United States General Accounting Office

GAO Report to Congressional Committees

April 1997 DEFENSE

RESTRUCTURING

COSTS

Information Pertaining to

Five Business

Combinations

GAO/NSIAD-97-97

GAO United States

General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-276318 

April 1, 1997

The Honorable Ted Stevens

Chairman

The Honorable Daniel K. Inouye

Ranking Minority Member

Subcommittee on Defense

Committee on Appropriations

United States Senate

The Honorable C. W. Bill Young

Chairman

The Honorable John P. Murtha

Ranking Minority Member

Subcommittee on National Security

Committee on Appropriations

House of Representatives

Section 8115 of the Fiscal Year 1997 Department of Defense (DOD)

Appropriations Act1

 requires us to examine restructuring costs2 of defense

contractors involved in business combinations since 1993. In response,

this report provides information on restructuring costs, including specific

costs associated with workforce reductions and the services provided to

workers affected by business combinations. It also identifies other funds

used to help laid-off workers find new employment and describes why the

effectiveness of restructuring costs used to assist laid-off workers in

gaining new employment cannot be determined. In addition, the report

discusses the extent of savings achieved from the business combinations

relative to restructuring costs paid by DOD.

To accomplish our work, we focused on five defense contractor business

combinations: (1) Hughes Aircraft Company’s acquisition of General

Dynamics Corporation’s Missile Operations, (2) the United Defense

Limited Partnership (UDLP) between FMC Corporation’s Defense Systems

Group and Harsco Corporation’s BMY Combat Systems Division,

(3) Martin Marietta Corporation’s acquisition of General Electric

Company’s aerospace and other business segments, (4) Northrop

Corporation’s acquisitions of the Grumman Corporation and the Vought

Aircraft Company to form the Northrop Grumman Corporation, and

1

Public Law 104-208, September 30, 1996.

2

Restructuring costs cover a wide range of expenses, such as personnel relocations, severance pay,

early retirement incentives, equipment relocations, plant rearrangements, and facility closures.

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(5) the merger of the Lockheed Corporation and the Martin Marietta

Corporation to form the Lockheed Martin Corporation.

Results in Brief The five business combinations had spent about $849 million at the time of

our review for such restructuring activities as the disposal and relocation

of facilities and equipment, consolidation of operations and systems,

employee relocation, and workforce reductions. Of this amount, the

business combinations spent about $89 million, or 10 percent, on

workforce reductions, which consisted of severance pay, temporary

continuation of health benefits, and outplacement services. About 

15,000 workers left the companies as a result of the business

combinations. Severance pay represented about 89 percent of total worker

benefits. Expenditures for services to assist laid-off workers find

reemployment totaled $4 million.

In addition to those services provided from restructuring costs, we

identified about $48 million in Department of Labor (DOL) grants made

either directly to the contractors or to locations where workers were laid

off as a result of the business combinations or normal downsizing.

Moreover, there were at least 163 federally funded programs and funding

streams that provided employment training assistance, of which 9 are

targeted specifically for laid-off workers. During fiscal year 1996, funding

for one of the nine programs totaled about $1.1 billion; however, no readily

available means exist to determine the extent to which the majority of

these funds, which are distributed at the state and local levels, were used

to assist workers affected by the five business combinations. The business

combinations were also providing some services that were not included in

restructuring costs, but rather were paid as normal overhead costs.

We were unable to determine the effectiveness of services for workers laid

off specifically as a result of the business combinations because

information critical to making such a determination—including

reemployment rates, workers’ previous and current salaries, and

satisfaction with their new jobs—are not maintained by the business

combinations and are not readily available from other sources. In general,

little empirical information is available on specific services that are the

most useful and cost-effective.

The Defense Contract Audit Agency (DCAA) estimated that, as of

September 30, 1996, DOD had reimbursed these business combinations

about $179 million toward its share of the $849 million the combinations

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had incurred for restructuring activities. DCAA also estimated that DOD

realized restructuring savings totaling $347 million from the business

combinations during the same period. Therefore, for every $1.00 DOD has

paid so far in restructuring costs, DOD has realized savings of $1.93. DOD

officials believe that additional savings have been realized, but they did

not document those savings. An industry representative also commented

that these estimates cover only the period through September 1996, and

therefore, do not reflect savings that may be realized in future periods. It

should be noted, however, that the estimates also do not reflect any costs

that may be incurred in subsequent periods. Finally, these estimates do not

reflect DOL grant expenditures or any assistance from other federal

programs or funding streams.

Of the $179 million paid to the business combinations, DCAA determined

that $18 million, or about 10 percent, represented additional costs to DOD

as a result of the July 1993 decision to pay for restructuring costs on

certain contracts transferred from one company to another after a

business combination. The percentage of additional costs relative to the

total amount paid may not be the same for future business combinations.

