Critics worry R&D cuts will hamper ability to catch Airbus. Veteran aerospace analyst Ron Epstein joins Aviation Week’s Guy Norris to discuss.

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Below is a rush transcript of Aviation Week’s January 14, 2021, Check 6 podcast.

Joseph Anselmo:        Welcome to this week's Check Six podcast. I'm Joe Anselmo, editorial director for the Aviation Week Network. With Boeing's commercial aircraft deliveries down about 90% last year, from their peak, the company is scrambling to conserve cash. Last week, Boeing announced plans to close its Advanced Developmental Composites Facility, a manufacturing R&D Center in the Seattle area.

                                    The move raises two questions. One, is Boeing in danger of shortchanging R&D investments that will be critical to the company's future competitiveness?

                                    And two, is this another sign that Boeing is slowly pulling its commercial operations out of the Seattle area, as evidenced by its decision last fall to consolidate assembly of 787 in South Carolina?

                                    Joining me to discuss this, is Aviation Week, Senior Editor Guy Norris, who has covered Boeing for decades. And we have a special guest today. Ron Epstein, Managing Director for Aerospace and Defense at Bank of America.

 Welcome Ron, let's start with you. I want to quote from a research note that your team put out last week. You wrote, "The closure of the ADC without any discussions is a yellow flag. We remain highly concerned about Boeing's commitment to R&D in general, unless the company wants to concede more market share to Airbus. Boeing must continue to innovate and prepare for the next civil aviation up cycle." So tell us what's behind that thinking.

Ron Epstein:               So a couple points, Joe. One, as you know, we've been talking about what airplane Boeing could do next. And given the pullback on the NMA aircraft that we were maybe hoping they'd do a year or so ago, it's a worrying trend that given the financial pressure on the company, that they're retrenching from a lot of things, in particular R&D. So when you see a facility like the ADC get closed, which was, I don't know, a hot point for innovation. A lot of the innovation that went on 787 was done there. The innovation on the wings of the new 777X, a lot of that was done there. And my understanding is, a facility where you could go experiment, you could play, you could do things in a low-risk environment where you didn't have to make a huge investment. I find that as a worrisome trend, particularly at a time when the company is under pressure.

                                   You tend to see when things get tough, companies think about R&D spending as discretionary. I take a counter view, R&D spending is not discretionary. It's a required thing for the future of our business. And particularly in aerospace, where you do have tough competitors and an existing tough competitor in Europe with Airbus, and potentially emerging competitors in places like China, you need to keep focused on it.

Joseph Anselmo:        Okay. But the reality is, they don't have any cash right now around with deliveries down so much. As the MAX deliveries start to spool back up and their cash flow improves, will that provide them with a little more leeway to increase R&D?

Ron Epstein:              Yeah. I mean, of course it will, but I guess I take issue on, they don't have cash right now. They have a big balance sheet. They have a big defense business, and this is a time where you kind of have to swallow hard a little bit, maybe take on a little more debt than you want and work through it. There's many other companies that have worked through instances where their balance sheet and macro situation was much worse. I mean, what comes to mind is if you just go back when Embraer originally brought the [ERJ] 145 to market, they were a recently privatized government-owned company. And they had many things going against them. They brought that aircraft to market. So I think it's a willingness to commit to what you do and going forward with it.

Joseph Anselmo:        Okay. Guy Norris, following things, this closing of the R&D Center has maybe been a little bit overblown in the press. You've spoken with them this week. What are they saying?

Guy Norris:                 Yeah. Thanks, Joe. Basically it looks like the streamlining process that's going on at Puget Sound is essentially bringing down a lot of the overhead, the facilities, and that some of this has been misinterpreted really, perhaps overblown as we saying, in terms of what this means for Boeing's overall research and development strategy. And perhaps sort of indications where there aren't many of a slow down or a sort of a retraction, in some of this, in the scale of their R&D.

                                   So just to put it in perspective, there's no doubt about it because of the situation, Boeing has obviously cut back on R&D. It had to, as part of its survival plan at the moment. I think at the moment, the end of September, which was the last real figures we heard, they were looking at they'd spend about half a billion dollars in R&D. Which represented a 26% decline on the previous year.

                                   So there's no doubt that's happening, but whether this particular aspect is part of that or not, they're basically saying, "No." The ADCC is a part of a bigger building, the Developmental Center, which was opened in the '60s for the Boeing Supersonic Program. It's been a vital part of Boeing's sort of incubation for new technologies, particularly as Ron mentioned, the 787 Program, which it played a vital part in helping develop the one piece composite barrel system.

                                    It's also continues to be used by their defense side a lot, the B-2 wing, the F-22 wing, all of that stuff was done in the contained kind of almost classified environment, which is possible in this almost windowless facility. So the fact that they're moving out of the smaller units and dispersing it to, two other existing composites, developmental centers within the Puget Sound area, shouldn't be taken necessarily as a sign of further attraction in this area.

