Delayed Audits Cause Ripple Impacts, Part 2
In the first part of this 2-part article, we discussed the interesting CBCA decision that Stephen Avery brought to our attention. As noted in Part 1, this was an acronym-filled decision and, if you didn’t start by reading Part 1, we expect you’ll get lost. So go read Part 1 now, please.
Let’s recap a bit: The dispute was ostensibly about claimed costs in a subcontractor’s termination for convenience settlement proposal but really seemed to center on the subcontractor’s lack of final billing rates. DCAA had audited the subcontractor’s ICS for its FYs 2003 through 2007 but it took until the actual filing of the claim before the CMS contracting officer got around to unilaterally establishing final rates for those years. Final rates for the subsequent years were never established, even though DHHS/CMS auditors spent at least two years auditing them.
The prime (GHI) claimed it could not reach a final settlement on the subcontractor’s (DCCS) termination settlement proposal without final billing rates. The subcontractor claimed on-going costs related to supporting the incurred cost audits and in supporting close-out of its subcontract. For its part, the government customer (DHHS/CMS) asserted that it had no role in negotiations between a prime contractor and its subcontractor while at the same time telling the prime contractor that the on-going costs claimed by DCCS were both unreasonable and unallowable.
Before the Board were dueling motions for summary judgment.
The government first argued that the post-termination costs claimed by DCCS were unreasonable and unallowable, because they were due to the “willful failure of the [sub]contractor to discontinue costs.” The government argued that it was “unreasonable” for DCCS to be put in a better position, financially speaking, than if the contract had been allowed to run its course. In this vein, the government noted that the contract, by its terms, ended in November, 2011. Thus, costs incurred after that date were unallowable.
The government’s second argument was that DCCS’ claimed costs were “not supported by accounting data and other information sufficient for review by the government.” The government asserted that DCCS’ alleged failure to provide required supporting documentation “interfered with CMS’s ability to consider which charges might constitute allowable charges.”
With respect to the government’s first argument, DCCS argued that it had “an unavoidable contractual obligation to support the Government’s audit of its termination settlement proposal and indirect cost rates for all open years.” DCCS argued—
Had CMS audited and settled the open contract years or negotiated the termination settlement proposal in a timely manner, DCCS could have placed all of the audited records in permanent storage and discontinued operations. However, CMS did not do either of these things. Instead, CMS required DCCS to undergo a protracted audit. As a consequence, DCCS was compelled to continue to incur costs in order to close out the subcontract in accordance with the requirements of FAR 52.216-7.
In addition, DCCS asserted that it was not seeking to better its financial position as the result of its claimed costs. Instead, DCCS argued –
Even if the subcontract had run its normal course, the post-completion costs incurred by DCCS in supporting the Government’s audit and settling final indirect cost rates would still be allowable and allocable to the subcontract. Contractors frequently continue to incur costs for this purpose after the end of a physically complete cost reimbursement contract since final indirect cost rate proposals are not submitted until after the end of each fiscal year.
With respect to the government’s second argument, DCCS countered that it had made all of its accounting data and other supporting information available for CMS review, but that the CMS auditor(s) “declined to review it.” Thus, DCCS argued that the government’s “real complaint” was that —
… DCCS declined to make copies of the supporting data, but nothing in DCCS’s subcontract or the FAR requires a contractor or subcontractor to incur the cost of copying voluminous records that are otherwise made available for the Government’s review and inspection. DCCS fully satisfied its contractual obligation by offering to make the records available for CMS’s examination, audit and reproduction
The CBCA resolved the parties’ arguments by ruling that DCCS was entitled to its post-termination costs. As Judge Goodman wrote for the Board—
First, respondent implies that DCCS’s costs continued after the effective date of the termination due to the willful failure of the contractor to discontinue costs. There is no evidence to support this allegation of willful failure to discontinue the types of costs sought by DCCS. Respondent also alleges that the magnitude of the costs claimed by DCCS is out of proportion to those incurred by subcontractor in responding to the audit of its indirect costs through 2011. However, respondent’s allegation focuses on DCCS’s response to the audit, and does not take into account the alleged costs for migration and storage of information after termination. Allegations as to magnitude of costs do not defeat entitlement to such costs, but only raise questions as to quantum
There will still need to be a trial to decide quantum, unless the parties are able to reach a settlement beforehand.
