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Budget cuts continue to hit global arms makers' revenues-report

* Commercial revenues rose 14.9 percent in first half

* Second half of year likely to show continued pressure on defense

* Companies cutting costs, looking for revenues elsewhere

By Andrea Shalal-Esa

WASHINGTON, Oct 2 (Reuters) - Tighter military budgets in the United States and Europe reduced the revenues of top weapons makers by one percent in the first half of the year and are likely to continue to depress sales in the full year, a new study by Deloitte LLC showed.

Defense companies in the top 20 global aerospace and defense (A&D) companies reported a $1.3 billion drop in revenues in the first half, after a 3.3 percent decline in 2011, according to the report published on Tuesday. The top 20 companies account for about 71 percent of total global industry revenues, Deloitte said.

At the same time, record-setting production of commercial aircraft pushed commercial revenues 14.9 percent higher, which help increase overall revenues in the combined aerospace and defense sector by $7.2 billion, or 5.5 percent increase.

"It is clear that we're probably looking at continued contraction in the defense industry. There's just not enough work to go around," Tom Captain, leader of global and U.S. aerospace and defense analysis for Deloitte, told Reuters.

He said the second half of the year would show at least a similar level of decline in defense revenues, although U.S. companies were cutting costs, trying to drum up more foreign orders, and taking other measures to survive the downturn.

Lockheed Martin Corp , Boeing Co , Northrop Grumman Corp , and other big weapons makers are due to report third quarter earnings later this month.

Captain said the overall industry posted an 8.8 percent increase in operating earnings and a 3 percent rise in operating margins in the first half of the year, largely due to commercial aircraft deliveries and cost-cutting measures.

But gains in the commercial sector far outpaced those reported in defense, where earnings rose a meager 1.5 percent in the first half, according to the report.

Continued instability in the defense spending forecasts also weighed on share prices in the sector, with the aggregate market capitalization down 0.6 percent in the first six months of 2012, after a 6.3 percent decline in 2011, Deloitte said.

Captain said U.S. plans to reduce projected defense spending by $487 billion over the next decade were already beginning to affect arms makers, even as they sought to stave off an additional $492 billion in additional cuts that are due to take effect starting in January.

"We are at an inflection point," Captain told Reuters. "We are at a new place going forward and ... it's daunting in terms of the changes and the challenges."

U.S. companies were taking steps to survive the downturn in defense spending, including moving aggressively into adjacent markets such as health care information technology, cutting costs and laying off workers, Captain said.

He said U.S. defense companies shed 44,000 jobs in 2010 and the number was expected to double this year, amid mounting budget pressures. If Congress was unable to avert the additional budget cuts, a total of 160,000 jobs could be lost over the next year or two, although expansion into adjacent markets and foreign sales could offset that trend somewhat, he said.

He said many big companies in the sector were also investing in development of new weapons such as micro unmanned vehicles and laser weapons to anticipate further military needs.

Merger and acquisition activity had stalled until the budget outlook was clearer, but would likely pick up once Congress and the Obama administration reached a deal on the additional budget cuts slated to take effect in January, he said.

He said Deloitte was advising companies on a number of M&A activities, including spinoffs, carve-outs and acquisitions, but he did not expect any of those deals to conclude until the budget outlook was clearer.

Captain said he ultimately expected BAE Systems

and EADS

to complete their merger talks, since the combined company would be better balanced between commercial and defense activities.

"It makes sense," he said, although he cautioned that the company's complicated ownership structure could create some headswind for the combined group.

(Reporting By Andrea Shalal-Esa;Editing by Sofina Mirza-Reid)

((andrea.shalal-esa@thomsonreuters.com)(202-321-7839))

Keywords: DEFENSE OUTLOOK/

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