Interview – December 11, 2006

HDS: Hi this is Ann Marie Fleming with HomelandDefenseStocks.com.

HDS: In this month’s conversation with Scott Sacknoff, manager of the SPADE ® Defense Index, ticker symbol, DXS, we will be discussing the recent Congressional elections and what its impact will be on the homeland security sector. Mr. Sacknoff, thank you for joining us.

SMS: My pleasure Ann Marie.

HDS: A few days prior to the election you wrote a piece forecasting the Democratic Party’s victory in the House and Senate races and offered several reasons why the results would have a minimal impact on defense and homeland security. Would you recap that for our audience?

SMS: Sure. Fundamentally, the Democratic Party is constrained by its desire to capture the White House in 2008. After capturing control of the Congress for the first time in more than a decade, the Democratic leadership is likely to focus on more moderate and achievable issues. As part of this, the party has come out in favor of defense and homeland security over the last year in order to take this issue away from Republicans in 2008. Combined with budgets that have already been approved for fiscal year ’07 and some anticipated gridlock inside Congress and with the President, a relative status quo without any new, large initiatives is likely.

HDS: How will this impact companies involved with homeland security?

SMS: Although Democrats are in charge of Congress for the first time since 9-11, they are unlikely to pursue a major overhaul of the Department of Homeland Security and its plans until after the 2008 election. Iraq is still front and center when it comes to the overall discussion. Based on comments, the Democratic-led Congress in 2007 and early 2008 will focus on achieving smaller objectives in four key areas:

• Implementing many of the 41 recommendations made by the 9-11 Commission including improving the sharing of intelligence information and boosting cargo screening at airports and seaports
• Directing funds toward improving security for mass transit, rail, and chemical plants
• Screening all ports of entry for nuclear materials; and
• Improving the interoperability of first responder communications

HDS: How will this impact the budget for the Department of Homeland Security?

SMS: The agency’s budget has risen about $2 billion annually in each of the last several years and the changes on Capitol Hill should not impact this trend. The Democratic leadership has already called for increased budgets in the area of homeland security and, should this occur, much of it will be allocated directly to the states for their provisioning. Keep in mind that homeland security activities extend beyond the Department of Homeland Security. Other agencies such as DARPA, the Defense Advanced Research Projects Agency, and the military services (the Army and Navy, predominantly) have seen an increase in research initiatives designed to improve border and homeland security.

HDS: Will there be any impact on recently awarded programs such as SBI, the Secure Border Initiative?

SMS: It shouldn’t. The biggest problem for the program will be its execution. Barely two months after awarding a $67 million contract to Boeing as prime contractor to establish operational control over a 28-mile stretch in Arizona, the total cost of the program is already coming into question. DHS Inspector General Richard Skinner recently stated that the cost to properly ensure the security of the Mexico and Canadian border would be from 4 to 15 times the publicly promoted $2 billion cost. If true, obviously we can expect support on Capitol Hill to decline with revisions to the current proposed plan and design to follow.

HDS: How is the first responder market doing?

SMS: Companies operating in this area should see additional resources flow from Washington as they issue grants to the states to improve the interoperability of first responder radios. Gartner, a market intelligence firm, recently reported that the sector would grow from a 2006 market size of $7.1 billion to $9.4 billion by the end of the decade, a growth rate of about 7.2% annually or about $500 million a year. The market has attracted a wide array of companies including defense firms such as ITT and Raytheon and communications firms like Motorola.

HDS: Lastly, what has been the Wall Street reaction over the last year to companies operating in the homeland security area?

SMS: As we speak, the SPADE Defense Index, which incorporates companies involved with homeland security as well as defense and space, is hitting all-time highs and investors who invested in the Powershares exchange-traded fund which tracks this index have seen their investment gain nearly 17% since the beginning of the year. However, while the large and mid-cap defense firms that operate business lines in the homeland security market have for the most part done well, many of the small and mid-cap firms who specifically focus on the security market have seen their share prices swing up and down. Rather than the sector moving up or down as a whole, these companies have moved based on their company’s individual performance or related news, such as the need to screen liquids at airports. Taking a look at the November gainers and laggards in the ‘SPADE Investor’ newsletter, there are 3 security companies in the top 7 and 3 in the bottom 7. Some companies have been in both categories several times during the year; up one month, down the next.

HDS: Once again, thank you for taking the time to discuss the homeland security market.

HDS: If you are interested in getting more information about the SPADE Defense Index, please visit www.spadeindex.com. Investors should note that the exchange traded fund trades under the symbol ‘PPA’. Historical data for the SPADE Defense Index can be found using the index symbol ‘DXS’.

And as always, the information presented in this interview is for information purposes and should not represent a solicitation or an offer to purchase an investment product. Investors interested in the Powershares ETF trading under the ticker ‘PPA’ should visit the powershares.com website for a prospectus.

Disclaimers:  The information presented in this interview is for informational purposes and should not represent a solicitation or an offer to purchase an investment product.  SPADE and the SPADE Defense Index are registered trademarks of the ISBC.  Powershares is a registered trademark of Powershares Capital Management.