In the first part of this 2-part series, we related two lessons that Stephen Avery took away from this decision. We would like to add our takeaways, as well.
First, as we’ve written before, we believe that once a contractor (or subcontractor) has submitted a proposal to establish its final billing rates, then the government has a duty to audit that proposal in a timely manner. There is nothing in the FAR that establishes what “timely” means in this context, but we believe that the government has a duty to move with reasonable dispatch. In this case, the government had audit reports from DCAA for 4 years’ worth of incurred cost, but failed to do anything with those reports. That smells like negligence and a potential contract breach to us.
Second, we think GHI took an incorrect position, in that it assumed it could not finalize contract costs without a set of government-approved final billing rates. As we’ve written before, the government is not a party to negotiations between a prime and its subcontractors; the government’s determination of provisional and/or final billing rates is not dispositive with respect to those negotiations. What that means is that GHI could have always entered into negotiations with DCCS and established final billing rates with respect to the subcontract and with respect to the termination settlement proposal. The government audit of DCCS’ proposed final billing rates was irrelevant to the two parties’ discussions.
Yes, the prime contractor is taking some risk. It is taking the risk that the final billing rates it negotiates with the subcontractor may include costs found to be unallowable by the official government audit, whenever it is performed. But that risk can be mitigated. It can be mitigated through representations and it can be mitigated through indemnification.
More importantly, consider that—in this case if in no other—an early finalization of indirect cost rates and an early negotiation of the termination settlement proposal and an early close-out of the DCCS subcontract would have avoided nearly $1 million worth of costs. Not to mention it would have avoided a protracted dispute involving several sets of very expensive attorneys—costs that are very likely to be unallowable.
Taken as a whole, we think the correct answer is obvious and we hope our readers do better than GHI with respect to the issue of subcontractor rate finalization and close-out.
Finally, the third point is less black-and-white and more of an opinion based on many years of doing this work. A contractor (or subcontractor) has a choice regarding its cost accounting practices. Just because a cost can be allocated to a final cost objective as a direct cost doesn’t mean that it has to be treated as a direct cost. With respect to this particular case, DCCS could have chosen to treat audit support and contract close-out tasks as indirect activities, which means that they would be absorbed into overhead and not charged as direct costs to the subcontract.
When you charge audit support and contract close-out tasks as direct costs, you create several problems. First, you have to propose those costs and get them priced and funded. Second, you have to have funds left over after performance to cover those tasks. Finally, you create a never-ending cycle, because each year of audit support creates more direct costs that have to be billed and supported through audit. You never ever finish charging direct costs, unless you charge them as non-billable, which means margin erosion. Far better—in our mind at least—to stop the direct charges as soon as possible so that the final contract costs can be determined. Thus, we are strongly biased towards treating those tasks as indirect activities.
Assuming that DCCS had more than one cost-type contract and thus submitted an annual final billing rate proposal and support the audit of that proposal regardless of whether its GHI subcontract was active, then that approach would have gone a long way towards proactively solving the problems that ultimately led to the litigation in which it found itself—litigation that is apparently still ongoing. Obviously if the only cost-type contract DCCS had was its subcontract with GHI, then that logic really doesn’t work. But for many of our readers, that logic will work and it makes good sense to us to move in that direction.
So, to wrap up this 3,200 word deep-dive into one CBCA case, let’s recap the takeaways.
From Stephen Avery we should remember that, while cooperation with government auditors is of paramount importance, a contractor does not have to bend over backwards in order to support an audit. The contractual responsibility is to provide accounting records and other supporting information to the auditor(s) as requested; but there is no contractual responsibility to make copies of those records or to provide them in electronic format.
