Milton Field Systems Preview

MILTON FIELD SYSTEMS, INC.
PART A

INTRODUCTION

Associated Defense Systems, Inc. (ADS), a major U.S. defense and aerospace company, is in the initial phases of acquiring Milton Field Systems, Inc. (MFS). MFS is a defense electronics and services firm, which is a wholly-owned subsidiary of Josephson Technologies Company. MFS is being divested because it does not fit into Josephson's core focus, being its only non-commercial subsidiary.

ADS is conducting a due diligence review in preparation for a formal offer for MFS. This review will be presented to the ADS Board of Directors. ADS has hired your management consulting firm to supplement the in-house due diligence team (under normal non-disclosure and insider trading provisions). Your firm has been directed to focus on corporate culture and ethics at MFS. ADS wants to assess any issues in integrating MFS into the ADS corporate culture. You will conduct interviews with key senior staff members of MFS as well as review their organizational reporting relationships, internal hotline data, employee survey data, and public sources. Your report will identify risks and strengths in the areas of culture and ethics, and will include recommendations on how to integrate MFS culturally into ADS. Your firm is not responsible for structuring any part of the final closing documents.

BACKGROUND

MFS is a mid-tier company in the defense arena, which has had ambitions to compete with the larger firms in the field (e.g., Lockheed, Raytheon, Boeing, etc.). MFS made major advances toward this goal by acquiring businesses in the armored vehicle arena (which includes personal armor). Through this strategy, MFS' revenues grew from $11 billion eight years ago to nearly $20 billion three years ago. However, the growth from the armored vehicle business was not sustainable due to government budget reductions and strategic defense policy shifts. Growth in its other core business areas has not been able to offset the revenue decline in the armored vehicle arena. Revenues in the most current completed year dropped to $14 billion. Profit margins (before interest and taxes) have dropped from 12% to 9.7% over the last three years. Employment over the last five years was 37,000 in 2011; 40,000 in 2012; 36,000 in 2013; 30,000 in 2014; and 27,000 in 2015. It continues to hold steady at the last number. MFS has increased its focus on foreign military sales in an attempt to offset the lost revenue. MFS' major competencies, other than in the armored vehicle arena, are in defense electronic systems and intelligence analysis support. These latter two niche competencies make it an attractive acquisition target.

Three years earlier, Bill Stone was promoted from within to Chief Executive Officer (CEO) of MFS. He had joined MFS seven years ago from a larger competitor and led the armored vehicle business. As CEO, Bill rapidly replaced much of the senior staff. His first initiative after becoming CEO was implementing an aggressive shared services strategy. This strategy centralized transaction-oriented and "back room" functions, such as accounts payable, payroll, information technology (IT), procurement, recruiting, training, benefits administration, etc. Service centers were created under functional control by the senior HQ staff, with operations directed by a general manager. Bill has made very public statements about the importance of employee communication and succeeding "the right way" — ethically and in compliance with the law.

Organization Chart
The organization chart for MFS is included as Attachment 1.

Message to Employees from Bill Stone on Becoming CEO
"I am proud to lead Milton Field Systems. Our commitment to quality and supporting our men and women in uniform is well known. Don't lose focus on that. I want to add two values that are important to me. First, we will succeed, but we will succeed the right way. We will comply with the law. We will treat each other with respect. My door is open if you have any concerns. Second, we will be decisive. I don't believe that consensus produces the best decisions. I want your input, but once a decision is made, I expect we will all drop the discussion and execute. You are a great team and I am proud to become your leader."

EXCERPTS FROM INTERVIEWS

Carter Williams, Senior Vice President, Human Resources
"Hello, I'm Stacy Adams, Mr. Williams' Executive Assistant. I'll show you to his office. Did you check in with Security? Sorry to ask, but I'm new and I'm still getting acquainted with the procedures. Mr. Williams' previous executive assistant was let go last month and I'm still finding my way around. Mr. Williams has been very patient!"

Carter Williams: "The culture within the company has definitely changed for the better since Bill Stone became CEO. I've worked with Bill before and he made it clear early on that decisiveness was the order of the day. We want to be nimble in reacting to business issues. That attitude has been adopted by his staff as well. The current staff is in line with Bill's strategy. Some of the carryover folks from the old regime kept raising objections, so Bill replaced them with folks who supported him. You must have a united front to handle business in difficult times.

