Market Share: Third quarter is a charm -- for most

Bill Loomis

As I write this, most of the publicly traded federal IT firms have reported third-quarter results. While they generally have been better than investors expected, the larger companies' organic revenue growth rates, which exclude acquisitions, have slowed to 12 percent from 13 percent in the second quarter and 15 percent in the first.

While the fiscal 2003 budget process delayed funding for some programs, we are starting to see the record increases in civilian and defense spending last fiscal year convert to bid opportunities and contract awards.

Even while the defense budget was passed almost on time, the Iraq war and delays in the first defense supplemental spending bill caused some program disruptions.

While CACI International Inc.'s quarterly contract award amounts declined from September 2002 to June 2003, it had doubled the amount of contracts it bid in the June quarter as opportunities became available, which resulted in a record amount of contract wins in the September quarter.

We are seeing a similar situation at Anteon International Corp., which almost tripled the dollar amount of its bids outstanding in the third quarter.

I believe organic revenue growth for many of the public federal IT companies will accelerate next year, given the pickup in contract award activity.

MTC Technologies Inc.'s revenue grew 63 percent in the third quarter compared to third quarter 2002, with earnings per share growing 39 percent year-over-year.

SI International Inc. showed 10 percent organic revenue growth in the quarter, but 35 percent EPS growth driven by sharp expansion in its operating profit margin from 6.9 percent to 7.8 percent.

ManTech International Inc. had internal revenue growth of 12 percent, overall revenue growth of 39 percent and EPS growth of 21 percent. Despite strong operating profit margin improvement at ManTech in the quarter, from 8.4 percent to 8.9 percent, and impressive revenue growth, EPS were hurt by the impact of the company's follow-on stock offering late last year, which boosted shares outstanding 22 percent year-over-year.

Dynamics Research Corp. had 12 percent organic growth and 32 percent total revenue growth. With operating profit margin flat at 6.8 percent, EPS grew 23 percent.

Last year's third quarter EPS were down 21 percent though, making the comparison easier. The company has been showing steady improvement in its margins and organic growth this year; though following the announcement of its third quarter results, it lowered its earnings guidance for the fourth quarter, citing contract award delays.

PEC Solutions Inc. had a tough quarter. Revenue was down 18 percent year-over-year and EPS down 40 percent vs. its very strong quarter a year ago. With most of its revenue coming from the Department of Homeland Security, PEC has been hurt by contract award delays associated with the agency's formation. As I write this, one leading company, SRA International Inc., had not yet reported its third quarter earnings.

With the federal IT stocks trading at historically high valuations (27 times 2003 EPS earnings and 23 times 2004 EPS estimates currently), investors seem to be expecting the companies to raise their earnings expectations quarterly, and are disappointed if they do not.

Bill Loomis is a managing director of the Technology Research Group at Legg Mason Wood Walker Inc. He can be reached at wrloomis@leggmason.com. 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 herein, please write to: Legg Mason Wood Walker, Inc., 100 Light St., P.O. Box 1476, Baltimore, MD 21203, Attn: Research Department.

About the Author

Bill Loomis is a managing director at Stifel Nicolaus.

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