Comments_to_Proposed_FY18_-_FY22_MOU.pdf

18 November, 2016

Scott Rader

USTRANSCOM/TCAQ-P

Chief, Pricing Branch 508 Scott Drive Scott Air Force Base, IL 62225

RE: Draft FY18-22 Memorandum of Understanding Comments

Dear Mr. Rader:

Attached please find Atlas’ comments to the draft FY18-22 Memorandum of Understanding between each of the CRAF carriers and USTRANSCOM.

Following is a summary of the changes we recommend and explanation of why we believe the changes are necessary to the draft you provided. Also, attached is a markup of your draft. Because it was provided in PDF form, we have changed the color of your changes to a light blue color. Our recommended changes are then in track changes in red and blue color for ease of review.

Our understanding is that you will provide carrier recommended changes to all carriers and then call a meeting or conference call, as necessary, to discuss the items. Please let us know if you have any questions that we can respond to or clarifications we can make ahead of the further discussions.

Sincerely, Atlas Air, Inc.

Ronald A. Lane Special Advisor

Attachment 1 – Summary of changes Attachment 2 – Marked-up Draft MOU

Atlas Air, Inc. Ronald A. Lane Phone: +1 562 810-2323 2000 Westchester Avenue Special Advisor Email: ron.lane@atlasair.com Purchase, NY 10577-2543

Attachment 1

Summary of marked changes to the Draft FY18-22 Memorandum of Understanding

Lead-in: - Period of effectiveness off MOU has been added.

MOU para 2: - Changes to differentiate MOUs from prior intergovernmental MOUs

MOU para 3: - Minor clarifications.

MOU para 4: - Changes to more accurately portray legal underpinnings.

MOU para 5: - Minor changes.

MOU para 6: - Minor clarifications..

- “as close as practicable” added to require USTC to arrive at as accurate rates as practicable.

- Phrase added to describe what carrier concerns are being referred to.

MOU para 7: - Period of effectiveness of MOU has been added.

Attachment Title page - Subject number 7 added. “Determination of Uniform Rates; Other

Fair and Reasonable Compensation”.

Attachment para 1: - word changes to clarify the sentence.

Attachment para 1.1.1.3: - FACILITIES CAPITAL EMPLOYED. The present scaling provides for a 5% change between less than 5 years and 5 to 10 years of age with all other 5 year increments at a 2.5% change. We recommend the increment between less than 5 and 5 to 10 years be reduced to 2% and the same 2% be applied for all other increments.

We see no justification for the first increment to be greater than the others, and for the most part aircraft under 10 years of age aren’t assets that make sense for AMC/USTC operations due to under-utilization.

Further, new, significant technological developments for aircraft do not occur in increments of time as short as five years.

Due to sheer numbers, the backbone of today’s commercial cargo aircraft, as well as, AMC/USTC’s operating commercial cargo aircraft is still the B747-400F purpose built freighter. (The younger B747-8F has the same underutilization issue.) The older of the purpose built freighter aircraft are now approaching 20 years and are still the most efficient modern aircraft for AMC/USTC’s operations.

Until the B747-8F aircraft become more prevalent in AMC/USTC operations, we believe the B747-400F purpose built freighter aircraft should not be further degraded for the Facilities Capital Employed calculation.

In fact, the nose door equipped purpose built freighters are the newest and most fuel efficient of the B747-400 freighters and provide greater capability and flexibility to AMC than their passenger converted sister aircraft, the B747-400BCFs. As such, when made available and utilized by AMC to move pallet trains of cargo should be afforded a premium on a use basis to make up for the higher value they afford as is the case in the commercial world.

The B747-400, B777-200ER and B767-300ER passenger aircraft are likewise the most efficient aircraft available for AMC/USTC’s operations and are of similar age, if not older, to the purpose built freighter.

In summary, the upper end of the scale at 25% is appropriate for capital intensive assets and even older used aircraft are highly capital intensive, so a reduction from 25% to 10% at greater than 25 years is too steep a reduction relative to the capital employed.

Attachment para 1.1.4: - COST EFFICIENCY FACTOR. The Cost Efficiency Factor currently is in increments of 3% with a 1% increase in profit for each increment. Achieving non-fuel savings year over year beyond 3 to 4% against inflation of approximately 3% is unsustainable in the airline industry, especially at the upper end of the current scale. We recommend the cost savings be incremented at approximately 2% up to greater than 6% with approximately half the savings being attributed to the carrier instead of the present one-third going to the carrier today.

