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1 December 2016

F-35 funding in chaos

DoD and Lockheed Martin still struggling to agree contract terms

Earlier in the year I highlighted that there were serious problems with F-35 contract negotiations (Lockheed Martin names and shames the US DoD). Last week’s announcement that Lockheed is to receive $1.3bn of ‘stop gap’ funding to continue production of LRIP 10 whilst negotiations drag on, together with the unexpected and unilateral contract announcement for LRIP 9 earlier in November, indicate that the situation has got worse not better in the past four months. So what does the future hold for the programme, particularly under Donald Trump as President?

In Lockheed Martin’s 3Q earnings statement (25 Oct) the company emphasized again that it is effectively building aircraft without any idea how much it is going to be paid for them. This is a farcical situation for the largest ever military procurement programme, but sadly is indicative of the chaotic procurement processes within the US DoD.

“In 2014 and 2015, the Corporation received customer authorization and initial funding to begin producing F-35 aircraft to be acquired under low-rate initial production (LRIP) 9 and 10 contracts, respectively. The Corporation continues to negotiate these contracts with its customer. Throughout the negotiation process, the Corporation has incurred costs in excess of funds obligated and has provided multiple notifications to its customer that current funding is insufficient to cover the production process. Despite not yet receiving funding sufficient to cover its costs, the Corporation continued work in an effort to meet the customer’s desired aircraft delivery dates. Currently, the Corporation has approximately $950 million of potential cash exposure and $2.3 billion in termination liability exposure related to the F-35 LRIP 9 and 10 contracts.”

On 2 November the US DoD then issued the $6.1bn LRIP 9 contract on for 57 F-35s unilaterally, without finalising the agreement with Lockheed Martin. Negotiations to combine LRIP 9 and 10 into one big contract for 150 aircraft worth around $14bn reportedly fell apart, leading to the DoD issuing the LRIP 9 contract unexpectedly. Lockheed Martin issued another statement saying:

“The contract for LRIP 9 announced today was not a mutually agreed upon contract. We are disappointed with the decision by the government to issue a unilateral contract and we will evaluate our options and path forward.”

The $1.3bn undefinitised contract action (UCA) announced last week will cover costs incurred for long-lead work on the LRIP 10 batch of aircraft. This is the first UCA for LRIP 10 but the pentagon used the same mechanism a number of times to cover costs on LRIP 9 before awarding the full contract.The full LRIP 10 contract remains under negotiation.

The F-35 programme is too mature now to risk cancellation, the value of the export orders alone ensures that the US will pursue the aircraft. However, it is Lockheed Martin’s main driver of top line growth over the next decade, so questions must surely be asked about what margin the company is going to make on the programme?

The F-35 is likely to be high on Donald Trumps agenda when he takes office. He criticized the aircraft during his election campaign:

“I hear that it is not very good. I hear that our existing planes are better. Test pilots are saying it doesn’t perform as well as our existing equipment which is much less expensive. So when I hear that, immediately I say we have to do something because they are spending billions.”

Lockheed Martin is probably pinning its hopes on the fact that Trump and his new Defence Secretary (whoever that may be) decide the best way to improve the programme is to spend more money on it.

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