Market Share: Boatload of issues stall fiscal 2006 spending plans

Bill Loomis

Federal IT service stocks trailed off in the past month, following concerns that emergency funding for hurricanes Katrina and Rita would pressure federal IT budgets. Supreme Court hearings, Katrina investigations and other issues also have delayed fiscal 2006 spending bills.

Although we have faced delays in non-Homeland Security Department civilian spending bills during the past few years, the defense bill generally has passed on time. But with the Senate behind schedule, it appears there will be a continuing resolution on the defense side for a month or more. We expect an even longer delay on most non-DHS civilian spending bills. The DHS spending bill probably will be passed before this column is published.

Although we hear of some spending delays as government officials worry about when and how much fiscal 2006 money will arrive, the delays appear to be minor. We also have not heard of funds being reprogrammed to different agencies, though some contractors have reported shifting people to the Gulf Coast region to repair systems or help relocate for government offices.

As we work through the fiscal 2006 spending bills, investors will shift focus to the president's fiscal 2007 budget request to be given to Congress next February. With about 77 percent of the public federal IT service companies' revenues coming from defense and intelligence agencies, investors' focus will be on where defense spending will shake out in fiscal 2007.

We have not had any specific guidance on what that budget would look like, or if we will be seeing any new program budget decision changes -- such as Program Budget Decision 753, a spending plan that calls for $6 billion in cuts in 2006 and $30 billion in cuts through 2011 -- until late in the year or early next year. Though there is occasional talk about growing deficits, there does not seem to be a strong deficit reduction push in Washington, and we would note that defense spending as a percentage of gross domestic product continues to be well below the level seen during the Vietnam War and President Reagan's defense buildup.

Other issues investors are keeping an eye on are contract award activity and procurement changes. New contract awards seem to be less of an indicator of future revenue growth, as companies report more instances of scope or contract expansion on existing contracts versus the award of new contracts. Contract award activity seems OK this quarter, with some companies, such as CACI International Inc. of Arlington, Va., and Computer Sciences Corp. showing stronger award activity than last quarter.

Changes at the General Services Administration also have drawn investor attention, mainly on how the Get It Right program and the reorganization is slowing some GSA procurements and prompting the Defense Department, particularly the Navy, to use its own contracts, such as Seaport, instead.

I generally expect the public federal IT service firms to report third quarter 2005 results at least in line with expectations and give good outlooks, which may comfort investors at least to the year's end, at which time they likely will worry more about fiscal 2007 budget growth.

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.

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