Oregon Freeze Dry, Inc., No. 3749 (March 5, 1993). Docket No. SIZ-93-2-11-13 UNITED STATES OF AMERICA SMALL BUSINESS ADMINISTRATION OFFICE OF HEARINGS AND APPEALS WASHINGTON, D.C. SIZE APPEAL OF: ) ) Oregon Freeze Dry, Inc. ) ) Appellant ) Docket No. SIZ-93-2-11-13 ) Solicitation No. ) DLA13H-93-R-7001 ) Defense Logistics Agency ) Philadelphia, Pennsylvania ) DIGEST A challenged firm that merely adds preservatives to a complete product provided by a supplier is not a significant contributor to the manufacturing process and will not be considered the manufacturer of the end item being procured. A challenged firm will not be found to be in compliance with the 50 percent rule where its cost evidence is inconclusive and insufficient to show that its contribution represents more than 50 percent of the value of the item being procured. Where the challenged firm has entered into a subcontract with a supplier and has failed to produce probative evidence to show that it, rather than the supplier, contributes the majority of the necessary specifications for the item being procured, a finding that the two firms are affiliates under the ostensible subcontractor rule is appropriate. The scope of a Regional Office's size inquiry and determination is not limited solely to the issues raised in the size protest that initiated the size determination. DECISION March 5, 1993 BLAZSIK, Administrative Judge, Presiding: Jurisdiction This appeal is decided under the Small Business Act of 1958, 15 U.S.C. 632 et seq., and the regulations codified at 13 CFR Part 121. Issues Whether a challenged firm that merely adds preservatives to a finished product provided by its supplier can be considered to be the manufacturer of the end item being procured. Whether a challenged firm that fails to produce convincing evidence of its costs can be considered to be in compliance with the 50-percent rule. Whether a challenged firm that enters into a subcontract with a supplier but fails to produce probative evidence to demonstrate that it, rather than its supplier, contributes the majority of the necessary specifications for the item, can be found to be affiliated with its supplier under the ostensible subcontractor rule. Whether a Regional Office's size inquiry and size determination is limited to the issues raised in the size protest that initiated the size inquiry. Facts On December 16, 1992, the Defense Logistics Agency, Philadelphia, Pennsylvania, issued this solicitation for "Shelf Stable Bread" and classified it under Standard Industrial Classification code 2051 (Bread and Other Bakery Products, Except Cookies and Crackers), having a 500-employee size standard. The solicitation was totally set aside for small businesses, and the offers were due on December 24, 1992. The product to be supplied under the solicitation is for shelf stable bread that can be used by military personnel in the field as a component of "Meals-Ready-to Eat." 1/ On the same date, December 24, 1992, the unsuccessful offerors were notified that the successful offeror was Oregon Freeze Dry, Inc. (Oregon Freeze or Appellant). Award of the contract was also made to Oregon Freeze on the same day. Sterling Foods, Inc. (Sterling), received notification of the award on December 28, 1992, and filed a timely protest with the Contracting Officer on that date. 2/ In its protest, Sterling asserted that Oregon Freeze does not qualify as the manufacturer of the product to be provided but that, in fact, U.S. Bakery, Inc. (Bakery) is the manufacturer of the bread being procured and that Bakery is a large firm under the size standard at issue. Thereafter, on January 5, 1993, the Contracting Officer forwarded the protest to the Seattle Regional Office of the Small Business Administration (SBA) for a size determination. The Regional Office file contains Oregon Freeze's SBA Forms 355 and 1340, its by-laws, incorporation papers, financial information, and other data. Although the Regional Office requested that Oregon Freeze submit information on Bakery, including Bakery's SBA Form 355, Oregon Freeze failed to do so. The following uncontroverted facts are of record. Oregon Freeze is a packager of freeze dried foods. As a packager, it lacks the manufacturing capacity to produce the items being solicited and, thus, it buys the bread from Bakery, its supplier and subcontrac tor, which are shipped to Oregon Freeze in packages that already contain some preservatives such as glycerol, sugar ester, and sorbic acid. When Oregon Freeze receives the packages, it repackages them and adds pre-assembled packets of chemicals to absorb the oxygen within each package and further preserve the bread. For the applicable period, Oregon Freeze's SBA Form 355 shows that the firm employed less than 500 persons. Oregon Freeze's President is Herbert Aschkenasy; William R. Impey is the firm's Senior Vice President, and Phillip A. Unverzagt is the Secretary/Treasurer. Mr. Aschkenasy and his wife each own 38.9 percent of Oregon Freeze's stock. Oregon Freeze's SBA Form 355 also showed that Mr. Aschkenasy is Chairman of the Board of Directors of SAIF Corporation (SAIF). SAIF is a non-profit insurance underwriter, created by the Oregon State Legislature, that employs over 1,000 persons. 