Breakout Session #808 Gary Winebrener National Systems Division Manager of Contracts General Dynamics C4 Systems April 1

2. Contract Construction and Clauses for Financial Success Breakout Session #808 Gary Winebrener National Systems Division Manager of Contracts General Dynamics C4 Systems April 16, 2008 9:40am–10:40am

3. Contract Financial Performance Goal Contract type, terms and conditions, and profit/fee to enable excellent financial performance with proper contract execution

4. Contract Financial Performance PRESENTATION OUTLINE • Financial Goals • Definitions • Proper Contract Type • Discussions of Individual Contract Types • When Used • Characteristics (Good and Bad) • Profit / Fee • Payments • Regulatory / Statutory Requirements / Limitations • Best Practices • Further Payment Considerations • Further Profit / Fee Considerations • Contracting Officer Responsibilities • Profit Analysis Factors

5. Contract Financial Performance Financial Goals To Be Met • Cash flow • EBIT – Earnings before interest and taxes • Orders • Sales

6. Definitions Direct Labor (Wages paid to employees) + Labor Overhead (Insurance, benefits, training, etc.) + Material (Standard piece parts, COTs items, etc.) + Major Subcontract Costs (Special development efforts, etc.) + Other Direct Costs (ODC) (Travel, reproduction, freight, etc.) = Prime Cost + General and Administrative (G&A) Costs = Subtotal Costs + Cost of Money = Total Cost (Direct labor, labor overhead, G&A, material, subcontracts, ODC, COM) + Profit/Fee based on Subtotal Costs = Sell Price

7. Proper Contract Type for Program • FFP – Firm Fixed Price • Well defined Statement of Work • Costs fairly well defined • Higher risk for contractor • FPI – Fixed Price Incentive • CPFF – Cost Plus Fixed Fee • Effort not that well defined (all cost type contracts) • Lower risk for contractor (all cost type contracts) • CPAF – Cost Plus Award Fee • CPIF – Cost Plus Incentive Fee • CPAF/IF - Cost Plus Award Fee / Incentive Fee • T&M – Time and Material • Labor Hour – Same as T&M only no material • FFP LOE - Firm Fixed Price Level of Effort (LOE) • Others and multiple type

8. Firm Fixed Price Contract • Suitable for use in procurements when reasonably definite design or performance specifications are available and whenever fair and reasonable prices can be established at the outset (FAR 16.202-2) • Maximum cost, performance, and schedule risk to contractor • Maximum profit potential for contractor • Not subject to cost adjustment because of cost experience if the Statement of Work remains the same. • Contractor assumes full responsibility for all costs under or over the firm fixed price • Contractor has a maximum incentive for effective cost control and contract performance to improve profits.

9. Firm Fixed Price Contract • Profit - No limit specified in FAR • Different levels depending upon circumstances • Payments • One payment upon completion • Low cost efforts • Short term efforts like 3 months or less • Progress Payments • Performance Based Payments • Milestone Payments

10. Firm Fixed Price Contract • Payments (continued) • Progress Payments (FAR 52.232-16) • Allows progress billing of allowable/billable costs incurred at the customary progress billing rate • Monthly billings • $2500 or more billings • 80% of costs whether or not actually paid • Amounts billed by subcontractor but not paid • Includes allowable Cost of Money as incurred cost for Progress Payment purposes • Structure deliverables to get full payment ASAP • Payment ordinarily in 30 days

11. Firm Fixed Price Contract • Payments (continued) • Performance Based Payments (PBP) (FAR 32.1004 and FAR 52.232.32) • May be made on whole contract or on a deliverable item basis • Be very careful on how CLINs (Contract Line Item Number) are defined • CLIN with 10 widgets at $100 each has 10 deliverables • CLIN with 1 lot of 10 widgets at lot price of $1000 has one deliverable • PBP basis may be for described event (milestone) or measurable performance criterion • May be for more than one series of severable and/or cumulative performance events or criteria performed in parallel

12. Firm Fixed Price Contract • Payments (continued) • Performance Based Payments (continued) • Can bill up to 90% of total effort before final billing of deliverable item or whole contract value • FAR 32.1004(a)(2)(iv) - “Because PBP are contract financing, events or criteria must not serve as a vehicle to reward the contractor for completion of performance levels over and above what is required for successful completion of the contract.” • FAR 32.1004(b)(2)(ii) – “Not to exceed 90 percent of the contract price if on a whole contract basis, or 90 percent of the delivery item price if on a delivery item basis

13. Firm Fixed Price Contract • Payments (continued) • Performance Based Payments (continued) • PBPs must be “commensurate with the value of the performance event or performance criterion” • PBP can include profit • PBPs are not limited to 90% of cost of the performance event or performance criterion. Can be 100% of cost and 100% of profit. However, sum of PBPs of deliverable or whole contract cannot exceed 90% of deliverable or contract price until final invoice for deliverable and/or contract completion.

