Defense contractors’ IT businesses under pressure

July 29, 2012

The largest defense contractors reported last week new challenges to their information technology businesses as the government adapts to shrinking budgets.

In the Washington area, IT contracting is particularly important. Tanks, missiles and aircraft are typically built elsewhere, but IT services happen here, meaning that these declines could take a particularly large toll on the region.

Falls Church-based General Dynamics’s range of work spans private jets, military vehicles and computer programs. But the area under the most pressure is the company’s information systems and technology business, which includes IT services, cybersecurity and battlefield communications equipment.

The unit “was challenged again in the second quarter as customer award activity continued to fall short of expectations,” said Jay L. Johnson, General Dynamics’s chairman and chief executive, in a call with investors last week.

The company reported that profit fell to $634 million ($1.77 per share), down from $653 million ($1.76) for the same period a year earlier. Quarterly revenue grew very slightly to $7.92 billion, but the information-systems business was the only one of the company’s four units to see profit and sales declines.

IT services is generally a lower-margin business that doesn’t produce the kind of profits seen in other areas, such as military equipment. But the business has become tougher as spending slows and the government increasingly chooses the lowest-priced offering, rather than seeking the “best value.”

IT work has also taken a greater share of the pain of budget cuts because it’s a “short-cycle” business, meaning it typically is paid for out of current funds. A plane or tank rolling off the assembly line this year, for example, has typically been largely paid for because of the time it takes to set up production facilities, order parts and manufacture the equipment.

“The shorter-cycle businesses . . . [are] going to feel the budget pressures earlier on,” said William Loomis, managing director at Stifel Nicolaus, which has a business relationship with a number of government contractors. “It’s easier to tell the person running your network [to] have three people not show up on Monday than restructure a large weapons program.”

Bethesda-based Lockheed Martin last week reported a profit of $781 million ($2.38 per share) for the three-month period, up from $742 million ($2.14) for the same period a year earlier. Quarterly revenue grew 3.3 percent to $11.92 billion.

But like General Dynamics, the company’s information systems and global solutions business was the only one of its four business units to see its sales and profit drop.

At Falls Church-based Northrop Grumman, quarterly revenue fell about 4 percent to $6.27 billion, and the company’s information systems unit saw the steepest decline in sales.

Still, the unit was able to boost its profit margin to 10.9 percent for the quarter, up from 9.3 percent for the same period the previous year.

Wes Bush, Northrop’s chairman, president and chief executive, in a call with investors last week attributed the improvement to a shift away from “commodity” services, or those that are so common that the government generally makes its decision based on price, to more technical services.

“Generally speaking, the larger companies are choosing margin over volume right now,” Loomis said.

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