I .‘i : - . United States General Accounting Office GAO Fact Sheet for the Chairman, Committee on Armed Services, House of Representatives August 1990 B-2 BOMBER Contract Structure and Selected Provisions GAO,‘NSIAD90-230FS c United States GAO General Accounting Office Washington, D.C. 20548 National Security and International Affairs Division B-224698 August 17,199O The Honorable Les Aspin Chairman, Committee on Armed Services House of Representatives Dear Mr. Chairman: As requested, we have developed information on the contract structure and selected provisions affecting contractor and government risks under the B-2 low-rate initial production contract. Currently, five B-2s are included under this fixed-price incentive contract with Northrop Corpo- ration’s B-2 Division, and the Air Force is in the process of negotiating with Northrop to add five additional aircraft to the contract. Six aircraft are also being acquired under a development contract. Northrop, the prime contractor, is responsible for ensuring that the B-2 Results in Brief meets system specifications and for managing major subcontracts. Cur- rent legislation requires that contracts include warranty provisions that provide coverage for design and manufacturing requirements and pro- tect against defects in material and workmanship. Although not required by law, the low-rate initial production contract also provides a performance warranty. However, the government’s ability to enforce the performance warranty may be affected by the test program. As of June 1990, under the present delivery schedule, testing is scheduled for completion 10 to 18 months after the warranties for the initial five pro- duction aircraft expire. The low-rate initial production contract establishes a cost-sharing arrangement that also applies to warranty costs. Unless Northrop has a substantial cost overrun, the Air Force would pay 80 percent and Northrop 20 percent of allowable warranty costs. Northrop’s liability under the warranty provision is limited to $100 million for the five air- craft. The Air Force pays for all costs to identify, develop, and test cor- rective actions for deficiencies under its full-scale development contract, which is a cost-reimbursable contract. According to Air Force officials, the B-2 warranty was obtained at no additional cost to the government. Regarding the warranty being consid- ered for the next five aircraft, the Air Force has asked Northrop to pro- pose a warranty in which Northrop would assume much greater responsibility for the cost of corrective actions. Page 1 GAO/NSL4DSO-23OFS RZ (‘ontracts B-224698 Please contact me at (202) 2754268 if you or your staff have any ques- tions concerning this fact sheet. Major contributors to this fact sheet are listed in appendix II. Sincerely yours, tf!fIZ*y Director Air Force Issues Page 3 GAO/NSIAB9W?39FS B2 Contracts Appmdix I Low-Rate Initial Fhduction contract Structure and Pmviaions table I. 1 is primarily the result of the change in the B-2 schedule. Addi- tional cost increases due to a subcontractor strike, a decision to shift aircraft buys to later years, and the purchase of other B-2 related items are yet to be negotiated. Consequently, the program office estimates the low-rate initial production contract costs will increase substantially. Under the contract, Northrop has total system performance responsi- Total System bility. Northrop is responsible for integrating the B-2, its subsystems, Performance components (hardware and software), and government-furnished prop- Responsibility and erty. It must also undertake any actions necessary to ensure that the total system will meet all requirements. Northrop is also responsible for Subcontractor selecting subcontractors and effectively managing the subcontracts Management required to perform the work. Northrop is required to monitor the major subcontractors’ performance and provide reasonable assurance to the Air Force that contract requirements will be met. 10 USC. 2403 requires contractors to guarantee that weapon systems Warranty Coverage conform to design and manufacturing requirements and are free from defects in materials and workmanship. Also, if the weapon system pro- gram is in mature full-scale production-that is, production of more than 10 percent of the total number planned or the initial production quantity, whichever is less-a performance warranty is necessary. The B-2 low-rate initial production contract covers these three areas. How- ever, the performance warranty was not necessary because only 5 of the 127 planned production aircraft were included in the contract. According to Air Force officials, the warranty obtained was at no addi- tional cost to the government. The Air Force plans to add five additional aircraft to the contract by October 1990 and has requested that Northrop propose a cost estimate for these aircraft, which were authorized by the Congress in fiscal years 1989 and 1990. It has also asked Northrop to propose costs for a new, more stringent warranty provision for the aircraft. The Secretary of Defense advised the Congress on May 20, 