FSS Contractor Defrauded USPS, Whistleblower Says

A whistleblower is claiming that his former employer, Northrop Grumman, defrauded the U.S. Postal Service by providing it false information about the Flats Sequencing System.

The ex-employee “alleges that the company violated the False Claims Act in a number of ways with respect to the FSS contract [and] alleges damage to the USPS in an amount of at least approximately $179 million annually,” Northrop Grumman stated in its recent quarterly financial report to the U.S. Securities and Exchange Commission. The ex-employee also “alleges he or she was improperly discharged in retaliation.”

Magazines accidentally ejected from an FSS machine.

Northrop Grumman was the lead contractor for the FSS – 100 football-field-sized machines designed to sort catalogs, magazines, and other flat mail. The company has sued USPS for non-payment, and the Postal Service has counter-sued with a claim that Northrop’s late and substandard work prevented the FSS from realizing its expected cost savings.

So far, the FSS has resulted in higher mail-handling costs that have outweighed the Postal Service’s decreased delivery costs. But postal officials expect productivity to rise early next year when flats mailers will be required to present mail for FSS ZIP codes in a manner that is optimized for FSS.

The Washington Post has identified the whistleblower as Beau Michaud and says his complaint charges that Northrop Grumman and a subcontractor “repeatedly made false certifications about the machines’ speed, reliability and accuracy” and that they “provided the Postal Service with a fraudulent handbook for the machines.” (Update: Michaud's complaint was posted online by Save the Post Office on Nov. 10, 2013.

An FSS machine tore the cover of this mail piece.

A LinkedIn profile indicates Michaud was a technical trainer and engineer for Northrop. Someone identifying himself as Beau Michaud has reportedly been contacting postal experts to get photographs of mail that was damaged by FSS machines.

USPS has made a number of adjustments to its procedures and to the machines themselves to minimize torn covers, “foldovers,” and other damage that resulted in employees nicknaming the billion-dollar investment the "Flats Shredding System."

Northrop “intends vigorously to pursue and defend” both the whistle-blower case and the USPS litigation, its says in the SEC filing.

Related articles:

• Flats Litigation System: USPS and Vendor Battling It Out Over Huge FSS Machines 
• FSS Postage Rates Will Raise Issues for Cataloguers, Publications, Printers, and USPS  
• FSS Machines Running Far Slower Than Planned 
• USPS Admits FSS Is Losing Money

 

Flats Litigation System: USPS and Vendor Battling It Out Over Huge FSS Machines

A multimillion-dollar dispute between the U.S. Postal Service and the long-time vendor that built its troubled Flats Sequencing System has landed in court.

Northrop Grumman claims USPS owes it $179 million for work on the $874 million contract. USPS has largely rejected the claims and responded with its own claims for $341 million "because it did not realize certain cost savings it expected from deploying the systems," Northrop Grumman said in an April financial report. The company recently told stock analysts that it had decided "to deemphasize the domestic postal automation business going forward."

The company filed suit against the federal government Friday in the U.S. Court of Federal Claims, appealing the Postal Service's rejections of its claims and asking the court to declare USPS's claims as being without merit. Northrop Grumman's entire filing can be accessed here, while Law360 has a good overview of the case.

The next generation
As Northrop Grumman's lawsuit notes, "the FSS is a massive system of machines" representing "the next generation of automatic delivery point sequencing equipment designed to reduce the processing costs of flat mail," such as magazines and large envelopes. So far, however, the 100 "Flats Shredding System" machines have not performed as planned, though they apparently have led to some decreases in operating costs.

FSS Machines Shuffled Again -- But Do They Work?

The U.S. Postal Service announced yesterday that it is putting the Flats Sequencing System into five new locations but has still not revealed whether the machines work as intended.

As a result of declining volumes of catalogs, magazines, and other flat mail, the number of facilities getting the first 100 FSS machines is 47, up from 32 that were planned just a year ago.

San Diego will get two machines, while one each will go to Brooklyn, Cleveland, Dallas, and Pittsburgh. Palatine, IL will get an additional machine. Carol Stream, IL; Denver; Indianapolis; Middlesex-Essex, MA; Providence, RI; and Sacramento, CA will each lose a machine.

