Contractors Jockey for Position in New Budget Environment
Lots of news to catch up on regarding defense contractors, including organization restructurings, divestitures, and relocation's.
First,
let’s look at Northrop Grumman. On December 15, 2009 NOC completed the
sale of its TASC advisory unit to General Atlantic LLC and KKR for
$1.65 billion in an all-cash deal. As we previously noted, tighter organizational conflict of interest (COI) rules make it more difficult for defense contractors to both advise government officials and to sell goods/services to them. As one story notes, “Since
the TASC acquisition announcement in early November, company officials
have been working to separate ties to Northrop Grumman and demonstrate
it is in full compliance with U.S. government organizational conflict
of interest policies.” Analysts
have speculated that other defense contractors may have to divest
themselves of similar advisory entities in order to comply with the
tighter rules.
Just
a couple of weeks later, on January 4, 2010, NOC announced that it was
moving its corporate headquarters from Century City (Los Angeles) to
“the Washington area” in order to be closer to its government
customers. The Washington Post reported:
“We are a global security company, and all of the federal processes,
whether the executive branch or Congress, are in the Washington area,"
said Wes Bush, Northrop's chief executive and president. "We think
we'll be able to do a better job for our customers and our company by
having our corporate office there."
The Baltimore Sun reported:
"We're
trying to both protect the jobs we have and build more jobs for the
company, and we think the best way to do that is be very engaged with
our customers," McClain said. "It's something our company leadership
has discussed over probably several years, but it's a disruptive thing
to do to the people involved. So we thought with the change to the
leadership we have had, that this is a good time to bite the bullet and
make the move."
The
move, involving some 300 corporate leaders and staff, is expected to
take place by the end of 2011. Jack Northrop founding the company in
1939 and it was the last aerospace/defense contractor to remain in Southern
California. Once the national center for aerospace development,
Southern California watched as its companies were acquired (e.g.,
McDonnell Douglas, Rockwell) or left the region (e.g., Lockheed, CSC). Other large non-defense engineering companies, including Fluor, also have moved out of the area in recent years.
Second, SAIC announced on
September 24, 2009 that it had relocated its corporate headquarters
from San Diego to MacLean, VA. The SAIC press release announced:
"This
move will formally relocate the corporate executive leadership team
closer to our federal government customers enabling us to better
respond quickly and efficiently to their critical needs, while
maintaining a significant presence in San Diego," said SAIC Chief
Executive Officer Walt Havenstein.
"Although our headquarters location has changed, our commitment to
customer satisfaction and high ethical standards remains constant."
Third, ITT Corp. announced on January 5, 2010 that it was restructuring its defense segment, reducing the number of business units from seven to three, and will be cutting jobs in 2010. The defense segment is ITT’s largest business, at $6.3 billion in annual sales is represents more than 50 percent of the New York-based conglomerate’s revenue. DefenseSystems.com reported:
The
new defense segment will be called ITT Defense and Information
Solutions. David Melcher, who joined ITT about 16 months ago, will lead
the new division as president. The restructuring was driven in part by
shifts in defense priorities and budgets and the customer's demands for
more integrated and network-centric solutions, he said. “We
are positioning ITT to be in a better position than ever to support our
customers’ emerging technology needs, while also greatly enhancing our
ability to stake out new markets,” Steve Loranger,
ITT’s chairman, president and chief executive officer, said in a
statement. “This move will also allow ITT to achieve greater operating
efficiencies and optimize our cost structure, which will help drive
successful business strategies for continued top line growth.”
“This reorganization is a strategic action to better address the
evolving needs of our customers, the cyclical nature of defense
spending and the need to continue to deliver value to our shareholders,
while maintaining ITT’s most critical investments and competencies,”
Melcher said. The reorganization marks ITT's recognition that it needs
to approach the market less as a product company and more as a systems
and solutions provider, he said.
Reports indicate that ITT Defense plans to cut two to three percent of its workforce.
Astute
readers may see a common thread in the seemingly disconnected corporate
actions. As this site has reported several times (e.g., here and here) most
forecasts indicate a flattening of the defense budget followed by a
steady decline, as it enters another of its cyclical downturns.