From Apogee Consulting, Inc., we hope you will remember that the contractor (or subcontractor) should make every effort to push the government into performing an audit of the annual final billing rate proposal, and should call-out unreasonable delays in performing those audits or in negotiating final billing rates once those audits have been completed.
In addition, we hope you will remember that the prime contractor (or higher tier subcontractor) is responsible for negotiating final billing rates with respect to its subcontracts, and the government is not a party to those negotiations. As a prime, you can—and you should—establish final billing rates for your cost-type subcontracts as quickly as possible, so as to avoid unnecessary costs. As a subcontractor, you should proactively push your prime to come to the negotiating table.
Finally, think about how you treat the activities such as preparation and audit support of the annual final billing rate proposal, and contract close-out. Consider whether it makes more sense to treat them as indirect activities. If it makes sense to do so, document that decision and follow it consistently.
DOE Establishes Process for Contract Audits Through Private Sector
 We’ve been watching this coming for some time and now here we are. The Department of Energy has established an official process for contracting officers of non-M&O contracts to use “an alternative to Defense Contract Audit Agency (DCAA) audit support.”
DOE Policy Flash 2016-37, dated July 28, 2016, revised DOE Acquisition Guide Chapter 42.101 (“Audit Requirements for Non-Management and Operating Contracts”) to advise DOE contracting officers that there is an alternative to using DCAA. As the revised Chapter notes alternative approaches are necessary because, “DCAA’s services are not always readily available in a timely manner for audits of final indirect cost rate proposals (sometimes referred to as incurred cost proposals).”
Yep. DCAA’s audit services are not always readily available. Some might even say that DCAA is prohibited for performing audit services on behalf of DOE. Prohibited by Public Law. DCAA would like to believe that it will once again be permitted to perform audit services on behalf of non-DOD agencies, and perhaps it will—but not today. Today those non-DOD agencies that had come to rely on DCAA auditors have to make do without them. DOE is one of those affected agencies and they are signaling clearly that they are moving forward—at least in the near-term—without DCAA. This DOE Policy Flash makes it official.
What is the alternative to using DCAA? It’s the private sector, as we’ve suspected it would be. According to the new policy guidance—
As an alternative to DCAA audit support, DOE/NNSA Contracting Officers may obtain audit services from a private sector provider of audit services. One available option is a Blanket Purchase Agreement (BPA) for audit services that is currently in place with CohnReznick, LLP. Orders for audit support can be placed by any DOE/NNSA Contracting Officer through individual awards issued against BPA DE-MA0011836. Each order placed against the BPA is awarded and administered by the field site Contracting Officer placing the order. For further information regarding placing orders for audit support with CohnReznick, LLP, please contact the BPA Contracting Officer's Representative (COR), Salem Fussell, at
This e-mail address is being protected from spambots. You need JavaScript enabled to view it
.
Thus, DOE is moving on without DCAA. It has at least one private sector CPA firm available to assist its contracting officers with proposal audits, Disclosure Statement reviews, business system reviews, and incurred cost submission audits. This is a watershed moment for those involved in government contract cost accounting and compliance.
Will NASA follow the trail that DOE is blazing? It remains to be seen.
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Delayed Audits Cause Ripple Impacts, Part 1
Respected practitioner Stephen A. Avery, leader of DCAA Compliance (headquartered in New Mexico), recently published an article that focused on a decision by the Civilian Board of Contract Appeals (CBCA). You should follow the link and read his thoughtful article.
Stephen drew two conclusions from the CBCA decision: (1) A contractor under audit has no obligations to make copies of documents for the auditor(s), and (2) A contractor under audit has no obligations to make electronic copies of documents available to the auditor(s), except for certain documents related to electronic billings. Stephen emphasized the obligation to support the audit and to respond to auditors’ reasonable requests, and to make documents available to an auditor. But he also encouraged contractors to “stand up for your rights.”
We read Stephen’s article and wanted to look at that CBCA decision for ourselves. When we looked at it, we saw other lessons we wanted to share with our readers.
