SPEAKERS CONTENTS INSERTS
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[H.A.S.C. No. 10814]
THE AIR FORCE TANKER LEASE PROPOSAL
COMMITTEE ON ARMED SERVICES
HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
JULY 23, 2003
HOUSE COMMITTEE ON ARMED SERVICES
One Hundred Eighth Congress
DUNCAN HUNTER, California, Chairman
Page 2 PREV PAGE TOP OF DOCCURT WELDON, Pennsylvania
JOEL HEFLEY, Colorado
JIM SAXTON, New Jersey
JOHN M. McHUGH, New York
TERRY EVERETT, Alabama
ROSCOE G. BARTLETT, Maryland
HOWARD P. ''BUCK'' McKEON, California
MAC THORNBERRY, Texas
JOHN N. HOSTETTLER, Indiana
WALTER B. JONES, North Carolina
JIM RYUN, Kansas
JIM GIBBONS, Nevada
ROBIN HAYES, North Carolina
HEATHER WILSON, New Mexico
KEN CALVERT, California
ROB SIMMONS, Connecticut
JO ANN DAVIS, Virginia
ED SCHROCK, Virginia
W. TODD AKIN, Missouri
J. RANDY FORBES, Virginia
JEFF MILLER, Florida
JOE WILSON, South Carolina
FRANK A. LoBIONDO, New Jersey
TOM COLE, Oklahoma
JEB BRADLEY, New Hampshire
Page 3 PREV PAGE TOP OF DOCROB BISHOP, Utah
MICHAEL TURNER, Ohio
JOHN KLINE, Minnesota
CANDICE S. MILLER, Michigan
PHIL GINGREY, Georgia
MIKE ROGERS, Alabama
TRENT FRANKS, Arizona
IKE SKELTON, Missouri
JOHN SPRATT, South Carolina
SOLOMON P. ORTIZ, Texas
LANE EVANS, Illinois
GENE TAYLOR, Mississippi
NEIL ABERCROMBIE, Hawaii
MARTY MEEHAN, Massachusetts
SILVESTRE REYES, Texas
VIC SNYDER, Arkansas
JIM TURNER, Texas
ADAM SMITH, Washington
LORETTA SANCHEZ, California
MIKE McINTYRE, North Carolina
CIRO D. RODRIGUEZ, Texas
ELLEN O. TAUSCHER, California
ROBERT A. BRADY, Pennsylvania
BARON P. HILL, Indiana
Page 4 PREV PAGE TOP OF DOCJOHN B. LARSON, Connecticut
SUSAN A. DAVIS, California
JAMES R. LANGEVIN, Rhode Island
STEVE ISRAEL, New York
RICK LARSEN, Washington
JIM COOPER, Tennessee
JIM MARSHALL, Georgia
KENDRICK B. MEEK, Florida
MADELEINE Z. BORDALLO, Guam
RODNEY ALEXANDER, Louisiana
TIM RYAN, Ohio
Robert S. Rangel, Staff Director
John Sullivan, Professional Staff
Kate Gordon, Staff Assistant
C O N T E N T S
Wednesday, July 23, 2003, The Air Force Tanker Lease Proposal
Wednesday, July 23, 2003
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WEDNESDAY, JULY 23, 2003
THE AIR FORCE TANKER LEASE PROPOSAL
STATEMENTS PRESENTED BY MEMBERS OF CONGRESS
Hunter, Hon. Duncan, a Representative from California, Chairman, Committee on Armed Services
Skelton, Hon. Ike, a Representative from Missouri, Ranking Member, Committee on Armed Services
Curtin, Neal, General Accounting Office
Essex, Maj. Gen. Paul W., Director, Plans and Programs Headquarters, Air Mobility Command
Plueger, John L., President and Chief Operating Officer, International Lease Finance Corporation
Sambur, Dr. Marvin R., Assistant Secretary of the Air Force (Acquisition)
Wynne, Michael, Acting Under Secretary of Defense for Acquisition, Technology and Logistics
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Hunter, Hon. Duncan
Skelton, Hon. Ike
Essex, Maj. Gen. Paul W.
Plueger, John L.
DOCUMENTS SUBMITTED FOR THE RECORD:
[The Documents submitted can be viewed in the hard copy.]
QUESTIONS AND ANSWERS SUBMITTED FOR THE RECORD:
[The Questions and Answers can be viewed in the hard copy.]
Page 7 PREV PAGE TOP OF DOCMr. Hunter
THE AIR FORCE TANKER LEASE PROPOSAL
House of Representatives,
Committee on Armed Services,
Washington, DC, Wednesday, July 23, 2003.
The committee met, pursuant to call, at 10:04 a.m., in room 2118, Rayburn House Office Building, Hon. Duncan Hunter (chairman of the committee) presiding.
OPENING STATEMENT OF HON. DUNCAN HUNTER, A REPRESENTATIVE FROM CALIFORNIA, CHAIRMAN, COMMITTEE ON ARMED SERVICES
The CHAIRMAN. The committee will come to order. Today the full committee meets to receive testimony on the Air Force proposal to lease a hundred Boeing 767 tanker aircraft. In December 2001, Congress authorized a multi-year pilot program for the lease of up to 100 Boeing 767 air refueling aircraft under certain terms and conditions cited in the legislation.
Last year Congress also passed legislation requiring that prior to entering into a lease for these aircraft, the Air Force submit both a report on implementation of the agreement and notification of its plans to begin a new start program for the lease of the aircraft. Earlier this month, the Air Force submitted both its report and the required new start notification to Congress.
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As a start point for today's discussion there should be no doubt that our aerial refueling fleet is one of those unique strategic military capabilities that grants U.S. military forces the desired global reach to respond quickly anywhere in the world. They enable other aircraft to fly farther, stay airborne longer and carry more weapons, equipment and supplies. And clearly the operation in Iraqi Freedom has demonstrated the importance of the air bridge, whether it is working tactical aircraft into a war scenario or bringing long-range stuff from the United States and other areas around the world to a focal point in the military theater.
Today the 43-year-old KC135 represents 90 percent of our Air Force air refueling tanker fleet. The other 10 percent resides in our newer, 17-year-old KC10 tanker fleet. However, operating costs for the KC135 fleet are increasing. A major concern is the unpredictable nature of corrosion. Since all our KC135's were originally procured within a six-year period between 1959 and 1965, and are all aging approximately equally, a corrosion problem discovered in one or more KC135's could lead to a fleet-wide grounding of the entire fleet until that problem is addressed.
There are few who question the fact that our KC135 fleet is old and needs to be replaced. Rather the questions are when should a replacement program begin, will we lease or eventually purchase a replacement for the KC135 fleet? If we lease or purchase, are the terms and prices acceptable to allow us to meet both our air refueling requirements and remain within our future budgets? Is the Boeing 767 the best aircraft to replace the KC135 fleet? And what programs will we have to delay or cancel to stay within our budgets?
Leasing an aircraft is, to some degree, like leasing a car. Upfront leasing costs are lower than for a purchase and would reduce the impact of currently budgeted programs. But, over the long-term leasing will cost more. In this case the Air Force tells us that leased costs for the 100 Boeing 767 tankers could be 1 to 11 percent more expensive than a purchase depending upon assumptions used.
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Since the lease proposal for military aircraft is new to both the Department of Defense and to Congress, members also need to understand the acquisition policy implications about how major military equipment replacement programs, such as the proposed lease in question may be implemented for other future military systems.
To address these and other important issues, the committee has invited a distinguished panel to testify before us today. And from the Office of the Secretary of Defense (OSD), we have Mr. Michael Wynne, Acting Under Secretary of Defense for Acquisition, Technology and Logistics.
And Secretary Wynne, thank you for being with us today.
From the Air Force we are glad to have Dr. Marvin R. Sambur, Assistant Secretary of the Air Force for Acquisition.
And, we thank you, Dr. Sambur.
We have Major General Paul W. Essex, Air Mobility Command Director for Plans and Programs.
We thank you for being with us.
We also have Mr. Neal P. Curtin, the General Accounting Office's (GAO) Director of Defense Capabilities and Management.
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And, we thank you for being with us, Mr. Curtin.
And, finally I am pleased to welcome, from the outside, Mr. John L. Plueger, who is President and Chief Operating Officer of International Lease Finance Corporation. And, Mr. Plueger's a great citizen who has an enormous amount of commercial experience and expertise in leasing large aircraft. That is what he does. And he has come a long ways and volunteered to come in as a good citizen with important information on a critical subject.
And we thank you for being with us. And also your son, Alex, is with us today. And we are pleased to have him also.
And, Alex, thank you for accompanying your dad and being part of this team.
And, now, let me recognize the committee's ranking member, my partner, the gentlemen from Missouri, Mr. Skelton, for any remarks he is likely to make.
[The prepared statement of Mr. Hunter can be viewed in the hard copy.]
STATEMENT OF HON. IKE SKELTON, A REPRESENTATIVE FROM MISSOURI, RANKING MEMBER, COMMITTEE ON ARMED SERVICES
Mr. SKELTON. Mr. Chairman, you cover the waterfront quite adequately, so let me ask unanimous consent that my opening statement be put in the record and also
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The CHAIRMAN. Without objection.
Mr. SKELTON [continuing]. I wish to acknowledge the presence of the ranking member on the Appropriations Subcommittee on Military Affairs, Norman Dicks, who came to Congress in the same year group and that he be allowed to sit in and also participate. And I ask unanimous consent for that as well.
[The prepared statement of Mr. Skelton can be viewed in the hard copy]
The CHAIRMAN. Well, is there any objection to Mr. Dicks, our good colleague, participating? Without objection, normally
Mr. TIAHRT. What about Mr. Tiahrt
The CHAIRMAN. We welcome you. Well, you know, Mr. Tiahrt is a former member of the committee here. I think his old chair is still warm. So, without objection we will let Mr. Tiahrt participate also. Thank you.
Is there anyone else who would like to make an opening statement? I think Mr. Bartlett, who has heldalready held a hearing in his subcommittee on this issue and has done a lot of work would like to make an opening statement.
The gentleman from Maryland is recognized and then the gentleman from Kansas, Mr. Ryun.
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Mr. BARTLETT. Thank you, Mr. Chairman, for holding this very important hearing. The subcommittee, which I have the pleasure to chair, has followed the issue of airborne tankers very closely. In fact, as you know, within the last month our subcommittee held a hearing on the status of the current tanker fleet and airborne tanker future requirements. What we learned in that hearing was that there are many unanswered questions that should be answered, should be addressed before making a decision that makes a major change in acquisition policy, while also having major potential increased cost consequences to the American taxpayer.
And having read today's witness statements these questions remain unanswered. Several points are worth noting. First, analytically, the data indicates the current tanker fleet is quite healthy. In May, the active fleet of KC135 had a mission capable rate of 85 percent, the Air Force objective. On the corrosion issue, only anecdotal information has been provided by the Department of Defense (DOD). Right up until Congress authorized the lease of a new tanker aircraft in 2001, the Air Force had been quite consistent in saying that there was no urgent requirement for replacing the tanker fleet.
When Congress authorized this 100 aircraft pilot program in 2001, there was no Air Force budget request for new tanker aircraft. To the contrary, the Air Force completed an economic service life study of its tanker fleet in early 2001 and concluded that ''The fatigue life of the KC135, with adjustments made for the affect of corrosion on crack growth, should permit the aircraft to remain viable through the year 2040.''
Second, we are told that the fleet is increasingly costly to maintain, yet projected costs to increasepredicted costs will increase one to two percent a year through 2004. Such low inflation rates would be the envy of the medical and educational sectors of our economy.
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Further, while the number of days required in depot maintenance for the aircraft increased through 2002, this trend has recently reversed and the number of aircraft in depot maintenance status reversed three years ago. And according to GAO provided data has dropped 45 percent in the three-year period.
