亨廷頓·英格爾斯工業 (HII) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2011 Huntington Ingalls Industries earnings conference call. My name is Crystal, and I'll be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to turn the conference over to your host for today, Mr. Andy Green, Vice President, Investor Relations. Please proceed.

Thanks, Crystal. Good morning, and welcome to the Huntington Ingalls Industries second quarter 2011 earnings conference call. With us today are Mike Petters, President and Chief Executive Officer; Barb Niland, Corporate Vice President, Business Management and Chief Financial Officer.

As a reminder, statements made in today's call that are not historical fact are considered forward-looking statements and are made pursuant to the Safe Harbor provisions of federal securities law. Actual results may differ. Please refer to our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results. Also, in their remarks today, Mike and Barb will refer to segment operating income and total and Ingalls operating margin in the second quarter of 2010, excluding non-recurring items, which are non-GAAP measures. Reconciliation of this adjusted operating margin to the comparable GAAP measure is included in a schedule that accompanied our earnings release. We have posted presentation slides on our website today that we plan to address during the call to supplement our comments. Please access our website at www.huntingtoningalls.com and click on the Investor Relations link to view the presentation as well as our earnings release.

With that, I would like to turn the call over to Mike.

Thanks, Andy. Good morning, everyone, and thanks for joining us on today's call.

I am pleased to report Huntington Ingalls Industries' results for the second quarter of 2011, our first full quarter as an independent, publicly-traded company. Today we reported sales of $1.6 billion, down slightly over last year. Operating margin was 5.8%, up significantly over last year, although last year's operating income included a $113 million charge related to the Avondale wind-down. Adjusting for that charge, operating margin was 5.4% last year. Diluted earnings per share was $0.80, up from a loss of $0.23 a year ago. During the second quarter, we continued to be awarded new contracts, including the award for DDG 113, the first ship in the DDG 51 restart, as well as additional work on the Roosevelt refueling and complex overhaul. Our backlog was $16.8 billion at the end of the quarter, essentially flat over last quarter.

Now walking through each of our major programs. For DDG 51s, as I just mentioned, we received a contract award for DDG 113 and are in the process of bidding for DDG 114 and 116. We expect the next DDG 51 ships to be awarded later this year, and we're pleased that the Navy recognizes the value these ships bring to the fleet. This procurement, our first competitive program since Hurricane Katrina, provides the first external measure of our progress at Ingalls and also provides us the opportunity to demonstrate the advantages of serial production.

On LPDs, we anticipate builder's trials and delivery of LPD 22 by the end of the year. However, the Navy is considering additional scope that could delay delivery into early next year. LPD 23 was christened in May, and LPDs 24 and 25 continue to make progress. As we mentioned on the last call, we have finalized the contract and begun construction of LPD 26, and we expect LPD 27 to be awarded in 2012. As we communicated to you previously, LPDs 22 through 25 are challenging, and we anticipate improved operating results once these ships, with along with LHA 6, are delivered.

As for LHA 6, we are making good progress and expect the ship to be 75% erected, meaning structurally complete, by the end of the year. And while we are pleased with the progress on the ship, we recognize that the majority of the risk lies ahead in the outfitting and testing phase of construction. We also anticipate a contract on LHA 7, the next America class amphibious assault ship, by year end. Regarding national security cutters, we recently completed highly successful builder's trials and are currently conducting acceptance trials on NSC 3, which is scheduled for delivery to the Coast Guard later this year. We continue fabrication work on NSC 4 and expect the contract award for NSC 5 in the near future. Our Coast Guard customer has expressed a high level of satisfaction with the two cutters that are currently operating in the fleet, and in fact, the commandant recently visited our Ingalls shipyard in Pascagoula and was very complimentary of the teams work on this very important program.

For the DDG 1000 program, we continue construction on the deckhouses, hangars, and vertical launch systems for DDG 1000 and 1001, and we expect an award for the same items for DDG 1002 by early 2012. Our Gulfport facility, part of Ingalls, is fabricating these deckhouses, employing our unique knowledge and experience in composites technology. In carrier construction, CVN 78 is approximately 26% complete and is now 50% erected. The ship is on schedule for delivery in 2015, and although we lowered our booking rates in the first quarter to reflect where we are in the program, our overall profit expectations for the contract remain unchanged, and we are pleased with the ship's progress. Ford, like most lead ship contracts, is a cost-type contract that reflects the risk associated with building a new design and the sharing of that risk with our customer, the Navy.

On CVN 79, recently named the John F. Kennedy and the second carrier in the Ford class, we have begun cutting steel for the ship under the construction preparation contract for CVN 79. In carrier refuelings, or RCOHs, we undocked Roosevelt during the second quarter and expect to redeliver the ship to the Navy in late 2012 or early 2013. Advanced planning continues for the RCOH of CVN 72 Abraham Lincoln and execution should begin in early 2013. This work continues to go well, and HII is uniquely positioned in this business. For carrier inactivations, we continue to plan for CVN 65 Enterprise to enter the yard in 2013. Enterprise will be the first nuclear-powered carrier to be decommissioned and inactivated. This represents a new business for us, another area where we bring unique and highly-specialized capabilities to the table.

