Market Share: First quarter strong for most federal IT companies

Overall first quarter results were strong for most publicly traded federal IT companies, as they met or beat investor expectations and maintained or raised their earnings guidance.The organic growth rate ? growth not including the impact of acquisitions ? for most companies was double digit at 14 percent or higher. Also, most of them reported better-than-expected revenue from defense clients and lower-than-expected or just-in-line revenue from civilian agency clients. The notable exception was Computer Sciences Corp., which saw its organic defense revenue growth decline 7 percent but had higher-than-expected organic growth with civilian agencies, up 12 percent. The slower growth from civilian agency customers was not entirely a surprise. The 2003 federal civilian spending bill didn't pass until February, five months into the government's fiscal year. PEC Solutions Inc. had the most difficult first quarter among publicly traded federal IT service firms, at least in terms of investors' original expectations. In February and March, the company announced that first quarter results would be lower than expected because of contract delays, especially on one of its largest deals. Earnings per share in the first quarter was 12 cents vs. 14 cents a year ago, and below investors' expectation of 20 cents.First quarter revenue was $43.5 million, up almost 14 percent year-over-year and 9 percent organic growth. Despite the company's difficulties, PEC still reported an operating margin of 13 percent, below the year-ago 16 percent but still well above its peers. PEC was particularly hurt this quarter because it is facing declining revenue in two of its largest contracts: its subcontracts on the Navy-Marine Corps Intranet deal and its contract to deploy biometric identification systems for an undisclosed client. Meanwhile, PEC is not seeing significant new contract awards because of the delay in the fiscal 2003 civilian agency spending bill, coupled with holdups associated with the Department of Homeland Security's organization. Civilian agencies represent 60 percent of PEC's revenue, making the company more dependent on these agencies than are other public contractors.PEC's revenue growth in the next three to five years is favorable, in my view, though its above-average profit margins could be more difficult to maintain as the company grows. The company seems well-positioned to benefit from the federal homeland security IT services market, which saw strong fiscal 2003 spending boosts.Following PEC's Feb. 11 announcement of lower expectations, its shares fell from $28.80 to $18.48 the next day. Business continued to worsen, and the company preannounced again March 13, sending the stock from $15.80 to $9.80 the next day.Investors seemed to be expecting further bad news, because when PEC actually reported April 22 and its results and forward guidance were in line with its preannouncement, the stock began rising and recently closed at $14.65. PEC is currently trading at 22 times consensus 2003 estimates vs. the 19 times average for the publicly traded federal IT service firms ? and well below the 37 times price-to-earnings multiple that PEC traded at a year ago. I believe that whether PEC continues to have an average valuation or returns to its high-flying status will depend on its success in generating substantial new business over the next couple of quarters.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.