Third, there is no current tanker requirements analysis using the present national strategy. The most recent analysis was done in 2001.
Fourth, an analysis of alternatives for choosing a replacement tanker aircraft has not been accomplished. Several other options resist replacing our tankers if there is a need to do so. No analysis on these options has been provided. The Air Force hasn't even been able to provide the cost data on procuring the tankers on the same schedule as the proposed lease.
Fifth, the recent report to Congress on the lease provides no analytical data upon which to base a lease versus buy decision. Such an analysis will not be available until next month. What is available indicates that it will cost up to $1.9 million more to lease versus buy the aircraft. The greater cost to lease is easy to understand when one notes that the bonds will be issued to support the lease of the tankers will be at rates one half of a percent to five percent higher than U.S. government debt. Lease proponents indicate that the $1.9 billion higher cost to lease the aircraft is based on a multi-year procurement that they say Congress is unlikely to approve.
Yet, at the same time, the same proponents are asking us to approve a multi-year lease for the same 100 aircraft. If we accept the requirement for new tankers why would we approve a multi-year lease of 100 aircraft and not a multi-year procurement of 100 aircraft at considerably less money? And, finally, we are being asked to approve a multi-year lease for 100 aircraft with a total cost of $20 billion to $25 billion to meet a supposed urgent requirement for tankers at the same time the Air Force is asking us to approve the retirement of 68 of the existing KC135Es over the next 3 years. If the tanker requirement is so urgent, why are the tankers being retired? If the requirement isn't so urgent but aircraft condition is a concern, why not modify the remaining 65 KC135E aircraft being retained to our models at a total cost of less than $2 billion less than 1 year's worth of lease payments? This would allow us to take the time to do the proper analysis of alternatives and it might be noted that currently Es are in depots being converted to Rs and the administration has asked for an increase in this year budget of monies to modify another four Es to Rs.
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Mr. Chairman, I have not seen the analysis that indicates our current tankers are such extreme condition that supports this drastic action on our part justifying a major change in acquisition policy and costing the taxpayers, by current estimates almost $2 billion more than procuring the aircraft.
Again, Mr. Chairman, thank you very much for holding this very important and timely hearing.
[The prepared statement of Mr. Bartlett can be viewed in the hard copy.]
The CHAIRMAN. I want to thank the gentleman I want to thank him as the Chairman of Projection Forces for the important hearing that he held on same subject and we have two other members who wish to speak, the gentleman from New Jersey, Mr. Saxton, and the gentleman from Kansas, Mr. Ryun.
The distinguished gentleman from New Jersey.
Mr. SAXTON. Thank you, Mr. Chairman. I would just like to note at the outset that numerous studies that have been done by the Air Force and by other organizations indicate a great potential weakness in our current tanker fleet. Going back as far, for example, as 1995, there were two studies addressing the fatigue, one was called the Fatigue Life study of the KC135. And in 1995 an air mobility master plan was developed noting the serious potential problems because of fatigue in these tanker platforms.
Page 15 PREV PAGE TOP OF DOC And between 1994 and 1995 there were a series of studies done by the RAM Corporation, which pointed out similar weaknesses in the KC135 airframes. Then in 1996 the GAO did a study and concluded in part that the cost to operate increased betweenthe KC135 increased by 24 percent between 1996 and 2001 and drew conclusions that as time passed by with regard to these aging frames, that the cost of operating the frames would continue to increase at an accelerated rate.
Then in 1998 an engine modernization study showed that re-engining would, in fact, create some efficiencies in the KC135 re-engined R models, but would be insufficient to overcome the substantial initial investment. And then in 2000 an air mobility master plan was again constructed, put together by the Air Force and the major factor was pointed out in the master plan the major factor limiting the ability to move forward with the KC135 program was, in fact, a corrosion issue, which provided substantial limits.
More recently, a tanker requirement study, which was done to study the tanker requirements that would occur by 2005 the results of this study identified the need for approximately 500 to 600 KC135R equivalence and approximately 900 to 1,000 air crews to be available to meet the refueling requirements depending upon the scenario that developed by 2005.
So, Mr. Chairman, there are two sets of facts here. One set of facts involving the requirement, another set of facts involving the limitations placed on our ability to meet that requirement by this old airplane and corrosion and other issues. And, so, I think that while I appreciate the position that some take, that we need to justify this lease carefully. We do, in fact, need to do that. But, the facts are the facts. A 42-year-old airplane that has corrosion problems and other potential problems can probably not be expected to be able to meet the requirements that exist.
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And, so, we have a choice to make. We can use money that we would otherwise use for the F-22 program or the joint strike fighter or C-17 requirements and shift them into a multi-year purchase. Or we can find a way to get airframes that we need in a more rapid way. That is what this issue is all about, those sets of facts.
And, so, I thank you for holding this hearing this morning so that we can further discuss this very important issue. I just finished reading a book that identified the mechanisms and the ways and the methods of warfare that we currently use. The book was about our war in Afghanistan. And without a robust tanker capability we can't do those operations. This is an extremely important issue that sometimes, you know, we don't read about big old tankers that lumber out there and refuel our war fighters. But, this is a crucial issue and one that we need to come to an appropriate conclusion on. Thank you.
The CHAIRMAN. I thank the gentleman for his very eloquent statement.
And, the gentleman from Kansas, Mr. Ryun, also has a statement.
Mr. RYUN. Thank you, Mr. Chairman. Thank you for holding this hearing and I want to thank our witnesses for coming to testify this morning and I look forward to their statements.
Before we begin I want to offer a couple more thoughts on this very important procurement project. From dangers posed by regional instability to the continued war on terrorism, the need for a strong force platform remains a top priority of our military. The Air Force tankers are, therefore, an essential tool of our nation's war fighters. As the Pentagon report to Congress on the tanker lease project states, ''Our military success in Afghanistan and Iraq were critically dependent on air refueling to extend the range of our air lifters, sensor aircraft, Navy, Marine Corps, and U.S. Air Force bombers and strike aircraft. These conflicts, along with the ongoing war on terrorism heightened homeland security have increased air refueling requirements.''
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This being said, these critical important tools are unfortunately the Air Force's oldest combat aircraft. As a member who has an Air National Guard base in his district with a tanker mission, I have seen firsthand the importance of and difficulties facing our tanker fleet. Forbes field currently has 10 KC135Es in a fleet with an average age of around 43 years; the Forbes aircraft are some of the oldest tankers in our military. Although the air crewman at Forbes Field and around the county do a fantastic job maintaining and repairing these aircraft, the poor reliability and operational limitations of these older planes are making them increasingly less useful for our war fighting efforts.
If an aircraft is only mission capable 71 percent of the time, which, General Zettler stated during his June 24 testimony in regards to the E model, their effective utilization in combat situations are limited. In addition, the KC135's are experience unpredictable corrosion. Operating maintaining costs are escalating while operational requirements continue to only increase. The outdated planes are clearly becoming the Achilles heel in our nation's air fleet. The simple fact is that we need new tankers. This lease agreement has gone through a rigorous process to ensure the needs of our military and to respect our taxpayers that they are both met.
I am very pleased that the Secretary of Defense has finally approved this plan. And, with that, I looked to our witnesses' testimony this morning. Thank you.
Mr. Chairman, thank you.
The CHAIRMAN. I thank the gentleman for his statement.
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And, again, thanks to our panel for being here and Secretary Wynne, why don't you start off and we will go right down through the panel. And without objection, all written statements will be taken into the record.
STATEMENT OF MR. MICHAEL WYNNE, ACTING UNDER SECRETARY OF DEFENSE FOR ACQUISITION, TECHNOLOGY AND LOGISTICS; MR. MARVIN R. SAMBUR, ASSISTANT SECRETARY OF THE AIR FORCE (ACQUISITION); MAJOR GENERAL PAUL W. ESSEX, DIRECTOR, PLANS AND PROGRAMS HEADQUARTERS, AIR MOBILITY COMMAND; MR. NEAL CURTIN, GENERAL ACCOUNTING OFFICE AND MR. JOHN L. PLUEGER, PRESIDENT AND CHIEF OPERATING OFFICER, INTERNATIONAL LEASE FINANCE CORPORATION
Mr. WYNNE. Thank you very much, Mr. Chairman. I appreciate the opportunity to come before you today to talk about the substance and the policy implications of the Air Force tanker lease proposal. On May 23, the department announced the secretary's decision to approve the Air Force proposal to enter into a multi-year pilot program for leasing general purpose Boeing 767 aircrafts under the authority in Section 8159 of the Appropriations Act of 2002.
There is consensus within the Department that we must start recapitalizing the airborne tanker fleet as soon as possible and also that re-engining the KC135E aircraft will not necessarily extend their service life. Options include an aircraft incorporating a new design or a varying of an existing aircraft. An aircraft based on a new design would cost the department research and development funds and some estimates are that such a new aircraft would cost in the range of $200 million per unit.
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While a planned commercial derivative, if it was to be available, was estimated to cost between $150 million to $160 million. There are only four suppliers who could develop and produce such a tanker aircraft. That would be Boeing. We received a proposal from Lockheed Martin. We have received a proposal from the European Air Defense Systems, EADS and the Russians. And only three currently produce wide-body aircraft.
The department's plan and the President's fiscal year 2004 budget was to begin tanker development program, our commercial derivative plan in fiscal year 2006. With the first tanker delivery targeted for fiscal year 2009. However, when the Congress gave us pilot program authority to lease, this allowed the department to aggressively pursue a tanker design based on the 767 airframe before its commercial production line ended, an option which might not have been available in fiscal year 2006. On its face, this is clearly a less expensive alternative than new development. It also has far less cost risk than waiting until fiscal year 2006 when the same commercial opportunity might no longer exist.
The Air Force proposed leasing tankers and brought their proposal to the leasing review panel, which compared the merits and shortcomings of both leasing and purchasing KC767 aircraft given the 767 line remained open for both leasing and purchasing.
Based on input from the co-chairs of this panel, the secretary determined that the lease option best met the needs of the Air Force and was preferable because leasing minimizes the near-term cost to the Department of Defense and delivers the aircrafts sooner. If we were to purchase the aircraft and Boeing were to deliver on the same schedule, as it will under the lease, it would require billions of dollars more in the future year defense program, the FYDP. As we have pursued a goal of stability in programs, such a reallocation would have been counter to that goal of stability and disrupted many ongoing programs, which would have had a deleterious effect.
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On July 10, the Secretary of the Air Force notified the defense committees that the department intends to lease 100 Boeing 767 aircraft under the multi-year aircraft lease pilot program and provided a report on tanker leasing to those committees. In accordance with the Section 8159 of that Appropriations Act. It requires the Air Force to wait at least 30 calendar days after it submitted that report before entering into such a lease.
We also provided to the defense committees and to the appropriations committees a new start notification and will not award a contract until the defense committees have approved this new start. As of today, I am pleased to report to you that we received approval from the defense committees, subcommittees of the House and Senate appropriation committees.
While a proposed lease will provide for delivery of a total of 100 KC767 aircraft, approximately 60 of which will be delivered in the future year defense program time period. The department intends to recapitalize the airborne tanker fleet fully, and, therefore, will likely go beyond this initial 100 aircraft in the future. The Air Force has been directed to develop a long-range recapitalization plan beyond the current lease proposal and we will address that plan in the President's fiscal year 2006 budget.
Before I conclude my remarks this morning, I would like to mention the department's broader approach to leasing for major pieces of military equipment. The department issued direction on the multi-year leasing of capital assets in the November 2001 memorandum. It encourages the use of multi-year leasing as a means of acquiring capital assets where it makes good business sense.
Page 21 PREV PAGE TOP OF DOC The department also at that time established a leasing review panel whose purpose is to review all lease proposals projected to cost a total of $250 million or more over the life of the lease. After the panel reviews the leasing proposal it then makes a recommendation to the appropriate authority for approval.
