With Cautionary Spending, Contractors Turn to Execution for Sustainability
After fighting off the sequestration woes in late 2013, government contracting firms continue to provide mixed signals. Midyear Q2 earnings released over the past month revealed not a changing Aerospace and Defense landscape, but rather a need for more efficient business models executed by government contractors. While award activity for many has risen off the sequestration floor, the spending outlook by the Pentagon has continued to be cautious and consequently cash flow for most firms isn’t coming in as strong as a year ago (Q2 2013). Companies like Boeing, Raytheon and Booz Allen have experienced modest success maintaining backlog, but others like ManTech have been constrained by new business award delays and the Afghanistan draw down. As a result, this month’s release of top Aerospace and
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When we last checked in on our government services indices back in October 2013 following Q3 earnings calls, our contractors were fresh off 16 days of sequestration, the budget debate had been postponed for another few months, and the overarching theme across all calls could be summed up in one word: uncertainty. Though this uncertainty surrounding long-term budget cuts has not completely subsided, the January 2014 bipartisan appropriations bill certainly had many executives breathing a (slight) sigh of relief during Q4 2013 earnings calls, released in late January and early February:
“Sequestration is eliminated for fiscal years 2014 and 2015 and replaced with reduced spending levels. The law also removed the across-the-board spending reduction methodology previously in place under sequestration and restored the ability for government agencies to move funds and discreetly allocate resources to higher priority areas, a critical revision that we have been seeking since the Budget Control Act was established back in 2011.”
– Lockheed Martin Corporation
“We are pleased that a fiscal year ’14 budget agreement has been signed… providing some near-term sequestration relief. This averts another disruptive government shutdown and provides our customers at least a near-term planning horizon.”
– The Boeing Company
“The end of sequestration does mean our customers can now allocate funds to the critical programs we support. We know that Cyber and C4ISR are going to see increases in 2014 and 2015.”
– KEYW Corporation
Companies not reporting as of date of publication: EGL, ICFI, LDOS, MANT, NCIT, VSEC, XLS
While cautiously optimistic about the federal budget going into 2014 and beyond, several contractors echoed one harsh
During the last two weeks of October and first two weeks of November, all major Tier 1 and Mid-Tier Defense and Government Services contractors reported calendar Q3 results. This was good news for our Tier 1 index, who all reported Earnings Per Share (“EPS”) ahead of analyst expectations and raised full year 2013 EPS guidance. The market responded positively to the news, as four of six companies in our index experienced share price increases the day following the release of Q3 results. However, our Mid-Tier index did not fare as well, as over half of the companies lowered either revenue or EPS guidance (or both). Eight of 11 contractors in our Mid-Tier index experienced share price drops following the release of their Q3 earnings.
Based on calendar Q3 results, it appears continuing sequestration has impacted the Mid-Tier index more significantly than the
Government contractors of all sizes have certainly felt the impact of reduced spending and sweeping cuts over the last year. However, it is likely that the greatest damage is still to come. DoD spending cuts are expected to increase by 40% in FY2014 as compared to FY2013 ($52B vs. $37B). Additionally, mitigation tools and resources that have reduced the impact in FY2013 may not be available in FY2014 and future periods.
To date, the DoD has cut spending through furloughs and reductions in training, travel, and maintenance expenses. Additionally, the DoD has used unobligated funds from prior years to soften the impact of sequestration. Approximately $6B of unobligated funds from prior years was used to dampen spending reductions. Current sequestration plans demand $1 trillion of spending reductions over a 10-year period, with only $37B of that amount realized in FY2013. As the effectiveness of some of these mitigation techniques diminish, leaders will have to make tougher decisions on what expenses to attack next.
Continue reading about the challenges and implications of an uncertain future market in Aronson Capital Partners’ September Market Update.