Accordingly, A&D companies are jockeying for position, trying to
maximize their share of the shrinking pie. We predicted a renewed emphasis on cost cutting, as well on program execution. We also noted two companies – Lockheed Martin and EADS – who were actually adding to their executive ranks in order to enhance customer relationships and ensure program execution.
What
we are seeing looks like more than the routine reshuffling of
executives within a corporation. We seem to be witnessing companies
executing strategies designed to position themselves to survive—or even
thrive—in the upcoming storm that the budgetary warning clouds
portend. Look for more of the same in the coming months.
Space-Based Threats: Detection and Reaction
The final 2009 edition of Aviation Week & Space Technology
carried a story about “space situational awareness” (SSA), which the
authors asserted may be “one of the few military space arenas where
governments believe they can create real cross-border cooperation.”
The article cites recent events that highlight the shared threats facing space assets, such as the February 2009 collision
between an Iridium telecom satellite and a defunct Russian
satellite—and posits that the omnipresent threat posed by orbiting
space debris may spur international cooperation, such as the exchange
of radar data and the development of shared access to other data.
The
AW&ST article noted that “European nations are emerging as standard
bearers” for the shared approach to SSA. The December 1, 2009 adoption
of the Lisbon Treaty
will spur the pooling and sharing of resources—including SSA
data—within the European Union, according to the article. The article
notes, however, that the EU’s focus has been primarily civil rather
than military. For example, the EU has “initiated a draft code of
conduct … that, among other things, would prohibit the militarization
of space.” More recently, the European Defense Agency (EDA) has become
more involved, “helping to coordinate different requirements.”
In addition, “military planners are making some headway in increasing
the involvement of commercial satellite operators in space traffic
control, and the space insurance industry is becoming involved, too.”
The AW&ST article reports that France has started work on an improved version of its Graves radar,
which “was specifically designed for space surveillance,” and is
already in operational use. Germany is developing an SSA center at Kalklar
Air Base (also home to the EU Rapid Response Air Initiative (RRAI),
which (according to the article) should be operational by early 2010.
But
it’s not just the Europeans who are interested in a joint approach to
SSA. In mid-November 2009 (according to the article), “U.S. and French
experts met to begin discussing how potential conflicts [in data access
policy] might be remedied … the talks are later to be broadened to
include Germany and other European nations.”
Meanwhile, as readers of this site know, “the U.S. is increasing oversight of space traffic and is ready to begin deploying a[n] … orbit[al] tracking-and-detection capability.” Among other initiatives, the Space-Based Space Surveillance (SBSS)
satellite system “will detect and track space objects, such as
satellites and orbital debris generating data the Department of Defense
will use in support of military operations. NASA may also use the
information to calculate orbital debris collision avoidance measures….”
But
the foregoing efforts are focused solely on detection of space-based
threats. What about reaction? Apparently, Russia is thinking about
how to defend the Earth from the space-based threats posed by asteroids
that stray too close to our orbit. On
December 31, 2009, reports emerged that Russian scientists are planning
to meet “in secret” to develop a plan to prevent a potential collision
with the asteroid Apophis in 2036. According to ASDNews.com,
although the Russians initially are planning the response “in a closed
meeting of our collegium, the science-technical council,” they admit
that “a serious plan to prevent such a catastrophe would probably be an
international project involving Russian, European, U.S., and Chinese
space experts.”
While
Russian scientists are focused on taking action to prevent a collision
that might result in the loss of “hundreds of thousands” of lives, NASA
is more optimistic about the situation. Although the agency announced that Apophis
would pass within 18,000 miles of Earth’s orbit in 2029, “NASA later
said that it has ‘all but ruled out’ the chance of the asteroid hitting
the Earth in 2036,” according to an article
on DigitalTrends.com. The ASDNews.com article quotes NASA as stating
that “"Updated computational techniques and newly available data
indicate the probability of an Earth encounter on April 13, 2036, for Apophis has dropped from one-in-45,000 to about four-in-a-million.”
