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State Auditor Mike Foley Examines State's Web Site Contract That

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State Auditor Mike Foley Examines State's Web Site Contract That Powered By Docstoc
					FOR IMMEDIATE RELEASE                        Contact: Mike Foley
October 23, 2007                             State Auditor’s Office: (402) 471-2111




                 State Auditor Mike Foley Examines
        State’s Web Site Contract That Flows Profits to Kansas

(LINCOLN, NE) State Auditor Mike Foley released a “white paper” prepared by his office that
examines a longstanding government contract with a company called Nebraska Interactive (NI) -- the
firm that has managed the official Nebraska State government web site since 1995.

        Nebraska Interactive (NI) is a wholly-owned subsidiary of NIC USA, Inc. based in Olathe,
Kansas. Since the year 2000, roughly $1.5 million in profits generated from the Nebraska State
government web site have flowed to the Kansas parent company. In addition, the Nebraska subsidiary
company now has an accumulated net worth of $1.2 million – all of which is owned by the Kansas
parent company.

      “I understand the corporate contractors that we do business with need to operate in a for-profit
manner,” said Foley. “Now we must look to the future of the ever-expanding world of on-line
government services and decide if the current arrangement is in the best interests of the taxpayers of
Nebraska.”

        During the most recent fiscal year, there were over $5.6 million dollars in gross revenues from
transactions on the portion of the State’s web site developed by NI – a figure that is growing steadily.
In addition, other State agencies, such as the Game and Parks Commission offer on-line services that
total more than $1 million in annual revenue. The Game and Parks on-line services operate separate
from the services under the NI contract.

        Of the $5.6 million in gross revenues on the NI developed web pages, about $3.5 million went to
the state agencies.

       Insurance companies and financial lenders used the Department of Motor Vehicles web site to
buy approximately $2.3 million in driver records and perform title, lien and registration searches on
vehicles last year. Other corporate and institutional users of the web site spent $726 thousand
procuring various corporate filings available from the Office of the Secretary of State. Employers,
attorneys and others doing background checks and court case studies spent $85 thousand last year to
review Nebraska District and County Court cases through the State Supreme Court’s state-wide court
records data base.
        When these transactions occur, the web site contractor, NI, receives a fee to cover its costs of
developing the software that enables the on-line search and purchase of State government records. A
chart in the white paper shows a steadily rising revenue stream to the contractor for its portion of the
financial transaction.

        The status of the current contract with NI is a matter pending before the State Records Board
who will take up the question at a November 14th meeting at the State Capitol. State Auditor Foley
serves on the State Records Board as do the other Constitutional officers and other parties. The board
will vote on whether or not to re-bid the contract or extend it for an additional one year period. Another
possibility discussed in the white paper is that of having the web site development work incorporated
into the functions of an existing State government agency with web site development expertise.

        Copies of the State Auditor’s white paper and a response white paper prepared by Nebraska
Interactive (NI) are attached to this press release.
                                       Nebraska.Gov
                       White Paper for Nebraska State Records Board

Situation
The Nebraska State Records Board (NSRB) must make a determination on whether or not to
extend the existing contract for network manager services between the NSRB on behalf of the
State of Nebraska (State) and Nebraska Interactive, LLC (NI), formerly Nebraska Interactive,
Inc., for one additional year. Network manager services include marketing, developing, and
maintaining the State’s web portal to governmental information and services. This portal was
originally called Nebrask@ Online and is now called Nebraska.Gov.

NI has been the contracted Network Manager for Nebraska.Gov (formerly Nebrask@ Online)
since 1995. The initial term of the current contract was February 1, 2004 to January 31, 2007.
The contract also contained two additional extension periods. The first was a two year period
from February 1, 2007 to January 31, 2009, that has already been exercised. The second period
is for one year, February 1, 2009 to January 31, 2010. The second extension period is the one
currently under consideration.

The NSRB must notify NI by January 31, 2008, their intention to extend the contract for the
additional one year period or let it expire at the end of the current term, January 31, 2009.

If the NSRB extends the current contract for the specified one year period, it will expire on
January 31, 2010. The NSRB would spec and bid out a new three-year provider contract during
calendar year 2009. The new contract would be effective February 1, 2010.

