亨廷頓·英格爾斯工業 (HII) 2012 Q1 法說會逐字稿

Good morning, and welcome to the first quarter 2012 Huntington Ingalls Industries conference call. My name is Montoya, and I will be your operator today. All participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference. (Operator Instructions) I would now like to turn the presentation over to Mr. Andy Green, Vice President of Investor Relations. Please proceed, sir.

Thanks, Montoya. Good morning, and welcome to the Huntington Ingalls Industries first quarter 2012 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 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, a non-GAAP measure. Reconciliation of this metric to the comparable GAAP measure is included in the appendix of our earnings presentation that is posted on our website. We plan to address the posted presentation slides 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 first quarter of 2012. Today, we reported first quarter sales of $1.57 billion, down 6.9% from the same period last year and earnings per share of $0.67 down from $0.92 in the first quarter of 2011. First quarter segment operating margin was 6.4%, a significant improvement from 5.0% last year, and we ended the quarter with $551 million of cash on the balance sheet in line with what we told you on the fourth quarter call. Total backlog at the end of the quarter was $15.5 billion compared with $17.4 billion last year.

Now, it's only been about six weeks since our last call so not much has changed with respect to our major programs or outlook. That being said, overall it was a good quarter for us, and one that reflects the dedication, talent, and commitment of our 38,000 ship builders. Newport News continues to execute on major programs such as construction of the Navy's newest aircraft carrier Ford, construction of Virginia class submarines and the overhaul of Roosevelt, while preparing for construction of Kennedy, the refueling of Lincoln, and the inactivation of Enterprise. At Ingalls, we continue to make significant progress toward delivering the legacy LPDs and LHA 6 America while securing new business in amphibious ships, national security cutters, and destroyers. With two legacy ship deliveries this year and the remaining two scheduled for next year, the Ingalls team is closing in on returning margins to normal and sustainable levels. Overall, we are on track to deliver our goal of 9%-plus total operating margin in 2015 on a flat revenue base.

Before I get into more detail about our individual programs, I would like to make a few comments on the defense environment, the budget, and how we are proactively managing our business in the face of continued uncertainty. Remember that because of the long duration of our contracts, the majority of the programs we are working on today and for the next few years are already in backlog having been funded under previous appropriations. When we look at major program decisions and budgeting, generally speaking, this impacts our revenue not this year or next but a few years out. Earlier this year, the administration announced a strategic shift to the Pacific and the subsequent budget request reflected the priorities necessary to support the new strategy. As we said on the last call, the budget request was generally supportive of Navy programs including the construction of Kennedy, nine Block 4 submarines, nine DDG 51s, and the Lincoln refueling. As we expected, there was less support in amphibious ships with LHA 8 being pushed out a year and LSDX delayed two years -- two programs which are critical to the Navy's and Marine Corps' ability to accomplish their missions.

The potential for sequestration, however, clouds the outlook for defense spending although it's difficult to say much about it given it is unclear as to how it would be implemented. And, despite all the commentary from industry and government about sequestration and the negative effects it could have on the US industrial base and our military's ability to meet its commitments, so far nothing definitive has happened to change the prospects of it occurring.

Now, amidst all of the external uncertainty around defense spending, internally we are aggressively managing our existing programs, pursuing cost reduction initiatives, and looking for innovative ways to improve ship affordability. Every day, we work closely with our partners, the US Navy and the US Coast Guard to ensure that the ships they need to accomplish their missions are more affordable, provide the required capabilities, are of high quality, and are delivered on schedule. At both Ingalls and Newport News, we are constantly evaluating ways to reduce the cost of building the finest and most advanced warships in the world without sacrificing the 126-year-old tradition of high quality and performance that our customers have come to expect. This includes reducing overhead, more efficiently managing the highly complex and nationwide ship building supply chain, improving learning curve efficiencies, boosting labor productivity, and maximizing the significant benefits of serial production.

Two good examples of this are the Virginia class submarine and the national security cutter programs where we've combined detailed, consistent class planning with strong quality management and program oversight to achieve true serial production which maximizes learning curve efficiencies and makes these highly capable ships affordable for our customers. The submarine and cutter programs are just examples. We are applying these concepts across the Company which we believe will result in a more efficient organization that fully supports the Navy and Coast Guard ship building objectives.

So now, I will just hit a few highlights of our major programs. LPDs 23 and 24 should go to sea trials in the next few months, and we expect to deliver both ships some time in late summer or fall. We successfully launched LPD 25 last month and are continuing to ramp up construction of LPD 26. We are working under a long lead material contract for LPD 27 and expect to finalize the construction contract for LPD 27 in the near future. LHA 6 America remains on schedule to launch early this summer and deliver next year, and we are in the process of negotiating a contract for the next America class amphibious assault ship LHA 7 which the Navy just recently named Tripoli.

