Ross Wilkers

MARKET ANALYSIS

Budget delays, Trump vacancies cloud services' picture

The government IT and services market is certainly experiencing some disruption and cloudiness from a combination of budget uncertainty on Capitol Hill and vacancies in key executive branch leadership positions.

The most recent round of large contractors’ quarterly earnings calls indicate that determining the impact of the delays on individual companies’ bookings and sales depends on which firm you ask.

But a universal theme is that these vacancies are poorly timed given that the full-year fiscal 2017 budget wasn’t in place until May and only runs through September. That gives agencies more certainty than a continuing resolution but the passage of the appropriations package so late in the fiscal year changes how agencies think about their budgets.

”The CR has constraints, agencies don’t start anything new so there’s less room and less need for day-to-day decisions until after the appropriations bill is signed,” Professional Services Council CEO David Berteau told me. “The execution is much more important after the bill is passed and with five months left, anything agencies need to do must be done at a more rapid level.”

That rapid level coincides with the fourth quarter of the federal government’s fiscal year. More than 34 percent civilian agency contract spending takes place during that period, Deltek’s Kevin Plexico told a WT Industry Day event in July.

In an Aug. 4 research note, investment bank Drexel Hamilton called the July to September a “very strong bookings period.” It expects that tradition to continue this year. Analysts at Wells Fargo Securities noted July 28 that agencies have a desire to spend all of their budget now because it will ensure the same budget levels for fiscal 2018 in the event of another CR being passed in September for several months.

Contractors have signaled to investors they expect the next federal fiscal year to start with a CR, which Berteau anticipates also.

Berteau said agencies work with three budgets at one time: the budget they have for the current fiscal year, another budget up for review on Capitol Hill and a third they assemble for submission to the Office of Management and Budget. Civilian agencies must give their budget requests to OMB by September, while defense and intelligence agencies have to hand theirs into senior Pentagon leadership separately.

And that is where industry feels the impact of Donald Trump administration vacancies, being tracked here by the Partnership for Public Service and the Washington Post. Of the 577 positions being followed: 354 have no nominee, 117 have been confirmed and 106 have been formally nominated. No positions are awaiting confirmation.

Certain decisions at agencies can only be made by a Senate-confirmed employee, which can include awards of certain large contracts.

Those three budgets “don’t come together very well at the program level, they only come together at the senior level. It’s not visible until later in the process,” Berteau said.

In the more recent round of earnings calls, large government services companies were more likely to cite the transition as a factor in their results than those lower down the food chain. And comments from these calls signal that the larger the business opportunity, the more likely it is to see disruption.

At the higher end, General Dynamics and Leidos both reported some disruptions in the first half of this year on a combination of budget uncertainty and the vacancies.

In second quarter earnings, General Dynamics lowered expectations for its almost $9 billion IT product and services segment to flat for the year after a first half slump. CEO Phebe Novakovic told investors in the July 26 call that vacancies at agencies have helped make it “difficult to process contracts and get authorized and appropriated funds obligated to contracts.”

By comparison, Leidos raised revenue guidance to $10.1 billion-$10.4 billion from the prior $10 billion-$10.4 billion range. The market’s largest services contract “benefited from extensions of key higher margin programs” amid a trend that “has been for things to be sole source extensions (and) postponed,” CEO Roger Krone told investors in Leidos’ second quarter call July 30.

Krone also struck an upbeat tone on the May federal budget agreement that “provided clarity on spending levels through September,” plus the Senate’s confirmations of top Defense Department leadership roles earlier this month that included new DoD acquisition head Ellen Lord.

“Despite this progress… high numbers of unfilled leadership appointments and the approaching government fiscal year-end continue to serve as headwinds, in our view, to a more normalized procurement and acquisition pace with our customers,” Krone told investors.

Other large contractors with more than $1 billion in annual revenue have recently said their individual businesses were for the most part not disrupted by the budget dynamic and slowness of appointments.

The $5.8 billion-revenue Booz Allen Hamilton reported “robust increases, requests and requirements” among its core defense and intelligence business as CEO Horacio Rozanski said in the firm’s first quarter call Aug. 7. Booz Allen also is “seeing strength” with Veterans Affairs and other health agencies, Rozanski said.

In the $5 billion CSRA's first quarter call Thursday, CEO Larry Prior specifically cited September as a “defining month in the fiscal year for both industry and government” after “being on the edge of our seat” in July and August. “We are expecting that it will be, not just a normal September but a robust September, and all the signals we see are showing that,” Prior said

Engility and ManTech International at $2.1 billion and $1.6 billion in respective annual revenue echoed the same sentiments in their earnings calls and signaled they have no short-term concerns. But executives at both companies acknowledged the impact some vacancies could have for certain companies and programs on the horizon.

“Normally the size of programs that we are competing on are not going high enough in the organization to be slowed by a lack of a director or deputy director,” Engility CEO Lynn Dugle told investors July 30. “But as we pursue larger deals and if that doesn’t turn around here and we (don't) start getting a quicker fill on jobs, it would definitely start impacting how the 2019 budget comes together because you need a new team in to build that from the bottom up.”

“I think it's a factor in the industry for those companies who… have multiyear funding or large platforms that just need the executive level sign-off on the types of procurements that exist,” ManTech President and Chief Operating Officer Kevin Phillips said July 30.

One program that could fall under that category is the $3.5 billion Navy NGEN IT services contract recompete due for award next year. Leidos, a subcontractor to DXC Technologies on the current iteration, has NGEN-R in the pipeline but its “best read of that is it could be delayed a year,” Krone said July 30.

“The individual programs are much easier to single out as being delayed with their greater level of visibility,” Berteau told me. “I think all of our members feel that. Some of the mid-size members have as tough a time because they don’t have the resources to tide them over with breadth and diversity of income.”

Contractors are reporting opportunities to submit proposals for at a rate similar to that of previous years, Berteau said. ManTech’s Phillips told investors his company expects to see “a lot of proposal activity” over the next year and “strong award activity” through September.

Contract spending through September could go down however if agencies get conservative due to uncertainty over the FY 2018 budget, Berteau told me. He also noted that agencies have to submit their reorganization proposals to OMB based on Trump’s 2018 budget blueprint, against which many lawmakers have proposed higher spending levels.

Appointees confirmed by the Senate in batches would not have their “inboxes won’t be cleared out on the first day,” Berteau said.

Another upcoming event that industry will have its eye on is Congress’ deadline to address the debt ceiling in September. That must be done in conjunction with either a continuing resolution or a full-year budget for fiscal 2018.

The debt ceiling issue is a factor that “will drive the CR until January,” Phillips said.

"Talks to avoid a government shutdown and a credit default will surely grab the headlines but our customers are continuing to operate and focus on their missions," Prior said.

About the Author

Ross Wilkers is a senior staff writer for Washington Technology. He can be reached at rwilkers@washingtontechnology.com. Follow him on Twitter: @rosswilkers. Also find and connect with him on LinkedIn.

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