14. Firm Fixed Price Contract • Payments (continued) • Performance Based Payments (continued) • Must have clear acceptance criteria and Government must be able to verify successful performance of event or performance criterion • Requests for payment no more frequently than monthly • All PBPs in any billing period shall be included in one request • Make many PBPs to maximize cash flow

15. Firm Fixed Price Contract • Payments (continued) • Milestone Payments • Payments for accepted supplies and services that are only part of contract requirements (FAR 32.102(d)) • Frequent – monthly or more often • Consider billing size • Administrative efforts • Key to defined events • Clear acceptance criteria • Independent of cost but should bear some relationship to value of effort being billed

16. Firm Fixed Price Contract • Best Practices • Tightly defined scope of work • Loosely defined will lead to loss • Well defined specifications with NO stretch goals • Tightly monitor program for scope creep. • Changes in scope should be addressed by ECPs adequately priced to cover the scope changes • Do not assume existing products meet requirements without close review • Be sure “proper invoices” are submitted including additional invoice requirements • Track Government fund citations

17. Firm Fixed Price Contract • Best Practices • While bidding, review and know impact of all specifications and referenced requirements • Well defined acceptance criteria to know when task is complete • Be sure the work can be done and Engineering is not overly optimistic • Manage subcontractors closely so they do not cause overrun

18. Cost Plus Fixed Fee Contract • Suitable for use only when uncertainties involved in contract performance do not permit costs to be estimated with sufficient accuracy to use any type of fixed price contract (FAR 16.301-2) • Minimum risk to contractor - Customer bears the risk • Limited fee (profit) potential for contractor • Cost-reimbursement contract provides payment to contractor of allowable costs and negotiated fee that is fixed at the inception of the contract • The fixed fee does not vary with actual cost, but may be adjusted as a result of changes in the work to be performed under the contract

19. Cost Plus Fixed Fee Contract • Fixed Fee (FAR 15.404-4(c)(4)) • Does not vary with actual cost, but may be adjusted as result of changes in work performed under the contract • R&D program: 15% maximum • Non R&D program: 10% maximum • Percentage is target fee dollars divided by target cost dollars when contract definitized • Fee cannot be defined in contract as percentage of cost • Caution: It is advisable to know the Government’s “color of money” when negotiating the CPFF contract if the work content is questionable as R&D or non R&D • Final Fee Payment (FAR 52.216-8) • CO can withhold payment of fee after 85% of fixed fee is paid or $100K (whichever is less) until final payment

20. Cost Plus Fixed Fee Contract • Limitation of Cost (FAR 52.232-20) • Notify CO in writing if costs will exceed 75% of estimated cost specified in Schedule B in next 60 days • CO can change 60 days to 30 to 90 days • CO can change 75% anything between 75% and 85% • Government is not obligated to reimburse Contractor for costs incurred in excess of the estimated cost in Schedule B • Contractor is not obligated to continue contract performance incurring costs in excess of estimated cost in Schedule B • Notification is critical to allow the CO to increase estimated cost and funding by contract modification • If incurred costs exceed estimated costs and CO subsequently increases estimated costs, incurred costs in excess of the previous est. costs shall be allowable unless CO issues termination notice

21. Cost Plus Fixed Fee Contract • Limitation of Funds (FAR 52.232-22) • Funding added incrementally by contract modifications • Notify CO if costs will exceed 75% of funded amount in next 60 days • CO can change 60 days to somewhere between 30 to 90 days • CO can change 75% to anything between 75% and 85% • Government is not obligated to reimburse Contractor for costs incurred in excess of funding • Contractor is not obligated to continue contract performance incurring costs in excess of funding • Notification is critical to allow the CO to increase funding by contract modification • If incurred costs exceed funding allowed and the CO subsequently increases funding, the incurred costs in excess of the previous estimated costs shall be allowable unless CO issues termination notice

22. Cost Plus Fixed Fee Contract • Payments (FAR 52.216-7 and -8 need to be in contract) • Invoicing not more often than once every two weeks • Invoice for allowable costs (direct labor, direct travel, ODC, allocable and allowable indirect costs, materials) • Bill cost plus percentage of fixed fee • Amount of fee billed determined by Finance • Best Practices • Watch contract costs and contract funding like a hawk. Make sure costs are within Schedule B estimated cost and authorized funding • Notify CO of needed funds and how much in plenty of time to allow timely modifications so that schedule is not affected and there is no need for company risk funding. • Know if CO has more funds available for good business decisions • Be sure to monitor program for scope creep. Submit ECPs for scope increases to increase target cost and FEE.

