DoD Civilian Furloughs Have Begun

Starting this week, about 650 thousand Defense Department civilians are taking their furlough days. At one time, DoD projected that its employees would have to take 22 furlough days. Now, its down to 11 days; one day a week for the next eleven weeks. DoD estimates that this will save almost $2 billion between now and the end of the fiscal year (September 30th).

There are a lot of stories, articles and blogs warning of dire consequences resulting from these furloughs. With respect to Government procurement, companies might see delays in contract negotiations and contract awards. Contractors might get slower responses (it that's possible) from their contract administrators (DCMA). The auditors will still prioritize demand work (e.g. proposal evaluations) and that means that they'll slip that much further behind in beating down their incurred cost audit backlog. Billings should not be significantly affected because of the prompt payment act but you might see payments pushed back closer to the 30 day maximum instead of the customary 15 or 20 days.

We think that the impact on performance will be much greater than the eleven furlough days. We've gone through these before. The memos, staff meetings, and water cooler discussions that precede furlough days eat into productive time. Feeling overworked yet very under-appreciated wears on ones psyche. You don't really want to start something when you come back from a furlough day because you know the next one is coming up.

Last month, DoD issued a memo warning against "borrowing" military manpower to perform civilian duties. The memo also warned against using contractors to fill civilian roles.

Unless Congress acts to remove the sequestration, future years will be similarly impacted. Already DoD is warning Congress of the impact on the fiscal year 2014 budget. Additional furlough days in fiscal year 2014 is already being touted as a way of dealing with sequestration-based shortfalls.

Contractors to Share DoD Furlough Burdens

Yesterday, when testifying before the Defense Subcommittee of the Senate Appropriations Committee, Secretary of Defense Chuck Hagel told Senators that DoD contractors will share the burden of spending cuts, including the furloughs facing the Department's civilian workforce.

The DoD Comptroller, Robert Hale who testified at the same hearing told the Senators that the 700 thousand defense contractors who work throughout the Department "...are in for some changes".

The Department of Defense is taking a $37 billion sequestration spending cut this fiscal year. While about $2 billion is coming out of furloughs for civilian workers, the majority of that cut will be coming out of contracts. That means a "sharp drop" in the number of contracts in the department.

The hearing also touched on the high cost of contract employees in general. One Senator cited a recent study that concluded contractors, on average, were twice as expensive as civilian employees. Contractor employees make up 22 percent of DoD's workforce but represent 50 percent of its personnel related costs. Evidence of a problem in this area comes from Edward Snowden's (the NSA employee who leaked classified information) revelations that was making $200 thousand per year, living in Hawaii, while performing relatively little work (his employer said he was making $122 thousand, not $200 thousand).

Government contractors, and Defense contractors in particular, have already been feeling the effects of sequestration because a lot of contracting actions are suspended or cancelled. We've had contractors tell us about specific cases where solicitations have been cancelled because of sequestration. If the Secretary's testimony comes to fruition, the impact will be felt even more directly as existing contracts are terminated in whole or in part due to funding limits.

Sequestration Impact

Based on our informal survey of a number of Government contractors, there has been no specific contracting officer guidance yet on what to expect or plan for concerning the sequestration. Everyone is just cautiously waiting. Most companies expect sequestration to have some impact on existing and future workload but at this point, its business as usual.

On Monday, the Department of Energy (DOE) sent out a letter to its contractors (blaming Congress for the sequestration) advising them of some of the potential impacts they could feel as a result of the sequestration. This letter reads, in part,

At this time, the Department of Energy is asking every step to mitigate the effects of these cuts. However, the Department may nevertheless need to take certain actions with regard to particular contracts and assistance agreements in order to comply with the required budget cuts.

For procurement contracts, the Department of Energy may decide not to exercise an option or may need to negotiate lower prices or other terms via a bilateral modification to meet the constraints imposed by sequestration. The Department may also determine it necessary to stop or suspend work, reduce the scope of work, or partially or completely terminate your contract for convenience. Additionally, planned contract actions for new work may be re-scoped, delayed, or canceled depending on the nature of the work and the degree to which it directly supports the agency's mission goals.

For financial assistance agreements, the Department may decide not to issue a continuation award - including not awarding incremental funds on multi-year awards - and may require negotiation of a reduction in the scope of your award.

To the extent that your contract or financial assistance agreement is affected due to these budget cuts, you will be contracted by the appropriate Contracting Officer with additional details.

Thank you for your continued partnership with the Department of Energy, and for your cooperation as we work together to manage these unfortunate circumstances.

We don't know how DOE and contractors are going to work together to manage the sequestration circumstances. It seems to us that all of the decisions will be DOE's.

Sequestration Impact - Contact Your Contracting Officer

Much has been written and discussed about the looming sequestration potential. March 1st is coming up real soon. The impact, if sequestration occurs, will impact many contractors. Those in the service sector will feel the impact more than others.

DoD issued a couple of notices on its website concerning potential sequestration. One posting addressed to the DoD workforce warned that it would be forced to place the vast majority of its civilian workforce on administrative furlough. The other posting stated that if sequestration occurs, furloughs will begin in late April. We also learned that DOE (Department of Energy) has been engaging its major contractors in discussions regarding the potential impact of sequestration.

While uncertainty abounds, contractors need to contact their contracting officers (CO) and gather as much information as possible on the impact that sequestration will have on their own contracts and programs. While contracting officers might not yet have a lot of information, anything and everything will help in planning for the impact of sequestration.