On the Virginia class submarine program, just this past Sunday, we delivered SSN 781 California, the latest submarine in the program, more than eight months early. The first three boats of block three are under construction, and we have begun the process of ramping up production to two submarines per year. In the second quarter, we held the keel laying ceremony for SSN 783 Minnesota, the last of the Newport News block two delivery boats. As has been said numerous times by many, this is arguably the most successful shipbuilding program today. It's in true serial production, and the teaming is going very well.

At Avondale, LPDs 23 and 25 remain under construction, and we continue the early stages of implementing our plan to wind down the operation. I want to re-emphasize that this decision was made in light of the Navy's 30-year shipbuilding plan and an overcapacity in the industrial footprint. We continue to see positive performance results on these two ships, which is a testament to the quality of our shipbuilders at Avondale.

Overall, we are pleased with the progress we've made on each of our major programs. Our challenges with the LPD and LHA 6 programs remain a top priority, and though our long-term outlook for sales and operating margin remains unchanged from what we've said previously, let me provide some additional color. Because of the timing of the spinoff, the contract awards for DDG 113 and LPD 26 were delayed, which has created some pressure to the top line in 2011. Because of this timing issue, we expect the second half of this year to look similar to the first half.

Looking at 2012, we expect year-over-year improvement in operating margin as we begin to replace legacy contract revenue with revenue from new business. By the end of 2012, we expect to have delivered LPDs 22, 23, and 24, a significant portion of revenue that is now being booked at zero margin. As these ships roll off, we expect the associated loss of sales to be offset by progress on ramping up Virginia class production in Newport News and construction of DDG 113 and LPD 26 at Ingalls, all programs which we expect to perform well. As a reminder, we typically book new business at a lower operating margin in the early stages of construction than we expect to average over the life of the ship. Then, as we progress on the ship and retire risk, we generally see margins increase. This normal performance pattern should result in margins expanding slowly in 2012 and then beginning to accelerate in 2013 once the legacy LPD and LHA 6 contracts are completed and the new business has gained traction.

Before I turn the call over to Barb for more detail on the financials, I'd like to talk a little bit about what's happening in naval shipbuilding. As most of you are aware, in recent weeks, there's been a lot of speculation regarding the shipbuilding budget, including not only the timing of the next carrier in the Ford class, the John F. Kennedy, but also the Navy's long-term carrier construction plan. Right now, the plan of record is for CVN 79 to be funded in the fiscal 2013 defense budget, with a construction contract being awarded shortly thereafter. We began preparing for the construction of Kennedy at Newport News several years ago, and we are already cutting steel for this ship under the construction plan and contract. Because of the size, complexity, and cost of an aircraft carrier, these ships tended to come under a lot of scrutiny when funding comes up for budget approval, and Kennedy is no different. Predictably, as part of the normal budgeting process, various options related to new aircraft carrier construction or the size of the carrier fleet are always evaluated, but the ultimate outcome is only certain once the defense budget is finalized and signed into law. It is important to remember, however, that the total cost of a carrier includes not only our contract for constructing the ship but also the shipboard equipment and systems that the government purchases through the nationwide supply chain.

We believe that building these statements of national purpose on four-year centers is the most efficient and cost effective approach for the Navy and the US taxpayer. That being said, our current plan of building carriers on five-year centers helps maintain much-needed stability in the shipbuilding industry, including the supply chain and our own skilled workforce. Extending the carrier build cycle to six or seven years not only increases the overall cost of the ship but would also have a severe and far-reaching impact nationwide. At HII alone, we purchase between $2.5 billion to $3 billion of materials from suppliers in nearly every state. These suppliers also typically provide components to other Navy ship programs as well, so any negative impact on their carrier business also has a negative impact on their other Navy programs and the cost to complete other ships. In addition, the increasing pressure to reduce the federal deficit means every program, not just aircraft carriers, is under scrutiny as the Navy attempts to balance shipbuilding needs with funding constraints. How this ultimately plays out in a steady or declining budget scenario is unclear, but what is certain is that naval shipbuilders are going to be tasked with providing the highest quality ships at the lowest possible cost.

Importantly, the United States fundamentally remains a maritime nation with global economic and security interests. As such, our country will always have a strategic need to project power overseas, and our Navy will continue to be tasked with supporting that mission. Make no mistake, nothing projects power as effectively and efficiently as an aircraft carrier which has proven time and again its ability to support our country's military, political, economic, and humanitarian objectives worldwide and on very short notice. In fact, aircraft carriers have been the backbone of the US fleet in maritime strategy for over two-thirds of a century, and we believe they will remain so.

