Exclusive: Retrofits to add $1.7 billion to cost of F-35 - GAO report

Retrofits of F-35 fighter planes to fix problems found in flight testing will likely top $1.7 billion, a U.S. government watchdog said in the draft of a new report about the Pentagon's Joint Strike Fighter program.

Extensive restructuring efforts and progress on technical issues have put the Lockheed Martin Corp F-35 program on a more solid footing, but the plane's long-term affordability remains a big concern, the Government Accountability Office said in the draft, a copy of which was obtained by Reuters.

It said the F-35 program, which has been subject to massive delays and cost overruns and now has a price tag close to $400 billion, met most of its management objectives in 2012. But it still faced big costs because of earlier decisions to start building planes before development and testing were further along. A final report is due out next week.

The F-35 is an advanced "fifth generation" fighter meant to serve the U.S. Air Force, Navy and Marines for decades to come. But the program's soaring costs and technical complications have now put it in a critical position, where any new setbacks or cuts in orders from the U.S. military and its allies would drive the cost-per-plane up still further.

The GAO draft report offers the agency's most positive outlook yet for the Pentagon's most expensive weapons program, which has seen a spate of negative news in recent weeks, including two engine-related groundings this year.

But it also underscores concerns about the long-term future of the program given budget reductions in the United States and other countries that plan to buy the radar-evading warplane.

"Overall, the F-35 Joint Strike Fighter program is now moving in the right direction after a long, expensive and arduous learning process," GAO said. "Going forward, ensuring affordability - the ability to acquire aircraft in quantity and to sustain aircraft going over the life cycle - is of paramount concern."

No comment was immediately available from the Pentagon's F-35 program office or Lockheed.

The program faces substantial costs to retrofit planes to address problems discovered in flight testing, GAO said.

Such "rework" would add $900 million to the cost of the first four batches of jets build by Lockheed, GAO said, plus about $827 million over the next six batches for a total of $1.7 billion.

Last June, GAO had forecast rework costs of $373 million for the first four batches of jets, but gave no estimate for the remaining batches.

Lockheed agreed in its contract for a fifth batch of jets to pay for 55 percent of any cost overruns up to a certain ceiling, and all cost overruns beyond that. Retrofit costs are now shared equally by the Pentagon and the contractor.

COST OVERRUNS SEEN REACHING $1.2 BLN

GAO said cost overruns on 63 planes built by Lockheed in the first four production batches were now expected to reach $1.2 billion, of which the government will have to pay about $756 million. That marks an increase from GAO's last estimate in June 2012, which forecast a cost overrun of $1.04 billion.

Lockheed is building 58 planes for the U.S. military under those first four production contracts, plus five for international partners who helped fund the plane's development.

The report said cost overruns were declining as production costs were coming down, and Lockheed was delivering jets faster. Lockheed signed a contract with the Pentagon at the end of December for a fifth batch of planes, and both sides hope to reach a deal for the sixth and seventh batches this summer.

The GAO report reiterated the agency's concerns about the long-term procurement and sustainment cost of the F-35. It said current plans would require the Pentagon to spend $10.6 billion each year through 2037 on the program, putting "an unprecedented demand on the defense procurement budget."

It said the cost of each plane would rise if the Pentagon cut its plans to buy 2,443 F-35s or the eight foreign partners - Britain, Italy, Australia, Canada, Norway, Turkey, Denmark and the Netherlands - reduced their plans to buy 697 aircraft.

Industry executives and military officials say U.S. moves to defer orders for 410 aircraft in recent years have already jacked up the cost per plane, and costs will rise further unless Congress averts $500 billion in mandatory defense spending cuts slated to take effect over the next decade. Those cuts began to roll in last week.

GAO said the Pentagon's Cost Analysis and Program Evaluation office had calculated that the average cost of the plane, which has already nearly doubled to $137 million from $69 million originally estimated, would rise by 6 percent if all 697 foreign orders vanished.

The cost would rise by 9 percent if Washington only bought 1,500 jets and the partners stuck to their orders. But it would surge 19 percent if Washington bought 1,500 jets and the partners bought none, according to the GAO report.

(Editing by Martin Howell and Xavier Briand)