Breakout Session # 810 Nicholas Sanders Director, West Coast Government Contracts Practice

2. Performance-Based Payments: FASA’s Step-Child Grows Up Breakout Session # 810 Nicholas Sanders Director, West Coast Government Contracts Practice PricewaterhouseCoopers LLP April 27, 2005 2:25 – 3:25 PM NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

3. Surprise! – The Step-Child is Born • FASA (1994) • “A tsunami of procurement reforms” • “Streamline the acquisition process and minimize burdensome government-unique requirements” • No Agency had asked Congress for PBPs • Industry not pushing for financing reform NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

4. PBPs – The Infancy is Problematic • More an effort to reform DoD program management than a contract financing reform • DoD’s first look: “not sure what it meant” • 1995: FAC 90-33 creates FAR 32.1 • Narrowly tailored toward sole source acquisitions of non-commercial items • Use prohibited on competitive awards NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

5. PBPs – The Toddler Has Potential • 1998: Spector Memo • “PBPs have proven to be an effective means of providing contract financing, with reduced burden to both government and contractors.” • 1999: DoD Class Deviation • “DCMC anticipates this change will result in reduced indirect expenses … and will reduce the administrative costs associated with cost-based financing.” NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

6. PBPs – The Kid Stays in the Show • March 2000: FAC 97-16 • “Preferred Government financing method when the contracting officer finds them practical, and the contractor agrees to their use” • Used on competitively awarded FP non-commercial acquisitions • Including R&D contracts and FP subcontracts under CP primes • Excluding Part 14 Sealed Bidding acquisitions NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

7. PBPs – Reaching Adolescence • Nov. 13, 2000: Gansler Memo • “Both parties should be able to reduce non-value added cost-based oversight.” • GOAL: By GFY 2005, PBPs “should be the most prevalent form used in fixed-price contracts, such as those for complex services or for production efforts.” NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

8. PBPs – Reaching Adolescence • January 2001 DoD Guide to Incentive Strategies for Defense Acquisitions • “… DoD has begun to change the traditional control mechanisms used to ensure reasonable prices, on-time delivery, product quality and superior performance.” NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

9. PBPs – Reaching Adolescence • January 2001 DoD User’s Guide to Performance Based Payments • Revised 30 November 2001 • PBP “strengthens the government industry relationship and further’s DoD’s commitment to revolutionize its business affairs.” NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

10. Government Enhanced schedule and technical focus Reinforced program manager and IPT roles Broadened contractor participation Contractor Enhanced cash flow Reduced administrative expense PBPs – The Promised Advantages NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

11. Progress Payments Up to 80% of incurred costs for large businesses Up to 85% for small businesses Incurred costs must be adjusted per 52.232-16 PBPs Up to 90% of contract, CLIN, or SLIN value (including profit component) Incurred costs not relevant to PBP values after end of negotiations Enhanced Cash Flow??? NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

12. PBPs – Interesting Quotes from the User’s Guide – 1st Edition • “The contracting officer should encourage the contractor to submit PBP requests electronically, by facsimile, or even telephonically.” • “The parties must … be as innovative as possible in designing processes that provide for expedited review and payment times while adequately protecting the government’s interests.” NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

13. So What are PBPs? • Contract financing payments • “Preferred method” when C.O. finds them practical and contractor agrees to their use • Based on attainment of individual, objective contract milestones (“trigger events”) • Trigger events – and their billing values – are the subject of bilateral negotiations during contract formation NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

14. So What are PBPs? (Continued) • Accomplishment of milestone = entitlement to receive negotiated amount of financing payment • NOT payments for accepted items • NOT progress payments based on costs incurred • NOT progress payments based on % complete NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

15. So What are PBPs? (Continued) There is NO regulatory relationship between PBPs and performance-based contracts. NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

16. PBP Details • Severable events = stand-alone events not tied to any other action • Example: “Submission of software development plan” • Cumulative events require prior or concurrent completion of other events • Example: “Completion of system integration testing” NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

17. When To Use PBPs • FP non-commercial contracts that qualify for contract financing • Probability of progress is high, such as follow-on contracts or for work that is very similar to prior contracts NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

18. When Not to Use PBPs • Sealed bids • Contracts for A/E services, construction, or shipbuilding • Contracts where progress is uncertain • R&D contracts NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

19. When Can Contract Financing Be Used?FAR 32.104(a) (Large Businesses) • First delivery at least six months ARO • Contract expenditures will significantly impact contractor’s cash flow • Contractor demonstrates actual financial need or unavailability of private financing NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

