Why services contractors have a difficult landscape to cross

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The continuing resolution, having now eaten up nearly five months of the fiscal year, is starting to affect the market valuations of publicly traded federal contractors. That may not seem like a concern of the government, but think again. The Federal Drive with Tom Temin spoke to the president and CEO of the Professional Services Council, David Berteau.

Interview transcript:

Tom Temin: David, what’s going on here? You’re finding that some companies are having talent issues and capital issues because of uncertainty over this whole market?

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David Berteau: Tom, there’s two things going on here. And one, I think, who would have thought that we would miss the old sequester budget caps from that were in place from 2012 through 2021. Remember, we were so eager for those to be over with, and then we could go back to regular order? Well, it turns out that having caps also meant you had a floor and you had a starting point for an agreement that you could get full appropriations. We don’t have that anymore. And I think this CR is proving to be a little harder. I know, the government says we know how to operate under a CR. Good grief, they’ve certainly practiced. It’s been 11 out of the last 12 years for every agency. But what we’ve seen in the analyst calls that some of the publicly traded companies, PSC members have had, is the stock market is dinging them, because they’re saying their revenue has not met targets, in large part because the CR has slowed down new awards, which of course it does. In fact, new awards or new efforts are largely prohibited under a CR. Well, why does this matter? Of course, it matters because companies more than ever, are dependent on the financial marketplace for access to capital. And that capital is going to only flow to companies at reasonable rates, if in fact, they’re meeting their objectives, their financial objectives. There’s plenty other places for money to go if it’s not going into government contractors. This is a serious concern, and the government’s not paying much attention to it at all.

Tom Temin: Yeah, the government that says it can operate on a CR is like saying, you know, a runner can operate with a broken leg, but it may not be optimal.

David Berteau: You’re not going to win the race that way, OK.

Tom Temin: Then what does this do to their competitive ability, though, maybe the smaller, more agile contractors can get through this better than the publicly traded ones?

David Berteau: Well, we’re still seeing a good pace of solicitations. In other words, the government’s asking companies to submit bids. But everybody is equally hobbled if the government doesn’t award these contracts. We’re seeing options being exercised, we’re seeing extensions of contracts. But every company large, middle sized and small has to hang on to people that were proposed in a bid. And we’ve asked our member companies, are you seeing an increase in the number of times the government requests you to extend the period of validity through your bid? You know, it’s good up to a certain date? Well, would you extend that for another 90 days? Would you extend up to 180 days? We have some that have been extended over a year now. How do you hang on to your key personnel, when you’re not making money to pay for them? No company large, medium or small can do that.

Tom Temin: And how do you stay with your price bid, when we have wage inflation that’s starting to kick up?

David Berteau: Well, exactly. On top of the difficulty of hanging on in the face of fewer awards, we’re seeing 5%, 6%. In fact, the numbers that came out Friday show about a 6% inflation across the country in wages. This is fine if you’re a manufacturer, and you’ve got built into your contract an escalation clause of 2% or 3% per year, because it’s expected that inflation will hit component parts and suppliers. But for services contracts it’s frequently the opposite. There’s usually an expectation that your learning curve will bring costs down. So you’ve got an expectation of reduced costs and a reality of increased costs. This has got to go somewhere. We’ve actually heard a comment from one federal agency component that said industry will just have to suck it up. Well, Tom, you can’t suck it up when your margins are less than your your wage inflation.

Tom Temin: Yeah, there are legendary contracting officers who said, well, I don’t see why you need to make more than your cost. What do you need profit for as long as you can cover the payroll?

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David Berteau: There’s a bit of a lack of understanding of the basic laws of capitalist economics there. You don’t stay in business if you don’t make a profit. And this is back to point one. If the financial marketplace doesn’t think you’re profitable, you’re gonna get squeezed at both ends. Your cost in and your access to capital.

Tom Temin: Better to be Amazon this week than Facebook, I guess. We’re speaking with David Berteau, President and CEO of the Professional Services Council. And interestingly, as we talk about the CR, which expires next weekend, there’s no clear path to a non-extension of the Feb. 18 deadline. We’re bumping up into the signals for the 2023 budget, which is past pass back at this point. And now you know, you’ve got budgets bumping up against budgets.