23. Cost Plus Fixed Fee Contract • Best practices (continued) • State change in estimated cost and total new estimated cost in every modification changing cost • State change in fee and new total fee in every modification changing fee • State change in funding and new total funding in every modification for funding. • Check all math and dollar numbers in changes for accuracy • Make sure ACRNs are clear and properly specified to CLINs/SLINs. • Do not have ACRNs cross CLINs/SLINs • Make sure the funding type (color of money) proper for CLIN/SLIN type (R&D, production, O&M) • Get twice monthly billings • Watch out for fee redetermination clause (if cost runs low, lower the fee)

24. Cost Plus Fixed Fee Contract

25. Cost Plus Award Fee Contract • Cost reimbursement type contract usually for product development and services where mission feasibility is established, but measurement of performance / achievement is usually subjective in nature. It is neither feasible nor effective to devise predetermined objective incentive targets. (FAR 16.405-2) • Proper Use of Award Fee Contracts and Award Fee Provisions • Shay D. Assad, Director, Defense Procurement and Acquisition Policy, memo dated April 24, 2007 • “It is the policy of the Department that objective criteria will be utilized, whenever possible, to measure contract performance.” • Incentive fee contracts or mixed fee contracts that include incentive fees preferred • Higher level review required if there is not objective incentive criteria used in evaluations • Memo defines award fee percentages in terms of meeting “the basic (minimum essential) requirements of the contract.”

26. Cost Plus Award Fee Contract • Fees • Base Fee fixed at inception of contract (FAR 16.405-2(a)(1)) • Award Fee may be earned in whole or in part during contract performance (FAR 16.405-2(a)(2)) • Base fee and award fee percentages are the negotiated fee dollars divided by estimated cost dollars when contract definitized • Fee cannot be defined in contract as percentage of cost • No percentage limitation on fees (e.g. total of base fee and award fees can be 18%)

27. Cost Plus Award Fee Contract • Fees • If performance is unsatisfactory or marginal, no award fee is earned • Award fee determination and amount are unilateral decisions made solely at the discretion of the customer. They are not subject to appeal.

28. Cost Plus Award Fee Contract • Fees (DoD) (DFAR 216.405-2) • Base Fee fixed at inception of contract and may not be more than 3% (DFAR 216.405-2(c)(iii)) • Weighted guidelines are not to be used • May include provisional award fee payments • Made no more often than monthly • For initial period no more than 50% of the amount available for that period • For subsequent periods, 80% of previous period’s evaluation score times award fee available for current period. • Are superseded by interim or final award fee evaluation • If provisional payments exceed payment determined by the period’s evaluation score, the contractor shall repay the excess • Contracting Officer may reduce or discontinue provisional payments if it does not appear contractor’s performance is commensurate with provisional payment. CO must notify contractor in writing of reduction or discontinuance.

29. Cost Plus Award Fee Contract • Payments (FAR 52.216-7 and -8) • Invoicing not more often than once every two weeks • Invoice for allowable costs (direct labor, direct travel, ODC, allocable and allowable indirect costs, materials) • Bill cost plus percentages of fees • Amount of fee billed determined by Finance • Percentage of base fee • Provisional billing of award fee (negotiable) • Award fee billings addressed in Award Fee Plan • Limitation of Cost (FAR 52.232-20) • See CPFF discussions on Limitation of Costs • Limitation of Funds (FAR 52.232-22) • See CPFF discussions on Limitation of Funds

30. Cost Plus Award Fee Contract • Best Practices • See CPFF Best Practices • Avoid use of “to satisfaction of COTR”, Contracting Officer or purely subjective evaluation of one person • Use objective criteria tied to performance wherever possible • Consider business relationship and adversarial Prime • Best Practices - Award Fee Plan Considerations • Award Fee Periods • Award fee evaluations administratively intensive • Optimum period is about 6 months • 12 month period is too long for financial performance • Start at 100% and go down, not at 0% and go up • Evaluations should be in 90% to 100% range • Evaluations 85% and lower not good