"Internal communications is an important part of setting the culture. Our employee communications program has won awards in the industry. How do we decide what gets communicated? There is a very careful vetting process to make sure we say exactly and only what we want to communicate. The vetting process always includes Bill's senior staff and Bill often makes the final decision himself. You need to communicate, but you have to be smart about it. We try to keep our messaging to the employees positive. That's important in view of the layoffs we have had the last two years. The decline in the armored vehicle division and other key program losses had a direct effect on our staffing levels."

Alice Rankin, Senior Vice President, General Counsel
"I'm Ms. Rankin's Paralegal, Ron Casey. I'll escort you to the conference room. It's really busy around here with the possible sale of the company. Plus, I'm trying to get all the outside counsel bills paid before the end of the month. Ms. Rankin got a nice discount on the legal fees from her old firm based on paying sooner than our normal net 45 days. And believe me, that firm gets the lion's share of our outside counsel business, so it's a big savings. Here's the conference room. Ms. Rankin will be with you in just a moment."

Alice Rankin: "You need to understand that the Josephson corporate office really doesn't understand the government contracting regulatory requirements, so they leave it to us. Besides legal matters, I'm also responsible for our ethics and compliance program. We had a chief ethics and compliance officer (CECO) who reported directly to our CEO. I joined MFS when Bill Stone took over as CEO. One of the first things we looked at was our organizational structure. We needed to reduce our costs to allow for other, higher priority functions to be expanded. It made sense to put the ethics and compliance responsibility under Legal and do away with a separate CECO. Legal was always consulted anyway on regulatory compliance matters or situations where there might be company liability. We could ensure that sensitive information was protected under the attorney-client privilege or attorney work product doctrine. The CECO was always pressing for disclosure of possible violations to regulatory authorities. And, she always pushed for providing more information to employees about how complaints to the hotline were resolved. ‘Just sanitize the cases,' she said — remove details that identify individuals. What's wrong with doing that? Employee privacy — no matter how you sanitize the case results, someone might be able to figure out who and what you are talking about. For example, we received a complaint from Carter Williams' executive assistant last year alleging abusive conduct by Carter and one of his direct reports. We couldn't substantiate it. Turns out Carter wasn't happy with her performance and was going to write her up in her next performance evaluation. We suspect it was a preventative complaint — a complaint filed in advance of being let go, so she could then claim retaliation. Now, how could we ‘sanitize' that case? In any case, the less the employees know about ‘how the sausage is made', the better. We do provide a summary report of complaints and hotline activity to Bill's senior staff. I'll get you a copy of the year-end chart for 2015.

"How do we handle our foreign business compliance? The objective, of course, is preventing bribery of foreign officials — complying with the Foreign Corrupt Practices Act (FCPA). The big risk is the actions of your third party agents — independent consultants in the foreign country who provide assistance in obtaining business within that country. The attorneys in our divisions are responsible for vetting these agents. I know ADS uses a central vetting group of specialists, but what we do is far more cost-effective and puts the vetting close to the business. The division attorneys understand the environment and can react quicker. We check the proposed agent against standard information sources for reports that might raise a red flag. Then we conduct a personal interview — usually over the phone — with the proposed agent. The division attorney sends the recommendation to my deputy general counsel who gives the final approval to sign an agreement with the agent. There have been a lot of agents processed over the last two years since we are expanding our overseas business. Some of our division management folks just don't understand why we have to do this, but we get the vetting done quickly. Our process works. We have no FCPA violations to worry about."

Bart Dennis, Vice President, Finance
"I'm Sharon Henry, Mr. Dennis' assistant. I'll show you to his office for your meeting. Bart is a nice man, you'll like him. He's one of the few left over from the old regime. Mr. Stone brought in a lot of new faces. Carter Williams, Elliot Matthews, Margaret Howe, and Steven Crowe all worked with Mr. Stone at his previous company. It's nice for him to have familiar faces, but I'm glad he kept Bart on board."

Bart Dennis: "From your interview request, I understand you want to cover the effect of the budget on our business structure. The shared service approach did increase HQ costs, but that increase was to be offset by accompanying cost reductions in the divisions. It's hard to disagree with the theory. Services will now be provided more economically from the service centers. After recovery of start-up costs, we assumed a positive payback within two years. Some of my budget analysts were skeptical of the estimated payback after the two year absorption of start-up costs. It all depends on what assumptions you make. Bill Stone made it clear he wanted this project to go forward and his direct reports lined up in support. I put my budget analysts' concerns on the table, but it was clear which way Bill and his key advisors wanted to go. I decided not to push the issue! So, we made the business case work. Bill also wanted to beef up some areas — Government Relations, Communications, and Marketing — so we had to reduce costs in some other functions. For example, we eliminated the CECO position and staff and put the function under Legal. We also reduced the Internal Audit staff and the scope of planned audits.

