Defense Holds Key To Boeing's 2005, Division Chief Says

Boeing defense chief James Albaugh predicts challenges.

Even as it works to put the scandals of 2004 to rest, aerospace giant Boeing Co. has turned its attention to the mounting challenges for 2005, chief among them slowing defense spending that could hobble the industry's largest programs.

The Chicago-based firm acknowledges that defense spending, which has helped offset losses in its commercial business, will likely begin to slow and that the controversy surrounding its hiring of former Air Force procurement official Darleen A. Druyun, who has admitted giving the firm preferential treatment, will continue to make business more difficult.

Spending on the war in Iraq and a growing budget deficit will soon begin to squeeze funds for large weapons programs, said James F. Albaugh, the head of Boeing's defense unit. "I think we're seeing the knee of the curve. You've got a budget that needs to be balanced, the war, and I think going forward there is going to be certainly a flattening of the budget," Albaugh said in an interview.

The Bush administration appears more determined to contain the deficit than it did during its first term, which would require slowing the growth of defense spending, according to Cai von Rumohr, a defense analyst for SG Cowen & Co. The wars in Iraq and Afghanistan make it impossible for the Pentagon to cut personnel and maintenance budgets, putting expensive weapons programs in doubt, he said.

The budget crunch will put new weapons systems under a microscope, Albaugh said. He noted as an example the now-defunct Comanche helicopter, which the Army canceled because it was no longer deemed essential to modernizing the military. "Programs that are in trouble, I think, will come under a lot of scrutiny and potentially could become bill payers," he said. "So our focus in '05 is to . . . make sure that we don't have programs that are going to come under attack just because of their performance."

Boeing also has spent nearly two years attempting to repair its image after two damaging scandals. First, it admitted that some employees had proprietary Lockheed Martin Corp. documents during a rocket-launch competition in mid-2003. More recently, the company fired its chief financial officer, Michael M. Sears, for illegally hiring Druyun to help run its missile defense business. Druyun, who also was fired from the company, was sentenced to nine months in prison. Boeing has said it was not aware of receiving preferential treatment from Druyun.

Albaugh acknowledged that the Druyun controversy has put pressure on the firm. In several instances, he said, existing contracts are being more heavily scrutinized and other contracts the company would traditionally expect to receive without a competition have not materialized. "Follow-on programs that we might have gotten sole-source, I think will be competed in the future," Albaugh said. "And we're fine with that."

"I think the team has done a good job despite some of the issues that we have within the company," Albaugh said. He cited a few examples of recent Boeing successes: the delivery of the 200th F/A-18 Super Hornet; progress the firm has made on its unmanned combat jet, the X-45; and a surprise victory over Lockheed in a competition for a $4 billion Navy contract to build submarine-hunting aircraft.

Meanwhile, Boeing will also spend the next year trying to salvage an opportunity to sell refueling tankers based on its 767 aircraft to the Air Force after its previous proposal collapsed in the Druyun controversy. Defense Secretary Donald H. Rumsfeld is expected to decide early next year how the Air Force will modernize the aging fleet, but the Pentagon has already announced that Boeing will now face competition for the program. That has raised the possibility that European Aeronautic Defence and Space Co., using an Airbus plane, could emerge with a competing bid.

"We haven't been sitting on our hands over the last several months," Albaugh said. "We have been looking at how we can continue to drive the costs of the tankers down and provide additional capabilities."

And there are questions about the future of the government rocket-launch market Boeing now shares with Lockheed. The Air Force began studying the possibility of eliminating one of the contractors from the market last year after some in Congress questioned the rising costs of rocket launches. And in recent months the Air Force has raised the possibility of Lockheed and Boeing forming a joint venture to manage the rocket launches so that one would not be pushed out of the market entirely, according to industry sources familiar with the discussions.

While Lockheed has said it would "support any discussion of alternative approaches," Boeing has rejected the idea of a joint venture. The Pentagon likely will have to eliminate one of the companies from the market to keep costs down, possibly by the end of the decade, Albaugh said.

"We have invested heavily in the Delta IV rocket and we have met all the requirements of the [rocket-launch] program," he said, adding that he thinks the Boeing rocket would be favored if the military were to rely on just one company.

"We don't have any interest in forming any kind of joint venture with Lockheed Martin."