                                    And it did affect, obviously, the jobs of around 30 people, I believe. So it's another, sort of, indication of the head count reductions that they're going through. But the work itself will be continuing and be federated out to other sites around Puget Sound.

Joseph Anselmo:        Ron, in your research note -- And I should correct myself. I said, it was last week. It was actually early this week it was put out – but one other concern raised in that note was just, a loss of expertise from that workforce in the Seattle area that has roots going back 105 years. You want to talk about that?

Ron Epstein:               Yeah, so like I mentioned, it could be an impact of 30 jobs. My understanding is, in the Research Facilities itself it had less than 100 people doing work. So when you think about losing 30 heads out of that business, if indeed that's where they're coming from, or that business unit, that's a significant cut. What worries me is there is value in having a central research function, particularly around more forward leaning progressive research on manufacturing and composites, whatever you want to do. So I do find it a yellow flag that they're doing this, and that's worrisome.

                                    And like I said earlier, R&D is not discretionary, particularly for an airplane company in global competition. It's part of the cost of doing business. And you have to push through because the cycle will turn and you want to be there for that. So, anyway, that's where I stand on that…. It's also worrisome when you lose people that have been in a facility potentially for generations. It's intellectual capital that's in many cases, not written in books that it's hard to transfer. A lot of it gets transferred in an apprentice type relationship. So you worry that those skillsets got lost.

                                   Just as a quick aside, my first role in industry, I was at McDonald Douglas and I hired into their business [when] we were in the midst of a defense downturn, and a lot of the key skillsets had left the business.

                                   And a lot of that doesn't get documented. So when you get into these downturns and you lose that intellectual, a capital that's stored in this, in people's heads, it's very worrisome.

Joseph Anselmo:        From the investor point of view, Ron, Guy and I saw you at the SpeedNews Suppliers Conference back in March, in California, the last time I was anywhere in person. And back then you were talking about then investors would probably react negatively if Boeing launched the new market airplane that's since shelved, the NMA. That's changed since then, hasn't it? The investor sentiment.

Ron Epstein:              Yeah. I would say, the rule of thumb always has been that, you probably don't want to own the shares of any airplane company when they launch new airplane because that brings a lot of risk along with it. And obviously we've seen that truckloads of that with both the development of 787 and then more recently with everything that happened with 737 MAX. But we've done some informal survey work with the investment community. And I think there's broader recognition that the time has come where Boeing does have to do something to remain competitive with their key competitor.

                                    In the narrowbody market it's not lost on anybody, that the share shift from Boeing to Airbus, particularly in the segment of larger narrow body aircraft

Guy Norris                  I think it's interesting that what I'm seeing is the divergence between the investor kind of opinion, or at least investor wishes, and what Boeing themselves has sort of seem to be signaling to us.

                                   There's a lot of feeling within the Seattle area that, thank goodness, NMA wasn't pushed out and launched. Thank goodness they decided even before the pandemic to rethink the whole idea. They're really sort of imagining a world in which having committed to that program, and begun this suddenly the whole industry is bogged down in this disaster that's happening at the moment.

                                    So I think it's a very interesting dichotomy in there. You have that sort of aspirations and where the investment world would like things to go. And maybe the grim reality of what Boeing seems to be going through in the commercial world at the moment. One of the things that really backs that up in a way is, I just listened earlier today to Chris Raymond, who's the Chief Sustainability Officer at Boeing. He's the first guy ever to hold that position I suppose. It's a new role at Boeing.

                                    But one of the things he really did imply at least, was that, when you're looking forward to what Boeing is looking at for its product development strategy, he gave a very clear message that the way they see things going for the next, certainly the first few years of this decade is, they're going to really focus on the use of sustainable aviation fuel, for example, to help meet that kind of the goal of keeping the sort of environmental footprint, sustainable growth going. Rather than accelerate or push forward with the development of a next generation product.

                                    And he said that with the enormous backlog that they've currently got, even not withstanding the losses they've had on the Max backlog, and the slower production rates, which will be required over the next two years, as the industry gets back on its feet. That's going to stretch out that backlog to the point at which it would have been the time when they would have normally been rolling in new products. Now they've got an additional two year sort of barrier buffer, and I think that's going to play into their decision-making when they strategize on when to launch and what to launch.

                                   So I know it was just observations that I'm kind of getting here from various parts of the Boeing's side of it.

Ron Epstein:               I would say this, I think that's unfortunate, short term, maybe short-medium term view. Ultimately you're bringing a product to market and it'll be in the market for hopefully 30 years or so. And the decisions they make now can have big implications on how things play out hopefully, and it seems realistically. This will all be behind us in maybe a year or two, maybe better than that, depending on I think there's really no exact consensus on how things come back. But for sure, for all the reasons we traveled before we'll travel again.

                                    So I think you have to, as a company, be aware of that and you want to have the products to bring to market. The sustainable aviation fuel angle with, for sure that's great. I mean, that's something that the industry should be looking at, but the hardware side of it, it's also incredibly important too.

