If the Defense Department fails to provide additional funding for the F-35 fighter program as the fifth production lot, aircraft prime contractor Lockheed Martin [LMT] would face a $1.2 billion termination liability by the end of 2011, the company said yesterday.
The termination liability on the next-generation multi-role fighter program stood at about $750 million at the end of September, Lockheed Martin said yesterday as part of the release of its third quarter earnings results.
Shortly after Lockheed Martin released the Joint Strike Fighter figures, the Pentagon said it remained committed to requiring the defense firm to share the costs associated with modifying the aircraft in the fifth low-rate initial production run (LRIP 5) of 30 airplanes, but would also work in “good faith” to reach an agreement on a contract.
The Defense Department awarded Lockheed Martin a $522 million contract in July 2010 for long-lead materials for LRIP 5 (Defense Daily, July 7, 2010). That funding ran out in February 2011 and since then Lockheed Martin has been pumping its own money into to program to maintain the schedule and the supply base, which is why the company says it’s so exposed by the troubled program should the government decide to cancel it.
On top of that, earlier this month the Defense Department said that additional LRIP 5 funding for the contractor that was appropriated by Congress in April will be contingent on the company accepting a “new and unprecedented contract provision,” Bob Stevens, Lockheed Martin’s chairman and CEO, said on yesterday’s earnings call.
The “concurrency clause” would require Lockheed Martin to assume more of the financial risk as part of the program for system development. Concurrency refers to the government beginning low-rate acquisition of the F-35 while development and test activities are still ongoing, which is how the aircraft program, like others before it, is being managed.
But now the government wants to shoulder less of the financial risk instead of the 100 percent it currently does for the low-rate production contracts. The F-35 Joint Program Office said all of the concurrency costs in the previous four LRIPs were covered by the government.
In describing what concurrency is, Stevens pointed out that “Neither industry nor the government can predict how these complex and sophisticated systems will behave when subjected to the extraordinary demanding environments our customers must confront.” He said that where the test program has already made revelations in the aircraft, the concurrency clause “may be workable” as the company and its partners stand behind the program.
“This kind of concept breaks down, however, when extended to cover the unknown, that is discoveries that might occur in the future but are not known and cannot be predicted today,” he said.
That means the concept needs to be explored further before “arriving at a fair and equitable cost share,” he said.
In the end, Stevens said the LRIP 5 funding should not be held hostage to the concurrency clause. He would like the LRIP contract negotiations wrapped up this year.
The F-35 Joint Program Office said it “continues to work in good faith with Lockheed Martin to discuss an agreement that is in the best interests of the American taxpayers.” JPO said it was committed to ensuring that any new contract include a cost-sharing provision for developmental modifications as outlined in an August memorandum from then-Pentagon acquisition chief Ashton Carter, who became deputy defense secretary earlier this month.
The memorandum requires the production contract for LRIP 5 aircraft “to reflect a reasonable allocation for Lockheed Martin to share in the concurrency-cost risk associated with achieving F-35 configuration and capability requirements,” the Joint Program Office said yesterday.
As for the F-35 flight test program, Stevens said it is 9 percent ahead of schedule for the year and 10 percent ahead for the year in terms of test points. In absolute terms, the flight-test schedule for 2011 is 92 percent complete completed year-to-date and 95 percent completed in terms of test points.
Regarding the financials in the third quarter, results were strong. Sales increased 7 percent to $12.1 billion from $11.3 billion while net income increased 25 percent to $700 million, $2.10 earnings per share (EPS), from $560 million ($1.54 EPS). Wall Street had expected $1.81 EPS.
The company boosted its EPS forecast for the year by a nickel to between $7.40 and $7.60 to account for higher segment operating profit.