David Berteau: And as it turns out, Tom, under the budget law, that budget is supposed to be submitted just about now. By the first or second week of February every year. We’re not going to see that. In fact, the reports are that OMB has just issued the pass backs, that is the requirements to agencies to adjust their ’23 budget late last week. So we’re still at least six or eight weeks away from any budget submissions.

But the bigger question is, what does the administration assume for the FY 22 column of an FY 23 Budget? We’ve got nothing but a CR in place. One thing we’re watching for as the Congress debates an extension to the CR this week, is how far out will that extension go? If it goes to mid-March, that’s a sign that we’re getting progress on the deal and may have a full year appropriation to go through the rest of the fiscal year. If it goes out until April and beyond, that’s not a good time. And it says we may be further out. And of course, as you and I had discussed, there’s not only a possibility of CRs for this year, but it will probably extend, as it usually does, into FY 23. And then when the new Congress taking office next January, it could extend well into calendar year 2023. What a disaster that’ll be both for the government and for contractors.

Tom Temin: Yes, because as you point out, normally, the president’s proposal comes out sometime in February. And so if that is delayed to March, or April, or even early May, which is not unheard of, from the White House, then Congress is going to pretty much be done for the year by August, because that’s when they start the tong war for the midterms.

David Berteau: And within the agencies, what this means is, I may have money available under a CR, it’s at the FY 21 level, not the FY 22 proposed budget level. But I don’t know how much I’m going to get or when I’m going to get it for future. So I’m not going to spend, I’m not going to commit all my funds right now, we could run the risk of in fact, existing funds expiring unobligated, even though there’s important work to be done, and the vehicles are there to get it done. This is a bad risk for everybody.

Tom Temin: Well, they can always use it to pay off college loans for people, I suppose. And also affecting contractors has been the CMMC program of DoD, the Cybersecurity Maturity Model Certification program, and that had a 2.0 version come out some months back. And now they have moved the whole program from one office to the other. Interestingly, under the CIO, instead of under acquisition at the Pentagon, and what are contractors saying about that? I think this is something they generally wanted?

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David Berteau: CMMC 2.0 is a new process; it is still unfolding. It may take a year or more before we’ve actually got a change to the clause in the DFARS supplement come into play. And so it’s not active in any contracts. Now, moving it under the CIO to us at PSC has two possible advantages. One advantage is, we believe that the cybersecurity threat is not only to government contractors, it’s also to government internal systems. And as you saw with SolarWinds, and the Microsoft Exchange Server attacks. In fact, a recent GAO effort pointed this out, many of the targets of those attacks and the victims of those attacks were government systems themselves, not a contractor systems. So the CIO could have the purview over both of these, it would be a positive benefit, if in fact, that’s the way the newly confirmed CIO John Sherman tackles this question.

Tom Temin: And the final question too, by the way, the America COMPETES Act didn’t seem like a big contractor deal. But you’ve identified a couple of issues. And there’s no reconciliation with the Senate version yet. So we might or might not see legislation soon. But what’s going on there with respect to IT contractors?

David Berteau: Well, the hallmark of this bill was the $52 billion of supplemental appropriations for the microchip industry. And of course, we know about chip shortages across the board. And if you’ve tried to buy a car, you know that you’re having trouble getting one delivered anytime in this decade, perhaps. But buried in here in the House version, the Senate version passed last summer, the House version has new provisions in it. Buried in it are some requirements for IT contractors, which are not precisely defined in the bill to meet some real tests on supply chain that we think are going to be trouble. It says it requires DHS to issue guidance requiring the contractors identify the origin of a lot of elements of their supply chain, including software products and services they supply and then certify that those components and those services are free of vulnerabilities and then notify DHS in the event they find one. Well, the notification part’s pretty easy. The certification part is the hard part. Because who knows what the provenance of software is, all you got to do is look at the JavaScript Log4j escapade that we’ve been on where agencies are still struggling to fix this. And so are companies because they don’t know, there’s millions of cases where this is out there. Putting this burden on every company large, middle sized and small to be able to do something that the government can’t do itself is unconscionable, impractical and it will not work. So we’re going to work to try to tackle that question as they go to conference.

Tom Temin: David Berteau is President and CEO of the Professional Services Council. Thanks so much.

David Berteau: Thank you, Tom.

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