Thank you, Mr. Chairman, for the opportunity to testify before this committee. I would be pleased to answer any questions that you or members of this committee might have.
[The prepared statement of Mr. Wynne can be viewed in the hard copy.]
The CHAIRMAN. Thank you, Mr. Wynne, and folks we are going to have a series of votes. So, why don't we try to get Dr. Sambur'swe are going to have six votes in fact. The first 15 minute, the rest fives. Why don't we try to get Dr. Sambur's statement in, maybe even General Essex's and then we will break for votes.
Dr. Sambur, thank you for being with us.
Secretary SAMBUR. Chairman Hunter, Congressman Skelton and members of the committee, thank you for the opportunity to appear before you today. I will be delivering the oral statement for the Air Force. Let me begin with a ''to the point'' statement as to why we need, urgently need, a positive response to our tanker proposal.
First, tankers are critical to the defense of our country. Out of 24,200 total United States Air Force sorties flown in Operation Iraqi Freedom, 6,200 were tanker sorties, only 2,600 left in the actual United States Air Force fighter sorties.
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Second, the KC135's, which make up 90 percent of the tanker fleet, are over 40 years old and are beginning to show real signs of wear and are being used at a steady state tempo over the last 2 years that were never forecasts or even imagined before September 11, 2001. More importantly, the Air Force has placed flight restrictions on the KC135Es because of corrosions in the engine struts because this corrosion is becoming widespread and is only expected to get worse, the Air Force has deemed that the risk of relying on the KC135's to meet our mission requirements is too high.
Therefore, the United States made the decision to retire the KC135Es and utilize the 135Es aircrew to fly more hours on the slightly younger KC135Rs.
Third, we looked at several alternatives to our tanker needs. We seriously evaluated a tanker offering from Airbus and we took a very, very hard look at the possibility of re-engining the KC135Es. And the fact is we could spend billions to put new engines on an old airframe. But, still not stem the aging issues currently being faced.
Fourth, the financial means the business community uses to compare lease versus buy is net present value. For the tankers with the assumptions agreed to by OSD and Office of Management and Budget (OMB) the difference between purchase and lease is less than 1 percent.
Fifth and most importantly, leasing affords the fielding of 60 new tankers to our forces by fiscal year 2009, whereas the same funding stream only delivers four aircraft by fiscal year 2009. Purchasing on the same delivery schedule as the lease will require more than $11 billion of additional funds across the FYDP. Let me repeat that. More than $11 billion of additional funds across the FYDP, funding that does not currently exist within the Air Force plans and can only be obtained by seriously reducing the overall capabilities of the Air Force.
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The bottom line, the five years we gain in delivering all 100 aircraft tankers compared to a purchase to the Air Force is very, very significant. I would like to use what I call the Fedex example. People are willing to pay a premium nearly $30 to have a letter delivered the next day when a 37 cent stamp you can get the mail delivered only two days later. We view this five-year gain as a much-needed insurance policy against the unknown, unknown aging aircraft issues that are becoming more apparent every day.
The Air Force cannot afford a catastrophic incident that will ground the tanker fleet. We urgently need to recapitalize now.
Thank you for your consideration. And I have made the Air Force statement and thank you very much. And, I heard the bell ring, so
[The prepared statement of Mr. Sambur can be viewed in the hard copy.]
The CHAIRMAN. Thank you. Dr. Sambur, I thank you for your statement.
I am told now that we have devolved the votes down to one vote. So, we will recess for the vote and we will fire up again in about ten minutes. Thank you, gentlemen, and we will start with you General Essex.
Page 24 PREV PAGE TOP OF DOC The CHAIRMAN. Gentlemen, we will go ahead and fire up understanding that the other witnesses are being rounded up now. Please, pardon us; because we had originally a five-vote schedule and then after the first vote, the decision was made to roll those votes and I had already sent word down to let everybody take a break until noon. So, we apologize, that is show business.
Dr. Sambur, you completed your statement.
And, General Essex, please proceed, sir.
General ESSEX. Sir, Dr. Sambur gave the Air Force statement, so I will pass to Mr. Curtin.
The CHAIRMAN. Okay.
Mr. CURTIN. Thank you, Mr. Chairman and members of the committee. You have asked us for preliminary observations on the Air Force's proposal and any other issues that might be of use to the committee in its deliberations on this matter. And I want to be very clear right up front that at this point GAO really has not had time to do all of the types of analysis that we had hoped to do. The Air Force report was just sent to the Congress and we received it on July 11. And we just saw the draft lease itself last Friday, July 18.
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So, what you see in my prepared statement is a series of questions and issues for consideration that we are pursuing now and that I believe the committee should be aware of as it considers this proposal. And since my full statement is being placed in the record, I want to take just a couple of minutes to highlight some of these key considerations.
First, the Air Force report acknowledges that leasing is more expensive, but its analysis indicates the net present value difference of only $150 million favoring purchase. We have not had time to validate the Air Force analysis, but it does appear to have followed the OMB A94 guidelines. We do know that in some of the sensitivity analysis the Air Force did the cost difference in favor of purchase was even greater, including one case in which the difference would be $1.9 billion under an assumption of a multi-year procurement for the purchase option.
Since this type of analysis, this net present value analysis, is so sensitive the assumptions used will be conducting additional sensitivity analysis to show the range of comparisons between lease and purchase.
Second, the Air Force does not make the case that leasing is cheaper. Instead, the real main argument for the proposal is that there is an urgent need to begin replacing the current tanker fleet. And leasing provides aircraft earlier and more quickly than purchase under current budget constraints. Leasing would provide the first planes in August 2006, whereas, under the current procurement plan the Air Force would not receive the first plane until fiscal year 2009.
Page 26 PREV PAGE TOP OF DOC In our view this urgency, the urgency of the need is really a matter of how much risk the Air Force and the Congress are willing to accept. We pointed out as far back as our 1996 report that the Air Force needed, at that time, to start planning to replace the aging fleet of KC135 tankers. They were 35 years old at that point. And we thought that was getting kind of old.
The Air Force said at the time
The CHAIRMAN. When did you point that out?
Mr. CURTIN. In the 1996 report.
The CHAIRMAN. That the tanker replacement needed to commence shortly.
Mr. CURTIN. That the Air Force needed to start planning for the replacement of that fleet back at that time, yes. We did not specify when it should start. We said the fleet is aging, would be developing maintenance problems. It is time to start looking at the replacement.
The Air Force said at that time, though, thatand really up until about, 18 months ago that the tankers were a lower priority, that replacement could wait until later in this decade. The KC135's are increasingly difficult and expensive to maintain, but the Air Force has been able to meet the heavy demands of the past two years with the existing fleet. The risk is that the aging planes would incur some fleet-wide problem in the intervening years between 2006 and 2009 that would jeopardize the mission and there is just no way to see the future and predict how likely such a fleet-wide grounding would be. The third item, under the proposal the aircraft will be owned by a special purpose entity that will borrow money to pay Boeing and in turn be reimbursed by the Air Force through the lease payments. This is an unusual arrangement for the Air Force and I think for the federal government. It is important for the Congress to have a good understanding of how this will work and the implications of it, especially how the government's interests are protected under such an arrangement.
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Fourth, the Congress also needs to be aware that as part of the lease contract, DOD plans to contract with Boeing as part of the lease agreement, DOD plans to contract with Boeing for logistics support. It will total over $5 billion during the period of the lease, about $50 million per aircraft. Boeing would handle all maintenance above the flight line level. We don't know at this point to what extent the Air Force considered other options for maintenance, such as competition or public private partnership, which might have been a more economical logistics approach.
Fifth, there are also some issues to consider when the leases expire at the end of each six-year period. Under the agreement, the aircraft are supposed to be returned to the owner, the special purpose entity at the end of the lease. At that point, the Air Force would have made lease payments of about 90 percent of the value of the aircraft and the Air Force would actually incur additional costs estimated at about $778 million to remove Air Force specific equipment from the aircraft before returning them.
But, more importantly, the Air Force turning these airplanes back in would lose tanker capacity that it would somehow have to replace, either by additional leases, by additional procurements. In other words, if the Air Force really leases these planes for six years and then turns them back in, this proposal probably does not make good sense, either financially or militarily. The need for tankers is a long-term need.
The CHAIRMAN. And not to cut in Mr. Curtin, but aren't these tankers, obviously, the fleet we have got now have longhave a high endurance quotients. They have been going for over 40 years. So, as I understand the six years, is not with any intention to not retain the tankers and that in reality we are going to keep these babies flying for a long time? We are going to buy out the lease. So, the key question really is that residual. But, that rather the six years was based on, at that point, money being cheaper for the government than it is for industry and it making sense to buy out the lease. Is that
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Mr. CURTIN. That is true.
The CHAIRMAN. I mean nobody has said a tanker's going to have a six-year life and then it is gone and you might as well turn them back in. We are flying 40-year tankers.
Mr. CURTIN. The Air Force report makes pretty clear that thelet me put it this way. This is set up as an operating lease, not a capital lease. So, the Air Force cannot automatically exercise an option and procure these at the end of each six-year lease period. They have to come back to Congress for some sort of authority and for funding.
The CHAIRMAN. But, don't they have a contractual right to do that with Boeing, do they not?
Mr. CURTIN. It will be part of the agreement that will be signed with Boeing that the Air Force can exercise an option to buy these at residual value. All the analysis is based on turning the aircraft back in. The Air Force report submitted to Congress says we are going to turn these back in.
The CHAIRMAN. I understand. That is why we have got you today to talk about what is really going to happen.
Mr. CURTIN. Yes.
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The CHAIRMAN. Okay.
Mr. CURTIN. Well, that is what I am trying to do is make it clear that for this to work, you need to
The CHAIRMAN. I understand. You are following a formula.
Mr. CURTIN. You need to consider the total cost of this.
The CHAIRMAN. You are following the formula that has been laid out for you. Okay. But, we want to have some insight into what we are really going to do because we all know we are really going to keep them and a tankers have a longer life than six years.
Mr. CURTIN. Yes. Exactly. And let me make that point. The proposal does allow the government to purchase the aircraft at the end of the lease period at the residual value, which is estimated and I don't think there is a firm number in the agreement at this point at about $44 million per aircraft in then-year dollars, 4.4 billion if you buy all 100 of those. And to exercise that option you have to come back to Congress for authorization and funding as the leases expire.
And the only thing I want to point out is that Congress needs to understand that is not a six-year deal. This is tankers that you are going to have for the next 20 or 25, 30 or 40 years, however long this fleet lasts. And you need to look at the total cost of that, not just the lease payment cost.
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And there are a lot of numbers in the Air Force report, but I am not sure there is anything that tells what the total program cost is for the entire life of these aircraft. And then one final point and I will stop, just to make you aware, the lease agreement itself has not yet been finalized.
The Air Force has told us the lease is still in draft, subject to change. They have let us read it in the Pentagon. We haven't been able to get a copy of it. And the Congress just needs to be aware that some details of the lease are still subject to change. And I will stop there.
The CHAIRMAN. And is this deal completed at this point?
Mr. CURTIN. It is probably better to ask the DOD and the Air Force.
The CHAIRMAN. Is the deal legally concluded at this point, Dr. Sambur?
Secretary SAMBUR. There are some terms and conditions that we are still trying to resolve. It is our expectation within the next week at most we will have everything
The CHAIRMAN. Okay. But, the point is, the terms areit is not a deal. It is not a contract a binding contract at this point?
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Secretary SAMBUR. It is not a binding, because neither company has signed.
The CHAIRMAN. I have got you. Okay.