The revised schedule released yesterday shows the last of the 100 machines starting up in May 2011. Eleven machines are already sorting mail, and another 37 are in various phases of installation or start-up.

Eight months ago, USPS's Office of Inspector General said that "deploying FSS machines to additional sites is premature" until the system "demonstrates operational stability and achieves the minimum performance requirements under field test conditions". But postal officials decided that the results were good enough and providing enough cost savings to press on with more installations.

A third round of acceptance testing was scheduled for last fall, but USPS has not revealed the results. Various sources, however, report that the machines have still not met the standards specified in the contract with the manufacturer, Northrop Grumman.

For more information on the system that is intended to revolutionize the handling of flat mail, please see:

• Flats Sequencing Forecast: Cloudy With a Chance of Bravado 
• Can the Flats Sequencing System Be Fixed?  
• The Unofficial Guide to Flats Sequencing

Flats Sequencing Forecast: Cloudy With a Chance of Bravado

Despite equipment problems, schedule delays, and evidence of engineering miscues, postal officials are eagerly moving ahead with installation of the Flats Sequencing System.

The U.S. Postal Service’s recently released annual report says FSS “is revolutionizing the way we process flat-size mail, such as magazines and catalogs, by sorting it in the order in which it’s delivered by carriers. This new technology will deliver high-impact efficiency and improve mail processing, and make sure customers get even more value from the mail.”

Other recent USPS statements and presentations about FSS have been equally positive, generally ignoring such negatives as two failed acceptance tests and the reported replacement of the engineers who designed the system. The huge machines definitely seem to be reducing the Postal Service’s operating costs; the question is whether the savings will be great enough to justify the roughly $1 billion investment.

Below is a roundup of recent items about the Flats Sequencing System. Further information about FSS can be found at The Unofficial Guide to Flats Sequencing.

• Behind Original Schedule: Eleven machines are up and running in four locations, while another 16 are being installed in nine other facilities, according to postal officials. (See the recent presentation to MTAC for details.) A year ago, the schedule called for about one-third of the 100 Phase I machines to be running by now, but equipment problems and a need to rework the plan in light of volume decreases has put Phase I about six months behind that schedule. Phase I is now to be completed in 2011 rather than late 2010.
  
• Replaced Engineers?: Postalnewsblog.com included this in a summary of a late October meeting between postal officials and USPS management associations: "The current FSS deployment has been plagued by software issues. The USPS will continue its plans to install equipment but the actual deployment from a use standpoint must be resolved by the contractors. DPMG Donahoe advised that the USPS is working with the contractors to resolve the bugs in the system and that the contractor has replaced all of the engineers who have been working to correct the bugs." Financial statements of the contractor, Northrop Grumman, reveal nothing about the problems.
  
• Full Speed Ahead: USPS is moving forward with FSS installation despite the Office of Inspector General's recommendation that it install only one more machine "until the system demonstrates operational stability and sucessfully passes the field acceptance test." (See Can the Flats Sequencing System Be Fixed? for more details.) FSS improved in its second acceptance test but still failed; results of the third test have not been revealed.
  
• Good Results: "We exceed 98% quality on a daily basis," Deputy Postmaster General Pat Donahoe said in a recent video. USPS learned from the mistakes that were made on delivery-point sequencing of letters, enabling it to have a smooth start-up of machines, he said.
• No News Is Good News: As far as mailers are concerned, FSS has been a non-event so far. Most indications are that service has not suffered and that there have been no other major problems where FSS has been implemented.
  
• Volume Down: The volume of flat mail declined nearly 14% during the fiscal year that ended Sept. 30, with a smaller decline projected for the current fiscal year. The original FSS plan assumed stable or rising volume, but flats mail has declined about 35% in the past three years. As a result, the 100 Phase I machines are being deployed in 42 locations rather than the 32 in the original plan. (See Declining Volumes Lead to FSS Expansion for details.) A revised deployment schedule has been "under development" for several months.
  