Attachment para 1.2.1: - MAXIMUM FUEL PROFIT. The current provision provides no profit above the fuel cap which in itself is not fair or reasonable. The logic of that change 5 years ago was that carriers did not assume any greater risk or experience any greater costs to manage their fuel procurements at prices above a five year average cost level. The provision also provides no profit on cost greater than actual fuel peg rate when lower than the cap.

This is inconsistent with the logic for the cap on profit above the cap rate because neither carrier risk nor their costs to manage their fuel procurements are no less if the fuel cost is less than the cap amount. If the fuel pegged rate is less than the cap rate, the profit should still be based on the cap amount.

Attachment para 4: - The most recent modification leaves only one Escalation Index that applies to the remaining cost elements to be escalated. As of this writing we have not determined what an additional fair and reasonable index might be, but we believe it would be best for all concerned to have at least one additional transparent index to count as a portion of the escalation factor.

Attachment para 5: - WEIGHTING OF RATE. One suggested word change from “Forecast rates” to “Prospective rates”. Suggest also that the last sentence be further evaluation for deletion.

Attachment para 7: - DETERMINATION OF UNIFORM RATES; OTHER FAIR AND

REASONABLE COMPENSATION. The MOU currently only addresses certain elements of ratemaking, but does not define the rate outcome. It also does not address the process for dealing with certain anomalies such as circumnavigation or treatment of additional expenses not considered in the rate base or applicable Uniform Rate.

Circumnavigation is a concept that has long been part of the ratemaking compensation scheme, and often certain unanticipated expenses arise. The response to those issues when raised by carriers has often been to the effect that “it all works out in the wash,” when in fact that is not the case. Failure to make adjustments in such circumstances would render the rates unreasonable and unfair.

RATEMAKING

MEMORANDUM OF UNDERSTANDING

BETWEEN

(CARRIER)

AND

UNITED STATES TRANSPORTATION COMMAND

Effective

FY2018 through FY2022

1. The purpose of this Ratemaking Memorandum of Understanding (RMOU) is to establish guidelines to facilitate establishment of rates for passenger, cargo, and 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 include augmenting are to augment the airlift capability of United States Transportation Command (USTRANSCOM) and assuring a readily mobilizedto assure a mobilization base of aircraft available to the Department of Defense (DOD) for use in the event of any level of national security contingency.

2. For purposes of this RMOU, the parties accept the USTRANSCOM explanation that the

The origins of the CRAF program can be traced to Executive Order No. 10219, 2 March 1951, 16

F. R. 1983. In thatis 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 (DOD) 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 agreementMOU was rescinded by an interagency memorandum of understanding (MOU)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 MOU 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. For purposes of this RMOU, the parties also accept USTRANSCOM’s description that theThe history of ratemaking to price DOD airlift services 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 the 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 the 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. On 31 December 2011 the FY12

National Defense Authorization Act (FY12 NDAA) was signed into law. The law obligesauthorizes the Secretary of Defense to establish fair and reasonable rates for payments made to participants in the CRAF program. The FY12 NDAA states in Section 366, “Chapter

931 of title 10, United States Code is amended by inserting after section 9511, the following new section” 9511a. “The Secretary of Defense shall determine a fair and reasonable rate of payment for airlift services provided to the Department of Defense by air carriers who are participants in the Civil Reserve Air Fleet Program.” In addition, the FY12 NDAA adds “the

Secretary of Defense shall prescribe regulations for purposes of subsection (a.)” The DAR

Council communicated to USTRANSCOM that it believes it is appropriate for

USTRANSCOM to implement Section 366 into the USTRANSCOM Supplement as it relates only to the USTRANSCOM CRAF contracts. Title 32, Code of Federal Regulations was amended on 28 May 2015 by adding part 243, Department of Defense Ratemaking

Procedures for Civil Reserve Air Fleet Contracts.