If the NSRB decides not to extend the current contract beyond January 31, 2009, it would spec
and bid out a new three year provider contract during calendar year 2008. The new contract
would be effective February 1, 2009.

In either situation, the current contract states “…upon termination as provided in the terms of this
contract, NSRB shall be entitled to a non-exclusive perpetual right-to-use-only license with
rights to modify as it desires (either itself or using Approved Contractors), for no additional
compensation, to the software as it exists as of that date.” This would mean that the NSRB
would still be able to use all Nebraska.Gov web functions that exist on the termination date until
the new vendor would be able to implement their software applications.

Background
All of NI’s employees are Nebraska residents and the majority of the work required to support
Nebraska.Gov is done in Lincoln by local staff.

NI is a wholly owned subsidiary of NIC USA, Inc., based in Olathe, KS. NIC was founded in
1991 when it developed the nation’s first electronic government services for the State of Kansas.
They currently maintain long-term eGovernment outsourcing contracts with 20 states and three
local governments per their own website.

NIC’s core business solution is the self-funded model, which allows governments to build
eGovernment services without using taxpayer funds. This is the model that the State and NI use
in the current contract. Under this model, NI, as the vendor, is responsible for the development
costs and revenue collection of all services offered on Nebraska.Gov. State agencies and NI
work together to develop services that can be provided through the web. The Agencies charge

Prepared by Auditor of Public Accounts      Page 1 of 6                           October 23, 2007
                                           Nebraska.Gov
                           White Paper for Nebraska State Records Board

their standard fees that they would charge for a walk-up, mail, or phone request. NI also charges
an agreed upon convenience fee for utilizing the web access portal. This convenience charge is
the primary revenue stream for NI.
Services currently available through Nebraska.Gov include:
    • Drivers Records Searches
    • Title and Lien Searches
    • Full access to the JUSTICE state-wide court records system
    • Corporate Entity Searches (including document images and Letters of Good Standing)
    • Sales Tax Permits
    • EFS (Effective Financing Statements) Searches
    • UCC (Uniform Commercial Code) Filing and Searches

Under terms of the current contract, NI receives 90% of this convenience charge directly. The
NSRB also receives 5% of the convenience charge. The remaining 5% of the convenience
charge is to be used by NI to develop new services or make improvements to existing services, as
directed by the NSRB.

NI is also at risk for collecting all funds for services and convenience charges from usage of
services on Nebraska.Gov. Monthly, they remit all fees for services and convenience fees for the
previous month to the NSRB, whether NI has collected them or not. The NSRB then distributes
the proceeds from service fees to the appropriate State agencies and remits the 90% of
convenience fees due back to NI.

Below is a chart compiled by the APA from NI’s monthly Payment Statement Summaries for
State Fiscal Year 2007, July 1, 2006 through June 30, 2007, showing the breakdown of fees
collected by NI for State agencies through Nebraska.Gov. This only reflects State agency fees
which are collected through Nebraska.Gov and does not include State agencies collections which
are processed through other on-line services.

                             Total fees collected Statewide were $3,520,844.
                                                      Sectetary of State, $726,374




                                                                           Health & Human Services,
                                                                                   $148,210

                                                                              State Records Board,
                                                                                    $144,330

                                                                               Natural Resources,
                                                                                   $129,910

                                                                               Supreme Court, $85,459

                                                                              Legislative Council, $1,050




             Motor Vehicles, $2,285,511




Prepared by Auditor of Public Accounts        Page 2 of 6                                           October 23, 2007
                                                               Nebraska.Gov
                                               White Paper for Nebraska State Records Board

          NI has seen steady growth in revenues from their contract with the State. Below is a chart
          complied by the APA from Nebraska Interactive, LLC audited annual financial statements issued
          by PricewaterhouseCoopers LLP.
                       $2,500,000