Background Prior to July 1993, DOD had a long-standing practice of not permitting

defense contractors to charge restructuring costs to flexibly priced3

contracts that were transferred4 from one contractor to another as a result

of a business combination. The rationale for this practice was that DOD

should not have to pay increased costs merely because one contractor is

combined with another contractor.

In July 1993, DOD changed its long-standing practice and uniformly began

permitting defense contractors to charge restructuring costs to transferred

flexibly priced contracts after a business combination, provided (1) the

restructuring costs were allowable under the Federal Acquisition

Regulation (FAR)5

 and (2) a DOD contracting officer determined the

business combination would result in overall reduced costs to DOD or

preserve a critical defense capability. According to DOD officials, this

3

Flexibly priced contracts are a family of contracts under which the total amount paid to the

contractor is dependent on the allowable costs the contractor incurs in performing the contract.

4

The transfer of contracts from one contractor to another involves a process called novation. The

novation process requires a written agreement executed by the seller, buyer, and government, in which

the government agrees to the transfer of its contracts.

5

The FAR contains guidelines for determining whether a particular restructuring cost is an allowable

charge to a government contract. It also describes certain organization costs, such as legal and

consulting fees applicable to business combinations, that cannot be charged to a government contract.

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action was consistent with the flexibility provided by federal regulations.

However, when asked, DOD officials stated that they were unaware of any

instances where DOD had previously allowed restructuring costs to be

charged to transferred contracts.

As a result of its concerns over the payment of these costs, the Congress

enacted section 818 of the National Defense Authorization Act for Fiscal

Year 1995,6

 which prohibited payment of restructuring costs to a defense

contractor until a senior DOD official certified that projections of

restructuring savings from the business combinations were based on

audited cost data and should result in overall reduced costs to DOD.

Section 818 also required the Secretary of Defense to report to the

Congress on DOD’s experience with defense contractor business

combinations, including whether savings associated with each

restructuring actually exceed restructuring costs.7

The Congress modified authority for paying restructuring costs in section

8115 of the Department of Defense Appropriations Act for Fiscal Year 1997

by prohibiting payment of those 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 exceeded the costs allowed and the

Secretary of Defense determined the business combination would result in

the preservation of a critical capability, and (3) the DOD restructuring

report for 1996 was submitted.

As of December 31, 1996, the Under Secretary of Defense (Acquisition and

Technology) had certified five business combinations for restructuring

payments.8

 Table 1 shows the certification dates for the business

combinations in our review. We also included in our review the

Hughes-General Dynamics business combination because DOD has

included the combination in its restructuring reports to the Congress.

However, the Hughes-General Dynamics combination did not go through

the certification process because the combination occurred prior to

enactment of the Defense Authorization Act for Fiscal Year 1995.

6

Public Law 103-337, October 5, 1994.

7

Section 818 required DOD to submit reports to the Congress on defense contractor restructuring

activities for fiscal years 1995, 1996, and 1997. DOD transmitted the required reports for fiscal years

1995 and 1996 on June 18 and December 23, 1996, respectively. We subsequently refer to these reports

as DOD restructuring reports.

8

We examined four of the five certified business combinations. We did not examine Martin Marietta

Corporation’s acquisition of General Dynamics Corporation’s Space System Division because we were

already examining two other business combinations involving Martin Marietta Corporation.

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Table 1: Business Combination

Certification Dates Business combination Date certified

UDLP May 15, 1995

Martin Marietta-General Electric:a

5 projects September 19, 1995

3 projects February 14, 1996

5 projects September 17, 1996

Northrop Grumman February 14, 1996

Lockheed Martinb November 26, 1996

aOne additional project is nearing certification.

bAdditional projects are expected to enter the certification process.

The Defense Contract Management Command (DCMC) has lead

responsibility for implementing DOD’s restructuring regulations. According

to DCMC officials, they are tracking an additional 10 defense contractor

business combinations that are currently in or expected to enter the

various stages of the certification process.

Restructuring Costs For the five business combinations we examined, certified restructuring

costs totaled about $1.4 billion. At the time of our review, the companies

had spent about $849 million (see table 2). To reflect the uncertainty in the

cost estimates and reduce the need for recertification if the costs

increased, ceilings ranging from 104 percent to 142 percent of certified

costs were established for the restructuring projects. The contractors will

not be permitted to charge DOD costs in excess of the portion of these

ceilings applicable to DOD.

9

9

Restructuring costs and cost ceilings are allocated to all of a contractor’s customers. DOD’s portion of

restructuring costs and ceilings, therefore, depends on its share of the contractor’s total business base.

