By Joey Cresta, Research Analyst
Completion of defense and intelligence IT programs creates revenue growth headwinds as IS&GS lets more commoditized work expire
Changing procurement patterns among U.S. federal agencies continue to weigh on Lockheed Martin Information Systems & Global Solutions (IS&GS). Partly due to the federal government’s propensity to break up large existing contracts into multiple smaller contracts awarded primarily on the basis of price, business unit revenue fell 4% year-to-year to $1.3 billion, and operating margin declined 220 basis points to 8.2%. This shift reduced Lockheed’s advantage of touting past performance to win new deals and compelled the company to divest IS&GS, which will join Leidos later this year.
IS&GS’ 1Q16 results outperformed company revenue and profit guidance, causing Lockheed to increase guidance to an 8% revenue contraction and 7.5% operating margin for full-year 2016. An improved outlook helps to instill confidence in the assets Leidos will add to its portfolio, but we expect revenue declines to accelerate across 2016 as work winds down on existing programs and IS&GS walks away from lower-margin business. While this will impact top-line performance, exiting these contracts, combined with headcount rationalization in advance of the Leidos merger, supports an improved profitability outlook.
Lockheed’s relationship with the VA shows the strengths of a combined Leidos-Lockheed healthcare IT portfolio
One of the primary benefits TBR sees in the Leidos-IS&GS merger is in combining the two companies’ healthcare IT services (HITS) portfolios, as the deal more than doubles the size of Leidos’ existing HITS business. Leidos, bolstered by its large-scale electronic health records (EHR) integration deal with the U.S. Department of Defense, has a significant footprint with the Defense Health Agency but expands with agencies such as the Department of Veterans Affairs (VA), Department of Health and Human Services, and Centers for Medicare and Medicaid Services by combining with IS&GS.
In 1Q16 Lockheed subsidiary Systems Made Simple provided proof points of the advantages the merger provides in healthcare IT. In March the company won a five-year task order to help the VA streamline disability claims processing under the Transformation Twenty-One Total Technology (T4) contract, and the company was one of 21 firms named to the 10-year, $22.3 billion T4 follow-on vehicle.
With the VA’s IT budget up 5% in FY16 and the agency in need of improved cybersecurity, better constituent services and other IT modernization efforts, we believe there is broad addressable opportunity for the combined Leidos-IS&GS entity over the next two years. Particularly noteworthy is the VA’s uncertainty on updating its VistA EHR; if the agency chooses to adopt a commercial-off-the-shelf EHR solution instead, Leidos would be in prime position to secure another high-profile healthcare deal.
Investments in small business partners provide tangible benefits to Lockheed’s commercial cyber portfolio
IS&GS’ commercial cyber portfolio, which will also transfer to Leidos once the merger closes in 2H16, gained depth in 1Q16 with the release of the Wisdom EDR solution in collaboration with Israeli-based Cybereason. In 2015 Lockheed invested $10 million in Cybereason for solution development, providing evidence that differentiated small business partners provide cost-effective ways of expanding portfolio depth. Wisdom EDR adds machine learning and behavioral analytics to Lockheed’s threat intelligence, which we believe will support improved profitability of engagements with a cyber component.
In 1Q16 security intelligence and analytics provider LogRhythm and managed security services vendor Solutionary joined Cybereason in Lockheed’s Cyber Security Alliance. Federally focused firms have struggled historically in commercial markets, but we believe Lockheed is taking the right steps to address market needs by building a robust alliance network, which also includes technology market leaders such as Microsoft, Dell and HP, to engender a security ecosystem that fosters the knowledge share, industry best practices and collaboration necessary in a rapidly changing threat environment.
Please feel free to use this content with TBR and analyst attributions. Contact Joey Cresta at +1 603.929.1166 or via email at joey.cresta@tbri.com for additional commentary.
