the work.

Dennis Muilenburg, chief executive of Boeing Co’s (BA.N: )
defense business, said his company supported the Pentagon’s
efficiency drive, but reforms were being implemented unevenly.
For instance, extended government audits sometimes delayed the
Pentagon’s ability to finalize contracts with companies, which
dragged profit margins lower.

“We’re aligned on intent. We need to drive that into the
contractual details,” he said.

Tom Captain, an analyst with Deloitte LLP, said the defense
and aerospace sector’s profit margins had been between 9
percent to 12 percent in recent years, lower than other
industrial companies. As a whole, the sector had already
improved productivity by over 100 percent.

“The Defense Department could take a lesson from the
private sector,” he added.

David Van Buren, assistant Air Force secretary for
acquisition, told participants he was eager to hear from the
industry about ways to cut costs and help make profits more
robust.

“There is a way forward with industry,” he said.

Carter singled out the Pentagon’s biggest weapons program,
Lockheed Martin Corp’s (LMT.N: ) F-35 fighter program, saying
more work was needed to get that program’s costs under control
and ensure its total cost never reaches the $382 billion
projected by Pentagon cost estimators.

“There isn’t going to be ever more money,” Carter said.

Van Buren told the conference the Pentagon’s recent
low-rate production contract for a fourth batch of F-35 fighter
planes was written to jibe with Carter’s 23 specific
cost-cutting measures, including a move to fix price incentive
contract terms sooner than initially expected.

He praised efforts by Boeing to cut overhead costs in its
space division and said the Air Force was also working closely
with Northrop Grumman Corp (NOC.N: ) to reduce costs on the
high-altitude unmanned Global Hawk aircraft.

Carter said the Defense Department had scrapped most
weapons programs that were not performing well or were no
longer needed, although a few terminations could still be
announced. He gave no details on which programs could be cut.

The Pentagon was working hard to ensure that new weapons
programs would be more cost-efficient than in the past. He
noted the replacement for the Ohio class submarines that carry
nuclear missiles, a new presidential helicopter, long-range
strike for the Air Force and the Army’s new ground combat
vehicle would all be structured to avoid the rampant cost
growth of earlier weapons programs.

Carter hoped Congress would approve a plan by the Navy to
buy new coastal warships from both Lockheed Martin and the U.S.
unit of Australia’s Austal Ltd (ASB.AX: ) after both teams
proposed lower than expected prices. The Pentagon rejected the
initial pricing, deciding to buy just one ship, but changed its
mind after the most recent bids were submitted.
(Reporting by Andrea Shalal-Esa; editing by Andre Grenon)

UPDATE 1-Pentagon says cost cuts not aimed at profits