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All Eyes On The Second Quarter

Bill Loomis

Once again, investors will focus on earnings over the next few weeks. With so many information technology service companies ? and technology companies in general ? having pre-announced poor first quarter results, the focus will really be on the outlook for the second quarter and second of the year.

Everyone is looking for signs of the bottom and that the fall off in commercial IT demand has stabilized. An early sign for the turn that I am looking for is hearing the heads of large companies speak more positively about their outlooks. The views and concerns of the chief executive officer spreads throughout an organization, and only when the CEOs begin to feel better about their own businesses will the IT purse strings open up, in my view.

In the switch of the decade, the federal IT companies are feeling good about their outlooks. Investors agree, having bid up the valuations (price to earnings and price to revenue) in the group of government IT service companies we track to a level higher than the commercial e-business and traditional commercial IT service firms.

While the outlook for federal and state government IT services looks brighter than ever, there are some serious near-term issues that could impact business.

On the state side, there has been more press about states looking to trim costs in the face of falling tax revenue because of the weakening economy. As the slowdown in the commercial IT space has shown, IT budgets will get hurt when the cost-cutting ax swings.

In the federal government, the Bush administration has brought agency leadership changes, as well as chief information officer changes. We have not yet seen much impact from these.

And while company leadership shuffles occur periodically, three of the largest government IT units had leadership changes this quarter: Affiliated Computer Services Inc., Computer Sciences Corp. and Electronic Data Systems Corp.

CSC's Milton Cooper will retire at the end of May after heading the federal unit for eight years. He is being replaced by Paul Cofoni, who headed CSC's commercial outsourcing unit.

At EDS, Albert Edmonds succeeded Bill Dvoranchik, who is retiring after 30 years. And ACS' Harvey Braswell replaced Bill Woodard, who resigned from the company to pursue other interests.

Over the next several weeks, most of the government IT service firms are expected to report higher earnings per share, with the exception of BTG Inc. Investors expect BTG to post lower EPS of 12 cents vs. 17 cents a year ago, as the company has been investing at the expense of earnings in an effort to boost revenue growth.

CSC also will have lower EPS for the quarter, with investors expecting 35 cents vs. 84 cents a year ago. CSC indicates its government business (25 percent of total revenue) is doing well, but its commercial systems integration and consulting business is experiencing revenue shortfalls as well as pricing pressure.

On the other hand, EDS, with about 14 percent of its total revenue in government, has supported analyst EPS estimates of 56 cents vs. 47 cents for the quarter. Surprisingly, the $20 billion revenue giant indicates it is seeing no pricing pressure and no drop in demand.

Investors expect usually consistent ACS to report EPS of 63 cents vs. 53 cents in the quarter. ACS' federal unit has not been meeting its planned growth over the past two quarters, showing only low-single-digit internal growth in the last quarter of 2000, though ACS continues to meet overall investor expectations.

Consensus estimates for CACI International Inc. are EPS of 47 cents vs. 38 cents a year ago, while PEC Solutions is expected to show strong growth with EPS estimates of 9 cents vs. 6 cents a year ago. Investors favor PEC, giving the stock an unprecedented valuation for federal systems integrators of four times revenue and 39 times consensus 2002 EPS estimates at its 52-week high earlier this year.

Maximus, a company focusing on state and local business process outsourcing, is expected to post EPS of 45 cents vs. 40 cents a year ago.

Bill 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 shares of BTG Inc., CACI International and PEC Solutions. Within the last three years, Legg Mason Wood Walker has managed or co-managed an underwriting of PEC Solutions. 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 upon request.

About the Author

Bill Loomis is a managing director at Stifel Nicolaus.

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