亨廷頓·英格爾斯工業 (HII) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 Huntington Ingalls Industries Earnings Conference Call. My name is Chanel and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Andy Green, Vice President of Investor Relations. Please proceed.

Thanks, Chanel. Good morning and welcome to the Huntington Ingalls Industries Third Quarter 2011 Earnings Conference Call. With us today are Mike Petters, President and Chief Executive Officer; and Barb Niland, Corporate Vice President, Business Management and Chief Financial Officer. As a reminder, statements made on 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 the remarks today, Mike and Barb will refer to certain non-GAAP measures, including segment operating income, adjusted segment operating income, adjusted segment operating margin, adjusted total operating income, adjusted total operating margin, and adjusted diluted EPS in the third quarter of 2011.

All adjusted figures exclude a non-cash goodwill impairment charge. Reconciliations of these metrics to the comparable GAAP measures are included in a schedule that accompanied our earnings release and is posted on our website. 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 and reconciliations. With that, I'd 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 third quarter of 2011. Today we reported sales of $1.59 billion, down 4.3% from the same period last year. A $300 million non-cash goodwill impairment charge, which was driven by adverse equity market conditions and not a change in our outlook, resulted in a reported net loss of $248 million for the quarter and a loss of $5.07 per share. Barb will have more to say on the charge in her presentation. Excluding the impact of the charge, total operating margin was 6.9%, up from 4.6% last year, and diluted earnings per share was $1.05 for the quarter, up from $0.86 in 2010.

Total backlog at the end of the quarter was $17.3 billion, up about $400 million over the second quarter. Third quarter was a very successful quarter for the Company. We booked $2.1 billion of new awards, including new construction contracts for DDG-114, the second ship in the DDG-51 restart, and NSC 5, the Coast Guard's latest National Security Cutter. We also booked several sizable maintenance and repair contracts at AMSEC and Continental Maritime and Newport News Shipbuilding won a large maintenance contract to support the Navy's nuclear propulsion program in upstate New York. We delivered 2 ships during the quarter, the submarine California and NSC 3 Stratton, and we began to ramp up production of Virginia-class submarines to 2 per year. Overall, the third quarter demonstrated the strong momentum we've generated since the spinoff last spring. We continue to perform in line with our long-term expectations and we're excited about our prospects going forward.

Now I'd like to review each program in a little more detail, starting with Ingalls Shipbuilding. For the DDG-51 restart, as I just mentioned, we received the award for DDG-114; our second DDG award in just over 3 months. Obviously, we were very disappointed that we did not win the DDG-116 competition. Yet keep in mind that, of the 62 ships to date under the original program, Huntington Ingalls built 28 of them and we've been awarded 2 of the first 4 in the restart. Historically, we have a strong track record for quality and efficiency in this program and looking ahead, we strongly believe that with the management team and operating system we have in place and with a continued focus on cost reductions and efficiency, we will be competitive and positioned to win a substantial share of future DDG awards. On the LPD program, we successfully completed builders trials of LPD-22 San Diego and we expect to complete acceptance trials and deliver the ship to the Navy by the end of the year. We continue to make progress on LPDs 23 through 25, have begun construction of LPD 26, and are working under a long lead material contract for LPD 27.

We remain on schedule to deliver LPDs 23 and 24 next year and LPD 25 in 2013. We are currently negotiating for the construction contact for LPD 27 and expect to have it in place sometime next year. In the LHA program, we continue to make progress on LHA 6, with a successful translation of Modules 1 and 2, along with a Pascagoula record, 571-ton lift to erect the deck-house super-structure. We expect the ship to be 75% structurally erected by the end of the year. As I've said before, 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 anticipate a contract on LHA 7, the next America-class amphibious assault ship, by early next year.

The third quarter saw a couple of key milestones for the National Security Cutter Program, including the delivery of NSC 3 Stratton and the construction contract award for NSC 5, the fifth ship in the program. NSC 4 is also under construction and is progressing well. These ships have been well-received by our customer, the US Coast Guard, and we are very proud to be part of this important Homeland Security program. For the DDG-1000 program, the team at our manufacturing facility in Gulfport employs some of the most advanced composites fabrication technology in the world for the deck-house's and hangers for DDG-1000 and 1001. This proven technology, combined with a highly skilled workforce, positions us to continue the program's strong performance on the DDG-1002 contract, expected to be awarded in early 2012.

