FY08TOFY12MOU.pdf

UNITED STATES TRANSPORTATION COMMAND

508 SCOTT DR

SCOTT AIR FORCE BASE IL 62225-5357

MEMORANDUM FOR ALL CARRIERS 4 May 07

FROM: USTRANSCOM/TCAQ-P

SUBJECT: FY08-FY12 Memorandum of Understanding (MOU)

1. Our 16 Apr 07 cover letter to the FY08 Proposed Uniform Rates and Rules for International Service referenced the MOU for FY08-FY12 was in the coordination process within USTRANSCOM. This process is now complete. Attachment 1 is the new MOU for your signature. Please mail the MOU with original signature to United States Transportation Command, Command Acquisition, ATTN: William Prather, 508 Scott Drive, Scott AFB IL 62225-5357. The MOU must be signed and on file with USTRANSCOM prior to execution of a FY08 contract.

2. The FY08 proposed rates were developed using the attached MOU procedures as briefed at the MOBREP Conference on 21 Sep 06 and summarized in a briefing provided to the carriers on Industry Day, 18 Apr 07. The MOU establishes the foundation by which USTRANSCOM establishes uniform rates for carriers participating in the USTRANSCOM CRAF airlift program.

3. Per carrier request at Industry Day, Attachment 2 is a comparison of the FY03-FY07 MOU and FY08-FY12 MOU.

4. If you have any questions please call me at 618-256-4208.

//SIGNED//

WILLIAM J. PRATHER

Supervisory Price/Cost Analyst

2 Attachments

1. MOU w/1 Attachment

2. Comparison of the FY03-FY07 MOU and FY08-FY12 MOU

RATEMAKING

MEMORANDUM OF UNDERSTANDING

BETWEEN

(CARRIER)

AND

UNITED STATES TRANSPORTATION COMMAND

1. The purpose of this Memorandum of Understanding (MOU) is to establish guidelines to facilitate establishment of rates for passenger, cargo, combi, and aeromedical evacuation airlift services with certificated air carriers willing to participate in the Civil Reserve Air Fleet (CRAF) program. The objectives of the CRAF program are to augment the airlift capability of United

States Transportation Command (USTRANSCOM) and to assure a mobilization base of aircraft available to the Department of Defense for use in the event of any level of national security contingency.

2. The origins of the CRAF program can be traced to Executive Order No. 10219, 2 March 1951, 16 F. R. 1983. In this order, the Secretary of Commerce was directed to formulate plans and programs to meet the requirements for civil air transportation to include plans for the transfer or assignment of aircraft from civil air carriers to the Department of

Defense to meet defense mobilization needs. By joint agreement on 15 December 1951, the

Secretaries of Commerce and Defense established the CRAF program to augment military airlift capability in times of emergency. Several years later, Executive Order 10999, 20 February 1962, 27 F.R. 1527, directed the Secretary of Commerce to prepare plans with respect to all degrees of national emergency. As a result, the 15 December 1951 MOU was rescinded by an MOU dated

8 August 1963 in which the Secretaries of Commerce and Defense jointly recognized “the requirement for incremental activation of the CRAF to meet varying defense emergency needs for the civil airlift augmentation to the military airlift capability.” To meet this requirement, USTRANSCOM structures award of aircraft service contracts to insure that a mobilization base of aircraft is capable of responding to any level of defense emergency. Executive Order 11490, 30 October 1969, 34 F.R. 17567 rescinded Executive Order 10999 and designated the Secretary of Transportation responsible for developing plans to utilize civil air transportation resources to meet civil and military needs during national and defense-oriented emergencies. Executive

Order 12656, 18 November 1988, 53 F.R. 47491 rescinded Executive Order 11490 and further defined emergency preparedness functions of various government departments and agencies.

The 8 August 1963 MOU was rescinded by an MOU between the Secretaries of Transportation and Defense dated 7 May 1981. The 7 May 1981 MOU defined responsibilities of both secretaries and established a five-year review cycle for the MOU. The 7 May 1981 was rescinded by an MOU dated 15 September 1987. The current MOU between the Secretaries of

Transportation and Defense, dated 10 November 1998, concerns departmental cooperation on the

CRAF program and remains in effect indefinitely, unless amended by mutual agreement or terminated.