You know, I think, Mr. Curtin, one thing that is important to us if you conclude that we do need tankers and we need to acquire them in some way. I think the one thing that you couldthat would be instructive for us that your shop could provide is this is a comparison. If you presume that we are going to keep them, right? It is not a six-year deal. It is a positive as a six-year deal for purposes of doing the deal, but we are going to keep them and you add up how much money you pay, whether it is monies transferred pursuant to a lease or transferred pursuant to a sale, how much we pay for what we get. And lay those things side by side. And, just up to the six-year point, because you presume if at that point you have got a pink slip on 100 tankers and you need to arrange with a contractor if you haven't arranged earlier for a certain warranties or maintenance that that islet us presume that is going to be fairly consistent in cost whether you acquired them initially by lease or by sale. At that point you got a pink slip on 100 tankers.
Up to that point, what have you paid for what you have? And when did you pay it? And have you done that analysis?
Mr. CURTIN. I don't have those numbers. The best way tolet me explain two different types of comparisons, the comparison the Air Force has done is using the A94 net present value criteria, which is the way you compare different alternatives. So, you look at this flow of money under purchase or under lease. Once you have decided that lease is the way you are going to go, then I think you need to look at the total cost of the program if you are going to consider buying the aircraft eventually, work that total cost. Generally the way Congress would look at that is either in then-year dollars, the dollars paid each year or in constant dollars, either fiscal 2002 or fiscal 2003. Usually we use the most recent and when the program starts, use those constant dollars to compute the whole cost of the program. So, you have got a pretty good basis to understand what the whole programs going to cost.
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And I haven't seen that analysis done. They may have that, but we haven't seen it yet.
Secretary SAMBUR. Mr. Chairman, may I just make a comment?
The CHAIRMAN. Certainly.
Secretary SAMBUR. Because I think this will be informative. If you have the net present value that is required by A94 is the same on both sides, it is the equal assumptions on the buy versus the lease. What we have in our report is that at the end of the lease you give it back, but to make the equation equal at the end of the six-year period even if you buy them, you sell them. So, it is an equal comparison of the financial worth of buying versus the financial equation of leasing. So, I don't want people to misinterpret that the leasing numbers are different than the buying numbers in the comparison sense. They are the same comparison. The same difference of one percent would have held if we had the assumptions you buy it and don't give them back versus the point that Mr. Curtin was making.
So, the one percent difference is a fixed difference and accurately reflects the disadvantaged financial condition of leasing versus buying.
Mr. CURTIN. I don't disagree with that. The only difference is that once you have made that comparison, what the numbers show is $11.4 billion as the net present value of the leases being paid over each six-year period or the total of about 11 years that we will have these aircraft. That 11.4 does not include what you are going to have to spend afterwards to acquire them.
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The CHAIRMAN. You are talking about the buy out at the end?
Mr. CURTIN. Right. Even though, for a comparison basis, it is
The CHAIRMAN. I understand. What you are saying is if you presume that you want to know how much money you got to pay under a lease or a sale until you by golly hold the pink slip to it at the end of six years, then you add up how much money you pay to lease it and what the buy out is.
Mr. CURTIN. Yes, that isI mean that number, it seems to me Congress would want to know that number worked out in some type of constant dollars or
The CHAIRMAN. Sure. Because, for example, if you buy the Ford Taurus and you are paying 350 bucks a month and they tell you congratulations at the end of your six-year lease, you can now own the Ford Taurus for a mere $25,000 residual payment, it probably isn't a great deal. If they let you have it for $1,000 it sounds pretty good.
Secretary SAMBUR. We actually have that within our contract. There is a defined residual value that makes sense. And, again, I just want to emphasize this is an apples to apples comparison between buy versus leasing that is reflected in the report. And what Mr. Curtin is talking about is that we would need to add on in their present value point of view, on both sides of the equation, $2.7 billion.
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The CHAIRMAN. Well, precisely.
Secretary SAMBUR. And that is one both sides of the
The CHAIRMAN. And, Dr. Sambur, so what would be good for the committee to have? And if you and Mr. Curtin, after we get finished here, could give us this, maybe collaborate and give us this.
Secretary SAMBUR. Certainly.
The CHAIRMAN. If you presume, which we all know the real world is we are going to keep these things past six years and we are going to buy them out.
Secretary SAMBUR. Right.
The CHAIRMAN. So, therefore, that buyout that residual payment is relevant because we really are going to pay it. So, if you take the leasing payments that we make, the present value and add the residual payment, you get the total dollars that the U.S. government has paid to Boeing to receive one, count them, one, tanker aircraft, whether you buy it or lease it. One count them, one, and one each on a 100 aircraft buy. If we have that number. If you folks could collaborate and get that number that is very instructive for the committee I think.
Secretary SAMBUR. Okay. I actually have a document. I will share it with Mr. Curtin right now and at the end of the meeting we can give it to Mr. Sullivan.
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The CHAIRMAN. Okay. And please proceed, Mr. Curtin, I didn't mean to divert you here.
Mr. CURTIN. The timing is good because I was going to wrap up and just say that we have raised other questions in our prepared statement and issues that you may want to pursue with the Air Force today or raise for the record. And I will stop there and be glad to take questions after Mr. Plueger.
[The prepared statement of Mr. Curtin can be viewed in the hard copy.]
The CHAIRMAN. Thank you very much, Mr. Curtin.
And we now have a gentleman who may have more experience than anybody in the world in leasing big aircraft. Mr. John Plueger. And, Mr. Plueger, thank you, again, as a U.S. citizen for coming in and coming up to the table here and giving your thoughts on this proposal. And, you know, I think it would be good because you involve yourself in lots of leases of big aircraft and kind of instructing the committee on what the considerations are when you go into a lease versus a purchase.
And I know you do have a pretty lengthy statement here and we will take it into the record without objection. If you want to summarize that and kind of go right to the heart of what you think the things are we should look at please feel free to do that.
Once again, thank you and thank you for bringing Alex along. And, Alex, I hope you get a tour of Washington, D.C., while you are here.
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Mr. PLUEGER. Thank you, Chairman Hunter, that is very kind. As, Mr. Chairman, you have mentioned, originally I was asked to read my entire statement. I will try and go through the statement and cut out those parts, which I think might miss the purpose of this point. But, nevertheless I will start and if there is any time constraints, please let me know.
My name is John Plueger and I am the president and chief operating office of International Lease Finance Corporation, ILFC, a commercial airline operating lease company based on Los Angeles, California. We are wholly owned by American International Group, AIG, which is world-wide insurance and financial services company traded on the New York Stock Exchange and based in New York.
I also have with me today Mrs. Julie Sackman, ILFC's executive vice president and chief legal counsel. You have asked me to speak
The CHAIRMAN. Ms. Sackman, thank you for being with us. We appreciate it.
Mr. PLUEGER. Before I begin, I would like you and the committee to clearly understand that I am not qualified to comment on government or military procurement practices or programs as I have no experience in this area and have never been involved in any military procurement, nor has my company. I am also not qualified to comment on the technical aspects or the financial costs of converting or building a Boeing 767 200ER or 300ER on which the tanker platform is based into a military air refueling aircraft. In fact, my knowledge of the KC767A leasing program is limited to the report, Mr. Chairman, that you sent me, entitled Report to the Congressional Defense Committees on KC767A Air Refueling Aircraft Multi-year Lease Pilot Program.
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But, I do know something about commercial airline operating leases, which I have been doing for the past 17 years at ILFC. We were founded in 1973 and most people consider us the pioneer of the aircraft lease. We did our first aircraft lease, the DC8 to Air Mexico in that year. Today we have a fleet of more than 600 jet aircraft on lease to approximately 160 airlines worldwide. Our leasing fleet includes almost all models of jet aircraft offered for sale by Boeing and Airbus. Our lease fleet specifically includes 60 Boeing 767 aircraft. So, that aircraft type accounts for almost ten percent of our total fleet.
As measured by firm order backlog, meaning the number of aircraft that we have ordered but have not yet been delivered, ILFC is the single largest customer of both Boeing and Airbus. Specifically, with respect to Boeing, ILFC today has 148 aircraft on firm order for delivery scheduled through 2009. Many people find it hard to believe that a leasing company, as opposed to an airline is actually the largest commercial customer for Boeing and Airbus. But, it reflects the dramatic growth and importance of the operating lease as a financing aircraft procurement and flexibility tool for many, if not most, of the airlines today.
I would like to begin this operating lease 101 discuss with a review of the general structure and pricing and financial parameters a commercial airline operating lease is. I would like to stress that these are generalizations. Each operating lease deal is heavily negotiated and customized, as you would well imagine. Furthermore, in the highly competitive operating lease industry that exists for commercial airliners today there are many variations and differences offered by a variety of excellent companies.
I specifically do not and cannot speak for any of my competitors and I don't see myself here today as a self-appointment industry spokesperson, but rather just as one of its members who was invited to speak before you.
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As most of the committee members know, in an operating lease, the leasing company, referred to as the lessor, purchases and retains ownership of the aircraft throughout the lease period. The lessee has complete use of the aircraft, maintains and insures the aircraft at the lessee's expense and makes lease payments, also called rental payments to the lessor for the use of the aircraft over a fixed period of time called the lease term. And as we have heard earlier today in this context it is quite similar to leasing a car.
And, just with a car lease, at the end of the lease, the aircraft must meet certain minimum return conditions or else extra lease charges and penalties are incurred. Because the lessee leases the aircraft and ownership stays with the lessor, the lessor does not show the aircraft as an asset on its balance sheet. Correction, the lessee does not show the aircraft as an asset on its balance sheet, nor does it record a liability on its balance sheet for the lease payments. Instead, the lessee records the rental expense for the lease payments on its income or profit and loss statement, as each payment is made along with a footnote disclosure in the financial statements as to the future payment obligations under the lease.
Therefore, the operating lease becomes a method of so-called off-balance sheet financing for commercial aircraft. Because the airline does not borrow money to purchase the aircraft there is no debt associated with the aircraft and, therefore, the airline does not leverage or add debt to its balance sheet. Thus, providing a benefit to today's over leveraged airlines that face mountains of debt.
In order to obtain an aircraft under operating lease an airline negotiates a lease agreement that usually, but not always includes some form of security deposit, generally cash, but sometimes a letter of credit or bank guarantee. The security deposit paid is a heavily negotiated aspect of the lease transaction. Security deposits can range in amount anywhere from one to three months worth of lease rental payments. The security deposit provides added financial security to the lessor for the lessee's performance of the lease obligations. At the end of the lease, if all lease obligations have been satisfied, including the aircraft being in a proper condition at return, the security deposit is normally returned to the lessee.
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Whatever the amount of the security deposit, however, it is a small fraction of the amount that an airline would otherwise have to pay in progress payments to the airframe manufacturer if the airline were purchasing the aircraft new. Such progress payments can amount to as much as 30 percent or more of the total cost of the aircraft during the period of time that the aircraft is being built.
To use an example, if an airline were purchasing a new $100 million aircraft, the airline might have to pay as much as $30 million in progress payments to the aircraft manufacturer while the aircraft is being built. In contrast, that same aircraft obtained from a leasing company might only require a security deposit payment of as low as $1 million to $3 million. When the aircraft is completed, an airline buying new aircraft has to pay the balance due the purchase price, which is the amount still owing after progress payments are made. Whereas, nothing more is due under the operating lease except for the rental payments, which are usually made monthly or quarterly during the lease term.
This points out a feature and an aspect of the operating lease which the committee has discussed today and that is you only need a small fraction of the cash or financing to obtain an aircraft under an operating lease versus purchasing the aircraft. It is for this same reason that many of us, as we now know, lease cars instead of buying them. Leasing requires less cash and the monthly payments are lower.
That brings us to aircraft to lease pricing. In the case of ILFC and several other major leasing companies, aircraft purchase agreements are negotiated directly with the aircraft manufacturer for a specific quantity of aircraft and model types to be delivered over a future period of time. Most of these aircraft orders are speculative, meaning that not all of the aircraft being ordered have necessarily been placed on lease to an airline. However, since cost is the number one issue of airlines today speculative aircraft orders are necessary in order to generate the pricing levels that only large quantity aircraft orders provide.