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Table 2: Certified Costs, Cost Ceilings,

and Incurred Cost, by Business

Combination

Dollars in millions

Business combination Certified Ceiling Incurred

Hughes-General Dynamics $366.1a $370.0 $327.3

UDLP 36.4 38.0 38.6

Martin Marietta-General Electric 214.5 226.3 193.4

Northrop Grumman 70.4 100.1 75.1b

Lockheed Martin 686.5 724.0 214.9

Total $1,373.9 $1,458.4c $849.3

aCertified costs for the Hughes-General Dynamics combination are estimated rather than certified

because the business combination was not subject to the certification process.

bIncurred costs for the Northrop Grumman combination include an estimate of cost-to-complete

the restructuring.

cDOD indicated that its projected share of the cost ceiling totaled $809.3 million.

Restructuring after a business combination includes a wide range of

activities, such as the disposal and modification of facilities, consolidation

of operations and systems, relocation of workers and equipment, and

workforce reductions. We grouped incurred restructuring costs for the

five business combinations into broad categories (see table 3). Disposal

and relocation of facilities and equipment was the largest category of total

incurred restructuring costs.

Table 3: Incurred Restructuring Costs

by Category Dollars in millions

Category Incurred

Disposal and relocation of facilities and equipment $452.7

Relocation of employees 100.0

Benefits and services for laid-off workers 88.9

Consolidation of operations and systems 81.4

Restructuring planning and implementation 57.8

Other 68.5

Total $849.3

Costs Associated With

Workforce Reductions

In total, the five companies projected that about 19,000 workers would

leave as a result of the business combinations and, at the time of our

review, about 15,000 had left (see table 4).

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Table 4: Projected and Actual Number

of Workers Leaving Organizations as a

Result of the Business Combination

Business combination Projected Actual

Hughes-General Dynamics 6,600 6,441

UDLP 483 500

Martin Marietta-General Electric 1,171 1,222

Northrop Grumman 450 450

Lockheed Martin 10,678 6,312a

Total 19,382 14,925

aThis number will increase as Lockheed Martin completes its planned restructuring projects.

The wide variation in the number of job losses reflects differences in the

nature of the restructurings. For instance, Northrop Grumman’s largest

restructuring project involved closing the former Grumman corporate

headquarters in Bethpage, New York, resulting in the loss of about 

250 employees. By contrast, the Lockheed Martin restructuring involved

closing facilities in New Jersey, Pennsylvania, and Texas, and

consolidating various launch operations, radar and microwave operations,

and corporate laboratories.

Of the nearly $1.4 billion in projected restructuring costs, the five business

combinations estimated they would spend about $175 million for benefits

associated with workforce reductions. The costs included severance pay,

temporary continuation of health benefits, and outplacement services. The

estimated costs for worker benefits and services varied among the

combinations, ranging from 8.6 percent to 23.9 percent of total certified

restructuring costs as shown by table 5.

Table 5: Estimated Costs for Benefits

and Services for Laid-Off Workers by

Business Combination

Dollars in millions

Business combination

Total

certified

costs

Estimated costs

for benefits and

services Percent

Hughes-General Dynamics $366.1 $31.5 8.6

UDLP 36.4 8.7 23.9

Martin Marietta-General Electric 214.5 24.0 11.2

Northrop Grumman 70.4 9.3 13.2

Lockheed Martin 686.5 101.1 14.7

Total $1,373.9 $174.6 12.7

Of the $849.3 million already incurred for restructuring costs, the five

contractors had expended $88.9 million, or about 10 percent, for benefits

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and services for workers that left the corporations because of the business

combinations (see table 6). However, Lockheed Martin has not completed

its restructuring activities. Some of these activities are projected to involve

additional workforce reductions, which will lead to additional severance

and outplacement costs.

Table 6: Incurred Costs for Worker

Benefits and Services by Business

Combination

Dollars in millions

Business combination

Total

incurred

costs

Costs incurred

for benefits and

services Percent

Hughes-General Dynamics $327.3 $31.3 9.6

UDLP 38.6 5.3 13.7

Martin Marietta-General Electric 193.4 22.5 11.6

Northrop Grumman 75.1 8.8 11.7

Lockheed Martin 214.9 21.0 9.8

Total $849.3 $88.9 10.5

Severance pay was by far the largest worker benefit and comprised about

88 percent and 89 percent of the estimated and incurred costs for worker

benefits and services, respectively (see table 7). Each of the five business

combinations provided severance pay to workers, and four provided for

the temporary continuation of health benefits and other services to assist

laid-off workers find new employment.

