by Joseph Walent, Analyst
General Dynamics’ Information Systems and Technology continued to feel the pinch in 2Q12
General Dynamics Information Systems & Technology continued to register the effects of pervasive uncertainty in the federal IT market during 2Q12, posting year-to-year revenue contraction of 9.9% to $2.53 billion. Like its peers, prolonged decision cycles and delays in the allocation of funds on engagements continued to create an adverse business environment for IS&T. Funding holdbacks affected IS&T’s tactical communications business to the greatest degree despite the groups effort to push into adjacent markets during the quarter. With the outlook for the remainder of the year anticipating a continuation of the adverse conditions in the first half, compounded by the increasing threat of triggering sequestration at year end, and the uncertainty created by election year politics, IS&T restated its full-year guidance for revenue to a 7% contraction from the previous year’s level, up from the revision made in 1Q12 of 5% contraction. TBR expects IS&T will register improved traction for its healthcare IT and cybersecurity solutions, combined with a broader market approach (state & local, federal civilian, international) for its tactical communications solutions in 2H12,which will help decelerate the rate of revenue contraction to midsingle digits in 3Q12 and 4Q12.
While the delays for purchases of higher-margin Tactical communication solutions continued in 2Q12, the revenue mix for IS&T shifted toward services, yielding a 170 basis points year-to-year drop in operating margin for the IS&T group to 8.9%. TBR expects overall cost reduction efforts, including facility consolidation, business unit restructuring and headcount rationalization undertaken by IS&T during the quarter, will combine with resurgent tactical communication order activity to improve profitability in 2H12.
IS&T’s Tactical Communication Systems segment bolstered its short- and long-term growth prospects
General Dynamics’ IS&T One Source joint venture, a collaborative, cross-departmental unit designed to draw resources from across the Tactical Communications, IT and ISR segments, was instrumental in capturing a position on the U.S. Department of Homeland Security’s TacCom program, a five-year, $3 billion ID/IQ contract. The deal win combined with the integration of its acquisition of IPWireless in late 2Q12 into General Dynamics’ C4 Systems business unit, Tactical Communications, will regain positive momentum in 2H12.
IS&T also announced the expansion of its Fort Bliss, Texas, facility to include an EDGE Innovation Center, the twelfth of its kind worldwide. Sponsored by General Dynamics C4 Systems, the EDGE facility will provide IS&T with hands-on access to prospective clients and end users of its Tactical Communications products. TBR believes the increased collaboration with product users and EDGE partners will not only allow IS&T to better tailor its soldier, vehicle and network-based communication solutions for its DoD clients but also provide opportunity to test its solutions for entry into adjacent public safety and emergency response markets.
Leveraged new products and alliances to position IS&T as a leader in mobile cybersecurity
The introduction of IS&T’s ProtecD@R mobile PC data encryption tool, paired with the announcement of an alliance with Samsung to produce smartphones and tablets with defense-grade cybersecurity in 2013, positioned General Dynamics as a leader in the security of mobile computing and handheld devices. TBR believes this builds on the company’s legacy of secure defense-based communications networks (WIN-T) by adding capabilities that will be more applicable for use by federal and state & local civilian agencies.
Progress in integrating Vangent is driving improved healthcare IT revenues
General Dynamics’ move to expand its healthcare-based revenues with the acquisition of Vangent Inc. is already paying dividends, as indicated by year-to-year revenue growth of 78.4% in 2Q12, according to TBR estimates. While healthcare IT margins experience downward pressure as integration of Vangent continues, TBR expects margins to capture low-double-digit levels following a drop to 9.1% in 1Q12, according to estimates.
TBR believes General Dynamics will continue to seek attractive opportunities to expand its healthcare portfolio through acquisition and alliance activity as federal healthcare IT spending intensifies in comparison to the overall federal IT services market. According to a study by Deltek in late 2011, federal health IT spend will increase at a 7.5% CAGR through 2016, while total federal IT spending over the same period will decline at a -1.8% CAGR.
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