But first, the acronyms. You gotta know the acronyms because there are a lot of acronyms in the decision. The prime contractor was Group Health Incorporated (GHI) and its subcontractor was Douglas Consulting and Computer Services (DCCS). GHI had a contract with the Department of Health and Human Services (DHHS), Centers for Medicare & Medicaid Services (CMS). Part of GHI’s contract related to management of Initial Enrollment Questionnaires (IEQs).
Got all that? Let’s check. How well do you understand the following?
DCCS had previously developed IEQs, which were paper documents, in another CMS contract. GHI’s prime contract with DHHS required that DCCS be a subcontractor, in order to handle the IEQs. Thus, pursuant to its prime contract, GHI entered into a subcontract with DCCS on November 1, 1999.
How did you do? Did that make sense? If not, go back and review the acronyms. If you got all that, then let’s rock on.
Now for the facts, which come from the CBCA decision. On May 18, 2011, DHHS partially terminated GHI’s prime contract to eliminate paper-based IEQs. In response, GHI terminated its subcontract with DCCS in its entirely, on May 20, 2011. “On June 8, 2011, DCCS submitted to GHI a termination settlement proposal in the amount of $1,608,278. GHI provided a copy of DCCS’s proposal to CMS on June 13, 2011, and requested a meeting with CMS and DCCS to resolve the open cost issues.”
What were the “open cost issues” to be discussed? According to the decision, the open cost issues were related to audits that had been performed in 2011 by the Defense Contract Audit Agency (DCAA). DCAA had performed Incurred Cost audits on DCCS for the years 2003 through 2007. Although the audit had been performed, the indirect cost rates for those years had not yet been “finalized”—that is to say, CMS had not yet issued a determination as to whether the final rates would be the rates that DCCS had submitted, the rates that DCAA had recommended, or somewhere in between. Without those final rates (which FAR 52.216-7 calls “final billing rates”) DCCS couldn’t close out its contracts. More to the point, without those final rates, DCCS and GHI could not reach agreement on DCCS’ proposed termination settlement costs.
Let’s note here that the lack of final billing rates was identified by GHI as an issue impeding timely negotiation and resolution of DCCS’ termination settlement proposal within one week of its receipt. Despite early identification, apparently there was never any discussion of the open cost issues. Instead, DHHS/CMS then started to audit DCCS’ incurred costs for the years 2008 through 2010. Granted, those years needed to be audited, but there was no apparent nexus between finalizing rates for FYs 2003 through 2007 and the completion of audits for other years. Each year needs to stand on its own (absent a dispute) and the decision to audit later years instead of using the existing audit reports to finalize the earlier years is … puzzling.
Another puzzle is why didn’t DCAA continue to perform the audits on DCCS’ claimed costs? Why did DHHS/CMS suddenly decide, in 2011, that it should perform contract audits with its own resources? The decision didn’t say.
The DHHS/CMS audit approach was somewhat puzzling, as well. As noted in the decision, “At CMS’s request, DCCS on September 9, 2011, submitted its incurred cost proposals for 2003 through 2010 to the CMS auditors, even though the incurred cost proposals for 2003 through 2007 had already been audited by DCAA.” (Emphasis added.) We are unable to conceive of any reason to expand audit scope to encompass previously audited years, unless the reason is that DHHS/CMS was simply rejecting the DCAA audit findings for some unstated reason. Or, perhaps, DCAA did the type of "audit" that it's now doing for "low-risk" contractors--which is to say, no audit at all. It's possible DHHS/CMS had to "reperform" DCAA's audits because DCAA didn't actually do any audits. (Obviously we don't know the actual reason.)
Anyway, the expanded audit continued for some period of time; the parties differed as to when it actually started, but seemed to agree that that audit ended in October 2013. (We suspect the differences in start dates relate to the performance of risk assessment activities versus audit procedures. To a contractor being audited, an auditor Request for Information is a Request for Information, regardless of the auditor’s purpose in asking. And, as we’ve noted before, the line between risk assessment and performance of audit procedures is really rather blurry.)
