Impact of "Negative" Reviews

Last Friday's news illustrates the importance of good internal control systems and strong ethical values.

Last Thursday, AeroViromment, a predominantly Government contractor in Southern California, disclosed in its 10-K filing with the SEC that it had been under investigation by the Department of Justice over its billing practices since February. Friday morning, its share prices immediately took a 10 percent hit and caused the company to expend considerable resources to prepare statements, press releases, and answer questions from reporters, stock analysts, and others. Its amazing that one tiny footnote can cause so much chaos and have such a financial impact.

The statement implies that AeroVironment was somewhat in the dark themselves over what might have triggered the DOJ investigation. It states that the investiagtion "may" have resulted from DCAA audit activity but they were not certain. 

“We are currently cooperating with this investigation, which we believe may be the result of prior DCAA [Defense Contract Audit Agency] audit activity. An unfavorable outcome to such an audit or investigation by the DCAA, DOJ or other government agency, could materially adversely affect our competitive position, affect our ability to obtain the maximum price for our products and services, and result in a substantial reduction of our revenue.”

AeroVironment must have spent most of Friday in damage control. In one of its clarifying statements, it stated that the investigation focuses on three areas:

• The appropriateness of certain expenses included in the company’s fiscal year 2006 Incurred Indirect Cost Claim (reconciliation of projected rates to actual rates.)
• Billing labor rates associated with time and materials government contracts.
• Billing rates for Small Unmanned Aircraft Systems maintenance and repair contracts.

Trying to downplay the 10-K disclosure, the company also stated that it does not believe the probe will have a material impact on its business, and so far has not had an impact on the company’s ability to receive government contracts. AeroVironment said it believes most of the issues have been previously addressed in the DCAA audit processes, and that time and materials government contracts have accounted for less than 1% of the company’s revenue over the last 6 years. The company said it is cooperating with the investigation, and that no claim has been filed against AeroVironment to date.

We have no insight beyond what has been reported. However, in our experience, there is more to this than what AeroVironment wishes. If the "audit issues" were previously addressed, there would be no need for a DOJ investigation. Additionally, while any auditor can report a SIC (Suspected Irregular Conduct), most of them are administratively closed because there is no merit to the allegation or the impact is so insignificant as to not warrent further investigation. Therefore, in the rare case that DOJ intervenes in the case, there is probably some fire with that smoke. We haven't heard the end of this story.