• Increase font size
  • Default font size
  • Decrease font size
Apogee Consulting Inc

Inadequate Business Systems

Nick Sanders
E-mail Print PDF

You might remember, as we do, the time when DCAA blasted “inadequate” contractor business systems, and blamed those systems for “millions of dollars” of contractor overbillings to the Department of Defense. Of course, DCAA was talking about LOGCAP contractors in Southwest Asia (including Iraq and Afghanistan) but – as we predicted – very few people caught that nuance and, instead, the unsupported comments were taken to apply to all defense contractors.

Thus, it wasn’t long before we had a series of proposed rules and public law revisions that led to the current DFARS contractor business system oversight regime, a regime about which we’ve written at length.

Maybe those LOGCAP contractors had deficiencies in their business systems; maybe not. That was more than a decade ago and times were different. In particular, at the time DCAA had been under intense criticism for poor quality audits, and there is no reason to think that the audits they performed on LOGCAP contractors’ business systems were of any better quality than the audits they performed of other contractors’ business systems. We’ll likely never know the truth of the assertions made by the DCAA Director at the time—which were made under oath.

What we do know is that, today, almost all contractor business systems audited by DCAA (or “reviewed,” if performed by DCMA) are found to be adequate.

We know this because, from time to time, DCMA publishes statistics on the status of contractor business systems. These statistics aren’t published in the Federal Register. For the most part, the average Joe doesn’t get to see them. However, sometimes they get handed out to industry groups and passed around within the membership. (We’ve written before about the benefits of joining an industry group such as AIA or NDIA. You really should.) Sometimes one of our clients gets a copy and gives it to us as an FYI.

The last set of contractor business system statistics we have seen was dated April, 2021. That’s a bit dated now but, if you have nothing, then even a bit dated view of business system status is interesting. But before we recap the stats, let’s talk about the methodology. First, DCMA measures contractor business systems by CAGE Code. Basically, a CAGE Code is issued at the intersection of a facility and a geographic location. As you might guess, some contractors only have one CAGE Code while other contractors have dozens of them. (Government entities have CAGE Codes too, but that’s not relevant to this article.)

The point is, you can’t correlate CAGE Codes to contractors. So when we report that DCMA is tracking roughly 8,900 CAGE Codes in its contractor business system reporting, don’t think that that means DCMA is tracking roughly 8,900 individual contractors. They’re not.

Also, remember that the focus of the DFARS business system oversight regime is on the largest defense contractors. Mandatory payment withholds for system inadequacies will only be implemented on contractors that are subject to Full CAS coverage. Thus, don’t over generalize the data to the entire defense industrial base.

Now, having set the stage, we know that, as of April 30, 2021, DCMA was tracking 8,871 contractor business systems by CAGE Code. That is to say, DCMA reported business system status for 8,871 individual CAGE Codes.

Of the 8,871 CAGE Codes, only 62 had disapproved business systems. That’s a vanishingly small percentage.

Note, however, that those 62 disapproved contractor business systems had generated $45.4 million in cumulative payment withholds.

Which systems had the most disapprovals?

The Accounting System was, by far, the system with the most disapprovals (27/62). That said, disapproved Accounting Systems only drove $90,000 in payment withholds. That implies the disapprovals were being experienced by smaller contractors—i.e., those not subject to Full CAS coverage.

Next was the Estimating System (15/62). Payment withholds associated with disapproved Estimating Systems were, cumulatively, $3.4 million.

No other contractor business system broke double-digits, in terms of disapprovals. But we did note that Earned Value Management (EVMS) accounted for 62 percent of all cumulative payment withholds, even though there were only 9 CAGE Codes with disapproved EVM Systems.

The point of this article is that, unlike the asserted findings within the 2010 DCAA testimony about LOGCAP contractors, todays’ contractor business systems are very much adequate. That is a factual statement based on reported DCMA statistics.

Was the 2010 DCAA testimony inaccurate?

Or has the past decade of focus on contractor business systems led to significant improvements by contractors?

It’s not likely that anybody reading this blog article will ever know the answers to those questions for sure. But what we do know is that DCAA and DCMA continue to audit, and review, contractor business systems. Payment withholds continue to be levied against the largest contractors, and sometimes those payment withholds reach high levels, significantly impacting contractor cash flow.

