UPDATE 1-Lockheed offers warranty for missile interceptor

* Interceptor deliveries have been delayed

* Holdup hinges on subcontractor’s safety switch

* Production is “badly needed” - U.S. general (Adds Lockheed, O’Reilly comments, airborne laser test)

WASHINGTON, Aug 17 (Reuters) - Lockheed Martin Corp LMT.N offered to assume additional liability to start production of part of the multibillion dollar U.S. shield against ballistic missiles, the head of the U.S. Missile Defense Agency said on Tuesday.

Army Lieutenant General Patrick O’Reilly told reporters he thought it was fair for Lockheed to take financial responsibility for costs related to any further production delays involving interceptor missiles for its Terminal High Altitude Area Defense, or THAAD.

“So I’m very open to do that with Lockheed,” O’Reilly told a defense writers’ breakfast, adding that the interceptor production was “badly needed.”

Lockheed’s initiative would come amid stepped-up efforts by Defense Secretary Robert Gates to get more bang for the Pentagon’s buck. Gates is seeking to free more than $100 billion in overhead savings over five years to invest in forces in the field and modernizing their kit.

O’Reilly said the Missile Defense Agency was eyeing potential competitive bids worth as much as $37 billion over the next five years as it moves away from sole-source contracts.

Contractors are already jockeying for a potential $600 million annual contract to continue development and sustainment of the sole long-range missile defense, known as ground-based midcourse, or GMD.

A $419 million THAAD production contract has been withheld from Lockheed because a part made by a subcontractor has yet to pass all qualification tests. The piece is a safety device manufactured by Moog Inc MOGa.N called an optical block switch. It is designed to prevent accidental missile launch, said Richard Lehner, an agency spokesman.

O’Reilly said Lockheed, the Pentagon’s No. 1 supplier by sales, had offered to assume liability for any stop-and-restart production line costs pending completion of the switch’s qualification, expected in February.

Lockheed, the THAAD program’s prime contractor, said it was confident that it had a solution in place that would clear the way for a production go-ahead next month.

“We have taken responsibility for delivering the successful optical block switch solution as promised,” Cheryl Amerine, a company spokeswoman, said in an email to Reuters. She did not respond to questions about the company’s increased risk.

Lockheed anticipates that delivery of its interceptors for the first THAAD battery will start in the fourth quarter of this calendar year, Amerine said.

O’Reilly said he had personally discussed the holdup with officials of the United Arab Emirates, which is seeking THAAD systems worth as much as $7 billion through a government-to-government sale and which would be the system’s first overseas customer.

THAAD operates alongside other elements of the emerging missile shield, which the United States has said is designed to thwart attacks that could be launched by countries like Iran and North Korea.

THAAD interceptor deliveries originally were supposed to have begun in March. The first ground units were delivered to the U.S. Army about 18 months ago. They have been through extensive tests and are in “very good position to be ready to deploy” except for the interceptors, O’Reilly said.

The delayed production contract would cover 26 interceptors and a third and fourth THAAD batteries, using funds appropriated by Congress for this fiscal year. It also would include an option for another 22 interceptors using fiscal 2011 funds, Lehner said.

A spokeswoman for East Aurora, New York-based Moog, Ann Luhr, said her company was barred by contract from commenting on its programs as a subcontractor.

On another subject, O'Reilly said the Missile Defense Agency had concluded that an experimental airborne laser aboard a modified Boeing Co BA.N 747 had twice the range originally expected.

The chemical oxygen iodine laser is to be tested again early Wednesday at a California range after two delays, first tied to a problem with a target missile, then to a glitch in the targeting system’s software, O’Reilly said.

The goal is to shoot down a target more than 100 miles away, twice the range demonstrated in a Feb. 11 test, and it may even have greater range than that, he said.

Last year, Gates reduced the Airborne Laser program as part of Pentagon budget belt-tightening.

Boeing provides the aircraft, battle management and overall systems integration. Northrop Grumman Corp NOC.N supplies the megawatt-class laser and Lockheed supplies the beam control and fire control systems.

Editing by Toni Reinhold and Bernard Orr