3. The history of ratemaking to price DOD airlift service is nearly as long as the history of

CRAF. Between 1955 and 1962, the DOD relied upon price competition to meet its commercial airlift needs. However, this procurement method resulted in predatory pricing issues and failed to provide service meeting safety and performance requirements. Congressional Subcommittee hearings held at the time determined price competition to be non-compensatory and destructive to the industry. As a result, the ratemaking process was implemented under the regulatory authority of the Civil Aeronautics Board (CAB). Ratemaking continued under CAB until deregulation in 1980. At that time, civil air carriers and DOD’ s contracting agency for long-term international airlift, Military Airlift Command (MAC), agreed by MOU, that CAB methodologies by which rates for DOD airlift were established produced fair and reasonable rates and furthered the objectives of the CRAF program; and, therefore, the parties agreed to continue to use CAB methodologies for establishing MAC uniform negotiated rates under a

MOU renewed every five years. MAC became Air Mobility Command (AMC) on 1 June 1992.

Ratemaking continued under AMC until 1 January 2007 when DOD’ s contracting authority for long-term international airlift was transferred from AMC to USTRANSCOM. Ratemaking continues to date under the contracting authority of USTRANSCOM.

4. USTRANSCOM is required to contract with certificated air carriers by Section 401 of the

Federal Aviation Act of 1958. Accordingly, carriers holding authority to engage in air transportation pursuant to Section 401 of the Federal Aviation Act of 1958 are required by 14

CFR, Part 241 to comply with a Uniform System of Accounts and Reports (USAR) for certificated air carriers. This comprehensive system of accounts and reports was established to provide uniformity and consistency in a regulated industry. With the demise of the CAB, the responsibility for accounts and reports was transferred to the Department of Transportation

(DOT). The USAR under DOT is called Research & Special Programs Administration (RSPA) reports. USAR was the foundation for the CAB’ s economic regulations and policy statements.

USTRANSCOM continues to use RSPA reports, formerly USAR, in the development of the annual uniform negotiated rates.

5. The DOD augments its airlift capacity by using commercial airlift in a manner that contributes to sound economic development of an increased, modern civil airlift capability and enhances the ability of civil carriers to support the military forces in time of war with maximum effectiveness. USTRANSCOM accomplishes this through the negotiation and award of DOD airlift service contracts to U.S. air carriers which own or otherwise control aircraft suitable for allocation to the CRAF. These contracts are awarded using uniform rates to promote the objectives of the CRAF program.

6. USTRANSCOM uses ratemaking methodologies found in Attachment 1 for establishing pricing of airlift services. The parties to this MOU agree that these methodologies are effective means of establishing fair and reasonable rates and furthering the objectives of the CRAF program. The parties, therefore, agree to these ratemaking methodologies in negotiating rates for future DOD airlift services. In furtherance of this agreement, and as a condition of its continued participation in the CRAF program each carrier agrees to furnish USTRANSCOM with the financial and operational information required by USTRANSCOM to adequately make a determination of fairness and reasonableness of price. USTRANSCOM also agrees to conduct an annual review of this information and to negotiate with the carrier to determine its projected cost that would properly be allocable to any future DOD airlift service contract. To facilitate negotiation between the parties, USTRANSCOM may issue proposed rates for carrier comments.

USTRANSCOM will consider all carrier comments and then issue final rates. Carriers should first address their concerns to the ratemaking team for resolution. Ratemaking issues that are not resolved to the carrier’ s satisfaction through discussions with the ratemaking team may be directed to the contracting officer. If resolution cannot be made by the contracting officer, concerned parties may contact the ombudsman appointed to hear and facilitate the resolution of such concerns. Please refer to your USTRANSCOM contract for the contact information of the ombudsman. In the event a ratemaking issue is not resolved through the ombudsman process, the issue will be forwarded to the Director of Acquisition, USTRANSCOM, for the final agency resolution.

7. This MOU will be effective through 31 October 2012. Either party may terminate this MOU by giving the other party 90-days written notice, subject to continuation of any obligations of the carrier pursuant to the terms of a contract or separate agreement that references, incorporates, or otherwise relies on the terms of this MOU.

8. USTRANSCOM will allocate appropriate military peacetime airlift among participating

CRAF carriers. Carrier participation in the USTRANSCOM Peacetime Airlift Program will be wholly voluntary. Any properly certified and DOD-approved carrier may participate in the

CRAF program if it offers aircraft useful to CRAF, agrees to and complies with the conditions of this MOU, and executes a USTRANSCOM contract.

9. The parties understand that this MOU imposes no financial or contractual obligation upon either party. Placement and pricing of DOD airlift services and commitment of aircraft to the

CRAF program will be accomplished via contracts awarded after solicitation and negotiation in compliance with applicable laws and regulations.

