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A Game Plan That's Working So Far

Bill Loomis

By Bill Loomis



With the fourth quarter earnings season almost over, publicly traded commercial and federal IT service companies have reported earnings generally in line with expectations.

But one company that reported fourth quarter 1998 results in line with estimates, Electronic Data Systems Corp., saw its stock sway during the past two weeks.

The Plano, Texas-based company recently announced that it is suing Xerox, one of its largest customers, over a contract dispute, and said first quarter 1999 results will be below expectations.

That news sent the shares down from $52 to $44 over two days, only to rebound back to $48 the next week after EDS announced the record $6 billion-plus outsourcing contract with MCI WorldCom and purchase of MCI Systemhouse of Ottawa.

The systems integrator vowed that its new chairman and CEO, Richard Brown, will clarify EDS' outlook after it reports first quarter results April 29.

Meanwhile, one of the major concerns investors have about the IT services industry is the impact of year 2000 spending on non-year 2000 IT spending.

In general, my colleagues and I have not seen a significant slowdown in either the government or commercial IT services market related to year 2000 spending.

Most of the publicly traded federal integrators are doing some year 2000 work on existing contracts.

While most have stories of a few contracts falling victim to year 2000 budget diversions, this has not had a net negative impact on earnings.

In the commercial arena, year 2000 IT service revenues are dropping faster than expected at public IT service companies.

Most of the clients of the larger public integrators are large, billion dollar-plus revenue companies, so this trend may not be indicative of what is happening to smaller companies.

The reason for the fast drop off is that projects are generally being completed faster than expected and at less cost than budgeted. Also, there are less testing services than expected as companies bring those services in-house and use automated testing tools.

However, the IT service companies that have a large amount of year 2000 service revenues, but also offer a wide range of other service offerings ? such as Keane and Complete Business Solutions ? have been meeting investors' expectations.

These companies and others are experiencing an acceleration in non-year 2000 IT service projects, particularly Internet-related application development, as resources devoted to year 2000 projects are freed.

One area that is being impacted by year 2000 spending is the enterprise resource planning market. Leaders in the group, including SAP, PeopleSoft, Baan and most recently J.D. Edwards, have reported a dramatic slowdown in new license sales.

With a 12-month to 18-month implementation time for such systems, they were no longer an option to solve a company's year 2000 problem starting in the third quarter last year. That's when the slowdown first become evident.

The IT service companies that implement ERP systems have seen some slowdown in revenue, but the growth of other markets such as customer management systems and Internet-related projects are making up for the slowdown.

Although there is still a year to go, the game plan of Keane and other large IT services companies is working: Use year 2000 work to get new customers, do a good job and then sell them even more non-year 2000 services.



Bill Loomis is managing director of the Technology Research Group at Legg Mason Inc., Baltimore. He can be reached at wrloomis@leggmason.com. This information should not be construed as advice designed to meet the investment needs of any investor.

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