"The senior staff supports all of Bill's innovations — for example, the addition of a second company jet. It enables the staff to travel with fewer schedule constraints. Bill was happy when I figured out how to justify that in the HQ budget. (Laughing) Now all I have to do is figure out a way to fit Bill's senior staff holiday party in the budget!"

Nate Jacobs, Director of Internal Audit
Nate Jacobs: "Sorry I kept you waiting. Most of my staff is on the road right now. Let's go to a conference room and we can talk. I've been in this position for nearly three years and I'll be rotating out of it in the next six months. Bill Stone uses this job as a rotational development position. I'm ready for a new assignment. It's been great to see the business from this perspective, but it's a stressful job. I balance being a member of the team and also being the independent watchdog — it isn't easy! Bill listens, but at the end of the day, you had better be ‘on message' with him. Yes, my staff has been reduced quite a bit since I took over. Budget cuts reduced my audit staff from eight to five, and reduced my budget for using subject matter experts from the divisions to assist in specialized audits. So, our audit program had to be reduced as well. We had to drop planned audits of our export and FCPA compliance programs, as well as external professional services procurement. We maintained our financial ‘health check' reviews, of course. We have to be ahead of the game to ensure compliance. Bart Dennis doesn't want any surprises when our external audit firm does their year-end review.

"Areas of concern? I'd like to see tighter controls on retention of professional services. Human Resources, Government Relations, and Legal spend extensively for outside services. Because those are such specialized areas, Procurement doesn't really get as involved. We did audit the procurement process on other HQ expenditures and the process seems sound. We spend a lot of money on unusual items such as the two company jets, the private security staff for Bill, and the security systems that were installed at his home. We want to make sure that we follow a process that is free from improper influence and maximizes value. The audit report validated that."

EXCERPTS FROM EMPLOYEE SURVEY REPORT

Employee survey charts are included as Attachments 2 through 7. MFS data is from the 2015 employee survey conducted by the Ethics Research Center (ERC). ADS data is from the 2014 employee survey conducted by ERC. NBES data is from 2013 National Business Ethics Survey conducted by ERC.

MFS HOTLINE ACTIVITY SUMMARY FOR CEO AND SENIOR STAFF

The Hotline Activity Summary chart is included as Attachment 8.

EXCERPT FROM PUBLIC SOURCE (INDEPENDENT ONLINE BULLETIN BOARD FOR DEFENSE COMPANY EMPLOYEES)

Advocate1218: The big shots at MFS cut corners and they look the other way and party. Bill Stone rents out the local modern art museum, claims it's a donation, and they serve Dom Perignon to the senior staff. The only one of Stone's staff that showed up to the party the next week for the HQ peasants was the HR guy. He stayed about 30 minutes and bolted after pressing the flesh and telling a few jokes.

richie: The holiday party smells, but there are even bigger issues you're talking about.

Advocate1218: Yea, what I heard was that the International Marketing VP bypassed the vetting process — such as it is — to hire an agent in South America to help land a big sale. This agent was "well connected." Punish a VP? Hah! The GC covered for him and papered the file with an after-the-fact approval.

Marko: Hey, that's not such a big deal, they all do it. Worry about the day-to-day stuff in the office. My girlfriend works there and she says they really dump on the lower level folks. If you don't have a director's title, they treat you like a servant. The senior folks play nice when there's an outsider around or a lot of people in a meeting. Apart from that, you can really get chewed out and cussed at for almost anything. They forget to tell you to set up a meeting? All of sudden it's your fault and they're screaming. That sort of thing. They talk about "open door" policies and wanting input, but you're better off keeping your head down and just agreeing with them — or you wind up gone.

richie: Why don't you just call their hotline? They shouldn't be allowed to get away with this stuff! Here at ADS, we call the hotline and the ethics officer gets involved.

Advocate1218: That's a joke, right? They got rid of our CECO three years ago. Calls go to Legal now and drop into a black hole. Takes forever to get a response and then it's "We can't substantiate the allegation" and a lot of weasel words to cover their behind. Why bother?

Marko: My girlfriend says just agree with Bill Stone and you'll get along fine. Even if he's wrong.

This case was written for the Daniels Fund by Charles Chadwick, Senior Advisor, Ethics Research Center (ERC), the research arm of the Ethics & Compliance Initiative (ECI).

© Daniels Fund 2016. All rights reserved.