Beleaguered McDonnell Bets on a New Jet : Aerospace: The company needs fast federal approval for its big new airliner. McDonnell’s long-term health--and U.S. supremacy in the industry--may hang in the balance.

At a scorching test site in the Sonoran Desert, a team of 500 McDonnell Douglas employees is racing to obtain government certification of the new MD-11 jetliner before their company runs out of time--and money.

The mostly young engineers, technicians and pilots at the site near Yuma, Ariz., are working around the clock in two 12-hour shifts, flight-testing four of the jumbo aircraft. It is one of the fastest-paced certification programs in industry history. And the future of the MD-11 program--perhaps even the health of the St. Louis-based corporation--is tied to their success.

By the company’s account, it will come close to its goal of getting the MD-11 certified by the end of October and capture $350 million of badly needed cash this year. If so, that will be some rare good news for the firm’s Douglas Aircraft unit in Long Beach.

The company remains plagued by a whole range of financial and operational problems that have led to major losses, tardy deliveries of aircraft to customers, extensive layoffs and sagging morale.

Besides the highly leveraged and risky MD-11 program on the commercial side, Douglas is confronting an uncertain future with its Air Force C-17 cargo jet program, which carries enormous financial perils. Company officials disclosed last week in interviews that a major cost review now under way could create new cash difficulties later this year.

So great are Douglas’ problems that the company’s executives have had to struggle to assure workers and outside observers that they are not close to writing off the commercial aircraft business and shuttering Douglas, which employs 40,500 workers in Long Beach and Torrance.

Nonetheless, in a long-term sense the company is very much in a struggle for its survival. Just last year, it slipped from its No. 2 world ranking as a producer of commercial jet aircraft when Airbus Industrie delivered more aircraft seats.

The continued existence of Douglas Aircraft is critical to the United States’ position as the international leader of aerospace. Company officials insist that they are committed to the challenge. Indeed, they have invested a fortune in it. And that’s why, right now, so much is riding on what’s happening in the dusty Arizona desert.

So far, McDonnell officials said, the MD-11 flight test program is ahead of schedule in demonstrating the aircraft’s flying capabilities, but somewhat behind schedule in testing the tricky avionics--or advanced electronics--system in the highly computerized cockpit.

If the company meets the Oct. 31 certification goal, delivers the five planes and earns the $350 million, it would abate the ferocious growth in McDonnell’s debt.

“We will obtain certification by then,” asserted Joe Ornelas, the affable MD-11 flight test manager in Yuma. “The question is whether we will have some loose ends. That is a possibility.”

By “loose ends,” Ornelas did not mean parts of the airplane but capabilities that do not require immediate certification and will not prevent deliveries to airlines. At McDonnell Douglas’ St. Louis headquarters, however, executives are exercising more caution.

A recently negotiated bank loan agreement has enough flexibility so that the company will not face a liquidity crisis under even “the most Draconian scenario,” said Herbert J. Lanese, senior vice president and chief financial officer. By Lanese’s handicapping, the firm has a 50% chance of getting the MD-11 certified by Oct. 31.

Moreover, a recent letter to employees by McDonnell Chairman John F. McDonnell raised eyebrows when he said the MD-11 certification program was “essentially” going well “except for the avionics.” It appeared that he was laying groundwork for the later disclosure of new problems.

Certification by Oct. 31 “is important, but not critical,” Lanese said. He added: “If you look at what I’d consider to be a Draconian scenario, you wouldn’t get certification until March. . . . That could require an increase of $1.2 billion in our debt.”

He said only “a very severe problem . . . would force us into a certification that late.” With certification on Oct. 31, however, debt would grow by just $400 million to $450 million, he said.

A new credit agreement with its lending consortium allows McDonnell to increase its debt in 1992 to a level 15% greater than the sum of its shareholder equity, preferred stock and subordinated debt. Current equity is $3.3 billion; the firm has no preferred stock or subordinated debt but is likely to issue some in the future.

“We not only can survive the worst-case scenario, we’ve provided financial flexibility over and above the worst case for us,” Lanese said.

A little flexibility may be a good thing. The Douglas Aircraft unit alone posted a pretax loss of $222 million on revenue of $4.7 billion last year, and sustained a further loss of $84 million on sales of $1.1 billion in the first quarter of this year.

