1. Under the direction of Commandant (G-EAE), I entered into a series of negotiations between Textron-Lycoming, their legal counsel (McKenna, Conner, and Cuneo) and the United States Government. As the Aeronautical Engineering Project Officer, I worked closely with trial attorneys from the Civil Division of the U.S. Department of Justice. The purpose of these negotiations was to explore a potential out of court settlement of civil breach of contract and criminal False Claims Act allegations regarding the contracts to provide LTS101 turbine engines and spare parts to the U.S. Coast Guard. These negotiations commenced on 28 July 1989 and after various sessions culminated in a conceptual settlement agreement on 2 November 1989. I acted as lead negotiator for the U.S. Coast Guard. Mr. Charles Kuintzle, Vice President, Business Strategies, was the lead negotiator for Textron-Lycoming. Formal acceptance of the settlement offer pends review within the Department of Justice and the U.S. Coast Guard as well as the award of a contract to effect many of the settlement provisions.

2. The settlement agreement is very complex and is documented in a Memorandum of Understanding, reference (a). The settlement involves multiple periods with discrete terms for each of the periods. I will not repeat the specific settlement terms, but instead I will discuss the intent of the settlement and the benefits to the Coast Guard.

3. The intent of the settlement was to: (a) make the Coast Guard whole for past damages, (b) prevent the accruing of future damages, (c) provide by Textron-Lycoming cost-capped maintenance support at a fair and reasonable price and with reasonable effectiveness until such time that a "mature" LTS101-750B-2 can either stand on its own or the Coast Guard can replace the engine on the HH-65A helicopter, and (d) provide an economic incentive for Textron-Lycoming to develop and implement technical improvements at their own cost and risk to mature the engine. I will discuss the various terms and conditions of the settlement to explain how all these goals have been achieved.

4. The $17 million cash payment reimburses the government for damages incurred in buying and maintaining the LTS-101. Calculation of actual damages is quite complex and often subjective. The HH-65A major system acquisition contract did not contain an explicit warranty nor guarantee of engine service life. Some very general requirements were incorporated, primarily by reference.

The reliability and durability of the LTS-101 has been so poor that is reasonable to assume that it was not contract compliant regardless of the specific language of the contract.

Additionally, there were a number of False Claims Act allegations of criminal fraud that despite significant litigative risk may have yielded punitive damages to the government as well as other legal remedies. After prolonged negotiations we agreed that absent specific contract terminology, the failure rates for engine spare parts that were listed in the required "Provisioning Parts List" best represented the expectations of both parties as to compliant reliability and durability of the engine. A complex math model, reference (b), was prepared by the Coast Guard which compared these expected service lives to calculated actual service lives. Actual service lives were calculated using spare part consumption data from the Aircraft Repair and Supply Center (AR&SC) mainframe computer data base. Additional costs such as excess depot labor and transportation charges were also included in the math model. Textron-Lycoming's acceptance of provisioning oriented forecast failure rates as minimum acceptable performance was a major concession.

Coast Guard consumption data and the derived experienced service lives are very soft, and would have been extremely difficult to prove in a strict legal environment. Given that actual historic damages are extremely difficult to quantify and prove, the $l7 million cash settlement represents a very fair offer that exceeds any reasonable estimation of single damages. This cash amount will not convey to the Coast Guard. Instead it will be paid to the U.S. Treasury to reimburse theoretical incremental appropriations that were necessary to support the LTS101. All other terms of the settlement were constructed to insure that the Coast Guard receives the benefit of the bargain.

5. Future damages are prevented by the"Power by the Hour" (PBTH) fixed price maintenance contract. Historical damages could continue to accrue between signing the conceptual settlement agreement and award of the PBTH contract. To prevent this from occurring I insisted upon a transition period with its own method of preventing damage to the Coast Guard. During the transition period, which commences immediately upon signing the settlement M.O.U. and extending until award of the PBTH contract, Textron-Lycoming will perform 5 no cost engine overhauls per month.

This transition period shall not exceed 6 months, which is considered the maximum fair amount of time to award the PBTH contract. If Textron-Lycoming lacks the capacity to complete 5 overhauls per month, credit for whole engine overhauls (not the equivalent PBTH charge) will carry forward. Between the cash settlement and the transition period, the Coast Guard is thus assumed to be made whole as it commences the PBTH period.

6. The meat of the settlement for the Coast Guard is the six year, commercial derivative PBTH agreement. PBTH is a common commercial fixed price per engine hour maintenance agreement utilized to guarantee future support costs for potentially risky turbine engine maintenance. It is widely used for two reasons: (1) to pool large numbers of engines owned in small increments by small operators thus each operator bears an average cost and is in effect "insured" against premature failures while paying a small premium over true average costs; and (2) to help market immature or high maintenance engines by offering a cost-capped maintenance program during the early operational years. The Coast Guard, like other military services, is not normally a PBTH customer. As a fleet operator, we already spread our support costs over a large base, and as a sophisticated customer we carefully evaluate and assume maintenance and support risks without artificial economic enticements. The very unsettling past and uncertain future of the LTS101 make a PBTH agreement highly advantageous. Normally the military would not be offered a PBTH agreement. The Coast Guard specifically requested this arrangement as part of any potential settlement.