From a more macro perspective, the range of missions that modern warships are required to conduct exceeds anything the ship designers ever contemplated. Yet the flexibility designed into these ships, along with the best trained sailors and marines in the world, enables them to accomplish these missions. And what truly enables the flexibility of today's Navy results from what I characterized as volume at sea. By this, I mean the ability to put large, multi-mission platforms that can operate at sea anywhere in the world in support of our national interest. And today's fleet is built around four major platforms that demonstrate this volume at sea concept each and every day -- aircraft carriers, submarines, destroyers, and large deck amphib ships. As the Navy's sole source provider of aircraft carriers and amphibs and one of only two providers of destroyers and submarines, we are well-positioned to help the Navy achieve its objectives on fleet structure and operational capability. And the more successful the Navy is, the more successful we are.

Let me reiterate that 2013 remains the critical inflection point for Huntington Ingalls as the Avondale shipyard winds down and LPD 25 and LHA 6 are delivered. Post 2013, we believe we'll see the true earnings and cash flow potential of the business start to materialize, uncluttered by the overhang of today's problematic contracts. As such, we remain committed to our target of 9%-plus operating margin by 2015 on flat revenue, which translates into significant growth in earnings per share and substantial recurring cash flow.

In summary, Huntington Ingalls posted year-over-year improvement in operating margins and cash flow this quarter. We remain well-positioned to support the Navy's and Coast Guard's shipbuilding requirements across multiple platforms of ships and submarines, and we remain firmly on track to deliver the long-term operating margin we've discussed in the past. Importantly, this quarter's earnings demonstrate margin improvement at Ingalls, and although we have challenges remaining, including the closure of the Avondale shipyard and completion of LPDs 22 through 25 and LHA 6, we are confident that we have the right management team and the right systems in place to effectively meet those challenges and create value for our shareholders.

And with that, I'll turn the call over to Barb Niland for some remarks on the financials. Barb?

Thanks, Mike, and good morning to everyone on the call. I'd like to briefly review our consolidated and segment results as disclosed in the press release, then wrap up with some more detail on our capital structure and liquidity.

If you'll turn to slide four of the presentation, reported second-quarter sales decreased $47 million from the same period last year, driven by lower sales volume on the DDG 51 program, with the deliveries of DDG 107 and DDG 110, along with last year's completion of the Enterprise dry docking. The lower volume was partially offset by higher sales on the LHA program, the National Security Cutter program, and the advanced planning contract for the CVN 72 USS Abraham Lincoln RCOH. In addition, during the second quarter of 2010, the LPD program was impacted by the decision to wind down shipbuilding operations at our Avondale facility, which resulted in a revenue reduction of $115 million to reflect revised estimates to complete LPD 23 Anchorage and LPD 25 Somerset.

Segment operating income in the quarter was $98 million, up $108 million from the same period last year. Total operating income was $91 million, up from a negative $20 million. Total operating margin was 5.8% for the quarter, compared with negative 1.2% in 2010. Excluding the $113 million pre-tax charge related to our Avondale facility, total operating margin was 5.4% last year, compared to 5.8% this year.

Diluted earnings per share was $0.80 for the quarter, compared with a loss of $0.23 last year. These figures are not necessarily comparable, given the Avondale items in last year's results and the higher interest expense this year from our new debt structure. Diluted share count was $49.6 million, an increase of about 80,000 shares quarter-over-quarter. The increase in diluted shares over the first quarter was unusually large, due to the conversion of stock awards as a result of the spend, which had little effect in the first quarter, as we only had two days as an independent Company. Going forward, we expect diluted share count to increase at a significantly lower rate.

Cash from operating activities for the second quarter was $186 million, up $91 million over last year. Capital expenditures for the quarter were $21 million, down from $28 million last year. For the full year, we expect capital expenditures to be approximately 3% of sales, excluding the $36 million paid to the state of Louisiana reflected in the first quarter.

Turning to slide five, Ingalls' revenues for the three months ending June 30, 2011, decreased $6 million from the same period in 2010, primarily driven by lower sales in the DDG 51 program, and partially offset by higher sales in the LHA program. Operating income for the quarter was $19 million compared, with an operating loss of $94 million in the same period in 2010. Ingalls' operating margin was 2.7% for the quarter, compared with a negative 13% for the same period last year. This quarter results include negative cumulative margin corrections of $19 million on the LPD 22 through LPD 25 contract, partially offset by performance improvements on other programs. Excluding non-recurring items related to Avondale, Ingalls' operating margin was 2.3% in the second quarter of 2010, compared to 2.7% this quarter.

Turning to slide six, Newport News revenue for the quarter decreased $41 million or 4.5% from last year, primarily driven by lower sales volume on the Roosevelt RCOH and Ford, partially offset by higher sales volume on the advanced planning contract for the Lincoln RCOH. The year-over-year decrease was also driven by non-recurring performance improvements realized on the Virginia class submarine program in the second quarter of 2010. Newport News' operating income for the quarter was $79 million, compared with $84 million last year. The decrease was primarily due to lower overall sales volume and from the 2010 impact of the Virginia class submarine program that I previously mentioned. Newport News' operating margin was 9.1% for the quarter, relatively flat compared to last year.