4. USTRANSCOM is required to contract with U.S.certificated air carriers certificated by the Department of Transportation (DOT) under Title 49 U.S. Code Chapter 411, including formerby Section 401 of the Federal Aviation Act of 1958, as amended. Airccordingly, carriers holding authority to engage in air transportation pursuant to former 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 DOTthe Department of Transportation (DOT). What was tThe USAR under the CAB became theunder DOT is called Research & Special Programs Administration

(RSPA) reports under DOT. 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 designed to that contributes to sound economic development of an increased, modern civil airlift capability and to enhances the ability of U.S. aircivil 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 operateown 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 developed and now uses the ratemaking methodologies found in

Attachment 1 for establishing pricing of airlift services. The parties to this RMOU agree that these methodologies are an 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 FY18 through FY22. In furtherance of this agreement, and as a condition of its continued participation in the CRAF program theeach carrier party to this RMOU 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 utilize this information in the cost base from which it conduct an annual review of this information and to negotiates with the U.S. air carriers participating in the CRAF program to determine as close as practicable its projected cost that would properly be allocable to applicableany future DOD airlift service contracts. To facilitate negotiation between the parties, USTRANSCOM shallmay issue proposed rates for carrier comments.

USTRANSCOM will consider all carrier comments before issuing and then issue final rates.

In case of any disagreement aboutbetween the Parties on the fairness or reasonableness of the final rates issued by USTRANSCOM, Ccarriers shallshould first address their concerns to the ratemaking team for resolution. Ratemaking issues that are not resolved to athe carrier’s or the carriers’ 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. The carrier shall Please refer to itsyour 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 RMOU will be effective for applicable contracts from 1 October 2018 through 31

30 October September 20172022. 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 RMOU.

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 RMOU, and executes a USTRANSCOM contract.

9. The parties understand that this RMOU 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 RMOU supersedes any 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

ATTACHMENT

INTERNATIONAL USTRANSCOM RATEMAKING METHODOLOGY

Subject Paragraph

Full Rate of Return 1 Minimum ReturnProfit 21 Depreciation 32 Utilization 43 Cost Escalation 54 Weighting of Rate 65 Participation 76 Determination of Uniform Rates; Other Fair and Reasonable Compensation 7

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 revenues of major carriers as reported to the Department of Transportation. Below is an example of how the cost-of-debt, and cost-of-equity are computed:

1.1 COST-OF-DEBT (COD) COMPUTATION.

COD = Risk Free Rate (RFR) + (Weighted Debt Spread/100)

RFR = Return on 20 Year U.S. Treasury Yields. Treasury yields in affect at time of the proposed and final rates will be used.

Weighted Debt Spread = Carrier’s Spread for Transportation * Carrier’s Revenue Weighting. The Weighted Debt Spread is converted to a percentage by dividing the Weighted Debt Spread by 100. The following table provides examples of the Weighted Debt Spread calculation and the Weighted Beta Calculation.

Credit Spread for Carrier’

Weighted Debt Weight

Carrie

Bet

Rating

Transportatio

Revenu

Weighting Spread Beta 5 (000) A B C D E F G (C*E) (A*E) A 4.7

D 625 $10,400 17.28% 108 0.8122

B 3.7

B- 440 $18,100 30.07% 132 1.1126 C 1.5

BBB 186 $1,700 2.82% 5 0.0423

D 2.5

B 360 $30,000 49.83% 179 1.2458 Total $60,200 100.00% 424 3.2129

1. Betas (B) are obtained from Value Line Investment Survey. 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 by revenues for Department of Transportation’s Major carriers. 5. The beta is weighted by revenues for Department of Transportation’s Major carriers.

1.2 COST-OF-EQUITY (KE) COMPUTATION.

KE= (RFR + (B x Equity Risk Premium (ERP)) + Future Expected Risk Premium (FERP)

RFR = Return on 20 Year U.S. Treasury Yields. Treasury yields in affect at time of the proposed and final rates will be used.

B = Weighted Betas will be obtained from Value Line’s Investment Survey for the majority of the Department of Transportation’s Major (Group 3) carriers

ERP = Equity Risk Premium = Annualized S&P 500 Return – RFR

FERP = Published Expected Equity Risk Premium – Historical Equity Risk Premium

1.3. 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 recently acquired 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.

1.4. SHORT-TERM LEASED AIRCRAFT. Short-term leased equipment will receive the Full Return on Investment less the treasury cost of money mandated by the Office of Management and Budget as a return on annual lease payments.

1.5. 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.

21. MINIMUM RETURNPROFIT. USTRANSCOM will calculate minimum returnprofit based on the weighted guidelines methodology established in Defense Federal Acquisition Regulations 215.404. In cases where a carrier’s investment base no longer yields a return on investment equal to or greater than the minimum return percent of total operating cost then the minimum return based upon the weighted guidelines will be provided. For purposes of determining total operating cost in thecalculating minimum returnprofit, fuel cost will be the carrier’s fuel burn rate multiplied by the fuel cap amount, as indicated in paragraph 21.1.2.1 below.

