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Defense Contractor Restructuring: DOD Risks Forfeiting Savings on Fixed-Price Contracts (Letter Report, 07/17/98, GAO/NSIAD-98-162).

Pursuant to a legislative requirement, GAO provided information related
to defense contractor restructuring, focusing on: (1) the Department of
Defense's (DOD) use of contract price adjustment clauses, also called
reopener clauses; (2) DOD's limited use of reopener clauses for
fixed-price contracts; and (3) the potential benefits of using reopener
clauses in future business combinations.

GAO noted that: (1) the time it takes for restructuring savings to be
included in DOD contract prices can be considerable; (2) for the
contractor business segments GAO examined, it took an average of about
21 months from the announcement of the acquisition or merger to the time
that contractors reflect the restructuring savings in reduced overhead
rates; (3) during this period, DOD awarded over 600 fixed-price
contracts or contract modifications worth about $3.9 billion; (4)
however, despite repeated recommendations from the Defense Contract
Audit Agency and Defense Contract Management Command, contracting
officers rarely included reopener clauses for savings in fixed-price
contracts awarded during this period; (5) with reopener clauses,
contract prices that were negotiated before savings and were included in
overhead rates used to price DOD contracts could be adjusted downward
once savings were determined, thereby reducing contract costs; (6)
without reopener clauses, DOD cannot recoup its share of restructuring
savings; (7) DOD contracting officers cited various reasons for not
using reopener clauses; (8) these reasons included the desire to have
contracts with no loose ends and concerns that the use of the clauses
would cause an excessive administrative burden in renegotiating contract
price adjustments; (9) another factor that appeared to influence the use
of reopener clauses is the level of contractor resistance; (10) also,
one contractor commented that such a clause was not required by current
DOD regulations; (11) the use of reopener clauses can result in
substantial savings to DOD; (12) in one case in which a reopener clause
was exercised, the contract price was reduced by almost 4 percent, or
about $1.8 million; and (13) unless DOD takes steps to include reopener
clauses in its fixed-price contracts with companies forming business
combinations, it risks losing further substantial savings resulting from
contractor restructuring.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-98-162
     TITLE:  Defense Contractor Restructuring: DOD Risks Forfeiting 
             Savings on Fixed-Price Contracts
      DATE:  07/17/98
   SUBJECT:  Department of Defense contractors
             Defense procurement
             Contract costs
             Defense contracts
             Procurement regulation
             Defense cost control
             Overhead costs
             Price adjustments
             Fixed price contracts

             
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Cover
================================================================ COVER


Report to Congressional Committees

July 1998

DEFENSE CONTRACTOR RESTRUCTURING -
DOD RISKS FORFEITING SAVINGS ON
FIXED-PRICE CONTRACTS

GAO/NSIAD-98-162

Defense Contractor Restructuring

(707295)


Abbreviations
=============================================================== ABBREV

  DCAA - Defense Contract Audit Agency
  DCE - Defense Corporate Executive
  DCMC - Defense Contract Management Command
  DFARS - Defense Federal Acquisition Regulation Supplement
  DOD - Department of Defense

Letter
=============================================================== LETTER


B-277897

July 17, 1998

The Honorable Strom Thurmond
Chairman
The Honorable Carl Levin
Ranking Minority Member
Committee on Armed Services
United States Senate

The Honorable Floyd Spence
Chairman
The Honorable Ike Skelton
Ranking Minority Member
Committee on National Security
House of Representatives

Section 818 of the National Defense Authorization Act for Fiscal Year
1995 (P.L.  103-337) requires us to report periodically to the
Congress on the implementation of the Department of Defense's (DOD)
policy on defense contractor restructuring.  We have issued three
reports pursuant to this legislative requirement.\1 This report
focuses on DOD's use of contract price adjustment clauses, also
called reopener clauses, which can be used to ensure that DOD
receives its fair share of contractor restructuring savings on
fixed-price contracts awarded to companies involved in a business
combination between the time a combination is announced and the time
that restructuring savings are reflected in the mechanism used for
pricing contracts.\2 Specifically, we discuss (1) DOD's limited use
of reopener clauses for these contracts and (2) the potential
benefits of using reopener clauses in future business combinations. 


