c. During the negotiations, NAVSHIPS laid out its position, point by point, so that Litton could have the opportunity to correct any misunderstanding or errors in factual data, and Litton was invited to rebut the NAVSHIPS tentative position. Litton indicated general disagreement with the conclusions. Nevertheless, it was unable to reconcile its claim with the evidence presented by NAVSHIPS.

d. The amount of the claim approximates Litton's projected cost overrun on this contract. Nearly all of this overrun has been found by NAVSHIPS to be due to Litton's mismanagement of the contract and over-optimism in its bid. Litton did not appear to be at all concerned that its claim does not support a payment anywhere near the $37 million figure. The company's position seems to be that it spent the money so it is up to the Navy to cover all Litton costs and all the profit included in its bid regardless of whether the overrun was Litton's or the Government's fault.

e. Mr. Marandino made no attempt to negotiate. Thus, NAVSHIPS' efforts in presenting the facts to Litton were a waste of time, except that the Litton response to the specific points raised by NAVSHIPS seemed to confirm that the NAVSHIPS' analysis is sound.

4. In attempting to attribute its cost overruns to the Navy, Litton has, in my judgment, overstepped the bounds of propriety. Analysis of the claim indicates misrepresentation, if not fraud. Many elements in the claim appear contrived and are irreconcilable with facts contained in the company's own files. Enclosure (2), among other things, discusses one example -- a case where Litton claimed an extra $4.5 million figure as uncollectible escalation when, in actual fact, there was no basis whatsoever for the $4.5 million.

5.

In view of the history of this Litton claim, I recommend that a formal board be convened to investigate this claim and to determine whether Litton's actions constitute a violation of the False Claims Act or of other federal statutes. As an alternative the Department of Justice could be asked to review it.

6. The Litton claim is a complex matter. NAVSHIPS has gone to great pains to get to the bottom of the case and determine the facts -- a step too often not employed in past handling of NAVSHIPS claims. Based on the effort expended in this case, unusual for NAVSHIPS, the Navy is in a strong position to contest the claim before any tribunal and to limit payment to that amount actually owed Litton. For this reason the claim should be settled on its merits through the normal contracting officer decision and appeals board circuit, and not by extra-legal action.

:

MEMORANDUM FOR COMMANDER, NAVAL SHILP SYSTEMS COMMAND,

WASHINGTON, D. C.

ATTENTION: Mr. Richard D. Everett

20360

SUBJECT: Audit Review and Analysis of Escalation on the 680's!
Claim, Ingalls Nuclear Shipbuilding Division, Pascagoula,
Mississippi

In accordance with your request, this office has reviewed the.. contreccor's proposed method of including escalation in its latest revised claim for the 680 submarine contract.

The contractor's' latest claim submission is presented on a basis which allows for the over or under recovery of escalation for the total contract. The proposed method is unacceptable to IXCAA because it represents a method which allows for a total repricing of the contract. We recommend that the claim be priced separately from the basic contract and change orders. The incorporation of any pricing method of a porai contract repricing method will allow for recovery

of losses on the basic contract and cau not be recommended.

There are two other methods of pricing escalation on the subject claim which we have explored. One method would be to price the :claim on a de-escalated basis and revise the escalation contract formula for payment of escalation applicable to the claim. The other method would be to price the claim on an escalated basis. The method of pricing

the claim on a de-escalated basis on an after-the-fact basis is not acceptable because of the problems inherent in determining the deescalated base labor and overhead rates as well as base estimates for materials. It is almost impossible, especially in overhead rates, to split incurred costs into the categories of escalation costs and base incerred costs. Based on our detailed review and analysis.we recommend that the claim be priced on an escalated basis and that the basic portion of the contract remain on a de-escalated basis as originally priced in the contract. This recommended method is in consonance with the change order pricing formula on the contract.