21.1. WEIGHTED GUIDELINES. The weighted guidelines will be applied separately to operating costs less fuel and then to fuel costs.

The Wweighted guidelines assigns profit percentages tomethod focuses on four profit factorsareas of risks based upon a structured approach. The four risk areasprofit factors include performance risk, contract type risk, facilities capital employed, and cost efficiency factor.

21.1.1 APPLICATION TO OPERATING COSTS LESS FUEL.

21.1.1.1. PERFORMANCE RISK. Performance risk is broken down into two categories, technical and management/cost control.

21.1.1.1.1. TECHNICAL. All non fuelnon-fuel cost will consist of a 60% weighting. Assigned rates will range between 3% and 7% dependent on carrier input along with TCAQ-P analysis.

21.1.1.1.2. MANAGEMENT/COST CONTROL. All non fuelnon-fuel cost will consist of a 40% weighting. Assigned rates will range between 3% and 7% dependent on carrier input along with TCAQ-P analysis.

21.1.1.2. CONTRACT TYPE RISK. Operating cost less fuel will be assigned 5% for contract type risk.

21.1.1.3. FACILITIES CAPITAL EMPLOYED. The assigned range for equipment will be dependent on the carrier’s average age of the fleet, which may consider modern equipment upgrades, and based upon the table below:

A/C

<5Y

5 to<10Yr

10 to <15Yr 15 to <20 Yr

20 to <25 Yr ≥ 25 Yrs 25% 2023% 17.521% 1519% 12.517% 1015%

21.1.1.4. COST EFFICIENCY FACTOR. A cost efficiency factor will be assigned based upon the individual carrier’s percentage decrease in total operating cost less fuel compared to the carrier’s total operating cost less fuel used in the immediately preceding final published Uniform Rates and Rules. The assigned percentage will be based upon the table below:

≥ Prior Cost

Cost Savings up to 32%

Cost Savings ≥32% to 64%

Cost Savings >64% to 96%

Cost Savings >96%

0% 1% 21.5% 32.5% 450% of savings

If this table does not adequately predict cost efficiency such as when a carrier’s year-over-year increase is a result of operations to high cost locations or a carrier has introduced a fuel efficient aircraft with no prior year’s comparisons, carriers are encouraged to provide a narrative explaining justification for a higher cost efficiency rating. Supporting documentation of the proposed cost efficiency factor must be included. Any narrative provided is limited to 10 5 pages in length.

21.1.2 APPLICATION TO FUEL COST.

21.1.2.1 MAXIMUM FUEL PROFIT. Profit on fuel will be applied up to a maximum amount per gallon, or cap. The cap will be calculated as a five-year rolling average of fuel paid by CRAF carriers as reported on fuel reconciliation summary reports, from April through March for the previous 5 years, and tracked in the TCAQ-P fuel database. Significant incidents of abnormally low or high fuel cost through DESC will be evaluated and adjusted as necessary.

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In the event the fuel pegged rate is greater than the cap amount, the cap will be used in determining fuel profit. If the fuel pegged rate is less than the cap, the cap amountactual fuel pegged rate will also be used to determine fuel profit.

21.1.2.2. PERFORMANCE RISK. Performance risk is broken down into two categories, technical and management/cost control.

21.1.2.2.1 TECHNICAL. Fuel cost will consist of a 30% weighting with an assigned rate of 4%.

21.1.2.2.2 MANAGEMENT/COST CONTROL. Fuel cost will consist of a 70% weighting with an assigned rate of 5.5%.

21.1.2.3. CONTRACT TYPE RISK. Fuel cost will be assigned 0% rate for contract type risk.

32. 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 recently acquired older aircraft out of production which may be affected by aging aircraft issues. USTRANSCOM will apply economic life standards for rotables acquired after 1 July 2010 at 10 years, zero percent residual.

Rotables acquired prior to the 1 July 2010 will continue previously established economic life standards at 16 years and 10 percent residual.

43. 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 USTRANSCOM utilization. Any carrier proposing USTRANSCOM utilization versus system utilization will be required to provide documentation on how utilization is tracked, to include the carrier’s methodology for allocating down time to various customers. Carriers proposing utilization in USTRANSCOM service which is accepted in the rate due to sufficient supporting documentation will be required to consistently propose and support utilization derived from USTRANSCOM service from the year it is proposed to the end of the MOU period. 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.

