The following is the text of a news release from Austal Ltd.:
(MOBILE, Ala.) — Austal Ltd. provides the following update on its littoral combat ship (LCS) program in the U.S. and the impact on the company’s FY 2016 earnings. As previously advised, Austal has experienced ongoing schedule and margin pressure on the LCS program following delivery of LCS 6 in August 2015, Austal’s first as prime contractor.
The delivery of LCS 6 and 8, completion of preparations for the shock trials of LCS 6 and favorable preliminary results from the first two physical shock trials of LCS 6 which were undertaken in June 2016, have enabled Austal to define a revised baseline design for a shock-rated vessel built to U.S. Naval Vessel Rules.
The “shock tests” are a contractual obligation that requires the ship to survive the effects of a local explosive blast. The LCS is the first aluminum trimaran in the world to undergo such an analysis and test. The test regime qualifies the vessel’s entire class and no further shock trials are expected for subsequent vessels.
Initial findings of the shock trials are that the implementation of these design modifications have been successful, providing Austal with greater certainty about the baseline LCS design and estimated cost of construction, and how that applies across the LCS program.
Austal has undertaken an extensive review of the LCS program to gain greater clarity on the costs associated with building to the revised baseline design and to quantify the impact across the life of the LCS program and concluded the following:
• The cost of building the littoral combat ships to meet the shock-rating standard and U.S. Naval Vessel Rules is materially more than what was previously estimated.
• The cost of modifying vessels and components already constructed to meet the shock standard and U.S. Naval Vessel Rules is materially more than what was previously estimated.
The cost of modifying vessels and components already built has been exacerbated by the concurrent construction schedule with 10 LCS of a total of 11 LCS under contract at various stages of construction since April 2015. 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.
Cost increases associated with the revised baseline design are shared 50/50 with the U.S. Navy up to a ceiling price per the LCS contract structure. This will reduce the negative profit impact to Austal.
The change of estimate means that too much revenue and profit was attributed to work already completed. Work in progress (WIP) is overstated because additional costs will be incurred to meet the shock standard and U.S. Naval Vessel Rules. This is being written back as a one-off, $115 million downward adjustment to revenue and work in progress (WIP) in FY 2016.
Austal has initiated discussions with the U.S. Navy about increases in design scope that may improve Austal’s position. Austal has not recognized any value associated with these discussions in its profit calculations due to the preliminary nature of the process.
Austal Chief Executive Officer David Singleton said the financial impact from the LCS program was clearly disappointing, however, the outlook for the U.S. business remained positive in terms of the generation of future profits and cash flows.
“Operationally, we have implemented a considerable number of modifications to LCS 8 which has only recently been contractually delivered to the U.S. Navy. This is only the fourth ship of the 13 LCS ordered by the U.S. Navy to date,” he said. “Initial findings from two shock tests performed in June 2016 on LCS 6, the only vessel that will undergo the tests, have been favorable and provide us with confidence on the baseline design and cost of construction across the program to meet the standard.
“The predicted U.S. shipbuilding margin is made up of a combination of the stable and predictable performance from the EPF program and now combined with 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.
“Pleasingly, the expeditionary fast transport program (formerly called JHSV) is performing financially well and provides a clear example of the benefits of being able to work through first-in-class issues.
“Meanwhile, Austal 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.”