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Boeing Acts Fast To Repair Damage

By | August 4, 2003

      With the worldwide launch business slumping, Boeing [NYSE: BA] is scrambling to defuse the crisis over a scandal that could cost the company $1 billion and already has resulted in its suspension from future bidding on Evolved Expendable Launch Vehicle (EELV) contracts.

      The aerospace giant needs to take action to convince U.S. Air Force officials to remove the suspension as soon as possible. Boeing admitted last month that several of its employees used thousands of pages of documents from Lockheed Martin [NYSE: LMT] during the 1998 bidding for EELV contracts, which resulted in Boeing winning most of them. The Chicago-based company’s first steps to repair the damage were to dismiss the employees who were responsible and to hold a four-hour training program in ethics for all 75,000 of its workers during a company-wide stand-down.

      The Air Force’s EELV space-lift modernization program aimed at improving space-launch capability and standardization is a critical source of potential business for Boeing and its recently developed Delta IV rocket. The Air Force will not lift the suspension until Boeing takes corrective actions to ensure it once again is operating its business units responsibly.

      The Air Force will give Boeing a chance to clean house and restore its eligibility to bid on contracts as quickly as the next 60 to 90 days. With up to 20 launches on the line during the next round of EELV bidding, Boeing could gain or lose billions of dollars in potential launch contracts, depending on how the Air Force views the company’s actions.

      On July 24, the Air Force revoked the award of seven launches previously given to Boeing and reassigned them to Lockheed Martin. One of those launches is scheduled for late 2005, two each in 2006 and 2007, and one each in 2008 and 2009.

      Three additional launches in 2005 that the Air Force had not previously awarded to Boeing also were assigned to Lockheed Martin.

      The exact size of the unexpected windfall to Lockheed Martin is unclear. “We are still in negotiation with the Air Force,” said Jeff Adams, director of news and information at Lockheed Martin. “None of the 10 launches are priced orders yet.”

      If Boeing immediately puts in place corrective actions that include training of employees, setting up an employee hotline, and reforms at the affected business units, the suspension could be lifted well in advance of an upcoming third round of EELV bidding, according to Air Force Undersecretary Peter Teets.

      West Coast Launches

      The Air Force imposed a further penalty on Boeing by eliminating its exclusive rights to launch from the West Coast. Lockheed Martin now will be allowed to develop a launch site at Vandenberg Air Force Base in California.

      The change will provide a second launch service capability on the West Coast for assured access to space, said Teets, who was president and COO of Lockheed Martin between 1997 and 1999. Lockheed Martin is responsible for financing the estimated $200 million cost of upgrading the current Atlas IIAS capability to handle an Atlas V, while the Air Force will assume its standard role of leasing the facilities from the company, he added.

      The Air Force has a vested interest in allowing Boeing to regain its status as one of only two U.S. EELV providers as soon as possible. It is necessary for the U.S. government to have two healthy families of launch vehicles.

      “One of my highest priorities is to make certain that we have assured access to space for these vitally important spacecraft that we are launching on a regular basis,” Teets said. “I would like very much to see a successful business going forward in government contracting for both Boeing and Lockheed Martin with their Delta and Atlas families of vehicles,” he added. “I’d like to see healthy competition.”

      Teets also recognizes that the fallout from weak demand in the commercial satellite marketplace will push up the launch price for government missions. The fixed costs incurred by the companies to provide launch services now will be spread over a smaller number of missions that will push prices higher than originally expected.

      “The original set of EELV launch prices were established at a time when both companies were planning on a very strong commercial marketplace, which would allow unit reductions in price,” Teets said. “Now the realities have changed. That market is not robust and there’s very little success in the commercial marketplace. So the only answer, in order to have a successful business going forward, is to have higher prices.”

      Lockheed Martin officials could not assess the financial impact of the Air Force’s decision to assign 10 additional launches to the company since the business model and pricing for those missions remain unsettled.

      The EELV launches stripped from Boeing were not factored into the $1.1 billion charge the company took last month to cover weaknesses in its commercial launch business, higher mission and launch costs for its Delta IV program, and cost increases at its satellite manufacturing business. Those costs also included the development of a new rocket engine for Delta IV and construction of a rocket manufacturing facility in Decatur, Ala.

      Prudential Securities analysts concluded in a July 24 research note that Lockheed Martin would see an immediate positive impact on its Space Systems unit from the changes to its long-term launch manifest and near-term launch schedule.

