No Bailout Is Foreseen on Defense Pacts

When the Pentagon canceled a major Lockheed contract under punitive terms Friday, it sent a menacing signal to the entire defense industry that the government will not bail out contractors facing major losses on weapons programs.

The nation’s defense industry is facing billions of dollars in losses on troubled contracts signed in the 1980s, when companies agreed to develop and produce new technology at fixed prices. At the time, the industry was euphoric over the Ronald Reagan Administration defense buildup.

Now, those contractors have encountered the normal types of problems in developing new technology and are facing massive overruns that have wiped out profits. Many companies are going deeply in debt and investors have shunned owning defense company stocks.

Last year alone, major prime contractors lost an estimated $2.3 billion on such contracts, and by some estimates the total liability already incurred and still confronting the industry may approach $6 billion.

Moreover, the problem comes at the worst possible time because defense spending is falling quickly and the companies have little chance of restoring their financial health in the near future. Companies that have tried to make a quick exit from the arms industry have found few buyers for their defense divisions.

“The whole defense industry is a disaster,” said former Undersecretary of Defense Donald Hicks. “And the people who signed on all these contracts are gone.”

Lockheed’s losses on the Navy P-7A anti-submarine patrol aircraft canceled Friday could amount to $300 million, though the firm already established a reserve to pay those costs last year. One positive outcome to the development is that it precludes even greater future losses.

Virtually every major contractor has been stung at least once with a money-losing fixed-price contract, most of them originating with the Navy during the administration of Navy Secretary John F. Lehman Jr.

Just last week, General Dynamics took a $450-million charge on its troubled A-12 attack jet for the Navy and vowed to press a claim against the service to recoup the money.

McDonnell Douglas Corp. lost $31 million on its T-45 Navy trainer jet program last year and faces additional charges. Grumman Corp. agreed to develop a new version of its F-14 at no profit and then incurred a $120-million loss.

Five major aerospace firms agreed in 1986 to develop a new Air Force fighter at a collective loss estimated to be $1.4 billion. Now the program has been delayed and some experts doubt it will ever be built.

Rockwell International Corp. has had an estimated $100-million overrun on a tiny program to develop the AC-130U gunship for the Air Force. Hughes Aircraft lost $250 million in the 1980s to build a new missile for the Air Force, which has yet to begin production.

The Lockheed case was notable because the company not only agreed to develop the aircraft, it also agreed to build 125 of the Navy P-7A anti-submarine patrol planes at a fixed price of $600 million.

Industry sources believe the Navy refused to bail out Lockheed because to have done so would have set a precedent. “They are worried about opening the floodgates if they renegotiate any of these contracts,” said one industry official. “I think that was a major factor in their decision to terminate Lockheed. They would rather give up one airplane than to set a precedent.”

Lockheed was facing a projected overrun as high as $1 billion on its fixed-price contract to develop the Navy P-7A anti-submarine patrol aircraft. When it received the award in January, 1989, Lockheed thought the aircraft would closely resemble its prior P-3 patrol aircraft. But the awful reality came quickly: To satisfy Navy requirements, the aircraft would have to be virtually all new.

To make matters worse, the P-7A contract contained production options that carried fixed prices far below Lockheed’s projected costs. A knowledgeable source said Lockheed’s cost was roughly $47 million per aircraft, but it was to be paid just $40 million.

The Navy would not back down, and Lockheed Chairman Daniel M. Tellep vowed that he would never build the aircraft at a loss. After months of negotiations, an impasse was reached and the Navy terminated Lockheed’s $600-million contract on Friday for default.

“The problem we are seeing in the industry once more underscores the disastrous effects of fixed-price, total-package procurement,” Tellep said in an interview Saturday. “And it is not beneficial either to the (Pentagon) or to the contractors.”

Navy officials could not be reached for comment Saturday.

Though Tellep lost the P-7A program in the dispute with the Navy, Lockheed may be far better off than if it built the aircraft under the Navy’s terms, Tellep said. “We do not expect further losses,” he said.

Lockheed has vowed to appeal its termination under terms of default. A default means the Navy can demand a full refund of all money it paid to Lockheed or can find an alternative producer for the P-7A and sue Lockheed for any costs in excess of its contract with Lockheed.

Tellep considers the latter outcome unlikely from either a technical or legal standpoint. But the Navy could still demand a refund of the roughly $200 million it paid to Lockheed before it canceled the contract.

Lockheed has incurred costs of about $300 million on the program so far, Tellep said. Last year, it took a $300-million charge against profits to pay for expected cost overruns. So, the company has already written off the full cost of the program.

“If our appeal is successful, as we expect it to be, we will recover a major portion of the prior $300 million,” he said. Even though Lockheed signed the P-7A contract, Lockheed General Counsel Joe Twomey contends that it is a flawed contract and violates provisions of federal law.