Navy unhappy with LCS bids, wants cost cap raised

WASHINGTON (Reuters) - The U.S. Navy is unhappy with the bids submitted by Lockheed Martin Corp (LMT.N) and General Dynamics Corp (GD.N) for three more shore-hugging warships and will ask both companies to go back and provide more information, said sources briefed about the Navy's plans.

At the same time, the Navy also is talking with lawmakers about modifying a $460 million cost cap imposed by Congress for new Littoral Combat Ships purchased in fiscal 2008 or later, said the sources, who asked not to be identified.

Some Navy officials have suggested in the past that the cap should be raised to as high as $560 million, said one congressional aide, who asked not to be named.

Industry officials say inflationary pressures, including a 21 percent rise in steel prices, mean the cap will eventually have to be changed.

The new price compares to the initial projections of $220 million per ship, a figure Navy Secretary Donald Winter now says was unrealistic from the start.

"There's a limit to what we can expect in terms of low cost ships," he said in an interview last week. He said the Navy could not reasonably expect to buy a warship for the cost of a fast coastal ferry.

Asked if the cost cap would have to be raised, he said, "I don't know yet. We're working through that matter right now."

The Navy confirmed its officials have been meeting with lawmakers to "discuss the details and implications of the LCS cost cap," but declined to give any details.

"The Navy remains committed to effective cost control and has modified contracting strategies and management practices to provide program stability for this important new class of warship," said Navy spokesman Lt. Cmdr. Victor Chen.

Congressional aides said lawmakers were deeply skeptical about the Navy's latest stance on the cost cap, which was written into law with strong guidance from the Navy last year.

Last month, the Navy drew criticism when it first announced a plan to end the DDG-1000 destroyer program after two ships, then reversed course two weeks later and said it would build three DDG-1000 destroyers. General Dynamics and Northrop Grumman Corp (NOC.N) are the contractors for the destroyers.

"The Navy has lost credibility," said one aide. "There is a continued perception that the Navy can't make up its mind."

But the aide added, "I think Congress would agree with the Navy that the bids the companies submitted are unacceptable."

In order to meet the cost cap, both companies removed items from the ships, including a gun and a fire-suppression system, a move that has clearly troubled Navy officials and lawmakers.

A spokeswoman for Rep. Roscoe Bartlett, said Bartlett supported a move by the House of Representatives to adjust the cost cap for inflation -- up to a maximum of $10 million this year -- a move not matched by the Senate thus far.

But Bartlett was still waiting for more information from the Navy so he could "adequately consider the short-term and long-term issues about LCS," said spokeswoman Lisa Wright.

Chen said the Navy planned to brief Bartlett on Friday.

The Navy had planned to award new LCS contracts -- two ships to the winning bidder and one to the other -- by early August, but officials are tight-lipped about any award date.

Winter stressed that the Navy still plans to buy 55 of the new ships, even though the cost of the first ships has more than doubled to around $500 million each from the early projections. He said officials are continuing to do all they can to drive future costs down.

Industry executives, citing inflation and other factors that drove up the cost of the first ships, say it will be hard for either company to build the next few ships for less than $460 million, especially under a fixed price contract.

Lawmakers mandated fixed price contracts for the next LCS ships after the cost of the first two ships more than doubled, but congressional aides say that move was supported by Winter.

Ironically, a former Senate staffer Sean Stackley involved in drafting the legislation has since been appointed the Navy's top acquisition chief, and he is now the Navy's point man in the latest talks about raising the cost cap.

A fixed price deal would make the companies bear the burden of cost increases, but industry executives -- still smarting from requirements changes imposed by the Navy after the start of work on the first ships -- are wary of further changes.

Companies typically add cost to cover potential risks they face when offering pricing for fixed price contracts.

Both companies refused to accept fixed price terms when the Navy tried to renegotiate its contracts for the second ships each of the companies was due to build, ultimately resulting in the Navy's decision to cancel those contracts.

"They were unable to come to agreement because the Navy's expectations went far beyond what the contractors felt they could prudently offer," said defense analyst Loren Thompson of the Virginia-based Lexington Institute.

The companies only reluctantly submitted fixed price bids when the Navy launched a new competition for three ships -- one in fiscal 2008 and two in fiscal 2009 -- this spring.

Fred Moosally, who heads Lockheed's ship systems, last month said inflationary pressures, including a 21 percent rise in steel prices, would make it tough to meet the cost cap.

(Reporting by Andrea Shalal-Esa; editing by Carol Bishopric)