By Marina Malenic

Citing “significant errors” committed by the Air Force, the Government Accountability Office (GAO) yesterday upheld Boeing‘s [BA] challenge of the service’s decision to award a multi-billion-dollar aerial-refueling tanker contract to Northrop Grumman [NOC] and industry partner European Aeronautic Defense and Space Co.

“Our review of the record led us to conclude that the Air Force had made a number of significant errors that could have affected the outcome of what was a close competition between Boeing and Northrop Grumman,” the auditors said in a statement released June 18. “We therefore sustained Boeing’s protest.”

GAO’s statement calls on the service to reopen discussions with the two industry teams and to “obtain revised proposals, re-evaluate the revised proposals, and make a new source-selection decision, consistent with our decision.”

The Pentagon, however, warned on Tuesday that further delays in revamping its aging tanker fleet would pose a “real problem.”

The KC-X tanker aircraft is “the number one acquisition priority of the Air Force,” Defense Department spokesman Geoff Morrell told a press conference. “It is 10 years overdue. The average age of this fleet is 47 years old.”

Morrell insisted that the Air Force’s decision process had been “fair and transparent.”

But the GAO’s conclusions yesterday are bound to raise troubling questions about the Air Force’s ability to conduct a significant acquisition competition. The tanker competition marks the second rebuke from the agency over a large acquisition program since the tanker-lease scandal broke in 2004.

The Air Force last year reopened bidding on its Combat Search and Rescue replacement helicopter (CSAR-X) contract following contractor protests. Three companies seeking the CSAR-X development contract submitted their latest proposals in January. A winner is expected to be picked later in the year. Boeing initially won the contract for 141 aircraft in November 2006. Lockheed Martin [LMT] and Sikorsky [UTX] twice filed protests with the GAO, spurring the Air Force to reopen the competition.

While GAO’s decision is not binding on the Air Force, the announcement is a setback to the service’s attempt to adjust course following the forced resignations of service Secretary Michael Wynne and Chief of Staff Gen. Michael Moseley earlier this month. The two stepped down in reaction to a report in which the Air Force was faulted for oversight of the nuclear arsenal.

The Air Force awarded the tanker contract, estimated to be worth more than $35 billion, on Feb. 29. Although the Air Force intends to procure up to 179 of the aircraft, the contract in question is for an initial system development and demonstration, as well as procurement of up to 80 aircraft.

Boeing challenged the service’s technical and cost evaluations, conduct of discussions and source selection decision in a March 11 protest.

The Air Force’s original solicitation said award of the contract would be on a “best value” basis and provided bidders a detailed evaluation scheme with technical and cost factors and their relative weights. The solicitation also identified desired features of the aircraft that bidders were encouraged, though not required, to provide.

GAO’s statement says Boeing’s protest was sustained on seven counts:

1. The Air Force “did not assess the relative merits of the proposals in accordance with the evaluation criteria identified in the solicitation” and “did not take into account the fact that Boeing offered to satisfy more non-mandatory technical ‘requirements’ than Northrop Grumman.”

2. The service “used as a key discriminator that Northrop Grumman proposed to exceed a key performance parameter objective relating to aerial refueling to a greater degree than Boeing.” That decision “violated the solicitation’s evaluation provision that ‘no consideration will be provided for exceeding [key performance parameter] objectives.'”

3. The service “did not demonstrate the reasonableness” of its determination that Northrop Grumman’s proposed tanker could refuel all the service’s current fixed-wing tanker- compatible receiver aircraft in accordance with current procedures, as required by the solicitation.

4. The Air Force “conducted misleading and unequal discussions” with Boeing by telling company representatives that their proposal had fully satisfied a key performance parameter objective but later determining that it had only partially met the objective. The service, meanwhile, continued discussions with Northrop Grumman relating to its satisfaction of the same objective.

5. The service “unreasonably determined” that Northrop Grumman’s refusal to agree to a specific requirement for depot-level maintenance was an “administrative oversight” rather than a “clear exception to a material solicitation requirement.”

6. The Air Force’s evaluation of military construction costs in calculating the bidders’ most probable life cycle costs was “unreasonable.” During the protest evaluation, the Air Force “made a number of errors in evaluation that, when corrected, result in Boeing displacing Northrop Grumman as the offeror with the lowest most probable life cycle cost.”

7. The service “improperly increased Boeing’s estimated non-recurring engineering costs” by using unreasonable data inputs in a simulation model.

Boeing Vice President Mark McGraw released a statement within hours welcoming the GAO decision.

“We appreciate the professionalism and diligence the GAO showed in its review of the KC-X acquisition process,” McGraw said. “We look forward to working with the Air Force on next steps in this critical procurement for our warfighters.”

A statement from Northrop Grumman said the company would “review the GAO findings before commenting further.”

GAO said the decision in favor of Boeing “should not be read to reflect a view as to the merits” of the teams’ respective aircraft.

“Judgments about which offeror will most successfully meet governmental needs are largely reserved for the procuring agencies, subject only to such statutory and regulatory requirements as full and open competition and fairness to potential offerors,” its statement says. “Our bid protest process examines whether procuring agencies have complied with those requirements.”

GAO’s full, 69-page decision cannot be released in its entirety because it contains proprietary and source selection-sensitive information. The agency said it has instructed counsel for both parties to identify information that cannot be publicly released so that a more complete version of the document can be made available.

Despite the good news for Boeing and a quick spike up in the company’s stock price after the GAO broke the news, the company’ shares closed up less than half a percent to finish trading yesterday at $74.65, up 27 cents. There still is no guarantee the Air Force will reverse direction and award the tanker program to Boeing and Wall Street overall yesterday had to grapple with continued concerns about the financial sector and an earnings warning from shipper FedEx [FDX].