Pentagon Weighs Ending Speedy Payments to Contractors Started for the Pandemic

(Bloomberg) -- The Pentagon is reviewing whether to end increased progress payments to defense contractors, a policy started two years ago to buffer the impact of Covid-19 on subcontractors. Under the program, $6.7 billion was expedited through December.

A combined $5.3 billion has been paid to the biggest contractors: Lockheed Martin Corp., Boeing Co., Raytheon Technologies Corp., Northrop Grumman Corp. and General Dynamics Corp., Defense Department spokesperson Jessica Maxwell said in a statement. 

Under the policy put in place in March 2020, large companies have been given expedited payments for as much as 90% of incurred costs in billings, up from 80% previously. The figure climbed to 95% for small businesses, up from 90%. The policy was instituted with the intent that major contractors would pass along payments to their subcontractors rapidly to mitigate the coronavirus pandemic’s effect on programs and employees, keep firms solvent and bolster cash flow.

“The department has begun reviewing the criteria and process for reverting to the pre-Covid-19 customary progress payment rates,” Maxwell said. “The department will provide advance notice to industry before any changes are put into effect.” Asked what prompted the review, Maxwell said the Pentagon’s office of Defense Pricing and Contracting “has been monitoring the operational and economic need for the increased progress payment rates since the start of the pandemic.” 

Alison Lynn, spokesperson for the Aerospace Industries Association, said the group believes the “review will validate the importance of cash flow and the effectiveness of progress payments in delivering it.” That’s “particularly important for small and medium-sized businesses that remain stressed from the pandemic, labor shortages, supply disruptions and now inflation,” she said.

Buyback Surge

The payments have been monitored by the Defense Contract Management Agency to ensure they haven’t been diverted to pay dividends and share repurchases. Pentagon officials have said repeatedly there’s been no evidence of abuse even as the major defense companies last year executed a record number of buybacks.

Asked if the surge in buybacks was a factor in the review, Maxwell said “although the department is aware of substantive increases in DOD contractors’ share buybacks during 2021, it is important to acknowledge that the additional finance payments provided by the increased progress payment rate cannot be directly linked to share buybacks.”

That’s because contractors “must have already incurred costs before they receive the increased progress payments associated with related DoD contracts,” she said.  

Still, Byron Callan, managing director for Capital Alpha Partners LLC, said the buybacks might have influenced the decision to review whether to continue the rushed payments.

“The scale of share buybacks in 2021 by major U.S. defense primes suggests they have very ample resources to help subcontractors without DoD accelerated progress payments,” he said.

Lockheed, Raytheon, Northrop Grumman, General Dynamics and L3Harris Technologies Inc. reported spending $15.5 billion on net buybacks, the most in any year so far, Callan said in a note to clients. Average annual buybacks from 2011 through 2020 totaled $5.7 billion, he said. 

Callan said in an email that he accepted the Pentagon’s conclusion that there’s been no diversion of payments that were supposed to go to subcontractors but “the open issue is why accelerated payments are still needed when the four largest contractors used $15.5 billion of cash for share repurchases” last year.

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