April 12, 2007 / 9:42 PM / 13 years ago

UPDATE 2-US Navy ends Lockheed ship deal after cost overruns

(Adds Lockheed, General Dynamics comments, more from Navy)

By Andrew Gray

WASHINGTON, April 12 (Reuters) - The U.S. Navy said on Thursday it was terminating its contract with Lockheed Martin Corp. (LMT.N) to build a shore-hugging Littoral Combat Ship that encountered major cost overruns.

“The Navy worked closely with Lockheed Martin to try to restructure the agreement for LCS-3 to more equitably balance cost and risk, but could not come to terms and conditions that were acceptable to both parties,” a Navy statement said.

The new class of ships is designed to operate in shallow waters to hunt for submarines and destroy underwater mines. The Navy eventually wants to buy 55 of them.

Lockheed, the largest U.S. defense contractor, was contracted to build the first and third of the ships using its design, while No. 4 contractor General Dynamics (GD.N) is building the second and fourth with its own design.

The ship being terminated by the Navy is the second of the Lockheed ships, known as LCS-3.

In January, the Navy estimated the first Lockheed ship would cost $350 million to $375 million, far above the initial projection of $220 million. The Navy issued a stop-work order on LCS-3 and sought to renegotiate the contract.

The Navy said it remained committed to completing construction of the first Lockheed ship, LCS-1. It said it would closely monitor General Dynamics’ costs for its two ships, LCS-2 and LCS-4.

“LCS continues to be a critical warfighting requirement for our Navy to maintain dominance in the littorals and strategic choke points around the world,” Navy Secretary Donald Winter said in the statement.

“While this is a difficult decision, we recognize that active oversight and strict cost controls in the early years are necessary to ensuring we can deliver these ships to the fleet over the long term,” Winter said.

Lockheed expressed disappointment at the decision.

“We believe that our proposal was fully consistent with the secretary’s stated desire to bring the benefits of increased competition to shipbuilding while holding the Navy’s industrial partners accountable for cost performance within their control,” Lockheed Chief Executive Officer Bob Stevens said.

Navy officials said Lockheed remained eligible to bid to supply other LCS ships in fiscal years 2008 and 2009.

The Navy plans to stick with the General Dynamics and Lockheed designs through those years before selecting a single design and allowing other companies to bid to build it.

Currently the Navy intends to buy two more LCS ships in 2008 and three in 2009, although those plans have to be approved by Defense Secretary Robert Gates and Congress.

“We hope and expect Lockheed Martin and its team members will compete for future opportunities as costs and risks in their design become better defined,” Rear Admiral Charles Goddard, the Navy’s program executive officer for ships, told reporters at the Pentagon.

A General Dynamics Corp. (GD.N) representative said the matter did not affect its own Littoral Combat Ship program.

“We’re focused on delivering the most capable and most affordable LCS ship we can to the U.S. Navy. This is an issue between Lockheed and the Navy,” said General Dynamics spokesman Rob Doolittle. (Additional reporting by Bill Rigby in New York)

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