At Avondale, the workforce there continues to perform very well and we are continuing with our plan of record to wind down operations. That being said, when we first announced this decision, we emphasized that we deliberately decided to complete construction of the 2 LPDs being built at Avondale, LPD 23 Anchorage and LPD 25 Somerset, to enable us time to work with federal, state, and local officials to explore redeployment opportunities for the skilled and talented workforce at Avondale. In fact, we just recently announced an agreement with the state of Louisiana whereby the state would provide some very attractive incentives for a joint venture. This agreement enables us to aggressively seek out a credible partner and a sustainable market and we will leave no stone unturned in this effort.

Now turning to Newport News, in aircraft carrier construction, CVN-78 Ford is 29% complete and is over 50% structurally erected. During the quarter, we erected the ship's stern as a single 825-ton super lift, one of the largest of the 162 major sections of the ship. The program remains on track, and the ship is on schedule for launch in 2013, with expected delivery in 2015. On CVN-79 Kennedy, structural manufacturing, material procurement, and design and planning are underway, under the construction preparation contract. Although there has been much speculation regarding the 2013 budget and the procurement of Kennedy, the current plan is to begin full construction of the ship in 2013. The RCOH for CVN-71 Roosevelt continues to go very well and due to expand the repair work scope for the Navy, under the contract, the ship is now scheduled to be re-delivered in mid-2013. Advanced planning continues for the refueling of CVN-72 Lincoln and execution should begin in early 2013. For carrier in activations, we are currently in the fourth year of the 5-year planning contract, as we prepare for CVN-65 Enterprise to enter the yard in mid-2013 for defueling of its 8 nuclear reactors.

On the Virginia-class submarine program, during the third quarter, we delivered SSN-781 California, the latest submarine in the program, more than 8 months early. Commissioned 2 weeks ago, California was described by the Navy as the most combat-ready of any Virginia delivery to date. The first 4 of the Block II boats have been delivered and the first 4 boats of Block III are under construction. This includes SSN-787, marking the beginning of the program's 2 submarine per year build plan. For the Company as a whole, our long-term outlook remains unchanged and we are on track to achieve the targets we've discussed since the spin off. All of our programs continued to perform in line with expectations. We continue to make progress on LPDs 22 through 25 and LHA 6, but risk remains on these programs. We are also seeing strong performance out of our other programs, such as the refueling overhauls, National Security Cutters, DDG-51s, LPD 26 and 27, aircraft carrier construction, fleet services, and the Virginia-class submarine program.

In the near term, based on our third-quarter results and what we're seeing so far in the fourth quarter, we expect to finish out the year at a run rate of sales and earnings similar to what we've seen in the first 9 months. Although it is still early to comment in any detail on 2012, we still expect to post year-over-year improvement and segment operating margin as we begin to replace legacy contract revenue at Ingalls with revenue from new business. By the end of 2012, we expect to have delivered LPDs 22, 23, and 24, and to have made substantial progress ramping up VCS, DDGs-113 and 114, and NSCs 4 and 5, and LPD 26. Margin improvements should continue into 2013 after we've delivered LPD 25 and LHA 6, the last of underperforming contracts. Beyond 2013, we continue to expect our margin expansion to accelerate significantly on our way to our 2015 target of 9% plus. Before I turn the call over to Barb for more detail on the financials, I'd like to make a few comments on the defense budget and the future of shipbuilding. First, I want to emphasize that we have no crystal ball and we have no way of knowing exactly what the super committee might or might not do. What we do know, however, is that the Navy and Coast Guard have missions all over the globe protecting America's vital strategic interests. The fleet, including the ships and personnel, is already stretched to its limit in the effort to fulfill those obligations. To maintain the fleet and its mission profile going forward, our customers are going to have to do more with fewer dollars. We've heard the same speculation you have concerning defense budget cuts. Unfortunately, in today's deficit reduction environment, virtually every program is being closely evaluated and its cost is under the microscope.

In the past few months, for example, there has been widespread public speculation regarding various naval shipbuilding programs. But I encourage you to remember that is just that -- speculation. Until we see a final budget, we won't know for sure the impact on our programs, if any. One thing I will note, however, is that the discussions around the defense budget over the past several months have become significantly more thoughtful with respect to the broader implications of the cuts. What began as a swift hypothetical strokes of the pen to cut large programs, looking primarily at the dollar amount directly tied to those programs, has now evolved into more rational discussions that include the significant tangential effects of large program cuts. Although I won't comment on specific programs, rest assured that we are closely engaged with the Navy and Coast Guard during this process and we will continue to work with them to support their program needs in the most cost-efficient manner possible.