In the NSC program, we were awarded a long lead, material contract award for NSC 6 and expect a construction contract for NSC 6 in 2013. CVN 78 Ford is now 76% structurally erected. The program remains on track, and the ship is on schedule for launch in 2013 with expected delivery in 2015. We are in the construction preparation phase for CVN 79 Kennedy and expect to have a construction contract in place some time in 2013. In submarines, we expect to launch Minnesota, the last Block 2 submarine late this year with expected delivery in mid-2013. We expect a contract award for Block 4 in 2013 for at least nine boats to be built between 2014 and 2018.

Looking ahead to the rest of 2012, we don't see any changes to what we discussed on the last call. We expect stable performance out of Newport News relative to 2011 and modest segment operating margin improvement at Ingalls. Overall, this year should look like 2011 on the top line although segment operating margins should show some improvement.

In summary, we began 2012 with results right in line with our expectations, and subject to potential sequestration, our long-term outlook is unchanged. Our backlog remains healthy and should increase significantly over the next 24 months as our new business pipeline contains LHA 7, LPD 27, at least nine Virginia class Block 4 submarines, CVN 79 construction, the Enterprise inactivation, and the construction of multiple DDG 51s. Although defense budgets are under pressure, we believe we are well positioned across multiple platforms to support our nation's naval strategy. Our entire Company is intensely focused on providing affordable, high quality ships for our customers, and we are firmly committed to creating value for our shareholders. So with that, I will turn the call over to Barb Niland for some remarks on the financials. Barb?

Thanks, Mike. Good morning to everyone on the call. I would like to briefly review our consolidated segment results as disclosed in the press release. Turning to the financials on slide four of the presentation, reported first quarter sales were down 6.9% compared to the same period last year. The decrease was mainly driven by lower volume following the delivery of NSC 3 and LPD 22 in 2011 and lower volume on the Roosevelt RCOH and the VCS program. These were partially offset by higher volume on the construction preparation on Kennedy and the advanced planning on the Lincoln RCOH.

First quarter segment operating income was $101 million, and total operating income was $80 million. Segment operating margin was 6.4%, up from 5% in 2011. Total operating margin was 5.1%, up only slightly from the same period last year due primarily to $13 million higher pension expense and a $9 million difference in deferred state taxes in 2012. Diluted earnings per share for the quarter was $0.67 compared to $0.92 for the first quarter 2011. The decline in EPS was driven mainly by higher interest expense, pension expense, and deferred taxes.

In line with what we said in the fourth quarter call, we ended the quarter with $551 million in cash. Cash used in operating activities was $329 million, an improvement of $35 million over the same period last year. Generally, we are cash users in the first quarter, and this trend reverses over the remaining three quarters. We saw that in 2011 and expect a similar pattern in 2012. Additionally, during the first quarter, we contributed $122 million to our pension plans, approximately 50% of our expected full-year contribution. We expect the remainder of our 2012 pension contributions to be weighted toward the second and third quarters.

Capital expenditures were $27 million, down from $63 million in the first quarter last year. As a reminder, capital expenditures in the first quarter of 2011 included a $36 million reimbursement to the state of Louisiana for our cooperative endeavor agreement associated with the wind-down of the Avondale shipyard.

Turning to slide five, Ingalls revenues for the first quarter of 2012 decreased $69 million, or 9.1% from the same period of last year, driven primarily by the delivery of NSC 3 and LPD 22 in 2011. Ingalls operating income for the quarter was $20 million compared with $17 million in the same period in 2011. Ingalls operating margin was 2.9% for the quarter up from 2.2% last year driven by the delivery of LPD 22 San Diego.

Turning to slide six, Newport -- excuse me one second. Okay. So, turning to slide six, Newport News revenues for the quarter decreased $45 million, or 4.8% from the first quarter 2011 primarily driven by lower volume on the Roosevelt RCOH and the VCS program. This was offset by higher volume on the construction preparation contract for Kennedy and advanced planning efforts on the Lincoln RCOH. Newport News operating margin for the quarter was $81 million compared with $67 million in the first quarter last year. Operating margin was 9.1% for the quarter compared to 7.1% in the first quarter 2011. The increase in operating income was primarily driven by the one-time negative adjustment in Q1 last year of approximately $9 million on the Ford contract and additional risk reduction on the VCS program. Interest expense for the first quarter was $30 million, and the effective tax rate was 34%, both in line with our expectations. That wraps up my remarks, and with that, I will turn the call over to Andy for Q&A.