      Lockheed Martin’s interest in building a West Coast launch facility suggests it expects to win “significantly more launches,” the Prudential analysts concluded.

      Ethics Training

      Boeing official Walt Rice said he was one of the roughly 75,000 employees of St. Louis-based Boeing Integrated Defense System who participated in four hours of ethics training July 30. Employees unable to attend the training that day will be offered opportunities for a make-up session to ensure 100 percent participation, he added.

      Work stopped as Boeing employees around the world took part in a four-hour course that emphasized the company’s commitment to the highest ethical standards, Rice said. Members of Boeing’s Phantom Works, Shared Services Group and the entire Boeing Washington DC Operations staff participated in the course, as well.

      The training extended to the workforce of the Boeing-led Sea Launch joint venture, including dozens of employees at sea on board a launch platform.

      In addition, Boeing is having former Sen. Warren Rudman review its company-wide ethics program and procurement integrity program. Sen. Rudman is a partner in the Washington, D.C., office of the law firm of Paul, Weiss, Rifkind, Wharton & Garrison and former chairman of the Senate Ethics Committee. He also was a member of the Conference Board’s Commission on Public Trust and Private Enterprise that recommended significant reforms related to corporate governance, business ethics, and auditing and accounting issues.

      Boeing officials said they hoped that the former senator would be able to complete his review in 60-90 days. The Rudman review will look at management or cultural factors that could affect how Boeing’s policies and procedures are enforced.

      Teets expressed his “sincere hope” that Boeing would move quickly to take meaningful corrective actions to allow him to lift the suspension and allow the company to participate in the EELV bidding process.

      Probe’s Findings

      The Air Force General Counsel’s Office and the Space and Missile Systems Center reviewed thousands of documents and concluded that Boeing committed serious and substantial violations of federal law. The Air Force concluded that the amount of Lockheed Martin’s proprietary material in Boeing’s possession at the time of the EELV bidding process was extraordinary – totaling approximately 25,000 pages. The information provided critical insights into Lockheed Martin’s proprietary cost and pricing.

      As a result, the Air Force suspended three Boeing Integrated Defense Systems business units and three former Boeing employees from eligibility to bid on new government EELV contracts.

      “We have found that the problem existed within these three Boeing units and that it was contained therein,” Teets said. “On the other hand, I do need to give all due recognition to the fact that there is a Department of Justice criminal investigation going on right now, and that could reveal, under oath or under deposition, facts that we didn’t have available to us.”

      On July 22, Boeing revamped its corporate structure and placed the operations that were suspended from Air Force EELV mission bidding under Boeing Air Force Systems. Will Trafton, vice president and general manager of Boeing Expendable Launch Systems, will continue to lead the launch business and now reports to George Muellner, senior vice president of Air Force Systems (See SN, July 28).

      The individuals suspended from Air Force contract bidding are William David Erskine, a former ground operations lead on Boeing’s EELV program; Kenneth Branch, former senior engineer-scientist on Boeing’s EELV program; and Larry Dean Satchell, a former member of Boeing’s EELV proposal team. Erskine and Branch were terminated, while Satchell was reprimanded and subsequently retired, company officials said.

      “There is no doubt that our standards of behavior were violated; that is unacceptable,” said Boeing CEO Phil Condit. Boeing’s Integrated Defense Systems unit is one of the world’s largest space and defense businesses with $25 billion in annual revenues.

      Lingering Litigation

      Meanwhile, Lockheed Martin is continuing its lawsuit against Boeing for ethical breaches conducted in the EELV bidding process. With a “clear responsibility to our customers and our shareholders,” Lockheed Martin is forging ahead with its litigation to ensure it is compensated for the full extent of its damages, Adams said.

      “As a result of Boeing’s conduct, our ability to actively and effectively compete in the medium-, intermediate- and heavy-lift space launch market was impaired,” Adams said. “We are seeking to address that impairment to ensure that necessary corrective actions are taken to prevent a recurrence of future document issues.”

      The Air Force investigation concluded Boeing violated the Procurement Integrity Act, which was passed by Congress to ensure that the bidding for U.S. contracts takes place in a fair and ethical manner, Adams noted.

      –Paul Dykewicz

      (Peter Teets, Major Angela Billings, U.S. Air Force, 703/695-0640; Jeff Adams, Lockheed Martin, 301/897-6308; Dan Beck, Walt Rice, Boeing, 314/234-2149; Rory Cohen, Teofilo Bacungan, Prudential Securities, 212/778-8272)

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