                       $2,000,000




                       $1,500,000




                       $1,000,000




                         $500,000




                              $-
                                           2000           2001           2002          2003          2004        2005            2006
                   Revenues             $1,170,047      $1,288,085     $1,437,746    $1,537,980   $1,859,457   $2,036,243      $2,155,732
                   Cost of Revenues      $870,122       $933,364       $1,213,425    $1,186,474   $1,392,658   $1,531,798      $1,757,991
                   Operating Income      $299,925       $354,721       $224,321       $351,506     $466,799    $504,445        $397,741


          NI’s annual financial reports are issued on a calendar year basis, January 1st through December
          31st. Revenues reported in their annual financial statements are for NI’s portion of the fees paid
          for on-line services. Cost of portal revenues includes all direct costs associated with operating
          the portal on an outsourced basis including employee compensation, telecommunications, data
          processing, maintenance, and all other costs associated with the provision of dedicated client
          service such as office facilities as noted in NI’s annual financial statements.

          Below is a table of NI’s net profit (after taxes), distributions to shareholders, and net advances
          from (payments to) affiliated companies complied by the APA from Nebraska Interactive, LLC
          audited annual financial statements issued by PricewaterhouseCoopers LLP.

Calendar Year                           2000           2001            2002           2003          2004          2005             2006          Total
Net Income after Taxes                $ 203,000      $ 230,005       $ 139,834      $ 216,083     $ 287,477    $ 256,557       $ 316,263     $ 1,649,219



Distribution to shareholders                                         $ (680,364)                                                             $   (680,364)
Advances from (payments
to) affiliated companies, net         $ 153,300      $ (695,869)     $ 470,360      $ (398,375)   $ (28,245)   $ 28,368        $ (386,471)   $   (856,932)
Total Distributions &
Advances                                                                                                                                     $ (1,537,296)




          Prepared by Auditor of Public Accounts                          Page 3 of 6                                       October 23, 2007
                                       Nebraska.Gov
                       White Paper for Nebraska State Records Board

Considerations
   • Anecdotal evidence from several State agencies indicates that the level of service
      provided by NI is not meeting the State’s expectations. Agencies have turned to other
      vendors for their individual web needs. Agencies that have turned to the Nebraska Office
      of the Chief Information Officer (CIO), a division of the Department of Administrative
      Services (DAS), for service to meet their needs include the Historical Society,
      Department of Revenue, Real Estate Appraiser Board, and Game & Parks. Game &
      Parks specifically will begin contracting with the CIO to develop a new online permit
      issuing system in November 2007. The CIO’s was awarded this contract based upon the
      strength of their proposal submitted in a competitive bidding process. Game & Parks
      collects approximately $1 million annually from on-line services. The quality of service
      provided by NI to several major agencies that provide significant contract revenues has
      also come into question and may require the attention of the Board.

   •   If the Board finds that services and quality of performance have been lacking with NI
       under the current contract, then the Board should consider several options, one of which
       is putting the contract out for bid in 2008 if that would result in a greater benefit for the
       State in 2009. However, another option might be to require the current vendor to provide
       firm assurances to improve service and performance to the expected standard under the
       existing contract, allowing an extension for 2009 without the disruptions of a change of
       vendor in 2009. Either way the State under these circumstances would be benefited
       compared to extending the current contract “as is” through 2009.

   •   The CIO has recently been increasing its ability to provide the same services within the
       State and now has 14 developers on staff. While the CIO did not offer to bid in 2004, the
       CIO may be able to do so in either 2008 or 2009, depending upon whether the existing
       contract is extended through 2009 or not. If the CIO were capable of bidding and secured
       the contract, this might create a potential significant cost savings to the fee users of the
       online services of Nebraska.Gov as well. With no profit motive, the CIO might deliver
       the same services for reduced user fees or keep the existing user fees thus providing the
       CIO with resources to develop new services faster and to improve existing services. A
       new contract bidding and bid evaluation process might shed additional light on these
       issues.

   •   As shown in the chart above, since the year 2000, NI has generated over $11.5 million in
       fees from on-line services and has spent about $8.9 million on the operations of the
       Nebraska.Gov web site. Thus the enterprise has garnered about $2.6 million in gross
       profits since the year 2000. On an after tax basis, the net income earned by NI was $1.65
       million since the year 2000.

