In February 2011, Boeing won the competition to develop the Air Force’s next generation aerial refueling tanker aircraft, the KC-46. This program is one of a few weapon system programs to use a fixed price incentive (firm target) contract for development in recent years. Defense officials stated that a fixed price incentive (firm target) contract was appropriate for the program because KC-46 development is considered to be a relatively low-risk effort to integrate mostly mature military technologies onto an aircraft designed for commercial use. The KC-46 development contract is designed to hold Boeing accountable for cost associated with the development of four test aircraft and includes options to manufacture the remaining production lots. The contract limits the government’s financial liability and provides the contractor incentives to reduce costs in order to earn more profit. 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. We previously reported that both the program office and Boeing have estimated that development costs would exceed the contract ceiling price. As of March 2014, Boeing and the program office estimated costs would be over the ceiling price by about $271 million and $787 million, respectively. The program office estimate is higher because it includes additional costs associated with performance as well as cost and schedule risk. In all, 13 production lots are expected to be delivered. The contract includes firm fixed price contract options for the first production lot in 2015 and the second production lot in 2016, and options with not-to-exceed firm fixed prices for production lots 3 through 13. The contract also requires Boeing to deliver 18 operational aircraft by August 2017. In addition, all required training must be complete, and the required support equipment and sustainment support in place by August 2017. Contract provisions also specify that Boeing must correct any required deficiencies and bring development and production aircraft to the final configuration at no additional cost to the government. After the first two production lots, the program plans to produce aircraft at a rate of 15 aircraft per year, with the final 6 aircraft procured in fiscal year 2027. 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 large tanker). Boeing plans to modify the 767 aircraft in two phases to produce a militarized aerial refueling tanker: In the first, Boeing is modifying the 767 with a cargo door and an advanced flight deck display borrowed from its new 787 and calling this modified version the 767-2C. The 767-2C will be built on Boeing’s existing production line. In the second, the 767-2C will proceed to the finishing center to become a KC-46. It will be militarized by adding air refueling capabilities, an air refueling operator’s station that includes panoramic three-dimensional displays, and threat detection and avoidance systems. The Federal Aviation Administration (FAA) has previously certified Boeing’s 767 commercial passenger airplane and will certify the design for both the 767-2C and the KC-46. Boeing established plans for the FAA to accomplish the 767-2C and the KC-46 certifications concurrently rather than consecutively, which is the typical procedure. The Air Force also has to certify the KC-46 and will use the FAA’s findings to make the overall airworthiness determination. See Figure 1 for a depiction of the conversion of the 767 aircraft 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. Unlike the KC-135, it will allow for two types of refueling to be employed in the same mission—a refueling boom that is integrated with a computer assisted control system, as well as a permanent hose and drogue refueling system. The 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. The KC-135 is restricted in tactical missions and does not have sufficient defensive systems relative to the KC-46. 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. KC-46 total program acquisition costs (development, production, and military construction costs) have remained relatively stable since program start, changing less than 1 percent since February 2011, and the program is meeting schedule and performance goals. Boeing set aside $354 million in contract funds to address identified, but unresolved development risks. As of December 2013, Boeing had about $75 million remaining to address these risks. Based on Boeing’s monthly usage, we calculate that the management reserves will be depleted about 3 months before the KC-46’s first flight and approximately 3 years before the development contract is completed. The government, however, would bear no financial risk for future work if Boeing uses all of its management reserves as long as the Air Force does not make changes to the KC-46 requirements, schedule, or other relevant terms and conditions of the contract. Our prior work has found that flight testing is likely to uncover problems that will require management reserves to address. The KC-46 total acquisition cost estimate has remained relatively stable since February 2011 although there have been some minor fluctuations among the development, procurement, and military construction costs that make up this estimate. The largest change is in the program’s development cost estimate, which has decreased by about $345 million, or about 5 percent. Development cost reductions can be attributed to fiscal year 2013 sequestration cuts, support for DOD’s Small Business Innovative Research fund, and cuts to a fund dedicated to tanker replacement. According to program officials, these reductions have not affected the program because it had set aside funds to address engineering changes, which have not occurred thus far. Overall, total acquisition and unit costs have decreased less than 1 percent and quantities have remained the same. Table 1 summarizes the initial and current estimated quantities, costs, and milestone dates for the KC-46 program. The October 2013 development cost estimate of about $6.8 billion includes several contracts for various activities. For example, the program office awarded Boeing a contract for $4.9 billion to develop 4 test aircraft and budgeted over $0.3 billion for the development of aircrew and maintenance training systems. An estimated $1.6 billion is needed to cover other government costs, such as program office support, test and evaluation support, contract performance risk, and other development risks associated with the aircraft and training systems. The procurement cost estimate of $40.3 billion is to procure 175 production aircraft, initial spares, and other support equipment. The military construction estimate of $4.2 billion includes the projected costs to build aircraft hangars, maintenance and supply shops, and other facilities to house and support the KC-46 fleet at 10 main operating bases, 1 training base, and the Oklahoma City Air Logistics Complex depot. Boeing is also meeting the high level schedule milestones. Most recently, it conducted the critical design review (CDR) in July 2013, on schedule. However, there are indications that the start of initial operational test and evaluation, which is scheduled for May 2016, may slip. DOD’s Office of the Director, Operational Test and Evaluation, which is responsible for approving operational and live fire test and evaluation within each major defense acquisition program, recently issued its 2013 annual report and continued to recommend that the Air Force plan for a 6- to 12-month delay to the start of initial operational test and evaluation to allow more time to train aircrew and maintenance personnel and verify maintenance procedures. The KC-46 program office agrees that the test schedule is aggressive, but does not believe the delays are certain. The program office projects that the KC-46 aircraft will meet the requirements of all nine key performance parameters by the end of development. Satisfying these key performance 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. See appendix III for a list of the KC-46 key performance parameters. The program office has developed a set of metrics to help gauge its progress towards meeting the performance parameters. For example, one metric tracks operational empty weight because in general, every pound of excess weight equates to a corresponding reduction in the amount of fuel the aircraft can carry to accomplish its primary mission. Boeing currently projects that the aircraft will meet the weight target of 204,000 pounds. At the outset of development, Boeing set aside $354 million from contract funds in a management reserve account, about 7 percent of the contract ceiling price, to address identified, yet unresolved, development risks. Last year we reported that Boeing had accomplished approximately 28 percent of the development work and had allocated about 80 percent of the contract’s management reserves. We raised concerns about the high rate at which the management reserves were being used because doing so early in a program is often an indicator of future contract performance problems. Since then, there have been two major actions related to management reserves in 2013.