If you are a larger defense contractor—or want to become one—then you need to focus on your business systems.

 

Air Force One, Maybe

Nick Sanders
E-mail Print PDF

The VC-25A aircraft, commonly known as “Air Force One,” needs to be replaced. This has been known for several years. The existing Boeing 747 aircraft—highly customized to meet Presidential needs—have been operating for more than 20 years (one report says nearly 30 years). The replacement aircraft, dubbed the VC-25B, has been in the works since contract award (to Boeing) in 2015.

It has not been a smooth ride.

President Trump tweeted his opposition to the Air Force One replacement program before he was sworn into office, complaining about excessive cost (“more than $4 billion”). In an effort to placate the Commander-in-Chief, the US Air Force bought a couple of used aircraft originally intended for a Russian airline, but that didn’t really work out in terms of cost control. At the moment, the replacement program is expected to cost $5.3 billion, even though Boeing’s contract is firm, fixed-price and valued at $3.9 billion (reportedly). One report says the tech manual used for maintenance and repairs costs $84 million all by itself. We didn’t confirm, but at least one report asserted that Boeing has taken a $486 million charge against earnings to cover its program overrun. Ouch.

But Boeing’s program is in even more trouble than simple budget pressures. It is also late.

If you were looking for “on-time, on-budget,” this is not your program.

As the Financial Times reported—

The programme represents a sliver of Boeing’s top-line, which totalled $58bn in 2020. Yet it concerns some analysts because it is another black eye in a string of problems ranging from minor to catastrophic: debris left in the USAF’s KC-46 refuelling tankers, the Starliner crew capsule that failed to reach the International Space Station, the halted 787 deliveries and the two crashes of the 737 Max that killed a combined 346 people.

The Air Force One problems contribute ‘to an overall impression of Boeing having serious programme management and execution deficiencies, both in their commercial and military businesses’, said Teal analyst Richard Aboulafia.

‘It’s one on top of another, on top of another,’ added Bank of America analyst Ron Epstein. ‘That’s the issue, not Air Force One per se. It’s yet another fumble . . . It really makes you question what’s going on in their engineering organisation.’

Why is the program now estimated to be a full year behind original schedule?

According to reports, Boeing has offered two excuses for the program delay. The first is COVID-19. Apparently, the pandemic impacted Boeing’s ability to work on the aircraft. We expect that’s going to be a common excuse used by many contractors for schedule delays. Indeed, epidemics are one of the expressly listed causes for “excusable delays” found in the FAR. Reports state that Boeing has filed a Request for Equitable Adjustment (REA) with respect to its COVID-19 impacts. We’ll have to see what happens with that REA request.

The other rationale offered by Boeing is more interesting. Boeing is blaming a supplier, GDC Technics, for at least a part of the delay. According to various reports, GDC Technics was the supplier that was responsible for the aircraft’s interior. Obviously, the interior is a fairly critical aspect of a Presidential aircraft.

News reports indicate that Boeing terminated its subcontract and filed suit against GDC Technics in April, 2021. In its suit, Boeing alleged that the company had fallen more than a year behind schedule on designing the VC-25B interiors. GDC then countersued Boeing, claiming that Boeing had mismanaged the program.

Somewhere in the middle of the lawyer-led “He Said, She Said” battle, GDC Technics filed for bankruptcy, citing Boeing’s withholding of $20 million in payments the company said it was owed for completed work.

Regardless of the merits of the parties’ litigation allegations, this is but the latest example of the importance of diligent supply chain management. Responsible prime contractors don’t let their suppliers fall a year behind; they deploy leading risk indicators and take effective action when the risk indicators start flashing yellow. We’re going to assert (without knowing) that Boeing didn’t do that in this case.

This blog has emphasized the importance of effective supply chain management over and over. We’ve written so many articles on the subject we felt the readership had tired of our rants. Apparently, the folks at Boeing aren’t readers of the blog.

They could have read this 2010 article, in which we pontificated that—

Your preoccupation with internal matters, your management metrics that focus only on internal issues (such as headcount), your application of Lean and Six Sigma solely to your own production line, your attempts to control cost growth by forcing suppliers into firm fixed-price development contracts or into making huge program ‘investments’—these actions betray a management naïveté, an erroneous impression that the management approach that worked to put a man on the Moon is the same approach that will lead to successful program execution in the 21st century.

