by Joseph Walent, Analyst
General Dynamics Information Systems and Technology continued be battered by ongoing uncertainty in the Federal market
The shadow of potential sequestration accentuated the pervading contraction and deceleration of government outlays for General Dynamics Information Systems & Technology (IS&T) solutions and services in 3Q12. IS&T revenue contracted 7.8% year-to-year to $2.47 billion, with continued downward pressure on Tactical Communication Systems business and lower volume in Information Technology Services business. IS&T’s exposure of the short-term contracts prevalent in IT services delivery, the shift to “lowest price, technically acceptable” in procurement policies and increased reduction of scope on current engagements precipitated General Dynamics to re-evaluate its full-year revenue guidance of a 7% contraction to between a 8% to 9% contraction year-over- year.
TBR believes the close of the Federal Government’s fiscal year at the end of the quarter served to stimulate award activity. As a result, IS&T secured funded backlog of $8.22 billion and total backlog of $10.11 billion, up sequentially 9.4% and 8.7%, respectively. TBR also believes IS&T’s planned migration to higher value Tactical Communications solutions business will further secure demand consistency in 2013, led by the Warrior Information Network – Tactical (WIN-T) program sets.
The mix of IS&T revenue continued the shift to lower margin IT service delivery, combined with the effect of a $25 million charge taken by IS&T as part of a revaluation of certain inventories of ruggedized-computer inventory, yielded operating margin of 8.1% during 3Q12. Removing the impact of the one-time charge IS&T operation margin would have been 100 bps higher, or 9.1% for the same period. TBR expects stronger sales in Tactical Communications programs, and the increased impact of Healthcare IT services delivery will push IS&T operating margin to 9.2% during 4Q12. With prevalent uncertainty around revenue, TBR expects IS&T to maintain a clear focus on managing to maximize profitability through efficient execution on engagements.
IS&T is leveraging acquisitions to diversify into commercial businesses
TBR believes that IS&T accelerated its push into commercial market capabilities as a hedge to their large government contract exposure. TBR also believes that with an approximately $2.8 billion cash position, they will continue to acquire companies with commercially oriented products and are in high growth areas such as cybersecurity, wireless and healthcare IT.
During 3Q12, IS&T acquired two companies, Fidelis Security Systems and Open Kernel Labs. The acquired companies share common themes in that they serve commercial and government customers and they are in growth markets of cybersecurity and mobile. TBR believes that these acquisitions play into a broader theme of acquiring companies that have dual government/commercial client bases so GD can leverage its core government client expertise to generate synergies and at the same time diversify internationally and domestically into adjacent markets of public safety and commercial markets.
Concentration of cybersecurity expertise allows IS&T to capitalize on a fast growing market
The launch of the Global Security Operations Center (GSOC) gives IS&T a cybersecurity platform that incorporates multiple third-party security technology providers onto one scalable, cost effective solution. An integral component in solution development and delivery will stem from the two Customer Integration Labs in Orlando, Fla., and Waynesville, N.C., that offer staging for clients so they can ensure their systems are safe by testing them under real life conditions. Lockheed Martin IS&GS introduced a similar approach in 2008, giving it an jump in the federal cyber spend, which TBR estimates will expand from $9.3 billion in 2011 to $14.3 billion in 2016.
GD IS&T’s delay in delivering a defined cybersecurity solution will place it at a disadvantage to its peers that were early movers in establishing centralized cybersecurity solution centers. By moving aggressively to pull its resources together into a single solution and offering the same quality and depth of service as its competitors, IS&T can build market share with current customer sets.
Contract wins in Healthcare IT show momentum building in key growth areas
IS&T continued to expand its breadth of healthcare IT work in 3Q12 winning two significant contracts. One of the contracts was to provide support services for vaccine, drug and medical device development programs to the Army. The second deal entails the provision of software engineering and support services for the U.S. Indian Health Service’s electronic health information system, providing General Dynamics with greater exposure to non-military healthcare delivery management, paving the way for commercial segment healthcare IT engagements.
These healthcare IT contract wins will provide momentum to IS&T to push further into the market with TBR expecting ongoing investment by the company expanding its service portfolio through organic capability development and bolt-on acquisitions. TBR believes cloud related Healthcare IT spending, estimated to grow at 20% CAGR, will be a central area of focus for IS&T in 4Q12 and 2013.
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