• More Street Time: FSS is meeting its goal of giving letter carriers "less time in the office, more time on the street," Donahoe said in the video. Carriers who used to case (sort) seven to eight feet of flats are now casing one to two feet, he said.
• A Few Tweaks: "An ergonomic stowage and retrieval system has been designed for delivery vehicles receiving FSS flats with a limited deployment set for 2010. An FSS optimization effort is underway in Northern Virginia to streamline current operations and reduce manual processing of flats," according to USPS's recent 2009 Comprehensive Statement on Postal Operations.
• Site Deployment: "FSS deployment requires precise integration of facility expansions, operational moves, equipment migrations, equipment disposals, and site preparation activities including training and staffing. Site readiness in all 31 original Phase 1 locations is complete," the operations report says.
  
• Change of Location: Postal officials revealed two weeks ago that San Diego is replacing San Francisco as a Phase I location. There was no word on whether that meant Bay Area flats sorting would be consolidated into San Jose, which is slated for four Phase I machines.
• Delayed Rate and Regulation Changes?: Eventually, mailers will package flats for FSS areas differently (e.g. larger bundles, no carrier-route bundles) than non-FSS areas and will presumably have a different price structure for FSS. There was talk that the new packaging regulations and the accompanying rate changes would be implemented in 2010, but the Postal Service's promise not to change rates for most classes of mail next year probably means a 2011 implementation.
  

Can the Flats Sequencing System Be Fixed?

It may be time for the U.S. Postal Service to go back to the drawing board on the Flats Sequencing System, which faces trouble on two fronts.

USPS is pressing ahead with installation of the football-field-sized FSS machines, even though the system recently fell short of standards for the second time in an acceptance test. The throughput rate improved over a test late last year but was still 23% short of the standard, USPS's inspector general's office recently revealed.

The inspector general's report recommended installing only one more FSS machine "until the system demonstrates operational stability and sucessfully passes the field acceptance test." The machines are supposed to automate the labor-intensive process of handling such flat mail as catalogs and magazines. (See "The Unofficial Guide to Flats Sequencing" for more information.) Only a handful of the 100 machines in Phase I of the FSS program have been installed.

USPS management acknowledged that FSS "did not meet the key contract performance requirements" and said it would conduct another acceptance test, but indicated it would not slow deployment of the machines.

"When fully deployed, the expected annual FSS savings are $600 million. As such, it is in the best interest of the Postal Service to take advantage of every available opportunity to sustain the deployment while ensuring that it does not adversely affect the forecasted savings and/or increase operational burdens," wrote David E. Williams, acting vice president at USPS, in response to the inspector general's report.

The math seems to be on Williams' side. Achieving annual savings of $600 million with an investment of only $1.4 billion looks like a good deal; even if the machines last only 15 years, that would represent a 40% internal rate of return. That gives the Postal Service and lead contractor Northrop Grumman plenty of incentive to fix the machines.

But then there's the second problem with FSS: Not only is it not yet living up to its design, but the design may already be obsolete.

The system was designed under the assumption that flats volume would continue growing into the future. Large postal rate increases, competition from other media, and the economic recession have reversed that trend, causing flats volume to decline at an annual rate of about 11% the past two years.

USPS management has responded by increasing the territory that will be served by Phase I machines. A few days ago, it added more ZIP codes to the program, bringing the total to 2,314 instead of the approximately 1,300 in the original design.

That means each machine will serve far more addresses than originally intended, some in ZIP codes that did not qualify for the program at first. And some of the machines will go to locations that didn't originally pass muster for Phase I. All of this suggests that the $600 million estimate, which has been around for at least a year, is no longer valid.

Insiders say postal executives have already concluded that the machines are too big and need to be tweaked in other ways. But estimating the level of flats volume 5 or 15 years from now, or what type of machine could best handle that, could be quite a challenge.

Failure of the machines to meet contractual standards so far might be a blessing in disguise for the Postal Service: That could give it leverage to force Northrop Grumman to make desired changes to the design. Or even grounds to cancel the contract and go back to square one.

To anyone who has heard postal officials talk enthusiastically about FSS, the idea of USPS abandoning the program seems extreme.

But consider this fact: Much of the work on and learning about FSS has been done at Dulles, VA, where three machines are running and a fourth is being altered. Five days ago, the Postal Service announced that it has begun a feasibility study "to determine if efficiency could be increased by consolidating mail processing operations" from Dulles to the nearby Northern Virginia facility in Merrifield.