Chaos, cash and COVID-19: How the defense industry survived — and thrived — during the pandemic

WASHINGTON — U.S. Air Force leaders faced a dilemma. The service needed a key raw material from Italy for one of its critical nuclear modernization programs. But in the early days of the coronavirus pandemic, as industrial facilities shut down and transit between nations slowed, it was unclear how the material could reach the United States.

Air Force officials were so worried that they eventually authorized military aircraft to fly to Italy to pick up the remaining supply in person, averting an interruption in one of the nation’s most strategic weapons programs.

According to Will Roper, who led Air Force acquisition efforts under the Trump administration, the ordeal was one example of when the Pentagon had to make a “worst-case scenario call” to protect the U.S. military’s technological edge as COVID-19 threatened the defense-industrial base. This sense of urgency would prove common over the next year.

As the pandemic spread, the reality of having a global supply chain that featured a number of small, sole-source suppliers, as well as an aging industrial workforce, collided into a calamity — one that threatened to irreparably damage the American defense industry.

“I had moments in March, getting up at 3 o’clock in the morning and wondering what crisis was going to happen that day,” Roper said. “Just wondering, would we be able to keep the industrial base solvent to support military readiness and modernization?”

The chaos arrived quickly: On March 4, 2020, the only impact the novel coronavirus had on the American defense industry was temporary shutdowns at F-35 production sites in Japan and Italy. But nine days later, the pandemic was widespread enough in the U.S. that President Donald Trump declared a national state of emergency. And by March 25, the U.S. military officially suspended all travel, deployments and exercises as it tried to get a handle on the disease.

A year into the pandemic, a Defense News review tried to measure its toll on the defense industry. The full scope of damage is complex and still coming into focus, but a broad outline is becoming clear. Among the findings:

• Early in the pandemic, Pentagon leaders worried about the health of the industrial base and program timelines. However, the largest firms have rebounded, and the biggest projects are mostly on track. In the past year, at least half of the Pentagon’s major defense acquisition programs experienced some kind of delay as a result of COVID-19. Programs were able to recover, often in a matter of months following nearly $5 billion in federal aid and efforts to push money more quickly to suppliers. Pentagon leaders have not listed all of the specific programs which have faced delays.
• Smaller companies — already imperiled before the pandemic — are still struggling, with as many as 1 in 7 believing they will never return to pre-pandemic levels.
• Industry invested roughly $10 billion to reconfigure production lines and build infrastructure for remote working, costs that if not addressed by Congress could become amortized over time and potentially lead to overall per unit price increases.
• Finally, quantifying the human toll on the workforce is nearly impossible. The Pentagon has not tracked deaths in the defense industry, and only two companies Defense News contacted acknowledged employee deaths from the pandemic. BAE Systems said it mourned the losses of “several” employees, while Boeing said that “unfortunately some of our Boeing teammates and their family members have tragically lost their lives due to the virus.” Neither company disclosed overall figures. In addition, local reports have identified deaths from other companies, including Lockheed Martin. With an aging workforce making up much of what the National Defense Industrial Association trade group counts as 1.1 million defense-industrial base workers, the total number of deaths is likely larger.

“COVID-19 was horrible, but it could have been a lot worse. And if it had been, I don’t think we would have been ready for it,” Roper said. “The worse, second sin that we could commit is to not learn anything from the first pandemic and not get prepared for the next one.”

Industry interrupted

The initial response to COVID-19 from the defense industry was to slam the brakes.

Textron Aviation furloughed 7,000 workers on March 18; Boeing paused production at its Seattle, Washington, facility on March 23; around the same time, CAE instituted mandatory pay cuts and temporary layoffs, with the company’s CEO declaring the financial impact on commercial aviation would be worse than after 9/11.

The situation looked dire, but a year later, prime contractors told Defense News that the industry has largely returned to business as normal. Our staff asked the United States’ largest defense contractors — including Lockheed Martin, Boeing, Raytheon Technologies, Northrop Grumman, BAE Systems, Huntington Ingalls Industries and General Dynamics — how they each fared over the last 12 months. (L3Harris Technologies declined to comment.)

None provided detailed rundowns of how many programs were delayed by the pandemic or what pandemic-related financial losses entailed, with spokespeople instead discussing any lingering impact in broad terms.

Raytheon, for instance, has not “experienced any long-term challenges meeting customer requirements” and felt only “minimal” disruptions to its work at the start of the pandemic. Huntington Ingalls Industries, the nation’s largest shipbuilder, acknowledged “impacts on both cost and schedule” for some programs, but said it would be “inappropriate” for the company to make those public. And Northrop Grumman continued to “deliver for our customers and execute on our programs.”

BAE, which offered more specifics, said it experienced “some delays” in procurement on both the industry side and from the government in terms of delayed requests for proposals.

