Pentagon May Tell McDonnell to Pay Back Some Funds

The Pentagon is weighing a decision on whether to demand that McDonnell Douglas pay back some of the money it has received on the C-17 cargo jet program because the firm is said to have done less work than it has been paid to do, key government officials said Thursday.

If the Pentagon demands such a pay-back, which is known in government parlance as a “negative ratio,” it would add to the St. Louis-based aerospace firm’s already-high debt burden.

“The challenges for McDonnell are bigger than people realize,” said Paine Webber analyst Jack Modzelewski. “This company is not going to see the 21st Century if they don’t solve these problems.”

The government stopped paying McDonnell for the C-17 work in July after it concluded that the firm’s cost estimates to complete development of the aircraft were no longer valid. The company at that time was projecting that it would complete development for $300 million under its $4.9-billion cost ceiling.

Since then, the Pentagon has estimated that McDonnell will exceed its cost ceiling for developing the C-17 by as much as $500 million and will exceed its target cost by much more.

McDonnell acknowledged on Wednesday that it would “likely” exceed the cost ceiling, but on Thursday a spokesman said that, after a reevaluation, “As of today, we think we are going to come in under the ceiling (for development).”

McDonnell Vice President Michael Birch said Thursday that he did not have any information about whether the government will demand a pay-back.

“In the strictest sense, they could ask us to pay back money or they could withhold future payments,” he said. “The government will get their money, make no doubt about it.”

Even with that prospect, Birch emphasized that the company “has a solid line of credit” that would carry it through any potential problems.

The government decision to stop paying McDonnell dates back to earlier this year.

“All of a sudden, something went wrong,” a government official said. “That something was last spring when it became clear that the company’s numbers were bad.”

The “bad numbers” eventually translated into the estimate that McDonnell would overrun its contract and, as a corollary, that it would accomplish less work than it was being paid to do.

When a contractor exceeds a cost ceiling on a fixed-price contract such as the one for the C-17, the company rather than the government usually bears the liability. But with C-17 overruns, McDonnell will not bear losses until the combined ceilings of three different contracts are exceeded. The three include one for development and two for production of six aircraft. The combined ceiling is $6.57 billion.

A loss on the development contract could be avoided, for example, if McDonnell completes the two production contracts under budget. Such a prospect is considered unlikely by many experts, given the depth of McDonnell’s problems on the program. The firm’s purchasing system was disapproved by the Air Force earlier this year.