Newsflash: it will not. …

Program quality and execution risk cannot be transferred to suppliers. The prime contractor is responsible to the customer for the program. Period. If your attorney counsels otherwise, you should hire another attorney. If your subcontract manager or buyer or procurement specialist tells you that cost or schedule or quality or performance risk has been controlled by pushing it downwards in the supply chain, you should put a better support team in place.

Because you cannot build a wall between team members on a program; you cannot say, “This is your responsibility and this is my responsibility.” You cannot transfer risk; the most you can do is to share it. The more that design information and risk information is shared, and communicated, and managed as a team, the better the outcome. When you treat your suppliers as individual entities that succeed, or fail, on their own, then you will always suboptimize your outcome. That is axiomatic. It is a nearly inviolate law of 21st century program management.

Or they could have read this 2014 article, in which we opined that—

One of the truisms we have learned about creating an effective program management culture is that effective subcontractor management may be the most important single factor driving program outcomes. The success or failure of your program very likely hinges on how well you are managing performance that you have pushed outside your factory to external suppliers. We have observed this axiom over and over, whether discussing the Boeing 787 program or the Airbus A380 program or major defense acquisition programs. We have also observed that program execution risks found in the supply chain are, as a rule, under-managed.

Or they could have read this 2015 article, which focused on counterfeit electronic parts, in which we asserted that—

Many of the largest prime contractors have made a specialty of subcontracting out large portions of the SOW, to the point where they like to call themselves ‘system integrators’ and point to subcontract management as one of their (few) core competencies. Their program win strategy is to lock-up and deliver large teams of individual corporations (along with those corporations’ local Congresspersons and Senators). And it tends to work for them often enough that they keep on doing it. Either they have figured out how to manage the risks associated with supply chain management or, perhaps, they haven’t noticed that those risks keep increasing … and so they keep on with what has been working for them.

But make no mistake, those risks do keep increasing.

Point is, we’ve got a fairly strong pedigree in the area of effective subcontractor management (including supply chain risk management). We’ve got more than thought leadership on the topic—we’ve got hands-on experience in helping large program management teams at very large contractors get a handle on how to manage their supply chain risk. That thing that people now call SCRM (Supply Chain Risk Management)? We were practicing it more than a decade ago.

Based on what we guess about Boeing’s Air Force One replacement program, the program team didn’t read our articles and didn’t implement effective supply chain management techniques.

Thus, when a British Bank of America analyst states “It really makes you question what’s going on in their engineering organisation,” we believe we know the answer.

Dear Boeing, our contact information is on the website. You might want to give us a call.

 

An Update on Performace Based Payments

Nick Sanders
E-mail Print PDF
SINCE THEIR IMPLEMENTATION IN 1995, regulations and guidance governing the use of performance-based payments (PBPs) have undergone several revisions...more
 

Executive Compensation Failure

Nick Sanders
E-mail Print PDF

Claiming only allowable compensation is tricky. It requires a decent amount of analysis. One of the trickier aspects of the compensation analysis is understanding that the compensation ceiling changes over time. One may also need to understand that the compensation ceiling applies to different groups of employees, or even different groups of customer contracts, depending on the year in which the costs were recorded (and/or the year in which the contract was awarded).

And this doesn’t really even apply to challenges to compensation reasonableness. That’s a whole ‘nother thing. No, we’re simply talking about compliance with FAR 31.205-6(p). It’s tricky, and contractors are required to get it right.

It’s so tricky, that DCAA has so far failed to issue comprehensive guidance to its auditors via the Selected Areas of Cost Guidebook. Chapter 10 of the Guidebook (Compensation for Personal Services) is “under construction,” and has been that way for years.

Nonetheless, it is DCAA’s position that a contractor who claims compensation costs in excess of the 31.205-6(p) ceiling(s) has claimed an expressly unallowable cost. (See the Contract Audit Manual at 6-414.8.) Recently, this position was put to the test at the Armed Services Board of Contract Appeals (ASBCA).