As a result, the company countered by ramping up production rates on certain programs, per a spokesperson. That includes “more than doubling our overall monthly combat vehicle production over the course of the year. The pandemic timing was particularly challenging for our earlier, [low-rate initial production] phase programs, such as [the Army’s Armored Multi-Purpose Vehicle] as we were producing the first production vehicles. Despite the supply chain impacts of COVID, we successfully delivered at least one vehicle of each of the five AMPV variants to the Army by the end of 2020.”

Ellen Lord, who served as undersecretary of defense for acquisition and sustainment — the Pentagon’s top official on industry — during the crisis, described a “triage” effort by the armed services’ acquisition officials to focus attention on key programs that could not afford any delays, such as nuclear modernization and shipbuilding. The latter was a particular concern, she said, because of the close-quarter requirements for workers building a submarine or aircraft carrier.

For the Air Force, this effort was led by Maj. Gen. Cameron Holt, the service’s deputy assistant secretary for contracting. Roper, his civilian boss, charged Holt with starting a task force aimed at minimizing the pandemic’s impact on the defense industry while working with agencies such as the Federal Emergency Management Agency on COVID-19 relief.

“The ultimate dropping of the ball would have been losing companies that were needed for readiness,” Roper said. “And I really felt like COVID was just as much about sending a signal to adversaries that no domestic crisis can disrupt military readiness.”

As the virus traveled the country, the Air Force tracked 43 major companies and their supply chains — spread across sectors that included aviation, space, shipbuilding and soldier systems — that were “threatened” by work stoppages or more existential concerns that could put vendors at risk of going out of business, Holt said.

Overall, the Pentagon injected $4.6 billion into the defense-industrial base between the start of the pandemic and Jan. 31, 2021, according to Department of Defense spokeswoman Jessica Maxwell. That included roughly $4 billion in increased progress payments, $73.2 million in reimbursements for industry and $700 million in funds from the Defense Production Act, she said. That legislation provides presidential authorities to expedite and expand the supply of materials and services from private industry for the purpose of national defense.

Some acquisition efforts began suffering delays. According to department figures provided to Defense News, between June 2020 and February 2021, a monthly average of 40 programs experienced delays related to COVID-19, with a median impact of two months.

“Of the 54 programs that had a delay and have now recovered, 20 were granted schedule relief. Most relief was for three or more months,” Maxwell said in a statement. “The average delay experienced was about two months, which could take several months to recover for any given program.”

Overall, there have been 48 major defense acquisition programs, or MDAPs, that suffered from pandemic-related delays. Of those, 22 MDAPs continue to experience delays, Maxwell said. Some of the delays were reported at the time: For several weeks in March and April, Boeing halted work at its Philadelphia, Pennsylvania, and Seattle-area facilities, pausing production of the KC-46 tanker, P-8 maritime aircraft, V-22 tilt-rotor aircraft, H-47 cargo helicopter and MH-139 helicopter. And due to slowdowns within its global supply chain, Lockheed Martin ultimately fell short of delivering 141 F-35 fighter jets in 2021, delivering only 120 planes after having to decelerate its production line.

Despite those delays, the defense industry is overall doing fine, said Byron Callan, an analyst with Capital Alpha Partners.

“Financially, it’s great. Companies have positive cash flow and no company suffered major trauma,” Callan said. “There are a lot of congratulations to go around for the department and industry for managing this thing. Within its own little environment of defense contracting, things went very well.”

The major contractors are “swimming in excess cash” thanks to a mix of government efforts, including increased progress payments and payroll tax deferrals under the Coronavirus Aid, Relief, and Economic Security Act, added analyst Jim McAleese, of McAleese and Associates.

Small business survival

Discussions with the major contractors led defense leaders to focus their attention toward smaller suppliers. That group had been identified through a series of Pentagon reports as fragile and, for some critical components, nearly nonexistent.

“We would have major primes calling about somebody, you know, four or five levels down in the supply chain who were shutting down or were devastated for one reason or the other,” Lord told Defense News in a recent interview. “And what we found was that a lot of the issue was just pure cash flow and not being able to deliver, therefore not being able to get paid, therefore not be able to order their supplies and so forth.”

As a result, on March 23, 2020, the Pentagon announced it was increasing progress payment rates for defense items under contract from 80 percent of cost to 90 percent for large businesses, and from 90 percent to 95 percent for small businesses — essentially flooding cash into the industry by paying for more of a project upfront.

In both private and public settings, Lord then pressured the primes not to keep the extra cash on hand but to push it down to suppliers to keep lower-tier producers open. Had the DoD not acted quickly, “we would have seen a lot” of lower-tier suppliers go out of business, she said. Lord, like Roper, left the Pentagon when the Biden administration took over Jan. 20.

