Forecast remains cloudy and cool for IT services

Market Watch | Financial views of a competitive environment

"Public federal IT service stocks are down 5 percent year-to-date." Bill Loomis

Rick Steele

The business environment for the federal information technology services companies continues to be challenging, with the companies largely reporting lackluster fourth-quarter results and outlook for 2007, with a couple of exceptions. Services companies' stocks are down an average 5 percent so far this year, while the aerospace and defense stocks we track have risen an average of 5 percent.
By comparison, the Standard & Poors 500 index is down 1 percent.

With the costs of the war in Iraq increasing and the funding not keeping pace, we continue to see pressure on IT and other more discretionary spending areas. In contrast, the aerospace and defense firms such as Lockheed Martin Corp. and Northrop Grumman Corp. are doing well as their defense equipment businesses benefit from the war and the strong growth of the defense procurement budget. Their stocks have been outperforming the services companies as a result.

Reviewing the fourth-quarter earnings reports reveals that CACI International Inc. led the group, even with lower-than-expected earnings and outlook. The company's fourth-quarter (second quarter of fiscal 2007) earnings per share were down 10 percent compared to the same period a year ago, and CACI charted 1 percent organic revenue growth. The company lowered its forecast for the next two quarters significantly, bringing its fiscal 2007 EPS guidance range from $2.91-$3.15 to $2.45-$2.65. CACI's fiscal year ends June 30.

SRA International Inc. also disappointed investors, with EPS up 4 percent on 1 percent organic revenue growth.

SRA lowered its fiscal 2007 EPS forecast from a range of $1.20-$1.28 to $1.06-$1.08. SI International Inc. also predicted disappointing 2007 earnings and revenue. Each of these companies pointed to the impact of the civilian agencies' continuing budget resolution, and slow awards and contract growth because of funding constraints with defense agency clients.

Two bright spots in the quarter were the results of NCI Inc. and Stanley Inc., both of which reported solid earnings and revenue performance and issued upbeat forecasts of double-digit growth.

ManTech International Corp. predicted sluggish growth in first quarter 2007, including internal revenue growth of about 5 percent and earnings per share rising only slightly if at all compared to the same period a year ago, but it points to an expected ramp-up of several contracts that it believes will buoy its fortunes. One is the $159 million, 16-month contract it won in January to support Army mine-clearing and other systems in the Middle East, which will drive organic revenue growth toward 20 percent by the year's end.

The fourth-quarter performance of the larger companies were mixed, with both Northrop Grumman and Lockheed Martin showing solid growth in their IT units, forecasting high single-digit and double-digit organic revenue growth in their respective IT units, while General Dynamics Corp. is forecasting relatively little organic growth in its IT unit. Computer Sciences Corp.'s federal unit had organic revenue growth of 6 percent in the quarter. Perot Systems Corp. reported negative 3 percent organic growth in its federal unit in the fourth quarter but expects 13 percent organic growth from its federal business in 2007.

The next item I am watching closely is how quickly the $120 billion government fiscal 2007 defense supplemental spending bill passes Congress and is signed by the president. President Bush has been threatening a veto based on the current language of troop deployment restrictions and a withdrawal timetable. A delay in the passage of this bill beyond April or May will likely result in further delays in many nonwarfighting programs, and it could result in further forecast cuts among the federal IT service firms.

Bill Loomis is a managing director at Stifel Nicolaus, which acquired Legg Mason's Capital Markets Group in December of 2005. He can be reached at

Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situations or needs of individual investors. For additional information and current disclosures for the companies discussed in this article, please write to: Stifel Nicolaus, 100 Light St., Baltimore, MD 21202, Attn: Research Department.

About the Author

Bill Loomis is a managing director at Stifel Nicolaus.

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