Navy Cancels $600-Million Lockheed Plane Contract

The Navy announced Friday that it has canceled a $600-million Lockheed Corp. contract to develop the P-7A anti-submarine patrol aircraft, declaring that the firm had “failed to make adequate progress” toward completing the program.

The unusual punitive action poses major financial risks for the Calabasas aerospace firm, which was the prime contractor in the troubled program that would have been worth up to $5 billion for 125 aircraft.

The Navy canceled Lockheed’s role in the program under terms known as “default,” citing the firm’s “inability and/or unwillingness to meet other requirements of the contract.”

The P-7A contract cancellation is among the largest programs ever in which a contractor’s role has been terminated by a military service, apparently eclipsing the 1985 termination of the $4-billion Sgt. York anti-aircraft gun program at Ford Aerospace in Newport Beach. The Lockheed cancellation is the largest termination for default.

The contract cancellation clearly hurts Lockheed’s standing as a major aircraft producer. It leaves the company producing just the C-130 cargo aircraft, a program that is three decades old. The company also is competing to build the Air Force’s advanced tactical fighter. The P-7A cancellation may hurt the firm in that competition, as well, damaging its image and boosting its costs.

“We believe the Navy has no legal or contractual basis for default termination,” Lockheed Chairman Daniel M. Tellep said in a statement issued Friday. “We are confident that (an) appeal will be resolved in Lockheed’s favor.” The statement blamed delays in the program on the Navy and said the cost overruns were forced on the company by requirements that were “unattainable.”

Although Lockheed’s P-7A contract with the Navy was signed in January, 1989, the firm was already two years behind schedule by earlier this year and had incurred a 50% cost overrun. The firm has been overwhelmed by the complexity of the engineering task, which seemed relatively easy when executives signed the contract.

Lockheed had expected the P-7A to closely resemble its predecessor P-3 aircraft, but engineers soon discovered that for structural reasons the P-7A would have to be virtually an entirely new aircraft.

The Navy action left many questions unanswered about whether it would attempt to resurrect the P-7A program and whether it would force harsh termination penalties on Lockheed. A Navy spokesman said it will demand unspecified restitution. But the firm will be spared the difficulties of pursuing a program on which it already was massively over budget.

The company employed about 900 workers on the program at its Rye Canyon facility near Valencia as of late last year, but in recent months some of the jobs have been eliminated. Lockheed recently announced a plan to transfer future production of the aircraft to a plant in Marietta, Ga.

Under the initial $600-million contract, Lockheed was to develop the P-7A aircraft and build two prototypes. Production of the 125 aircraft was to continue through the year 2001. The P-7A was intended to be the Navy’s principal aircraft for finding and destroying enemy submarines. It would have carried torpedoes and missiles.

Just nine months after receiving the award, Lockheed was forced to write off $300 million in overruns on the development work.

In recent months, almost all work on the program ground to a halt while Lockheed and the Navy negotiated a restructuring of the contract. But the negotiations deadlocked and each side waged a war of words. The Navy threatened to hold Lockheed in “default” and the company vowed to never build the aircraft at a financial loss.

In May, when Lockheed was seeking to be relieved of its obligations under the contract, a Navy official declared: “Those guys signed up to a firm, fixed-price contract to build 125 airplanes. In Lockheed’s wildest dreams, the Navy would just forget about the program.”

Congress seems certain to scrutinize the P-7A affair and, in the current environment of reduced defense spending, may decide to cancel the entire program.

“The whole thing will have to examined by Congress,” said a senior staffer on the House Armed Services Committee. “Lockheed made some pretty hellacious mistakes.”

Lockheed’s handling of the program may help potential opponents. “I don’t know if Congress is going to stand up and cheer when the Navy comes back and says, ‘Well, we blew that one and now let’s start over,’ ” said Wolfgang Demisch, an aerospace analyst at UBS Securities in New York.

Lockheed said it would file a prompt appeal and that it expects the Navy to change the contract cancellation terms to a type known as “termination for the convenience of the government.”

Under a convenience termination, the Pentagon essentially releases a contractor from certain legal obligations and pays for the cost of shutting down assembly lines or severing subcontracts with small firms.

But a default termination is the Pentagon’s ultimate weapon against a contractor. Under default, the Navy could find another contractor to build the P-7A, then sue Lockheed for any additional costs over its original agreement with Lockheed, according to federal contracting experts.

Even though such an outcome seems unlikely, according to experts contacted Friday, the threat of such an action could be used to obtain large concessions from the company.

“What we have is a game of high-stakes poker,” said Lawrence Harris, an analyst at Bateman Eichler, Hill Richards. Harris said he doubted the Navy could find many aircraft producers who would be willing to take over the P-7A program on the difficult financial terms that he said had been imposed on Lockheed.

It is unclear whether Lockheed’s $300-million reserve on the P-7A will cover all of its termination costs. “We are in murky territory,” Harris said. “These are major policy issues.”

Lockheed’s P-7A contract contained options that could have forced Lockheed to produce the aircraft at a loss. Those options would have forced Lockheed to build the aircraft for an estimated $38 million each, while its average cost to produce the aircraft were believed to be $60 million.

If Lockheed had been forced to build all 125 aircraft under such terms, it would have faced a loss of $2.75 billion. Such a loss could have bankrupted the firm. The termination of the contract could relieve it of that financial threat.

The House Armed Services Committee aide said: “We are getting different reports on what the financial implications for Lockheed are.”