The smart money is on intelligence

In real estate, it's all about location, location, location. These days, in federal systems integration, it's all about intelligence, intelligence, intelligence.

Integrators report that intelligence-related projects — whether with agencies, the Defense Department or individual military services — have fueled business in fiscal 2003. The trend shows up in their financial reports. Information technology initiatives falling under the broad mantle of national security are getting the dollars. That's good news for integrators already positioned in that space and an incentive for others to get there through acquisitions (see Federal Computer Week's Federal List, Sept. 15).

Contracting officers trying to evaluate the financial health of a company they are considering hiring need to consider more than simple revenue or even profits. The quarterly and annual reports a public company files with the Securities and Exchange Commission reveal how its assets match up against liabilities, how much debt it owes and how its interest and taxes affect the bottom line.

But strong revenue growth is always a good sign, and double-digit growth has been common this year among integrators with the right business mix. In one example, a focus on national security helped propel CACI International Inc. to a record fiscal 2003 revenue of $843.1 million, a 24 percent increase over the previous year. Profits grew from 40 percent for the year that ended June 30 to $44.7 million — another milestone for the company.

But the soon-to-close fiscal year hasn't been without wrinkles. Delays in appropriations bills earlier this year put a damper on civilian agency spending. In addition, the Homeland Security Department, which was expected to produce a bounty of integration work, has proven to be a challenging environment.

That said, integrators expect continued government interest in enhancing intelligence systems and boosting security in fiscal 2004. "That's a trend line that I continue to see," said Jack London, chairman and chief executive officer of CACI. "There's a lot of momentum."

And with momentum comes the opportunity to sustain double-digit top-line growth and solid profit margins in the coming fiscal year. Integrators expect intelligence and security-related projects to continue to drive their business.

Classified growth

CACI's recent earnings conference underscores the importance of intelligence as a growth factor. Company executives reported that CACI's domestic command, control, computers, communications, intelligence, surveillance and reconnaissance (C4ISR) business soared 22 percent for the fourth quarter that ended in June and 37 percent for the fiscal year.

C4ISR aims to extract actionable information from intelligence and reconnaissance sources and give that information to field commanders who use it to direct warfighters. It facilitates what military planners call the sensor-to-shooter loop. C4ISR integrators perform a variety of roles, including technical assistance, program management and systems integration. Overall, intelligence business represents 20 percent of CACI's U.S. operations.

Company officials point to tactical intelligence — intelligence at the warfighting level — as one area of emphasis. The company added capability in that field through its May acquisition of Premier Technology Group Inc.

London said the national security theme permeates other areas of the company's business, including recent contracts with the Justice and State departments, among others.

The story is similar at SRA International Inc., where Ernst Volgenau, president and chief executive officer, called defense and intelligence work the company's fastest-growing area. Revenue for the company's June-ended fourth quarter increased 25 percent, from $101.4 million in the same quarter last year to $127.1 million. Operating income grew 75 percent, from $7.7 million to $13.5 million. Operating income for the company's 2003 fiscal year surged 127 percent, from $18.5 million to $42 million.

In January, SRA acquired Adroit Systems Inc., which provides C4ISR services to intelligence and defense organizations.

Growth in classified programs helped fuel the growth of Raytheon Co.'s intelligence and information systems sector, according to an SEC document filed in August. That sector, which houses the company's IT integration work, saw a 15 percent increase in revenue for the second quarter, which ended June 29 — from $457 million to $525 million.

Likewise, classified programs played a role in the expansion of Northrop Grumman Corp.'s IT sector, said Ronald Sugar, Northrop Grumman's CEO, in remarks to financial analysts. Northrop Grumman IT sales grew more than 11 percent — to $1.1 billion — for the company's second quarter, which ended June 30.

Expansion has not been as healthy at American Management Systems Inc., which has been restructuring in recent months. Its $84.5 million in federal revenue for the quarter that ended June 30 was the same amount it reported a year ago.

AMS has completed the acquisition of R.M. Vredenburg and Co., which specializes in intelligence, and is banking on increased interest to build sales. The country's concerns have shifted from the Cold War's focus on the Soviet Union to the pursuit of "an ephemeral foe," said John Hillen, AMS' senior vice president for defense and intelligence. Meanwhile, rapid advances in IT provide the opportunity to retool front-office and back-office systems.

"Take the two forces together and you have a pretty dramatic backdrop for transformational change," Hillen said. That change is steering business in the integrators' direction. Hillen reported that AMS captured $100 million in intelligence business in the first five months of the calendar year.

Homeland security: Mixed bag

DHS is expected to become a major market for integration services. Projects began to move during fiscal 2003, but most of the activity was among individual agencies within the department. Departmentwide projects have been slower to congeal.

"We don't find ourselves spending an enormous amount of time and energy pursuing homeland security areas," London said. He noted that CACI does have work with DHS agencies such as customs and the Coast Guard. As for departmentwide initiatives, "our strategy is to be knowledgeable and available and responsive" when those projects emerge, he said.