3/ In a narrative submitted by Oregon Freeze to the Regional Office, Oregon Freeze's Counsel stated that Oregon Freeze has entered into a subcontract with Bakery, whereby Bakery will provide all the bread required in the solicitation and Oregon Freeze will perform the preservation of the product. According to the narrative, the preservation consists of a new technology that adds an oxygen scavenger to the package containing the bread. Counsel asserted that, based upon information supplied by Bakery to Oregon Freeze, Bakery's direct labor costs are $.0144 per bun and its overhead costs are $.0181 per bun. Counsel noted that in an affidavit from Mr. Phillip Unverzagt, Oregon Freeze's Senior vice-president, supra, Oregon Freeze's direct labor costs are calculated at $.0494 per unit. Counsel asserted that this labor cost is calculated without additions for overhead and he concluded from these facts that Oregon Freeze's share of the total labor costs is more than 60 percent of the total and thus exceeds the 50-percent rule requirement set forth in 15 U.S.C. 644(o) The Regional Office issued its determination on January 28, 1993. Based upon the above facts, it first found that, pursuant to 13 CFR 121.1605(c), since Oregon Freeze failed to supply an SBA Form 355 from Bakery, or any other information concerning that firm, Bakery is an other-than-small firm for purposes of this procurement. 4/ Regarding compliance with the 50-percent rule, the Regional Office found that Oregon Freeze did not supply detailed financial data to permit a thorough and accurate cost analysis for both companies and that it could not determine with accuracy whether, in fact, Oregon Freeze was in compliance with the 50-percent rule. The Regional Office also found that, pursuant to 13 CFR 121.401(a)(1) and 13 CFR 121.401(c)(2), Oregon Freeze is affiliated with SAIF inasmuch as Mr. Aschkenasy occupies key positions in both firms, as shown before, and is, thus, in a position to control both entities (Oregon Freeze and SAIF). Accordingly, the combined employees of the two firms exceed the applicable 500-person size standard. 5/ Additionally, it found that Oregon Freeze is not the manufacturer of the product. In this regard, the Regional Office noted that the facts show that Oregon Freeze is buying a complete and finished product from Bakery, that the product as purchased is completely usable in the form in which it is received, and that Oregon Freeze is merely adding something (the preservative process) to extend the life of the product, but is not changing the product's essential nature. Thus, since there can be only one manufacturer of the end item being produced, the Regional Office concluded that Bakery is the manufacturer of the end item under the subject solicitation and, since Bakery has been found to be other than small, the product required by the solicitation is not provided by a small business. The Regional Office further found that by supplying the complete and finished product, bread, Bakery performs a fundamental role in the procurement rendering Oregon Freeze and Bakery affiliated under the ostensible subcontractor rule in 13 CFR 121.401(1)(4) since the ostensible subcontractor is performing the essential elements of the work. Based upon the above findings, the Regional Office made the following determination: Oregon Freeze Dry, Inc. and U.S. Bakery, Inc. are affiliated for the subject procurement inasmuch as the subcontractor, [Bakery], is performing the majority of the work specified in the procurement.... Oregon Freeze Dry, Inc. does not qualify as small for the subject procurement...as it is supplying the product of a concern that is other than small. Oregon Freeze Dry, Inc. is other than small for purposes of federal procurement under...size standards of 1,000 employees or less because of its affiliation with SAIF. Appellant received the size determination on January 29, 1993, and timely filed an appeal from that determination by letter postmarked February 4, 1993. 6/ Appellant raises the following arguments for reversing the Regional Office's determination. Appellant argues that, contrary to the Regional Office's finding, Oregon Freeze is the manufacturer of the product being procured. In support, Appellant argues that Oregon Freeze employs an innovative technology in adding preservatives to the product and thus makes a significant and crucial contribution that changes the essential character of the bread being supplied by Bakery. In this connection, Appellant argues that the sworn affidavit of Mr. Unverzagt, supra, demonstrates that Oregon Freeze supplies more than 50 percent of the labor costs in creating the product and, in the absence of contrary evidence, Appellant's costs must be accepted. Appellant argues that the Regional Office erroneously concluded that Oregon Freeze and Bakery should be considered affiliates under the ostensible subcontractor rule set forth at 13 CFR 121.401(1)(4). Appellant argues that its relationship with Bakery is one of supplier and purchaser and that they are engaged in a legitimate subcontractor relationship. Moreover, Bakery is merely the supplier of the product and does not have a "controlling