Turning to slide 7 on capital structure, we ended the quarter with $910 million of total liquidity, consisting of $381 million of cash on hand and $529 million available under our revolving credit facility. Our debt remained relatively flat over last quarter at $1.9 billion. Interest expense increased from $15 million in the first quarter to $30 million in the second quarter, due to the new debt structure associated with the spinoff. With regards to Avondale, we have updated our estimate of the total cost to complete the wind-down from $310 million to $271 million. Our time frame has not changed, and we anticipate completing the wind-down activities in 2013, once LPD 25 is delivered. We expect to submit our revised proposal to the Navy later this month.

That wraps up my remarks, and with that, I'll turn the call over to Andy for Q&A.

Thanks, Barb.

As a reminder, before we start the Q&A, we request that you limit yourself to one question and one follow-up so that we can accommodate as many people as possible. Crystal?

(Operator Instructions).

Today's first question comes from line of Robert Spingarn with Credit Suisse. Please proceed.

Could you talk about -- you sort of did give guidance in time of the second half of the year being similar to the first half. But Mike, what are the obstacles that remain here in getting even more specific? Is it Avondale? And perhaps you can put the answer in the context of what Barb just said on the lower cost estimate now?

Okay. You know, first of all, we think that -- as we've described the business over the past six months, there's a lot of -- there are a lot of moving parts, and some of these parts get to be relatively large. It's kind of lumpiness in the business I think is what Barb calls it. When we look back at the first six months of this year, and we look at the things, we had some things that went well for us that were upticks. We had some things that could've gone better, which between those, they all sort of netted out, and they gave us a first half of the year that looks about what we think the business is going to look like for the second half of the year, relative to our revenues and our earnings.

Cash flow is even more lumpy than that, and so we're a little bit more reluctant to talk about that one, but we think that the LPDs, getting 22 through to delivery, is a big deal for us here in the second half of the year. Our plan and our commitment is to drive it to delivery by the end of the year. The Navy is working with us on that, but we're trying to jam a lot into the sock here towards the end of the year on that ship, and so we'll see how that one turns out. We're committed to making sure that that's the highest quality delivery.

Relative to Avondale, we've updated our proposal. That reflects the experience so far. We've had -- when we first put that proposal together, we were making some pretty conservative estimates on the things that -- what things were going to cost us, relative to this restructuring. As we've gone through and restructured and gone through the Tallulah and Wagman process and updated our estimates, we've lowered our estimate for the total cost of the restructuring.

How should we --?

Just evidence that things are going pretty well

Mike, how should we think about the talk that perhaps not all the cost is reimbursable? Or maybe the better way to ask this is, what is reimbursable? What are you expecting?

Let me first of all start at -- this is a negotiation that will be going on between us and the Navy throughout the whole process. And so, we have an estimate for what we think it will cost, the Navy will have their estimate for what they think it will cost, and we will be both working to refine those estimates. And so I think what's happening here is you're getting a lot of early publicity, I think, around this negotiation.

But Barb, do you want to add anything to that?

No. You know, we firmly believe all of the costs associated with this restructuring are recoverable. The reason why you submit a proposal is -- what you do is you get an advanced agreement that you included in your rates on all your new contracts that you bid, and it's all billable costs. But what happens in the end is, after you've experienced all the actual costs and you negotiate your overhead rates in the out years and close them out, is when all the final decisions will be made on that.

So, if there is eventually a disconnect between your proposal and what they reimburse, how and when would we see that booked? And where in your statements?

You would see its way out in the out years, after the closure.

Okay.

I'll reiterate, we stand firm. Everything we've put in that proposal is allowable and allocable.

Okay. Thanks very much.

Mike, if I could just finish by asking you to update us on the Ford program and the discussion there about some overruns and your exposure there? Thank you.

Sure. You know, the Ford is the lead ship. Lead ships are always challenging. As I said last quarter and I said again today, we remain committed to our financial targets on that program. We've laid out some -- a path for how we expect to retire risk on that program, and things are going pretty well. Actually, the management team there is aggressively working to retire that risk and improve the overall performance on the program.

It is a lead ship, and because it's a lead ship, we did a couple of things in partnership with the Navy to get the ship under contract. We set some -- what I think are pretty aggressive targets for that construction, and then we work through, how do you share the risk of the lead ship between us and the Navy? And the Navy and the Company remain committed to driving that program forward. From my own experience, I've been involved with several lead ships. Quite frankly, this lead ship is going better than any other that I've been involved with.

Our next question comes from the line of George Shapiro with Access 342. Please proceed.

Yes. Good morning.

Good morning, George.