--------------------
\1 See Related GAO Products for these and other reports on defense
contractor restructuring issues. 

\2 See appendix I for examples of restructuring savings reopener
clauses. 


   BACKGROUND
------------------------------------------------------------ Letter :1

As a result of the significant decline in defense expenditures since
the late 1980s, defense contractors have been consolidating and
restructuring their operations to increase efficiencies and become
more competitive in the defense marketplace.  Many of the
consolidation and restructuring activities resulted from defense
contractor acquisitions and mergers.  In July 1993, the Under
Secretary of Defense for Acquisition concluded that it was in the
government's best interest to encourage defense contractors to
consolidate and restructure their operations, which was expected to
reduce costs to DOD.  To achieve that goal, the Under Secretary
stated that DOD would pay restructuring costs on contracts
transferred as part of a merger or acquisition if the business
combination was expected to result in overall reduced costs for DOD
or preserve a critical capability that might otherwise be lost. 

Due to concerns about DOD paying defense contractors to restructure
their operations after a business combination, the Congress enacted
section 818 of Public Law 103-337 in October 1994.  This legislation
prohibited payment of any restructuring costs until a senior DOD
official certified that projections of restructuring savings from the
business combination were based on audited cost data and should
result in overall reduced costs to DOD.  In the conference report on
this legislation, the conferees stated that contracting officers and
auditors should understand that they have no obligation to pay
restructuring costs in the absence of detailed evidence of the
benefit to the government.  DOD codifies federal acquisition policy
in its Defense Federal Acquisition Regulation Supplement (DFARS). 

The Congress further limited DOD's authority for paying restructuring
costs in section 8115 of the DOD Appropriations Act for Fiscal Year
1997.  That legislation prohibited payment of these costs for
business combinations occurring after September 30, 1996, unless (1)
restructuring savings for DOD were projected to exceed allowed costs
by a factor of at least two to one or (2) the projected savings to
DOD were to exceed the costs allowed and the Secretary of Defense
determined that the business combination would result in the
preservation of a critical capability.  The Secretary of Defense is
currently required by 10 U.S.C.  2325 to determine in writing that
the projected savings will be at least twice the amount of allowed
costs or that the savings will exceed costs allowed and that the
combination will result in the preservation of a critical
capability.\3

DOD projects that its share of restructuring savings will amount to
$4.1 billion and that its share of the restructuring costs will
amount to $856 million, which represent a net savings of $3.3
billion.\4 Restructuring savings come from both direct and indirect
costs.  Direct costs are identified specifically for each contract. 
Indirect costs, on the other hand, represent the general operation of
the business.  Indirect costs are often referred to as overhead costs
and include expenses that benefit all contracts at a particular
business segment, such as maintenance, plant security, and legal and
accounting expenses.  The contractor recovers these overhead costs
through forward pricing rates, which are rates negotiated between the
government and the contractor to use in pricing future contracts. 
When restructuring activities reduce indirect costs, DOD realizes the
savings through lower overhead charges to its contracts. 


--------------------
\3 National Defense Authorization Act for Fiscal Year 1998, Public
Law 105-85, November 18, 1997. 

\4 These figures include the six certified combinations as well as
one combination that is not subject to the certification requirement
but is included in DOD's reports to the Congress on defense industry
restructuring. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

The time it takes for restructuring savings to be included in DOD
contract prices can be considerable.  For the contractor business
segments we examined, it took an average of about 21 months from the
announcement of the acquisition or merger to the time that
contractors reflect the restructuring savings in reduced overhead
rates.  During this period, DOD awarded over 600 fixed-price
contracts or contract modifications worth about $3.9 billion. 
However, despite repeated recommendations from the Defense Contract
Audit Agency and Defense Contract Management Command, contracting
officers rarely included reopener clauses for savings in fixed-price
contracts awarded during this period.  With reopener clauses,
contract prices that were negotiated before savings were included in
overhead rates used to price DOD contracts could be adjusted downward
once savings were determined, thereby reducing contract costs. 
Without reopener clauses, DOD cannot recoup its share of
restructuring savings. 

