FEDERAL PRISON INDUSTRIES, INC. (FPI) INDUSTRY INVOLVEMENT GUIDELINES VIOLATION EXPANSION OF BAGS AND SACKS The Federal Prison Industries Reform Act of 1988 established the Industry Involvement Guidelines which, in part, provide procedures that FPI shall follow prior to initiating production of a new product or significant expansion of production of an existing product. Urbach, Kahn & Werlin PC, certified public accountants (UKW) reviewed Federal Prison Industries, Inc.'s (FPI) policies and procedures for ensuring compliance with the Industry Involvement Guidelines, and conducted a comprehensive historical analysis of all products produced by FPI to determine FPI's compliance with those guidelines. The UKW review identified one instance of significant expansion of an existing product in 1994 where FPI was not in compliance with the guidelines process. Significant Expansion of Bags and Sacks: Background. Bags consist of both canvas and nylon bags currently produced at seven different "cut and sew" factories. FPI includes several different types of bags under this product definition, some of which are found in different Federal Supply Classification (FSC) categories, including 5140, 8105, 8415, and 8465. The 4-digit SIC code 2393 has been used as the primary determinant to help define those items that may be classified as bags. Capacity for bag production is difficult to evaluate for purposes of the guidelines since contracts are moved between factories based on workload, and tarpaulins, other covers and speciality canvas products are produced interchangeably with bags at several textile factories. Since a majority of bag sales come from making mail bags for the US Postal Service, contract delivery requirements have resulted in large swings in sales levels since 1989. FPI sales dropped from $13.8 million in FY 1991 to $10.9 million in 1992, and then again down to only $4.7 million in FY 1993. From 1993 to 1994, sales of bags increased back to $12.8 million (nearly its previously achieved levels) due primarily to sales increases at existing factories, along with $1.5 million in sales from two newly activated facilities, Fort Dix and Manchester. Market Share. One of the biggest difficulties in monitoring potential FPI expansion is being able to determine the size of the market. This is particularly problematic since bag purchases can fall into one of several different FSC codes, and one of the largest Federal buyer of bags (the US Postal Service) is not required to report its purchases to the Federal Procurement Data Center. Compounding the difficulty of determining the size of the Federal market is the fact that Federal purchase data is unavailable for up to 12 months after the end of any fiscal year, making it difficult for FPI to monitor market share on a timely basis. In order to estimate FPI's market share for bags, UKW combined the figures for FSC categories 5140 -- Tool and hardware boxes, to include FPI's tool bags, and 8105 -- Bags and Sacks. UKW reports that these two codes account for approximately 90% of FPI's bag sales and should be reasonable to use for evaluation purposes. As calculated by UKW, FPI's three year moving average market share for bags went from slightly over 7% in 1993 to over 10.5% in 1994. Although this is somewhat due to FPI's increased sales, the level of government purchases declined from over $170 million in 1991, to just $70 million in 1994. Since production increased at the existing factories at the same time Fort Dix and Manchester began bag production and since FPI's market share increased, this production increase should have triggered a market share review and a request for Board approval at that time. It is important to point out, however, that FPI sales were actually less in 1994 than had been achieved three years earlier (in 1991). That is, even though FPI sales actually declined, the guidelines were exceeded since the original rules were based on capacity triggers rather than sales. Thus its expansion, which was based on added capacity, coupled with an otherwise declining market, led to an increase in market share which should have triggered the guidelines process. Fiscal Year 1995. Sales of bags increased again in 1995, from $12.8 million to $17.6 million. As identified in FPI's Fiscal 1995 operating plan, this increase was related to the renewed increase in demand from the U.S. Postal Service for mail bags. While FPI sales and market share increased in 1995, UKW did not determine that FPI capacity expanded in 1995 by at least 10% to trigger a market share review at that time. FPI Request for Ratification of Past Violation: FPI acknowledges the UKW finding that it should have conducted a market share review and sought Board of Directors approval before significantly expanding its capacity and market share (as a result of overall declines in the Federal market) in bag production during this same time period. UKW has recommended that the FPI Board should ratify FPI's previous bag production level as representing a reasonable share of the market for the following reasons: (1) In evaluating the potential impact of this expansion on private industry, several factors should be considered. The UKW review was unable to identify a clearly identifiable bag industry, mostly due to the accessibility of equipment and materials and the flexibility of production. The production of bags requires simple equipment, usually a series of cutting tables, sewing machines, and -- for mailbags -- a rivet machine. This allows FPI and private manufacturers the flexibility to produce a variety of cut and sew items other than bags. Most bags produced by FPI require canvas "duck" cloth or nylon which are widely available commercially. There are also many products besides bags which may be produced from these materials. (2) As indicated above, production capacity for bags was difficult to evaluate in terms of compliance with the Guidelines since contracts are moved between factories based on workload, and tarpaulins, other covers and speciality canvas products are produced interchangeably with bags at several textile factories. (3) A majority of sales come from mail bags for the US Postal Service, where contract delivery requirements have resulted in large swings in sales levels since 1989. FPI sales were actually less in 1994 than had been achieved three years earlier (in 1991). That is, even though FPI sales actually declined, the guidelines were exceeded since the original rules were based on capacity triggers rather than sales. Thus its expansion, which was based on added capacity, coupled with an otherwise declining market, led to an increase in market share which should have triggered the guidelines process, and a request for Board approval at that time. (4) Finally, but perhaps most significantly, a large portion of FPI's bag sales come from contracts to the United States Postal Service for mail bags. Since FPI does not have the benefit of the mandatory source with the Postal Service, UKW indicates that these sales should be excluded from other sales in determining the impact on private sector manufacturers. The review did not segregate these sales for the purposes of the analysis. This violation by FPI of its own rules, while, in part, related to shortcomings in internal procedures established by FPI to monitor and ensure compliance, is also significantly related to the complexities and ambiguities of the process, its product definitions, and data limitations, as detailed by UKW in the report. While FPI's new rules by no means eliminate all of these data limitations and complexities, they do provide somewhat more practical and concrete guidance on defining a product, and facilitate monitoring of production levels for expansion purposes in the future. Summary: In light of the factors described above, UKW recommends that the FPI Board of Directors retroactively ratify the past expansion in bags production. Given the particular circumstances of the expansion, including the fact that the majority of sales were to the US Postal Service, for whom FPI is not a mandatory supplier, the minimal impact, if any, FPI's production is believed to have had on the industry, and the time period when the expansion occurred, FPI concurs with UKW's recommendation, and recommends that its Board ratify this significant expansion, and bring closure to this issue. Request for Public Comment: This announcement solicits comments from interested parties concerning any impact related to FPI's failure to comply with the guidelines process during the time period in question. Comments on this notice are due within 45 days of the date of publication in the CBD. All comments received will be forwarded to FPI's Board of Directors for consideration as the Board evaluates FPI's request for ratification of this past violation. Please forward any comments to: Manager, Planning, Research and Activation, Federal Prison Industries, Inc., 320 First Street, N.W., Washington, D.C. 20534. The publication: Review of Industry Involvement Guidelines Process, Final Report, dated April 1998 and prepared by Urbach, Kahn and Werlin PC, certified public accountants is available to interested parties. Requests should be made to: Manager, Planning, Research and Activation, Federal Prison Industries, Inc., 320 First Street, N.W., Washington, D.C. 20534. Posted 09/25/98 (W-SN254613).

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