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Now, aircraft prices are, of course, a matter of extreme sensitivity to everyone in the industry today and therefore pricing is closely guarded because it is the main factor that determines competitive advantage or disadvantage for airlines and for leasing companies. In every major competitive aircraft campaign at an airline or aircraft leasing company there are wild stories about concession levels and discounts, most of which are pure speculation for competitive bragging.
In truth, ladies and gentlemen, most of the time you only know for sure what you paid for the aircraft, not what anyone else pays for the aircraft. Only one thing is for certain that discounts and concessions from the list or catalogue price are, in fact, given. And in order for 100 or more aircraft by the most credit worthy buyer would certainly command the highest concession levels offered by any aircraft manufacturer for commercial or civilian airlines. Aircraft prices are quoted on an escalation basis
The CHAIRMAN. Let me hold you up on that, on that point
Mr. PLUEGER. Yes.
The CHAIRMAN [continuing]. Very quickly, Mr. Plueger, because you just hit a point that is going to be real important for us. And that is that you have a lot of experience in the aircraft leasing world and that this is a major order, obviously, by the most credit worthy buyer. So, on the question of whether or not the concessions and discounts were given I would simply ask Dr. Sambur, from your point of you, have you had access to or an understanding of to your satisfaction what commercial lessees have been paying for similar aircraft?
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Secretary SAMBUR. What we do is two things. First of all, we had a
The CHAIRMAN. In other words, you know that you are making a big purchase with a very creditworthy lessor and you have a right to get a great deal. Do you think you got a great deal compared to the commercial market?
Secretary SAMBUR. Yes, we do. And the way we know that is two ways. One we had a confidentiality agreement between one of the major buyers of this and we compared our price to theirs. And ours was better with comparable quantities and second of all we asked Boeing to make sure in this contract that we had the most favored price, meaning that nobody would ever get a better price. And we went further. We asked them did anybody in your past record ever get a better deal than this with comparable prices and they went back and looked through their entire records of what they sold this and they have assured us in writing that we have gotten the best deal of anybody that they have sold this plane to, counting inflation. Inflation was the only caveat that they used because some of these deals have gone over a very long period of time.
So, the only caveat in that statement was counting inflation, the Air Force has gotten the best deals that they have ever gotten and will be the best deal that they will ever give.
The CHAIRMAN. Okay. Thank you.
Page 42 PREV PAGE TOP OF DOC Mr. Plueger, please proceed, sir.
Mr. PLUEGER. Sure. Thank you. Getting back to pricing for a moment, as I said, there is a lot of wild speculation. But, for these wide body aircraft today, in a period of very distressed market pricing, depending upon the specific airframe manufacturer, discounting or concession level is anywhere from 15 to 30 percent or more from the published catalogue price would not surprise me in the civilian or commercial world for an order of 100 wide-body aircraft today.
In the commercial world, an order of 100 wide-body aircraft, which some people also call twin-aisle aircraft, such as the 767, regardless of whether the order is by an airline or by a leasing company, would command a heavily fought commercial campaign between Boeing and Airbus. Such a large order, particularly in these extremely difficult times for the airlines and airframe manufacturers would obviously be highly coveted. But, the competition lever is not limited just to Airbus and Boeing. There is an equally brutal campaign fought by the engine manufacturers for the order. The 767 series of aircraft, for example, can be powered by engines manufactured by Pratt & Whitney, General Electric or Rolls Royce. The percentage of discounting of engine prices can far exceed that of the airframe.
Now avionics which is a term generally used to include aircraft communication and navigation radios, autopilots, radar, GPS systems, ground prox systems, et cetera represent another area of competitive bidding and negotiation, as are other components, such as wheels, tires, brakes and the auxiliary power unit, or APU.
Normally in a commercial aircraft operating lease structure where the lessor purchases the aircraft directly from the manufacturer, the lessee does not know the actual price paid by the lessor for the aircraft. The commercial airline operating lease industry is highly competitive and, as most of the committee members are probably aware, there is currently an oversupply of commercial airliners today as the airline industry worldwide, and in particularly here in the United States, suffers the most severe financial losses in history.
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In this environment lease rates, which are the actual lease price or payments made by the lessee to the lessor are largely market driven. The lease rates are obviously the most negotiated factor in virtually all operating leases. However, there are factors that generally influence lease rates. These factors include the duration or length of the lease term, generally, the longer the lease term, the lower the lease rate. So, a six-year lease, as is contemplated for the KC767A, would generally have a lower lease rate than a four-year lease, but would have a higher lease rate than a ten-year lease. ILFC's average lease term for a new wide-body or twin-aisle aircraft is about seven years.
A second factor would be the credit worthiness or the perceived financial risk of the airline. And a third factor would be the customization costs of the aircraft for the airline. And, generally speaking, specification and configuration costs that are uniquely attributable to a specific airline are priced into the lease rate by amortizing the cost of such customization over the lease term. Therefore, a longer lease term helps lower the lease rate because there is a longer period of time over which those customization costs can be spread.
A fourth factor would be other cash inflows in a lessor provided by the terms of the lease, such as security deposits and maintenance reserves, which I will discuss shortly. And whether the lessor retains the interest earned on these amounts. A fifth factor would be other cash outflows made by the lessor, such as engine or spare parts financing or the purchase of used aircraft from the airline in order to make room for the new aircraft.
And the last factor would be the strategic importance of the customer to the leasing company and the future business potential of the customer. Now, in the marketplace today there is a wide variation of lease rates as a function of the supply and demand of each particular aircraft model and the factor, such as lease term that I just mentioned. In today's world, lease rates on new wide-body or twin-aisle aircraft currently range from about .5 percent to about .8 percent, which is five tenths to eight tenths of a percentage point per month, multiplied by the cost of the aircraft.
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Therefore, in the marketplace today 100 million aircraft, depending on which aircraft might be, might lease for about $500,000 to $800,000 a month, depending on the model aircraft and a variety of factors and market pressures as previously mentioned.
The lease rates themselves can be structured in different ways depending on the transaction. For example, lease rates can be quoted on a fixed basis, that is each payment is the same throughout the entire lease term. Alternatively, lease rates can be quoted on a variable rate based on financial interest rates such as LIBOR or Prime. Under a variable rate the lease payments fluctuate based on the interest rate index being used.
There are a variety of other lease rate structures, such as stair step lease rates that start out low and then step up gradually over time. Multi-currency lease payments can be structured. Seasonally adjusted lease rates can be structured to match the cash flow of the airline. This is only a sample of the structuring flexibility inherent in the operating lease.
Additional flexibility in operating leases may include lease extension options, which I have not heard discussed today, early termination options, options to rollover into other aircraft types and purchase options. There are many other considerations and issues regarding the operating lease for commercial airliners. I eluded to some of those considerations earlier, specifically aircraft maintenance, insurance and return conditions, which are all the responsibility of the lessee under traditional operating leases. After the lease rate itself, the maintenance and the return condition sections of an operating lease are the most heavily negotiated simply because there are millions of dollars at stake for each aircraft.
Page 45 PREV PAGE TOP OF DOC The aircraft must normally be maintained pursuant to a maintenance program that is approved by the aircraft manufacture and the aviation authority under which the airline operates, such as the Federal Aviation Administration in the United States. Many operating leases contain maintenance reserve charges for major airframe and engine overhauls, the use of life limited parts on engines, the landing gear and the auxiliary power unit. Under these provisions the airline pays either to the lessor or to a third party maintenance provider a fixed charge for each hour or for each cycle that the aircraft might operate.
In this way a fund or a savings account is therefore built up that has been used for major overhauls and maintenance, which can amount to millions of dollars on both the airframe and engines. The airline draws on that fund when such major maintenance expenditures are incurred. Such maintenance reserves provide the lessor with additional security that the airline will have the funds available when needed for major maintenance work. Any money left in these maintenance funds usually stays with the lessor at the end of the lease.
The return conditions that the aircraft must meet at lease expiry are of pivotal importance and it is often said that the profitability in operating leases can be made or lost in the return conditions of the lease. Generally speaking, in addition to meeting all air worthiness requirements of the aviation authority under which the airline operates, upon return of the aircraft at lease expiration the aircraft must usually conform to one of two broadly accepted standards, the United States FAA or, alternatively, the European joint air worthiness requirements. When a new aircraft is leased, there is usually a requirement that the aircraft, engines and components, be in a so-called half-life condition at return, meaning that the aircraft, engine and critical parts are halfway between major overhauls.
Page 46 PREV PAGE TOP OF DOC And analogizing again to the car situation, if a car goes to the shop every 10,000 miles for major work, the car would be returned with at least 5,000 to go until it has to go into the shop. The aircraft engines must meet certain performance and remaining life standards, the airframe must be delivered usually fresh from its 15-month inspection called a seat check. All airworthiness directives must be complied with, and AD is a specific repair or modification of inspection that is required to be performed on the aircraft in order for it to be deemed air worthy and legal to fly. There are many other technical matters dealing with the return conditions, but suffice it to say that it is an area where both lessee and lessor have major financial exposure.
Closely related to aircraft return conditions are issues regarding the unique specification requirements of the airline? Some airlines, for example, have a unique audio video passenger entertainment system or proprietary interior layout, which much be removed at aircraft return. Removing such items at the end of the lease can also lead to large financial costs, which are normally the responsibility of the lessee. This may or not be a significant issue on the KC767A program.
Aircraft insurance coverage has been another area of increasing consideration and review in the operating lease structure. Under the terms of an operating lease the lessee airline is responsible for all insurance coverage as dictated by the terms of the lease. Terrorist events, declining aircraft values and increasing liability exposure have elevated insurance costs and therefore the insurance provisions of operating leases have been open to new levels of scrutiny, cost analysis and negotiation.
Just for example ILFC generally requires a minimum liability coverage of at least $1 billion on its aircraft leases, as well as aircraft hull values that decline over time as the aircraft depreciates. Other insurance issues addressed in the operating lease include war risks, compensation deductible levels and more. And, particularly since 9/11 the lessor makes up government guarantee in lieu of commercially purchased third party and war risk liability insurance.
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When an operating lease terminates normally, the lease contract has run and all contractual obligations, including return conditions, have been satisfied, the aircraft is returned to the lessor and the security deposit is refunded to the lessee. The lessor may have lined up another follow-on lease customer for the aircraft or the lessor may sell the aircraft. There is normally no further requirement or financial obligation on the part of the lessee to the lessor once the aircraft has returned.
For example, the lessee does not normally guarantee or pay a fee towards the residual value of the aircraft. The lessee has no exposure to the aircraft residual value. This illustrates what many airlines consider as a benefit of leasing versus owning. During periods of economic stress, such as we see today in the airline industry and the commercial aircraft marketplace, the lessor takes all the residual value risk. The lessee simply walks away. And in this way, also, the airline is not burdened with a particular aircraft type or size when a different one may then better fit the airline's operational needs.
The committee should be aware that in order for a lease to be considered an operating lease as opposed to a financial lease, wherein the lease is reflected on the balance sheet of both of the lessee and lessor, in the commercial world the Financial Accounting Standards Board has set forth four general requirements in a statement 13 as follows.
Number one, the present value of the minimum lease payments must not exceed 90 percent of the value of the aircraft at least inception. Number two, the lease term cannot be greater than 75 percent of the economic useful life of the aircraft. Number three, there can be no bargain purchase option at the end of the lease. And, number four, the title to the asset or the aircraft cannot transfer to the lessee at the end of the lease. It appears to me that these requirements may be mirrored in governmental accounting by OMB circular A11.