DOD contracting officers cited various reasons for not using reopener
clauses.  These reasons included the desire to have contracts with no
loose ends and concerns that the use of the clauses would cause an
excessive administrative burden in renegotiating contract price
adjustments.  Another factor that appeared to influence the use of
reopener clauses is the level of contractor resistance.  Also, one
contractor commented that such a clause was not required by current
DOD regulations. 

The use of reopener clauses can result in substantial savings to DOD. 
In one case in which a reopener clause was exercised, the contract
price was reduced by almost 4 percent, or about $1.8 million.  Unless
DOD takes steps to include reopener clauses in its fixed-price
contracts with companies forming business combinations, it risks
losing further substantial savings resulting from contractor
restructuring. 


   REOPENER CLAUSES FOR SAVINGS
   HAVE BEEN RARELY USED
------------------------------------------------------------ Letter :3

The Defense Contract Audit Agency (DCAA) and the Defense Contract
Management Command (DCMC) have repeatedly recommended that
contracting officers use reopener clauses for savings when
negotiating fixed-price contracts with business combinations. 
Despite billions of dollars in contracts awarded between the
announcement of the acquisition or merger and the time that
contractors reflect the restructuring savings in reduced overhead,
reopener clauses for savings have rarely been used.  In fact, the
business segments we reviewed identified only 12 instances in which
reopener clauses were included in contracts.  One of those reopener
clauses has been successfully exercised, resulting in $1.8 million in
recouped restructuring savings, or about 4 percent of the contract
price. 


      DOD AWARDED BILLIONS TO
      BUSINESS COMBINATIONS
---------------------------------------------------------- Letter :3.1

The time between the announcement of a business combination and the
point at which restructuring savings are reflected in reduced
contract prices to DOD can be considerable.  For the contractor
business segments we reviewed, the time ranged from 11 months to 3
years and averaged almost 21 months.  During this period, DOD
continued to negotiate noncompetitive fixed-price contracts with the
contractors involved in business combinations.  DOD awarded the
contractor business segments we reviewed over 600 noncompetitive
fixed-price contracts worth about $3.9 billion. 

In those contract awards we reviewed, uncertainty over the impact of
restructuring on overhead rates was frequently discussed during
negotiations and, as a result, some overhead rates fluctuated
significantly.  For example, records of one negotiation stated that
the buyer received new overhead rates about every 45 days.  Records
from another negotiation stated that the contractor had used five
different sets of rates to develop its proposal.  In addition, some
contractors were involved in more than one business combination.  For
example, one contractor was involved in four business combinations
between November 1992 and April 1996.  In some cases, contractors had
merged or acquired again before overhead rates could be updated to
include savings from the prior combination, which started the whole
process over as restructuring costs and savings were calculated for
the new combination. 

In this fluid and uncertain environment, fixed-price contracts would
normally be risky for both the buyer and the seller because such
contracts, once awarded, cannot be repriced.  This risk is
particularly significant for DOD because restructuring savings are
expected to significantly exceed restructuring costs and are more
difficult to estimate than restructuring costs. 

DOD addressed the contractors' risk by allowing restructuring costs
to be included in their overhead rates before certification, provided
that the contract include a downward reopener clause to remove
restructuring costs if the combination was not certified.  However,
DOD does not require reopener clauses to ensure that it receives its
appropriate share of restructuring savings.  Rather, DOD leaves the
use of such clauses to the discretion of the contracting officer. 


      REOPENER CLAUSES FOR SAVINGS
      ARE FREQUENTLY RECOMMENDED
      BUT RARELY USED
---------------------------------------------------------- Letter :3.2

DCAA and DCMC have repeatedly cautioned buying commands and
contracting officers to protect the government's interest when
negotiating fixed-price contracts with companies involved in business
combinations, often recommending the use of downward reopener clauses
to ensure that the government can claim its share of restructuring
savings.  In some cases, DCAA provided examples of reopener clauses
that could be used. 

