The second quarter of 2020 saw the height of a global pandemic, the bottoming out of the U.S. economy and a variety of first-, second- and third-order consequences that varied by industry and sector. While the federal government is a reliable customer to serve amid a raging pandemic, federal contractors were not fully immune to COVID-19’s disruptions.
Top executives in the government services space highlighted opportunities, headwinds and strategic initiatives in their second-quarter earnings calls, per Bloomberg. Specifically, the companies represented were ManTech International Corp. (MANT), Booz Allen Hamilton (BAH), Leidos Holdings (LDOS), ICF International (ICFI), Parsons Corp. (PSN), Perspecta (PRSP), Pacific Architects and Engineers (PAE), Vectrus (VEC) and CACI International Inc. (CACI). While each company told its unique story, five key themes rose to the surface.
1. Awards are delayed, but there is no shortage of opportunity
Despite COVID-19, there has been no shortage of opportunities and requests for proposals for government services. Typical levels of government outlays continue based on current fiscal year budget appropriations in addition to heighted COVID-19-related fiscal stimulus. Government spending not only continues during periods of economic downturn, but it also can be used to stimulate the economy, battle unemployment and protect U.S. citizens.
Roger Krone, chairman and CEO of Leidos, noted that the company submitted more proposals during the pandemic (mid-March – June 2020) than the same period in the prior year.
However, contract awards are slipping to the right. Specifically, contractors are seeing this in a slowing of individual indefinite delivery, indefinite quantity task order awards. John Mengucci, president and CEO of CACI, noted they saw a slowdown in awarding individual indefinite delivery, indefinite quantity task orders but are working with their government customer to pick that pace back up.
2. Strategic M&A is a focus, and consolidation will continue
The M&A pipeline is steadily refilling after the near standstill experienced in the first quarter. Strategic M&A remains a key priority as companies seek to grow, increase capability and diversify the agencies they serve and contract vehicles to which they have access.
Executives at ManTech, Booz Allen Hamilton, ICF International, Parsons, Perspecta, PAE, Vectrus and CACI noted a continued focus on strategic M&A. Corporate development teams continue to assess possible targets. Deal flow will likely increase as debt markets loosen, due diligence resumes and more assets are shopped on the market.
Strategic M&A remains a key priority as companies seek to grow, increase capability and diversify the agencies they serve and contract vehicles to which they have access.
3. The extension of CARES Act section 3610 is paramount
An extension of section 3610 of the CARES Act past Sept. 30 is of utmost importance for mission critical needs in the intelligence community. This section allows agencies to modify contract terms in specific situations to ensure a ready-state workforce in an effort to maintain national security.
Kevin Phillips, president and CEO of ManTech, noted, “the provision has allowed us and the broader industry to maintain talent critical to national and homeland security. …Should there be a lapse, it is possible that our broader industry may be forced to furlough or take other more drastic measures with respect to the part of the talent base that are unable to serve customers.”
Industry leaders, including Mengucci, expect bipartisan support from Congress on this matter. However, the authorization to extend may not come until later in September, based on the congressional calendar.
4. Remote work is being embraced
With the exception of pockets within the intelligence community, government customers and contractors have smoothly transitioned to remote work, and contractors are confident in their ability to acquire, train and retain talent virtually.
Many contractors may consider reducing their real estate footprint going forward. John Wasson, president and CEO of ICF International, said, “We can work very effectively in a virtual environment, and we don’t have to have people in the office five days a week. Also, I think, over time as leases expire, we will certainly be looking to reduce our facilities footprint, and that’s our third largest cost in the company.”
“…over time as leases expire, we will certainly be looking to reduce our facilities footprint, and that’s our third largest cost in the company.”
5. Digital transformation is accelerating
COVID-19 has accelerated the federal government’s existing focus on digital transformation and IT modernization. This continues to be a focus, with opportunity for cutting-edge technology and innovation.
Mac Curtis, chairman and CEO of Perspecta, referred to IT capabilities at the enterprise level under a managed services or agile development construct as “not seen as a commodity, rather as the key enabler of the [government’s] mission.”
Horacio Rozanski, president and CEO of Booz Allen Hamilton, commented on the ability of artificial intelligence to “scale through the federal government and create real value,” another signal of the government embracing the next technological evolution.
The second quarter was tumultuous for the U.S. economy and equity markets. However, the pandemic brought a mix of opportunities and headwinds to the government services sector. Continued recovery and fallout is expected through the end of the calendar year, with an uncertain degree of extension into 2021 and beyond.
Company executives in the sector remain agile in an effort to anticipate future government spending trends and public health needs. We expect third-quarter earnings calls to center around the November presidential and congressional elections, given the influence the presidential administration and Congress will have over future budget authorizations and appropriations.