Those who watch IT spending are getting a sense of fourth-quarter deja vu. Much like last year, IT industry observers are becoming embroiled in a debate over whether the fourth quarter will enjoy a so-called budget flush, in which CIOs scramble to spend every dollar of their budgets before the year ends. Earlier this year, analysts assumed that software vendors would enjoy a boost in the fourth quarter from this seasonal phenomenon. Now, some are starting to wonder. "My conversations with people who buy software suggest there won't be
a budget flush ," said Pat Walravens, a software analyst with JMP Securities. "If anything, people seem to be rewarded if they don't spend money at the end of the year." Walravens cited a survey he conducted in June, in which only four of 31 respondents said they would have a budget flush -- and they were all in government. The use-it-or-lose-it thinking that typically fuels a burst of spending at the end of the year seems to have left corporate America, Walravens added. Almost two-thirds of respondents in his survey said they were setting their budgets at least twice a year. "Budgets are being watched so carefully from month to month that they wouldn't have a whole lot at the end," Walravens said. "One respondent said, 'We set the budget once a year and cut it 12 times a year.'" Others, however, tend to believe that the fourth-quarter flush will just end up smaller this year. Morgan Stanley analyst Chuck Phillips, who oversees a survey 10 times a year of 225 IT executives, noted that last year everyone was predicting there wouldn't be a fourth-quarter budget flush. That dire prediction never came true. "It (the flush) came right on schedule and surprised everyone," Phillips said by email. "I think it will be smaller this year, but still measurable. Investors may look right past it and worry about Q1, which is a valid concern." Indeed, a year ago, Morgan Stanley's survey found that 54% of CIOs said they did not plan to spend more on tech products and services in the second half of 2001. Then in January, a slew of software and hardware companies, including SAP ( SAP) and Sun Microsystems ( SUNW), beat estimates on a fourth-quarter rebound. And the gross domestic product report reported that business spending on information-processing equipment and software grew at about a 0.6% annualized pace in the fourth quarter, the first time it increased since the fourth quarter of 2000. Morgan Stanley's most recent survey, in June, found that 40% of respondents indicated they plan to spend more on technology products and services in the second half of the year than in the first. That's actually an improvement from the findings in February and March surveys, when 36% of respondents said they would spend more. In the June survey, 53% said they do not plan to spend more on technology in the second half of the year, down from 56% in March and 54% in February, while 6% said they are uncertain. Josh Freedman, a technology analyst at Berger Financial Group, suggested such surveys have to be taken with a grain of salt. "It's not in vogue to say you're going to spend more than you did in the first half of the year," he said. But then if you ask CIOs if they are planning to spend their entire budget, they say yes, Freedman said. "There is more money in budgets to spend this half because there has not been linear spending," Freedman said. "My guess is you see an uptick in spending, but it's probably not huge." Indeed, in interviews, CIOs indicated they're basically staying on course with their budgets this year. "We're not reducing our spending and we're not increasing it," said Irving Tyler, vice president and chief information officer of Quaker Chemical ( KWR)in Conshohocken, Pa. "We're spending the appropriated funds but not entering into new products, not because of the economy but because we're full up in work." But for some companies, staying the course doesn't necessarily mean a mad dash to spend every last dollar in the fourth quarter. "We're not going to cut back or open the floodgates," said Steve Agnoli, CIO of the law firm Kirkpatrick & Lockhart, which has 10 offices nationwide. Most of the IT department's capital spending, however, comes earlier in the year, said Agnoli, who predicts his department will come in a little under budget this year, as is typical. What is alarming, however, is that fourth-quarter estimates already have been trimmed more than normal, according to First Call/Thomson Financial. Since July 1, analysts have cut fourth-quarter estimates by 4.9 percentage points to 29.9% year-over-year growth. The cuts are even greater for the 80 companies included in the S&P 500 tech sector index, said Chuck Hill, First Call's director of research. Analyst expectations for year-over-year fourth-quarter growth among those companies have fallen to 44% from 61% on April 1, and 54% on July 1, Hill said. "This has been pretty much a free fall," Hill said. The numbers are discouraging because they portend even more trimming to come, said Hill, who believes estimate trims have tapered off only because analysts have been on summer vacations. Walravens is among the analysts who have started to lower his estimates, accounting for the possibility of no fourth-quarter budget flush on a case-by-case basis for the software companies he covers. For instance, with enterprise software vendor J.D. Edwards ( JDEC), which just beat estimates for the fourth-straight quarter, Walravens looked at the historic trends and then discounted that for the current environment. Walravens, who has a strong buy rating on J.D. Edwards, found that in the past six years, the median sequential increase in license revenue in the fourth quarter was 50%. Walravens then estimated that this year the sequential increase would be half that, about 25%. That estimate, however, represented a 3.9% year-over-year decline in license revenue. After J.D. Edwards reported results, Walravens raised his estimate modestly to reflect a 2% year-over-year decline. (JMP hasn't done any banking with J.D. Edwards.) "I'm leaning more to sequential than year-over-year growth," Walravens said. "If there is a big budget flush, I may end up being too low as a result of that." But "I prefer that to the alternative," he added. If the fourth-quarter does enjoy a boost in budget flushing, the consequences may lead to another case of deja vu in January. That would leave investors and analysts scratching their heads, wondering if whether the cause is merely a seasonal uptick or a long-awaited improvement in IT spending, Walravens predicted.