Contract Management: Observations on DOD's Financial Relationship With the Anthrax Vaccine Manufacturer

Published by the Government Accountability Office on 1999-06-30.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                          United States General Accounting Office

GAO                       Testimony
                          Before the Subcommittee on National Security, Veterans
                          Affairs, and International Relations, Committee on
                          Government Reform, House of Representatives

For Release on Delivery
Expected at
10:00 a.m., EDT
June 30, 1999             MANAGEMENT

                          Observations on DOD’s
                          Financial Relationship
                          With the Anthrax Vaccine
                          Statement of Louis J. Rodrigues, Director, Defense
                          Acquisitions Issues, National Security and International
                          Affairs Division

                      Mr. Chairman and Members of the Subcommittee:

                      It is a pleasure to be here this morning to discuss the contractual
                      relationship between the Department of Defense (DOD) and BioPort
                      Corporation for production of the anthrax vaccine. I will discuss (1) DOD’s
                      investment in BioPort’s biologic facility and contracts to produce the
                      vaccine, (2) BioPort’s current cash flow situation, and (3) proposals to
                      improve the company’s financial health.

                      We have studied and reported on a number of issues concerning biological
                      terrorism for this Subcommittee and others. A list of related GAO reports
                      and testimonies is in appendix I to this statement.

Background            From the 1970s until 1998, DOD had been procuring the anthrax vaccine
                      from a biologic facility owned by the State of Michigan. The facility, first
                      known as the Biologic Products Division of the Michigan Department of
                      Public Health and later as the Michigan Biologic Products Institute, is the
                      only biologic facility in the country licensed by the Food and Drug
                      Administration (FDA) to produce the vaccine. In 1997, FDA identified
                      numerous manufacturing problems that could have led to the revocation of
                      the facility’s license. In response to concerns about the potential loss of
                      anthrax vaccine production, DOD began funding renovation efforts.
                      Production facilities were shut down in early 1998. Later, in the summer of
                      1998, the State of Michigan sold the facility to the BioPort Corporation for
                      $25 million. The company paid $3.25 million in cash, securing $12.15 million
                      in notes payable to the State of Michigan, and agreeing to pay $9.6 million
                      based on other obligations, including a percentage of future sales. The
                      contracts DOD had with the State of Michigan facility were transferred to

Results in Brief      DOD has made a significant investment in renovating BioPort’s biologic
                      facility to meet the military’s requirements for anthrax vaccine. However,
                      BioPort has experienced delays in completing its renovation efforts, and, as
                      a result, production of the vaccine is about 5 months behind schedule.

                      Because of the delays, the company has not received the revenues it
                      expected and now faces a serious cash flow problem. The cash flow
                      problem, we believe, is due to the company’s inability to achieve its overly
                      optimistic business plan. In response to its cash flow problem, BioPort
                      requested—and DOD has authorized—the sale of 70,000 doses to other
                      customers before meeting its contractual requirements with DOD. In

              Leter   Page 1                                                     GAO/T-NSIAD-99-214
                     addition, the company has proposed several actions to resolve its financial
                     problems, including asking DOD for advance payments and increasing
                     contract prices. DOD officials are considering what actions, if any, should
                     be taken to resolve BioPort’s cash flow problem.

DOD Investment in    Since 1988, DOD has provided about $112 million in contracts, including
                     options, to help ensure the viability of the anthrax vaccine biologic
BioPort’s Biologic   facility. As shown in figure 1, DOD’s contracts provided monies to (1)
Facilities           produce the vaccine, (2) renovate and expand the production
                     facility, (3) provide various support services, and (4) purchase equipment
                     to enhance production capacity.

                     Figure 1: Value of Contracts for the Anthrax Vaccine Biologic Facility
                     Dollars in millions







                                   i ne                         ion                       es             ent       a   l
                               c                          ans                         rvic             pm      Tot
                           Vac                      Exp                        t se            Equ
                                             i   on/                        por
                                   o      vat                         Sup


                     Source: GAO analysis of DOD contracts.

                     DOD has also provided contract terms and conditions to help ensure the
                     success of the anthrax vaccine program. For example, under Public
                     Law 85-804, which allows for government indemnification of contractors
                     for unusually hazardous risks, DOD indemnified BioPort against product
                     liability. In addition, DOD agreed to allow the company to sell up to 200,000
                     doses of anthrax vaccine to others, using government-furnished equipment
                     rent-free, after DOD’s requirements are met.

            Leter    Page 2                                                                                    GAO/T-NSIAD-99-214
BioPort’s Cash Flow   BioPort’s renovation efforts have taken longer than expected and delayed
                      production about 5 months. As a result, the revenues the company
Problems              expected to receive have not materialized. The company has continued to
                      accumulate costs, including significant payroll costs. According to BioPort
                      officials, the company does not have sufficient cash reserves or the ability
                      to obtain commercial financing at reasonable rates to cover its operating

                      BioPort projects a significant operating loss for the year ending December
                      1999.1 In fact, the losses are greater than those during fiscal years 1993-96
                      when the State of Michigan owned and operated the biologic facility
                      (see fig. 2).2

                      Figure 2: Biologic Facility Operating Losses in Fiscal Years 1993-96






                                                           1993               1994                 1995            1996
                        Losses in millions of dollars       -0.9              -2.6                 -6.5             -6.6

                                                                                     Fiscal Year
                      Source: Independent accountants’ reports.

