Job Worth Billions May Leave Hughes Straining to Catch Up With Costs

Ordinarily, the prospect of winning a big chunk of a $10-billion job would send any defense contractor gleefully into financial orbit. But, at Hughes Aircraft, things aren’t so simple.

Next month, the Pentagon will decide whether to give the go-ahead for full-scale production of the Advanced Medium Range Air-to-Air Missiles, or AMRAAMs. The missiles, now in the development stage, would replace 1950s-vintage Sparrows. The production contract would be worth $10 billion through 1992.

Hughes’ Missile Systems Group, based in Canoga Park, is the leading candidate to win much of the AMRAAM production contract because it has already done all the development work on the missile. But, even if Hughes is awarded the lion’s share of the production contract, making a profit on AMRAAM is anything but certain.

“Whether Hughes will ever make enough money to justify huge, enormous investments is tough to say,” said Wolfgang Demisch, an aerospace analyst for First Boston Corp.

That is because Hughes suffered through $255 million in cost overruns from 1983 to 1985 as it struggled to get the AMRAAM through the development stage. So Hughes is already that much in the hole.

To make matters worse, the Pentagon now insists that any AMRAAM production be shared with another contractor to keep the two companies in annual competition against each other and to hold down prices to Uncle Sam.

Lexington, Mass.-based Raytheon, a losing bidder in the design stage for AMRAAM, figures to be the other AMRAAM supplier. Raytheon has enjoyed success in recent years by winning production contracts without taking on development risks.

More ‘Attractive’ to Be Loser

Hughes claims this is unfair. “There’s a lot of people who say, the way this thing is set up, it’s a lot more attractive for everyone to be losers,” said Frank H. Beckett, manager of advanced product development for Hughes’ Missile Systems Group

“Hughes busted their guts,” said analyst Demisch. “Raytheon settles back and relaxes while Hughes spends all that money. Then Raytheon comes in and says, ‘May we have the blueprints please?’ ”

For Hughes Aircraft, which was acquired by General Motors in January, 1986, and is now part of the independently traded General Motors Hughes Electronics Corp., turning around AMRAAM is a crucial test of the company’s ability to remain a leader in the missile business.

Hughes Aircraft, based in El Segundo, had an estimated $7 billion in sales last year, about $1 billion of which came from the missile group. The missiles unit, which employs nearly 12,000--about 3,500 work in the San Fernando Valley--said it is now running at a profitable pace.

“The tough times are behind us,” declares missile group President D. Kenneth Richardson.

But the lessons of the AMRAAM development debacle aren’t lost. No longer will Hughes absorb all the development costs on contracts. Hughes has already said it will team with Raytheon in bidding for development of another advanced air-to-air missile (or Triple AM), which the Navy would launch from jet fighters to defend battle groups at sea.

The Navy plans to split up the winning team at the time of production, and the two contractors would compete against each other for annual production contracts, as with AMRAAM.

The Triple AM is expected to be worth up to $20 billion over its lifetime. Analysts say the AMRAAM decision will affect Hughes’ chances in the Triple AM contract, scheduled to be awarded this fall.

Hughes aside, for most defense contractors the missile business is only getting better. Missiles have been gaining an increasing share of the Pentagon’s budget, instead of more traditional programs for aircraft and ships. Total missile procurement leaped to an estimated $12.6 billion for fiscal 1987, up nearly five times from 1977.

Why the interest in missiles? Faster jets, such as the Air Force’s F-15s and F-16s, and the Navy’s F-14s and F-18s, need faster, more sophisticated missiles.

The AMRAAM is one of the first fully automated missiles, guided by an on-board radar transmitter that seeks out targets. The older Sparrow missile requires a pilot to guide it by radio control until it hit its target.

With the AMRAAM, a pilot can fire at a target up to 40 miles away, then, change his plane’s course to minimize his own vulnerability while the missile carries on its way. The AMRAAM is also fast, traveling at up to four times the speed of sound.

The Pentagon saw the need for developing such a missile during the Vietnam War, when only 10% of Sparrows fired from 1965 to 1969 hit their targets.

Design work for the AMRAAM began in 1976, with Ford Aerospace, General Dynamics, Hughes Aircraft, Northrop, Raytheon and Hughes taking part. Based on those designs, the Pentagon awarded contracts to build 20 prototype missiles to Hughes and Raytheon.

In December, 1981, Hughes was declared the winner, and the company received a development contract for the delivery of 122 missiles within 50 months at a ceiling price of about $556 million.

But Hughes had problems from the start: Bad computer chips and technical glitches for AMRAAM were exacerbated by troubles with Hughes’ other missile programs at the missile group’s Tucson, Ariz. facility. In the summer of 1984, the Air Force stopped accepting shipments of Hughes’ Maverick missiles because of exposed electrical wires, loose screws and improper soldering. The Navy took similar action against Hughes’ Phoenix missile.

Called Too Costly

As a result, Hughes shut the Tucson plant for six months, putting the AMRAAM far behind schedule. The missile also came under the scrutiny of Congress, which reduced money for the project.

The Pentagon was forced to lower AMRAAM’s performance requirements, and, in June, 1985, Defense Secretary Caspar Weinberger told a Senate subcommittee that AMRAAM “has been a disappointment to me.”

Hughes’ testing remains behind schedule. Of the 45 AMRAAM tests scheduled to have been completed through mid-March, noted Paul H. Nisbet, an analyst for Prudential-Bache Securities in New York, only 26 have actually been completed.

“Frankly, AMRAAM is no gem,” said Gary J. Reich, an analyst for E. F. Hutton.

$200,000 Average Cost

If the AMRAAM is put into full-scale production, the Air Force would buy 17,000 of them, at a ceiling price of $275,000 each. The Navy would buy 7,000. Hughes says it could produce them at an average cost of $200,000 each. Critics put the cost as high as $1 million each.

Last year, in an attempt to ward off Raytheon as a second-source AMRAAM competitor, Hughes proposed to produce all 24,000 missiles at a firm price of $6.2 billion. Raytheon then countered with a $6.1 million bid.

Despite the offers, the Pentagon decided to stick with its second-source plan.

Not all is lost, says Nisbet. He says the missile may well become a bigger hit as an export item. Both the West Germans and the British have expressed interest.