In February 2011, Boeing won the Air Force competition to develop the next generation aerial refueling tanker aircraft. Boeing received a FPIF development contract with incentives to control cost while limiting the government’s financial liability. The development contract is to design, manufacture, and deliver four KC-46 tankers for flight testing. The Air Force expects to exercise contract options for the first production lot in 2015 and the second production lot in 2016, both needed for Boeing to produce and deliver 18 operational aircraft in the final production configuration by August 2017. In addition, all required training must be complete, and the required support equipment, and sustainment support in place by August 2017. Then the acquisition strategy calls for Boeing to produce the remaining aircraft through year 2027 at a target rate of 15 aircraft per year. Separate competitions may occur for later acquisitions, nominally called the KC-Y and KC-Z, to replace the rest of the KC-135 fleet and the KC-10 fleet (the Air Force’s other large tanker). The KC-46 program’s acquisition strategy is to convert a commercial Boeing 767 airframe into a militarized aerial refueling tanker in two phases. In the first, Boeing is modifying their 767 airframe with a cargo door and an advanced flight deck display borrowed from the new Boeing 787 aircraft and calling this modified version the 767-2C. In the second, the 767-2C airframe will be further militarized by adding the air refueling capabilities, an air refueling operator station that includes panoramic three-dimensional displays, and threat detection and avoidance systems. Figure 1 depicts how the 767-2C aircraft is to be configured into the KC- 46 tanker. The new KC-46 tanker is expected to be more capable than the KC-135 it replaces in several respects. It will have a modernized KC-10 tanker refueling boom integrated with a fly-by-wire (computer assisted) control system and a permanent hose and drogue refueling system that will enable both types of refueling to be employed on the same mission.KC-135 has to land and switch equipment to transition from one mode to another. Also, the KC-46 is expected to be able to refuel in a variety of night-time and covert mission settings and will have countermeasures to protect it against infrared missile threats. Designed with more refueling capacity, improved efficiency, and increased cargo and medical evacuation capabilities than its predecessor, the KC-46 is intended to provide aerial refueling to Air Force, Navy, Marine Corps, and allied aircraft. Appendix II compares, in more detail, the current capabilities of the KC-135 with the planned capabilities of the new KC-46 tanker. The KC-46 program is one of only a few major weapon system programs in recent years to employ a fixed price development contract. In the past, DOD has typically used cost-reimbursement contracts in which the government pays all allowable costs incurred by the contractor. Recent legislation and defense policy now emphasize the use of fixed price development contracts, where warranted, to limit the government’s exposure to cost increases. Defense officials believe that a fixed price development contract is appropriate for this program because KC-46 development is considered to be a relatively low-risk effort to integrate mostly mature military technologies onto a well-defined commercial derivative aircraft. The KC-46 program estimates for cost, schedule, and performance are essentially unchanged from last year. While the current cost estimate shows an increase of about $217 million for development and procurement combined, program officials explained this increase was unneeded funding that will be returned to DOD. The contractor is running very close to its budget and schedule. Development work is more than one-fourth complete and the program successfully accomplished its preliminary design review (PDR) on schedule. Also, the program has now implemented metrics, in response to our prior recommendation, to measure the development progress toward achieving its nine key performance parameters and projects it will meet those requirements by the end of development. However, there are two areas of concern at this point. First, both the contractor and the government estimate that Boeing’s development cost will exceed the contract ceiling price of $4.9 billion, and second, the contractor has already allocated about 80 percent of the management reserves budget set aside for known and unknown development risks with about 5 years of work remaining. Since the start of the KC-46 program about two years ago, planned aircraft quantities and key schedule events remain unchanged. The program’s latest cost estimate shows a total increase of $217 million in development and procurement, but Air Force officials told us that this is due to unneeded funding from DOD budget adjustments and the Tanker Replacement Transfer Fund. Officials said that the February 2011 cost estimate remains the program of record and that these funding additions will be returned to DOD. The program also completed a major schedule milestone in April 2012 with a successful PDR that determined no major design changes were needed. The PDR is an important risk reduction activity as the