The
Russians aren’t taking any chances, though. The DigitalTrends.com article
reports that “The Russian researchers are considering a plan to send a
spacecraft to bump the large asteroid to a safer orbit.” Russian
Scientist Anatoly Perminov
is quoted as saying, “Calculations show that it’s possible to create a
special-purpose spacecraft within the time we have, which would help
avoid the collision. The threat of collision can be averted.” The
article notes that alternate methods to change the trajectory of an
asteroid include mirrors, light, or paint to change the way the
asteroid absorbs heat enough to shift its direction. These methods
would take about 20 years to change the path of the asteroid.
Twenty years is barely enough time to get ready for 2036, and it’s already too late to get ready for the 2029 encounter with Apophis. As John Wayne once said, “Slap some bacon on a biscuit and let’s go--we’re burning daylight.”
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Boeing Poised to Lose $271 Million in EELV Contract Payments
A December 29, 2009 story by Business Week reported that Boeing was
preparing to be told by DCAA in mid-January that it is going to take a
$271 million hit to its EELV program launch payments. According to the article, DCAA was currently finishing a review that was expected to assert that not only does Boeing owe the Government a refund on $82 million in payments already received by the company, it also owed
interest on that amount. In addition, future payments of $189 million
that the company “claims it is owed” may be forfeit. The article quoted Pentagon spokesman Navy Commander Darryn James as saying via e-mail—
The Defense Contract Audit Agency is reviewing whether Boeing ‘improperly billed’
the Air Force in a 2006-2008 contract for labor, management, quality
control and support costs that were incurred between 1998 and 2006 in
the Delta IV rocket program. Federal accounting standards require the billings take place in the year the costs were incurred. ‘These costing issues encompass very complex and highly technical accounting matters. The agency is aggressively pursuing this issue.’
To
add fuel to the fire, the article also reported that the DOD Inspector
General testified before Congress that the DCAA “regional manager”
“overturned a draft audit conclusion that Boeing shouldn’t be paid
anything because the company was in ‘potential violation of accounting
standards’.” Moreover, the article reported that the DOD IG had begun
a criminal investigation against the regional manager, who has hired a
lawyer.
The article also reported that, for its part, Boeing noted that “neither
the GAO nor the inspector general found that Boeing acted improperly in
its dealing with the government.” Further, Dennis Muilenburg, President of Boeing’s Integrated Defense Systems unit, was reported to have said in an interview that the company is entitled to the $271 million. According to Muilenberg, in 2006 the
Air Force agreed to pay the costs associated with the Delta IV booster
rocket launch services, he said. “We have a previous agreement that we
believe is proper and should be honored,” Muilenburg said.
Readers
of this site not only should fail to be surprised by this “news,” they
should also be able to point out several errors in the Business Week
story. We first reported
the DOD IG finding in late September, a full three months before
Business Week got around to it. At that time, we told our readers—
The
DOD IG confirmed prior GAO findings with respect to “Contractor A, Case
2” that the audit findings were impaired because of auditor
independence issues related to the Western Region Audit Manager (RAM),
and that the audit working papers were insufficient to support the
audit opinions. (“Contractor A” is responsible for the Evolved Expendable Launch Vehicle as well as the Delta IV rocket.) Moreover, the DOD IG confirmed that original audit opinion was changed without sufficient documentation.
As a result (according to the DOD IG), the U.S. Air Force may have
agreed to pay up to $271 million in unallowable costs either related to
losses on other contracts or to costs incurred in prior cost accounting
periods. The USAF Space and Missiles Center (SMC) agreed to suspend further payments to “Contractor A” pending resolution of the matter.
In that September article, we provided a link
to the full DOD IG report. Readers who cared to make the effort could
have learned more of the details, which were provided in the report.
The report detailed issues with Boeing’s unabsorbed “Program Management
and Hardware Support” (PM&HS) indirect cost pool
allocated to its Delta IV EELV program, as well as deferred production
costs at the Boeing/Lockheed Martin EELV joint venture known as “United Launch Alliance.”