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Now, although I am not here to comment on the KC767A program, it would be interesting to know whether it is possible and cost effective to convert existing Boeing 767 200 or 300ER aircraft into aerial refueling aircraft. The same question applies to converting existing DC10 aircraft, for example, into KC13510 aerial refueling aircraft. Given the KC135767A projected utilization rate of 750 hours per year, versus normal commercial airline utilization levels which well exceed 3,000 hours per year and given the current oversupply of aircraft and the resulting depressed market prices, and their ready supply of these aircraft types in the marketplace for many years to come, it might be a way of adding incremental air refueling aircraft to the Air Force fleet as needed if a cost effective conversion program existed.
Conversely, it would also be interesting to know if the KC135767A can be demodified back into a passenger or freighter aircraft without significant operational or weight penalties. If so, the aircraft has the potential for a higher residual value since it would not be limited to the aerial refueling mission, which might result in lower lease pricing over the long-term.
So, I am going to thank you, Chairman Hunter and committee members for giving me the opportunity to speak with you today. I hope you find this background information on commercial airline operating leases useful. I would be happy to answer any questions the committee may have.
[The prepared statement of Mr. Plueger can be viewed in the hard copy.]
Page 49 PREV PAGE TOP OF DOC The CHAIRMAN. Thank you very much, Mr. Plueger, for a very thorough statement and that is what we asked you do was give us a leasing 101. I think you did a great deal job at accomplishing that.
And, Alex, you can be very proud of your father. And our best to all your colleagues there at Harvard Westlake School in Los Angeles.
Mr. Plueger, let meyou have gathered from the previous testimony that we obviously contemplate keeping these tankers. The six-year lease is the vehicle for acquisition, but that we intend to keep them and keep them for a long time. And if that is the case, would you agree that the common sense analysis of this deal would be to take how much it would cost to buy the tankers
Mr. PLUEGER. Absolutely.
The CHAIRMAN [continuing]. And compare that with how much you are paying to lease them and buy out the lease at the end, add those figures together. And figure out what the difference is.
Mr. PLUEGER. Absolutely.
The CHAIRMAN. And then ascertain whether other factors, such as getting the airplanes earlier and not paying a lot of cash up front justifies the difference in the total amount of dollars paid. Does that make sense?
Page 50 PREV PAGE TOP OF DOC Mr. PLUEGER. It absolutely makes sense. And in the commercial world there is no difference. If you are going to keep an aircraft and operate it for a long, long period of time, just like you will a car, it is cheaper over the long run to buy it.
The CHAIRMAN. Well, let me ask you this. Obviously, you know that we have considerations
Mr. DICKS. Mr. Chairman, just one point. If you have the money, right?
The CHAIRMAN. Yes, we are going to
Mr. PLUEGER. If you have the money.
The CHAIRMAN. Yes. Thank you for that extremely concise cross-examination there, Mr. Dicks. But, the point that I am getting to is that we have a modernization program and we have analysis by the Congressional Budget Office (CBO) over the last several years to the effect that just to keep our platforms, trucks, tanks, ships, planes, halfway modern, that we should be spending a little more than $100 billion a year on the purchase of new equipment. We spend in the last few years before this new administration an average of about $50 billion. So, we were way behind. Now, we spend in this budget, a little over $70 billion. So, we are still about $30 billion behind. And, so, if you presume that we have other things we also have to buy and they are costing a lot of money, like the F-22, like the C-17 and other platforms, and we need to conserve our cash. Is that a valid consideration?
Page 51 PREV PAGE TOP OF DOC Mr. PLUEGER. I believe it is.
The CHAIRMAN. In terms of going with the lease?
Mr. PLUEGER. I believe it is.
The CHAIRMAN. So, let me ask you, Dr. Sambur, based on those boundaries, that is presume you are going to keep these birds for a long time and that you add up how much money the government pays pursuant to the lease, the lease payments, plus the buy out chunk that you got to pay at the end to keep them, and you compare that to the outright purchase, what is the rough comparison?
Secretary SAMBUR. Well, that is the net present value that we talked about.
The CHAIRMAN. Yes. We can't hear the mike.
Secretary SAMBUR. That is the net present value that we have been eluding to throughout, which has that exact analysis in A94 and that is where the difference with the approvedagain, I want to emphasize this, with the approved assumptions that OSB and OMB made the difference is less than 1 percent in the neighborhood of $150 million in a $17 billion type of procurement. So, the question that you are offering me is that penalty worth it in terms of us being able to afford in the Future Year Defense Program (FYDP) 60 tankers delivered versus only three to four. And I tell you yes because not only is a delivery issue, the A94 does not include the maintenance costs that are included in keeping these older things going for the extra five years. That is not part of the analysis.
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The CHAIRMAN. Well, now, let me ask you a question. But, if we presume that if you go with the sale and you get them later, although you have given us an analysis in which we could receive the tankers on a delivered basis that roughly approximates by sale, roughly approximates a delivery basis of the lease. You are talking about maintenance costs avoided.
Secretary SAMBUR. For the older tankers.
The CHAIRMAN. For the older tankers.
Secretary SAMBUR. Because we would have had to keep them five years longer.
The CHAIRMAN. Yes. Have you got that figured out?
Secretary SAMBUR. We have an approximation that
The CHAIRMAN. How much is it?
Secretary SAMBUR. I think it is many billions of dollars. I will take that for the record and I will get back to you.
The CHAIRMAN. If you could. In fact, if you could get it from of your folks before the end of the hearing that is an important factor. Incidentally, what is the mission capable rate for the present birds?
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Secretary SAMBUR. I will give you General Essex who has the up to date figures on that.
The CHAIRMAN. General.
General ESSEX. Sir, over the last 5 years, the KC135Es have averaged 71.9 percent mission capable, and the KC135Rs, 78 percent. Now, of course, more recently and I think Mr. Curtin mentioned an 85 percent MC rate in his written testimony. We do have spikes where we can get up to something like 85 percent. And when we are in contingency operations, a war, we pour everything we can we defer a lot of actions and so forth. So, you will see spikes. But, on the average, which is, I think, a better measure, the MC rates have been about 72 percent for the Es and 78 percent for the Rs.
The CHAIRMAN. Okay. So, you got more than a quarter of your birds that aren't mission capable?
General ESSEX. Right, on the average.
The CHAIRMAN. On average?
General ESSEX. Right. And
The CHAIRMAN. Okay.
Page 54 PREV PAGE TOP OF DOC Now, let me ask Dr. Sambur, if you go back to unit cost of these birds
Secretary SAMBUR. Right.
The CHAIRMAN. As I understand it, and you tell me if I am wrong on this, the cost of the birds with the tanker package appended is roughly $130 million a bird, is that right, $131 million?
Secretary SAMBUR. Yes. Can I just elaborate on that cost?
The CHAIRMAN. Certainly.
Secretary SAMBUR. Because I think it was eluded to before that there is a slight catch in that $131 million price. That $131 million price assumes that we pay upfront and then you wait approximately three years for the plane to be delivered. Now, obviously, if you look into the situation that you could actually take that $131 million and invest it during that three-year period of time you have actually lost the use of your money and that one $131 million could be worth a lot more after 3 years. What we have agreed with Boeing is that instead of this $131 million, we will pay them their actual construction loan costs, which is approximately $7 million and at time of delivery we will give them then $138 million. That is equivalent to the 30 percent number that you talked about in terms of progress payments. And that is a much better deal that we were able to get from Boeing. That we would only pay their actual construction costs as opposed to giving them progress payment.
Page 55 PREV PAGE TOP OF DOC So, the reason why I wanted to amplify on that is because there is a lot of confusion as to what is actually involved in that number. It is really a lot more than $131 million.
The CHAIRMAN. Okay. If you take that $131 million then
Secretary SAMBUR. Sure.
The CHAIRMAN. And you add the buyout that you are contemplating right now is $40 million per bird?
Secretary SAMBUR. Again, there is a little bit of confusion with this analysis here. The $131 million is the buy price. Now, the difference between the buy price and leasing is when you lease a car, for example, you first negotiate what that buy price should be. It is independent of whether you lease or you buy.
The CHAIRMAN. Okay.
Secretary SAMBUR. And then you decide as was eloquently done in this 101 what the various conditions of lease rate and interest rate and all those other things and you decide at the end of the lease what the residual value is. What is, you know, the price that you will pay for that car after the six-year period?
The CHAIRMAN. I understand.
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Secretary SAMBUR. Now, the $131 million includes everything. Now, if you take into consideration your progress payments after the six-year period of time I think there is a $20 million approximately and someone can correct me if I am wrong, that you would owe at the end of that period to pay off and get the car or get the plane as ownership.
The CHAIRMAN. Well, I thought the total amount was $4 billion and that would be $40 million a piece. I thought that was, $4 billion was cited.
Secretary SAMBUR. There is a lot of factors in the $40 billion. For example, there is inflation.
The CHAIRMAN. I understand.
Secretary SAMBUR. That is a good number.
The CHAIRMAN. Okay. Here is what I want to know. If you add thenumber one, we have agreed that your analysis shows that $131 million for the package, that is the modified aircraft, is in the Air Force's opinion a reasonable price.
Secretary SAMBUR. Right.
The CHAIRMAN. That is an appropriate price. And that is what you would pay if you bought them. If we put these on a purchase operation. What is the total in payments that would be made for that airplane through the lease payments under the lease construct?
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Secretary SAMBUR. Well, you can do it backwards.
The CHAIRMAN. Well, we will figure it out. But, just tell me what the total is.
Secretary SAMBUR. The total payments is aroundin then-year dollars is $17 billion. And then you add an additional $4 billion approximately to buy them.
The CHAIRMAN. Okay. It is $17 million
Secretary SAMBUR. Billion.
The CHAIRMAN. Okay.
Secretary SAMBUR. Plus $4 billion.
The CHAIRMAN. So, that is $170 million per bird?
Secretary SAMBUR. Right.
The CHAIRMAN. And then how much for the buyout?
Secretary SAMBUR. $4 billion.
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The CHAIRMAN. Okay.
Secretary SAMBUR. $21 billion is the total cost.
The CHAIRMAN. So, you are paying, in total dollars, you are paying $210 million per bird, dollars transferred from Treasury to contractor over this period of time?
Secretary SAMBUR. Right. And that includes inflation, the interest you pay and everything.
The CHAIRMAN. I understand.
Secretary SAMBUR. Right.
The CHAIRMAN. So, the question is, does the difference between the $131 million, which was what you think would be a reasonable purchase price if you just outright bought them, does that compare favorably or does the $210 million that you are paying in total payments compare favorably with the $131 million and what you look at as first your financial factors in terms of the fact that you are getting theseyou obviously pay more over a period of time than if you buy something up front, there is an interest rate or an inflation rate that you have got to look at. And then you look at theat what I would call the policy factors, that is needing birds and needing your money to do other things with in the early years. And you have looked at that and you think that the $210 million compares favorably with the $131 million considering those factors?
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Secretary SAMBUR. Yes. And if I could just add one, Mr. Chairman, the financial committeethe way you did the analysis is looking at the total payments.
Secretary SAMBUR. But when a financial person says how do we actually make this comparison, what is the tool that we use to make a comparison when money, which has a value associated with time, goes over a long period of time that uses net present value analysis? It is a standard analysis. When you look at it that way, which takes into consideration that money has value that changes with time
The CHAIRMAN. We understand.
Secretary SAMBUR [continuing]. The difference is only one percent. That is the $150 million number that we keep talking about.
The CHAIRMAN. And that includes the buyout?
Secretary SAMBUR. That includes everything. That includes buyout, that includes the maintenance. That includes everything. That is in the report that we gave to Congress.
The CHAIRMAN. Okay. Now, let me ask Mr. Plueger one question. And I apologize to my colleagues for taking so much time. But, it is kind of complicated thing.