Thanks, Barb. Just as a reminder to everyone, we request that you limit yourself to one initial question and one follow-up. And, always are welcome to get back in the queue for any additional questions so we can get as many as possible. With that, I will turn it over to you, Montoya, to manage the Q&A.

(Operator Instructions) Our first question comes from the line of Carter Copeland of Barclays. Please proceed.

Good morning, Andy, Mike, and Barb. I know this is a tough topic to address, but I wondered if you could talk a little bit about sequestration and scenarios you are evaluating and how ship building may differ from other programs that we would see at your peers on things like overhead flexibility, or the lack thereof? How we should think about the impact of long-term funding and perhaps unspent funds that you could live on a little bit longer than programs that are incrementally funded? Lastly, if there are scenarios in your mind that could push programs into a Nunn-McCurdy position where we could see stop work orders or anything like that? Anything you are evaluating as you think about scenarios? Any color you could provide would be really helpful.

Sure. That's a wide open question. Let me see if I can bring a little bit of color to it. Thanks for the question. We've said from the beginning that this prospect of sequestration -- it's out there. But, the vast majority of the work that we need to do in the next three to five years to achieve the objectives that we have been talking about for the last year, we have under contract. We really have two more contracts to get -- the LHA 7 and the LPD 27 contract -- we're close on those. We just have got to get those finished. Those are really the last two of the original set of contracts that we talked about a year ago that really push us out to the three- to five-year time frame. Our focus in that body of work is to retire the risk that we have in some of our heritage work. The LPD 22 delivery was a big milestone for us at the end of last year. This summer is going to be a big risk [retirement] summer for us with the launch of America, the sea trials and ultimate deliveries of LPD 23 and 24. This is -- we are in a place now where a big part of what we have been working on to retire risk, we are heading into the zone where it's time to get it retired.

Relative to the law and the sequestration, I don't know that I have any other particular insight in it than anybody else does. A whole lot of folks say that ultimately this is not going to happen. But, a whole lot of folks also say they have no idea how it may not happen. Or, if it does happen, it is going to have some different effect or maybe a reduced effect. There are a whole host of initiatives, but it doesn't appear to me, anyway, that there is any sense that there is some kind of an arrangement that's going to come out before the election that is going to bring any more clarity to this.

In our view, we step back and our business -- we have the advantage of really seeing the whole might of America come to bear in our shipyards. We have to invest in our work force. We have to invest in our facilities and our tooling and our plant. We have to support our supply chain. Our work force comes to us, and we make significant investments in them over time. The prospect of sequestration gives us pause as to what kind of investment we would need to be making over a period of time. When you step back and say that it takes -- it might take eight years to create a nuclear pipe fitter in Newport News, the question you have to ask yourself as you're starting that process today is what's the real prospect there? And, what's the return on that? We are thinking our way through that sort of thing.

When you step back and you think about capital investment in our facilities, now you are thinking about how do you invest in your core business when you are not really sure what the core business is going to look like the day after tomorrow. And so, we are thinking very carefully about that. And then, when you take a look at our supply chain, we have 5,000 suppliers across -- in virtually every state. This supply chain, already in ship building, has been thinned over the past several years. Roughly on the order of about 60% of our supply chain now is in a bit of a sole source position. If you step back and think about what sequestration could do to that, the 60% that are sole source -- that number could go up.

At the end of the day, we step back and we look at all of those things. The one thing we know for certain is that if sequestration happens, the cost of the programs that we are providing to the Navy and the Coast Guard will go up. Not necessarily the cost of the programs that we are executing today, but the cost of the future programs that will go up. You want to go buy another aircraft carrier. You want to compare it to the cost of the Ford. My forecast would be that it would be more expensive in the environment that gets created under sequestration. From my standpoint, it's a terrible way to run the country. I think that it's something that cooler heads are going to have to come together and find a solution to because we are just the ship builders.

I am sure that the entire industry is wrestling with this in the same way. We have the advantage of actually being able to step back and say that there is a day after sequestration and there's three to five years of things that we've got to go do to get right to meet our financial plans, and we can work on whatever the impact of sequestration is after it's over. A lot of the folks in our industry do not have that ability, and a lot of the folks in our supply chain do not have that ability. For us, it's important that strategically we get this right.

As far as particular scenarios, because of our -- because of the cycle time of what we are doing, we are not evaluating any particular scenario. Quite frankly, because I think the Pentagon may actually have this right. As soon as you start to evaluate any scenario, it becomes the straw man against which all other scenarios get measured, and I don't know that anybody particularly wants to be the straw man right now.