On the Air Force side, Holt’s task force accelerated $3.9 billion worth of progress payments and contract awards in the early months of the pandemic, hoping to push out money to defense primes and their suppliers to ensure companies could stay solvent.

One prime contractor that focused mostly on commercial work was “immediately put at risk,” Holt said. The unnamed company could not accept payments because of its commercial accounting system. The hundreds of companies that made up its supply base were in a similar boat, and although the prime was thought to have some liquidity that could cushion it from the worst effects of the pandemic, it was unclear how far it could spread its cash.

“Had we not done that and enabled a significant amount of advance payments and then [the] acceleration of contract awards, there would have been very severe impacts,” Holt said.

The Army also directed CARES Act funds to critical suppliers facing financial hardships, the service’s acquisition branch said in a statement.

One company, which manufactures organic light-emitting diode displays for aircraft and night vision devices, received stimulus money after the pandemic made it more difficult to procure required production equipment; the spread of the virus had caused cash-flow problems for the business.

Another company, which produces fabric for uniforms and body armor, received CARES Act funding after a downsized workforce caused a slowdown to production, the Army said.

But the focus on small businesses meant the Pentagon had to be on its guard for fly-by-night operations looking to cash in on money from the CARES Act.

“When you put, you know, a couple trillion dollars out there, the unfortunate reality is you get a lot of fraudulent companies and actually some adversary action where they’re really trying to get money for nothing,” Holt said.

In one instance, FEMA asked the Air Force task force’s market intelligence cell to conduct technical evaluations of companies who had responded to a wave of contract solicitations issued during the onset of the pandemic. The cell went a step further by vetting vendors.

“We avoided dozens, literally dozens of contractors that were literally just shells,” Holt said.

The cell also investigated a company that had emailed Air Force leadership about contracting opportunities. The business “looked very credible on the surface,” Holt said, but the cell found the firm was actually a shell company operated by an individual with an active arrest warrant, who is believed to be hiding in the Philippines.

A year into the pandemic, the vast majority of smaller suppliers are still operating. But there have been consequences.

In a survey, 70 percent of NDIA members — which includes a large proportion of small businesses — said last year that their bottom lines had been hurt by the pandemic. Nearly 13 percent said they believed their businesses would never return to the same level, and 30 percent thought their supplier network would be less reliable this year than last year.

“When I talk to our small businesses, the true impacts are continuing to be felt. We won’t have assessed the true impacts until later ... when the cameras get turned off; attention’s not being paid,” said NDIA Senior Vice President for Policy Wesley Hallman. “Even a 13 percent shakeout in the defense-industrial base would be pretty large, especially because [NDIA’s research shows the] base is reliant on single producers in many cases.”

Those concerns were echoed in the fall when an official from the Defense Logistics Agency warned that the agency was seeing a decline in smaller suppliers taking part in defense contracts.

Large and small businesses that rely on both the commercial and defense markets were particularly damaged due to the dramatic reduction in passenger traffic, which has in turn hurt demand for aircraft and related parts. Consultancy firm Deloitte projects the defense side will remain stable, but travel demand won’t rebound to pre–pandemic levels before 2024, fueling a slow recovery for the commercial side.

“The fact is the defense and aerospace sector relies on some of those economies of scale to be able to produce and be profitable, and so as [commercial demand] has gone down, they see a lot of challenges to [retaining] the workforce,” Hallman said. “A lot of companies are holding on for dear life, knowing that there will be a requirement [for them]. But they have to make it through this drop period in commercial aerospace to get to that growth curve on the backside.”

‘Domestic extinction’

The Defense Production Act is a longstanding, if fairly obscure, legal tool for the Defense Department to push money to vital suppliers. The DPA had already gained favor from key DoD and White House civilians who had begun using it to shore up targeted parts of the industrial base, following a landmark October 2018 report that warned of “domestic extinction” from sole-source suppliers.

Suddenly, the department found itself being tapped to use the DPA to flood the market with much-needed supplies, with the Air Force serving as the executive agent responsible for helping expedite the production of medical supplies and protective gear needed by the rest of the federal government.

One such incident occurred in late April, when the White House and the Department of Health and Human Services sought to increase the production of COVID-19 test swabs made by Puritan Medical Products, a small, family business based in Guilford, Maine. At the time, the company only had about 500 employees and one production facility, despite being the only approved swab manufacturer for certain tests.

“Puritan was faced with an enormous challenge,” Holt said. “They knew how to do what they did, [but] they had no idea how to reproduce their entire industrial capacity. They knew how to use their machines, but they had really no idea how and where to get new machines. And they didn’t have any experience in growing or rapidly scaling.”

Officials at the Air Force Research Laboratory quickly found one nearby defense company that might be able to help Puritan: General Dynamics Bath Iron Works, which builds Arleigh Burke-class destroyers for the Navy and had the ability to fabricate the machines Puritan needed at a new plant.

