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Thursday, June 21, 1990 - Page updated at 12:00 AM

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Fast Track -- Certification Scramble Goes On While Mcdonnell Douglas Faces Growing Financial Problems

The Los Angeles Times: Times Staff

LONG BEACH, Calif. - At a scorching test site along a runway in the Sonora Desert, 500 McDonnell Douglas employees are racing to obtain government certification of the new MD-11 jetliner before their company runs out of time and money.

The MD-11 is scheduled to be the first entry in the three-way race for planes in the 350-seat long-range market, and will be used to replace Douglas' aging DC-10s and Lockheed's L-1011s. Airbus Industrie is planning a similar plane, the A330, and Boeing is talking about a 777 to go into service in mid-1995.

The mostly young engineers, technicians and pilots at the desert site outside 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 its success.

Already, the health of the company is in question. Yesterday, the company said it will attempt to cut $700 million from its annual operating costs - a move that could lead to an estimated 10,000 layoffs.

Such cutbacks would come on top of the current plan to lay off 7,000 workers at the Long Beach-based Douglas Aircraft unit, which is losing money and facing a cash squeeze. The new round of layoffs covers all divisions of the company.

In a letter to employees entitled ``The Hard Reality,'' Chairman John McDonnell said that the cost-cutting plan will be implemented by early August and that there will be no severance payments or incentives for employees to quit. He said that the ``layoffs are driven by ongoing unsatisfactory business results.''

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

The company set a goal of certifying the aircraft by Oct. 31 and delivering five of the planes this year, which would earn it $350 million and slow the growth in McDonnell's debt.

``We will obtain certification by then,'' said Joe Ornelas, the 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 St. Louis headquarters, however, executives are exercising somewhat greater 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 Lanese, senior vice president and chief financial officer. Lanese said he thinks the company has a 50 percent chance of getting the MD-11 certified by Oct. 31.

``It is important, but not critical,'' Lanese said. Without MD-11 certification by late this year or early next year, the company's debt would grow by another $1.2 billion over the current $2.6 billion; but with certification on Oct. 31, the debt would increase by just $400 million to $450 million, he said.

The new credit agreement with McDonnell's lending consortium allows the company to increase its debt to a 1992 ceiling of 1.15 times the sum of its shareholder equity, preferred stock and subordinated debt. Current equity is $3.3 billion; the company has no preferred stock or subordinated debt but is likely to issue some in the future.

``If you look at what I'd consider to be a Draconian scenario, (in which) you wouldn't get certification until March, . . . that could require an increase of $1.2 billion in our debt,'' Lanese said. ``We not only can survive the worst-case scenario, we've provided financial flexibility over and above the worst case for us.''

He added that it would have to be ``a very severe problem that would force us into a certification that late.''

To be sure, the company's Douglas Aircraft unit has no shortage

of severe problems. It posted a pretax loss of $222 million on revenues 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.

A massive management reorganization last year, in which more than 5,000 executives were forced to reapply for their jobs, has deeply wounded morale. Moreover, the company has cut its work force sharply, and now further cuts are coming.

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

The company is behind schedule on all of its major aircraft-development programs - the MD-11, C-17 and the Navy's T-45 jet trainer, a workload that is straining its 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. But instead, it is another headache.

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

The extent of Douglas' problems often leads to speculation among workers and observers that McDonnell is one step away from writing off the commercial-aircraft business and shutting down Douglas Aircraft, which employs about 35,000 workers in Southern California.

But in his letter yesterday, John McDonnell said that the company is not considering a restructuring or ``the sale of component companies,'' apparently referring to the persistent rumors that the company will close Douglas Aircraft.

McDonnell told employees in the letter that, in addition to layoffs, the company intends to cut overtime, travel, new hiring, the use of consultants and other support activities.

Aerospace analyst Howard Rubel of C.J. Lawrence, Morgan Grenfell, an investment firm, called the cutbacks ``another missile from John McDonnell,'' but added that the radical step is necessary to improve the company's lackluster financial performance. Rubel said that a successful cost-cutting effort could lift McDonnell Douglas' productivity level to that of Boeing, when measured on the basis of sales per employee.

``They are shucking their paternalistic ways,'' Rubel said. But the new atmosphere is also deeply undercutting morale at the company. One scientist said yesterday: ``The morale is about what you would expect - not too high and those who remain here are under that much more stress.''

A catastrophic shutdown of Douglas, although not impossible if McDonnell were to face an extreme financial crisis, is clearly not what the St. Louis-based parent of Douglas has been preparing for in recent years.

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

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

But its position in commercial aircraft ``has been, for many years, the weaker side of our business,'' said a letter from the chairman to shareholders in the company's recently issued annual report.

In 1989, Douglas' world market share for large commercial jets slipped to less than 20 percent, putting it for the first time behind Airbus Industrie, the European consortium, (measured in terms of the number of seats delivered). Boeing is No. 1, with about 60 percent of the market.

Thus, on one side Douglas faces the Boeing juggernaut, offering a full line of aircraft, a reputation for excellence and a cash hoard of $2.9 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.

Still, even if all turns out well on Douglas' commercial programs, McDonnell Douglas is not out of the woods, financially. The Long Beach operation also is contending with yet another high-risk, multibillion-dollar program in the Air Force's C-17 cargo jet.

Development of the C-17 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 full loss.

That risk is no surprise, but there is another lurking danger.

The Air Force 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. The danger is that the Air Force will conclude that the C-17 production costs have further increased.

For all its risk, the MD-11 program could be a big success. It is a big airplane with a gross takeoff weight of 605,500 pounds and a price of more than $100 million each. Big airplanes can produce big profits.

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

Before any deliveries can be made, the Federal Aviation Administration must determine that the aircraft meets all standards and issue a certificate for the aircraft.

``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.''

Copyright (c) 1990 Seattle Times Company, All Rights Reserved.

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