Market Share

Volatile market masks contractors' strong foundations

Bill Loomis is managing director of the Technology Research Group at Legg Mason Wood Walker Inc. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of individual investors. For additional information and current disclosures for the companies discussed, please write to: Legg Mason Wood Walker Inc., Attn: Research Department, 100 Light St., P.O. Box 1476, Baltimore, MD, 21203.

The fundamentals of the federal information technology industry remain intact, despite the volatility of stocks over the past couple of months. Investors are attracted to the industry because of its long-term contracts, earnings growth and strong cash flow, particularly in the current market.

Second quarter results for the industry are in, and they generally meet or exceed consensus estimates. Anteon Corp., CACI International Inc., Dynamics Research Corp., MTC Technologies Inc., ManTech International Inc., PEC Solutions Inc., SRA International Inc. and Veridian Corp. all reaffirmed their comfort with consensus estimates.

On the negative side, I do not see anything significant to hurt fundamentals, but a few issues that have my attention. First, progress on fiscal 2003 budgets has been slower than expected, given it is an election year.

It appears there will be another round of continuing resolutions this year, but at this point, it is unlikely it will be anywhere as severe as last year. Also, the Office of Management and Budget has frozen IT funds related to the proposed Department of Homeland Security, pending a review to make sure redundancies are eliminated. Depending on how quickly reviews are completed, I do not believe this will have a significant impact on the industry ? except, of course, for those contractors that are working on an eliminated project.

The OMB review could speed up projects following the review process, by eliminating conflicts between the different groups making up the Homeland Security Department, something that tends to occur in large commercial mergers. In my view, this review makes sense. But OMB and the White House should be sensitive to the fact that reviews need to be done quickly to avoid the perception that bureaucracy is delaying the fight against terrorism.

Revenue and earnings per share growth in the second quarter were relatively strong among the publicly traded government IT contractors because of organic growth and the effect of acquisitions. Among the companies with stronger organic growth, Computer Sciences Corp. had a very strong quarter in its federal business, with organic revenue growth of 18 percent and with federal clients now representing 29 percent of its revenue.

PEC Solutions had about 30 percent organic revenue growth and 58 percent revenue growth counting acquisitions. PEC reported second quarter EPS of 17 cents (before amortization of intangibles), above the consensus 15 cents estimate. PEC continues to be the standout financial performer in the federal sector, with growth and operating profit margins well ahead of its competition at 17 percent last quarter.

CACI had 15 percent organic growth, 25 percent counting acquisitions and reported EPS growth of 47 percent in the quarter, a penny above estimates.

ManTech reported total revenue growth of 13 percent, and EPS of 21 cents, well above the consensus estimate of 18 cents. MTC Technologies reported revenue growth of 12 percent and fully taxed second quarter EPS of 19 cents, well above the 16 cents consensus.

Revenue growth of other public federal companies was: Veridian at 11 percent total revenue growth, Anteon at 9 percent, and SRA at about 7 percent organic growth and 19 percent counting acquisitions. Each of these companies reported EPS that exceeded consensus estimates.

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