Page 60 PREV PAGE TOP OF DOC You have heard the figures, a $131 million package I would ask you to assume that that is the reasonable price of this modified aircraft for military purposes and the fact that over the six-year lease when you up with the pink slip at the end you are going to have paid $210 million. On the other hand, you will have kept a lot of cash in your pocket for a longer period of time. Is that within the range of what you would consider to be a reasonable deal as a businessman who makes lots of deals?
Mr. PLUEGER. I would say in the commercial area the difficulty with answering that question is none of us really knows what the real residual value of the airplane is going to be after six years or when the buyout point is. I am assuming there is a pre-negotiated number.
Secretary SAMBUR. There is a pre-negotiatedthere is a definitive number. As a matter of fact, we have a very unusual clause in the contract that basically states that we are guaranteed that money if, for example, they are able to sell the planes at a greater value, they have to refund back to the Air Force the difference.
The CHAIRMAN. But, I would say the most important
Secretary SAMBUR. And we are protected on both ends. It is a kind of an interesting clause that you might want to take a look at.
The CHAIRMAN. But, I would say the most important factor here is the fact that you are not flying these planes very hard. Seven of the 750 versus the 3,000 hours in the commercial planes. So, you are going to have birds that have a lot of life left in them. Is that a factor?
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Secretary SAMBUR. Can I just elaborate on that? There is a little bit of a confusion about what that term is. So, if I can just spend a second here. When you lease a car there is a requirement in there that says if you12,000 per year lease, if you have your car and you drive more than 12,000 miles per year you pay a penalty. The number that you saw in the contract that number of hours is just associated with the maintenance conditions on that car. You can drive that plane as much as you want except you have to pay a
The CHAIRMAN. I understand.
Secretary SAMBUR [continuing]. You know, just like you rent a car for 15,000.
The CHAIRMAN. I understand. Let me get back to Mr. Plueger.
If you assume that you are going to have birds with a lot of life left on them because you are going to average that rate which is roughly one-fourth of what the airlines, the mileage the airlines put on them, does that fall within the ambit of what you would call a reasonable deal?
Mr. PLUEGER. I believe it does with one caveat then in the commercial world a 767 200ER today, because of the stressed pricing probably would not realize that much residual value in today's marketplace. But, the marketplace changes. Aircraft supply and demand does change, which is why I say it is very hard to know what these airplanes are really going to be worth. That is also the reason why I asked if the aircraft could be demodified into a per passenger or commercial passenger or freighter status because at that point in time there is a marketplace for the aircraft. When modifications such as this are made sometimes, for example, in freighter modifications, aircraft cannot get all the weight out of them that was put into them to make the modifications and if that is the case they have a slightly lower value because they have less payload capability.
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So, it is a difficult question. I would just say that the gross numbers, the difference between $131 million to $44 million certainly appears to be reasonable but I would only point out that in today's commercial marketplace, and I have to emphasize that because there is no fair market value for a tanker. There is no market except for the U.S. Air Force and maybe other governments. Only to say that in today's value the 767 200ER probably would not meet $44 million.
Secretary SAMBUR. Can I just add to that? As you eloquently did in your statement, you talked about the requirements on A11. One of them is to have a commercial market. The way we were able to have A11 approved was that the value, the residual value, was based upon a freighter configuration. And if you know some of the specifications for this tanker there is considerable cargo capacity that does not have to be modified at the end. So, we had to play particular attention to those issues that you just talked about.
The CHAIRMAN. Good. That is good. Okay. Thank you very much.
If the staff could check how much time we have here, I wantokay, we got about ten minutes until a vote.
Mr. Plueger, once again, I want to really thank you for coming out and adding a really important dimension to this hearing. You have given us a lot of good insight here. We appreciate that.
Page 63 PREV PAGE TOP OF DOC And, Alex, you can be very proud of your dad.
And, my partner for Missouri, Mr. Skelton.
Mr. SKELTON. Thank you, Chairman Hunter. Mr. Chairman, thank you this is a very important hearing. And I appreciate your calling it. I have three questions. Two, which I would like to address to Mr. Wynne and Mr. Curtin.
I am just a country lawyer from a small town and I wish you would explain or convince me that this proposal is good, Mr. Wynne.
And, Mr. Curtin, a similar question put to you. Plus, how does this particular proposal policy affect future acquisition policies in 25 words or less, please?
Mr. WYNNE. Thank you very much, Mr. Skelton, I will try to getI am not sure I can handle the 25 words, but I will try. First of all, we have a need because we have an aging fleet. And we have had a holiday as you know and we are attempting to buy more than we have been authorized. We have used the authorities provided to us to effectively do that. We have evaluated the ways to do it and we have concluded that this is the best way to satisfy the rapid acquisition and supply to our war fighters of this kind of residual capability.
The different price that we are arguing relative to a new aircraft development program, which we would normally go through, as you well know from your many years, is large. Our capability to get a derivative commercial airliner to do this job is, therefore, attractive. And I think the ability, again, to secure these aircraft faster made this deal very attractive. The Boeing prices and the clauses that the Air Force got cemented our confidence in it because it allows our auditors to actually follow-up, which is highly unusual in a commercial buy.
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Second, we have established a policy board, although this is a rare, but not unknown, and as you know from your many years of service, sir, the Navy actually has entered into a leasing arrangement on maritime pre-positioning ships some long time ago to buy ships that are anchored off ofthat are actually bought, owned and operated through a leasing company and we have residual value on those.
I went to a conference in Britain where they actually have extended their budgetary authority in the same manner using build, own, operate, which did with the maritime pre-positioning ships and build, own, lease, which is what we are attempting here. This pilot program, done under A94 to satisfy a near-term requirement, adding to our capability to purchase, partnered by the Congress is a marvelous opportunity to use and explore this imaginative alternative to normal procurement.
That having been said, we have established a leasing panel and a policy that all leases that have a life value over $250 million will be reviewed by the leasing panel and then recommended to the appropriate approving authority, subject to the provisions of the A94 leasing provision.
Mr. SAXTON. [presiding.] If I may just interrupt we are about six minutes from a vote. So, in about one minute, I think we will leave and we will pick up with you when we get back.
Page 65 PREV PAGE TOP OF DOC Mr. CURTIN. I think the way I would answer that, Mr. Skelton is the cost difference, if there is a true urgent national security need to do this, the cost difference is not so great that it should be a show stopper. The real issue the committee needs to come to grips with is whether or not they consider the risks so high with this current fleet that you have got to act right away under this unique approach. And, you know, as I have said, there is a question of how much risk we have been accepting all along for this fleet. It is an old fleet.
What are the possibilities of a fleet wide grounding that puts a big chunk of your tanker capability out of commission. We have been accepting it. Can we continue to accept it for a few more years before we start a normal acquisition program and do all the kinds of requirement studies and analysis of alternatives that we would like to do, or do we need to start right away? And that is a tough question to answer. So, it is a judgment that you all need to be able to make.
Mr. SAXTON. Mr. Curtin, thank you very much.
We are going to continue with Mr. Skelton's questions when we return. Thank you.
Mr. SAXTON. We are ready to start again, if people could, kind of, get in their places and we will get going here.
Here is the situation. We have a series of ten votes. This vote will be about 15 minutes in duration and after that it is undetermined whether it will be 15-minute votes or five-minute votes. If they are 15-minute votes we will be going back and forth. If they are five-minute votes, we will have to stay there. They are going to be five-minute votes. So, what I would like to do, I am going to pass on my question time for now and go to Mr. Bartlett for his questions and then Mr. Dicks for his questions. And we are now operating under the five-minute rule.
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Mr. BARTLETT. Thank you very much. Before we decide to acquire these aircraft we need to get over two hurdles and I am not comfortably over either one of those yet. The first hurdle is do we, in fact, need at this time to acquire these aircraft? And the second hurdle is if we need to acquire these aircraft, is the lease the right way to go? So, I would like to address those two concerns in that order.
To address the first concern, what I would like to do is run through a very brief chronology. It begins in 1996 and I think this was in response to a GAO inquiry. The Air Force said that the KC135 is sustainable for another 35 years. And I think that Mr. Curtin testified to that. In January of 2001 the Air Force budget request had no request for new tanker aircraft. In February of 2001 the Air Force said, ''The fatigue life of the KC135 with adjustments made for the effective corrosion on crack growth, should permit the aircraft to remain viable through the year 2040.'' Now this is 5 years later than 1996 and by that time the Air Force was more optimistic about the remaining life of the aircraft. They now say that it will last until 2040.
By the way, it is my understanding that the evidence that corrosion is a problem is anecdotal. There is no definitive study documenting that, in fact, that is a major problem.
In November of 2001 the Congress included $30 million for R&D and $120 million for procurement to convert one commercial 767 aircraft. But the administration made no request to the authorizing committees. In January of 2002 the Air Force budget request had no new tankers. In January of 2003, just this past January, there was no Air Force budget request for new tankers. But, by May of this year, as a matter of fact, May 23, there was an Air Force public announcement of a lease agreement and on July 11 of this year the Air Force report to Congress was submitted on the lease proposal.
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Now, in fact, we need these airplanes so quickly, why are we retiring KC135Es when obviously they are easily convertible to Rs and nobody is suggesting retiring Rs? As a matter of fact there are now three Es being converted to Rs in request in this budget for monies for four more to be converted to Rs. So, I think the argument that there is an urgent need for these has not been made. And I am not persuaded by the consensus statement if we bought all of our platforms on a consensus statement I think that there would be some question about the rigor of our procedures for doing this.
Then the next hurdle, once you have gotten over the hurdle, because I am not yet over it, that in fact we need them urgently.
Mr. SAXTON. Mr. Bartlett.
Mr. BARTLETT. Because of the fact that the Air Force has never made that claim
Mr. SAXTON. Mr. Bartlett.
Mr. BARTLETT [continuing]. Until very recently? As a matter of fact, every claim they made in the past was that these old birds have a lot of life left in them, not to worry. They said at one time, by about 2020 we are going to start looking at replacing these planes. I am curious as to what happened in the few months since January of this year when no request was made and so now it is such a big urgent problem. And if you look at the dollars to buy these and I know that it is hard to compare our lease with a commercial lease, because the commercial people can write off half, about half if you are taxed about 50 percent on your profits, which is about where we are. Then the government, the taxpayers are paying half of your lease, is that correct?
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We don't have any tax write-off. We have to pay the whole thing. And, furthermore, there is another caveat there that is very interesting and that is that we borrow money at a much lower rate than other people. Again, as a matter of fact, about 15 percent of all the money to acquire these planes will be borrowed at 5 percent more than we pay for money. So, I would submit that it is very difficult to compare commercial lease, which would be a good deal with us, which would be a good deal. And I am not sure that $131 million versus $210 million in six years is a good deal for us. I have some serious question about the residual value of the planes. I think that they are probably worth, if they were to be sold on the market, Mr. Plueger, I think they are probably worth about $20 million less than the $44 million. And I think that that is what the market would bear, correct?
Mr. PLUEGER. Today the market does fluctuate. It does go up and down.
Mr. BARTLETT. But, that is where we are today?
Mr. PLUEGER. Correct.
Mr. BARTLETT. They would be worth about $24 million today as compared to $44 million. Now, who knows, they may be worth or less six years from now. But, that is what they are worth today. Now, if there is anything that I have said that is a gross error, I would like somebody to correct it. But, I just wanted these things on the record. I am chairman of the subcommittee. I think that we need to be responsible in our oversight responsibility. And I need to get over these two hurdles. And I am not over them yet. So, I need some help.
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Secretary SAMBUR. Okay. Maybe I can help you out here. Yes, your facts are correct about the Air Force reports. Just before we came back from the break a reporter asked me about that as well and I gave him an analogy, a true analogy, a friend of mine who had gone for a medical checkup in which he was told that everything was okay. A couple of months later he passed away.