31. Cost Plus Award Fee Contract • Best Practices - Award Fee Plan Considerations (Continued) • Provide for provisional billing • Percentage of base fee • Provisional billing of award fee (negotiable) • % of previous period • % of available for first period • Monthly or midpoint • Include award fee roll-over of unearned fee. (May encounter Government resistance due to internal guidance.) • Do not have double jeopardy for earned fees (earn and then be subject to another criteria) • Specify when award fee payment will be made after end of award fee period in addition to maximum times for the evaluation steps (e.g. “within 60 days”)

32. Cost Plus Award Fee Contract • Best Practices - Award Fee Plan Considerations (continued) • Clearly defined criteria and not opinion of one person • Mid-point evaluations by customer in writing to allow for mid-course corrections for superior performance • Have self-evaluation inputs to customer at mid-point and final evaluations. Do as CDRL. • Keep simple • Do not have too many evaluation factors in each period (defocuses really important factors) • Make sure evaluation factors are updated each evaluation period to be applicable for the period and phase of program • Make sure any changes affecting the current evaluation period must be by mutual agreement of both parties

33. Cost Plus Award Fee Contract Commentary • Award fees based mostly upon performance during the contract BUT: • GAO and others in Government argue award fee payments should be made on contract outcomes • Section 814 of the FY 2007 Defense Authorization Act • Ensure that all new contracts using award fees link such fees to acquisition outcomes • Ensure that no award fee may be paid for contractor performance that is judged to be below satisfactory performance or performance that does not meet the basic requirements of the contract • REAL PROBLEM HERE. CONTRACTING OFFICER COULD INTERPRET LATE CDRL AS NOT MEETING CONTRACT REQUIREMENT AND THEREFORE PAY NO AWARD FEE • See Shay D. Assad, Director, Defense Procurement and Acquisition Policy, memo dated April 24, 2007, as counter argument. [“the basic (minimum essential) requirements of the contract” ]

34. Cost Plus Award Fee Contract Commentary • Contract outcomes more suited for measurable incentive fees • Large disagreement within Government on how award fees should be administered and the criteria • See Nash & Cibinic Report, June 2007, Procurement Management, ¶ 24, POSTSCRIPT: AWARD-FEE INCENTIVES, by Vernon J. Edwards and Ralph C. Nash • See April 24, 2007 policy memorandum from the Director, Defense Procurement and Acquisition Policy on “Proper Use of Award Fee Contracts & Award Fee Provisions”

35. Cost Plus Award Fee Contract • Award Fee Criteria Examples • Use criteria important to customer and program and reasonable for the contractor • Be creative • Some criteria may be objective and measurable • Not limited to following examples

36. Cost Plus Award Fee Contract • Award Fee Criteria Examples Performance Factors • CDRLs • Quality and completeness • Accuracy and maturity • Timeliness of delivery • Customer acceptance of documentation • Avoid use of TBDs in documents • System Engineering • Design that meets or exceeds threshold and targets • Support of contract / mission objectives • Scalability • Defined interfaces • Successful design reviews (PDR,CDR, etc.) • Designs supported by modeling / simulation results

37. Cost Plus Award Fee Contract • Award Fee Criteria Examples (continued) Performance Factors • System Engineering • Effective transitions from design to fabrication to fielding to sustainment • Compliance to physical specifications (weight, volume, size, form factor, human interface, etc.) • Achieve range requirements (Line-Of-Sight or other) • Design, fabrication and test data quality and completeness • Compliance to performance specifications (especially critical ones) • Design drawing package delivery and completeness • Achieve desired field performance (need measurable field performance criteria)

38. Cost Plus Award Fee Contract • Award Fee Criteria Examples (continued) • System Engineering • Conduct studies to reduce risk • Exceeding critical requirements - Any item of significance: • Producibility • Reliability • Power • Weight • Size • Achieve software drop • Software reuse • Software lines of code writing efficiency • Software growth containment

39. Cost Plus Award Fee Contract • Award Fee Criteria Examples (continued) Performance Factors • Test • Successful test and evaluation of components/system (recognition for substantially exceeding requirements) • Successful completion of demonstration • Successful resolution of critical or major test failures / anomalies • All corrective actions complete (corrected root causes) • Start/finish key/significant test event • Verification level achieved • Formal and informal tests defined and conducted • Analysis and inspection quality and efficiency • Risk identification and mitigation • Simulation complete

40. Cost Plus Award Fee Contract • Award Fee Criteria Examples (continued) Performance Factors • Program Management • Demonstrate capabilities (equipment, management, etc.) • Demonstrate interoperability with other equipment • Deliveries to schedule • Conduct reviews (PDR, CDR, etc) or technical interchange meeting (TIMs) • Quality of the reviews (Presentations, presenters, answering questions and concerns, etc.) • Contract communications and reporting • Contract Status Report • Participation in regular periodic meetings, calls, conferences