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

54.1. TRAVEL COST INDEX. Percentage change in GII Travel Cost Index, as published by Global Insight, Inc. The percentage change is calculated by dividing the average index of the four quarters of the forecast period by the average index of the four quarters of the base period.

This index will receive a 20 percent weighting.

54.21. SCHEDULED FREIGHT AIR TRANSPORTATION INDEX. Percentage change in the GII – Scheduled Freight Air Transportation Index, NAIC 481112, as published by Global Insight, Inc., adjusted to remove fuel, direct labor, and capital equipment. The percentage change is calculated by dividing the average adjusted index of the four quarters of the forecast period by the average adjusted index of the four quarters of the base period. This index will receive a XX percent weighting. This index will receive an 80 percent weighting.

4.2 AIR TRANSPORTATION INDEX NUMBER 2. [A second air transportation index to be agreed between the parties.] This index with have a XX percent weighting.

65. WEIGHTING OF RATE. Forecast Prospective rates will be weighted on current fiscal year dollars plus prior fiscal year dollars of the aircraft included in the participation threshold defined in paragraph 76. Scheduled service cargo dollars flown at the uniform rate will be placed in the weighting of aircraft that the cargo moved on. [The last sentence needs to be clarified. I believe this is a carry-over from previous years when Cargo from disrupted Channel or Expansion flights may have been transferred to carrier Scheduled Service flights. I don’t believe this occurs anymore and would not be significant in any event. We suggest it be removed.]

76. PARTICIPATION. Carriers participating in the USTRANSCOM forecast year business shall provide cost and pricing data for USTRANSCOM rate reviews. However, carriers may submit cost and pricing data under any circumstances.

Data is required for carriers with revenues equating to five percent (5%) or greater of the class weighting (Large, Medium, Small) for one aircraft type (i.e., B-747-400, MD11, etc.) in charter passenger or cargo service. USTRANSCOM/TCAQ-C’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 2013 2016 rate review participation was determined by fiscal year-to-date dollar levels as of 31 July 20112014.

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 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

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USTRANSCOM, cost and pricing data will be required when the above conditions are met.

7. DETERMINATION OF UNIFORM RATES; OTHER FAIR AND REASONABLE

COMPENSATION. Rates shall be determined on a ton-Great Circle Mile basis for cargo and passenger-Great Circle Mile basis for passenger and separate rates shall be developed for each Category of Service (Large, Medium and Small). When Great Circle Pay Miles undercompensate carriers for required actual miles flown or actual costs incurred such as when certain geographic areas are prohibited or are impractical for overflight, or if costs are incurred that are not consistent with base year statistics, carriers shall be fairly and reasonably compensated by award of circumnavigation or extra miles, as appropriate.

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0.13", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, … + Start at: 7 + Alignment: Left + Aligned at: 0.13" + Indent at: 0.38"

Formatted: Font: (Default) Times New Roman, 12 pt

OMNI AIR INTERNATIONAL

Response to Proposed FY18–FY22 Memorandum of Understanding

OMNI AIR INTERNATIONAL

Response to Proposed FY18–FY22 Memorandum of Understanding

November 18, 2016

Overview – Large and Medium Class Passenger Rate

• Decline in business resulted in higher cost per seat mile.

• Next MOU needs to recognize significant wage increases and work rule changes throughout the industry.

• ROI deteriorating (teaming costs; risk of fuel not recognized; interest expense and taxes; capital invested not appropriately recognized).

0.0933

0.1004 0.1003 0.1053

0.0954

0.0865 0.0873 0.0827

0.0793 0.0778

0.0000

0.0200

0.0400

0.0600

0.0800

0.1000

0.1200

FY13 FY14 FY15 FY16 FY17

Uniform Rate Without Fuel

Medium

Large

$9.43 $9.51

$7.92

$6.57

$5.61

21.6% 21.5%

18.7%

16.3% 15.1%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

$9.00

$10.00

FY13 FY14 FY15 FY16 FY17

Overview ‐ B777 Profit

Return Percent

Omni Large Class Passenger Profit in Rate

$4.53

$3.61

$3.09 $3.19 $3.14

15.7%

12.5%

10.3% 10.5%

12.9%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

$5.00

FY13 FY14 FY15 FY16 FY17

Overview ‐ B767 Profit

Return Percent

Omni Medium Class Passenger Profit in Rate

• Inconsistency concerns industry: $4.00 reduction per mile on 777 for same operation with high reliability during all years.