role" in the performance of the procurement, as required by the ostensible subcontractor rule. The arrangement, thus, cannot render the firms affiliates. Appellant argues that the Regional Office's finding that Oregon Freeze and SAIF are affiliates because Mr. Aschkenasy controls both entities resulting from his position in Oregon Freeze and SAIF, is erroneous. Appellant asserts that SAIF is a non-profit state corporation and not a private business; thus, the regulation cited by the Regional Office, supra, regarding affiliates is not applicable. Finally, Appellant asserts that, since the protest did not raise the affiliation issue (affiliation between Oregon Freeze and SAIF), the Regional Office is precluded from raising the issue on its own for the first time in its size determination. Appellant also submitted an unsigned statement made by Daniel Berkowitz in support of Appellant. Mr. Berkowitz states that he is the Program Manager of Innovative Foods, Inc. and before joining that firm he was a Food Technologist in product develop- ment with the Department of the Army. Mr. Berkowitz states that he is the developer of the shelf stable bread which is the subject of the solicitation and that the development of shelf stable bread requires (a) a bread formula that is resistant staling [sic]; (b) a means for intra package oxygen removal and (c) a flexible packaging material that, when formed into a pouch that contains the bread, prevents moisture or gas transfer. This process is applied by Oregon Freeze to the bread baked by Bakery. According to Mr. Berkowitz, the dough which Bakery bakes does not have the properties necessary to be shelf stable and the changes that Oregon Freeze makes to the bread fundamentally changes the product and the nature of the bread. On February 24, Sterling filed a reply to the Notice of Appeal. Sterling maintains that, contrary to Oregon Freeze's self-serving assertions, the addition of the preservatives to the packages received from Bakery is neither a complex nor a technically sophisticated procedure. According to Sterling, Oregon Freeze simply adds the chemical packet before sealing the packages. Thus, Sterling argues, Oregon Freeze's contribution does not constitute a fundamental alteration of the product. Under these circumstances, Bakery is the entity which produces the end item for the subject procurement, not Oregon Freeze, and the latter does not qualify as the manufacturer for purposes of 13 CFR 121.906. Discussion Regarding Appellant's argument that it, rather than Bakery, is the manufacturer of the item being procured, the pertinent regulation, 13 CFR 121.906(b)(2), provides as follows: For size determination purposes, there can be only one manufacturer of the end item being acquired. The manufacturer for the purpose of this provision is the concern which, with its own facilities, performs the primary activities in transforming inorganic or organic components into the end item being acquired. The end item of a manufacturer possesses characteristics which, as a result of mechanical, chemical or human action, it did not possess before the original substances, parts or components were assembled or transformed. The end item of a manufacturer may be finished in the sense that it is ready for utilization or consumption, or it may be semifinished to become a raw material for a concern engaged in further manufacturing. Firms which perform only minimal operations upon the item being procured do not qualify as manufacturers. The following factors are evaluated in determining whether a concern is the manufacturer for the procurement: (i) The proportion of total value in the end item added by the efforts of the concern, excluding costs of overhead, testing, quality control, and profits; and (ii) The importance of the elements added by the concern to the function of the end item regardless of their relative value. Appellant's argument that its contribution to the procured item somehow transforms the character of the product to such a degree that it renders Appellant the manufacturer under the provisions of the above regulation, cannot be sustained. Appellant has given a description of the tasks it undertakes, which essentially consist of adding preservatives to the final package in order to further prolong its shelf life. The preservative process, however, could easily be added by the supplier, Bakery, and thus Appellant performs only minimal operations upon the item being procured. We have previously held that the mere adding of preservatives do not, in and of itself, constitute manufacturing within the meaning of the regulation. See, for example, Size Appeal of Evans Cooperage Co., No. 2812 (1988). In view of the case precedent, we find no merit in Appellant's contention. Moreover, while Appellant claims that its labor costs for processing the bread is over 50 percent of the total costs and, thus, it is performing more than 50 percent of the work stipulated, we agree with the Regional Office's assessment that Appellant has failed to provide detailed financial data to permit a thorough cost analysis or a clear understanding of Appellant's costs. Mr. Unverzagt's affidavit is a mere flat assertion, lacking supporting