Pentagon Protected From ‘Open-Ended’ F-35 Overruns, Lynn Says

The Pentagon is protecting itself from “open-ended” cost overruns on Lockheed Martin Corp. (LMT)’s F-35 jet, such as the $918 million estimated on the first three production contracts, Deputy Defense Secretary William Lynn told lawmakers last month.

The fourth production contract that’s been signed, a fifth that’s in negotiations and future orders “will include equitable sharing arrangements, as well as a ceiling price so as to cap the government’s liability” Lynn wrote July 25 to members of the Senate Armed Services Committee.

“The Department intends to prevent excessive overruns by continuing” the fourth contract’s approach and “aggressively applying” an analysis in the next agreement of what the jets “should cost,” Lynn wrote.

“This will provide a maximum limit on the Department’s liability for cost growth, increase the contractor’s incentive to control costs and ensure” the fifth production contract results in the “lowest price achievable,” Lynn said.

The Pentagon is “closely monitoring and concerned about cost growth in the program,” including a preliminary $1 trillion for long-term sustainment of the jets that’s “unacceptable and unaffordable,” Lynn wrote the committee chairman, Democrat Carl Levin of Michigan, and the panel’s top Republican, John McCain of Arizona. Bloomberg News first reported the estimate in April.

Overruns Shared

The lawmakers wrote Defense Secretary Leon Panetta last month expressing concern with cost overruns on the first 28 F-35s. Lockheed and United Technologies Corp. (UTX) will pay as much as $283 million to defray about one-third of the overrun while the government covers the rest, the program office and company said.

Lynn reminded the lawmakers the fourth production contract signed in November is the first of many future F-35 contracts that will employ fixed-priced provisions.

Lockheed, the No. 1 defense contractor, would earn $441 million in profit if it hits cost targets set in the contract.

The Bethesda, Maryland-based company has the potential to earn more -- or less -- depending on the eventual production cost of the fighter jets.

The $3.9 billion Lockheed contract sets a “target cost” of $3.46 billion for 32 aircraft plus a “target profit” for Lockheed Martin of $440.9 million, or nearly 13 percent, according to the Pentagon’s program office.

Lockheed and the Pentagon would share equally any savings if the jets cost less to build than the target cost. Similarly, they would share cost overruns up to 120 percent of that figure. The full burden would fall on Lockheed for overruns above that.

Shifting Funds

Lynn told the lawmakers that Pentagon officials negotiating the fifth production contract are “examining every element of cost.”

Separately, Lynn answered questions Levin and McCain posed about a pending Pentagon request to cover part of the overrun by shifting, or “reprogramming,” $179 million from other programs and $85 million in unearned Lockheed fees.

The lawmakers asked for the implications of rejecting the request to shift funds.

Lynn said one result may be to cancel three Air Force versions to pay for part of the overrun.

To contact the reporters on this story: Tony Capaccio in Washington at acapaccio@bloomberg.net;

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net.

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