Sugar, meanwhile, cited a 2002 Immigration and Naturalization Service contract as among the programs contributing to the growth of Northrop Grumman IT. The Technology Enterprise Automation Management Support program, which covers topics ranging from hardware maintenance to security, is designed to help INS, now reconstituted under DHS, achieve its homeland defense mission. The project has a potential value of $228 million.

Homeland security money is beginning to flow for the individual agencies that were combined into the new department, but not yet at an "integrated homeland security level," said Renny DiPentima, president of consulting and systems integration at SRA, in a recent call with analysts.

That could change in a few months with upcoming procurements, such as the Coast Guard's Security, Planning and Integrated Resources for Information Technology program. Industry executives anticipate that SPIRIT, an IT services vehicle, will be used across DHS.

Another notable DHS procurement is the Transportation Security Administration's Transportation Worker Identification Credential program. This program is expected to include such emerging technologies as contactless smart cards using radio frequency communication, said Bill Alsbrooks, business area manager for credential card business at Anteon Corp.

Civilian agency work, in general, has had its ups and downs this year. Delays in key appropriations bills brought numerous IT projects to a standstill earlier this year, according to integration executives. But now some suggest that the civilian sector has begun to rebound.

Pent-up demand has made the traditional end-of-fiscal-year IT spending surge, particularly in the civilian sector, Volgenau said. "We're seeing a lot of activity there."

Growth via acquisition

In addition to national security, acquisitions have proven an important source of growth for integrators.

Computer Sciences Corp.'s March purchase of DynCorp provides a dramatic example. CSC brought in $1.51 billion in revenue for the quarter that ended July 4 — a 91 percent increase over the $790.7 million revenue for the same quarter last year. An SEC filing shows that 87 percent of that growth came from DynCorp.

Acquisitions also played a role in revenue growth at CACI. The company reported that acquisitions contributed to 12.5 percent of its fourth-quarter federal growth rate of 21.5 percent. But the company's internal, "organic" growth rate was 16 percent for the year, and CACI executives expect organic growth in the 12 percent to 15 percent range going forward.

At SRA, Volgenau noted that acquisitions are an important part of the company's growth strategy. In the company's 2003 fiscal year, the growth rate attributed to acquisition was around 10 percent, while the organic growth rate was about 15 percent.

Acquisitions, naturally, add employees, but some integrators are hiring as well. SRA, for example, brought in 144 new employees in its fourth quarter and plans to hire 100 more in the first quarter of the next fiscal year. The award of the Advanced IT Services contract earlier this year has fueled the hiring wave. Under this contract, SRA serves as the systems integrator for the National Guard Bureau and the Reserve Component. Work includes overall program management for the Reserve Component Automation System.

Deja vu all over again

Federal spending activity has made the government an attractive integration market at a time when private-sector spending has been tepid at best. The current situation is a throwback to the early 1990s when federal integration was a rock of stability during a period of recession.

"It's a cyclical thing," said Jeffrey Kaplan, principal at Thinkstrategies, a consultancy following the IT services market. "Four or five years ago, integrators were looking at e-business opportunities in the commercial sector."

Today, government growth typically outpaces commercial expansion for integrators involved in both sectors. For CSC, U.S. commercial revenue declined 5.9 percent for the company's first quarter, while federal revenue surged — albeit mostly on the strength of the DynCorp acquisition.

Science Applications International Corp. experienced a similar pattern. The company's regulated segment, which includes federal business, saw revenue growth of 20 percent for the quarter that ended in April. Revenue for its nonregulated telecommunications segment declined 17 percent.

A look ahead

This back-to-the-future theme also applies to at least one potential trend for fiscal 2004: outsourcing.

The government has been outsourcing IT activities, such as claims processing, for years. The practice has exploded in the commercial scene, beginning with the data center outsourcing trend of the late 1980s. Some industry watchers now see an opportunity for business process outsourcing — the outsourcing of both business functions and the underlying IT — in the federal market.

"The federal government is an emerging market for business process outsourcing," said Don Taylor, CSC's vice president of federal sector sourcing. "It's a dynamic and growing market we need to be in."

That sentiment is also apparent at Lockheed Martin Corp., which earlier this year purchased the government operation of Affiliated Computer Services Inc. ACS' federal sector had carved itself a niche in business process outsourcing, working on such projects as Education Department loan processing.

CSC has business process outsourcing experience of its own, including long-running claims-processing contracts with the Labor Department and the Federal Emergency Management Agency's National Flood Insurance Program.

Taylor said that although the Bush administration's initiative to outsource civilian work that is not inherently governmental is meeting fierce resistance from federal employee unions and some lawmakers, the effort is driving outsourcing opportunities. Human resources, Taylor added, "is going to be a very large component of business process outsourcing on the federal side."

Moore is a freelance writer based in Syracuse, N.Y.