1990, that the Air Force intends to comply with the increased warranty requirements in the National Defense Authorization Act for fiscal years 1990 and 199 1. Current Warranty The current warranty provides that Northrop must be notified about defects or performance problems within 6 months after the Air Force accepts an aircraft. When a problem is identified, the costs to design, Page 5 GAO/NSIAD-96.236FS B-2 Contracts Appendh I Low-Rate Initial Production Gmtract Structure and Provisions not been tested by the time the warranty period expires. Program offi- cials believe sufficient testing will be completed early enough to ensure compliance with most specifications and requirements. If not, the offi- cials agree the government would have to pay the total cost to fix a defect. Table 1.3: Comparison of Warranty Periods to Flight Test Program Months remaining Warranty expiration between warranty Delivery date (6 months expiration and Aircraft no. date after delivery) completior! -__-- of testing 1 Apr 1992 Ott 1992 18 2 June1992 Dee 1992 16 3 Aug 1992 Feb 1993 .__~______ 14 ~~ ______ 4 ____ act 1992 - Apr. 1993 12 5 Dee 1992 June1993 10 Future Warranty The National Defense Authorization Act for fiscal years 1990 and 1991 directed the Secretary of Defense to report on the implementation of current warranty provisions in the B-2 program. In addition, it required that the Secretary report on warranties planned for future contracts. The Secretary of Defense reported to the Congress on May 20, 1990, that the Air Force has asked Northrop to propose the cost for warranty cov- erage on the next five aircraft. The proposal should be for a warranty with a cost liability limit equal to Northrop’s profit. This would then become Northrop’s financial liability for correcting defects. Further, any costs incurred by Northrop to correct defects would not be covered by the cost-sharing arrangement of the contract and would not be shared by the Air Force, as they would be under the current warranty. The Air Force cannot exclude or limit this coverage unless (1) it is deter- mined that a waiver is necessary in the interest of national defense or (2) an analysis shows the costs outweigh the benefits of the warranty. In either case, the Secretary must notify the Congress of any exclusions or limitations in the warranty coverage. Also, under the existing contract clauses, the warranty allows the Air Force 6 months to discover defects after accepting an aircraft. Under the planned warranty, Northrop will be asked to accept 1 year as the length of time the Air Force has to discover defects. Page 7 GAO/NSIAD9@239Fs B-2 Contracts Appenb I Low-Rate Initial Production contract Structure and Provisions Business Base Adjustment A contract price adjustment is allowed if Northrop’s B-2 Division busi- ness base changes due to government actions to delay, reduce, or termi- nate the B-2 contract. This provision allows Northrop an equitable adjustment if the B-2 Division’s business base changes by at least 5 per- cent because of government actions. The provision was included because Northrop based its price for the contract on producing 132 aircraft. The proposed reduction to 75 aircraft would therefore affect the pricing of this contract. This provision will be in effect in future contracts through delivery of the 72nd aircraft. To date, this provision has not been used to increase or decrease contract prices. Other Termination The Federal Acquisition Regulation requires standard contract termina- tion provisions. The regulation allows the Air Force to terminate the Provisions contract if Northrop fails to meet contract requirements or for the gov- ernment’s convenience. Under these provisions, the government must notify Northrop of the termination action and details. Costs are usually determined through negotiations between the government and the con- tractor. The contractor has 1 year after the notice of termination to submit a proposal for costs incurred. The government’s liability under these provisions depends on specific Termination Costs and termination scenarios. Before the recent proposal to reduce the number Government Liability of aircraft to 75, the B-2 program office estimated total liability for stopping the program at various times. The total government liability at the time of scheduled production decisions in fiscal years 1991, 1992, and 1993 was estimated by the program office to be $24 billion, $29 billion, and $36 billion, respectively. These estimates represent cumulative costs incurred at those decision points plus additional costs necessary to close out the contract. In addi- tion to any aircraft delivered, the Air Force would take possession of any aircraft sections and parts that were in the manufacturing process. The estimates were based on actual expenditure rates in the B-2 pro- gram for fiscal years 1987 and 1988 plus other estimating factors. We did not attempt to verify the estimates. Page 9 GAO/NSIAE96%3WS B2 Contracts -,,....,. a, . Requests for copies of GAO reports should be sent to: U.S. General Accounting Office Post Office Box 6015 Gaithersburg, Maryland 20877 Telephone 202-275-6241 .. The first five copies of each report are free. Additional copies are 1) $2.00 each. There is a 25% discount on orders for 100 or more copies mailed to a single address. Orders must be prepaid by cash or by check or ,ty “II ” .n ‘w,m.:.