Lockheed's Rough Ride with Rolls-Royce

LOCKHEED Aircraft Corp., a pioneer in plane building and long the biggest U.S. defense contractor, has gained fame through its Constellation and Electra aircraft, its Polaris and Poseidon missiles, its U-2 spy plane. Rolls-Royce Ltd. has become one of Britain's brightest industrial ornaments by making the most luxurious cars in the world, as well as engines for the Concorde supersonic jet, nearly every plane in the Royal Air Force, and rocket and diesel motors for road, rail and water transport in more than 100 countries. Last week those two storied giants threatened to push each other into a spectacular transatlantic financial collapse. Their plight was the result of inflation, management errors, soaring ambitions that were frustrated and the difficulties of taming a technology that is growing increasingly complex and costly.

The agent of trouble was that symbol of technology, the jet engine. In 1968 Rolls-Royce won an international competition to build the engines for the Lockheed L-1011 airbus, a 256-pas-senger trijet that is supposed to start flying for TWA and Eastern late this fall. Britons had hailed the contract award as a triumph of export salesmanship by Rolls, but it proved instead to be ruinous. Rolls agreed to deliver 540 engines for the "TriStar" at a fixed price of $156 million; by last November it had concluded that the cost of building them would be more than twice that. It asked the British government for help and got some loans, but not enough. Last week Rolls declared itself virtually broke and estimated that losses on the contract could exceed its entire tangible net worth of $456 million. After a series of emergency Cabinet meetings at 10 Downing Street, the British government decided to let shareholders appoint a receiver for Rolls. To its extreme embarrassment, the Tory government intends to introduce legislation this week that would nationalize all of Rolls except the auto and oil-engine divisions. Production of the cars will continue, though possibly under a change of ownership; Britain's Jensen Motors Ltd. is likely to bid to buy the profitable car division. A U.S. Cabinet member told TIME that the nationalized Rolls-Royce would continue building engines for Lockheed. But British officials declared emphatically that a state-run Rolls would make no more jet engines under the "impossible" Lockheed contract (Lockheed so far has received only 13). These officials said that the possibility of satisfactorily renegotiating the contract was only "a long shot."

Lockheed Chairman Daniel Haughton pronounced himself "completely surprised and appalled." Well might he be; Lockheed, too, is in precarious financial shape, and had been counting mightily on the L-1011 to help it recover from a series of staggering losses on military contracts. That will hardly be possible if the airbus becomes a plane without engines.

Losing Winner. The engine crisis climaxed a week in which Lockheed set a corporate speed record for careening between dangers. Only 72 hours before the Rolls debacle. Lockheed had escaped a threat of bankruptcy by settling an old contract dispute with the Pentagon--at the price of agreeing to take a $240 million loss on the C-5A cargo planes that it is building for the Air Force. The settlement came only a month before Lockheed was due to run out of the money needed to keep its military production lines going.

Ironically, Lockheed fell into the spin by "winning" the same sort of fixed-price pact that it later offered to Rolls-Royce. In 1965, it outbid Boeing and Douglas Aircraft (now part of McDonnell Douglas) for the contract to build the C-5A, the world's largest plane. The award was the first under a Pentagon policy, since abandoned, called "total package procurement" (TPP). It called for a manufacturer to do all the research, development and production for a major project at a price that could not exceed a certain ceiling. The idea was to reward the contractor who kept costs down by allowing him a large profit, and penalize the inefficient contractor by making him take a loss. The complex contracts also had clauses that were supposed to guard against windfall profits or catastrophic losses.

Lockheed agreed to produce up to 115 C-5As for a ceiling price of $2.3 billion. That turned out to be a severe miscalculation. The Viet Nam War increased demands on the aerospace industry so much that Lockheed had difficulty getting parts from suppliers. Inflation raised the price of everything. Lockheed found that in order to keep the plane's weight within Air Force requirements it had to use costly stainless steel, titanium and beryllium in place of cheaper plain steel and aluminum. Its planners also had overlooked such details as the fact that the C-5A's tail is six stories tall, and workers use up many costly man-hours just climbing down to the bathrooms. The plane turned out to be a technological triumph but a financial fiasco. In the mid-1960s Lockheed had been flying high, with three straight years of profits over $50 million, but by early 1970 Chairman Haughton informed the Pentagon that C-5A costs were busting Lockheed. His pleas for relief touched off a long dispute about who should pay how much of the cost overruns.

Deputy Defense Secretary David Packard last month offered Lockheed two choices: accept a fixed loss of $200 million, or fight the matter out in the courts. Haughton first chose to fight, expecting that Lockheed meanwhile would keep getting production money from the Pentagon; Congress had voted $200 million to keep Lockheed running. Two weeks ago, Packard withdrew the offer and delivered a virtual ultimatum. He notified Haughton that the Pentagon could find "no precedent" for making any payments on a contract under litigation. If the dispute dragged on, that meant a cutoff of Washington money --and bankruptcy for Lockheed.

Last week Haughton capitulated. Lockheed and the Pentagon expect to sign a renegotiated contract that will be a cost-plus deal--or really cost-minus. Essentially, the Government will pay Lockheed whatever is needed to complete production of 81 planes (current estimate is $3.7 billion). In return, Lockheed will refund $200 million, accepting that as a fixed loss. Lockheed has already written off $100 million of that as production costs for which it will not be reimbursed; it will pay the second $100 million in annual installments of $10 million, or 10% of pretax profits, whichever is greater, beginning in 1974. In addition, Lockheed will have to swallow "unallowed" costs, such as interest on funds that it borrowed to keep C-5A production going. The company estimates these costs at $40 million.

The C-5A deal will bring to $480 million Lockheed's total loss on four defense projects. The other three are the Cheyenne helicopter, the SRAM air-to-ground missile and nine Navy ship contracts. Lockheed had posted profits of $10.3 million for the first nine months of 1970 but will wind up reporting a full-year deficit of $80 million on sales of about $2 billion.

Continuing Cliffhanger. Despite the huge losses, Lockheed at midweek appeared to have escaped with a whole skin. For one thing, it expected to conclude within a month an agreement to borrow $600 million from 24 banks and three airlines to finance production of the L-1011 airbus. The banks had been holding up the credit to see how Lockheed made out in its negotiations with the Pentagon. Then the Rolls-Royce collapse turned everything upside down again.

Conceivably, Lockheed could buy engines for the L-1011 from either General Electric or Pratt & Whitney. But redesigning the plane for a different engine would cost so much time and money that Lockheed might be conceding an insurmountable competitive lead to McDonnell Douglas, maker of the DC-10 airbus. Eastern Air Lines announced last week that it is "exploring other options" to the L-1011; they include making fuller use of present equipment or buying DC-10s instead of the Lockheed TriStar. Moreover, Lockheed's bankers will hardly be eager to finance the L-1011 until the company can find some engines to put in the plane.

The Nixon Administration decided months ago that it could not permit a Lockheed bankruptcy. Such a failure would shake the company's 55,000 shareholders and 85,000 employees, its bankers, thousands of subcontractors that supply Lockheed and the economies of California and Georgia, where Lockheed production is concentrated. Washington will hardly be in a mood to let the British government force that disaster by reneging on the engine contract --and the U.S. does not lack clout in negotiating with London. For Lockheed and the governments of two old allies, the story promises to be a cliffhanger for months.

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