Lastly, it's important to remember the context of today's discussions and how, from a timing standpoint, the resulting decisions may or may not impact our business. There are 3 distinct time frames. The first, zero to 5 years, are already established. These are the contracts that are already in the backlog or that we're negotiating today. The debate right now is about the budget for 2013 and the results of that debate will become relevant in the next 5 to 10 years. Yet beyond all of that, what is really being debated today is the question of what kind of Navy will we have in 10 to 50 years? I'm confident, however, that HII is well-positioned to continue to support the Navy's missions, as we have done for more than 100 years.

In summary, Huntington Ingalls posted another quarter of improvement in operating income, operating margin, and free cash flow. Although risk remains in the LPD and LHA 6 programs, we continue to make progress on these ships, as well as ramping up new business. We remain firmly on track to achieve our stated sales and margins targets. At Huntington Ingalls, our goal is to provide US war fighter's with high quality ships at the lowest possible cost and on or ahead of schedule; objectives that we believe will create substantial value for all of our shareholders. 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 comments on pension. Before I get into our operational results, I'd like to discuss the goodwill impairment charge we took during the quarter. As you are aware, we normally perform a goodwill impairment test at the end of November, or more often if certain criteria are met. We performed our last goodwill test at the time of the spend and we determined there was no impairment. However, as a result of the decline in our stock price and market capitalization in the quarter, we were required to take a closer look at goodwill to evaluate for impairment.

We performed the relevant valuations and although our internal cash flow projection suggested a value above that implied by our stock price, the sharp decline in our market capitalization and decline in equity market multiples required an adjustment to goodwill. The $300 million non-cash goodwill charge does not have an impact on our liquidity or debt covenants. Keep in mind that this is an estimate and is subject to adjustment in the fourth quarter as we finalize our testing. I want to emphasize what Mike said. Our long-term outlook has not changed. This non-cash goodwill impairment charge was strictly driven by adverse equity market conditions.

Now, turning to the financials, on slide 4 of the presentation, reported third-quarter sales decreased $72 million from the same period last year, and I will provide more details when I discuss each segment results. Including the $300 million non-cash goodwill impairment charge taken during the quarter, GAAP reported segment operating loss for the quarter was $187 million. Total operating loss was $190 million and diluted loss per share was $5.07. Adjusted for the goodwill impairment charge, segment operating income was $113 million and total operating income was $110 million. Total operating margin was 6.9% compared to 4.6% for the same period last year. Adjusted for the goodwill charge, diluted EPS was $1.05 compared to $0.86 last year. Cash from operating activities for the third quarter was $232 million, up $59 million over last year. Capital expenditures for the quarter were $36 million, flat from last year. For the full year, we continue to expect capital expenditures to be approximately 3% of sales.

Turning to slide 6, Ingalls revenue for the 3 months ending September 2011 decreased $19 million, or 2.5%, from the same period in 2010; primarily driven by lower sales in the DDG-51 program, partially offset by higher sales in the National Security Cutter program. Excluding the non-cash goodwill impairment charge, Ingalls operating income for the quarter was $19 million, compared with an operating loss of $1 million in the same period in 2010. Ingalls adjusted operating margin was 2.6% for the quarter, up from essentially zero last year. Turning to slide 6, Newport News revenue for the quarter decreased $52 million, or 5.6%, from last year; primarily driven by lower sales volume on the Roosevelt RCOH and the Ford, partially offset by higher sales volume on the advanced construction contract for Kennedy and the advanced planning efforts on the Lincoln RCOH. Newport News operating income for the quarter was $94 million compared with $90 million last year. The increase was primarily due to performance improvements realized on the VCS program, offset by risk retirement on the Toledo DMP in 2010 that did not occur in 2011. Newport News operating margin was 10.7% for the quarter, up from 9.7% in 2010.

If you'll turn to slide 7, I'd like to make a few comments on pension. Please note that pension-related numbers are subject to year-end performance and measurement criteria. So what we're showing you here is simply to give you an idea of what 2012 pension could look like under certain conditions. This chart shows the sensitivity of our 2012 estimated FAS/CAS pension adjustment to the discount rate assumption and actual asset returns for 2011 and assumes an 8% long-term return on Assets going forward, which is slightly lower than last year's assumption of 8.5%. Given where we are today, our discount rate assumption would likely fall in the 5.25% to 5.5% range. With regard to cash funding and based on today's conditions, we expect net pension contributions of roughly between $75 million to $100 million in 2012. That wraps up my remarks, and with that I'll turn the call over to Andy for Q&A.

