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IT Services Market Undergoes Slowdown

Bill Loomis

With most of the information technology services companies having reported 2000 third-quarter earnings by now, I can summarize the results as basically unexciting, and with few signs that business will rebound in the next quarter or two.

Nearly all IT services companies ?
e-business, traditional or government ? reported revenue and earnings at or below expectations, with very few showing an upside surprise.

The slowdown in the IT services market is indisputable, evidenced by disappointing revenue growth ranging from the largest pure-play IT services company, Electronic Data Systems Corp., to the largest e-business solutions company, marchFIRST, and even the smaller, faster growing leaders in e-business solutions, Scient Corp. and Sapient Corp.

Both Scient and Sapient barely met expectations for the third quarter and had cautious comments about 2001 growth. Just a quarter ago, these two companies (and most of the e-business industry) were beating expectations by 10 percent or more.

The reasons for the weak results are a decline in business with dot-coms and lengthening sales cycles at larger, brick-and-mortar companies. With the dot-com threat diminished, at least for now, established companies seem to have a lower sense of urgency with e-business initiatives.

Most of the traditional IT services companies reported relatively weak third-quarter results, and as expected, guided fourth-quarter earnings expectations lower. The reasons were the same as those discussed in previous columns: slower-than-expected demand following year 2000 and the shift in the e-business market cited above.

I believe traditional IT spending, defined here as non-Internet-based IT projects, will pick up soon. We are seeing renewed interest in back-office systems, evidenced by a broad pickup in enterprise resource planning license sales, application outsourcing and other aspects of traditional IT. While we may not see another round of $50 million, three-year ERP implementations, there likely will be significant work to do on the billions of dollars of Y2K remediated legacy systems, as well as on the ERP implementations done in the mid-1990s.

However, one of the most disappointing aspects of the traditional IT companies' earnings reports was there seems to be little evidence of business picking up. In one case, Keane Inc., one of the largest midsized traditional IT services companies, actually reported lower contract bookings for the third straight quarter, and also indicated that fourth-quarter revenue will decline from that of the third quarter.

Government IT companies have not fared any better, though CACI International Inc. met revenue and earnings expectations. BTG Inc., however, fell short on both counts, with revenue declining sequentially and EPS Solutions coming in 2 cents below consensus.

  BTG cited unexpected contract delays and other factors. National Information Consortium Inc. announced disappointing results for two straight quarters, and American Management Systems Inc. has had weakness in its state and local government business, while its federal government unit continues to show good growth.

While many of the public IT services companies are having a difficult time, I am surprised by how well many private companies in the industry are doing. To be fair, many times upon closer inspection of their financial statements, I find they have had difficulties in the past year due to internal execution problems and were forced to make changes that the market is requiring for even the public companies today ? notably, a stronger, direct sales force and clearer focus.

While this has been a difficult and confusing quarter, I am still confident that demand for IT services will continue to be strong over time, as technology continues to be more complex and more important to business.


William Loomis is managing director of the technology research group at Legg Mason Wood Walker Inc., Baltimore. He can be reached at wrloomis@leggmason.com. Legg Mason Wood Walker makes a market in the securities of American Management Systems Inc., BTG Inc., CACI International Inc. and Scient Corp. EDS is a Legg Mason Select List core holding. This information is based on sources believed to be reliable but is not guaranteed as to completeness or accuracy and is not intended to be an offer to buy or sell any security. Opinions expressed are subject to change. Additional information available on request.

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