Aerospace analyst Paul Nisbet of Prudential Bache Securities, who considers himself an optimist on McDonnell Douglas, estimates that the Douglas unit will lose $94 million on sales of $5.3 billion in all of 1990. Paine Webber aerospace analyst Phil Friedman has projected a $125-million loss at Douglas this year.

A massive management reorganization last year, in which every one of the more than 5,000 executives were forced to reapply for their jobs, deeply wounded morale.

Moreover, Douglas is laying off 4,000 workers and eliminating 3,000 jobs that were assigned to temporary “contract” workers. Those cutbacks have further raised the anxiety of the work force.

“What does it tell you about the company if they suddenly discover that they have 7,000 too many workers?” one aeronautics expert said. “Usually, companies have layoffs when they have a declining work load, but Douglas is having cutbacks when they are facing an increasing work load.”

The firm is behind schedule on all of its major aircraft development programs--the MD-11, the C-17 and the Navy’s T-45 jet trainer. The huge workload is straining management resources.

The MD-80, an aircraft that has been produced in its current and earlier forms for several decades, should be a cash cow for the company. Instead, it is another headache.

Last year, Douglas forfeited $20 million to commercial customers because of late delivery penalties, according to internal sources. About 24% of MD-80 deliveries were late.

The most significant problem has been production of the aircraft’s nose section, which paces production of the total aircraft.

Douglas has had persistent problems meeting the production schedule of 2.5 nose sections a week. Just last week, it was forced to mate the fuselage and wing assemblies of several MD-80s before the noses were attached to the fuselages--an extreme measure to keep the production line moving.

To remedy the nose shortages, Douglas officials are setting up a second nose production line at the large McDonnell Astronautics facility in Huntington Beach. That line will produce one nose a week, while the Long Beach line builds up to three noses per week.

The extent of Douglas’ problems has made workers nervous, and the company’s handling of the layoffs didn’t help. Some workers were escorted off the property by security officers within hours of the notification.

Among the remaining employees, there is persistent speculation that Douglas will close. One Douglas scientist said recently in an interview that he is involved in an effort to develop a contingency plan for such a shutdown in his area, but it is not clear what magnitude of financial crisis would trigger such a contingency plan.

A catastrophic shutdown of Douglas, while not impossible if McDonnell were to face an overwhelming financial crisis, is clearly not what the parent company has been preparing for in recent years.

In each of the last three years, McDonnell’s biggest investments in property, plant and equipment have been in its transport aircraft sector--Douglas. Last year, it in vested $213 million at Douglas.

Senior executives said recently that the future of McDonnell is Douglas, because it provides the balance that will carry the military side of company through future declines in the Pentagon budget.

But its position in commercial aircraft “has been, for many years, the weaker side of our business,” according to Chairman McDonnell’s letter to shareholders in the firm’s recent annual report.

In 1989, as Douglas slipped behind Airbus for the first time, its share of the world market for large commercial jets fell below 20%. Boeing is No. 1, with about 60%.

Thus, on one side Douglas faces the Boeing juggernaut, which boasts a full line of aircraft, a reputation for excellence and a cash hoard of $1.2 billion. On the other side is the Airbus consortium, subsidized by the governments of France, Britain and West Germany and intent on developing its own full line of aircraft.

Even if all turns out well for Douglas’ commercial programs, McDonnell Douglas is not out of the financial woods. The Long Beach operation is also contending with yet another high-risk, multibillion-dollar program in the C-17. Development of the big cargo jet is more than a year behind schedule, and McDonnell’s spending on the project has risen to its $4.9-billion ceiling, beyond which the company will have to absorb all the overruns as a loss.

The Air Force, meanwhile, is conducting a formal “estimate at completion”--or EAC--on the C-17, an effort to determine how much money it will cost the company to complete the contract, Lanese disclosed.

An EAC is a projection of the cost of building the airplane and completing the contract, an analysis that is periodically done on all major military programs.

The danger is that the Air Force will conclude that C-17 production costs have further increased. That would mean McDonnell Douglas has booked too much profit so far and would have to take a charge against earnings.