In the claim it is our understanding that legal entitlement for au additional four quarters has been determined for escalation contract formula purposes. This office has reviewed in detail the revised material and labor spread which has been included in the tentative developed revised

CAR-1.24

July 11, 1972

SUBJECT: Audit Review and Analysis of Escalation on the 680's
Claim, Ingalls Nuclear Shipbuilding Division, Pascagoula,
Mississippi

In the contractor's latest revised proposal it included a computed figure of twenty-one million dollars for actual escalation. Aish, adjustment of approximately four and one-half million dollars for the over recovery, of escalation assuming that escalation recovery would be made on a total contract basis. We have had numerous meetings, with the contractor in an attempt to obtain supporting documentation and rationalization of these figures. The contractor did not make a computation of

actual escalation on the contract and could not support the twenty-one million dollar figure. In addition, they were never able, to support the four and one-half million dollar adjustment figure that was included in the proposal. Our analysis based on the information obtained, indicated that this four and one-half million dollar figure represented ei figure computed using total estimated contract incurred cost less monies received or expected to be received in claims;

In summary, based on our total analysis we recommend that the contract escalation formula (Article 16 of the contract) be applicable only to the basic price of the contract and that the claim be priced on an escalated basis. The escalated amount recovered through the formula will reasonably pay the contractor for iis accuui escalation on 'the contract. llowever, in settlement with the contractor, the agreement documentation should be prepared in a manner which will assure that the contractor understands that this represent's the total and final amount payable for escalation applicable to the basic contract.

CAR-1.24

July 11, 1972

SUBJECT: Audit Review and Analysis of Escalation on the 680's
Claim, Ingalls Nuclear Shipbuilding Division, Pascagoula,
Mississippi

formula by NAVSHIPS.

Our review was made to determine if the distribution of the material and labor cost was reasonable when compared to the actual distribution based on incurred cost. In addition, our review was made to determine the amount of escalation recovery that would be estimated to be paid through the revised tables for escalation versus the amount of computed actual escalation for the basic contrąċt., This computation is shown below for your information.

As shown above, our computation of actual escalation on the contract approximates the amount of escalation that will be recovered under the revised contract formula. It is understood that these figures and estimates are accurate within a range of 95 to 100%. We also made a computation of the escalation that would be recoverable under the formula if the distribution of material and labor were based on the actual distribution of incurred costs. That figure amounted to approximately seventeen million dollars. The distribution of labor and material as included in the revised contract formula by NAVCHIPS is considered to be very accurate and reasonable in relationship to the actual amount of computed escalation applicable to the basic contract.

Subj:

1.

Litton Systems, Incorporated, Ingalls Nuclear Shipbuilding Division, claims against the Navy on contracts for construction of SSNs 680, 682, and 683 and AES 32 through 35

As you know, NAVSHIPS was unable to reach agreement with Litton on either the SSN 680, 682, and 683 claim or on the AE 32-35 claim during negotiations on 17-19 July 1972. The two claims total about $75 million, but NAVSHIPS considers it owes Litton about $7 million. In view of this wide difference and since no agreements were reached, Litton was notified that a formal contracting officer's decision based on the NAVSHIPS position will be issued promptly. Litton, if it so desires, may then appeal to the Armed Services Board of Contract Appeals to settle the dispute.

2. These developments, in conjunction with the other problems
the Navy has been experiencing with Litton, may have considerable
impact on the company. One criticism leveled against the

Department of Defense in connection with the Lockheed C5A
case was that the Department of Defense did not make known
the full extent of its difficulties and actions with the
contractor. More recently, there have been press reports of
a Congressional inquiry to the Securities and Exchange Commission
regarding Litton's failure to disclose in its financial statements
the extent of its claims against the Navy and regarding the
extent Litton may be reporting earnings predicated on optimistic
projections of claim settlements. To avoid such criticism of
the Navy I therefore recommend the following:

a. NAVSHIPS should advise the Securities and Exchange Commission of the results of its recent negotiations with Litton and of the fact that it is preparing to issue a contracting officer's decision on these claims. This notification should indicate the amount of the contractor's claim and the approximate amount of the contracting officer's decision.