I had -- if you look at -- this is probably for Barb, but if you look for the provision for contract losses, which was $61 million at the end of the first quarter and now dropped to $52 million, and I'm sure -- the $19 million provision was also in there, so effectively it would have dropped by $28 million. Now, it seems like that will finish maybe by the end of the year, long before the LPDs get delivered. So, will we see just a continuation of these small, negative-cume catch ups like we saw this quarter, or how does that -- how does that wind up?

It depends how the programs progress, okay? I mean, I'd like to think that in a perfect world, everything would go smooth, but we've said all along that those are our risk programs, and the LPDs and LHA 6, and that we have the potential for small corrections as we go forward.

And George, I would just add that LPD 22, as the first of those four LPDs, that one probably -- when we implemented our class plans and operating system, it gets the least benefit of that, and so as we bring that ship through to delivery, we are certainly rolling all of the lessons from that back into the other three ships in the LPD class that we're working on.

Okay. And then could you just update us on where you stand in your pension, you know, with the markets doing what they've done the last few weeks? Obviously, returns are going to probably be less than expected, and the discount rate is going to be lower, so maybe just give us kind of a sensitivity in how you look at that.

Sure. As you know, our current plan is established annually, using assumptions based on the end of the prior year, and we carry that through the year. So for modeling purposes, along with a lot of different assumptions that go into pension accounting, we are using an average discount rate of 5.84%, and we did assume long-term asset returns of 8.5%. So that sensitivity would be -- look at a 25 basis point decrease in the discount rate would have approximately a $12 million increase in the FAS pension cost and a 25 basis point decrease in the long-term asset return, would approximately have an $8 million increase in FAS expense.

You know, we're not providing guidance on 2012, as we're in the midst of our upper annual operating plan process. And we're evaluating many scenarios associated with the risk recent market events, particularly as they relate to pension. But another thing you have to consider, too, that's another variable in there that it's difficult to quantify at the time, is also the impact that market performance would have to any CAS adjustments, excluding CAS harmonization. So, that could potentially offset some of the negative earnings impact associated with changes in the discount rate or long-term asset assumptions. It's a watch item for us, and we'll certainly address it more next year as we come through it.

Okay. Thanks very much.

You're welcome.

Our next question comes from line of Carter Copeland with Barclays Capital. Please proceed.

Hi, good morning, guys. This is [Mayer] in for Carter.

I just had a quick question here. You signed the award for DDG 113. I was just wondering if you can talk about any changes, let's say with this contract versus the prior DDG contact? So, just as you are going through the new contracting process in general, if you're seeing any sort of changes with the customer to anything that you are implementing that helps protect, I suppose, your business.

Well, I think, first of all, the DDG program has historically been a very successful program for both shipbuilders involved in it, and I frankly would argue that the DDG program showed the benefit of serial production before the Virginia class program came along. There is a five-year gap in the production of destroyers, and the 113 is the first ship following that gap in terms of the restart. During that gap, Dr. Carter put out some guidelines relative to 50/50 share lines and ceilings and things like that, that were absolutely brought to bear on this contract. But we were able to actually incorporate into our basis for the contract, both what we thought the impact of the five-year gap would be, as well as what our experience post-Katrina and our cost basis was. So, that's why we have the view that we'll be able to perform pretty well in that program, a program that we've performed very well on historically.

Great. And just another question, quickly. The -- in Ingalls, where you had the $19 million charges, you noted that there was offset by improved performances. I was just wondering, were there any sort of incentive fee benefits that were in the quarter? I don't know if anything related to the delivery of DDG 110. Were there any sort of one-time benefits in nature?

There were no specific delivery incentives and everything, but after you deliver a ship, you set up a small reserve for deferred work and things like that. And so it's across a couple programs, where we didn't spend as much money on deferred work, and as we've come out of warranty periods we just had -- it was about 5 or 6 different programs we had pick-ups.

Great. And just very quickly, any changes in the tax rate, and how do we think about deferred taxes going forward?

Let's see. What you see right now, for deferred state taxes, I would expect to see about a $3 million expense in each of the quarters going forward. The reason why you had $5 million going the other way in the first quarter was because we had 2 deliveries in the first quarter, with Mississippi and DDG 110. And normally, you would -- that would be ratable over the whole year, but because we had to close the books with Northrop, we had to take that benefit in the first quarter. So I would look at the deferred state taxes being about the same as they are this quarter going forward. But again, you know, there can be swings, based on timing of deliveries and timing of costs incurred, changes in reserves, things like that. So not a simple answer there.

As far as the effective tax rate, basically, from Q1 to Q2, the change -- we benefited a little bit by the domestic manufacturing tax deduction based on contract mix, but going forward, I would expect it to be in, say, the 35% to 35.5% range.

Our next question comes from line of Jason Gursky with Citi. Please proceed.

Good morning, everyone. Two quick questions. First, Mike, maybe you could provide us with a bit of a history lesson, you know, dating back to the last time we went through declining defense budgets, and we've reduced our overall fleet of ships and then out at sea. Walk us through what that would look like from the shipbuilding industrial base's perspective and what that actually did to -- how long it took to build the ship or whether we ended up skipping some ships that were built.