The IG report noted that DCMA had entered into two Advance Agreements
with the contractor, one of which agreed that the government found
Boeing’s “Lot Accounting
a compliant practice under the CAS.” The second Advance Agreement
provided that “$271,152,672 in unabsorbed PM&HS costs that were
incurred prior to June 1, 2006, but were neither allocable nor payable
under prior [launch] contracts, may be reimbursed by the Air Force
under future contracts as a fixed-price line item.” The second Advance
Agreement called for the Air Force to make eight annual payments to Boeing of $33.9 million each.
Despite the Advance Agreements, DCAA audit reports issued in 2005
and 2006 asserted that the proposed amortization of the unabsorbed
PM&HS costs represented a noncompliance with Cost Accounting
Standard 406, because the costs had been incurred in prior cost
accounting periods. Alternatively, DCAA asserted that the PM&HS
costs represented losses incurred on other contracts, and thus were
unallowable pursuant to the cost principle at FAR 31.205-23. Boeing
refused to negotiate the Delta IV Buy III Launch Capability contract so
long as the Air Force agreed with DCAA. National security was at
stake. Having little choice in the matter, the Air Force considered
giving Boeing a waiver from CAS; instead, they convened a meeting with
DCMA and DCAA to identify “roadblocks” impeding successful negotiation
of the contract. (The Air Force denied that term was used.)
One
of the methods suggested to break the impasse was to “walk-through”
Boeing’s Lot Accounting processes. After that meeting, the DCAA
Regional Audit Manager (RAM) directed the auditor to drop allegations
of noncompliance with CAS 406. As the IG reported—
According
to the supervisor, lead auditor, and FAO manager, the DCAA RAM directed
the auditor to omit CAS 406 compliance testing and discussion of CAS
compliance from the audit of the contractor’s … proposed unabsorbed
PM&HS costs.
… The DCAA RAM reported to her supervisor, the Regional Director for
DCAA’s Western [Region]… that CAS 406 was no longer an issue. However,
she failed to report that this determination was not supported by the
results of audit procedures and that her field audit staff disagreed.
Based
on the foregoing, the DOD IG concluded that the RAM had violated the
independence requirements of (generally accepted) Government Auditing
Standards (GAGAS), and that the DCAA audit reports could not be relied
on by the Air Force for purposes of negotiating contract pricing.
Moreover, because the Air Force had entered into the Advance Agreements
based on the tainted audit reports, they may be invalid.
There were more details, of course. Among other things, there were indications that Boeing extended its definition of one “Lot” from two to 15 years.
(Though we note that the Air Force asserted in its comments that the IG
report was incorrect, and that Boeing had consistently used a Lot
Accounting period of 42 Common Booster Cores “regardless of time and
number of missions.”) The IG report also notes that the ULA JV had
concluded that it would not utilize Boeing’s Lot Accounting practices
because they neither complied with GAAP nor with CAS.
So
as with many government contract cost accounting matters, the truth is
both complex and hard to fathom. Will Boeing have to concede $271
million in payments to which it believes it is contractually entitled?
We’ll look forward to the final DCAA audit report(s), and hope that
they ignore any political pressure and focus solely on the facts, which
(apparently) even the DOD IG seems to have gotten wrong.
This
is a great example of how the facts matter, and how easy it is to
allege a problem, and how hard it is to refute an allegation. Clearly,
Boeing’s entitlement to the $271 million depends on its “Lot
Accounting” practices, why the PM&HS costs were not fully absorbed
by prior launch contracts, and how Boeing intended to amortize its
production costs under future programs (and whether it would be
permitted to do so under FAR and CAS parameters). As DCAA focuses on
generating high-quality audits that DCMA contracting officers and
buying commands can effectively utilize to make business decisions, we
hope they will keep this example in mind.
Los Alamos Testers Blow the Doors Off—Literally
From the gadfly activist group, the Project on Government Oversight (POGO), comes word
of a December 16, 2009 test of a Large Bore Powder Gun (LBPG) at
Technical Area 15 of the Los Alamos National Laboratory (LANL). The
test went awry and the Shock & Detonation Physics Group “heard a
loud unusual noise” and observed the doors being “propelled off the
facility.” Initial reports estimated the damage to be on the order of
$3 million. Parts of the LBPG cannon were “found outside the
building.”