Ology Bioservices, Inc. (Ology) appealed a Contracting Officer Final Decision applying a penalty for Ology’s inclusion of claimed executive compensation costs in excess of the FAR ceiling in its Fiscal Year 2013 proposal to establish final billing rates, which was submitted on time six months after the close of Ology’s fiscal year. However, DCAA had some issues with Ology’s submission and Ology was required to fix those issues and resubmit its proposal, which it did about six months later. DCAA audited the proposal and questioned costs. After the audit report was issued, and after a “lengthy negotiation” with the DCMA contracting officer—a period that lasted nearly six years (December 2014 through May 2020)—the COFD was issued, in which the contracting officer determined that Ology had claimed executive compensation costs that exceeded the FY 2013 ceiling by $1,749,890. As Judge O’Connell of the Board wrote, “The CO found that $979,938 of this amount was allocated to covered contracts and assessed Ology a penalty in this amount. In addition, she demanded interest that brought the total government claim to $1,109,160.”

In the Board’s analysis of the situation, the matter was not nearly as straight-forward as DCAA and DCMA claimed it was. Of particular import was the fact that OFPP had not published the FY 2013 compensation cap until March 15, 2016. “The government has not provided any explanation as to why there was such a delay in establishing the FY 2013 cap.”

Long-time readers of this blog know that we have complained about OFPP’s lack of diligence before. Several times. The fact of the matter is that OFPP didn’t like the ceilings that were calculated at the time, and expressed the dislike by failing to carry out the statutory duty imposed on the agency, the duty that required timely publication of the ceiling. The situation continued after the executive compensation ceiling became the contractor compensation ceiling and the new benchmarks were adopted during the Obama Administration. The situation is now so bad that even DCAA has told their auditors not to count on the OFPP and, instead, to calculate their own ceilings for audit purposes.

Back to Ology’s appeal.

Because the correct FY 2013 “cap” was not issued in time, the government’s position was that the FY 2012 cap applied to the costs that Ology had claimed. The rationale for that position was that, when OFPP had published the FY 2012 cap amount, the language used was ““amount applies to limit the costs of compensation for contractor employees that are reimbursed by the Government to the contractor for costs incurred on all contracts, after January 1, 2012 and in subsequent contractor FYs, unless and until revised by OFPP.” (Emphasis added.) Thus, even though the statute required an annual ceiling to be calculated and published, the government argued that the last published ceiling applied prospectively, on a flat-line basis.

The Board analyzed the statute that established the executive compensation ceiling (10 U.S.C. § 2324) based on the language in place at the time it would have applied to Ology. The Board concluded that the statute required publication of an annual cap value, and that it was unreasonable to hold Ology accountable for claiming costs in excess of an outdated ceiling. To be clear, the Board agreed that Ology had claimed unallowable costs; however, the Board found that the excess costs were not expressly unallowable and that Ology should not have to pay penalties and interest on the excess amounts.

Judge O’Connell wrote—

Neither the statute nor any FAR provision specified a date by which OFPP must establish the cap. While it is reasonable to infer that Congress granted OFPP some leeway as to when it would set the cap, we do not believe that Congress intended OFPP to have unlimited time to update the cap or for the government to apply an outdated cap for years on end. … Further, the government imposed on the contractor an obligation under the Allowable Cost and Payment clause to submit its final indirect rate cost proposal within six months of the end of its fiscal year, FAR 52.216-7(d)(2). The government required the contractor to certify at that time that the proposal did not include any expressly unallowable costs, FAR 52.242-4(c). To submit the proposal and make this certification, the contractor would have to know the cap for that year. …

While it is true that OFPP eventually met the statutory directive to establish an FY 2013 cap, it did so long after it would provide guidance to contractors, at least those who complied with their contracts by submitting timely indirect cost rate proposals. Applying the FY 2012 cap to 2013 compensation would have the odd effect of placing contractors who complied with their deadlines in a worse position than a contractor who waited until after the March 15, 2016 issuance of the FY 2013 cap to submit its proposal. The Board believes that Congress expected more of OFPP than a technical compliance with the statutory directive that was too late to be helpful. …

This dispute involves FY 2013 compensation and the FY 2013 would be the cap that applies, not the FY 2012 cap. The FY 2013 cap did not exist when Ology certified its FY 2013 indirect cost rate proposal and the government has, in any event, abandoned the argument that the FY 2013 cap could be applied retroactively to Ology’s FY 2013 proposal. Accordingly, there is no issue that requires a hearing. The government cannot carry its burden of demonstrating that Ology included expressly unallowable costs in its FY 2013 proposal and that a penalty was warranted. Ology is entitled to summary judgment that its FY 2013 executive compensation costs were not expressly unallowable at the time it certified its final indirect cost rate proposal because the FY 2012 cap was no longer applicable.