Interestingly, even though DHHS/CMS spent years auditing DCCS’ claimed costs, the one thing it didn’t audit was DCCS’ proposed termination settlement costs. The proposal was not within scope, apparently.
Meanwhile, DCCS kept a small staff on hand to support the DHHS/CMS audits and to support final contract close-out. On May 7, 2012 (nearly a year after termination) the following communication was noted by the CBCA—
… in response to an inquiry from the CMS contracting officer, GHI stated that while ‘all DCCS operational work under the contract has been completed, DCCS was continuing to incur costs to support final closeout.’ GHI’s email message further stated: ‘We are awaiting CMS’s determination as to whether these costs are allowable. Therefore, the termination settlement costs have not been fully paid. In addition, the costs for 2003-2007 have not been finalized and the costs from FY 2008 on are still awaiting audit and settlement.’
On May 11, 2012, GHI “requested the contracting officer extend the one-year period for submission of GHI’s final termination settlement proposal until completion of the audit of DCCS’s indirect cost rates for 2008 through 2011.” In other words, GHI believed it couldn’t submit its own termination settlement proposal (which would be for a partial termination for convenience from its point of view) until it could negotiate a final settlement with DCCS; and it couldn’t negotiate a final settlement with DCCS until DHHS/CMS finished the ICS audits and finalized DCCS’ rates.
Was that a valid position? The CMS contracting officer didn’t think so. He wrote to GHI –
I have been advised that the final settlement of termination and the audits are two separate items. We do not have privity of contract with DCCS other than to audit and settle their rates. … I cannot provide you an estimate when the audits will be complete. After the audits are complete then we have to settle the results of the audits.
GHI interpreted the CMS contracting officer’s response as expressing an intention to disallow any continuing DCCS costs. Among other things, GHI requested from DCCS “an explanation for DCCS’s position that the costs incurred since cessation of work under the subcontract are allowable, as well as an explanation why those costs are reasonable.”
Perhaps the GHI interpretation was correct, because the CMS contracting officer subsequently notified GHI that “costs submitted on behalf of DCCS associated with maintaining staff after the termination for the purpose of [supporting] the DHHS indirect rate audits would be deemed unreasonable and unallowable.”
Meanwhile DCCS was submitting interim payment requests (as one does when terminated for convenience) and most of those were getting paid. However, two payment requests were denied reimbursement. To be clear: CMS wasn’t going to reimburse GHI for two payment requests and therefore GHI told DCCS that it wasn’t going to pay DCCS.
Long story short: GHI submitted a sponsored claim in the amount of $815,128 and the CMS contracting officer denied it. GHI and DCCS appealed the denial to the CBCA. It was a this point that the CMS contracting officer “unilaterally” established final billing rates for DCCS for the years 2003 through 2007. The CBCA decision didn’t discuss whether or not that was a valid determination and, apparently, DCCS was not disputing that unilateral determination. In any case, that still wasn’t sufficient to move the termination settlement forward, because final rates were still lacking for 2008 through 2012, and there was still a dispute regarding the propriety of who needed to pay for the delayed audit support.
Before the CBCA were cross-motions for summary judgment. We’ll discuss the parties’ arguments and resolution of the issues in the next article.
Effective Subcontractor Management Built on Relationships
 The relationship between a prime contractor and a subcontractor (or between a higher-tier subcontractor and its own subcontractors) is the key to effective program management. Most people know this and many preach it – but in our experience very few practice it.
We discuss program management a lot on this blog. For all the CAS and FAR and DFARS stuff we post, and for all the DCMA/DCAA audit stuff we post, we keep coming back to program management. Why? Because if the programs aren’t effectively managed then everything else is reduced in importance. Program schedule slips and cost overruns put the squeeze on company cash flow and profits. Program problems divert management’s attention from other matters. Program problems today often mean fewer programs tomorrow (thanks to CPARS reports). Therefore, effective program management is the bedrock of the company, both today and tomorrow.
