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CSC's confidence infects investors

Maybe an optimistic forecast beats lowball games when giving earnings estimates these days.

Maybe an optimistic forecast beats lowball games when giving earnings estimates these days.

Shares of Computer Sciences, the second-largest independent technology services company, ended Friday with a gain of more than 10 percent for the week, a week that included a contract win of a disputed size and a fiscal first-quarter earnings report that barely topped already-low expectations. Shares on Friday were down 13 cents to $37.02

CSC last week reported fiscal first-quarter net income of $47.7 million, or 28 cents per share, a penny better than First Call's lowered consensus estimate. Revenue for the quarter was $2.7 billion. Shares on Friday were down 13 cents at $37.02

The quarter was relatively unimpressive, yet the company glowed with surprisingly strong confidence.

"CSC executives think they're seeing more business than the Street expected," said Greg Gieber, analyst with A.G. Edwards. "They went out on a limb."

The limb was sufficiently far out to leave several of Gieber's colleagues skeptical.

Although two brokerage firms upgraded Computer Sciences after the company's earnings report, at least six Wall Street analysts remained skeptical and used descriptions such as "challenging," "too high" and "unclear" in talking about the company's prediction that it would earn $2 to $2.10 per share in the current fiscal year.

Salomon Smith Barney analyst Patrick Burton typified the pessimistic view. "We believe the new guidance assumes a quick U.S. recovery, sustained performance in Europe and a strong March quarter," Burton wrote. "We disagree with these assumptions."

Not that Computer Sciences sees some kind of rebound anytime soon. The company's latest earnings forecast is much lower than its earlier prediction of $2.25 to $2.35 per share. In fact, last week's prediction is the third time since February that Computer Sciences has cut expectations.

But it didn't lower them to Wall Street's level. According to earnings tracking firm First Call, analysts on average were predicting fiscal-year earnings of $1.99, or a penny below the low-end of Computer Science's projected range. And after talking to executives, analysts lowered their estimates even further; First Call consensus now sits at $1.91 for the year.

The company's string of profit disappointments has analysts leery. While rivals such as Electronic Data Systems and Perot Systems were early in detecting the technology industry's shift to outsourcing corporate functions, Computer Sciences largely concentrated on professional services such as consulting--a market that caved in when the technology slowdown hit.

The company has since moved its focus to outsourcing, a shift highlighted by last week's win of a contract to upgrade the National Security Agency's technology. But even that deal turned into a minor controversy when the NSA announced the contract at slightly more than $2 billion; observers had been predicting it would be a $5 billion contract. Computer Sciences said the actual work could hit the $5 billion mark when the contract's scope is expanded, as happens to many major government contracts.

Even in a good economy, Computer Sciences' past missteps would have Wall Street concerned; in the current economic slowdown, the worries are magnified. At least two contracts, including one related to Nortel Networks, are seeing lower-than-expected profit margins.

"The company's commercial consulting and systems integration businesses continue to struggle in this difficult economic environment," J.P. Morgan analyst Robert St. Jean wrote. "CSC has taken some steps to address these issues...but it remains to be seen how long it will take for these measures to become effective. Additionally, it is unclear that the consulting and systems integration markets have reached a bottom."

Playing the game
Some analysts believe Computer Sciences needs to learn how to keep shareholders' demands as low as possible. One analyst suggested the company undertake a single, massive cut in its public projections.

"Why not just revise earnings aggressively down in order to better manage expectations and maybe surprise the Street going forward?" SG Cowen analyst Moshe Katri asked Computer Sciences executives during their quarterly conference call. "Therefore the Street will reward you much better than just keeping revising numbers down every quarter."

Wall Street in recent years has come to favor companies that "manage expectations," which essentially means setting financial targets that are low enough to be exceeded consistently. Conventional wisdom on the stock market says companies that "beat the numbers" are the ones with shares that rise the most.

Computer Sciences executives scoffed at the idea.

"We should tell you what we believe about the business," said Van Honeycutt, CEO and chairman of Computer Sciences. "Not what we believe about gamesmanship around guidance."

A.G. Edwards' Gieber agreed: "Van gave a very good, very solid answer, the type that any good CEO would give."

Gieber compared setting a low bar for corporate earnings to asking top-ranked golfer Tiger Woods to shoot 100 on a par 72 course--it says nothing about the company's true abilities. "It doesn't help us to do our job as analysts," Gieber said. "I want to know what a company's capable of."

The fact that Computer Sciences remains more confident than analysts despite the company's recent history could be taken as a positive sign, Gieber said. "They're aware of the risks when they're putting these things out," he said. "I think they have a fighting chance of making their number."

Judging by the stock's gains last week, investors think so too.