10. This MOU supersedes prior ratemaking MOUs between DOD and the carrier.

United States Transportation Command

(Carrier Name)

By By

(Signature) (Signature)

(Name/Title) (Name/Title)

(Date) (Date)

Attachment:

International USTRANSCOM Ratemaking Methodology

1 Attachment 1

INTERNATIONAL USTRANSCOM RATEMAKING METHODOLOGY

Subject Paragraph

Full Rate of Return 1 Owned/Capital/Long-Term Leased Aircraft 2 Operating Leased Aircraft 3 Working Capital 4 Minimum Return 5 Depreciation 6 Utilization 7 Cost Escalation 8 Weighting of Rate 9 Participation 10

2 Attachment 1

1. FULL RATE OF RETURN (ROI). ROI for USTRANSCOM service will be computed using the capital structure of CRAF carriers that receive full ROI from their flight equipment investment base. The debt-to-equity ratio is computed using Account 2995 (Net Stockholders Equity) and Account 2210 (Long-Term Debt) as reported on each carrier’s Form 41, B-1 Schedule (Balance Sheet). The base year is used to compute each carrier’s debt-to-equity ratio.

Below is an example of how the average debt-to-equity ratio, cost-of-debt, and cost-of-equity are computed:

Debt-to-Equity Computation:

(Acct #2995) (Acct #2210) Net Stockholders Long-Term Total Carrier Equity Debt Capital Equity Debt

A ($840,500,000) $8,600,340,800 $9,440,840,800 8.90% 91.10% B ($10,800,900,500) $6,900,500,600 $17,701,401,100 61.02% 38.98% C $7,100,500,300 $830,100,300 $7,930,600,600 89.53% 10.47% D ($7,500,700,500) $7,600,300,800 $15,101,001,300 49.67% 50.33%

Average Debt-to-Equity Ratio 52.28% 47.72%

Note: Parentheses indicate negative numbers and are treated as absolute numbers.

Cost-of-Debt Computation:

(000)

Credit Spread for Carrier's Weighted Debt

Carrier Beta1 Ratings 2 Transportation3 Revenues4 Weightin g Spread

A 4.70 D 625 $10,400 0.1728 108 B 3.70 B- 440 $18,100 0.3007 132

C 1.50 BBB 186 $1,700 0.0282 5

D 2.50 B 360 $30,000 0.4983 179 1,611 $60,200 1.0000 424

1. Betas are obtained from Yahoo Finance.

2. Source for carrier's credit ratings is Standard & Poor’s.

3. Reuter's is the source for Corporate Spreads for Transportation.

3 Attachment 1

4. The debt spread is weighted on carrier’s revenues who receive full ROI.

Cost-of-Debt:

Risk Free Rate (RFR) (10 Year U.S. Treasury Yield)1 4.86% Weighted Debt Spread (425/100) 4.25% Total Cost-of-Debt 9.11%

1Treasury yields in affect at time the proposed rate and final rates are computed will be used.

Cost-of-Equity:

Capital Asset Pricing model KE=Risk Free Rate (RFR) + Beta (B) x Market Risk Premium (MRP)) is used to compute cost-of-equity.

KE = Cost-of-Equity.

RFR = Return on 10 Year U.S. Treasury Yields. (Treasury yields in affect at time of the proposed and final rates will be used.)

B = Average Beta for USTRANSCOM carriers who receive full ROI. (Source: Yahoo Finance) Betas in affect at time of issuing proposed and final rates will be used.

MRP = 40 year historical geometric return on 10 Year Treasury Yields. (Source:

Damodaran online). The MRP is updated at the beginning of each calendar year.

2. OWNED/CAPITAL/LONG-TERM LEASED AIRCRAFT. New airframes and related support parts will receive full ROI on the net book value of equipment at mid-point of forecast year. USTRANSCOM will apply the economic service life standards of 14 years and 16 years with 2 percent and 10 percent residual for narrowbody and widebody aircraft, respectively.

USTRANSCOM will apply an economic service life of 10 years and 5 percent residual for used older airframes and related support parts. The 10 year and 5 percent residual applies to narrowbody and widebody aircraft that exceed the 14 years and 16 years from production date.

USTRANSCOM will also consider individual carrier’s internal depreciation policies supported by their accounting system.

3. OPERATING LEASED AIRCRAFT. Operating leased equipment will receive a 5 percent return on annual lease payments.

4. WORKING CAPITAL. Working capital will be provided in the investment base at 23 days cash operating expense. This will be computed on total operating cash less non-cash expenses (depreciation) shown on AMC adjusted column of contractor’s cost in the rate review package.