Although DCAA and DCMC can recommend reopener clauses for savings,
the contracting officers ultimately decide whether to use them. 
Contractors identified only 12 instances in which contracting
officers included reopener clauses in fixed-price contracts with the
business segments we reviewed.  DOD awarded these contractors over
600 noncompetitive fixed-price contract actions worth about $3.9
billion between the time the combination was announced and the time
that restructuring savings were reflected in overhead rates.  Six of
these awards with reopener clauses--all at the same business
segment--have a combined value of less than $12 million; DOD awarded
that business segment 142 noncompetitive fixed-price actions worth
almost $873 million during this period. 

Contracting officers and negotiation records cited various reasons
for not using reopener clauses, including the preference to have
contracts without loose ends and concerns about the administrative
burden of reopening a contract.  Another factor that appears to
influence the use of reopener clauses is contractor resistance.  In
one Navy buying command, where reopener clauses for savings were
generally not used, we found three instances in which the clauses
were considered but not used partly due to contractor resistance. 
For example, in the case of a $116 million award for electronic test
equipment, the contracting officer said that the contractor was not
receptive to a reopener clause and was even less receptive to another
proposal that the Navy not pay restructuring costs or pay reduced
restructuring costs instead of including a reopener clause. 

The Navy also considered reopener clauses in a $63 million aircraft
retrofit contract and an initial $123 million aircraft production
contract.\5 These contracts were awarded in June and December 1994,
respectively, with performance through 1997 and 1998.  This business
combination had been announced in March 1994, but there was no
restructuring proposal or restructuring agreement with the government
until 1996.  For the two business segments affected by these
contracts, the savings were not reflected in overhead rates until
September 1995 and March 1996.  According to the Navy lead
negotiator, the contractor did not believe that there would be any
restructuring savings during the contract performance periods and was
not receptive to downward reopener clauses. 

Some contracting officers and negotiation records also state that
reopener clauses were not used because of the administrative burden
of reopening a contract.  When a reopener clause is exercised, the
contractor submits a repricing proposal to the buyer that meets the
criteria established in the clause.  This proposal is then audited by
DCAA and negotiated with the contractor. 

One contract that contained a reopener clause, a $49 million foreign
military sales award, has been repriced.  That contract, awarded in
April 1995, was modified in September 1997 to include $1.8 million in
recouped restructuring savings, or about 4 percent of the total
contract price.  According to the contracting officer and price
analyst, an administrative burden was associated with reopening the
contract, but these officials did not believe that the burden was
unreasonable or excessive, particularly in light of the return.  The
officials also said that the interpretation of the reopener clause
language was never in dispute; the contractor knew that it had to
provide a repricing proposal that was auditable and separated
restructuring savings from any other changes to the contract. 


--------------------
\5 The final award for this contract after negotiation was $511
million. 


   DOD IS STILL AT RISK FOR LOST
   SAVINGS FROM FUTURE BUSINESS
   COMBINATIONS
------------------------------------------------------------ Letter :4

More recently, contracting officers appear to be recognizing the
benefits of reopener clauses, and their use seems to be increasing. 
However, the use of these clauses is still limited.  Unless DOD takes
steps to include reopener clauses in its noncompetitive fixed-price
contracts for companies forming business combinations, it risks
losing further substantial savings resulting from contractor
restructuring. 

With recent business combinations, contracting officers appear to be
using reopener clauses more often than in the past.  For example,
reopener clauses for savings were not included in any DOD awards made
to one business segment while it was undergoing restructuring during
1994 and early 1995.  However, that business segment subsequently
identified 14 contracts awarded by DOD that included reopener clauses
for savings.  These reopener clauses related to additional
acquisitions after the initial business combination.  In addition, a
Navy contract awarded to that contractor in September 1997 included a
reopener clause for savings in connection with a restructuring
project remaining from the initial combination. 