41. Cost Plus Award Fee Contract • Award Fee Criteria Examples (continued) Performance Factors • Program Management • Provides realistic insight and understanding of program “health” • Document action items, changes, and progress status • Establish professional business interaction at all levels • Fulfilling contractual, financial and legal requirements efficiently and effectively • Establish optimum working relationships with the customer and other members of the program team • Provide the policy, environment and interface that encourages high team spirit, morale and enhances relationships

42. Cost Plus Award Fee Contract • Award Fee Criteria Examples (continued) Performance Factors • Program Management • Deliver engineering model • Assignment of personnel with required skills (including tracking) • Meeting staffing profile at the beginning of program (e.g. have half the staff on schedule and full staff on schedule). • Communications as measured by responsive flow of oral and written information, including communications to/from subcontracts, vendors, and suppliers • Timeliness of communications, especially for problems (within x days of realization)

43. Cost Plus Award Fee Contract • Award Fee Criteria Examples (continued) Performance Factors • Program Management • Response to contract changes and technical direction to minimize adverse impact on cost, schedule, and performance • Award “terms” rather than money • Development of employee retention plan for select exempt employees • Achieve mission success during and/or after delivery • Providing assistance to make other subcontractors or Prime successful • Effective management of subcontractors • Risk reduction program (effectiveness in mitigating risks)

44. Cost Plus Award Fee Contract • Award Fee Criteria Examples (continued) Schedule Factors • Monthly / Cumulative SPI • Example: Greater than or equal to 0.95 will be considered highest rating. Less than 0.85 receives rating of zero • Responsiveness to correct variations • Planning and Scheduling • Establish realistic schedules and plans with sufficient flexibility to account for delivery uncertainties, rework, and requirement changes • Plans do not compromise reliability, quality, or technical integrity • Re-baselining effectiveness

45. Cost Plus Award Fee Contract • Award Fee Criteria Examples (continued) Schedule Factors • Key Milestone Dates • Meeting date gets highest rating • Extra recognition for beating critical milestone date • Graduated penalties for missing significant dates • Complete field test • Obtain certification • Definitize contract/subcontract • Adherence to scheduled events

46. Cost Plus Award Fee Contract • Award Fee Criteria Examples (continued) Cost Factors • Monthly / Cumulative CPI • Example: Greater than or equal to 0.95 will be considered highest rating. Less than 0.85 receives rating of zero. • Responsiveness to correct variations. • Life Cycle Cost Analysis complete • Implement effective cost monitoring, cost control and cost avoidance initiatives to eliminate waste, optimize productivity • Increase efficiency within the constraints of cost and schedule

47. Cost Plus Award Fee Contract • Award Fee Criteria Examples (continued) • Other Cost Related • Business Case Analysis is completed and submitted, • Performance to program cost estimate • Quality of cost reporting data • Contract Status Funds Report • Man-Hour Expenditure Chart • Funds & Man-Hour Expenditure Report • Program Status Report • Contract Data Status/Schedule Report

48. Cost Plus Award Fee Contract • Award Fee Criteria Examples (continued) • Other Sources of Ideas for Evaluation Criteria • See Profit Analysis section at the end of this presentation • Review DoD Weighted Guidelines for ideas and factors (DFAR 215.404-4)

49. Cost Plus Incentive Fee Contract • Suitable for use only when uncertainties involved in contract performance do not permit costs to be estimated with sufficient accuracy to use any type of fixed price contract (FAR 16.301-2) • “Initially negotiated fee is adjusted later by a formula based on the relationship of total allowable costs to target cost. There is a negotiated target cost, a target fee, minimum and maximum fees, and a fee adjustment formula. After performance of the contract, the fee payable to the contractor is determined in accordance with the formula.” (FAR 16.405-1(a)) • Technical and performance incentives based upon objective measurement criteria may also be used. (FAR 16.405-1(b)(2)) • Many incentive fees spread out during the life of the program may be used

50. Cost Plus Incentive Fee Contract • Incentive Fees • See award fee examples in CPAF section. Many of them are objective or could be converted to objective criteria. • Limitation of Cost (FAR 52.232-20) • See CPFF discussions on Limitation of Costs • Limitation of Funds (FAR 52.232-22) • See CPFF discussions on Limitation of Funds • Fees (FAR 52.216-10) • Minimum Fee based on cost specified at award • Maximum Fee based on cost specified at award • Other Incentive Fees • No maximum on sum of fees • Best Practices • See CPFF and CPAF Best Practices