Table 7: Costs Associated With Worker

Benefits and Services by Category Dollars in millions

Benefit or service Estimated Incurred

Severance pay $153.3 $79.5

Continuation of health benefits 13.4 5.6

Reemployment assistance 7.8 4.0

Totala $174.5 $88.9

aTotals may not add due to rounding.

Severance pay varied with such factors as whether the workers were

salaried or hourly employees and the length of time they had been with the

corporations. Additional differences were the result of the individual

contractor’s worker benefit packages before the business combinations.

For example, in the Hughes-General Dynamics combination, former

Hughes workers received severance pay, but former General Dynamics

workers did not. Also, neither the Northrop nor Vought Corporations had

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severance benefits for its workers, but the Grumman Corporation did.

After the business combination, therefore, former Northrop and Vought

workers received no severance benefits, but former Grumman workers

received the severance benefits they would have received had there been

no business combination.

Services Provided to

Assist Laid-Off

Workers Find New

Employment

The four business combinations that provided services to help workers

laid off find new employment estimated they would spend $7.8 million for

such services. At the time of our review, the four companies had expended

$4 million for these services (see table 8). The cost of these services

represents less than 1 percent of both the total certified and incurred

restructuring costs.

Table 8: Costs for Services to Assist

Laid-Off Workers Find New

Employment by Business Combination

Dollars in millions

Business combination Estimated Incurred

Hughes-General Dynamics $1.0 $1.0

UDLP 0.7 0.2

Martin Marietta-General Electric 1.4 1.6

Northrop Grumman 0 0

Lockheed Martin 4.7 1.2

Total $7.8 $4.0

The services provided to help laid-off workers find new employment fell

into two categories—educational and outplacement services (see table 9).

In the Martin Marietta-General Electric business combination, retraining

services were provided in accordance with the General Electric layoff

benefits plan. Under plant closing provisions, all former General Electric

employees were eligible for up to $5,000 tuition reimbursement for any

licensed or accredited occupational or educational courses up to 3 years

from the date of layoff. There was a requirement, however, that an

employee start at least one course within the first year after layoff. Former

Hughes employees were also provided educational benefits up to $5,000

for attendance at an accredited college or university and the successful

completion of classes that started within 1 year of the time the worker was

laid off.

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Table 9: Cost of Services to Help

Workers Find New Employment by

Category

Dollars in millions

Benefit or service Estimated Incurred

Retraining and educational assistance $2.0 $1.7

Outplacement services 5.8 2.3

Total $7.8 $4.0

In addition to providing educational assistance, Martin Marietta also

provided various outplacement services. As a result of a plant closing at

Bridgeport, New Jersey, for example, Martin Marietta operated an on-site

employment transition center for a 9-month period in 1994. Designed to

serve 392 employees affected by the plant closing, the center provided

career transition workshops, resume development, telephone and

interviewing skill practice, salary negotiations, career counseling, job

support groups, and job fairs. Martin Marietta incurred about $326,000 in

restructuring costs to operate the center. Martin Marietta established a

similar center to assist workers affected by the closing of a facility in

Conklin, New York. Restructuring costs for this center amounted to

$177,000, which included the salary costs for the center’s director and

counselor, equipment rentals, and telephone expenses.

Other Funds Used to

Assist Laid-Off

Workers Find New

Employment

In addition to services being paid through restructuring costs, services

were also funded by DOL grants and through normal overhead charges at

the business combinations. Services funded by DOL were available to

laid-off workers regardless of whether they were terminated as a result of

a defense contractor business combination or normal downsizing, and

some services were made available to workers from other companies.

However, neither DOL, the business combinations, nor the grant recipients

maintained records showing how many workers who used these services

were terminated as a result of the combination.

Services Funded by DOL

Grants

Many federally funded programs exist to assist laid-off workers find new

employment. We reported, for example, in February 1995 that at least 

163 federally funded programs and funding streams existed that provided

employment training assistance, of which 9 are targeted specifically for

laid-off workers.10 Among the most significant programs are those

authorized by the Economic Dislocation and Worker Adjustment

10Multiple Employment Training Programs: Major Overhaul Needed to Create a More Efficient,

Customer-Driven System (GAO/T-HEHS-95-70, Feb. 6, 1995) and Multiple Employment Training

Programs: Information Crosswalk on 163 Employment Training Programs (GAO/HEHS-95-85FS,

Feb. 14, 1995).

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Assistance (EDWAA) Act. In total, the Congress appropriated about

$1.1 billion in fiscal year 1996 EDWAA grants to help dislocated workers.