Thanks, Barbara. Chanel, would like to start the Q&A. And just as a reminder to all participants, please limit yourself to 1 question and 1 follow-up so we can get in as many as we can.

(Operator Instructions) Jason Gursky, Citi.

Mike, I'd love to just get some qualitative commentary from you if possible, on what you think the DDG-51 award went away from you and what impact this might have on your ability to sustain flat revenue outlook over the 5-year period out to 2015?

Well, as far as outlook goes, we're not changing the outlook based on this first competition. As I said, we're very disappointed that we didn't win that competition. On the other hand, this was the very first competition that we've had since Katrina happened. We've been doing a lot of work over the last 3.5 years, getting ourselves ready, doing the things that we thought were important and we didn't measure up. But what we have now is, we actually have a stake in the ground and a target to shoot for. Before that, we were doing what we thought was right and what we thought would make value and we made a lot of progress. We just didn't get all the way to where we need to be.

Now have a target to shoot for. We look forward to the next competition. We congratulate the team at Bath, we wis them well and we'll see them in the next competition. We're energized to go get it.

Okay. Great. I don't know if you've had a chance yet to see this report out today, out in the press. But there's some suggestion that you're going to see a 5% withholding on progress payments related to the DDG-114, due to some deficiencies and it sounded like management processes or something to that effect. I was wondering if you have any insights on that and what that means from perhaps an earnings and a cash flow perspective?

In all of our contracts, we usually end up with several kinds of disputes with our customers over various issues. This particular one I think has to do with earned value management systems, but we have a range of them. Those disputes and withholds are spelled out in our filings. Again, this is something we have engaged, frankly, with our customers on and we will continue to engage on. But as far as our outlook and flows for the business, we don't see this as having any effect.

Just to confirm, there's no impact to cash flows or earnings driven by this in the near term?

Not to our outlook, no.

Okay. Thank you.

Rob Spingarn, Credit Suisse.

Mike, you talked about LPDs 22 through 24 delivering by the end of '12 and you also mentioned 9% margin in the Gulf by '15. Are there any timing changes here? Was LPD 22 due this year? And the target on the margin, is that slipping to the right?

No, there's no change. We do expect 22 to deliver this year and 23 and 24 next year. Our target has always been the 9% plus in 2015. So, no change there. The team is performing right online and right on track with the plans that we've laid out.

Okay. Would you be able to give us some sense of how the margin plays out in '13 and '14? You've been clear that we shouldn't look for much in '12. '13 is really where we see a bit of a jump, just given the number of zero margin ships that depart in '12. But how do we think about '13, '14, '15 then?

Without being terribly specific, what we've said is that 2013 is a point of inflection for margin improvement. What will happen is by 2013, all of the underperforming contract work will be behind us and Avondale's situation would be behind us at that point, too. The new contracts will be coming on. Our bias towards conservatism on the front end of new contracts will be ramping up on those contracts in terms of margin recognition, which is why we see this getting up to the run rate in 2015. So, think of 2013 as a point of inflection.

How do you think about 2012 guidance and timing on that guidance?

At this point, I'm not sure that it makes a lot of sense for us to try to guide into this environment at all.

Is that more due to what's going on in Washington or is it the uncertainty around the Avondale closure situation?

I'd say yes. I'd say yes. Any one of these things would be completely assumption-driven. So to have 3 of these things and these 3 things, all of them being so assumption-driven, pick your set of assumptions, you get a set of numbers. From our standpoint, that's not effective in our communication plan. What we're trying to communicate is that we've got our eyes wide open on what the risks around these different issues are.

Just to finish up, you just had a great margin at Newport News in the quarter, I think everybody sees that. How sustainable are those performance improvements on Virginia? What else should we think about there and how do those margins go forward?

This is Barb. What I'd say is we have multiple ships under construction on the Virginia-class program and I don't believe 10.7% is sustainable and ratable. But during the third quarter, we had an unusual amount of favorable risk retirement, primarily related to the delivery of California and the New Mexico completing the warranty period. But because we have 6 subs under construction at any point in time, we have different risk retirements across each one of those ships. So, you will see some lumpiness in our return on sales in that program.

Okay. Thanks very much.

George Shapiro, Access 342.

Barb, I saw the provision for losses went down $21 million in the quarter, so you're at $31 million now, so probably runs out in the first quarter of next year, except that LPDs don't finish delivering until the end of next year. So why wouldn't there be the risk of another charge that needs to be taken there?

