Where’s the Profit? Profit Strategies on Cost Plus Contracts

John L. BaileyVeritas Advisory Group, Inc.

1601 Elm Street, Suite 3600, Dallas TX 75201214.720.1995

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Texas A&M Stadium Expansion

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Texas A&M Stadium Expansion

Planned Scope $300 Million Total Construction Costs 3 Year Schedule Phased Construction Between Football

Seasons Public Bid for Construction Manager-At-Risk

Lowest Bidder was a Manhattan-Vaughn Joint Venture

Total Fee $3.5 Million, or ~1.2% of Construction Costs

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Example of Typical Home Office Overhead

KBR Income Statement (in millions)

2009 2010 2011 3 Year TotalTotal Revenue $12,105 $10,099 $9,261 $31,465Cost of Revenue $11,348 $9,273 $8,463 $29,084Gross Profit $757 $826 $798 $2,381Gross Profit Percent of Revenue 6.25% 8.18% 8.62% 7.57%

Selling General and Administrative $217 $212 $214 $643SGA Percent of Revenue 1.79% 2.10% 2.31% 2.04%

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Example of Typical Home Office Overhead

Home Office Overhead ExpensesSum of 2006 Sum of 2007 Sum of 2008 Sum of 2009

Wages $2,949,258 $3,985,918 $8,070,145 $7,460,035Benefits $630,724 $141,562 $561,429 $1,271,974Employee Recruitment $507,272 $325,866 $225,134Consulting $191,668 $275,541 $628,061 $447,584Insurance $406,945 $583,870 $1,027,830 $669,118Janitorial $14,638 $14,971 $15,273 $24,508Maintenance $100,037 $123,702 $197,520 $201,613Office Supplies / Postage / Misc. $625,082 $553,958 $911,705 $475,691Rents & Leases $280,266 $361,202 $602,600 $649,647Taxes $443,914 $1,111,097 $1,426,565 $1,502,763Telephone $271,805 $326,521 $477,996 $486,873Travel $525,162 $710,828 $899,863 $739,842Utilities $109,125 $111,400 $197,716 $198,996Grand Total $6,548,624 $8,807,842 $15,342,569 $14,353,778

Total Yearly Billings $57,745,370 $87,866,624 $134,843,034 $108,109,966Percent of Yearly Billings 11.34% 10.02% 11.38% 13.28%

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Potential Explanation for Low Stated Fee

High Profile Project with Marketing Benefit Relationship Building in Anticipation of Future Work Contractor Only Attempting to Cover Otherwise Idle Employee

Costs Shared Savings Clauses Incentive Bonuses

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Potential Areas for Profit Recovery

Labor Costs

Equipment Costs

Self-Performed Work

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Labor Rates vs. Costs

Rates vs. Costs Rates may simplify billings. Potential billings are understood by both parties

Areas of Concern: Do rates reflect actual costs? Do all positions include rates or include provision to fairly assign

rates? How are rates defined for salaried employees? Is overtime included within the rate?

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Definition of Allowable Rates

Wages of the construction workers employed by the Contractor to perform the construction of the Work shall be charged as a Cost of the Work at the hourly wage rates for construction workers set forth in the billable wage schedule attached hereto as Exhibit A.

In lieu of the costs paid or incurred by the Contractor for taxes, insurance, contributions, assessments and benefits required by law or collective bargaining agreements and, for personnel not covered by such agreements, customary benefits such as sick leave, medical and health benefits, holidays, vacations and pensions for construction workers shall charge, as a Cost of the Work, a flat labor burden rate of 50% of the hourly wage rate wage applicable to each construction worker as set forth in Exhibit A.

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Exhibit A Wage Rate Schedule

Position Base Labor Rate

Burden @ 50% Total Labor Rate

Laborer $21.00 $10.50 $31.50

Carpenter $34.80 $17.40 $52.20

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Profit on Billing Rates

Position Base Wage Rate

Burden (48%) Total Employee Cost

Laborer $14.00 $6.72 $20.72

Carpenter $20.00 $9.60 $29.60

Example of Actual Employee Cost:

Comparison of Costs to Billing Rates:

51015

2520

404550

6055

3035

Am

ount

(D

olla

rs)

$14.00

$6.72

$31.50 Billing Rate

$10.78

Base Wage

Burden

Profit

Laborer

51015

2520

404550

6055

3035

Am

ount

(D

olla

rs)

$20.00

$9.60

$52.20 Billing Rate

$22.60

Base Wage

Burden

Profit

Carpenter

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Profit on Billing Rates

Profit on Overtime Rates:

Regular Time Overtime

51015

2520

657075

404550

6055

3035

Am

ount

(D

olla

rs)

$20.00

$9.60

$52.20 Billing Rate

$22.60

Base Wage

Burden (48%)

Profit

$30.00

$4.50

$43.80

1.5x Base Wage

Burden on OT (15%)

Profit

1.5X Billing Rate,or $78.30

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Limiting Labor Rate Profit

Personnel Costs. The actual Worker Wage Rate for Contractor’s hourly employees and the Monthly Salary Rate of Contractor’s salaried personnel who are identified to Owner in advance and in writing but only for the time actually stationed at the Project site with Owner’s prior consent. The Project Manager’s Monthly Salary Rate may be included in the General Conditions Costs only when the Project Manager is directly located on and managing the Project. All personnel costs are subject to audit to determine the actual cost of the wages, salaries, and allowable employer contributions incurred by the Contractor for services performed for the Project.