Funds provided under EDWAA are allocated by a formula in which

80 percent of the appropriated funds are provided directly to the states,

with the remaining 20 percent reserved for the Secretary’s discretion. The

discretionary funds may be awarded to projects for workers dislocated

due to mass layoffs, plant closures, disasters, and federal government

actions.

In addition, the Congress appropriated $150 million in fiscal year 1991 for

Defense Conversion Adjustment Program (DCAP) grants, which are

available to address the training and employment needs of workers

dislocated by defense downsizing, including consolidation actions

subsequent to cutbacks in defense budgets. DCAP grants can be awarded to

states or directly to defense contractors. The Congress also appropriated

$75 million in fiscal year 1993 for Defense Diversification Program (DDP)

grants to provide training, adjustment assistance, and employment

services to members of the armed forces and DOD and defense contractor

employees who were either involuntarily separated or laid off as a result

of reductions in defense spending.

DOL officials told us they do not collect information on whether EDWAA,

DCAP, or DDP funds were used to assist workers specifically laid off as a

result of defense contractor business combinations. These officials

indicated that some grant requests contain information that may make it

possible to relate the layoffs to specific factors such as plant closings.

However, they noted that service providers are not required to maintain

information or report on the reasons why the workers were laid off. These

officials acknowledged that because defense contractor business

combinations can result from decreases in defense spending, some of the

funds may have been used to assist workers dislocated as a result of these

business combinations.

We identified about $48 million in discretionary, DCAP, or DDP grants made

either directly to defense contractors involved in the business

combinations or to locations affected by those combinations. DOL awarded

Hughes two grants totaling $16 million to assist workers affected by

downsizing in southern California, and another two grants totaling

$1.2 million to Martin Marietta to assist workers in central Florida.

Another 10 grants—totaling about $31.1 million—were awarded to 8 states

that were affected by restructuring activities of the business combinations.

Three of these grants, totaling $21 million, were targeted to assist a group

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of 22 defense and defense-related companies or facilities in southern

California, including Northrop Grumman. A New York grant, totaling

about $5.3 million, was targeted to assist former Grumman employees.

Various outplacement services were provided under these grants,

including vocational and career guidance, job search assistance, and basic

skills training.

Although the amount of grant funds are significant for the five business

combinations we examined, DOD’s guidance for preparation of the annual

reports to the Congress on defense contractor restructuring activities does

not require reporting any information on DOL grants. Because these grants

are related to defense contractor restructuring activities, including grant

information in the reports—especially on those grants made directly to

contractors—would give the Congress useful information on funding

available to assist workers affected by defense contractor business

combinations.

Services Funded Through

Contractor Overhead

Several of the business combinations operated outplacement facilities

where workers could obtain assistance in finding new employment and

charged the operational costs to overhead expenses rather than

restructuring costs. For example, UDLP operated a center during the period

1994 through 1996 and all terminated employees—regardless of whether

they were laid off as a result of the business combination or normal

downsizing—could obtain assistance at the center in writing resumes,

arranging for job interviews, reviewing job listings, and other related

outplacement services. UDLP expended $205,000 in operating this center

during the 3-year period and paid an additional $109,000 to a consulting

firm to assist middle- and senior-level management officials find new

employment. UDLP charged these costs to overhead rather than

restructuring costs. Similarly, Northrop Grumman and Lockheed Martin

also provided counseling and/or outplacement assistance to help workers

find new employment and charged the costs to overhead expenses rather

than restructuring costs.

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Effectiveness of

Services Provided to

Help Terminated

Workers Find New

Employment Could

Not Be Determined

We were unable to determine the effectiveness of the services provided to

help laid-off workers find new employment. Like most organizations, the

five business combinations we examined did not have a comprehensive

system in place to evaluate outplacement effectiveness. Officials cited

various difficulties that prevent them from implementing such a system.

Similarly, information needed to determine the effectiveness of these

services is not readily available from DOL.

Two basic elements are required in a comprehensive system for assessing

the effectiveness of outplacement services: (1) criteria against which to

make the assessment and (2) a tracking system to collect relevant

performance information. Our work and work by DOL shows that most

organizations do not evaluate outplacement services in terms of such

criteria as whether those who received services are reemployed faster,

received higher salaries, or were more satisfied with the jobs they found

than a control group of those individuals who did not receive such

assistance.11 Participants at a recent workshop conducted by the Office of

the Deputy Assistant Secretary of Defense (Civilian Personnel Policy) and

the National Academy of Sciences concluded that no empirical work has

been able to identify the aspects of outplacement programs that are the

most cost-effective and useful in terms of these criteria.12

The business combinations we examined did not have a comprehensive

system in place to track the effectiveness of services they provided to

laid-off workers. Officials from Lockheed Martin, for example, told us that

comprehensive tracking is difficult, especially in cases of a plant closure

as there would then be no company representative on location to do the

tracking. In addition, some laid-off workers do not want further contact

with their former employer, making tracking difficult. Officials noted,

moreover, that former employees have no obligation or incentive to report

information regarding their subsequent employment status or salary

information.

