IT sector upbeat about 2010 prospects

Despite a recent dip in contract activity, companies expect their revenues to bounce back next year

Despite relatively light contract award activity so far this year, the publicly traded federal information technology and professional services companies continue to post earnings gains, helping their stocks keep pace with the broader market and outperform the tier one defense and aerospace stocks. For the year, the federal IT and professional services stocks are up 12 percent, below the tech-heavy Nasdaq, which is up 28 percent, but close to the S&P 500’s 14 percent gain. They also are higher than the aerospace and defense stocks, which are down 3 percent.

Among the public firms, ManTech International Corp. reported one of the strongest earnings per share growth results in the quarter, up 29 percent on 8 percent organic revenue growth, as the company had strong profit margin improvement from its Mine Resistant Ambush Protected support contracts in Iraq and Afghanistan. ManTech boosted its 2009 EPS guidance to between 19 percent and 22 percent growth.

Stanley Inc. matched ManTech, posting strong EPS growth of 27 percent in the quarter on strong profit margin improvement (organic revenue growth was 5 percent), but it lowered its fiscal 10 EPS guidance to between 7 percent and 11 percent growth, reflecting lighter than expected contract awards.

CACI International Inc. reported 23 percent EPS growth on 10 percent organic revenue growth, and left its fiscal 2010 EPS guidance unchanged at between 8 percent and 15 percent growth. NCI Information Systems Inc. continued its strong showings with 23 percent EPS growth and 13 percent organic revenue growth. The company raised its EPS guidance for this year to between 18 percent and 22 percent growth.

Dynamics Research Corp. also continues to improve, showing 26 percent EPS growth in the quarter on 4 percent organic revenue growth. DRC is projecting EPS growth in 2009 of 16 percent to 21 percent.

SRA International Inc. reported an EPS that was down 3 percent year-over-year on 3 percent higher organic revenue growth, but those numbers were actually better than investors had been expecting given the weakness in SRA’s commercial businesses. SRA gave upbeat fiscal 2010 EPS guidance of between 14 percent and 24 percent EPS growth based on improvement in its commercial businesses and accelerating growth in its core federal businesses.

ICF International Inc. reported 37 percent lower EPS, as the second quarter was the last quarter of its large Road Home contract with Louisiana. Excluding the Road Home contract, ICF showed 9 percent organic revenue growth. As recent contract wins ramp up, and the company compares year-over-year on the completed Road Home contract, I expect EPS to grow more than 20 percent next year.

All of the larger public federal IT service providers have shown a slowdown in revenue growth this year, with mixed profit margins. While Science Applications International Corp. had not reported its July quarter at press time, investors are expecting 15 percent EPS growth on 5 percent organic revenue growth. Lockheed Martin Corp.’s Information Systems and Global Services’ (IS&GS) unit had second quarter 2009 total revenue growth of 5.6 percent, down from 10.3 percent in the first quarter, while the unit’s operating margin of 8.2 percent also was down from 9.5 percent in the year-ago period.

Revenue growth in IS&GS’s defense (mission and combat systems, readiness and stability operations) and civil segments were offset by declines in its intelligence business, and the company lowered its growth forecast for IS&GS for the year.

The performance of Northrop Grumman’s Information Systems unit was in line with the company plan for the second quarter, with revenue growth of 2.9 percent, down from 8.4 percent in the prior quarter. Operating margin was 7.9 percent, down from 8.2 percent in the year-ago period due to weakness in its state and local business. General Dynamics Information Systems and Technology had revenue growth of 4 percent, below expectations as some work shifted into the next few quarters, but the unit posted strong operating margins of 10.7 percent.

While federal contract award activity has been light this year (and revenue growth slowing for many companies as a result), I believe the strong budget growth in fiscal 2009 and the request in fiscal 2010 should lead to an increase in contract awards over the next couple of quarters that will improve growth in 2010.

About the Author

Bill Loomis is a managing director at Stifel Nicolaus.

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