Although Ology won its victory, please don’t see this decision as a free rein to include the full amounts of contractor compensation in your final billing rate proposals. A ceiling still exists—albeit it must be manually calculated using the existing statutory formula because OFPP cannot be arsed to do its job. Costs claimed in excess of that (manually calculated) ceiling are still unallowable.

What this decision does, however, is provide support for the argument that costs claimed in excess of that ceiling are not expressly unallowable.

To that extent, it’s an important decision.

 

Hanford. Again.

Nick Sanders
E-mail Print PDF

Some places just keep coming up over and over again on this blog. Hanford, Washington, is one of those places. From a quick search, it looks like our first article set in this locale was published in 2013. It concerned time card fraud. Other articles followed. The former plutonium manufacturing site just seems to be a hotbed for corruption. It got to the point where, in 2017, we guessed the cause: “it must be something in the water.”

It’s not necessarily all about corruption in the classic sense of the term. The Dept. of Energy Inspector General has published reports critical of various Hanford contractors’ activities without explicitly calling those activities "corrupt." For example, in 2020, we reported that the DOE IG had expressed concerns with two contractors’ small business reporting accuracy. One of those contractors was CH2M HILL Plateau Remediation Company (CHPRC). CHPRC is a wholly owned subsidiary of CH2M (formerly CH2M Hill), which is now a wholly owned subsidiary of Jacobs Engineering Group (Jacobs). If you want to know the details, follow the link to our blog post.

Now, about a year later, CHPRC is back in the news. Or, at least, the subject of a Dept. of Justice press release. According to the press release, CHPRC agreed “to pay $3,038,270 million to resolve allegations that CHPRC violated the False Claims Act by submitting false and fraudulent small business subcontract reports.”

Are the issues the formed the basis of the fraud allegations the same as the ones that DOD IG reported on a year ago? They don’t seem to be.

Instead—

This settlement resolves allegations that CHPRC falsely reported to DOE regarding its HUBZone subcontracting efforts. Specifically, the settlement resolves allegations that CHPRC falsely represented that subcontract awards to two companies, Indian Eyes, LLC, and Phoenix-ABC A Joint Venture (“PABC”), were to HUBZone businesses, when in fact CHPRC knew that both entities did not have HUBZone status during the time period of the subcontracts.

Why would CHPRC want to “falsely represent” that certain subcontract awards were made to HUBZone businesses? According to the DoJ, “CHPRC’s contract provided for fee-based incentives regarding CHPRC’s success in subcontracting to HUBZone businesses, and for the imposition of monetary penalties if CHPRC missed its goals and failed to exercise good faith efforts to award HUBZone subcontracts.” In other words, CHPRC’s profit could vary based on the entities that received subcontracts.

As with many False Claims Act settlements, this one started with a qui tam suit. Apparently, the original 2014 suit was filed by “a Hanford-area small business” that is now known as Apogee Logistics. Let me assure you that Apogee Consulting, Inc. is not connected in any way with Apogee Logistics.

As we noted, CHPRC is owned by CH2M, which is in turned owned by Jacobs Engineering. Did Jacobs Engineering know about the 2014 suit when it acquired CH2M? Maybe. Maybe not.

But if it was aware of the pending litigation, it certainly could have established a settlement reserve. Had it done so, payment of the $3 million (and associated attorney fees) might not impact corporate earnings whatsoever. Investors will have to wait for the next quarterly earnings report to see if that’s the case.

 
More Articles...


Page 7 of 278

Newsflash

Effective January 1, 2019, Nick Sanders has been named as Editor of two reference books published by LexisNexis. The first book is Matthew Bender’s Accounting for Government Contracts: The Federal Acquisition Regulation. The second book is Matthew Bender’s Accounting for Government Contracts: The Cost Accounting Standards. Nick replaces Darrell Oyer, who has edited those books for many years.