   •   While NI is a Nebraska corporation, NIC, the parent corporation, is not. Of the $1.65
       million in after tax profits earned by NI in Nebraska, about $1.5 million flowed to the
       Kansas parent company.

   •   NI’s December 31, 2006 balance sheet reports total assets of about $1.7 million, and total
       liabilities of about $500,000; thus NI has a net worth of approximately $1.2 million, all of
       which is owned by the Kansas parent corporation.

Prepared by Auditor of Public Accounts     Page 4 of 6                           October 23, 2007
                                       Nebraska.Gov
                       White Paper for Nebraska State Records Board


   •   With the growth of IT companies in recent years, a new public bidding may bring new
       local companies into the bidding with innovative and progressive proposals. Allowing
       emerging new bidders in 2008 might be invigorating to the public bidding process.
       While Nebraska law does not allow any special privileges in the public bidding process to
       be extended to Nebraska-based companies, it would seem beneficial to allow more
       frequent bidding to give local IT companies at least an opportunity to compete for the
       contract.

   •   There was considerable interest in the contract the last time it was bid out. The
       mandatory pre-proposal meeting was attended by 38 representatives from 28 vendors.
       Seven vendors ultimately submitted proposals. These numbers indicate there is strong
       competition in this area and a new bidding may result in better services or rates for the
       State.

Conclusion
While the State has enjoyed a productive relationship with NI, a one year extension of the
existing contract through 2009 does not appear to offer a greater benefit than putting the contract
out for bid again. Competition in the market and the State’s strong RFP process will help to
ensure the State’s limited resources are used to the greatest advantage for taxpayers. Putting the
contract out for bid has four possible outcomes:

   1. A less beneficial contract is entered into by the State one year earlier than if an extension
      had been granted.

   2. NI remains the vendor of choice, with no real changes in contract terms.

   3. NI remains the vendor of choice, with a better proposal than the current contract.

   4. A new vendor is selected, providing a better proposal than the current contract.

Of these possible outcomes, two are positive, one is neutral, and one is negative. With only one
possible negative outcome, it would seem to be in the best interest of the State to put this
contract out for bid and not grant a one year extension of the current contract.




Prepared by Auditor of Public Accounts     Page 5 of 6                           October 23, 2007
                                       Nebraska.Gov
                       White Paper for Nebraska State Records Board

The Auditor of Public Accounts (APA) appreciates the response received from Nebraska
Interactive, LLC (NI) to the APA’s White Paper for the Nebraska State Records Board.

The APA wishes to address NI’s several observations regarding the APA’s white paper.

   •   NI Reinvestment – NI’s response: “The white paper does not address NI’s payment of
       portal operating expenses, or NI’s ongoing reinvestment in the portal – which has totaled
       more than $8.8 million over the past six years.”

       APA Response: The white paper does address NI’s payment of portal operating
       expenses and ongoing reinvestment in the portal. This is reflected in the graph on page 3
       as Cost of Revenues. As noted in the white paper, these were compiled from Nebraska
       Interactive, LLC audited annual financial statements issued by PricewaterhousCoopers
       LLP. As noted in these financial statement: “Cost of portal revenues includes all direct
       costs associated with operating the portal on an outsourced basis including employee
       compensation, telecommunications, data processing, maintenance, and all other costs
       associated with the provision of dedicated client service such as office facilities.” The
       APA also noted on page 4 in the fourth bullet that “NI has generated over $11.5 million
       in fees from on-line services and has spent about $8.9 million on the operations of the
       Nebraska.Gov web site.”

   •   Implications of Bid/Re-Bid Decision – NI’s response: “The APA’s characterization of
       the possibility of a “better” contract does not define what “better” would be, and does not
       take into account the risk that the state would not be able to obtain this “better” contract
       in the market.”

       APA Response: Better was not specifically defined as it would not be possible to define
       what all possible “better” outcomes would be. “Better” is intended to merely mean a
       contract containing terms that are more advantageous to the State than the current
       contract. The APA does address the “…risk that the state would not be able to obtain this
       “better” contract in the market.” One of the four possible outcomes listed by the APA is
       “A less beneficial contract is entered into by the State one year earlier than if an
       extension had been granted.”