That's about as candid as I can be about it. We are watching it. We are engaged. We are talking about the impacts -- the challenges in our industrial base -- in our ship building industrial base. We are working it very hard, but we were focused on retiring the risk in our business. Driving this business to where it needs to be over the next three to five years, and we have the tools in our hands today to do that.

Thank you very much. I know it's a tough topic to address, but I appreciate the color.

It's a little long-winded, too, I know.

That's okay. It's a tough topic.

Thanks for the question.

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

Good morning. If you look at the margins at Ingalls, they were improving. Could you talk a little bit about what operational metrics you are looking at in the Gulf right now, and how we should think of this margin improvement as fitting on some kind of a trajectory toward the goals that you've described.

First of all, I think the way to think about what's happening in the Gulf, I will go back to what we just talked about. We've done a lot of work over the last four years to put ourselves in position to retire a substantial amount of risk. The work that we are going to do in the next few months is going to be the culmination of that. The going to builder's trials on 23 and 24 are significant milestones. Launching LHA 6 is a significant milestone. We just launched LPD 25, another significant milestone. Over the next four months, you are going to see these milestones go by, and you will see us be able to step back with a little bit more certainty about -- okay, these things, just like with LPD 22, we were able to move it past another big piece of the risk.

As we've said all along, the year 2013 is really the inflection point for any sort of trajectory in performance at Ingalls. Our operating system is full of metrics where we do hot washes after every phase and do all kinds of things like that, but it's really going to be the ultimate delivery of LHA 6, the delivery of 23, 24, and 25, and the closure of Avondale. Getting those things out of our system and getting them behind us then puts us in a place to accelerate. As we said earlier today, you should see a little bit of an improvement year-over-year at Ingalls this year. After that, I think that 2013 becomes the inflection. The new work comes in, and we accelerate that into our goal of 9%-plus in 2015.

Related to that, when you think of LPD 25 over at Avondale, could you describe any progress in the thinking about the ultimate disposition of Avondale? And then also, how you ensure if that's the last piece of work that may be done there that you make sure that goes smoothly to the end point and gets delivered with the kind of quality and cost that you are targeting?

Sure. It's something that we think about every day. The plan of record today still is to close that shipyard. We do not have an alternative plan today. We continue to explore alternatives, but our plan is we are marching down the path of closure. 25's launch was a significant milestone because it was a high quality launch. The ship was in great shape when it went into the water. LPD 23 is in great shape as it gets ready to go out on sea trials. The work force at Avondale has done a magnificent job since the announcement when we were part of Northrup Grumman in 2010 of the plan to close Avondale. They have done an absolutely tremendous job on these last two ships. The things that we have done -- we tried to step back and think about the things that you just asked about -- what's going to happen when you have two ships left and you are going to close it? What's the disruption -- what's the potential for that to be? How do you manage your cost? How do you make it as variable as you can? We thought our way all the way through that. We put some incentives, for instance, for attendance and productivity in our labor contract, and our union leadership worked with us to do that in a very constructive way. All of those incentives have been met to date. We have another year to go on that, and we continue to be optimistic about how that's going to turn out. But, we're -- as we settle along -- this is a bit uncharted territory, and so we go into this with our eyes wide open.

Thank you.

Our next question comes from the line of George Shapiro of Shapiro Research. Please proceed.

Yes, good morning.

Good morning, George.

Could you tell us what percent of Ingalls business is currently making a 9% margin?

George, we don't break it out that way in any of our reporting. As we've said before, about 25% of our total revenue last year was in these heritage programs. The delivery of LPD 22 reduces that this year, and that's about as far as we have gone with it.

Okay. And then also, Barb, kind of my question I always ask. The contract for losses came down $7 million in the quarter. Clearly better than the fourth quarter because you didn't have LPD 22. Is that still sufficient, you think, to not require an incremental charge?

George, we talked about this as we go through 24 and even 23, and Mike just talked about it in 25. We feel pretty good about those ships, but we still don't know. So, there could be some incremental small charges as we go forward. Nothing that we anticipate or know right now. What I will tell you in terms of provisions -- in the fourth quarter, we were 89% complete on LPD 23 and 24. And, we are just about at 94% complete on those two ships right now -- or through the March 31 -- so through the reporting period. I believe those provisions are adequate right now.

Okay. Thanks. I'll get back in the queue.

Our next question comes from the line of Robert Spingarn of Credit Suisse.

