(Recasts with company statement)

By James Vicini and Will Dunham

WASHINGTON, Sept 22 (Reuters) - Private U.S. security contractor Blackwater USA denied on Saturday it was involved in illegally shipping automatic weapons and military goods to Iraq.

The statement by the company, whose contractors were accused by the Iraqi government of killing 11 people in Baghdad this week, came after a newspaper report that federal prosecutors are investigating whether Blackwater exported unlicensed military hardware into Iraq.

"Allegations that Blackwater was in any way associated or complicit in unlawful arms activities are baseless. The company has no knowledge of any employee improperly exporting weapons," the company said in a statement.

"This issue is completely unrelated" to Blackwater's U.S. government programs in Iraq, said the company, based in Moyock, North Carolina. It employs around 1,000 contractors to protect the U.S. mission in Iraq and its diplomats from attack.

The News & Observer of Raleigh, North Carolina reported that two former Blackwater employees have pleaded guilty in Greenville, North Carolina, to weapons charges and are cooperating with the federal investigation.

The newspaper quoted two unnamed sources as saying federal officials are probing whether Blackwater was shipping weapons, night-vision scopes, armor, gun kits and other military goods to Iraq without the required permits.

A U.S. Justice Department spokesman declined comment on the investigation.

Iraqi Prime Minister Nuri al-Maliki has suggested the U.S. Embassy stop using Blackwater after what Iraq called a flagrant assault by the firm's contractors in which 11 people were killed on Sunday while the firm was escorting an embassy convoy through Baghdad.

The Washington Post reported in Saturday's edition that the Iraqi government's investigation into the shootings has expanded to include allegations about Blackwater's involvement in six other violent incidents this year that left at least 10 Iraqis dead.

The issue of alleged weapons smuggling by a U.S. contractor in Iraq surfaced earlier in the week in a letter from a congressional committee chairman, Democratic Rep. Henry Waxman of California, to Howard Krongard, the State Department's inspector general.

"You impeded efforts by your investigators to cooperate with a Justice Department probe into allegations that a large private security contractor was smuggling weapons into Iraq," Waxman told Krongard in a letter dated Sept. 18.

Waxman's letter did not name Blackwater.

Waxman has asked the head of Blackwater USA, Erik Prince, to testify before his committee on Oct. 2 on its work in Iraq. The hearing will focus on whether the U.S. government's heavy reliance on private security contractors is serving its interests in Iraq.

The State Department said on Friday that it would thoroughly examine the use of private security contractors to protect American diplomats in Iraq.

In its statement, Blackwater gave its version about how the federal investigation began.

It said that when it was uncovered internally that two employees were stealing from the company, Blackwater immediately fired them and invited the federal Bureau of Alcohol, Tobacco, Firearms and Explosives to conduct a thorough investigation.

"The employees, who were former Marines and law enforcement, have been convicted and are currently negotiating sentencing in Raleigh with federal prosecutors," the company said.

The News & Observer reported that two former employees -- Kenneth Wayne Cashwell and William Ellsworth "Max" Grumiaux -- have pleaded guilty to possessing stolen firearms shipped in interstate or foreign commerce and are cooperating with the investigation.

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