October 30, 2013

WASHINGTON – The Pentagon this week said the Lockheed Martin Corp (LMT.N) F-35 program had made sufficient improvement to plan for higher production in fiscal year 2015, but contract awards would be tied to progress on the fighter jet's software, reliability and other issues.

"Program progress is sufficient for the department to budget for an increase in the production rate in fiscal year 2015," Frank Kendall, undersecretary of defense for acquisition, technology and logistics, wrote in a memorandum dated October 28 and obtained by Reuters on Tuesday.

"Award of higher production rates will be contingent on continued program progress," he wrote in the memo. He cited the need for progress in software development, improvements in a computer-based logistics system that is behind schedule, and resolution of several previously identified design issues.

The jet's reliability is also not growing at an acceptable rate, he said in the two-page memo.

The $392 billion F-35 Joint Strike Fighter, the Pentagon's biggest arms program, has seen a 70 percent increase in costs over initial estimates and repeated schedule delays, but U.S. officials say the program has made progress in recent years.

Lockheed is developing three models of the new radar-evading warplane for the U.S. military and eight countries that helped fund its development: Britain, Canada, Turkey, Italy, Norway, Australia, Denmark and the Netherlands.

"Success on the F-35 requires progress in all aspects of the program, and I am concerned that three areas in particular need additional attention: software development ... reliability growth and ALIS (Autonomic Logistics Information System)," Kendall wrote.

He said work on the final version of the software, known as 3F, was a particular concern since it was essential to achieving the desired combat capability of the F-35, and was running behind schedule.

He said the magnitude of the production increase in fiscal 2015, which begins October 1, 2014, would be determined by Defense Secretary Chuck Hagel as the Pentagon finalizes its budget plans.

Lockheed expects to deliver 36 of the plans in 2013. Current government plans call an increase in F-35 production to 45 jets in the eighth production batch, a deal the government expects to negotiate early next year.

Those plans call for production to increase to 70 in the ninth batch of jets, of which about half would go to Britain and other foreign buyers. The Pentagon plans to award Lockheed a preliminary contract to start buying some materials for those planes later this year or early next.

In the memo, Kendall told program officials to prepare by November 15 a range of acquisition options for that ninth batch of jets that would include "strong, event-based criteria and financial incentives" for Lockheed and engine maker Pratt & Whitney, a unit of United Technologies Corp (UTX.N).

He said he wanted a range of options given uncertainty about future U.S. budget levels, and to "provide a linkage between program performance and production quantities."

Kendall said he planned to "provide strong financial incentives to LM and P&W to complete development and drive down cost in both production and sustainment."

The memo also ordered the Pentagon's top official for systems engineering to complete an independent assessment of the manufacturing risks associated with increasing production by November 15.

Kendall also asked the head of the Cost Analysis and Program Evaluation office to finalize a new estimate for the cost to operate and maintain the fleet of F-35 jets over the next 55 years as part of the fiscal 2015 budget submission.

The CAPE's previous estimate was $1.1 trillion, but the Pentagon's F-35 program office puts the cost at $857 billion.

Kendall said the production costs were under control and coming down in line with projections, and progress in the development program had been close to plan.

Projected costs for operating and maintaining the plane were also decreasing, but further improvements were needed, the memo said.

It was also critical for the program to start follow-on development to meet the needs of the U.S. military and its partners to deal with emerging threats, the memo said.

Lockheed had no immediate comment on the memo.