Government contractors preserve profit through cost-cutting
By Marjorie Censer,
Recent earnings reports show that many government contractors have been able to maintain their profits through cost-cutting despite declining or flattening sales, but analysts are questioning how long companies can keep that up.
Take Falls Church-based Northrop Grumman, which said profits grew at the end of 2011. The company’s sales fell nearly 6 percent, to $6.51 billion, in the fourth quarter compared with a year earlier. But Northrop still posted profit of $548 million ($2.09 a share), up almost 46 percent from $376 million ($1.27) in the same period in 2010.
It’s a story that Michael S. Lewis, director of equity research at Lazard Capital Markets, said is being repeated in other contractors’ earnings reports.
“All the companies have significantly revised their cost structure, and it is certainly showing up,” he said.
Contractors have been reducing their head count, consolidating facilities and slimming their executive ranks. Lewis said companies are taking very close looks at their costs, even cutting in areas such as color printing and holiday parties.
“How much more can they cut?” Lewis said. “All the low-hanging fruit has already been picked. There’s not much fat in the infrastructure.”
McLean-based Booz Allen Hamilton, for example, said last week that in January it cut about 2 percent of its workforce — which would be equal to about 516 of the 25,825 employees the company reported late last year. The move, which Ralph Shrader, Booz Allen’s chief executive, president and chairman, said would help the company “get out in front” of government spending reductions, came as the company reported a nearly 166 percent increase in profit in its most recent quarter.
Bob Kipps, managing director of McLean-based investment firm KippsDeSanto, said cost-cutting is not a sustainable strategy.
“The benefits of the cost cuts occur, from a financial reporting perspective, almost immediately,” he said. But, “the negative effects on profit have not yet shown their face.”
During a conference call with investors, Booz Allen officials said the company would reinvest some of the savings achieved through cuts into beefing up growth areas such as cybersecurity.
Booz Allen is not the only company weighing the trade-offs. Though facing tough times, Reston-based information technology services contractor NCI has said it is resisting cutting too much.
The company, which has warned investors it expects a roughly $220 million decline in sales in 2012, has reduced its workforce by about 60 employees and consultants — or about 2 percent of its head count — and consolidated, terminated or renegotiated leases at five facilities.
“There is a balance that we needed to find between reductions in cost that would bring bottom-line immediate results and making sure that we had the engine that we needed to grow our way out of this problem, because we couldn’t save our way out of the problem,” Marco F. de Vito, NCI’s chief operating officer, said in a call with investors.
Kipps said companies have to find ways to grow, by differentiating themselves and their capabilities or by continuing to acquire growing businesses.
“There is only so much cost you can cut,” he said. “Cutting cost in this market is not really a long-term winning strategy.”