5. MINIMUM RETURN. In cases where a carrier’s investment base no longer yields a return on investment equal to or greater than 11 percent of total operating cost, then a minimum return

4 Attachment 1 of 11 percent of total operating cost including fuel will be provided. The total operating cost line is identified for each carrier aircraft type in the cost per plane mile appendices of the annual “Uniform Rates and Rules for International Service” document.

6. DEPRECIATION. USTRANSCOM will apply economic life standards for new aircraft at 14 years, 2 percent residual (narrowbody) and 16 years and 10 percent residual (widebody) aircraft. USTRANSCOM will apply economic life standards for used aircraft at 10 years and 5 percent residual (narrowbody and widebody aircraft). USTRANSCOM’s definition of used older aircraft is aircraft that exceed the 14 years (narrowbody) and 16 years (widebody) from aircraft’s production date. USTRANSCOM will also consider a shorter depreciation cycle supported by carrier’s actual accounting system. One example of this would be older aircraft out of production which may be affected by noise compliance and aging aircraft issues.

7. UTILIZATION. The carrier’s system average aircraft utilization by aircraft type as reflected on Schedule B-1, “All Services” of the request for cost data package, will be used to compute unit costs per plane mile for fixed costs and investment. USTRANSCOM will also accept utilization in USTRANSCOM service if the carrier provides support for a USTRANSCOM utilization. Where applicable, the traffic data shown on Schedule B-1 must coincide with those statistics reported on Form 41 reports and monthly USTRANSCOM worksheets for round-trips and one-ways. In the event a carrier’s average system utilization for a particular aircraft type is below the lower limit of 5 hours per day, then the minimum limit of 5 hours shall apply for ratemaking purposes.

8. COST ESCALATION: A general cost escalation factor will be computed each year using a weighted factor comprised of the following indices (all rounded to the nearest tenth of a percentage point).

a. Percentage change in adjusted ATA Airline Cost Index 1/ as published by the Air Transport Association of America for the 12 months ending the first quarter following the USTRANSCOM base year (year-ending September) from the same period for the previous year.

This index will receive a 34 percent weighting.

b. Percentage change in the PPI – Nonscheduled Air Transportation Index, PCU 4522#, as published by the Bureau of Labor Statistics for the 12 months ending December of the most current year from the same period for the previous year. This index will receive a 33 percent weighting.

c. Percentage change in the GII – Scheduled Freight Air Transportation Index 2, NAIC 481112, as published by Global Insight, Inc. for the 12 months ending December of the most current year from the same period for the previous year. This index will receive a 33 percent weighting.

9. WEIGHTING OF RATE. Forecast rates will be weighted on current fiscal year dollars plus prior fiscal year dollars. Scheduled service cargo dollars flown at the uniform rate will be placed in the weighting of aircraft that the cargo moved on.

5 Attachment 1

10. PARTICIPATION. Carriers participating in the USTRANSCOM forecast year business shall provide cost and pricing data for USTRANSCOM rate reviews. Carriers may submit cost and pricing data under any circumstances, but for carriers with $5M of business for one class of aircraft (i.e., B-747) in charter passenger or cargo service, data is required. (HQ AMC/A3K’s COINS database will be used to determine carrier business level as of 30 days after the close of the base period. For example, fiscal year 2008 rate review participation was determined by fiscal year-to-date dollar levels as of 31 July 2006.)

USTRANSCOM will allow 60 days for carriers to prepare data, and USTRANSCOM will not make this request until 30 days after the close of the base period for which data is being requested. For each day the cost package is late (for determination of lateness, the provisions of the Long Range International Solicitation which deals with late receipt of offers will be used), the carriers’ entitlement will be reduced by one percentage point per day up to a maximum of 30 percent for forecast year business. Where a carrier is a passive member of a teaming arrangement and not providing air transportation services for USTRANSCOM, they will not be required to provide cost and pricing data. For active members of a teaming arrangement providing air transportation service for USTRANSCOM, cost and pricing data will be required when the above conditions are met.

ENDNOTE:

1/The adjusted ATA index will include the following ATA components: Labor, Aircraft Fleet, Insurance, Maintenance Material, Landing Fees, Communication, Passenger Food and All Other Costs.

2/The GII index will include the following GII components: Labor, Benefits, Aircraft Parts, Aircraft Engines, Labor Costs in Aircraft Parts, Labor Costs in Aircraft Engines, General Material Used in Air Transportation, and Gasoline.

