Force Protection
On Friday, the maker of MRAP armored vehicles announced that thanks to some seriously messed-up internal accounting, it's going to have to (a) restate its earnings results for last year, (b) delay filing its 10-K, and (c) do a yeoman's job to have any chance of getting its numbers straightened out any time before mid-year.
A few days later, after what I can only imagine was a weekend full of shouting and recriminations, the company's CFO and COO both resigned. An outside accountant hired from Huron Consulting
Heavy is the head that wears three crowns
Pity, rather than congratulations, is in order for Mr. Moody, because the more time progresses, the more Force Protection looks like a corporate basket case. Take, for example, its "explanation" of the primary reason why Force must restate its numbers:
The competitive MRAP vehicle program contract awarded to us, subject to the joint venture agreement with General Dynamics Land Systems, Inc. (GDLS), has not been novated from us to Force Dynamics as of December 31, 2007. Therefore, we are responsible for and are required to account for and report all revenues and related costs associated with this contract. However, this accounting has no effect on our overall net income, but our net sales and the cost of sales are grossed up in similar amounts.
Huh?
Yeah, that's the reaction I had the first couple times I read through the statement. But after reading through it a few more times, here's what Force seems to be saying, in plain English:
- In fiscal 2007, Force had a contract to build MRAPs for the U.S. Marine Corps.
- Much of the work was then subcontracted to General Dynamics
(NYSE:GD) . - Because Force's name was on the contract with the USMC, Force "bought" MRAPs from General D, and then sold them to the military "at cost."
- Hence, while Force got the revenue on the contracts, it earned no profit whatsoever on that revenue.
Why?
Why would Force enter into such a deal, one in which it takes on all the administrative headaches of fulfilling the contract, but gets none of the profits? I suspect two factors were at work in Force's thinking. First, an altruistic motive: Force wanted to build as many MRAPs as possible, as quickly as possible, to save the lives of U.S. Marines -- profits be damned. Second, a capitalist motive: Regardless of who earned profit building the MRAPs originally, Force will ultimately profit from servicing the MRAPs in the field once they're built.
Lessons learned
Revelation of the accounting gaffe may explain another strange action on Force's part -- the firm's "substantial expenditures to equip a new facility [in Roxboro, N.C.] to produce our Cheetah vehicle." This, despite the fact that "we have not sold nor do we have any orders for Cheetah vehicles."
While it now appears that the knowledge never made its way onto Force's income statement, management is certainly aware that production constraints cost the company orders, and profits, from the MRAP program. In the upcoming struggle to win contracts to produce the Army's next-generation Humvee, the JLTV (Jolt), Force will again compete with a series of firms with production capacity far exceeding its own -- Oshkosh
My guess is that management fears finding itself once again forced to "give away the store" to a competitor, for lack of capacity, if it manages to win the Jolt competition. Force is spending so much to build the new Cheetah facility to fix this problem before it materializes.
Foolish takeaway
The risk, of course, is that there's no guarantee that Force will win the Jolt competition at all. If it fails, then the firm's current accounting "issues" may well become the least of its problems. The millions of dollars spent building production capacity for a Cheetah that no one wants could be money down the drain.