Similarly, information needed to determine the effectiveness of services

provided to workers laid off as a result of the business combinations is not

11Multiple Employment Training Programs: Most Federal Agencies Do Not Know If Their Programs Are

Working Effectively (GAO/HEHS-94-88, Mar. 2, 1994); Multiple Employment Training Programs: Major

Overhaul Needed to Reduce Costs, Streamline the Bureaucracy, and Improve Results

(GAO/T-HEHS-95-53, Jan. 10, 1995); Workforce Reductions: Downsizing Strategies Used in Selected

Organizations (GAO/GGD-95-54, Mar. 13, 1995); Employment Training: Successful Projects Share

Common Strategies (GAO/HEHS-96-108, May 7, 1996); and A Guide to Well-Developed Services for

Dislocated Workers, U.S. Department of Labor, Employment and Training Administration.

12Issues in Civilian Outplacement Strategies: Proceedings of a Workshop, National Academy Press,

Washington, D.C., 1996.

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readily available from DOL. DOL does not collect certain critical information,

such as participant satisfaction with the position obtained or the relative

success of control groups who do not participate in the programs. DOL

officials stated that they did maintain information that reflects various

measures of the effectiveness of DOL-funded programs at the aggregate

level, such as whether program participants obtained a new position and

participants’ average wages before and after receiving the services. DOL

officials expressed concern, however, about using their data, noting that

the service providers do not always submit accurate or complete

information. Finally, these officials noted that they could not provide

information pertaining specifically to any of the business combinations in

our review.

Comparing

Restructuring Costs

and Estimated

Savings

Defense contractors are required to maintain accounting records showing

the actual amount and nature of costs charged to government contracts.

These costs are generally billed to government contracts during the same

period they are incurred. As discussed earlier, however, the section 818

prohibition against payment of restructuring costs until certification of net

savings creates a requirement for the contractor to segregate restructuring

costs in its accounting records and to exclude these costs from any

billings, final contract price settlements, and overhead settlements until

the certification is made. After the certification, the contractor is then

permitted to begin charging restructuring costs to DOD contracts. The

contractor generally recovers restructuring costs over a 5-year period but

the recoupment period may be shorter, depending on the terms of the

advance agreement negotiated between DOD and the contractor.

Restructuring savings, on the other hand, are not recorded in a

contractor’s accounting records. Therefore, neither the amount nor the

nature of the savings can be determined by reviewing the accounting

records. Consequently, savings have to be estimated. For example,

Northrop Grumman estimated 5-year savings from closing the Grumman

corporate headquarters of about $215 million, of which about $100 million

represents the labor and fringe costs that would be avoided over the 5-year

period by laying off approximately 250 workers. These savings are

therefore an estimate of a cost avoidance over the 5 years—the costs of the

additional people that would have been needed had the headquarters not

been closed. Savings from restructuring activities we examined were

generally in the form of such future cost avoidances.

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The initial estimate of restructuring savings is simple in concept because it

makes the critical assumption that everything else, except for the

restructuring, is the same after a business combination as before. Because

things are never the same, it is difficult to precisely identify actual savings

several years after the initial estimate is prepared. The December 1996 DOD

restructuring report acknowledges this problem. It points out that

restructuring is not the only factor that has an impact on actual costs.

Other factors affecting costs include changes in the rate of inflation,

fluctuations in the business base, and subsequent reorganizations.

At the request of DCMC, DCAA did a study of the estimated amount of

restructuring costs paid and the estimated amount of savings realized as of

September 30, 1996, for the business combinations for which DOD had

allowed restructuring costs. DCAA estimated that DOD had paid

$179.2 million in restructuring costs and realized estimated restructuring

savings of $346.7 million as of September 30, 1996, for a net savings of

$167.5 million (see table 10).

Table 10: Estimates of Paid

Restructuring Costs and Experienced

Savings by Business Combination

Dollars in millions

Business combinationa Paid costs

Experienced

savings Net savings

Hughes-General Dynamicsb $124.3 $147.9 $23.6

UDLP 9.9 22.9 13.0

Martin Marietta-General Electricc 36.7 108.2 71.5

Northrop Grummand 8.3 67.7 59.4

Total $179.2 $346.7 $167.5

aLockheed Martin was not included in the DCAA study because it was certified after

September 30, 1996.

bRepresents savings on only eight contracts.

cRepresents restructuring costs and savings from the first eight certified restructuring projects.