                      1 BioPortconsiders its projected operating loss for the year ending December 31, 1999, proprietary
                      information and, therefore, it is not included in this statement.

                      2 Data   regarding the State of Michigan’s operating losses were available only for fiscal years 1993-96.

                      Page 3                                                                              GAO/T-NSIAD-99-214
                      In June 1999, the Defense Contract Audit Agency (DCAA) completed an
                      audit of BioPort’s financial condition to determine if the contractor has
                      adequate financial resources to perform its DOD contracts. According to
                      this report, there is substantial doubt that BioPort will be able to continue
                      performing its contracts. The company needs additional cash to meet
                      ongoing expenses and debt commitments. For example, under the terms of
                      its purchase agreement, BioPort must pay $8.8 million of its debt to the
                      State of Michigan on September 4, 1999.

                      We believe BioPort’s cash flow problem is due to its inability to achieve its
                      overly optimistic business plan. The company’s business plan, in addition
                      to meeting DOD’s requirements, provided for the sale of anthrax vaccine to
                      other customers. Because renovation efforts are taking longer than
                      expected, vaccine production for DOD as well as other customers has been
                      delayed about 5 months, and expected revenues have not materialized.

Efforts to Improve    BioPort recently requested and received DOD’s authorization to sell
                      70,000 doses of anthrax vaccine to other customers. DOD has approved the
BioPort’s Financial   sale of 30,000 doses to the Canadian Armed Forces, in part so the company
Health                can generate revenues to help cover operating expenses. BioPort intends to
                      sell the remaining 40,000 doses to other potential customers; these sales
                      would also require approval under export control regulations. DOD gave its
                      approval even though BioPort was not fully meeting its contractual delivery
                      requirements. BioPort officials indicated that the sale of the 70,000 doses is
                      expected to generate several million dollars of revenue.

                      In addition to this short-term action, BioPort has requested that DOD
                      modify its contract to provide for, among other things, advance payments
                      and significantly higher contract prices. DOD and BioPort are now
                      discussing these modifications.

                      According to BioPort officials, the company is proposing significant price
                      increases because (1) production capacity is less than it was planned to be,
                      (2) costs have increased, and (3) sales to other customers have not
                      materialized as planned. BioPort has informed DOD that it will not be able
                      to produce all of the 2.5 million doses or all of the 5.4 million doses
                      contractually required to be produced in option years one and two,
                      respectively. As shown in figure 3, the contractual price per dose was
                      expected to decrease as production quantities increased.

                      Page 4                                                      GAO/T-NSIAD-99-214
Figure 3: Contract Prices and Production Requirements

8                                                                            8

7                                                                            7

6                                                                            6

5                                                                            5

4                                                                            4

3                                                                            3

2                                                                            2

1                                                                            1

0                                                                            0
           Base Year                       Option I     Option II

                Price per dose

                Quantity of doses to be produced

Source: GAO analysis of DOD contracts.

BioPort’s proposed prices are several times higher than current contract
prices. Moreover, BioPort is proposing to provide DOD about 3 million
fewer doses than contractually required to better reflect its production
capabilities and its desire to increase its private sales. According to BioPort
officials, the reduced doses will be sufficient to support DOD’s
immunization policy.

According to DCAA, the company’s proposed price for the 2.5 million doses
currently under contract is overstated. In addition, the agency found that
BioPort’s accounting system was inadequate and recommended that any
company data submitted in support of the price increase be reviewed to
ensure accuracy before any contract price is renegotiated.

Mr. Chairman, Members of the Committee and Subcommittee, that
concludes my prepared remarks. For the record, major contributors to the
testimony were Johana R. Ayers, Ralph C. Dawn, Christopher P. Galvin, and
Paul M. Greeley. I would be happy to answer any questions you may have.

Page 5                                                         GAO/T-NSIAD-99-214
Page 6   GAO/T-NSIAD-99-214
Page 7   GAO/T-NSIAD-99-214
Appendix I

Related GAO Products                                                                     ApIenx

             Combating Terrorism: Observations on Growth in Federal Programs
             (GAO/T-NSIAD-99-181, June 9, 1999).

             Medical Readiness: Safety and Efficacy of the Anthrax Vaccine
             (GAO/T-NSIAD-99-148, Apr. 29, 1999).

             Gulf War Illnesses: Questions About the Presence of Squalene Antibodies in
             Veterans Can Be Resolved (GAO/NSIAD-99-5, Mar. 29, 1999).

             Combating Terrorism: Observations on Biological Terrorism and Public
             Health Initiatives (GAO/T-NSIAD-99-112, Mar. 16, 1999).

             Combating Terrorism: Observations on Federal Spending to Combat
             Terrorism (GAO/T-NSIAD/GGD-99-107, Mar. 11, 1999).

             Combating Terrorism: Efforts to Protect U.S. Forces in Turkey and the
             Middle East (GAO/T-NSIAD-98-44, Oct. 28, 1997).

             Combating Terrorism: Status of DOD Efforts to Protect Its Forces Overseas
             (GAO/NSIAD-97-207, July 21, 1997).

(707423)     Page 8                                                  GAO/T-NSIAD-99-214
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