We've talked about risk associated with getting those programs out of the yard. But right now, as we see it, both LPD 23 and 24 are over 85% complete at this time and they're going to deliver in the latter part of the first half of next year. So, we feel at this point in time, those provisions are about where they need to be.

Okay. Then one question on inventories, they certainly were better and your cash flow was very good this quarter, but they still seem like they're too high. Can you just go through what's happening there? Year-to-date, you're still up close to a couple hundred million dollars.

Sure. Not a problem. Our cash performance was actually pretty good, but I was really due to accelerated cash collections and just timing. Inventory is higher than the end of last year and part of it's due to accruing the Avondale restructuring costs. But also, we've talked about the performance on our LPDs and LHA 6 and it manifests itself in inventory with the retentions and the progressing on those ships. So you'll see a big change in that inventory as we deliver the ships. Right now we're just paying the price for that.

Okay. Thanks very much.

Heidi Wood, Morgan Stanley.

Yes, a couple of questions to circle back on Newport News. Can you break out, what were the contract cumulative adjustments in the quarter and maybe talk about the driver of these 22% services margins in the quarter? That was pretty impressive.

Heidi, we're not going to break them out, the numbers. But what I can tell you is the unusual events were just the delivery of California and then New Mexico coming out of the warranty period. So we had some pickups because we retired risk there. But across the program, we have different incentives. We have material incentives, schedule incentives, small business incentives. As we retire all that risks, we'll have cumulative pick ups there. When we make the complete modules and deliver modules, we'll retire risks there. We'll retire risks based on our cost performance, our labor performance. So, it's a constant watch across each of the ships.

The services margins -- can you talk to us about that uptick?

The services margins, there was a little bit of pick up related to, a very tiny amount, related to the Toledo DMP. Then in addition to it, it's just all of our Savannah River, the way we do that margin with no sales comes in and it's just timing. I don't expect to see that continue.

Should we think of the services margins as being more in the mid-teens on a sustained basis, Barb?

I think it'll be a little less than that because of the era funding that we received on the Savannah River contract. And that will be declining.

Okay. Mike, a question for you and then I'll turn it back over. Bigger picture, as you talk about the skyline and heading into '13 and beyond, and obviously the roll off of the previous 4 programs, you're intimating more favorable contract terms versus the past. But help us understand, across the industry, we're seeing evidence of much tougher contract terms coming out of the Pentagon. You have the F-18 multi-year at 0.5 the prior margins, KC-X signed it's fixed price development at zero, and F-35 LRIP V, which at this stage not signable [should] cost review by Shay Assad. So, what's happening specifically in your contracting environment that is enabling you to drive your confidence that you're going to be able to be seeing higher margins and better T's and C's through a defense budget down cycle?

That's a great question, Heidi. I think to answer that, let's go back and remember why we have underperforming contracts in the first place. The contracts that were signed on the LPDs and the LHA were signed in the aftermath of Katrina when the yard was being rebuilt, but the culture of the yard had been broken. So the cost baseline that was assumed in those contracts was not correct. What we are doing, while we absolutely recognize the points that you make, that there are certainly going to be different kinds of risk sharing, there's going to be different kinds of terms and conditions out there. The fundamental issue for us, is if we can get the cost baseline right, that's going to be a major improvement in where we've been over the last 5 years.

The contracts that we're negotiating today, we are negotiating those off of the cost baseline that we're actually performing to today. So we know what the cost baseline is for us to go get this work under contract. As I said, you're exactly right. There are other pressures out there that, if we were running had a full rate, I would say we'd be in the same boat as everybody else. But we're resetting the cost baselines right now in all of our contracting, so that overwhelms the effect that you talked about.

Okay. Good. Thank you so much.

Sam Pearlstein, Wells Fargo.

Barb, you had mentioned 3% of sales for CapEx, which if you do on the order of $6.5 billion, gives you about $190 million of CapEx. That's a pretty big step up from where you've been running. Can you talk about what we might see in the fourth quarter there and why it's going up?

You calculated about right and really, that's just kind of a normal phenomenon of end of year. All your vendors are going to get in their invoices and want to get paid by the end of the year, but also some of our work is completing towards the end of the year. So, we've talked about, we were finishing the inactivation facility, we have the extension on the MOF going on, getting ready for the 2 subs a year, we're buying equipment getting ready for the 2 subs a year because we've already started that second sub. So a lot of it, it's just timing at the end of the year. Somehow, the suppliers always get their invoices in at the end of the year to make their sales numbers, too, as they complete the work. I look for it to be real.