And then the second question is, with regard to your 2015 guidance, you suggested 9% operating margins on flat revenues. I'm just trying to get a sense of, when you say flat revenues, is that off of the 2010 full-year revenue base, or what you are now projecting for 2011?

Okay. The second one first. We are looking at flat revenues off of the 2010 base. The timing of revenues for this year has shown up, but I think that that's not a sustainable impact. That's just a timing issue.

As far as a history lesson goes -- now I feel old, when I'm the one being asked for the history lesson here. And I'll try to condense this as quickly as I can. The challenge that you have when you start to decline the budget is that people want to stretch things out. They want to delay procurements or they want to delay schedules. And what happens with that is that brings great inefficiency into the production line. What we saw, for instance, in our carrier production line was, we actually started to move away from the four-year centers of aircraft carriers.

In the 80s, we had 2, two-ship contracts. Imagine a two-ship contract for aircraft carriers. We did that twice in the 80s, and those ships -- the last two ships -- the last ship actually delivered in 1998, but starting with the follow-on ship, the carrier program started to become stretched out. It went from four-year centers -- the 76 was the first follow-on ship, and that ship was delayed about a year. The 77 was the one that came after that, and it was delayed a couple of years. The 78 came after that, and it was delayed a couple of years. And you could argue that in that time frame, when we bought 3 aircraft carriers, we actually missed one. We should have bought four to keep it on the efficient schedule.

Interestingly, what happened is the Pentagon realized that they were getting to the point on the aircraft carriers that they were pushing the limit of what they really wanted to afford, because of the inefficiencies that had been brought in by the schedule, and so that's when they started coming back to the four-year center or the five-year center in their budgeting process. We think that that's wise on their part to keep an eye on the balance between the inefficiencies created by stretching things out and the overall requirements of the declining budget. The challenge for the whole base is what drives our business is the ability to capture those efficiencies of repeat performance and stability of orders and making sure that we keep our workforce intact and developed to do the work, the follow-on work.

When you stretch out a program, instead of moving -- I'll take a destroyer program. You are the craftsman that works on the bow of the destroyer. You come off that ship and you can go right onto the next bow unit for the next destroyer. You capture all of the efficiencies. You've got all those lessons learned in your head, the learning curve is there. If you have to wait a year, you may not even be the person we put on the next bow for the destroyer, and so that's where the -- that, in a kind of nutshell is the challenge that we will have if things start to stretch out. It becomes a knowledge management issue, and it becomes a question of how efficient is the learning curve? You can't assume that you're going to capture 100% of the learning once you start moving the programs out. And I think that's really what the Navy's wrestling with right now, is where do we create the efficiencies, how do we preserve the efficiencies that we have?

That's helpful. Thank you.

Our next question is from the line of Doug Harned with Sanford Bernstein. Please proceed.

Good morning. I wanted to continue on the Ford for a little bit, because we've seen -- there was a report out this week talking about a $562 million increase over the target price due to what they say our construction inefficiencies. Perhaps could you talk about what this may refer to? Is this anything new? Does it relate at all to what you assumed in the first quarter when you adjusted rates? What's happening here?

Yes. I mean, as I said before, Doug, this is a new class of ship. When we took this ship on -- this isn't a new class of a small ship, this is a new class of the backbone of the fleet. There's new technology throughout the ship. The design parameters and the key performance parameters changed the ship pretty dramatically.

When you set down and say, okay, how are we going to go contract for this ship? The discussion that we have in the contract negotiations is all about how much risk is there? As it is a lead ship, there's a substantial amount of risk. And so then the question is, how do you want to share that? Does the contractor bear all of that? Does the government want to share in that? If the government and the contractor come to a agreement on how we're going to share the risk, you can actually drive the cost down in terms of the price.

And so what we've done is we -- first of all as a baseline set a 90 -- I'm sorry, a cost-plus type contract. You know, we have a -- and that then helps us manage the cost performance on the ship. We then have risk provisions that allow us and the government to work for achieving those targets. The performance on the ship right now is pretty solid. I've been on the ship very recently, and I like what the team is doing, the things that they have in place, the initiatives that they have to mitigate the impact of this being a lead ship. And so, from my standpoint, it's going pretty well.

And let me reiterate, our financial performance targets on this program have not changed. When we came through first quarter, we decided not to retire -- not to take credit for retiring risk yet, because we weren't satisfied with what we had seen, but that didn't change our overall targets. We're confident with where we're going today, and I think that Newport News' performance, as evidenced in this quarter report, is that they are on track.

So, you're saying that this report coming out regarding an overrun is nothing inconsistent with what you've been seeing and what you've been working with the customer on, doesn't really effect your margin outlook for it?

Yes. I mean, I'm not going to comment on any particular story that's out there. I would just say that we're very confident with the financial performance on that program.

