By Stephen Nellis Friday, August 31st, 2012

If a $55 billion cut to the U.S. defense budget takes effect on Jan. 2 as planned, small and mid-sized military contractors in the Tri-Counties stand to be hit the hardest by a $113 million reduction in the $1.2 billion that currently goes to defense spending in the region.

The military cuts are part of what is known as budget sequestration, a result of congressional gridlock. Last year, after a showdown on raising the nation’s debt ceiling, a so-called budget super committee was appointed to identify $1.2 trillion in deficit cuts. But Congress failed to adopt the plan, triggering across-the-board cuts to both military and non-military spending over the next decade, starting Jan. 2.

Defense spending is a large part of the regional economy. Contracts for the Tri-Counties totaled $1.2 billion in 2011 and could lose $113 million, about 9 percent, if sequestration proceeds as planned, according to the Center for Security Policy, a conservative think-tank with ties to military contractors.

In terms of employment, Naval Base Ventura County is the largest employer in Ventura County with more than 20,000 staffers, and Vandenberg Air Force Base is the largest employer in Santa Barbara County, with 6,330. Raytheon has 1,400 employees in Goleta, and Lockheed Martin has 400 in Santa Maria. Northrup Grumman, Boeing and Rolls Royce also do work in the region.

But it is those marquis names, most of them prime contractors, that will have the best ability to manage though any cuts. Mid-sized contractors and the businesses they employ — machine shops, circuit board companies and myriad other suppliers — will have the toughest time. It’s like a ripple effect in reverse — the shockwaves get more intense as they spread outward.

Santa Barbara-based Channel Technologies Group makes ceramic piezoelectric devices that go into underwater navigation systems for the U.S. Navy, among other things. It works with large prime contractors and has little control over how those prime contractors would deal with budget cuts.

“Our biggest concern right now is that the big boys decide to take more work in-house,” said Kevin Ruelas, CEO of the company. “They’re trying to retain their dollars, their work, their personnel.”
And in turn, Ruelas has to make the same kind of business decisions about his own company. Ruelas said Channel Technologies spent $8 million since 2008 with subcontractors within 50 miles of Santa Barbara and $20 million with subcontractors in the state of California.

“It’s work like that that would have to stop,” Ruelas said. “If we, as a mid-tier company, get hit with cutbacks, that will cascade down to our subs.”

Some smaller businesses are already feeling pinched between rising costs of doing business in California and increasingly stringent regulations for small contractors. DKB Resources in Santa Barbara makes printed circuit boards and has seen increased competition from larger contractors.

“Because there are fewer contracts being let, the bigger organizations that normally wouldn’t have bid on $1 million, $2 million contracts are now bidding on those contracts,” said Darya Bronston, president of the company. “The big guys are part of those bids now. It’s really changed the environment. There’s a squeeze.”

Lockheed Martin CEO Bob Stevens made headlines this summer with a letter to employees suggesting that sequestration would result in an immediate layoff of 10,000 workers. His critics countered that existing contracts wouldn’t be affected – only new contracts.

The reality of defense contracting is slightly more complicated, said Channel Technologies’ Ruelas. Most contracts are written with provisions that allow the government to break off its commitment when it sees fit. While Ruelas views some contracts, such as those supporting Virginia class nuclear submarines, as safe from cuts, early-stage research contracts could be in peril. “In some ways we feel a little secure in those short-term contracts. It’s the new work. Those are in prime jeopardy for getting terminated,” he said.

Budget sequestration was designed as a fallback provision so ugly it would scare both Democrats and Republicans onto common ground. Though it failed to do so, many observers believe Congress will act before the Jan. 2 enactment date. Both parties agree the deficit needs to be reduced and that the military should bear part of the burden. The Republican budget plan calls for a discretionary spending reduction to resolve the impasse, and Rep. Elton Gallegly, R-Simi Valley, argues that President Obama has sidestepped the issue during the heat of a campaign season.

“Both Republicans and Democrats in the House and Senate have appealed to the president on their willingness and desire to confer on sequestration, but he has ignored all entreaties,” Gallegly said in a statement to the Business Times.

U.S. Rep Lois Capps, D-Santa Barbara, argues that her party’s competing proposal, which would resolve budget issues with a combination of spending cuts and increased revenue, has been blocked by House Republicans “who continue to insist on eliminating the sequester only by taking a hatchet to programs that will help grow our economy and support our children, seniors and middle-income families without looking for a single penny of additional revenue from those that can most afford it,” Capps said in a statement to the Business Times.

In the meantime, contractors aren’t waiting for Congress. Some, such as defense conglomerate Teledyne Technologies in Thousand Oaks, have been slowly re-orienting their businesses toward commercial and industrial technologies over recent years. At Channel Technologies, Ruelas said the company is investing $2.5 million in new equipment to make its piezoelectrics smaller, better and cheaper for potential use in consumer electronics, such as phones that charge themselves as they bounce around in your pocket.

“Our future growth strategy is so exciting because we keep coming up with new ways to use our technology,” he said. “The better we can position ourselves to be on the cutting edge, the brighter the future is ahead of us.”