Okay. Then, when you mentioned the $75 million to $100 million of pension contributions, how does that compare to this year?

This year, we just had a small amount of pension contribution, so it is significantly more. The discount rates are driving that.

Okay. Just one follow-up, I know you don't want to talk about the Virginia-class positive adjustment in terms of the size. But it looks like in the first quarter you had 7%, 9% now 10% margin in Newport News, which is a business that I would have thought would be generally more stable. When should we start to see something where there aren't these big swings on a quarterly basis?

Well, that's the problem. When you look at our business on a quarterly basis, it's a little harder because of the lumpiness; both with cash, as well as risk retirements on the program. So, you really need to look at this business more instead of quarter-over-quarter, but more year-over-year type. Look at the total year.

Okay. Thank you.

Noah Poponak, Goldman Sachs.

Is there something that makes your third quarter margins seasonally strong relative to the other 3 quarters of the year?

What we were just talking about on the Virginia-class, just the fact that we delivered California, we came out of --

I'm not talking of this year, specifically. I mean on an ongoing basis every year. It looks like, historically, there's been some seasonal strength in the third quarter relative to the year, although it doesn't happen every year. I'm just wondering if there is something that would drive that for the Company?

I would say no, in general. I think you could note that our third quarter is the end of the government's fiscal year. So there may be, on kind of a random basis, there may be some effect of that might have a little bit of an effect. But in this particular case, the fiscal calendars have nothing to do, really, with this. This was about work that we finished and risks that we retired. It just happened to be this quarter.

Okay. Following up on the question before about tougher terms of trade with the Pentagon where you're kind of saying that you're starting point for your cost basis is in a substantially different place. How do you think, Mike, about the risk that, as you improve, when you go back to the negotiating table with the Pentagon, they seem, in a lot of other cases, very willing to strongly suggest that they need to then reset the bar again on you and have you share a lot of the improvements you've garnered with the customer?

As we've talked many, many times, when we go to negotiate a contract, we're in that end of the business where we're either a sole source supplier or we're in a head-to-head competition with 1 other supplier. We're not in that end of the business where there are 8 competitors out there and they're in a pretty strong competitive environment which drives the negotiations. So typically, in our negotiations, it's usually less about price and it's more about how are we going to share the risk that's here? The government wants to buy the ships that we're offering. We would sell the ships we're offering. We want to try to find a way to share the risk, because by sharing the risk, we are creating value for our shareholders and we're saving money for the taxpayers. So I think that, that discussion of how are you going to share the risk is what our negotiation's all about.

What gets lost in all of this is that if you sign a cost-type contract with the government, the reality is, even if you only retire 80% of the risk and you have to increase the cost by some dollars for the 20% you didn't retire, you've saved the taxpayers, in our contracts, you've saved the taxpayers hundreds of millions of dollars. Because if they had signed a price-type contract, the price would've been 30% to 40% higher. So, that's what the discussion is all about for us, really. It's less about the price and it's how do you craft the contract in a way that makes sense for the taxpayers and makes sense for the shareholders? For me, the center of that conversation is, do we have a common view of what the risk is? Do we have a view and can we create a common view of how we're going to share that risk? If they want to put all the risk on me, the have to pay me more for it. If we decide to share it, then that can be mutually beneficial to both of us.

That's helpful. If I could just sneak in one other quick one for Barb, I might be looking at the math incorrectly here, but it looks like you're saying that the '12 discount rate would be down 30 to 60 basis points versus '11. If I just look at the Moody's AA, it's down 125 basis point year-to-date. How do I foot that?

Yes. We used a discount rate based on AA bonds where the duration matches the timing of our pension flows. Based on where discount rates are today and everything, I'd probably looking at the lower end of our range we're giving you.

Okay.

But I won't know that until the end of the year. End of the year we do our measurement, it's everybody's guess what the market's going to do and where we're going to be.

Okay. Thank you.

Finbar Sheehy, Sanford Bernstein.

Just go back to contract awards again, you booked over $2 billion in awards for the quarter, but something we've been hearing elsewhere is that there has been slowing progress on moving contracts forward. Are you seeing any signs order flow being delayed or of orders you expected taking longer to be finalized?

What we're talking about at this point in our contract negotiations are contracts or ships that have been authorized and have either been fully appropriated or mostly appropriated and we're working our way through that. The negotiations are tough, but we don't see that things are being held back, if that's what you mean.