~nlll’~llR llr! ~“I lllll~lll~ .. United States First-Class Mail General Accounting Office Postage & Fees Paid Washington, D.C. 20548 GAO Permit No. GlOO Official Business Penalty for Private Use $300 Appendix Major Contributors to This Report National Security and Joseph C. Bohan, Assistant Director International Affairs Division, Washington, D.C. Cincinnati Regional Michael J. Hazard. Evaluator-in-Charge Office Michael J. Sullivan, Evaluator (392630) Page 10 GAO/NSWW23OFS B2 Contracts Appendix I Lmv-Rate Initial Production contract Structure and Pnwisions The contract includes provisions intended to protect Northrop’s invest- Termination ments and limit the government’s liability if the program is terminated Provisions in the or delayed for a significant period of time. On April 26, 1990, the Secre- Contract tary of Defense reduced the number of aircraft in the B-2 program from 132 to 75. This action could require further negotiations under some of these provisions. Protection of Contractor Two provisions protect Northrop’s investment in capital and leased equipment if the government terminates the contract. In fiscal year Capital Investments and 1990, the maximum government obligation under these provisions is Leases $215 million. This amount decreases to $194 million and $167 million in fiscal years 1991 and 1992, respectively. B-2 program officials stated that if the contract is terminated, these ceiling amounts would probably be reached by the current value of applicable equipment and leases. The purpose of these provisions was to give Northrop an incentive to invest up front in enough plant and equipment to produce the entire B-2 program. Coverage under these provisions exists through December 31, 1992, or delivery of the 74th production aircraft, whichever occurs first. The government will purchase the equipment items or leases covered if (1) the government does not buy through delivery of at least the 74th production aircraft, as evidenced by the second consecutive annual appropriation act that excludes procurement of B-2 production aircraft, or (2) if the contract is terminated for the government’s convenience before delivery of the 74th production aircraft. The Air Force has indi- cated that buying 75 B2s, 70 of which are production aircraft, could cause further negotiations under these provisions. Reimbursement for Idle Northrop is to be reimbursed for 3 years for the cost of idle facilities if Facilities or Capacity the B-2 program is curtailed. The payment to be made under this provi- sion is based on a formula that includes the cost of floor space, cost to occupy the space, equipment depreciation, and equipment utilization factors. Coverage decreases 25 percent each of the 3 years after curtail- ment, from 100 percent in the first year to 50 percent ln the third year. Equipment and Tooling Under this provision, the negotiated price of the contract excludes the Disposition Costs costs to remove, store, and transport government-owned equipment and tooling in case the contract is terminated, delayed, or reduced. This is a standard provision in production contracts. The Air Force has limited the liability under this provision to $430 million. Page 8 GAO/NSL4DSB23OFs 82 Contracts Appendix I Low-Rate Initial Production Contract Structure and Provisions develop, and test a corrective action are paid by the Air Force under the development contract, which is a cost-reimbursable contract. The costs to retrofit the approved corrective action into production aircraft are chargeable to the low-rate initial production contract. However, these warranty costs are limited to $100 million for the five aircraft. Unless Northrop substantially overruns target cost, the government would be responsible for 80 percent of the allowable warranty costs. The actual sharing of these costs, however, depends on Northrop’s cost performance on the contract. Contract cost sharing and profit provisions establish that once target cost is exceeded, Northrop’s profit is reduced as costs increase until Northrop is totally responsible for all additional costs. For example, if Northrop produces at target cost before the $100 million warranty costs are incurred, the government’s share would be $80 million, and Northrop’s profits would be reduced by $20 million. Table I.2 shows that this ratio continues until program costs reach the point at which Northrop would assume all costs, including the $100 mil- lion warranty cost. Table 1.2: Distribution of Warranty Costs Dollars in mdlions -- Contrr;; Profit before Contractor’s Profit after Contractor’s Derformance warrantv share warrantv At target cost $2,216 L-p $251 $20 $231 At lo-percent overrun 2,436 - 207 -- 20 -~ -~.-~.