And then on the DDGs, could you talk about the dynamic of the competition for DDG 114? 116 being the competition and the DDG 114 being one that is designated for you. How does this work in terms of your pricing, basically, when you're competing on 116, and how does that effect your thinking on 114?

Doug, we're in the middle of a competition here, so I'm not sure that I really want to talk about my pricing strategy. I would say that I am very pleased with the Navy's approach to this. And I think that this shows that the Navy understands the value of serial production that we're trying to put in place, that if we can get the rhythm going on destroyers, we can re-create the successful program that carried us through the last 15 years or so on that program.

You know, I testified last year to Congress that the plan the Navy had for buying 3 destroyers every 2 years was unstable. I believe that we ought to be buying 2 destroyers a year. And so my hope is that we'll be able to show the value of serial production here, which would then afford the Navy the opportunity to go do that.

But if you look in the Gulf, and say, the Avondale charges, which, you know, we understand those should be allowable costs. When you're competing on this program, do those allowable costs -- even though you can put those into your rates -- does that change your competitiveness at all?

You know, the competition is basically a total value competition, and so that's something we have to go deal with.

Okay. Great. Thank you.

Our next question comes from the line of Darryl Genovesi with UBS. Please proceed.

Good morning.

Good morning.

So just get to back to get back to Newport margins for a second. If I look back to 2010, it looks like in the first half of the year, your margins at Newport were in sort of the mid-8% range. And then in the second half they look like they are implied up above 10. And then so I was just wondering what exactly caused that step-up in that period, and how does that kind of reconcile back to what you were saying about this year's second half looking pretty consistent with the first half?

Yes. As with all our contracts and everything, we do have little one-time events or what I would call unusual events type things. So, as you -- particularly on the Virginia class submarine program -- as you come out of your post-delivery work and you completed deferred work with less hours than you had planned, or you deliver a ship and you retire risk, you have pick-ups as you retire those risks as you go forward. So, we saw a little bit of that going on last year.

Okay. Thanks. And then on the change to your estimate to close Avondale, I know part of that $310 million was cash, and then another part of it was related to an asset impairment. Is the change, the reduction to 271 all basically a cash impact?

Most of it, yes.

Okay. Thank you.

Our next question comes from line of Heidi Wood with Morgan Stanley. Please proceed.

Good morning, Mike and Barbara. How are you?

Good.

So a couple questions. Thanks for giving us some color, Mike, on your thoughts on 2012, and I just wanted to delve a little bit more in to it, if you don't mind. Can you give us a little bit more color on the puts and takes between the two major yards as we think through next year? In other words, does Newport News stay more or less flat from a margin perspective and the margin that you're talking about is principally at Ingalls? What are the puts and takes at Newport News as well next year that we ought to be aware of?

Yes, I think you've got it about right, Heidi. The Newport News folks are at the level today that we think they'll sustain. There may be -- as Barb just pointed out -- there may be one-time events that will occur from time to time there that would help -- could be better there. But generally, that's kind of the rate that we expect them to sustain. The real issue here is the rolling off of the forward loss contracts that we have on the LPDs. Delivery of 22 is a big issue for us, getting that done this year. That has -- will have an impact on this year, and if for whatever reason it moves into first quarter, it will be a timing issue. But getting it behind us is a very important thing to do.

But we are seeing really good work being done right now on 23 and 24. We expect to deliver those by the end of next year. And so if you kind of fast forward to where we are at the end of 2012, we are down to LPD 25 and LHA 6. And so that -- we will have started up the 113 and the LPD 26. And as we've been talking about, LPD 26 is a stand-alone contract, at this point, that presumes the cost baseline post-Katrina. And so we've -- we're expecting to perform at our normal and historic levels oj those programs for shipbuilding, not just inside the LPD programs. So really, it's the rolling off of the work in Pascagoula and Avondale that's going to drive the performance next year.

Great. And then on CVN 78, you talked about being 26% complete now. As we again think forward in the next kind of 12, 18 months, what are the potential milestone awards that you have? Are there some in '11 and did some occur in '12? And include in your answer where you be in terms of percentage completion by the end of '11 and by the end of '12?

We're basically -- we're into that process of the ship now where we are building the ship in the dry dock. And for the next couple of years as we head towards the launch, that's basically the volume of the work, okay? I think the launch is scheduled in 2013, and so between now and then, that's basically what we're after is get the ship manufactured. Our objective is really to make sure that launch is as high-quality launch as we can have, that we've got as much completion as we can possibly create. As we've seen across all of our programs, the more outfitting that we can do prior to launch, the better performance on the ship. So overall, we've got some pretty good targets there, but the next major milestone on that program, I would say, is the launch in 2013.

Okay. So there won't be any cumulative catch-up adjustments through the progress you make in 2012? Is that kind of what -- is that a better way to understand that?

You know, it depends on performance against our plans, performance and outfitting, how we're doing with schedule. I mean, Heidi, there's a lot of moving parts there.