• Inconsistency of return makes budgeting and fleet planning difficult.

• Charts on two previous slides show inconsistencies for industry due to DOD subjectivity allowed by MOU.

• Carriers were incentivized to modernize their fleets with the expectation of consistent profitability.

However, the current MOU has led to declining or inconsistent profitability over the past five years.

Profit Issues

• Subjective assignment of rates for Operating Cost Risk by analysts makes revenue planning for future contracts difficult and unreliable.

Performance Risk Technical ‐ Fuel Management/Cost Control ‐ Fuel

777‐200 767‐300 777‐200 767‐300 FY13 ‐ FY17 Fuel Costs 4.00% 4.00% FY13 ‐ FY17 Fuel Costs 5.50% 5.50%

Technical ‐ Ops Costs Management/Cost Control ‐ Ops Costs 777‐200 767‐300 777‐200 767‐300

FY17 Op Costs 4.50% 4.50% FY17 Op Costs 5.00% 5.00% FY16 Op Costs 4.50% 4.50% FY16 Op Costs 6.00% 5.00% FY15 Op Costs 4.50% 4.50% FY15 Op Costs 7.00% 5.00% FY14 Op Costs 6.00% 6.00% FY14 Op Costs 7.00% 7.00% FY13 Op Costs 6.00% 6.00% FY13 Op Costs 7.00% 7.00%

Performance Risk

Technical for the aviation industry should be considered above average risk for the following reasons:

• Higher than industry standard reliability metric required by contract for on time performance.

• Requirement for highly skilled workforce in all aspects of operation.

• Technically advanced equipment required for extremely complex long range international operations.

• Nature of contract demands high levels of oversight for safety and quality control.

• Risk of carrying the assets is on the CRAF participants thereby reducing the DOD’s risk of asset ownership.

Management/Cost Control should be awarded the highest risk factor for the following reasons:

• Contract demands intimate level of involvement by senior management.

• Uniform Rate requires reliable cost estimating systems audited annually by DCAA.

• Active in controlling costs for various aspects of the operation.

• Contract requires high levels of reliability – 94% (passenger) .

• International contract requirements involve significant management coordination:

– CRAF activation

– CBRN risk

– Terrorism

– Heightened security

– Foreign exchange rate risk

– High risk communicable diseases

MOU Proposed:

Fuel ‐ 0% Ops Costs ‐ 5%

• Fuel could be a zero risk factor if it were provided by the DOD at no cost to the carrier and all fueling arrangements were the responsibility of the DOD. Only then would the carrier be completely relieved of fuel risk and the rate would be void of fuel.

• Fuel is a competitive factor within the Uniform Rate therefore involves risk (see chart on slide 11).

• Aviation is a capital intensive industry and requires significant investment which is incompatible with short term (one year) contracts.

Contract Type Risk

• Fuel burn management is a competitive part of the Uniform Rate. Carriers strive to lower fuel burn for the benefit of Government and commercial customers.

• Carriers provide significant manpower for the management and tracking of fuel usage:

– Circumnavigating, aborted flights, taxiing, holding, maintenance ferries, training flights, planning, etc.

• Carriers manage the cash flow and bonding for all fuel purchases.

FY 14 Rate Aircraft $/mi Seats $/seat Revenues

Delta B747‐400 21.8530$ 400 0.0546 7.30% Delta A330‐200 13.9457$ 310 0.0450 6.20% Atlas B747‐400 22.2804$ 435 0.0512 20.50% Omni B777‐200 15.2335$ 380 0.0401 24.60% World MD‐11 17.3958$ 360 0.0483 41.40%

0.04710 cent per seat

• Carriers compete on fuel management everyday.

• Carriers (in yellow) must draw from other cost categories on each mission to cover fuel cost.

• If fuel is 30% of the rate, the fuel adjustment is only on the cost above or below 30% which does not make fuel 100% reimbursable or risk free.

Fuel pegged at $3.30 per gallon

Weighted Average Fuel Cost Provided in Uniform Rate

Contract Type Risk FY14 Fuel Cost by Carrier

Recommend setting the following risk factors:

Fuel ‐ 5% Ops Costs ‐ 6%

• Present Facilities Capital Employed table uses an unrealistic range for the aircraft operating under this contract.

