Market Share: Rosy outlook greets the earnings season

Wall Street is again focused on earnings season, which will be underway when this column appears. Last quarter, results from federal information technology firms generally beat investor expectations.Most of the leading publicly traded federal firms posted organic revenue growth (removing acquisitions) of around 15 percent. In general, I expect another strong quarter of results in the federal IT space, with accelerating organic revenue growth, driven by continued strong demand trends in the federal IT and professional services market. While demand seems to be a bit more consistent on the defense side because of the delay in approval of the civilian budgets, I am generally hearing of strong bid and proposal activity in both civilian and defense. While overall federal IT budget growth rates have likely peaked in fiscal 2003, federal IT spending can show a high single-digit annual growth rate over the next several years.Award activity from the Department of Homeland Security has been slow this year, as the agency struggles with a late budget, passed at the end of February, and as it organizes itself. The merger and acquisitions environment remains robust, a positive for stock valuations. The proposed acquisition of Veridian Corp. by General Dynamics Corp. has helped boost Wall Street's interest in the sector, and there could be more large transactions in the coming year, given the growing interest in the space.The key issues I will be looking for in the upcoming earnings reports include: The outlook for the commercial IT service firms is not as bright, though technology stocks have performed well this year. The combination of low investor expectations, historically attractive valuations and the expectation of improving results in the second half of the year and in early 2004 prompted buying interest in the commercial firms. I generally expect companies in the consulting and systems integration segment, such as Accenture Ltd. and BearingPoint Inc., to meet investors' second-quarter expectations.Anecdotal evidence from a number of companies -- as well as other factors such as spending surveys and a general lack of negative preannouncements -- suggests that demand in North America is stabilizing though Europe remains weak. However, there is still little evidence of a meaningful upturn in commercial IT spending.The commercial outsourcers will generally meet our expectations, including Affiliated Computer Services Inc., Computer Sciences Corp., EDS Corp., and Perot Systems Corp. While top-line growth should continue to be relatively weak for the outsourcers in the quarter, the demand environment is stable to improving. Also, I note that BearingPoint, CSC and Perot have about 27 percent, 40 percent and 15 percent, respectively, of their businesses with the government, and these units have been growing faster than their commercial business. Overall, I believe the second-quarter results and trends of both the federal and commercial IT service firms will be similar to those of last quarter. *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.