Contract Management: Observations on DOD's Financial Relationship With
the Anthrax Vaccine Manufacturer (Testimony, 06/30/99,
GAO/T-NSIAD-99-214).

Pursuant to a congressional request, GAO discussed the contractual
relationship between the Department of Defense (DOD) and the BioPort
Corporation for production of the anthrax vaccine, focusing on: (1)
DOD's investment in BioPort's biologic facility and contracts to produce
the vaccine; (2) BioPort's cash flow situation; and (3) proposals to
improve the company's financial health.

GAO noted that: (1) DOD has made a significant investment in renovating
BioPort's biologic facility to meet the military's requirements for
anthrax vaccine; (2) however, BioPort has experienced delays in
completing its renovation efforts, and as a result, production of the
vaccine is about 5 months behind schedule; (3) because of the delays,
the company has not received the revenues it expected and now faces a
serious cash flow problem; (4) the cash flow problem, GAO believes, is
due to the company's inability to achieve its overly optimistic business
plan; (5) 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; (6) in addition, the
company has proposed several actions to resolve its financial problems,
including asking DOD for advance payments and increasing contract
prices; and (7) DOD officials are considering what actions, if any,
should be taken to resolve BioPort's cash flow problem.

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

 REPORTNUM:  T-NSIAD-99-214
     TITLE:  Contract Management: Observations on DOD's Financial
	     Relationship With the Anthrax Vaccine Manufacturer
      DATE:  06/30/99
   SUBJECT:  Immunization services
	     Chemical warfare
	     Biological warfare
	     Department of Defense contractors
	     Financial analysis
	     Contract administration
	     Defense procurement
IDENTIFIER:  DOD Anthrax Immunization Program

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GAOSEAL.EPS GAO United States General Accounting Office

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 Wednesday,
June 30, 1999

CONTRACT MANAGEMENT

Observations on DOD's Financial Relationship With the Anthrax
Vaccine

Manufacturer Statement of Louis J. Rodrigues, Director, Defense
Acquisitions Issues, National Security and International Affairs
Division

GAO/T-NSIAD-99-214

Page 1 GAO/T-NSIAD-99-214

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 BioPort.

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 Let t er

Page 2 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 BioPort's Biologic Facilities Since 1988, DOD
has provided about $112 million in contracts, including

options, to help ensure the viability of the anthrax vaccine
biologic facility. As shown in figure 1, DOD's contracts provided
monies to (1) 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

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.

0 20

40 60

80 100

120 Vaccine

Renovation/ Expansion Support services

Equipment Total

Dollars in millions

Awarded Option

Let t er

Page 3 GAO/T-NSIAD-99-214

BioPort's Cash Flow Problems

BioPort's renovation efforts have taken longer than expected and
delayed production about 5 months. As a result, the revenues the
company 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 expenses.

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

Source: Independent accountants' reports.

1 BioPort considers 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.

-7 -6

-5 -4

-3 -2

-1 0

Fiscal Year Lossesinmillionsof dollars -0. 9 -2. 6 -6. 5 -6. 6

1993 1994 1995 1996

Page 4 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's Financial Health BioPort recently
requested and received DOD's authorization to sell 70,000 doses of
anthrax vaccine to other customers. DOD has approved the

sale of 30, 000 doses to the Canadian Armed Forces, in part so the
company 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 5 GAO/T-NSIAD-99-214

Figure 3: Contract Prices and Production Requirements

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.

0 1

2 3

4 5

6 7

8 Base Year Option I Option II

Price per dose Quantity of doses to be produced

5 6 8

7 4 3 2

0 1

Page 6 GAO/T-NSIAD-99-214

Page 7 GAO/T-NSIAD-99-214

Page 8 GAO/T-NSIAD-99-214

Appendix I Related GAO Products Ap pe ndi x I

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)

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