Even worse, if the C-17 costs increase, the Air Force would also conclude that it has been making progress payments to Douglas too fast for the amount of work it has accomplished. That could mean a reduction of contract progress payments--not what McDonnell needs in its current cash shortage.

Lanese said the company has begun conducting its own EAC.

“We thought it was just prudent for us to go through a pretty comprehensive look at our own program again,” he said. “When you’re in a full-scale development program, there’s a certain amount of risk. And that’s why we’re sensitive to making sure that when we do our EACs, we do a pretty thorough job of understanding just what our risk and exposure is.”

It is not clear whether McDonnell could handle a lengthy delay in MD-11 certification and a sharp drop in Air Force payments on the C-17, each of which might be catastrophic alone.

The magnitude of any possible drop in C-17 progress payments is a complete unknown. The recent annual report contained a financial footnote, however, warning that an increase in the EAC “would have a substantial adverse impact on future earnings.”

Lanese said there is a possibility that the EAC will show the C-17 to be further along than expected. But some Douglas sources say the aircraft is not progressing nearly as fast as it should to meet its scheduled first flight date in June, 1991. Just recently, the tail section was attached to the first aircraft, meaning that a substantial amount of structural, electronic and hydraulic work lies ahead before even ground testing can begin.

The picture is further complicated by the recent recommendation of Defense Secretary Dick Cheney to reduce future purchases of C-17s from 210 to 120, and to cut the peak rate of production to 24 planes a year from 29.

That recommended cutback, Lanese said, could provide a basis for a claim against the government.

“If you are going to cut the number of planes that are now part of that program, it affects not only our return on investment but the rest of the commitment on the program. And I think there’s probably a pretty good case for why we, as a contractor, would expect some kind of relief on that,” he said. “We’re going to have to talk to our customer (the Air Force) and see what can be negotiated.”

All the risks and unknowns on the C-17 make success in the MD-11 program all the more important. And it has the potential to help turn around Douglas. It is a big airplane with a gross takeoff weight of 605,500 pounds and a price tag of more than $100 million each. Big planes can produce big profits.

The MD-11 has sold well. Douglas has various types of customer commitments for 371 of them, including firm orders for 144. Douglas hopes to earn a profit making the MD-11, something it never did on the DC-10. The MD-11 is a derivative of the veteran DC-10, a three-engine jumbo jet.

“The program, from our standpoint, is going very well,” said Frederick Lee, chief of the FAA’s certification office in Long Beach. “I haven’t heard any complaints from our pilots.”

Analysts believe that Douglas will not face a certification crisis on the MD-11. “The probability that the aircraft will not be certified by next year is very low,” said Tassos Phillippakos, an analyst at Moody’s Investors Service, which recently downgraded its ratings on McDonnell Douglas debt. “If I were to take a bet, I think there is a high probability that the MD-11 will be certified by March, 1991.”

On a recent day when temperatures soared to 112 degrees at Yuma, spirits were remarkably high.

“There are no show-stoppers” that would seriously delay the program, said John I. Miller, Douglas’ chief of flight operations on the MD-11. He said the aircraft handles better than the DC-10 and recently came through stall tests without requiring aerodynamic tuning.

As for the avionics problems, flight test manager Ornelas first said, “It is not serious.” But, he added, “It is something that is a major challenge to us. It is something that is going to keep us busy right up to certification.”

Avionics, particularly avionics software, have caused some of the toughest problems for aircraft makers in recent years.

Douglas has subcontracted the job of integrating the MD-11’s avionics system to Honeywell, which is providing Douglas with badly needed help when problems develop, Ornelas said.

The two-pilot cockpit of the MD-11 may be the most automated in the industry, featuring seven computers that automatically handle a range of mundane tasks which consume a pilot’s attention on other aircraft.

For example, the DC-10 has 28 switches that must be activated to dump fuel in an emergency, a task that must be performed at the same time the crew is trying to deal with the cause of the emergency and fly the airplane. In the MD-11, pressing a single button will purge the fuel tanks down to the maximum landing weight, Miller said.

“We are going for the lowest pilot workload in the industry, and I think with this system we will achieve it,” he added.

Douglas has lots of problems, but climate hasn’t been one. The monotonously hot, dry days this year have forced few flight cancellations.

“Good weather in the bag,” Ornelas said, “is money in the bank.”