The fact of the matter is these reports which were written in good faith have been overtaken by actual events. I mean you talk about these anecdotal evidence of corrosion. We are finding significant amounts of corrosion that was never anticipated, never understood when these reports were written. It is analogous again to the medical report. You have gone a year ago and the person says you are okay and now he takes a new X-ray and decides and determines you now have a tumor.
The fact of the matter is that these things started to grow because, as Mr. Curtin talked about in the GAO report, these are very old planes that things start to go wrong with, all of the sudden and unexpectedly. That is the unknown issues. The fact that we are retiring 135Es is a further confirmation of the fact that these planes are becoming risky. What is happening right now there are flight restrictions because of the corrosion and the Air Force has deemed that these restrictions will only get worse and they are a prelude to increasing amounts of corrosion and it was better to take the aircrew off of the 135Es and use the slightly younger Rs at a more accelerated pace because there was a concern, a real concern, about the risk of flying these Es at increased rates. So, they took the assets of the pilots
Mr. BARTLETT. Excuse me, aren't we converting Es to Rs? So our argument that the Es are hazardous kind of goes away when you know you can put them through the depot and they will come out Rs. And, furthermore, you know, when the conditions changed and the doctor reported a year ago no longer is indicative of how you are now, at least a new doctor's report indicating that. I am not seeing any doctor's report, the equivalent of a doctor's report indicating that things really have changed. There is no study, no definitive study, no documentation that the corrosion problem is any worse now than it was made no request.
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Secretary SAMBUR. We can share with you those reports, very frankly we had to make a business case to my boss, the secretary of the Air Force, to substantiate this retirement because we understood, very much as you have just pointed out that there is a discrepancy in our logic when we at the same time say we have a need and we are retiring planes. So, we had to carefully, carefully establish our logic and the data.
Well, your logic is perfect. And there is something that has been on our mind because we understand that there is a discrepancy. How can you reclaim that we don't need tankers, or we need tankers so desperately and at the same time retire? And the simple answer to that is we have no confidence in the Es right now. And it was worth taking the risk
Mr. BARTLETT. Convert them to Rs in which you have
Secretary SAMBUR. Your question, I will give it to the expert General Essex so we can answer your questions because there are answers to all your questions. And, more importantly, your questions are good ones and we can answer them.
Mr. BARTLETT. I am looking forward to those answers.
Secretary SAMBUR. Okay.
Mr. BARTLETT. Thank you very much, Mr. Chairman.
General ESSEX. Do you want the answer?
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Mr. BARTLETT. Yes, sir. Go ahead, General Essex.
General ESSEX. On the issue of the health of the fleet, you mentioned it earlier, that is essentially the issue. What is the health of the fleet and what is the need to replace these airplanes now? And you brought up the reports and why weren't theywhy did they change? Let me just talk to those few things. The MC rate, 85 percent, yes, for one month is was 85 percent. It is averaging around, you know, in the 70s. That is not really the point. And I will get to that. The point is that you have a fleet of aging aircraft that are basically cancer victims. They are cancer patients. They have growing amounts of corrosion, which cause increased expense and reduced availability to the war-fighter.
Now, that is what I am interested in is the availability to the war-fighter, as well as the expense. You mentioned the reports in the past. GAO and RAND 1995 and 1996 said Air Force, you are going to experience exponential cost growth. We held off. We weren't sure. We weren't seeing it yet. We hadn't been doing all the inspections that we started doing and when we did we started seeing more problems. And also we then did our economic service life study. That economic service life study said and you referred to it, that we don't see a big problem coming. That we should be able to maintain these airplanes for a long time.
And in the beginning of 2001 and through 2000 and 2001 we believed that. We wanted to believe it. We certainly had every reason to want to believe that our fleet was going to be maintained and stay operational for a long time because we had a lot of budget pressures to try and work around. So, it was a good study. It was a very thorough study except that it made some very optimistic assumptions, which proved to be false. So, throughout 2001
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Mr. BARTLETT. Excuse me, let me point out that I think that your airplanes are now spending 45 percent less time in depots than they did 2 years ago, is that not correct?
General ESSEX. We put a lot of different
Mr. BARTLETT. This is hardly consistent with an increasing problem.
General ESSEX. Well, the economic service life study we found out in 2001 was extremely optimistic and that is when we raised the flag and said this has got to stop. In fact, we had planned for an analysis of alternatives to begin in 2002 and in 2001, May of 2001, we asked to accelerate that. Events overtook it before we got final approval for that before the end of the fiscal year.
About that same time, the chief of staff of the Air Force directed the Air Force material command to do everything possible to reduce the depot problem that we were then facing. We had 176 airplanes in depot at the peak. That is just incredible.
So, we poured every effort we could into doing that. We changed the rules. We deferred a lot of airplanes going into depot so that we wouldn't have to tear them apart and leave them apart. We put on extra shifts. We put a lot against this and that has been a success story. We have reduced the number of airplanes in depot down to a manageable level. But, we mined all the gold we can there. So, during the year of 2001 when we found out that just in the year since the data had stopped being collected that the economic service life study was too optimistic. We said we have got to look at this again. And we started looking at this again and in early 2002, we had a thorough review and we found that of all the costs that go into doing the depot work and the maintaining of the 135
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Mr. SAXTON. May I just interrupt. I want to give Mr. Dicks an opportunity to ask some abbreviated questions I guess. We are going to have nine five-minute votes. That is going to take us an hour and a half. So, when we leave here this time, I thinkpardon me? Yes. We are going to have nine five-minutes in a row. So, Mr. Dicks, if you would ask your series of questions and maybe
Mr. DICKS. I am going to miss one if youdo you want to miss this one?
Mr. SAXTON. Okay. We will miss this one and
Mr. DICKS. A live pair.
Mr. SAXTON. Right.
Mr. DICKS. Okay.
Mr. SAXTON. Let us do it.
Mr. DICKS. Thank you.
Let us go right to the heart of this. First of all, you know, there is an opportunity here with the 767's that could go away. This is a commercial plane. And one of the reasons why we have got to make this decision and act now is because there is a possibility that the 767 commercial line would be shut down. And, so, I think that is an important point.
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The other thing is we are going to save a lot of money by not having a development procurement program. We don't have to R&D. This is off the shelf. We are taking a commercial plane. Boeing has paid all the money to do the R&D. In fact, there are four planes for Italy, four planes for Japan, which will absorb a lot of thehelp us on the learning curve on these airplanes. So, you know, the idea of staying with this. And I have got this picture of the engine strut corrosion that I went out and personally visited out at Tinker Air Force Base and to see the corrosion and to see the condition of these planes was a sobering event for me because we had been doingI had been a strong supporter of the re-engining program, putting money into the budget every year to take some of thesedo some of the re-engining work.
But, it became clear to me that we were taking a risk. And I think the chairman pointed out in the previous hearing we had with the C141's, we all of the sudden had a block failure and these planes had to be shut down and could not be utilized for a period of time. And what we are worried about here is a block failure of the older KC135Es, which would not be good. Now, we are retiring them and because of that retirement we are going to save a substantial amount of money. I think it is several billion dollars of cost avoidance since we don't have to maintain the old planes and we don't have to do the re-engining, that is money that we can use for other things.
So, those are some of the points that I wanted to make. And the reason we did this in the first place is because we didn't have the money in the procurement budget. To Mr. Plueger's point about, you know, you lease because it is a cash issue. And we didn't have the money in the procurement budget to buy these planes. The only way we could do it was through the lease because it deferred the first payments until 2006. And the most important point we getwe will have 60 airplanes in 2009 if we do this. If we don't, if we go and start a procurement program now, as I understand it, either it is one plane in 2009 or four planes in 2009. That is a huge difference.
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So, we have got this opportunity. I think we should look at leasing in a more constructive way. I think we have built all kinds of barriers in the scoring rules and other things that make leasing less attractive. The government I think is making a mistake here. We should look at this as a way to do business and so those are just some of the key factors that I wanted to make.
Now, is there anything that I have said here that you guys would like to comment on?
Secretary SAMBUR. I think, Congressman Dicks, you are absolutely right. The only difference with the four versus one is the four sees the same funding profile. So, we would have to add thoseyou know, a few billion to make an apples to apples. The one comes from based upon our present plan. But, in any event that is a significant difference. Now the 60 versus four or one means a significant amount of Air Force and helps us reduce this risk of things that are becoming more and more apparent.
Mr. DICKS. Is there a possibility that you could have a block failure on the 135Es that have not been re-engined and restored?
Secretary SAMBUR. Here is General Essex.
General ESSEX. Yes, sir, that is a big risk. We have had them before and it is not just Es. It is the whole fleet, but Es especially. We have had them before, stab trim actuator, fuel boost pumps in the past and all these have caused fatal accidents.
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Mr. DICKS. And you are flying them with restrictions right now?
Secretary SAMBUR. The Es are flying with restrictions right now. And that is the point that I think is so significant right now. The fact that these Es are not really capable as tankers. We can't even take them to the Operation Iraqi Freedom. We just can't make it there.
Mr. DICKS. And for those people, including our friend the chairman, not this chairman, but Mr. Bartlett, who say well I love the KC135Rs, well, we are going to have a substantial number of KC135Rs around for the foreseeable future. Isn't that correct?
Secretary SAMBUR. You know, if we continue on this path it will take us at least 25 years to recapitalize. So, the Rs are going to be the route for a long, long period of time. And that is a bit frightening because if you are 25 to the 45 year age that they are at right now, you are going to have some tankers that are nearly 80 years old. So
Mr. DICKS. We have no experience with planes that are 80 years old?
Secretary SAMBUR. And I am not getting on one. I am not getting on them above 50.
Mr. DICKS. And I would think that anybody would be cautious about having their sons or daughters want to fly a plane that old.
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Secretary SAMBUR. Absolutely.
Mr. DICKS. With that old technology. I had a chance to go up to Everett to see the first plane that is going to Italy. And I want to point out this is not just a tanker. This has cargo capability, passenger capability and it can deal with both Air Force and Navy planes at the same time, isn't that correct?
Secretary SAMBUR. Not only that, we are able to take advantage of the extra cargo space to multiplex these tankers to become smart tankers, where we can put on communications equipment and use them in a very sophisticated network while it enables us to do a lot more than just being tankers. And multiplexes and multiplies the affective use of the Air Force.
Mr. DICKS. And I think this is, for Mr. Wynne, this is transformation. This is taking a commercial, off the shelf airplane, modifying it for military use, avoiding all that R&D expenditure up front. I mean I think this is a smart way to do this and it allows us to defer payments until 2006 and then six years of lease payments and then we buy the airplanes at the end. I think it is a very rational way to do this. In fact, it is the only way we could do it. I went down to the President and asked him to increase the procurement budget and there was no response. But, there was a response in favor of trying to do this lease deal. So, this was a pragmatic decision made in the Congress to give you the authority to do this because there was no other way feasible to do it. So, that is why I think it is such a good idea and we should be supportive of it here in the Congress.
Page 78 PREV PAGE TOP OF DOC Mr. WYNNE. To your point, congressman, is very innovative. It is a pilot program. It is going to teach us a lot about this kind of style of acquisition. And, as you pointed out also, it gives us airplanes early, which we dramatically appreciate because it allows us to deliver the capability of the war-fighter.
Mr. SAXTON. I would just like to say at this point that we have to vacate the room at 2:00. We are going to have a series of votes that are going to take us well passed 2:00, so we want to thank you, Mr. Wynne, Mr. Sambur, General Essex, Mr. Curtin and Mr. Plueger, for being with us. And shedding light on what to us is a new issue and I am optimistic that we are going to move through this and that we are going to proceed with this program. That is just my optimism I guess. But I think we are going to get there.
We want to thank you again for being here and we look forward to working with you in the future.
[Whereupon, at 1:36 p.m., the subcommittee was adjourned.]