program moves into integration and manufacture of the KC- 46. Table 1 summarizes the planned quantities, costs, and milestone dates approved when the program began in February 2011 and the most current estimates in October 2012. The current development cost estimate of $7.2 billion as reported in October 2012 includes $4.9 billion for the aircraft development contract and 4 test aircraft, $0.3 billion for the aircrew and maintenance training systems, and $2 billion for other government costs to include program office support, government test and evaluation support, contract performance risk, and other development risks associated with the aircraft and training systems. The total procurement cost estimate of $40.4 billion is to procure 175 production aircraft, initial spares, and other support items as priced in contract options. The military construction estimate of $4.3 billion includes the projected costs to build aircraft hangers, maintenance and supply shops, and other facilities to house and support the KC-46 fleet. Through December 2012, Boeing has accomplished approximately $1.4 billion (28 percent) in development work and has more than $3.5 billion (72 percent) in estimated work to go over the next 5 years. Boeing reports it is running very close to its budget for cost and schedule. Minimal schedule delays to this point are attributed primarily to design difficulties with the aerial refueling system, hardware deliveries for the system integration labs, and configuration changes to the commercial platform needed to accommodate military specific hardware. DOD officials do not expect these delays to affect the completion of critical tasks that ultimately determine whether Boeing can meet the required delivery date in the development contract. While the schedule delays are relatively small, studies of more than 700 defense programs have determined there is limited opportunity for a program to get back on schedule once they are more than 15 to 20 percent complete. Also, the pace of development work is expected to accelerate. So far, on average, about $60 million worth of work has been completed per month, but over the next year more than $100 million worth of work per month is planned. The program office currently projects that the KC-46 aircraft will meet the requirements of all nine key performance parameters by the end of development. These parameters are system characteristics considered critical or essential to developing an effective military capability. Satisfying these parameters will ensure that the KC-46 will be able to accomplish its primary mission of providing worldwide, day and night, adverse weather aerial refueling as well as its secondary missions. Several of these parameters address performance characteristics that are limited or do not exist in the current tanker fleet. For example, only 8 KC-135 aircraft have the capability to receive fuel from another aerial refueling tanker while airborne. At times this limits the range of the tanker force and lessens the efficient use of assets. The Air Force hopes to address this by enabling the entire KC-46 fleet to receive fuel from other tankers. Appendix III describes the key performance parameters for the KC-46 program. Our report on the KC-46 last year noted that the program had yet to fully implement specific metrics needed to measure progress against these parameters. As a result, we recommended it do so as soon as possible to help ensure that progress toward meeting these parameters can be appropriately measured. The program has now fully implemented metrics to help measure progress toward achieving these parameters. Now that these metrics have been fully established we plan to track their status in our subsequent annual reviews of the KC-46 program. The KC-46 development contract is designed to hold Boeing accountable for cost, limit the government’s financial liability, and provide Boeing incentives to reduce costs in order to earn more profit. At this point in the program, both the contractor and the government estimate that development costs will exceed the contract ceiling price of $4.9 billion and Boeing has already allocated about 80 percent of the contract’s management reserves, which are set aside for known and unknown development risks, with about five years of development work remaining. Barring any changes to KC-46 requirements by the Air Force, the contract specifies a target price of $4.4 billion and a ceiling price of $4.9 billion at which point Boeing must assume responsibility for all additional costs.Currently, both Boeing and the Air Force project that the development effort will exceed the $4.9 billion ceiling price, with the Air Force concluding that the primary reason is the schedule risk associated with the remainder of the development effort. If so, the contractor will have to absorb all costs above this amount. Table 2 provides development contract details, current contractor and government estimates to complete, and the projected amounts over ceiling to be absorbed by the contractor. The development contract performance baseline set aside $354 million in the management reserves account, about 7 percent of the contract ceiling price. As of December 2012, less than $72 million in unallocated reserves remain.