As POGO notes, LANL has a long history of technical problems and management issues. POGO’s comment on the latest incident? “… our past investigations have been concerned about security threats to the nuclear labs coming from outsiders.”
The National Nuclear Security Administration (NNSA) issued a statement
(reported on Wired.com) that flatly refuted the POGO report, saying,
“Despite claims to the contrary, the only thing ‘demolished’ in this
case was POGO’s credibility … and [this] is the sort of irresponsible
hyperbole we’ve come to expect from this group.” The NNSA stated that
the LBPG test was part of a “standard proof test for a catch tank in
the target chamber … [and] these types of experiments are routine and
responsible.” According to the NNSA statement, the LBPG tests are
“used to conduct measurements of material properties at pressures
needed for understanding nuclear weapons performance.”
Despite
the denial, the POGO reporter stood by his original story, noting, “The
explosion blew the doors off the building, separated the shielding of
two walls, and caused significant facility structural damage.” The POGO site contains a link to the LANL Occurrence Report (found here).
The Occurrence Report does not discuss why the LBPG was being utilized
nor does it discuss any root cause analysis regarding why such a
“routine” test could have failed so catastrophically.
We accept that there is a bona fide need to use LBPG “cannons” in the testing of material properties. We look forward, however, to learning how one could fail in such a way as to blow the doors off a presumably robust facility.
More
interesting, at least to us, is the role played by the NNSA in linking
the Department of Energy with the Department of Defense. As the NNSA
website (link above) tells us—
One
of the primary missions of NNSA is to maintain and enhance the safety,
security and reliability of the U.S. nuclear weapons stockpile.
NNSA, through its Office of Defense Programs, ensures that the U.S.
nuclear arsenal meets the country’s national security requirements and
continues to serve its essential deterrence role. In partnership with the Department of Defense, NNSA’s Defense Programs provides the research, development, secure transportation, and production activities necessary to support the U.S. nuclear weapons stockpile….
Today, NNSA uses and oversees a wide-range of breakthrough science
experiments, engineering audits and high-tech computer simulations,
including extensive laboratory and flight tests of warhead components
and subsystems, to keep the existing warheads reliable, secure and safe.
Every year, the Secretary of Energy is able to certify the reliability
of the stockpile without conducting an underground nuclear test.
The
NNSA manages eight sites in the Nuclear Weapons Complex. The eight
sites include the Los Alamos, Sandia, and Lawrence Livermore National
Laboratories. In addition, there are sites in Kansas City, and Amarillo (Texas). There is a test site outside of Las Vegas, and a production site near Augusta, Georgia dedicated to extracting Tritium (3H)
Gas for use in nuclear weapons. Finally, the Y-12 “National Security
Complex” in Oakridge, Tennessee is the nation’s “only source of
enriched uranium” for use in weapons and by the U.S. Navy.
We
find it interesting that the ostensibly civilian Department of Energy
has such an important role in maintaining the nation’s strategic defense.
Perhaps the linkage (or confusion?) between civilian and military uses
of nuclear energy traces its roots back to 1946, when President Truman
transferred control of “atomic energy” from military to civilian
hands. Truman established the Atomic Energy Commission (AEC)
to essentially control all facets of nuclear production, including
managing the National Laboratories. Critics have written, “the AEC had
become an oligarchy controlling all facets of the military and civilian
sides of nuclear energy, promoting them and at the same time attempting
to regulate them, and it had fallen down on the regulatory side ... a
growing legion of critics saw too many inbuilt conflicts of interest."
In 1974 the AEC was disestablished and replaced with the Nuclear
Regulatory Commission (NRC).
According to the NRC website, its only interest is in the commercial
uses of nuclear power; military production and sustainment is handled
by the NNSA within the Department of Energy. Use of nuclear weapons is (of course) under the control of the Department of Defense and the National Command Authority.
So
we’ve meandered from Large Bore Powder Guns to nuclear weapons. We’ve
learned that, even in a secured bunker inside a weapon testing site,
explosive mishaps can occur. We’re very happy that such mishaps occur
with LBPGs and not with nuclear weapons.
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