   •   Relationship Issues – NI’s response: “NI is not privy to the “anecdotal evidence”
       mentioned by the APA and welcomes the opportunity to learn more about it and address
       any concerns that have surfaced to others.”

       APA Response: The “anecdotal evidence” that the APA mentions should not be
       anything that NI is not aware of. The “anecdotal evidence” referred to by the APA is
       from informal discussions with other State agencies regarding their experiences working
       with NI. The APA is also aware that the Secretary of State and the Nebraska State
       Records Board has contacted State agency directors and is conducting an on-line survey
       regarding their experience with Neb.gov since the beginning of the current contract.




Prepared by Auditor of Public Accounts     Page 6 of 6                           October 23, 2007
October 22nd, 2007


   Response Of Nebraska Interactive, LLC, to Auditor of Public Account’s White
          Paper on Nebraska.gov for the Nebraska State Records Board

Nebraska Interactive (NI) appreciates the opportunity to respond to the Nebraska State
Records Board (NSRB) regarding the Auditor of Public Account’s (APA) White Paper
on Nebraska.gov.

NI has a distinguished history of outsourced management and application
entrepreneurship with Nebraska.gov. There are few self-funded eGovernment providers
in the private sector because it is a complex solution. To be clear — self-funded
eGovernment is not just about technology or individual software development efforts.
Self-funded eGovernment is about many dimensions that must be leveraged effectively,
including funding model proficiency, political outreach, payment processing, security,
marketing, customer service, public relations, training, accessibility & usability, and Web
design.

Over the past 12 years Nebraska Interactive has competitively bid three different times
(1995, 1997, 2003) and was, each time, awarded contracts with the state of Nebraska to
perform enterprise eGovernment services. During this time, NI maintained positive and
productive long-term relationships with 115 state agencies, cities and counties. We have
developed 109 eGovernment applications, designed nearly 100 web sites, and
Nebraska.gov and our partners have received numerous awards including Best of the
Web recognition in five of the last seven years. Best of the Web is a nationally
recognized award presented to state governments by the Center for Digital Government
for excellence in the provision of eGovernment services to constituents.

NI wishes to provide you for your consideration several observations regarding the APA
opinion paper:

   •   NI Reinvestment – The white paper does not address NI’s payment of portal
       operating expenses, or NI’s ongoing reinvestment in the portal - which has totaled
       more than $8.8 million over the past six years.
   •   Implications of Bid/Re-Bid Decision - In regard to the impacts of a bid versus
       re-bid, there are additional negatives that should be considered by the APA and
       the NSRB. The APA’s characterization of the possibility of a “better” contract
       does not define what “better” would be, and does not take into account the risk
       that the state would not be able to obtain this “better” contract in the market. Our
       view is that the current contractual terms are very advantageous to the state of
       Nebraska and could likely not be replicated by another provider with less
       experience in delivering enterprise eGovernment services.
   •   Relationship Issues - NI manages relationships through a Service Level
       Agreement approved by the NSRB with 115 agencies, cities and counties -- in
       addition to its relationship with the NSRB itself. It is expected that every
       relationship will have challenges from time to time. The important thing is how
       those challenges are addressed and remedied, and NI’s record in that regard is
       very strong. NI is not privy to the “anecdotal evidence” mentioned by the APA
       and welcomes the opportunity to learn about it and address any concerns that have
       surfaced to others.
   •   Nebraska – Centric - All NI’s employees are Nebraska residents. All of the
       work required to support Nebraska.gov is done in Lincoln by our local staff.
        Unlike many IT providers, we do not send projects to remote locations or
       parachute management into the office for occasional visits. This approach has
       allowed us to develop especially strong and mutually beneficial relationships
       across the state enterprise and with the NSRB in particular. There is no guarantee
       that any other replacement vendor would be Nebraska-based, or have a parent that
       is Nebraska-based.

As is illustrated by the chart on page 3 of the APA opinion paper, NI has successfully and
consistently increased the portal fee revenue earned through online services (Cost of
Sales) by nearly 100% in the six years from 2000 through 2006. Nebraska.gov’s revenue
has also increased by 100% during the same period because NI has a successful program
to market and drive adoption of each new application developed. This is positive news
for NSRB and the state of Nebraska because it illustrates that portal usage by constituents
continues to grow over time.