SUBJECT: Comparison of the FY03 - FY07 MOU and FY08 - FY12 MOU

Item FY03-FY07 MOU FY08-FY12 MOU

1. Full Return on Investment Calculation

Debt to Equity Ratio 45% Debt / 55% Equity 48% Debt / 52% Equity Use Actual Debt-to-Equity For CRAF Carriers Who Receive Full ROI. Debt-to-equity will vary year-to-year.

Capital Asset Pricing Model KE = RF1+B(KM-RF2) KE = Risk Free Rate + (Beta x Market Risk Premium) The application of the proposed full ROI model for the FY07 rates results in an increase in the full ROI from 11.41% to 15.59%.

KE = Cost of Equity

RF1= Risk Free Rate US Treasury Securities (YE Dec) Long Term 10 Yr Treasury Yields Plus Market Risk Premium Times an Average Beta For CRAF Carriers Who Receive Full ROI

B = Beta Average Beta For Industry Average Beta For Carriers Who Receive Full Return on Investment

KM = Long Term Return on S&P 500

RF2 = Long Term Government Bonds

KD = Cost of Debt Federal Reserve Baa Corporate 10 Year Treasury Yield Plus Weighted Debt Spread For Carriers were in favor of the proposed changes to the full ROI model.

Bond Transportation Industry Weighted by Carrier's Revenues

2. Owned Equipment & NBV of Equipment at Midpoint Narrowbody aircraft will be depreciated at 14 years and 2% Capital Leased/Long Term of Forecast Year and Uses CAB residual and widebody depreciated at 16 years and 10% Leased Equipment Depreciation Policies residual. Older equipment will be depreciated at 10 years and 5% residual or will consider carrier's depreciation policies.

3. Operating Leased 5% Return on Annual Lease No Change Equipment Payment

4. Working Capital 23 Days No Change

5. Minimum Return (Profit) 10% 11% The 11% is based on weighted guidelines and average profit industry profit margins.

Received four comments on minimum return. Two carriers were in favor of the 11% and two carriers want 12%. Carriers provided no analysis for the 12% other than the rate is needed to offset interest expense and team commission expense. Both of these cost are unallowable per FAR.

6. Depreciation CAB Policies and Carrier Applies CAB depreciation policies. Older equipment Verbiage is added to new MOU to define what older equipment is and also consider carrier's Depreciation Policies for Older exceeds 14 & 16 years. Older equipment will be depreciated depreciation policies.

Equipment at 10 years and 5% residual or consider carrier's depreciation policies.

7. Aircraft Utilization Carriers System Utilization and Carriers system utilization or utilization in USTRANSCOM Minimum Utilization of 5 Hours service. No change in the minimum utilization of 5 hours.

Added verbiage about removing days for heavy maintenance and down time for major modifications.

Remarks

5/4/2007 1 Atch 2

Item FY03-FY07 MOU FY08-FY12 MOU

8. Cost Escalation 75% - ATA Airline Cost Index 34% - ATA Airline Cost Index Positive comments were received from the carriers on the new escalation model.

25% - PPI-Nonscheduled Air 33% - PPI-Nonscheduled Air Transportation Index Transportation Index 33% - DRI-PPI Scheduled Freight Air Transportation

9. Weighting of Rate Current Fiscal Year Dollars Plus No Change Prior Fiscal Year Dollars

10. Participation Carrier's with $3M in revenues Carrier's with $5M in revenues are required to submit cost Proposed $10M. Carrier's comments to Sep 06 MOU briefing is they prefer to keep are required to submit cost data. data. Carriers are given 60 days to complete package. participation at $3M. Compromised and moved participation level to $5M. The $2M increase Carriers are given 45 days to Late submissions are penalized 1% a day. Maximum is based on increased USTRANSCOM revenue requirement levels.

finish package. Late submission penalization 30% of forecast business.

are penalized 1% a day. Maximum penalization 30% of forecast business.

Request for cost data will be made Request for cost data will be made 30 days after close of Request for cost data for the annual rate reviews will be made no later than 15 Aug of each 30 days after close of base period. base period. Base period is 1 Jul to 30 Jun. year.

Base period is 1 Jul to 30 Jun.

Items Outside The MOU:

1. Stop Charge Concept Each rate class receives $2,000 Currently under review. If changes are required they will be made for the FY09 contract.

stop charge for each directed stop.

2. Revenue Hrs vs. Block Hrs. USTRANSCOM allocation based Will allocate cost on revenue hours or block hours. Some CRAF carriers already use block hours and its industry practice to use block hours for on revenue hours. tacking cost.

Remarks

5/4/2007 2 Atch 2