By Sebastian Lagana, Analyst
General Dynamics IS&T’s U.S. Army exposure is resulting in steep revenue declines, but efficiency initiatives are improving margins
General Dynamics IS&T faced strong headwinds during 2Q14. Expected tepid demand from U.S. Army clients weighed heavily on results, driving a 15.2% year-to-year revenue contraction. Despite this steep decline, a growing backlog of new business enabled IS&T to improve guidance tendered at the outset of FY14 by 500 basis points. Despite this improved outlook, new guidance for a full-year revenue contraction of 15% implies double-digit year-to-year revenue declines in 3Q14 and 4Q14.
More encouraging was IS&T’s operating margin of 8.7%, which represented the group’s best performance in two years as improved delivery efficiency driven by the company’s Back to Basics initiative began to show benefits. While we do not expect the company to reach the 9% to 10% operating profitability range maintained by some of its peers, we expect the company to generate operating margins in the mid-8% range through the end of the year.
C4 Systems is leveraging secure commercial off-the-shelf communication-based technology to mitigate declining demand for legacy radio products
General Dynamics IS&T’s C4 Systems group long represented IS&T’s most profitable subsegment given the large amount of product-based work included within it, which was critical to putting in-field communication systems in the hands of soldiers in southwest Asia. However, as troop drawdowns in Iraq and Afghanistan have accelerated over the past five years, the C4 Systems business has suffered greatly, driving multiple years’ worth of year-to-year revenue contraction for the group. This, in turn, has resulted in significant pressure on IS&T as a whole in top-line performance as well as maintaining historical profitability levels as the sales mix shifts toward resource-intensive services work.
Although radio- and network-centric programs such as JTRS HMS and WIN-T still play a major part in the C4 Systems business, TBR has identified a push to expand capabilities in the mobility and Voice over IP market as clients increasingly demand secure, commercial-off-the-shelf (COTS)-based communication solutions. By leveraging prior acquisitions such as secure communications provider Open Kernel Labs as well as alliances with companies such as Samsung and Colt Canada, C4 Systems has enhanced legacy COTS-based products, including its Sectera vIPer phone, and is developing new COTS smartphone-based surveillance and targeting system data exchange capabilities for Canadian defense clients.
While in-theater troop drawdowns will continue to impact legacy business related to JTRS HMS and WIN-T, we believe C4 Systems is gaining traction with its suite of secure, COTS-based end-user communications products, in turn providing a boost to profitability for IS&T. This was most recently evidenced by the delivery of the 4,000th Sectera vIPer secure phone for the U.S. Department of State and the adoption of the same system by the FBI to replace legacy telecom equipment.
IS&T’s Fidelis subsidiary remains critical to cementing a position in cyber markets
GD Fidelis Cybersecurity Solutions announced two key cyber-related developments in 2Q14: inclusion in the Microsoft Active Protections Program, an emerging security threat update program, and a “Recommended” rating for its flagship XPS network security solution from independent security testing company NSS Labs.
As competitors such as Raytheon, Lockheed Martin and Booz Allen Hamilton continue to enhance their cyber-related predictive analytics, active threat monitoring and network gap analysis portfolios, IS&T has positioned its offering as a product-based network monitoring tool providing a first layer of protection against advanced threats. While this will command a lower price point, we believe this can be offset in part by increased profitability associated with product-based solutions.
Please feel free to use this content with TBR and analyst attributions. Contact Sebastian Lagana at 603.758.1857 or sebastian.lagana@tbri.com for additional commentary.