Increased revenue also means increased resources to build additional portal services and
to hire additional portal employees for development, maintenance and marketing. In
addition to the many new fee services launched during this time, an even greater number
of services for which no fee is charged (and which are therefore supported by the fee
services) were launched.

Revenue does not mean profit. The transparency that NI offers in its financial reporting
means that expenses are reported as expenses, and thus have no “margin”, or profit,
added to them. A typical software services company would charge a “fully loaded” rate
per hour for development, marketing, and so forth (with expense, overhead, and profit all
figured in the hourly rate). Management of Nebraska.gov on an “enterprise basis” means
that the gross profits the portal reports are the money available to pay all the portal’s
operating expenses (salaries, utilities, connectivity, rent, third party vendors, and so
forth), and thus the net income NI reports is actually its “fee” for the work that it does.
The enterprise model means that NI takes the risk of making no profit (or fee), and also
takes the risk of reinvestment paying off within the contract term.

In the chart on page 3, two significant dips in gross profit are shown, one in 2002 and one
in 2006. Both dips are results of key initiatives that required additional investment, above
and beyond our yearly investment, by NI (enterprise Web development for counties and
Cybertrust security certification making Nebraska.gov one of the most secure online
portals in the world). Reinvestment is a constant in any successful online environment.
Technology is always improving, service standards are constantly rising, and online
security threats are never-ending and constantly escalating. Periodically, larger than
normal investments are needed and as shown NI is willing to make both normal and
larger than normal investments. The self-funded model requires a contract term long
enough for the vendor to justify its on-going investments as well as its additional
investments of the type NI has made. Nothing will damage the self-funded model faster
than a series of short-term contracts, which will have the unintended effect of
discouraging exactly the type of investments that are most needed to deliver quality
services to the residents and businesses of the state of Nebraska.

The above discussion addresses the 90% of the convenience fee that actually flows by
contract to NI for all the purposes indicated above, such as portal operating expense
payment, reinvestment, NI’s fee, etc. For this portion, it is NI’s job to prospect with the
state agencies and initiate eGovernment projects, under the general oversight and
guidance regarding priorities given by the NSRB. Regarding the other 10%, the APA
correctly indicates that it is divided into two 5% portions, both under the direct control of
NSRB. One 5% portion is used by NSRB to direct NI to undertake projects that it desires
to be built. The other 5% is allocated by NSRB for its own Board expenses, including
staff salaries, and for grants to agencies, other vendors, or NI to complete projects as
requested and approved.

The APA cites four possible outcomes associated with putting the contract out for bid.
NI believes that there are three additional high risk negative outcomes overlooked by the
APA. First, the state ends up with a vendor that is an unknown entity in the portal
management role -- regardless of whether the proposal is better, worse, or the same.
Second, that under any of the outcomes, a rebid is a costly, though periodically legally
necessary procedure, that expends both resources of the state (in drafting the bid,
assessing the proposals, interviewing the candidates, negotiating a contract, and
accomplishing a transition, if needed) and of each vendor (in NI’s case, these resources
would be diverted from delivering additional portal services in favor of responding to the
state’s bid). Third, short-term contracts are a strong deterrent to needed capital
investment, as discussed above.

The market has been competitively bid twice in the past, most recently in 2003, and will
be again in 2009. It is not clear at all what advantage would be gained by a rebid one year
earlier. Our recommendation is to execute the remaining renewal term on the existing
contract. We are an established entity in the state with an outstanding track record of
success and are poised to continue the delivery of innovative eGovernment services on
behalf of the state.

We also welcome the opportunity to address performance issues that may exist; at the
same time, we must voice our concern regarding these unsubstantiated allegations that
were made in the document. In the spirit of our long-term and highly successful
partnership with the state of Nebraska, we hope that the state will continue to maintain
open lines of communications so any issues can be resolved quickly and to the state’s
satisfaction.

We look forward to continuing to make Nebraska.gov one of the finest government web
services portals in the world.




Brent Hoffman
President
Nebraska Interactive, LLC

				
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