DCAA did not project costs and savings for the five projects certified on September 17, 1996,

because actual experience through September 30, 1996, would have been minimal.

dEstimated savings are based on two of the six projects certified. These two projects accounted

for 90 percent of total projected savings.

Measured another way, the figures shown in table 10 indicate that DOD has

realized $1.93 in savings for each $1.00 of restructuring cost paid. DOD

officials acknowledged that while their estimates reflect $1.93 in savings

for each dollar reimbursed, they believed additional savings were being

realized. They explained that DOD had based its estimate of savings for the

Page 15 GAO/NSIAD-97-97 Defense Restructuring Costs
B-276318 

Hughes-General Dynamics business combination on only eight contracts

that demonstrated savings in excess of costs. They noted that

documenting higher savings was not considered a prudent use of

resources. An industry representative also commented that the estimates

covered only the period through September 1996 and therefore do not

consider savings that may be realized in future periods. It should be noted

that the estimates in table 10 also do not reflect any costs that may be

incurred in subsequent periods. Finally, the estimates do not reflect DOL

grant expenditures or any assistance from the other federal programs or

funding streams.

Of the $179.2 million DOD has paid to these four business combinations for

restructuring costs, DCAA determined that $18 million, or about 10 percent,

was charged to novated flexibly priced contracts. The $18 million,

therefore, represents the amount of additional costs to DOD as a result of

its decision in July 1993 to allow contractors to charge restructuring costs

to novated flexibly priced contracts. It should be noted that the 10 percent

in additional costs for these four business combinations may not be

representative of the percentage for future business combinations because

of differences in factors that determine the percentage, including the mix

of flexibly priced and firm fixed-price contracts and the period of time

required for certification.

Recommendation Because direct federal grant funds can be substantial, as in the

Hughes-General Dynamics and Martin Marietta-General Electric business

combinations, we recommend that the Secretary of Defense obtain

information about significant federal direct grants to defense contractors

involved in business combinations and include this information in the DOD

annual restructuring reports to the Congress. Such information could

include the grants’ dollar values, purposes, and periods of performance.

Agency Comments

and Our Evaluation

In commenting on a draft of this report, DOD generally concurred. DOD

suggested several technical clarifications, and we have incorporated them

in the text where appropriate. DOD’s comments are presented in its entirety

in appendix I. DOL did not indicate any overall assessment of the report,

but did provide several technical clarifications, which we have

incorporated in the text where appropriate. DOL’s comments are presented

in their entirety in appendix II.

Page 16 GAO/NSIAD-97-97 Defense Restructuring Costs
B-276318 

The Aerospace Industries Association (AIA) provided comments on a draft

of this report on behalf of the business combinations we reviewed. AIA

noted that, on balance, the report was objective. AIA offered several

technical changes to clarify the information provided, which we have

incorporated in the text where appropriate. AIA’s comments are provided

in their entirety in appendix III.

Scope and

Methodology

To respond to the requirements of section 8115 of Public Law 104-208, we

selected the three business combinations for which the Under Secretary of

Defense (Acquisition and Technology) had issued a letter of certification

as of September 30, 1996. Two additional business combinations were

certified by the Under Secretary of Defense (Acquisition and Technology)

on November 26, 1996, involving the Lockheed-Martin Marietta business

combination and Martin Marietta’s May 1994 acquisition of General

Dynamics Corporation’s Space System Division. We included the

Lockheed-Martin Marietta combination because of the large amount of

restructuring costs and savings involved in this combination, but excluded

the Martin Marietta-General Dynamics combination because we were

already examining two other combinations involving Martin Marietta.

While the Hughes-General Dynamics business combination did not have to

undergo the certification process, we included it in our review because

DOD has included the combination in its restructuring reports to the

Congress.

To determine the amount and nature of restructuring costs, we obtained

information from each of the business combinations and DOD showing the

amount and nature of certified and incurred restructuring costs at the time

of our review. We analyzed the information provided by the business

combinations along with DCAA audit reports and pertinent DOD and DCMC

records to determine the amount and nature of restructuring costs

incurred for workforce reductions and to identify the cost and nature of

services provided to assist laid-off workers find reemployment. However,

we did not independently verify the information provided.

