Jet Overruns Could Push McDonnell Toward Crisis

McDonnell Douglas Corp. has fallen into much deeper trouble on its Air Force C-17 cargo jet program and is projected to exceed the cost ceiling for developing the aircraft by as much as $500 million, according to defense officials citing a confidential Pentagon analysis.

Such cost overruns could precipitate a financial crisis at the nation’s largest defense contractor if the Pentagon doesn’t step in to rescue the company. McDonnell is developing and producing the C-17 at its Douglas Aircraft unit in Long Beach, which employs 40,000 people.

The Pentagon last week disclosed that it has stopped paying McDonnell for its work on the C-17 after concluding that McDonnell’s own cost estimates for completing the job of developing the jet were not valid. So far, $300 million has been withheld from the heavily indebted firm.

“McDonnell Douglas is in serious trouble,” a Pentagon official involved in analyzing the C-17 program said Wednesday. “It has started to get people’s attention. The real concern now is that this thing could blow up politically.”

McDonnell Douglas Vice President Michael Birch confirmed Wednesday that the firm at some point “is likely” to break the $4.9-billion ceiling for developing the C-17. But he rejected the $500-million estimate, saying, “We know it is going to be high, but not that high.”

Birch disputed any analysis of McDonnell that suggests that the firm is facing a financial crisis.

“We feel confident that we can make money on the C-17,” Birch said. “We are not going to do anything that hurts the long-term health of the corporation.” Birch said the corporation has expressed its concerns about the suspension of C-17 payments at the highest levels, including to Air Force Secretary Donald B. Rice.

Although McDonnell is not currently in jeopardy of running out of cash, a large liability on the C-17 program, which will cost the government $30 billion for a fleet of 120 aircraft, would create serious financial problems because the firm is investing heavily in its commercial MD-11 jetliner program and faces large potential losses on its troubled A-12 attack jet program for the Navy.

Congressional sources said late Wednesday that the Pentagon is working on an agreement to modify the C-17 contract but details were not available. Ultimately, Congress would have to approve any increase in funds for the C-17.

Some key military officials have said recently that the situation is so grave that without Pentagon intervention to help McDonnell, the company would eventually require a bailout by Congress. The officials have compared the situation to those that developed before the Lockheed Corp. and Chrysler Corp. bailouts.

“Everybody in the Pentagon is working to prevent a crisis,” an Air Force official said. “They just have to figure out the most plausible way of doing it.”

A Defense Department spokeswoman would make no comment Wednesday on the cost estimate, which was made by the staff of Undersecretary of Defense John A. Betti. Betti’s staff declined to discuss the estimate, but a Pentagon official familiar with the projection agreed to disclose its existence if he was not identified.

Even with the cost overrun, Birch said McDonnell will not begin to incur losses on the C-17 program until the combined ceilings of three different contracts are exceeded. The three contracts include one for development and two for production of six aircraft. The combined limit of those is $6.57 billion, according to Air Force spokesman Capt. George Sillia.

To avoid any financial liability if it overruns its development contract, McDonnell would have to make up the difference on the two production contracts. Given the C-17’s problems, experts are skeptical that production can be achieved at below budget. For example, Rep. John Dingell (D-Mich.), a C-17 critic, last week released documents that showed Douglas is spending 25.8 hours to accomplish production work that its own engineers said should take one hour.

Birch said McDonnell has financial strength to withstand the current problems with the C-17.

“We still have adequate capacity to borrow,” he said. “We still have hundreds of millions of dollars before we would exceed our debt coverage.”

McDonnell now has $2.9 billion in debt. It negotiated a new credit agreement with its bankers earlier this year, providing a debt ceiling of $3.7 billion.

The Air Force is separately conducting a cost performance review of the Douglas unit in Long Beach to assess the financial health of its military and commercial programs. The unusual review has resulted from serious concerns about Douglas.

Until last week, McDonnell was projecting that the C-17 development would be completed at $300 million under the $4.9-billion ceiling. The rapid turnaround appears to coincide with growing concern in the Pentagon.

Military officials began scrutinizing McDonnell’s cost reports more closely and concluded that the numbers did not support the estimate that development could be completed for $300 million less than the ceiling. That conclusion at least partly triggered the suspension of C-17 payments.

An internal McDonnell cost performance report, which was obtained by The Times, showed that as of several months ago the firm was reporting that it had spent 91% of its budgeted funds to complete only 70% of the C-17 development work. That would still leave the firm under its $4.9-billion ceiling.

But, during the most recent one-month period, McDonnell spent $110 million to complete development work that was budgeted to cost $47.2 million. By extrapolating from those figures, it is possible to conclude that the firm will overrun its C-17 development ceiling by even more than $500 million, a conclusion that some military officials are already asserting.

During much of this year, McDonnell officials have said they were meeting all of the so-called milestones set down by the Air Force for the C-17 and would complete assembly of the first plane by next month. But some government experts have worried that McDonnell is not fully meeting these milestones.

The Defense Department’s inspector general is investigating allegations that the Air Force approved the design of the C-17’s mission computer, even though the work was not completed.