-187 At 20.percent overrun 2,659 162 20 142 At ceiling 2,992 0 100 -100 tinder the contract, Northrop’s share of warranty costs would remain at $20 million unless costs began to approach the ceiling price. Under the current cost-sharing arrangements, this would not occur until target cost was exceeded by about $650 million, or about a 30-percent overrun of target cost. The 6-month period of coverage on warranty provisions may limit the government’s ability to enforce the performance warranty. Under cur- rent plans, the Air Force will not complete performance testing until April 1994, which is after the five low-rate initial production aircraft are to be accepted. As shown in table 1.3, flight testing of the develop- ment aircraft will not be completed until between 10 and 18 months after the warranties for these aircraft have expired. This could limit the Air Force’s ability to enforce the performance requirements that have Page 6 GAO/NSIAD9@230FS B2 Gmtmcts Appendix I Low-Rate Initial Production Contract Structure and Provisions The low-rate initial production contract, awarded in November 1987, is a fixed-price incentive contract that sets initial cost and profit targets and has a firm ceiling price. Firm targets for cost and profit will be set after the third development aircraft is delivered in 1991. The contract also establishes a cost-sharing arrangement to motivate Northrop to con- trol contract costs. If Northrop’s actual cost is below target cost, profits are increased proportionately, but if the actual cost exceeds target cost, profits are reduced proportionately. The contract values negotiated ini- tially, increases agreed upon in June 1990, and the current values are shown in table I. 1. Table 1.1: B-2 Contract Values Dollars m bihons Initial Increase -- Current Target cost $2.020 $0.196 $2216 Target proflt 0.251 0-0 Target price $2.271 $0.196 -- $2.467 Ceiling pnce 2.727 0 265 2992 The Air Force and Northrop negotiated initial target cost based on pre- liminary cost data from the development program. The target price is the target cost plus a profit factor. The Air Force and Northrop also agreed that the ceiling price would be 135 percent of the target cost. Under the cost-sharing arrangement, the Air Force pays 80 percent of all costs that exceed the target cost, and Northrop pays 20 percent until the total contract cost approaches the ceiling price of $2.992 billion. Northrop is solely responsible for costs beyond the ceiling price. Also, the Air Force and Northrop will share any underruns below target cost by the same 80:20 ratio. The final target cost and profit amounts will be negotiated after the third development aircraft is delivered because more cost information should be available at that time. Also, the third aircraft will contain equipment not on the first two and will more closely resemble the planned aircraft design. In 1987, at the time the low-rate initial production contract was being negotiated, a B-month schedule extension was being considered. As a result, a provision was included for a one-time increase in contract targets. The provision stated that Northrop would be responsible for the cost of 3 months of the delay and the government would be responsible for the balance. The $196 million increase in the target cost shown in Page 4 GAO/NSIAlB@-23O)oFs WZ Contracts 5224698 The low-rate initial production contract includes provisions to renego- tiate the contract if a prescribed number of aircraft are not purchased. It also includes termination provisions to protect Northrop’s invest- ments and limit the government’s liability if the program is terminated or delayed. The recent reduction in the total number of B-2 aircraft from 132 to 75 could require further negotiations under these provisions. The Air Force estimates that the low-rate initial production contract costs will increase substantially due to the reduction in the number of aircraft as well as schedule and other changes. Appendix I provides more details about this contract. To obtain the information for this fact sheet, we reviewed the low-rate Scope and initial production contract structure and provisions for warranties and Methodology contract termination or program delay. In addition, we discussed con- tract provisions with contracting officials from the B-2 program office and the Product Performance Agreement Center at Wright-Patterson Air Force Base, Ohio, and Northrop Corporation’s B-2 Division, Pica Rivera, California. As requested, we did not obtain agency comments on this fact sheet. However, we provided B-2 program officials with a draft of this fact sheet and incorporated their comments where appropriate. We are sending copies of this fact sheet to the Chairman, Senate Com- mittee on Armed Services; the Chairmen, Subcommittees on Defense, House and Senate Committees on Appropriations; appropriate congres- sional committees; the Secretaries of the Defense and the Air Force; and the Director, Office of Management and Budget. Page 2 GAO/NSL4MJO-230FS B2 Contracts
B-2 Bomber: Contract Structure and Selected Provisions
Published by the Government Accountability Office on 1990-08-17.
Below is a raw (and likely hideous) rendition of the original report. (PDF)