Some DOD buying commands have also expressed more interest in
reopener clauses.  At one Navy command, a proposed reopener clause
was disseminated to staff from the Office of the Assistant Secretary
of the Navy.  Contracting officers at that command said that the use
of reopener clauses for savings is being stressed by the head of
contracts and, as a result, reopener clauses have begun to appear in
awards.  One contracting officer cited the increasing number of
mergers as part of the reason for this increased interest.  Other
buying offices have also acknowledged that reopener clauses can be a
useful tool to protect the government's interest. 

While some DOD buyers have shown more interest in the use of reopener
clauses for savings, some new business combinations emphatically
oppose their use.  Several DOD buying commands expressed interest in
using reopener clauses for savings in awards to a contractor involved
in two business combinations formed during 1997.  In August 1997, a
senior DCMC executive provided a recommended reopener clause to
contract administrators at the affected business segments, who
forwarded the language to DOD buying commands.  The contractor,
however, informed DCMC and DOD buyers that it would not accept the
proposed reopener clause because current DOD regulations do not
require it.  The contractor stated that, under those regulations, a
downward reopener clause is only required to remove restructuring
costs if restructuring savings are not certified by DOD.  However,
DOD officials noted that the regulations are flexible and that
contracting officers are permitted to add reopener clauses in
addition to the one required by regulations. 


   CONCLUSIONS AND RECOMMENDATION
------------------------------------------------------------ Letter :5

DOD auditors and contract administrators have repeatedly recommended
to DOD buyers that reopener clauses for savings be used in pricing
contracts with companies involved in business combinations.  However,
contracting officers have generally declined to use the clauses for a
variety of reasons, including the desire to have contracts without
loose ends and to avoid the burden of reopening them.  Contractors
may also use the lack of DOD policy requiring the use of reopener
clauses as a bargaining tool in negotiations with DOD contracting
officers.  Recent attempts to use reopener clauses appear to have
increased.  However, some new business combinations actively oppose
their use and refuse to accept them.  In one instance, the contractor
cited the absence of a DOD requirement as support for its position. 
Thus, DOD faces a challenge in negotiating timely contracts while
protecting the government's interests, and it remains at risk for
lost savings as defense industry consolidation continues. 

We believe that the contracting officers' negotiation position would
be strengthened and they would be more likely to use reopener clauses
if there were a DOD policy requiring their use.  Therefore, we
recommend that the Secretary of Defense revise DFARS to require that
contracting officers (1) include reopener clauses for savings in
noncompetitive fixed-price contracts negotiated before the benefits
of restructuring savings are reflected in reduced overhead rates used
to price contracts or (2) provide a written justification in the
negotiation records as to why a reopener clause is not needed. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :6

In commenting on a draft of this report, DOD partially concurred with
our recommendation.  DOD agrees that the use of reopener clauses will
ensure that it receives its share of restructuring savings on
non-competitive fixed-price contracts awarded to defense contractors
involved in business combinations.  However, DOD does not believe
that the mandatory use of reopener clauses in all noncompetitive
fixed-price contracts is appropriate.  DOD stated that contracting
officers must use their professional judgment on a case-by-case basis
to decide when a reopener clause is warranted.  DOD said it would
revise DFARS to require that contracting officers consider using a
reopener clause in noncompetitive fixed-price contracts.  While we
believe DOD's commitment to revise DFARS is a step in the right
direction, it does not, in our view, go far enough.  Because the
evidence indicates that few contracting officers are using reopener
clauses, in spite of continuing recommendations to do so, we believe
that DOD should (1) require contracting officers to use reopener
clauses or (2) clearly document in the contract file their reasons
for not using them.  Implementing this recommendation would more
clearly convey DOD's support of reopener clauses, while still
providing contracting officers with the flexibility to not use them,
when justified.  In this regard, a number of business combinations
are pending and others are likely as the defense industry continues
to respond to reduced defense spending.  If reopener clauses continue
to be excluded from the majority of contracts awarded to business
combinations, DOD will not receive its share of restructuring
savings.  At a minimum, regardless of how DOD revises DFARS, it
should require that any decision not to use a reopener clause be
clearly justified in the contract file. 