The benefits include:

(a) Fixed price per engine hour, step priced from $85/hr in year one to $73/hr in year six. This average price of $79/hr compares very favorably to Coast Guard estimates of $213/hr as recently as spring 1989. Additionally, a conservative, independent estimate of current Coast Guard depot maintenance cost for the LTS-101 engines was developed by the Transportation System Center during September 1989. This conservative estimate was $142.00 per hour or nearly double the effective rate of the settlement agreement. Lastly, ARSC solicited a fixed repair price for the LTS-101 engine through an Invitation for Bid (IFB) during fiscal year 1987. The IFB was structured for contractors to bid a repair and overhaul price for several LTS-101 engine components along with the whole engine itself. Thirteen potential bidders, including all currently known potential sources for LTS-101 repair/overhaul, received the solicitation, but only four contractors actually submitted bids. Bid opening was held on 22 December 1987. Only one contractor bid on the whole engine line item. The sole bid price for whole engine overhaul was $99,242.32. Now, for comparison purposes, if we assume that the LTS-101 engine currently makes approximately 415 hours between failure (based on latest information from ARSC), then the price per overhaul under the PBTH contract (assume average $79.00 hourly rate) would be $32,785.00, or less than one-third the 1987 market price. Hense, the composite rate of $79.00 per hour is considered well below a market rate, as it should be considering the settlement-of-damages nature of its origin.

In the end the PBTH price of $79.00 is clearly determined a fair and reasonable price. And, this price includes all field and depot parts and depot labor, thus effectively negating any future expenditure on virtually all LTS-101 spare parts.

(b) The fixed rate includes the cost of developing and implementing the very expensive technical modifications that should mature the engine. A recent estimate for the initial incorporation of the planned product improvements in the Coast Guard fleet was $45 million.

The improvement and retrofit is entirely at Textron-Lycoming's cost and risk. The risk that the improvements as planned may come in behind schedule, over budget or are ineffective is considerable. If any problems arise with the development program, the Coast Guard, shielded by the PBTH agreement, is unaffected in terms of cost.

(c) Terms discussed above, combined with the five free field service representatives, allow the Coast Guard to cancel or greatly reduce the expensive sustaining engineering contract for the LTS101.

(d) Configuration control, with the exception of the specific provisions for the rebladable power turbine, is yielded to Textron-Lycoming. They are allowed this technical flexibility to pursue whatever modifications are necessary to mature the LTS101. The Coast Guard is protected by the very powerful economic incentive that Textron-Lycoming will have to mature the engine. While we pay fixed price, their costs can fall dramatically if they successfully mature the engine. This allows for potential profit if, and only if, the engine becomes satisfactory. If the engine matures more rapidly than expected, the Coast Guard has the unilateral right not to exercise any future options. Current estimates of internal Coast Guard depot costs to support the LTS101 are based upon the existing pricing agreements for spare parts. While Textron-Lycoming can obviously price their PBTH rates based on lower variable costs for internally sourced material, it is unreasonable to expect that their production is so greatly more efficient than current organic rework that profits are possible without substantive improvements in reliability and durability.

(e) The PBTH contract protects availability with maximum turnaround times of 60 calendar days, and minimum throughput of 40 engines per month which is approximately twice the current demand rate. To meet those aggressive requirements, Textron-Lycoming intends to build a new overhaul facility in the Southeast. If their performance is not contract compliant, liquidated damages provisions are included to compensate the Coast Guard for lost engine availability. In the settlement negotiations, Textron-Lycoming accepted the liquidated damages provisions as fair and representative of Coast Guard damages if engines are not timely delivered. Without the LTS101 engine the HH-65A is grounded. At program hours each HH-65A should fly 1.68 hours per calendar day. To replace the HH-65A with a leased aircraft, e.g. an Aerospatiale SA-365N1 (the closest commercial equivalent aircraft), would cost $42K/month plus $500/hour or approximately:

[($42K/mo) / (30 days/mo) = $1,400/day] = [($500/hr) x (1.68 hrs/day) = $ 840/day] = TOTAL = $2,240/day

It is unreasonable to attribute the entire aircraft dry lease cost to any one part, e.g. the engine, since it may be feasible to cannibalize aircraft to mitigate loss of aircraft availability. This effect is more significant for short term loss of engine availability than for long term. The agreed upon liquidated damages rates consider these effects, and fall within the cost to the Coast Guard of dry leasing an equivalent replacement aircraft.

(f) The step pricing arrangement offers two benefits. The Coast Guard is guaranteed lower future costs as the LTS101 matures and tracks down the experience curve. This is true whether or not Textron-Lycoming is able to actually achieve the maturation. Secondly it addresses risk sharing issues between Textron-Lycoming and the Coast Guard. The PBTH agreement transfers most of the current and future economic and technical risk to Textron-Lycoming. By offering the lowest rates in the out years, the Coast Guard has an economic incentive to exercise outyear options, thus encouraging long-term capital investment in the early years by Textron-Lycoming. This effect is conducive to program success.

(g) The LTS101 is not a military specification engine. As such it is not conductive to the normal DCASMA quality and production oversight. The agreement provides for a Coast Guard COTR in-plant at Textron-Lycoming to provide quality oversight. This COTR is intended to be a E-7 to E-9 Aviation Machinist Mate. The normal provisions of the government inspection clause would also apply.

(h) It is impossible to achieve an instantaneous production rate of 40 overhauls per month. The startup agreement provides for an orderly transfer of production from ARSC to the new Textron-Lycoming facility while still offering all the advantages of fixed rates and assumption of material responsibility by Textron-Lycoming. The ability to transfer for credit all existing inventories of LTSl0l material

at the initiation of contract performance is an extremely attractive provision. While this provision may be difficult to execute, it has tremendous economic value and should be pursued vigorously. The alternative startup agreement is far less advantageous to the Coast Guard, and should be only utilized after every attempt has been exhausted to execute the primary agreement.

7. Once the Coast Guard has yielded organic depot maintenance capability for the LTS101, it is potentially difficult to regain it. This is especially true if the Coast Guard is replacing the LTS101 with an alternative engine on the HH-65A. In that case, we may opt to allocate our technical and production resources to the new product. If the PBTH arrangement is very effective at supporting the LTS101, we may desire