Revision1--FY08-FY12MOU.pdf

UNITED STATES TRANSPORTATION COMMAND

508 SCOTT DR

SCOTT AIR FORCE BASE IL 62225-5357

MEMORANDUM FOR ALL CARRIERS 15 Aug 07

FROM: USTRANSCOM/TCAQ-P

SUBJECT: Revision 1- FY08-FY12 Memorandum of Understanding (MOU)

1. On 4 May 07, the original FY08-FY12 MOU was posted to www.fbo.gov under Solicitation HTC711-07-R-0004. Since this time changes have occurred requiring minor revisions to the original MOU. Each of these changes has been incorporated into the MOU’s ratemaking methodology attachment. The attached is the revised MOU ratemaking methodology.

2. If you have not signed the MOU as of this date, please replace the attachment in the original MOU in its entirety with this revised attachment and 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. If you have signed and mailed the original MOU to this office, please be advised that the MOU returned to you after USTRANSCOM signature will contain the revised attachment along with the original.

3. For the FY08 contract, USTRANSCOM is pursuing a waiver from the provision of the Truth In Negotiations Act (TINA) that requires certified cost and pricing data from contractors exceeding the business threshold in accordance with Federal Acquisition Regulations Part 15.403-4. USTRANSCOM, however, will be in compliance with TINA beginning in FY09.

Any carrier, therefore, over the threshold for one class of aircraft in charter or passenger service is required to submit certified cost and pricing data for the FY09 rates. The TINA threshold is currently $650K. This change requires a revision to paragraph 10 in the MOU attachment. See the attached, paragraph 10, for revision details.

4. An error was inadvertently made in the calculation of our debt-to-equity ratio for our new full rate of return (ROI) model. To correct this we applied the theoretical debt-to-equity ratio of 45 percent to 55 percent. This is the debt-to-equity applied to our previous model. See the attached, paragraph 1, for revision details.

5. Please forward any questions or concerns to me at 618-256-4208.

//SIGNED//

WILLIAM J. PRATHER

Supervisory Price/Cost Analyst

Attachment International USTRANSCOM Ratemaking Methodology, Revised 14 Aug 07

1 Revised, 14 Aug 07 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 Revised, 14 Aug 07

1. FULL RATE OF RETURN (ROI). ROI for USTRANSCOM service will be computed using the capital structure of 45 percent debt and 55 percent equity. The cost-of-debt and cost-of-equity are calculated from the carriers who receive full ROI. Below is an example of how the cost-of-debt, and cost-of-equity are computed:

Cost-of-Debt Computation:

Carrier’s

Credit Spread for Revenues4 Weighted Debt Weighted

Carrier Beta1 Ratings 2 Transportation3 (000) Weightin g Spread Beta 5

A 4.70 D 625 $10,400 0.1728 108 .8122 B 3.70 B- 440 $18,100 0.3007 132 1.1126

C 1.50 BBB 186 $1,700 0.0282 5 .0423

D 2.50 B 360 $30,000 0.4983 179 1.2458 1,611 $60,200 1.0000 424 3.21

1. Betas are obtained from Yahoo Finance. Beta factors at time of proposed rate and final rate are applied.

2. Source for carrier's credit ratings is Standard & Poor’s. Credit ratings in effect at proposed and final rates are applied.

3. Reuter's is the source for Corporate Spreads for Transportation. Corporate Spreads for Transportation in effect at time of proposed and final rates are applied.

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

5. The beta 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 (424/100) 4.24% Total Cost-of-Debt 9.10%

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.

3 Revised, 14 Aug 07

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 effect at time of issuing proposed and final rates will be used. A weighted beta is computed based on weighted revenues.

MRP = Long term 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 USTRANSCOM 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 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.

4 Revised, 14 Aug 07

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 an 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.

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.

Carriers with the amount of business exceeding the threshold in accordance with Federal Acquisition Regulations Part 15.403-4 for one class of aircraft (i.e., B-747) in charter passenger or cargo service are required to submit data. The threshold as of August 2007 is $650K. 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, FiscalYear 2009 rate review participation was determined by fiscal year-to-date dollar levels as of 31 July 2007.

In the event USTRANSCOM uses Federal Acquisition Regulations Part 12, Acquisition of Commercial Items, carriers with $5M dollars of business for one class of aircraft in charter

5 Revised, 14 Aug 07 passenger or cargo service will be required to submit data. 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.

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.