20. PBPs in Solicitations • Include clause 52.238-28, Invitation to Propose Performance-Based Payments (March 2000) • If use of PBPs will have a significant impact on determining best value offer, adjust proposed price to “reflect the estimated cost to the government” IAW FAR 32.205(c) NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

21. Progress Payments Contract type risk profit factor between 2.0 and 4.0 percent PBPs Contract type risk profit factor between 2.5 and 5.5 percent But note that PBP values and their frequency will affect C.O.’s analysis PBPs and DoD’s Weighted Guidelines Profit Analysis NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

22. Defining Events Utilize program execution schedule Need not be on critical path Must represent meaningful and essential steps in work execution Determining Values May have some relation to expenditure of funds Contractor will trade profit for cash flow Any rational basis may be used, including engineering estimates [FAR 31.1003(b)(4)] Negotiating PBP Trigger Events NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

23. Defining Events Do not represent meaningful performance (e.g., passage of time) Do not match production process Not enough, or too many Determining Values Advance payments (valued too high) No contractor incentive (valued too low) Failure to understand actual cash flow needs Negotiation No-No’s NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

24. Agree on Accomplishment • Objective, precisely defined, easy to measure • How is event accomplishment determined? • How will the contractor document? • How – and when – will the C.O. verify? • These are contract financing payments; avoid over-emphasis on verification • Pre-payment verification usually unnecessary • Avoid adding burdens PBPs were designed to eliminate NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

25. Incorporate the PBP Schedule Into the Contract • PBP event identifier • Brief description • If cumulative event, list associated events • CLIN/SLIN identifier • Funding information (e.g., ACRN) • Valuation amount • Rough date of planned occurrence NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

26. Contract Modifications will Affect the PBP Schedule • Add new PBP events to cover new or modified efforts; or • Revise existing event definitions, measurement methods, timing, or values; or • Other contract modifications that reflect agreement of the parties NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

27. Contract Modifications will Affect the PBP Schedule (Continued) • Whenever changes are made to a contract’s PBP structure, a revised summary should be distributed to all parties • The responsible payment office may be unable to promptly process payments if its contract information is not current NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

28. Processing PBP Payment Requests • Pre-payment verifications of event accomplishment not required by regulations or guidance • C.O. has discretion • Contractor performance record, financial strength, adequacy of admin. controls • “Post-payment reviews and verifications should normally be arranged…” • See FAR 32.1007(c) NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

29. Processing PBP Payment Requests (Continued) • Requiring contractor to submit voluminous supporting documentation undermines intent of PBP regulation and guidance • PBP payments not subject to Prompt Payment Act • WAWF-RA can process PBPs NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

30. Processing PBP Payment Requests (Continued) • PBP payment requests must contain • Contractor name and address • Date of payment request • Contract number/identifier • Contract-mandated documentation • Certification NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

31. Progress Payments Adequate accounting system and controls Property title with Gov’t. until progress payment liquidated PBPs Adequate records and controls Property title with Gov’t. until PBP liquidated Choosing Between PBPs and Customary Progress Payments NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

32. PBPs and LDD Gov’t. Property • Contractor must repay any PBPs related to LDD property needed for performance • Values of all PBP events associated with LDD property must be refunded • Versus contractor must repay unliquidated progress payments based on costs allocable to LDD property NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

33. Progress Payments Failure to comply with contract requirements Failure to make progress Unsatisfactory financial condition Excess contract inventory Payment delinquencies related to any contract costs Unliquidated amounts exceed fair value of undelivered contract work Contractor profit erosion PBPs Failure to comply with contract requirements Failure to make progress Unsatisfactory financial condition Supplier or subcontractor payment delinquencies Payment Reduction or Suspension NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

34. Progress Payments Repay all unliquidated amounts Residual property title vests with contractor PBPs Repay all unliquidated amounts Residual property title vests with contractor Default Termination NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

35. Final Thoughts • So far: no litigation, no defaults, no bankruptcies, no reported fraud • Some improper PBP events • “Definitization of contract; completed upon contractor signature” • “Attendance at Management System Review” • Some alleged “advance payments” NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

36. Final Thoughts (Continued) • PBPs represent a trade-off between initial negotiation efforts and administrative efforts • Upfront investment results in streamlined administration • Problems are encountered when the parties do not invest sufficient time in negotiating the PBP schedule NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”

37. Final Thoughts (Continued) • Compared to customary progress payments based on costs, PBPs represent a true paradigm shift that creates value for both Government and contractor NCMA World Congress 2005 “Prime Time: Contract Management at the Core of the Enterprise”