< 5 yr 5 ‐ <10 yr 10 ‐ <15 yr 15‐<20 yr 20‐<25yr > 25 yr 25.0% 20.0% 17.5% 15.0% 12.5% 10.0%

Aircraft Fleet Age

Facilities Capital Employed

• < 5yr & < 10 year aircraft fleets require a scheduled service operation in order to achieve greater than 12 hour per day utilization:

– Investment analysis for newer aircraft require high utilization to justify investment, the >10 year; above 20% not achievable in DOD rate.

– Charter Carriers performing the backbone of DOD business lease or purchase aircraft based on 7 to 8 hours per day utilization; this is typically aircraft in their mid life.

• Aviation has been identified as the highest risk industry by the GAO.

– Risks include:

• Responsibility of the carrier to maintain technologically up to date assets.

• CRAF provisions place significant capital investment at risk.

• High market demand for charter aircraft with international capabilities.

• Carriers are not encouraged to continue modernization of CRAF fleet under current return allowed by MOU.

Recommend setting the Facilities Capital Employed range from 18% ‐ 22%, with three increments, to simplify and offer stability to the profit element.

< 5 yr 5 ‐ <10 yr 10 ‐ <15 yr 15‐<20 yr 20‐<25yr > 25 yr Aircraft Fleet Age

18%20%22%

Comparison using escalated current base year costs is unreasonable and places carriers at a disadvantage.

Recommend using current base year costs prior to escalation.

Cost Efficiency Factor

• Performance Risk:

Technical – 7% Management/Cost Control – 7%

• Contract Type Risk:

Fuel – 5% Operations Costs – 6%

• Facilities Capital Employed < 10 years – 22% 10‐<20 years – 20% >20 years – 18%

• Cost Efficiency Factor:

Remove escalation from current base year costs

Recommendations for Weighted Guidelines

Issue:

• Proposed MOU increases economic life and residual value for rotables.

Recommend:

• Leave rotables economic life and residual value as it was in the previous MOU.

Depreciation

9.6

8.8 8.6 8.4

5.8

6.8 6.4

8.0

9.7 9.7

6.5 7.5

0.0

2.0

4.0

6.0

8.0

10.0

12.0

1‐Jan 1‐Feb 1‐Mar 1‐Apr 1‐May 1‐Jun 1‐Jul 1‐Aug 1‐Sep 1‐Oct 1‐Nov 1‐Dec

FY16 Base Year for Two B777

Utilization

Current Utilization uses major carriers’ system utilization which is unrealistic for forecasting a fair and reasonable uniform rate.

Utilization Issues:

• DOD business is unpredictable:

– Best charter months Sep and Oct; roughly 300 hours per aircraft.

– Worst charter months May – Jun; roughly 200 hours per aircraft.

o Crew guarantees and fix cost exceed that allowed in Uniform Rate.

• Base the rate on DOD utilization:

– The Uniform Rate should represent the cost of doing DOD business.

Utilization

Recommend:

• Removing use of system utilization and instead using average of charter carriers as a daily utilization for carriers providing system data.

• Analyzing the S‐1 and S‐2 data to determine a true DOD utilization for an accurate cost of doing DOD business.

• Removing days for major modification work due to aging aircraft (carrier is responsible for documentation).

• Removing 5 hour minimum.

Utilization

Cost Escalation Model Wgt

– NAIC 481112 (YE Sep vs YE Sep) 1.00

• This is representative of a small portion of the industry and it is high risk to use only one index to calculate escalation.

Cost Escalation Model Wgt

– NAIC 481112 (YE Sep vs YE Sep) 1.00

• This is representative of a small portion of the industry and it is high risk to use only one index to calculate escalation.

Cost Escalation

Recommend:

A4A Composite 50%

NAIC 481112 50%

Recommend:

A4A Composite 50%

NAIC 481112 50%

United Airlines 1600 Smith Street th Floor, HQSSK

Houston, Texas 77002

17 November 2016

USTRANSCOM/TCAQ-P

508 Scott Drive Scott AFB, IL 62225-5357 Scott.E.Rader.civ@mail.mil

Re: FY18-FY22 Memorandum of Understanding (MOU) for CRAF Ratemaking

The MOU’s foundation is to develop a fair Uniform Rate that incentivizes carriers to commit aircraft to the CRAF program. The realities of operating a modern, efficient and competitive airline capable of providing war readiness to the DoD is simply not supported by the declining CRAF rates (excluding fuel). Please consider this, in addition to the detail below, in determining the MOU which will drive rates over the coming five years.

1. Performance Risk United Airlines proposes that both Technical and Management/Cost Control categories be assigned the upper limits (7%), due to the type of risks associated with the CRAF contract.