And the bedrock of effective program management is effective subcontractor management.
This is especially true at the larger contractors, those that bill themselves as “system integrators” where 70% or more of program costs are incurred outside the contractor’s premises, by various subcontractors located in disparate geographical areas. These large companies have come to realize – too slowly, in the case of a few – that traditional subcontractor quality assurance and surveillance techniques are insufficient to manage the program risks in today’s environment. What worked in the 60’s and 70’s will not work in the second decade of the 21st century. New techniques are required to effectively manage a global supply chain; which is why Boeing had to significantly revamp how it was managing its 787 program suppliers.
So it’s funny, then, that Boeing has recently been in the news for screwing-over its suppliers. It’s funny (or ironic, if you will) that the company that had to figure out how to better manage its supply chain in order to get the 787 program back on track is the same company that is now (reportedly) working hard to piss-off those same suppliers. Yeah, a pissed-off supplier is not going to be your best supplier. Relationships matter.
We once heard the story about a helicopter manufacturer in Connecticut who had a very successful defense program. After 9/11 that program was deemed critical to kinetic operations in Southwest Asia. The customer wanted more product; it needed more flight capacity. The contractor, who was already working three shifts per day, seven days per week, couldn’t make any more product, and it would take 2 to 3 years to bring another factory online in order to increase capacity. What could they do?
Well, after consultations with the customer, the contractor decided to enter into a co-production deal with a smaller contractor up the street (metaphorically speaking). That smaller contractor had a factory and staff and engineers, and could be up and running in a matter of months. It was a win/win! The Presidents of two contractors met to hammer out an agreement-in-principle, shook hands, and then turned it over to the contracts folks to work up a contract that both parties would execute.
What happened after that is the moral of this little vignette. The Contracts folks from the big contractor decided to earn their salaries by screwing-over the little contractor. They negotiated hard and they negotiated from a position of strength, and they got concessions. After all was said and done, the FFP subcontract between the two contractors was priced so that the smaller contractor made very little profit. Obviously, all the new work reduced indirect cost rates and kept people employed and that was a tangible benefit, but the price was so low that any unexpected bump in the ramp-up of the new factory was going to cause cost problems (not to mention schedule slips).
So what did the smaller contractor do in response to the cost pressures imposed by the subcontract? It assigned its most junior personnel (i.e., the lowest-cost) to the project. It abided by the letter of the contract: no more. It took no risks and added no value and simply performed as directed.
What do you think happened?
Yep. The ramp-up of the new factory didn’t go well. There were delays. There were quality problems. And the smaller contractor didn’t worry too much about those problems, because it had contractual coverage. If the bigger contractor wanted something different --- well, that was a change order, wasn’t it? And change orders require proposals to identify cost and price impacts. And those proposals require fact-finding and negotiation. And those tasks took time and they took resources away from what actually mattered, which was getting the new factory up and running so that products could be shipped to the warfighters who desperately needed them.
Remember, the products being built were for flight. They carried people from Place A to Place B. They needed to work and work well and be safe. Quality escapes were not good. The government customer made its displeasure with the situation known via Corrective Action Requests (CARs). Including at least one Level 3 CAR.
Level 3 CARs are not good. At least one of them was leaked and was reported widely. That didn’t reflect well on management at either of the contractors.
So the moral of this little vignette is that prime contractors (and higher tier) subcontractors need to establish effective working relationships that supersede the contractual language under which they are working. If you damage those working relationships, if you screw-over your subcontractor, you are running the very real risk that your subcontractor is going to find a way to screw you right back. In this case, the smaller contractor screwed-over its bigger prime by following the letter of the subcontract instead of the spirit, by assigning qualified (but very junior) personnel to the program in order to live within tight price ceilings, and by sitting back and watching the trainwreck happen.
By the way, it was the new President of the bigger contractor that told us this story. The old President and several of his management team had “moved on” as part of the company’s corrective action plan implemented in response to that Level 3 CAR.
Relationships matter.