In addition, DOD commented that our description of DOD's procedures
used to price restructuring costs and savings into new contracts is
incomplete and gives the erroneous impression that restructuring
savings are not included.  DOD maintains that its regulations ensure
that restructuring costs and savings are priced into new contracts as
quickly as possible.  Even though DOD contracting officers may be
adjusting forward pricing rates (the mechanism used to price new
contracts) as quickly as possible, our work shows it is taking an
average of 21 months from the announcement of an acquisition or
merger to the time that contractors reflect the restructuring savings
in reduced overhead rates.  During that time, DOD continued to
negotiate and award substantial amounts of new contracts.  DOD's
comments appear in appendix II. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :7

To obtain background and program history information, we reviewed the
pertinent legislation and legislative history dealing with defense
contractor restructuring costs and DOD savings, including committee
reports and hearings regarding restructuring.  We also reviewed DOD
regulations related to restructuring; DCAA and DCMC guidance and
analyses regarding restructuring savings; and reports and analyses on
restructuring by the DOD Inspector General, the Office of Management
and Budget's Cost Accounting Standards Board, the Congressional
Research Service, and us. 

For our review, we included all the business combinations that had
been certified by the Under Secretary of Defense for Acquisition and
Technology as of September 30, 1997:  United Defense Limited
Partnership, Martin Marietta-General Electric Aerospace,
Northrop-Grumman-Vought, Martin Marietta-General Dynamics Space
Systems, Lockheed-Martin Marietta, and Hughes-CAE-Link.  For all
business combinations except Northrop-Grumman-Vought, we reviewed
specific business segments.  For Northrop-Grumman-Vought, we reviewed
the largest restructuring project, which was the consolidation of
corporate headquarters.  We obtained information from buyers
representing all the services:  the U.S.  Army Aviation and Missile
Command, the U.S.  Army Tank Automotive Command, the Air Force
Materiel Command's Aeronautical Systems Center, the Naval Sea Systems
Command, and the Naval Air Systems Command. 

We reviewed selected contracts for the buyers and business
combinations in our review to determine whether DOD auditors and
price analysts are recommending, and DOD procuring contracting
officers are using, reopener clauses for restructuring savings in
noncompetitive fixed-price contracts.  We used the DOD Individual
Contracting Action Report (DD350) database to identify such
fixed-price actions.  We used this primary source data for our
analyses because it is the official record of all DOD contract
actions over $25,000.  We did not validate or verify this data, but
we cross-checked it with buying offices when possible.  In some
cases, the buyers told us that the DD350 data was the only complete
data they had. 

From the DD350 database, we obtained data for all contracts of $20
million or more that DOD awarded to the business combinations in our
review.  For Hughes-CAE-Link, we dropped this threshold to all
contracts of $5 million or more because of the company's smaller
business base (training systems rather than weapon systems). 
According to the DD350 database, 625 fixed-price actions totaling
about $3.9 billion were awarded to the business segments in our
review during the relevant periods.  The buyers included in our
review accounted for about 38 percent of these actions and 40 percent
of the dollar amount, or 239 actions totaling over $1.5 billion. 

For contract actions, we reviewed negotiation memorandums, portions
of the contract awards, DCAA audit reports, and DCMC price analyses. 
We spoke with DOD contracting officers, other DOD procurement
officials, DCAA auditors, and DCMC price analysts.  We reviewed
guidance and other directives provided to contracting officers by DOD
buying commands.  In addition, we obtained and reviewed all
restructuring-related price adjustment clauses included in contracts
with the business segments in our review, as identified by DOD
analysts and contractor officials.  For those contracts for which
price adjustment clauses for savings were included, we determined
whether the clauses had been exercised and what the result had been. 
To do this, we spoke with responsible officials and reviewed contract
data and buying office guidance. 

We conducted our work from August 1997 to April 1998 in accordance
with generally accepted government auditing standards. 


We are sending copies of this report to the Secretary of Defense; the
Commander, DCMC; the Director, DCAA; and appropriate congressional
committees.  Copies will also be made available to others on request. 

Please contact me at (202) 512-4841 if you or your staff have any
questions concerning this report.  Major contributors to this report
are
Charles W.  Thompson, Maria Storts, and George C.  Burdette. 