methodology. Since Appellant failed to submit any information regarding Bakery, we cannot determine the true value of either Bakery's or Appellant's contribution and cannot make a definitive conclusion regarding Oregon Freeze's compliance with the 50 percent rule. Thus, Appellant has not shown sufficient grounds to conclude that it is the manufacturer of the product. Inasmuch as Appellant had failed to supply any information concerning Bakery's size, we are affirming the Regional Office's finding that Bakery is other than small. In consequence, Appellant is supplying the product of an other-than small firm and, thus, has failed to satisfy the requirement of the above-quoted regulation. Appellant has not shown sufficient grounds for reversing the Regional Office finding that Appellant and Bakery are affiliated under the "ostensible subcontractor" rule set forth in 13 CFR 121.401(1)(4). As we observed earlier, Appellant has presented nothing on this record to demonstrate that Appellant, rather than Bakery is the dominant force behind the contract performance or that Appellant is contributing the majority of the work required by the solicitation. Under these circumstances, there is no merit to Appellant's argument in this regard. We also must reject Appellant's argument that it and SAIF are not affiliated as a result of Mr. Aschkenasy's position as President of Oregon Freeze and Chairman of SAIF. The regulation at 13 CFR 121.401(c)(2) states: Control can arise through stock ownership, occupancy of director, officer or key employee positions; contractual or other business relations; or combinations of these and other factors. The record shows that Mr. Aschkenasy is the President of Appellant and that, with his wife, has controlling interest in Appellant inasmuch as they own over 77 percent of Appellant's stock, supra. He is also Chairman of the Board of SAIF, a large firm. Thus, because he is the principal officer of each entity, he is in a position to control both companies and through this control, affiliation between the firms arises for size determination purposes. Appellant, who has the burden of proof, has failed to produce any evidence either to the Regional Office or to this Office, to contradict Mr. Aschkenasy's potential to control both entities. Moreover, Appellant's argument that SAIF is a non-profit organization and thus somehow exempt from SBA's size regulations is inconsistent with the express language of 13 CFR 121.401(a)(1), supra, mandating that for size determination purposes all affiliates, whether organized for profit or not, must be included. Last, Appellant's argument that the Regional Office improperly raised the affiliation issue although the protest was silent on this subject, is without legal basis. We have previously held that the scope of a Regional Office size inquiry and determina- tion is not limited by the issues raised in a size protest. Size Appeals of Geo-Marine. Inc. and Menendez-Donnell & Associates, No. 3459 (1991). Conclusion Based upon the above analysis, the Regional Office's determination that Oregon Freeze Dry, Inc. is other than small for this solicitation having a 500-employee size standard is AFFIRMED, and the appeal is DENIED. This constitutes the final decision of the Small Business Administration. See 13 CFR 121.1720(a), (b), and (c). ___________________________________ Gloria E. Blazsik (Presiding) Administrative Judge _____________________________________ Elwin H. White (Concurring) Administrative Judge _______________________________________ G. Stephen Wright (Concurring) Administrative Judge _______________ 1/ The solicitation's specifications concerning the product states, in part: ...the shelf life of the packaged product shall be 6 months at 80 degrees.... One baked bread unit and one FDA approved oxygen scavenger packet shall be packaged in a container consisting of, as a minimum, a coextruded laminated film form-fill- seal package.... 2/ Thus, the protest was timely filed within five business days after the date of receipt of the Contracting Officer's notification of the identity of the awardee pursuant to 13 CFR 121.1603(a)(2) and will apply to the instant solicitation. 3/ Although Oregon Freeze failed to provide any information concerning SAIF aside from the fact that Mr. Aschkenasy is its Chairman, the Regional Office obtained the other information concerning SAIF from a recent Dun and Bradstreet report. 4/ That regulation states: If such offeror does not submit the completed SBA Form 355 and its answers to the allegations within 3 working days...SBA may assume that disclosure of the form or any missing part thereof or any missing answer to the allegations would be contrary to the interests of the protested concern, and SBA may determine that the protested concern is other than a small business. 5/ The regulation set forth at 13 CFR 121.401(a)(1) provides. that an applicant include all its domestic and foreign affiliates. It also states that all affiliates. Regardless of whether organized for profit. must be included. [Emphasis supplied.] 6/ Thus, the appeal is timely filed within the five business day rule set forth at 13 CFR 121.1705(a)(2), and will apply to the present procurement.