One contractor who contacted its CO got this mighty brush-off; "we don't know anything, and when we do, we'll pass it along". That kind of response is simply unacceptable. COs might not be too sympathetic right now as they are concerned about their own jobs but they are still on the clock, getting paid, and they should be doing their jobs which includes "administering" their contracts. If COs don't know, they should find out. Plans have been made and are being continuously updated. Contractors should be dogged in their pursuit of information. The sooner contractors have information concerning the impact of possible sequestration, the more time it has to plan and manage that impact.

Forward Pricing Rates

One of the major problems faced by contractors and the Government alike when establishing and negotiating  forward pricing rates (indirect rates used to price future work) is the inability to accurately forecast workload beyond the next year. Many contracts have periods of performance that extends three to five years and contractors must try to forecast what their indirect rates will be out in those years. If the contract is fixed price, failure to accurately estimate rates can lead to significant losses or windfall profit. If the contract is cost-type, failure to accurate estimate indirect rates can lead to funding issues or earlier than desired contract completion.

One certainty in Government contracting is the uncertainty over which programs will continue to receive funding. Will the Government buy 12 aircraft per year, or 20, or 25? That makes a big difference for contractors and their supply chains. Or, what about decisions to in-source work that is being contracted. How does one account for that possibility in their indirect rate build-ups? How about the looming potential of sequestration where, if it happens, significant cuts will be made to existing contracts? Was that information known a year ago? Those questions and concerns makes a big difference to a contractor's estimate of the business base used to allocate indirect costs.

Contractors' inclination is to be conservative in estimating future workload. The risk in missing workload estimates has a huge downside; monetary loss. The Government's inclination is that contractors are deliberately understating future workload in order to increase its indirect rates thereby enhancing corporate profits. The reality is that if the Government could be more accurate and certain and provide more assurance to contractors of its purchasing plans, contractors could provide better estimates of their forward pricing indirect rates and feel more comfortable in doing so.

Tomorrow we will discuss one step that DoD is taking to help contractors and its contracting officers to get a better handle on future DoD workload.

Administration Misses Sequestration Impact Report Deadline

As we reported here on August 13th, the President signed into law the Sequestration Transparency Act of 2012 which required the Executive Branch to provide a report to Congress by September 6th that details the programs, projects, and activities that will be impacted by $110 billion in cuts should there be no agreement on a budget.

September 6th has come and gone and there is no report yet.

Last Friday, the Administration, in its daily briefing, stated that the report would be issued this week. However, that date is not so certain based on this Washington Post editorial.

Companies that have legitimate concerns over how sequestration, if it comes to that, will impact them, will have to continue to wait.

Sequestration Transparency Act of 2012

Over the next few months, we'll be hearing a lot about the possibility of a sequestration that will arbitrarily cut  $110 billion out of next year's spending; half from defense and the other half from all other spending. One of the frustrations for Government contractors is the uncertainty that the cuts might have on their programs. Last week, we wrote about one of those uncertainties with respect to whether provisions of the WARN Act apply. Also last week, the President signaled that the military will be exempt from sequestration cuts (good for the military but that means other spending will get hit harder). Also last week, the President signed a law (the Sequestration Transparency Act of 2012) that requires the Executive Branch to detail by September 6, where the spending cuts would take place. (The bill passed both the Senate and House unanimously meaning that the President more or less had to sign it or face a veto override).

The report to Congress required by the Transparency Act should provide a pretty good idea where cuts are likely to come from, in the event of a sequestration. The Act requires a fair amount of reporting specificity including reductions at the program, project, and activity level. The report must also identify all exempt discretionary accounts and all exempt direct spending accounts.

By September 6th, we should have a pretty good idea of who's ox is going to get gored if there is a sequestration.

Sequestration and the WARN Act

"Sequestration" is one of the hottest political issues in Washington. It is a term for mandatory cuts to federal programs, the process of cordoning off money that may have been authorized by Congress but is now prohibited from being spent. The Government is facing one of the biggest sequestrations of all time - $600 billion out of Defense and another $600 from domestic programs. This sequester came up last year as part of the debt limit law as punishment for not coming up with a plan to cut the deficit.

If sequestration kicks in next January, there will be significant program cancellations and curtailments which could lead to plant closing and/or significant layoffs.

The WARN Act (Worker Adjustment and Retraining Notification Act) applies to employers with 100 or more employees and requires employees be provided with a 60-day advance notice when a plant is to be closed or there is to be a mass layoff.

There has been concern raised as to whether the WARN Act requires Federal contractors, including, and in particular, DoD contractors whose contracts may be terminated or reduced in the event of sequestration on January 2, 2013, to provide WARN Act notices 60 days before that date to their workers employed under Government contracts.

The Department of Labor (DOL) is the Agency responsible for implementing and enforcing the WARN Act. Last week, DOL issued guidance that emphatically stated that Government contractors are not required to provide WARN Act notices 60 days before January 2, 2013, in anticipation of a potential sequestration order that could be issued on that date. The guidance explains that such notices would be inconsistent with the purposes of the WARN Act.

This DOL guidance might be different than you've read elsewhere. Some contractors are considering issuing  WARN Act notices anyway, as a precaution,  Perhaps there is merit to that position. The Northrup Grumman CEO in responding to the DOL guidance stated: "... but I think simply saying you don't have to do it is perhaps not a fully considered position when it comes to recognizing the force of law".

One source reported that DOL " ... is not the sole entity in charge of making this determination." and you need to watch out for DCAA (Defense Contract Audit Agency) who might disallow severance payments, termination costs, and plant closures barring a WARN Act notice. We think that probably overstates DCAA's authority in light of clear guidance from DoD (who posted the DOL guidance on their Policy website).