David E.  Cooper
Associate Director
Defense Acquisitions Issues


EXAMPLES OF RESTRUCTURING SAVINGS
REOPENER CLAUSES
=========================================================== Appendix I

The following reopener clauses for restructuring savings have been
included in Department of Defense (DOD) awards to business
combinations.  Some of these awards were made to business
combinations that have occurred since the six combinations included
in our review. 

     "[Contractor] agrees to modify the subject contract to address
     any cost savings derived from [the contractor's acquisition of
     another contractor].  Any cost adjustments will be made on a
     downward adjustment basis only."

     ".  .  .  Within the contractually required period of
     performance of this contract, [the contractor] anticipates the
     negotiation of the external restructuring proposal which may
     impact [the Forward Pricing Rate Proposal] which formed the
     basis of the negotiated price on this contract.  Both parties
     agree to recalculate the negotiated price on a downward only
     basis based on the results of the negotiation of the external
     restructuring proposal.  This contract price adjustment, if
     required, will be executed within 90 days of DOD approval of the
     external restructuring agreement .  .  ."

     ".  .  .  At the time of negotiations for [this contract, the
     contractor] and the Government did not have a negotiated forward
     pricing rate agreement on indirect rates.  A mutual agreement
     has been formed where the contract effort may be billed with the
     rates as given in this contract until a negotiated Forward
     Pricing Rate Agreement is available with the indirect rates.  At
     that time, negotiations will reopen to finalize agreement on
     indirect rates, .  .  .  all of which will be subject to
     downward only adjustment from the date of contract award .  . 
     ."

     ".  .  .  The Government and the contractor acknowledge that
     under Public Law 103-337, in order for the Government to allow
     the restructuring costs, such costs must result in an overall
     net savings to the Government.  The Government and the
     contractor agree that, following [Under Secretary of Defense
     (Acquisition and Technology)] certification, and the following
     subsequent approval of the Forward Pricing Rates which include
     the [business combination's] restructuring impact, a net
     downward only price adjustment shall be effected .  .  ."

     "The parties hereto acknowledge that [the contractor has formed
     a business combination] and plans to submit a restructuring
     proposal to the Defense Corporate Executive (DCE).  All parties
     also acknowledge that this contract has been negotiated without
     consideration of the costing rate impact resulting from the
     submittal of the restructuring proposal and therefore any cost
     impact resulting from the final negotiation of the restructuring
     proposal shall be downward only.  After review and verification
     of the impact with the DCE, [the contractor] and the Government
     agree to modify the contract price accordingly."




(See figure in printed edition.)Appendix II
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
=========================================================== Appendix I



(See figure in printed edition.)



(See figure in printed edition.)

RELATED GAO PRODUCTS

Defense Industry Restructuring:  Updated Cost and Savings Information
(GAO/NSIAD-98-156, Apr.  30, 1998). 

Defense Industry Restructuring:  Clarification of Cost and Savings
Issues (GAO/NSIAD-97-186R, June 17, 1997). 

Defense Industry Restructuring:  Cost and Savings Issues
(GAO/T-NSIAD-97-141, Apr.  15, 1997). 

Defense Restructuring Costs:  Information Pertaining to Five Business
Combinations (GAO/NSIAD-97-97, Apr.  1, 1997). 

Defense Restructuring Costs:  Projected and Actual Savings From
Martin Marietta Acquisition of GE Aerospace (GAO/NSIAD-96-191, Sept. 
5, 1996). 

Defense Contractor Restructuring:  First Application of Cost and
Savings Regulations (GAO/NSIAD-96-80, Apr.  10, 1996). 

Defense Restructuring Costs:  Payment Regulations Are Inconsistent
With Legislation (GAO/NSIAD-95-106, Aug.  10, 1995). 

Overhead Costs:  Defense Industry Initiatives to Control Overhead
Rates (GAO/NSIAD-95-115, May 3, 1995). 

Defense Industry Consolidation:  Issues Related to Acquisition and
Merger Restructuring Costs (GAO/T-NSIAD-94-247, July 28, 1994). 

*** End of document. ***