Okay. I just wondered --

We look at it every quarter.

Absolutely. I was trying to understand if there was certain things you get done that enable you, that you had an agreement with the Navy, that you would get milestone awards when you hit certain junctures.

No. This is all about, are we ready to take credit for retiring risk that we have in the program? And if we get to a point that we think we've retired a certain amount of risk, then we'll step up. If we uncover new risk, then from time to time, we might have to step back. We don't anticipate at this point either of that. You know, between now and launch, we'll be doing those evaluations every quarter, and we'll see how that goes. But we are pretty happy with the performance on that program today in terms of what the team is doing, how they're executing the program, and the way ahead.

Our next question comes from line of Pete Kostiuk with Morgan Keegan. Please proceed.

Thanks very much. This is Brian Ruttenbur with Morgan Keegan. Couple questions. Just on -- back to the history lesson. How much did budgets get cut as you stretched out those carrier fleets in the '80s, to give us the rest of the history lesson? You talked about maybe one ship didn't happen because of the stretch out. Was there -- can you give us percentage cuts per year during the last downturn?

I don't know that I have any -- I don't have any good feel for that. You know, the shipbuilding construction account has been relatively flat for many, many years. Since -- I'd say since at least the latter part of the 90s. And frankly, if you look at it decade by decade, we would -- our perspective is that -- not sure how all these things are going to play out, but in order for the Navy to achieve its plan, the decade ahead probably is a little bit better funded than a decade we just came through, because in many Navy programs, we're going to be moving into serial production and producing ships, whereas over the last decade across the fleet, there's been a lot of lead ship construction and less serial production. So, fewer ships were produced. So I'm not sure -- I don't know off the top of my head a year-by-year where the budget went, but I think that typically, it's been I think fairly flat.

Great. Thank you very much.

Our next question comes from the line of Rob Takacs with SunTrust. Please proceed.

Good morning. Most of my questions have been answered. Can you just -- can you provide me the breakdown of backlog by segment? Do you have that?

Sure. Let's see. At Ingalls, the total backlog is $5.6 billion, and at Newport News, it's $11.2 billion for that total of $16.8 billion.

Okay. Okay. Great. Thank you.

Okay.

Today's final question comes from the line of Myles Walton with Deutsche Bank. Please proceed.

Thanks for taking the question. Good morning. Couple clarifications. The size of the positive adjustment in the second quarter on those 5 or 6 ships, what was the offset to the $19 million negative?

It was a little more than half.

Little more than half. Okay. And then, back on pension, the other clarification as it relates to funding in the out years. I know required funding this year is negligible. What does the funding profile look like from a mandatory perspective today? And then, Barb, do you have a sense of the sensitivities if you close the book today?

Yes. We're really not providing any of that information for the out years. Like we said, minimal pension funding requirements this year. I think it's like $3 million for our non-qualified plans, none for our qualified plans. So, as far as the out year goes, we're not providing any of that information right now.

Okay. And Mike, the real question, as you go into the next negotiation on the CVN 79, on a fixed-price basis, can you give us where CVN 78 will be, when you think the timing for the contracts would be? And how you're approaching that contract, given obviously you wouldn't have been all the way through the 78 yet?

Right. And this is not atypical, frankly. We'll be at a point -- assuming the plan of record -- that we would be negotiating this contract, probably -- it's a 2013 ship, so that's the year we would be negotiating the contract, the end of '12 and the beginning of 2013. Lots of data coming from the 78 to show us where we still think the risk might be in that program.

And as I've said a few times, this is a program where it's sort of a -- there's only one builder and there's only one buyer, so we quickly have to get into a negotiation that is not so much about the price, because we kind of know what the budget for the program is. Then it's a matter of, how are you going to allocate the risk on the program? And that's the way we think about all of these negotiations when we go into them is, what's the way that we're going to equitably share the risk? Or bear the risk? And if we're going to bear the risk, it's going to drive our price up. If there's going to be risk shared, it's going to drive the price down. So, that's the way we think about it, Myles. And they all -- every single negotiation I've been involved with has its own flavor.

Any reason to think that when kind of the initial booking rates on that contract is signed, it would be much different than what Newport News is currently booking?

You know, our booking policy won't change on that program. I'm sure that once we sign that contract, we will book conservatively. We'll have a full view of what we think the risks in the program are, and as we retire them, we will book up.

Okay. Thanks.

That does conclude our question-and-answer session for today. I would like to hand it back to Mr. Andy Green for closing remarks.

Let me just say thanks to all of you for being on the call today. You know, as I said before, we do remain well-positioned to support the Navy and Coast Guard's requirements across all of their platforms. And we remain firmly on track to deliver the long-term operating margin we've discussed in the past. I think this quarter demonstrates the path that we're on, and we look forward to working with you in the future. Now, Andy?

That concludes the call. Thanks, everyone.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes our presentation. You may now disconnect, and have a great day.