We also met with DOL officials and obtained information on federal grants

made to assist displaced defense contractor workers find new

employment. We reviewed files for grants awarded under the DOL

Secretary’s discretion or under the DCAP and DDP programs that DOL

officials identified as being targeted to locations in which restructuring

activities were occurring. To address the issue concerning the

effectiveness of outplacement services in assisting displaced workers find

Page 17 GAO/NSIAD-97-97 Defense Restructuring Costs
B-276318 

reemployment, we obtained and reviewed information provided from DOL,

DOD, academia, and each of the business combinations. In assessing

restructuring savings realized from the business combinations relative to

the restructuring cost paid by DOD, we examined the methodology DCAA

used to estimate the amount of restructuring costs paid by DOD and the

amount of estimated savings. We generally found their approach and

methodology to be reasonable and relied on their work to determine the

estimated amount of savings realized and costs paid by DOD as of

September 30, 1996.

We discussed various aspects of the restructuring costs and savings with

officials from each of the business combinations, DOD, DCMC, DCAA, the DOD

Inspector General, and DOL. Additionally, we provided summaries of our

work to the contractors’ representatives to review for accuracy.

We performed our review between October 1996 and March 1997 in

accordance with generally accepted government auditing standards.

We are sending copies of this report to the Secretaries of Defense and

Labor; the Commander, DCMC; the Director, DCAA; the Director, Office of

Management and Budget; and interested congressional committees.

Copies will also be made available to others upon request.

Please contact me at (202) 512-4841 if you or your staff have any questions

concerning this report. The major contributors to this report are listed in

appendix IV.

David E. Cooper

Associate Director

Defense Acquisitions Issues

Page 18 GAO/NSIAD-97-97 Defense Restructuring Costs
Page 19 GAO/NSIAD-97-97 Defense Restructuring Costs
Contents

Letter 1

Appendix I 

Comments From the

Department of

Defense

22

Appendix II 

Comments From the

Department of Labor

25

Appendix III 

Comments From the

Aerospace Industries

Association

28

Appendix IV 

Major Contributors to

This Report

31

Tables Table 1: Business Combination Certification Dates 5

Table 2: Certified Costs, Cost Ceilings, and Incurred Cost, by

Business Combination

6

Table 3: Incurred Restructuring Costs by Category 6

Table 4: Projected and Actual Number of Workers Leaving

Organizations as a Result of the Business Combination

7

Table 5: Estimated Costs for Benefits and Services for Laid-Off

Workers by Business Combination

7

Table 6: Incurred Costs for Worker Benefits and Services by

Business Combination

8

Table 7: Costs Associated With Worker Benefits and Services by

Category

8

Table 8: Costs for Services to Assist Laid-Off Workers Find New

Employment by Business Combination

9

Table 9: Cost of Services to Help Workers Find New Employment

by Category

10

Page 20 GAO/NSIAD-97-97 Defense Restructuring Costs
Contents

Table 10: Estimates of Paid Restructuring Costs and Experienced

Savings by Business Combination

15

Abbreviations

AIA Aerospace Industries Association

DCAA Defense Contract Audit Agency

DCAP Defense Conversion Adjustment Program

DCMC Defense Contract Management Command

DDP Defense Diversification Program

DOL Department of Labor

DOD Department of Defense

EDWAA Economic Dislocation and Worker Adjustment Assistance

FAR Federal Acquisition Regulation

UDLP United Defense Limited Partnership

Page 21 GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix I 

Comments From the Department of Defense

Page 22 GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix I 

Comments From the Department of Defense

Now on p. 3.

Now on pp. 3 and 4.

Page 23 GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix I 

Comments From the Department of Defense

Now on p. 5.

Now on p. 16.

Page 24 GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix II 

Comments From the Department of Labor

Page 25 GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix II 

Comments From the Department of Labor

Now on p. 2.

Now on pp. 2, 13, and 14.

Now on p. 11.

Now on p. 11.

Page 26 GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix II 

Comments From the Department of Labor

Page 27 GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix III 

Comments From the Aerospace Industries

Association

Now on p. 3.

Now on pp. 3-4.

Page 28 GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix III 

Comments From the Aerospace Industries

Association

Now on p. 3.

Now on p. 3.

Now on p. 4.

Now on p. 5.

Now on pp. 3 and 16.

Page 29 GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix III 

Comments From the Aerospace Industries

Association

Page 30 GAO/NSIAD-97-97 Defense Restructuring Costs
Appendix IV 

Major Contributors to This Report

National Security and

International Affairs

Division, Washington,

D.C.

John K. Harper

Timothy J. DiNapoli

Paula J. Haurilesko

John D. Heere

Rosa M. Johnson

Atlanta Field Office George C. Burdette

Erin B. Baker

Los Angeles Field

Office

Ambrose A. McGraw

Kenneth H. Roberts

Thaddeus S. Rytel, Jr.

San Francisco Field

Office

Ruth A. Hijazi

Donald Y. Yamada

(707219) Page 31 GAO/NSIAD-97-97 Defense Restructuring Costs
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