In contrast, Dr. Robert Carman told us about his supplier relationships. He told us about holding a competition to award a 5-year requirements contract. Several bids were received but not all approved suppliers bothered to submit bids. Several of the bids seemed lackadaisical but one stood out. And that one bidder received a subcontract award. Dr. Carman’s company agreed to award that one subcontractor its total requirements for that product for a period of five years.
And then Dr. Carman’s company won a major defense acquisition program. Huge. Lots of business for everybody, including suppliers.
And all that work went to the one successful bidder.
The other approved suppliers complained because they were losing significant amounts of business, but their complaints were baseless and they got nothing. Meanwhile that one supplier got record-setting levels of work.
Dr. Carman met with the senior leadership of that company every month for five years. They met and they reviewed status and they discussed issues of mutual concern. And they bonded. Relationships were forged.
Dr. Carman told us how those relationships overcame program challenges. His company needed a new product that involved new production techniques? No problem. The supplier initiated its own IRAD program to develop those new techniques. Those new techniques led to new orders – not only from Dr. Carman’s company, but from other A&D companies as well – because the supplier now had a competitive advantage in the marketplace. Dr. Carman’s company identified quality problems? No problem. The supplier deployed additional high-level resources; it hired consultants (on its own dime). It bent over backwards to help Dr. Carman out, because that’s what friends did for each other.
Contrast those two stories.
Now let’s look at Boeing and how it’s (reportedly) screwing-over some of its suppliers. Here is one link to many reports on the topic.
Apparently the problem started at Rockwell Collins, a publicly traded company. (In which we own a small number of shares of stock.) In its most recent quarterly financials, COL reported good numbers but degraded cash flow. According to Bloomberg: “While Rockwell Collins’s third-quarter profit of $1.63 a share beat estimates, analysts on a conference call focused on its disappointing cash receipts. The $138 million generated in the quarter was short of estimates, and the supplier’s earnings release predicted free cash flow would total about $750 million for 2016, the low end of its previous guided range.” That news didn’t help COL’s stock price (dammit!).
COL’s CEO told analysts “’In general, this is catching the supply chain off guard and it’s inconsistent with our contract.’ … While Boeing notified Rockwell Collins it was slowing supplier payments, ‘they’re delinquent for payments they had for the quarter.’” Bloomberg reports that Boeing is between $30 and $40 million behind in its contractually required payments.
And it’s not just Rockwell Collins. Boeing is also in the process of screwing-over GKN, another supplier. According to the Bloomberg article, “[Boeing] is negotiating a prolonged payment schedule with … GKN for parts including winglets, cabin windows and ice protection systems supplied across Boeing’s commercial fleet. Those changes have ‘already had an impact’ on working capital, GKN Chief Financial Officer Adam Walker said Tuesday ….”
For its part, Boeing admitted that it is in the process of changing its payment terms for large suppliers “to support [its] competitive position.” The Bloomberg article stated “Reuters reported earlier this month that Boeing was shifting supplier payments from 30 days to as many as 120 days.”
It’s a good thing this change of payment terms and alleged violations of subcontract agreements seems to be limited to Boeing’s commercial aircraft business. As we all know, if Boeing tried to do the same thing to its defense suppliers it would run afoul of certain FAR and DFARS requirements, and DCAA might find that it had a significant deficiency in its accounting system – which would lead to mandatory payment withholds. There are no such consequences on the commercial side of the house.
Unless, of course, you think about the two vignettes we related in this blog article. If you do think about them, you may realize that not all consequences are obvious. Some are stealthy and do long-term damage to the prime contractor (or higher-tier subcontractor) that maximizes its own results on the backs of its suppliers. Relationships matter, and decisions can damage relationships.
Maybe Boeing needs to relearn this lesson?
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Ten years later, the piper is being paid. Liabilities created in 2006, which DOD refused to budget for at that time and, indeed, through most of the past ten years, are now coming due. We are talking about the cost impacts associated with contractors’ defined benefit pension plans.