Guy Norris:                 Can I just say, and Ron, you raise a really important point, but the fact that whatever they're doing now is going to be vital for the next 30 years essentially. And what Boeing is also facing here is two, sort of, factors, which they've never really had to deal with before. One is, like Airbus, they're wondering what the heck the market is going to be like coming out of this because although people will have to travel again and we will see huge... The recovery, will it be the same in terms of the business world? Does business travel ever come back to the levels at which it was before with the development of virtual, like we're using now, like Teams and Zoom and so forth? There's been a sea change there, but will it ever come back? How long, and what form of recovery will it be?

                                    The other thing that's not really ever happened before is, in the early 2020s, now, there's a massive range of new technologies out there, which will fundamentally affect a lot of the decisions going on when it comes to product development strategy. I'm talking about the emergence of pro chiefly and propulsion hybrid electric systems. The potential for hydrogen as a fuel or a different fuel economy. There's materials systems propulsion, and fuel energy technologies there, the likes of which we've not been offered before.

                                   So knowing where all of these technologies will take us and how much they will drive into the baseline architecture of new air transport options. It's a smorgasbord and nobody really knows yet a lot of the answers on this. It's early days, but it's happening so quickly that I think it will ultimately affect the way that they make their product line decisions. Not necessarily for this immediate generation, but whatever they do, they realize they're going to have like an open type design. That's going to be adaptable to whatever technology comes in. And I think that's a complication to today's equation, which wasn't there before. So that might be another reason why whatever comes next, it's going to be a longer term decision and it's going to have to be considered really carefully.

Ron Epstein:               But to that point I would argue with [if] you're waiting for, hybrid electric or hydrogen propulsion on the scale that you'd need for a large commercial airplane, you're going to be waiting a long time. You're 100% right. That you have this smorgasbord of new technologies that are becoming available, but it seems the first place they're going to be applied, and applied meaningfully materially, will be on much smaller aircraft. And the one complication, I think that they have to deal with it. I would add to your list of two. And this in my view is a very important one. Ultimately, the pandemic has been the great amplifier. If you went into the pandemic strong, you came out stronger. If you went into pandemic weak, you came out weaker.

                                    And given the situation with the 737 MAX, Boeing vis-a-vis Airbus going into the pandemic, they were the weaker of the two. And I think what you're seeing coming out the other side here, Airbus is coming out relatively stronger and Boeing's coming out relatively weaker. Which to me begs the point that Boeing has to make these decisions and be forward looking, and make these moves and defend their turf.

Joseph Anselmo:        Ron, you've closely followed the rise of Embraer over the last 25 years. And I think people forget in the late 1990s, Bombardier owned the regional jet sector. And then they took a pause. And then when they ran into some financial difficulties, they shelved the BRJ-X, and they allowed Embraer to leapfrog them and never recovered from it. I'm not saying that Airbus, is going to leapfrog Boeing because it's already ahead of Boeing, but is Boeing in danger of permanently losing its lead to Airbus?

Ron Epstein:               I think it's premature to say that now. There are still things that have to play out in just going back in history. When you look at the Bombardier, Embraer situation, Bombardier shelled the BRJ-X and made a big adjustment [with] Trans, which was a big train business. They made a big strategic move into a different angle. Clearly Boeing's not doing that, but you do worry in their product development pipeline, if they don't address what's going on in the narrowbody market, that might be not recoverable, at least not for a very, very long time.

Joseph Anselmo:        Guy, we'll give you the final word.

Guy Norris:                 Well, I think that obviously it's a very strange time for the entire industry, but for Boeing in particular, and I agree with what Ron was saying in terms of it's too early to call it yet. And also to his point earlier about the March of technology. There is obviously going to be areas where yes, it's a complicated picture, but there's areas where this new technology isn't going to be a factor in the larger airplanes that Boeing plays in.

                                   But the thing we also ought to remember is that, Boeing's trump card generally has been its ability to cover the market with a broader array of wide body twin aisle products, which Airbus  has been able to really match it to any great extent. That's changing a little with the success of the A-350. Of course, they've got the A-380 now behind them, but I think going forward a lot of what we're seeing, will depend on the recovery of the international market, and the demand that we're going to see out of that market going forward.

                                    Whether Boeing addresses that first, or really looks to the singl- aisle replacement market, which I think is what the market really wants, then it's going to be in the core, but either way, we still don't know. And it's too early to tell.

Joseph Anselmo:        Well, we'll certainly have a lot more to discuss as the year goes on. Ron Epstein, always great to see you -- or hear you in this case. Thank you so much for taking the time to talk with our listeners. Guy Norris, thanks to you as well. And special thanks to our producer in Washington, D.C, Donna Thomas. That's a wrap for this week's Check 6, which now available for download on iTunes, Stitcher, Google play, and Spotify. If you like what you've heard, give us a positive review. We appreciate your feedback. Thanks for your time and stay safe.