Technical Factor Criteria for assigning above normal risk to the Technical category, as stated in DFAR 215.404-71-2, include (1) the requirement of highly skilled personnel to carry out the contract and (2) the carriers’ investments in their fleet, personnel and technology, have reduced both risk and cost for the government. Both of these criteria must be met as a CRAF participant.

Management/Cost Control Factor Criteria for assigning above normal risk to the Management/Cost Control category, as stated in DFAR 215.404-71-2, include (1) the contractor’s value added is both considerable and reasonably difficult, (2) the effort involves a high degree of integration or coordination, (3) the contractor has a good record of past performance and (4) the contractor has a proven record of cost tracking and control. All of these criteria must be met as a participant in the CRAF contract.

2. Facilities Capital Employed United Airlines proposes that the table used to determine this factor be adjusted to the realities of CRAF carriers’ fleet age.

3. Cost Efficiency Factor Remaining competitive in the complex airline industry is, understandably, an expensive endeavor. Holding an expectation that carriers’ costs will decrease over time is unreasonable in the realities of the given environment. In fact, on November 15, 2016, United Airlines released a News Release as part of an Investor Presentation, stating “The company will continue its rigorous cost management program and expects 2017 unit costs to grow 3.5% to 4.5% excluding fuel. The company expects 2018-2020 unit costs excluding fuel to grow less than 1% per year…”. This statement emphasizes that, given all initiatives to control costs in a competitive environment, the reality is that our costs cannot reasonably be decreasing. This is an unrealistic expectation of carriers who must remain competitive to succeed in such a challenging industry.

The DoD’s need to use air carriers during time of need is understandable, but it is essential that the DoD be aware of the reality of this industry.

4. Utilization United Airlines, as a commercial carrier, operates its commercial fleet using the most efficient scheduled network possible. As such, the utilization of this fleet is vastly different from utilization when operating DoD business. Looking at any typical passenger schedule for DoD will show that DoD utilization is likely close to 8 hours per day. The commercial industry’s ability to maximize efficiency should not subsidize the inefficient reality of the DoD’s airlift needs. United Airlines proposes that alternate methods of calculating utilization be considered.

United Airlines, as a large scheduled airline and the largest provider of passenger capability (as determined by mobility value), proposes that the MOU and Ratemaking process be reexamined to correlate with the reality of the industry. Decreasing rates certainly draw regular examination by carriers whether the risk of the program is a sound business decision.

Thank you for your consideration.

Amy Groom Sr Analyst Gov’t and Military Charters HQSSK CRAF Program Mobility Representative United Airlines 1600 Smith Street | Houston, TX 77002 Tel 713 324 2969 | Fax 713 324 7747 | Mobile 281 513 2346 Amy.Groom@united.com mailto:Amy.Groom@united.com

From: Herb Zimmerman To: Bilyeu, Penny R CIV TRANSCOM TCAQ (US); Rader, Scott E CIV TRANSCOM TCAQ (US);

kristina.r.schneider2.civ@mail.mail Cc: Troy Martin; Sheri Cholodofsky; Kurt Kamrad Subject: [Non-DoD Source] RE: FY18-22 Draft MOU Posted to FBO Suspense: 28 Nov 16 Miami Air Date: Friday, December 02, 2016 10:56:17 AM

All active links contained in this email were disabled. Please verify the identity of the sender, and confirm the authenticity of all links contained within the message prior to copying and pasting the address to a Web browser.

Good Morning:

Pursuant to my conversation with Penny yesterday, we completed a discussion on the MOU and the proposed changes for the period October 1, 2018 thru September 30, 2022. After reviewing the ratemaking methodologies presented in Attachment 1 of the Memorandum of understanding, the Management of Miami Air International does not believe that these methodologies represent an effective means of establishing fair and reasonable rates and furthering the objectives of the CRAF program. In particular, application of the methodologies has led to effectively lower rates, while actual costs of operating an airline (i.e., Technology, Personnel, Security, Equipment, etc.

) have been on the rise. It is our belief that an overhaul of the methodologies, incorporating aggregated input from all CRAF carriers is required to meet those objectives. Please let me know if you have any further questions.

Regards, Herb Zimmerman Sr. Manager Military Contracts Ph: 305-876-3641| Fax: 305-871-4222

Miami Air International | Caution-www.miamiair.com Phone: 305-876-3600 P.O. Box 660880 | Miami, FL 33266

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