That's what I was asking, yes.

No. We're not seeing the effect of that. We are seeing that things are taking a little bit longer just because of the, as I said before, trying to get a common view of what the risk in the program is and then trying to find a way to make sure it makes sense for everybody. That's taking a little bit longer now, but that's not a flow issue, I don't think.

Then just turning to the next opportunity on DDG-51s, when would that come up and when would you expect to be awarded?

Let's see. I think that's probably about this time next year is what I think the plan is at this point. But we'd have to confirm that. I think that's what it is. I think that the most important thing for our team right now is the feedback loop that we got from this last competition. Allow us to go in and see what the opportunities are for us to be more competitive.

Great. Thanks.

Brian Ruttenbur, Morgan Keegan.

Just a follow-up to some of the other questions to get clarity. Our G&A, can you talk about it in the fourth quarter? You had a drop from second quarter to third quarter. Can you talk about that just in the fourth quarter, near-term looking at your [toes]?

Yes. I hate to use the word lumpy all the time, but that's just kind of the way our business is. I would look at not a significant change in the fourth quarter to the third quarter.

Okay. Then most of your pension expense is going to be in the G&A line in 2012 because you're going to have that increase?

We will have an increase, yes.

And most of it will be in the G&A line?

Yes. Yes.

Perfect. Thank you very much.

Carter Copeland, Barclays Capital.

This is [Mayor] in for Carter. Mike, you've kept your 2015 long-term guidance the same in terms of flat revenues and a 9% plus margins. With not winning DDG 116, we're just wondering does this erode any of the cushion that you may have had or did something else fill its place as we look towards the longer term forecast?

Our general presumption in the DDG line is that we'll win about 0.5 of those and there's 4 ships have been awarded so far and we've got 2 of them. We've obviously got another competition coming up and we're getting ready to go do that. But the loss of this specific ship, while it is very frustrating, it's also very helpful to my team. It will allow us to be even more competitive for the next go round. All of that's not going to have, at this point, we don't see any change, any reason to change our outlook for 2015.

Okay. Then you mentioned that most of the risk on LHA 6 lies ahead. I was just wondering if you could give us some color in terms of how should we think about the phasing of risk on this ship? Where do you encounter most of the risk? Is it the last 25% or is most of it going to come up probably in the next quarter?

Yes. I think that on these kinds of programs, particularly the LHA 6 program, you're going to recognize it from when you find it on the ship. When you find it on the ship is when you're in the test program. If you've done the work, if things have come together the way you planned for, then the test program will validate the work that you've done. The uncertainty comes in because of the nature of the new design work and the nature of the way that we put in. Now, we've worked hard to improve our first-time quality in the business, and we're doing very diligent work. The program team on that ship is working very hard to define the scope of work as they're going through the construction process here. But it's really when you get into the testing program that you can validate either A, we've retired that risk, or B, we've got more work to go do before we're done with the work. So that's why it's backend loaded the way that it is.

Okay. And if I can sneak in one final one from Barb, did you mention, by any chance, what you expect free cash flow to be for the full year?

Good question. I talk about this all the time, our invoices are pretty big and at the end of the year, have a lot of invoices outstanding and it's all based on timing. So, very hard to give you a point estimate on that. If all goes well, I look for the trend to continue favorably. But we did have a great timing in the third quarter. A lot of invoices were paid early. So, I look at cash flow to improve a little bit.

Okay. Great. Thanks, guys.

George Shapiro, Access 342.

Just a follow-up, Mike, it looks like revenues this year may be coming in at [6.6] or so. Is that going to be relatively flat next year? Is there any color you can give? It would seem like Newport should be up and the Gulf down, if there's any color you could give on that?

I consider that, at this point, to be relatively flat. We are going through a phase where you'll see the work shift from one side to the other. In fact, you're already seeing some of that, but over the long-term, we don't see any reason to change the overall outlook for the business.

Okay. Next year you would expect the Gulf to be down and Newport to be up some to reach that flat kind of number?

We haven't provided any sort of guidance by division like that. We just have kept it at the corporate level and said, this looks pretty flat across the whole business.

Okay. Thanks.

Pete Skibitski, SunTrust.

Mike, I was wondering if you could share with us how much incremental financial liability you could potentially incur with regard to this Avondale venture or the MLU with the state of Louisiana? Because it seems like it complicates the shutdown situation there. You start to think about the success the US has had in commercial shipbuilding and so you wonder if you're maybe going to incur a lot of liability there.

