WASHINGTON — The Australian parent company of Mobile, Alabama-based shipbuilder Austal USA announced a $115 million write-off Monday due to higher-than-expected costs on its Littoral Combat Ship (LCS) program.
The company resumed trading on the ASX Australian Stock Exchange after halting trading June 30 to review its US shipbuilding operations. After closing at AUS $1.21 June 30, shares reopened July 4 at .95 cents but closed at 1.12.
The write-off was due, the company said in a note to investors, to "a significantly higher level of modifications to the ship design and cost than previously estimated."
The changes, Austal said, are driven by a "contractual requirement to meet the military shock standard and US Naval Vessel Rules," a set of building standards imposed by the US Naval Sea Systems Command.
The cost of building and modifying LCSs to meet the shock rating standard and US Naval Vessel Rules is "materially more than what was previously estimated," the company said.
The design changes were implemented after the Dec. 29, 2010, $4.4 billion, 10-ship fixed-price-incentive block buy contract for even-numbered ships from LCS 6 through LCS 24. All but the first of those ships are now under construction.
Under the terms of the contract, Austal said, the company and the Navy share equally in cost increases from the revised baseline design up to a ceiling price.
Costs beyond that ceiling, however, are borne by the shipbuilder.
"Too much revenue and profit was attributed to work already completed," Austal said. "Work in progress is overstated because additional costs will be incurred." Those costs amount to the $115 million write-off.
Austal builds LCS 2 Independence-class ships, which are given even hull numbers in the US Navy's numbering system. The company took over the role as prime contractor for the class beginning with the Jackson (LCS 6), replacing General Dynamics, which served as prime for the first two ships, also built at Austal's shipyard.
Delivery of the ships has habitually been late as Austal sought to find ever-improving ways of building the LCSs, thus improving costs. But the delays – which vary by ship and the date a schedule is approved – have not materially improved, and improvements have been offset by the need to go back and modify design features.
The need to modify ships in different stages of construction on an assembly line that is at full-rate production is causing "ongoing schedule and margin pressure on the LCS program," Austal said.
Nine LCSs are under construction in Mobile, all in various stages of completion, ranging from ships in the water in the final stages of fitting out, to those just beginning fabrication.
"The cost of modifying vessels and components already built has been exacerbated by the concurrent construction schedule," Austal said. "Modifications to vessels at an advanced construction phase will be more expensive and difficult to implement than pre-launch modifications or modifications to vessels not yet under construction."
Despite the negative financial news, Austal is upbeat that the survivability changes have been successful.
The Jackson is currently in the midst of Full Scale Shock Trials (FSST) off the Florida coast, a series of three tests where explosives are set off nearby the ship, which is measured and examined for damage. Jackson is the first LCS to undergo the shock trials, which are expected to be completed in mid-July.
A Lockheed-built ship, Milwaukee (LCS 5), will undergo shock trials later this summer.
The US Navy has reserved detailed comment on the Jackson's first two shock trials, other than to say no unexpected damage was incurred.
But Austal, in its statement, cited "favorable preliminary results," and noted that "initial findings of the shock trials are that the implementation of the design modifications have been successful, providing greater certainty about the maturity of the revised baseline design and the cost of construction."
Other sources also indicate the shock tests may be going better than expected, with results positively exceeding predictive modeling.
The US Navy already has announced the shock tests on the two ships will cost around $65 million – costs which include installing numerous sensors and gauges on the ships to measure blast effects, and the cost to remove the sensors and repair damages, including repairs conducted between the test shots and after they're completed.
Austal announced on July 4 it received an $11.2 million contract for repairs to the Jackson during and after the trials.
Austal chief executive officer David Singleton said the financial impact from the LCS program was clearly disappointing, however, the outlook for the US business remained positive in terms of the generation of future profits and cash flows.
He cited the Expeditionary Fast Transport (EPF) program – previously called the Joint High Speed Vessel (JHSV) – as performing "pleasingly." The ships are built in Mobile in a production line parallel to the LCS line.
Austal, Singleton said, has a much clearer understanding of the margins that will be generated from the remaining LCS vessels block buy contract. LCS margins are lower than EPF but will rise in later years as the design modifications are built into the baseline design of new ships without requiring modification of components already built."
The company, he added, remains in a strong financial position and is continuing to generate positive operating cash flows, which will support ongoing debt reduction and returns to shareholders."
An Austal USA official was philosophical about the situation.
"It's worth it to get it right," the official said. ""We'd prefer to not have any financial loss to this, but if that's the price we have to pay to get the ship correct, than that's what we need to do."
