This one is a puzzler ….

Headquartered in Newark, New Jersey, Ultralife is a multi-national engineering and manufacturing firm specializing in high-tech power and communications systems, as well as more prosaic battery and battery charger products. On April 29, 2011, the company filed a Form 8-K with the Securities and Exchange Commission (SEC), in which it announced that it had recorded a $2.7 million charge against First Quarter 2011 earnings, based on reaching an “settlement-in-principle” with the U.S. Department of Justice related to what appears to be allegations of defective pricing on three “exigent, non-bid contracts with the U.S. government.”

The Form 8-K reported that—

In September 2005, the Defense Contracting Audit Agency presented its findings related to its audits of the three exigent contracts and suggested a potential pricing adjustment of $1.4 million related to reductions in the cost of materials that occurred prior to the final negotiation of these contracts. … Under applicable federal law, the Company may have been subject to treble damages and penalties associated with the potential pricing adjustment.  In light of the uncertainty, the Company decided to enter into discussions with the government in April to negotiate a settlement.

We looked at the most recent Annual Report available to the public (for FY 2010) and noted that the U.S. Department of Defense comprised 11 percent of Ultralife’s total sales (down from 26% in the prior year). We did not find any discussion of the issue(s) noted above in the financial statement footnotes related to legal matters. However, in the section entitled “Potential Commitments” we found the following discussion—

We had certain ‘exigent’, non-bid contracts with the U.S. government, which were subject to audit and final price adjustment, which resulted in decreased margins compared with the original terms of the contracts. As of December 31, 2010, there were no outstanding exigent contracts with the government. As part of its due diligence, the government has conducted post-audits of the completed exigent contracts to ensure that information used in supporting the pricing of exigent contracts did not differ materially from actual results. In September 2005, the Defense Contracting Audit Agency (‘DCAA’) presented its findings related to the audits of three of the exigent contracts, suggesting a potential pricing adjustment of approximately $1,400 [$1.4 million] related to reductions in the cost of materials that occurred prior to the final negotiation of these contracts. We have reviewed these audit reports, have submitted our response to these audits and believe, taken as a whole, the proposed audit adjustments can be offset with the consideration of other compensating cost increases that occurred prior to the final negotiation of the contracts. While we believe that potential exposure exists relating to any final negotiation of these proposed adjustments, we cannot reasonably estimate what, if any, adjustment may result when finalized. In addition, in June 2007, we received a request from the Office of Inspector General of the Department of Defense (‘DoD IG’) seeking certain information and documents relating to our business with the Department of Defense. We continue to cooperate with the DCAA audit and DoD IG inquiry by making available to government auditors and investigators our personnel and furnishing the requested information and documents. The DCAA Audit and DoD IG inquiry have now been consolidated and the US Attorney’s Office is representing the government in connection with these matters. We recently received a settlement proposal from the US Attorney which was based on the non-acceptance of various positions submitted by us in discussions and exchanges related to these matters. We are now reviewing the settlement proposal for purposes of preparing our response. At this time we have no basis for quantifying any penalties or liabilities we might face on account of the DCAA Audit and DoD IG inquiry. The aforementioned DCAA-related adjustments could reduce margins and, along with the aforementioned DOD IG inquiry, could have an adverse effect on our business, financial condition and results of operations.

Okay. Let’s review and comment on what Ultralife reported.

1. The company received three “exigent” contracts. We looked-up “exigent” on the Internet and learned that such contracts are (apparently) issued when there is an emergency or similar compelling urgency. We then looked at FAR Part 18 and learned that a Contracting Officer has certain flexibilities available for use when conducting an “emergency acquisition”—as we assume these were. For example, emergency acquisitions may limit the number of sources sought and need not provide for full and open competition. Contracting Officers may solicit from a single source for contract awards valued up to $1 million, in certain circumstances. Contracting Officers may even request proposals orally under certain circumstances. Letter contracts can be used when appropriate. But with all those flexibilities available, we did not notice that a Contracting Officer had the authority to issue a contract without receipt of a proposal.

2. Given the foregoing, we are unsure what Ultralife meant by a “no-bid” contract. We would understand the terms “sole-source” or “single source” but “no-bid” implies that there was no proposal whatsoever. But that can’t be correct, because Ultralife reported that it had actual contracts, and that its contracts experienced “decreased margins” when compared to their “original terms”. Moreover, there had to be some original pricing, because that was what the DCAA audited in its post-award audits. Further, there had to be some negotiations involved, since Ultralife reported that DCAA had alleged that the cost of materials had decreased “prior to the final negotiation” of those contracts.

3. So we have to conclude that this was, despite Ultralife’s somewhat unique approach to describing the situation, a rather run-of-the-mill defective pricing allegation.

4. But what’s interesting is the implication that there was some sort of False Claims Act violation being alleged as well. The “treble damages and penalties” phrase doesn’t come from a TINA violation; that comes from the False Claims Act.

So we think, based on sheer speculation with absolutely no knowledge of the facts other that those reported herein, that Ultralife found itself facing allegations that it knowingly failed to disclose “cost or pricing data”—which led to a contract price so tainted that Ultralife’s invoices became individual violations of the False Claims Act. Yeah, that could run into a lot of money….

But wait a second. If these were truly emergency acquisitions then who put the “Price Reduction for Defective [Certified] Cost or Pricing Data” clause into the contract? Are you telling us that there were such urgent and compelling circumstances that the Contracting Officer found that it appropriate and justified to only approach one source—but at the same time that there was sufficient time to require Ultralife to submit a proposal, to disclose (certified) cost or pricing data, to negotiate a price, and then to put together a traditional full-clause contract? Really?

Maybe it’s just the tortured description provided by Ultralife … but in our view something doesn’t add up here. Something’s not making sense to us.

And because of this settlement, we’ll never know the details of the full story….