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Limiting Burden Related Profit

In lieu of the costs paid or incurred by the Contractor for taxes, insurance, contributions, assessments, and benefits required by law or collective bargaining agreements and, for personnel not covered by such agreements, customary benefits such as sick leave, medical and health benefits, holidays, vacations, and pensions for construction workers shall charge, as a Cost of the Work, a flat labor burden rate of __% of the hourly wage rate wage applicable to each construction worker for regular time hours and a flat labor burden rate of ___% for overtime hours. Actual burden rates are subject to audit by the Owner at each year end.

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Classification of Employee

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Classification of Employee

To the extent the worker’s position is not identified in Exhibit A (Wage Rate Schedule), written approval of the employee’s position and billing rate must be received prior to billing the Owner for employee’s work hours.

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Billing Salaried Employees

Typical Wage Rate Calculation

Assuming the project engineer actually works 50 hours per week

10 Hours billed to Owner with no cost to Contractor

Position Salary Hours Rate

Project Engineer

$52,000 52 Weeks x 40 Hours

$25.00 / HR

Position Rate Hours Worked

Amount Billed

Project Engineer

$25.00 / HR 50 Hours $1,250

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Billing Overhead Costs

Contract Language Allowing Home Office Costs: Wages or salaries of Design-Builder's

personnel stationed at Design-Builder's principal or branch offices and performing the functions as set forth on Exhibit "C". The reimbursable costs of personnel stationed at Design-Builder's principal or branch offices shall include a Ten percent (10%) markup to compensate Design-Builder for the Project-related overhead associated with such personnel. 18

Billing Overhead Costs

Home Office costs can be avoided if they are instead billed directly to the Project as a Cost of Work People: Owner’s Costs, Project executive,

Accounting, HR, Computers, Bonuses, etc.. Expenses: allocation of expenses such as

computers, phones, etc..

Home Office Cost Centers

Direct Job

Costs

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Profit on Billing Rates

51015

2520

404550

6055

3035

Am

ount

(D

olla

rs)

$15.00

$31.50 Billing Rate

$16.50

Base Wage(No BurdenIncurred)

Profit

Profit on Temporary Labor:

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Limiting Profit on Temporary Employees Construction supervisors and workers that

are not direct employees of the Contractor and are utilized by the Contractor in its Work shall be billed to the Owner at the actual costs incurred by the Contractor.

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Contract Language – Equipment Billing Rental Charges not defined:

Rental charges and the costs of transportation, installation, minor repairs and replacements, dismantling and removal of temporary facilities, machinery, equipment and hand tools not customarily owned by the workers, which are provided by Design-Builder at the Site, whether rented from Design-Builder or others, and incurred in the performance of the Work.

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Contract Language – Equipment Billing

Rental Rates Defined: Rental Charges for temporary facilities,

machinery, equipment, and hand tools not customarily owned by construction workers that are provided by the Contractor at the site, whether rented from the Contractor or others, and costs of transportation, installation, minor repairs, and replacements, dismantling, and removal thereof. Rates and quantities of equipment rented shall be in accordance with the Small Tool Rate Schedule attached hereto as Exhibit B.

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Exhibit B Equipment Rates

Equipment Description Monthly Rate

4x4 Truck $1,575

Lighting Station $1,320

Radios $85

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Actual Equipment Rates

Description Actual Cost Billable Rate Profit

4x4 Truck $600 $1,575 $975

Lighting Station $825 $1,320 $495

Radios $40 $85 $45

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Limiting Equipment Billing Profit

Rental charges for temporary facilities, equipment, and hand tools (except those customarily owned by construction workers), supplied to the Project site by Contractor, provided they are included in the list of allowable General Condition line items and Owner has approved the rentals and the rental rates in advance and in writing. Rental rates may include transportation, installation, minor maintenance costs, and removal costs. For tools, machinery or construction equipment rented directly from Contractor, the rental rate, including freight and delivery costs and all operating expenses except labor, shall be approved in advance by Owner and shall be in accordance with the “Rental Rate Blue Book for Construction Equipment” published by Penton Business Media dba Equipment Watch, latest edition, but no higher than the prevailing competitive rates for rental of similar equipment in the Project vicinity.

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Self Performance of Work by the General Contractor Bidding Requirements to demonstrate

reasonableness of price Potential of Separate Accounting Record

Requirements for each scope of work Owner Access to both sets of books Controls to assure contractor costs find

proper books

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Potential Impact of Hidden Profits

Contract - $145 Million Stated Fee – 4%, or $5.8 Million Additional “Hidden Profits” - $2 Million Added Fee – 1.4% Increased Fee by 35%

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Defining Fee Components

Fee includes, but is not limited to the following items Profit Financing Costs Bonuses, Incentives, Rewards, Stock Options, etc. Salaries of personnel not stationed at Project Relocation, Travel, and Per Diem Expenses Home or Regional Office Overhead and Expenses All other expenses not specifically defined as

allowable.

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End of Contract Audit Provisions

Allows for review of billed costs to check conformance with Contract Include production of actual job cost report,

not just billing report Include production of general ledger

Taking advantage of the final audit can be a cost effective way of ensuring the amount paid is appropriate

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Veritas Advisory Group Overview

Business and Construction Consulting Firm Focus on Dispute Resolution Dallas-Based Firm with a National Practice Provide bot cost and schedule analysis within

construction-type matters Principals have over 25 years experience 22 Full Time Consultants

Engineers Certified Public Accountants Financial Analysts/MBAs Construction Industry Professionals

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