When Holt called up the Bath Iron Works leadership team, its members “were incredulous that the Air Force was even calling them because they never do business for the Air Force,” he said. They were also a little concerned about the scope of work, which involved engaging Bath Iron Works’ supply chain to stand up a new plant making nasal swabs as well as the company’s expertise with government contracts, he added.

“I told them I was going to make them a direct subcontractor to a small business two hours from them,” Holt said. “They asked me: ‘How much experience does Puritan have working in federal government contracts?’ I said: ‘Zero.’ ”

In early May, Puritan announced the opening of a second production facility in Pittsfield, Maine. Under a $75.5 million contract, the company would produce an additional 20-40 million swabs per month at the second plant using machines made by Bath Iron Works to package the product.

“Within the next 90 days, they were over the capacity that we had targeted at full-rate [production],” Holt said. “We’ve expanded them several times since then, and today they’re actually standing up — under an Air Force contract — a new plant in Tennessee.”

Future strategy … and concerns

After a year of figuring out how to protect the industrial base, there are some clear lessons learned — and it’s important the Pentagon not forget them quickly, the former officials who spoke to Defense News all agreed.

“We adapt, which is a wonderful thing. But we need to pause and reflect and make sure we took note of what we learned we can do differently and better, and make sure we can memorialize that,” Lord said. “And to the degree possible, we now have that in policy and procedure.”

Under Section 3610 of the CARES act, the Pentagon gained authorities to reimburse companies for the work they did to keep their lines open. That includes everything from installing new secure facilities at industrial sites to cover for the fact government facilities were closed, to dramatic reworkings of the production plant floor in order to create 6 feet of space between workers.

However, Congress never appropriated funds for Section 3610, leaving industry to absorb the expenses, which were estimated by Lord to be about $10 billion by the end of fiscal 2020.

And while the defense industry won’t collapse under that weight, adding those costs — and production delays, as a more spread-out line will be unable to produce as many tanks or planes as a more efficient design — could have long-term impacts on a program.

“I think that the largest question for the defense-industrial base right now is how to get those one-time costs taken care of so they are not, in the end, amortized over the next few years of production, driving all costs for services and parts up,” Lord said. “So all of a sudden, the money that has been appropriated isn’t going to get you 100 aircraft; it might get you 51 aircraft or something.”

The concern there, she explained, is that rising program costs as a result of the one-time investment puts programs at risk of a Nunn-McCurdy breach, triggered when a program goes over 15 percent from its current baseline, or 30 percent of its original baseline. That sets off administrative requirements and increased oversight from Congress.

“If we don’t take care of one-time, nonrecurring costs, it’s going to muddy the record in terms of understanding the true costs,” Lord warned.

While a $1.9 trillion COVID-19 relief bill, which Congress passed on March 10, extended Section 3610 authorities, industry remains concerned it will not be fully funded.

“There’s never been a funding line against 3610; it’s always been funds as available, and that’s less than optimal,” Hallman said.

Another issue, said Callan, is that defense stocks are starting to lag behind overall market growth. He credits that to investors who note that while the companies may be cash rich now, they will have to start competing for budget funding against transportation investment, recovery efforts and other priorities under the Biden administration.

If there is a silver lining to the pandemic, Lord said, it is that across government and industry there is a new push to have as much of the supply chain in the U.S. as possible, with a particular emphasis on sole-source suppliers — an area where the Pentagon could find itself cut off thanks to anything from a natural disaster to a human-made catastrophe. (That topic will likely be covered by the House Armed Services Committee’s new Defense Critical Supply Chain Task Force, which was created in March 2021.)

But she acknowledged that having two suppliers for everything isn’t a feasible requirement to drop on the defense industry, saying that “in a perfect world, yes, you would do that. However, the cost of that is very, very significant.”

Roper agreed that the Defense Department needs to reexamine whether it should push certain critical supply chains back into the United States, even if it comes at an added cost.

“Having domestic supply is a strategic strength,” Roper said. “And one that the department — the nation — needs to think about more critically, what it’s willing to trust overseas sources for. They may be trusted, but what happens if you don’t have access to them? And that’s something that we should not learn a second time. That lesson was learned during COVID-19.”

With the rollout and distribution of several vaccines finally in motion, the defense industry has likely survived the worst of the COVID-19 pandemic, Holt said. But new strains of the coronavirus or other illnesses could easily turn into another crisis — one that may be more deadly.

“As we look forward in time — I hate to say this — but I really think that we’re going to have to be much more prepared for this to happen again, in some way, whether it’s a coronavirus or some other medical contagion of some kind,” Holt said.

“We haven’t seen the last of this.”

Joe Gould, Jen Judson and David B. Larter contributed to this report.