Our plan of record that we are executing today is that we're closing that facility. There are lots of reasons, lots of stakeholders who have hope for other outcomes and we are very respectful of that. We purposefully wanted to explore all of those other outcomes because we've got great shipbuilders there and we owe them the chance to go and explore the possibility of other outcomes. The state of Louisiana has stepped up and said, if you're able to find another path, the state is willing to create some incentives. You could think about this as we're on a path to closure, but if there's another way, they're trying to find a way to incentivize that.

What we've said from the beginning is that we've got to have 4 things fall into place for us to do anything other than close the shipyard. The first is we really do need a package of incentives from the state and they've come forward in a very big way and I compliment the state of Louisiana. They are working very, very hard to try to help us find another outcome. The second is that we needed to have some agreement with the Navy that we were under the far that we would be able to go explore these alternatives without giving up our rights as far as restructuring costs and closure and we got that. So that's the first 2 of the 4 things we need.

The last 2 things we need is we need a credible partner and we need a sustainable market. Now, if you put those 4 things on the list, you'd say okay, which of these are the toughest things to get? The sustainable market and the credible partner are clearly the toughest things to get and that's where we are now. I don't think there's any chance that we would be able to get a partner if we didn't have the state working with us and we didn't have the Navy working with us on this. But having said that, just because they are working with us doesn't mean that we'll get one. As far as the complication goes, until we have a partner, if we have one, and until we believe that there is some sort of sustainable market that, that partner wants to pursue, that we could support, we're on a path to closure. We've got that well scoped out.

There's a program plan that we're using. Unfortunately, we've continued to lay off people and we're closing shops there even as we go forward. It's not the most elegant approach to the business. It's what we owe to our fellow shipbuilders at Avondale, the folks that are doing such great work. We owe them, it's our responsibility to make sure that we turn over every rock looking for possibilities here. Stepping all the way back, what we're seeing is that there are a lot of folks out there who are looking for sites to do manufacturing. So who knows? We may be able to make something out of nothing here.

Can you envision a scenario in which you retain majority ownership of the yard post 2013? Or is that kind of a long shot and your preference and maybe the likelihood is you'll wind down your ownership whether or not the yard closes or not?

Yes, I'm not sure I want to be that specific yet. Our aperture is pretty wide open to possibilities. But the fundamental reason we're looking for a credible partner and a sustainable market is this needs to be in a place that's not in the Navy work that we're doing today. That means it's going to be in some line of work that we're not doing today where we don't have a whole lot of expertise. So, we're going to need somebody who understands the sustainable market that we're looking for. They understand what the keys to success are going to be there. They understand how to drive and orient the processes so they can be successful. We would think of that more as a follow role for us, as opposed to a lead role. But our aperture is wide open at this point.

Okay. Got it. One last question on a separate topic, can you share with us why sales volumes on the Ford would be down during the quarter? Were you in a transition mode between phases or something? Or was it an issue of number of days in the quarter?

No, it's really driven by the engineering con time is starting to decline a little bit and those constructions picking up. But we had last year, full-fledged engineering and construction going on at the same time. It's just a little decline on the engineering side.

I see. Okay. Thank you.

Yilma Abebe, JPMorgan.

One balance sheet question from me, given your cash balance and cash flow and expected cash flows going forward, can you comment on your expectations for debt paydown? Even if you don't want to talk about specific numbers, perhaps you can address, generally, your outlook on leverage?

Right now, what we're doing on the cash side is, and we've been saying this all along, until we get these LPDs and LHA 6 out of here, we're going to be conservative on our cash deployment strategy. Starting next year, we'll start taking a real hard look at a balanced approach. When we make that decision, we'll let you know.

Thank you. That's all I had.

Ladies and gentlemen, that concludes the Q&A session. I would now like to turn the call over to Mr. Mike Petters,

Thank you. I just want to thank you all for participating in the call this morning. Again, this was another great quarter of improvement for us in operating income, operating margin, and free cash flow. We do still have risk on the LPDs and LHA 6 programs. But we are making progress on those ships, and we are ramping up our new business and that means that we are still on track with the plan that we laid out at the beginning of this year.

Our goal here at Huntington Ingalls is to provide our war fighters with the highest quality ships at the lowest possible cost on or ahead of schedule. Those are objectives that we believe create value for all of our stakeholders. Thanks for joining us this morning and we look forward to seeing you in the future.

Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.