Good morning, everyone. Mike, I'm trying to reconcile on this Ingalls profitability issue some of the things that you've said, and it sounds like it's not just a question of delivering legacy ships and adding new ships, but you also have these initiatives across the yard that are intended to improve profitability toward that 9%. And then, listening to your answer George's question, it would seem to imply that really perhaps no ships in that yard are yet at 9%. One, is that an unfair assumption. I know I'm asking his question again, but I think it's important. And then, two in this environment, can you really expect to earn 9%-type margins on future contracts given what the Pentagon is doing on pricing?

As I said before, we are not going to break that out any more than we have. One of the things that you have to remember about what we do is that when we have a brand new contract we are fairly conservative in the way that we book it. When these heritage contracts are gone, we are going to have a handful of new contracts that we are working our way through. That's why the -- you see the ramp up after 2013 because the burden of profitability is going to fall on a handful of relatively new contracts.

As far as the Navy pricing goes, my sense of this is that at the end of the day, it's up to us to go and make sure that we get a solid contract that allows us to attract capital and talent to our business. So, it is a challenge. We've talked about this several times. When we go into a contract negotiation, it's often less about what the price of the contract is, and it's often more about what's in the risk and how are you going to share the risk and what's in the scope? We have had contract negotiations where the whole negotiation has been about scope. And so, I expect that we will be continuing to have those. It's certainly -- I think everybody who has ever been in this business for the last 200 years would say that those are always challenging, and they will continue to be challenging. It's our job to get that right, and that's what we intend to do.

Mike, if you are talking -- if you are focusing on scope in those discussions, then where do you get the comfort that you can hit 9% on the future contracts? And frankly, on the other ships that are in the yard now without really being there yet? Except for perhaps at Newport News which doesn't seem to me to be necessarily relevant at Ingalls.

First of all, we have contract structures that allow us to get there. Secondly, those are based on a very solid understanding of what the risk registers look like. Third, we have a leadership team that is focused on the retirement of those risks. We -- Barb and I have spent four years now building this team with Matt Mulherin at Newport News and Irwin Edenson at Ingalls -- have been building this team to make sure that we are focused on what we need to do to perform. I'm very proud of what those guys are doing today, and I'm very confident that as we go into this uncertain future -- this is the team that I want to go into that future with. I'm very comfortable with our prospect and our outlook for 9%-plus in 2015.

Thanks very much.

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

Good morning. I guess just sticking with Ingalls for a second, but on the top line, specifically. Can you just give us a sense of how close you are to a steady state revenue run rate at this point on your new ships -- the DDG 113, LPD 26, and NSC 4? Are those fully ramped up? Or, is there still upside on the top line there?

I think what you are going to see is a bit of a blend. We were still ramping up on the new ships, and we are going to be coming down on the heritage ships.

Understood on the heritage ships. If you could just address those three new ships individually, I think that would be helpful.

We've just started them.

Right. It's timing of how material comes into the yard. It will be timing top line for Ingalls. It will be timing on LPD 27 and LHA 7 contracts. But right now, DDG 113 and 114, NSC 4 and 5, and LPD 27 are on schedule and performing well.

And then, just in terms of building off Carter's question a little bit. As you are looking now to negotiate long-term contracts with the Navy on Virginia class submarine and on your DDG program, what can you do to kind of protect yourselves on those programs given that we still don't really have any clarity on the '13 budget? Or, on what's going to happen with the sequester, and I'd imagine that we may see a few more rounds of this budget cutting here in the next few years. Wondering if -- what are you doing in terms of billing and penalty clauses in case things get canceled down the road, et cetera?

First of all, every single negotiation has its own personality, if you will. So, there is no silver bullet that fixes this in every single negotiation. Each one takes on a life of its own, and the team that works it comes up with a range of solutions. Clearly, one of the issues that we have to deal with when we are negotiating a contract today is what our future business base might be. That becomes an item in our risk register, and it's something that we have to appropriately work through with the Navy about how much of that risk do they want to share. And, the more that they want to share, the more we can put it into the terms and conditions of the contract. If they want to share less of that, then that affects that the price they have to pay. That's kind of the general way we think about that. Whether it's our future business base or any of those other things that could happen to us, we put all of those on the risk register, and then we have a discussion with the Navy about what's the appropriate way to share that risk. The more risk they put to us, the more it affects our price.

Our next question comes from the line of Sam Pearlstein from Wells Fargo. Please proceed.

Good morning. Can you just talk a little bit about the milestones you've mentioned several times at Ingalls in terms of what are the major milestones we should be looking for over the summer? And then, just help me understand how we should see that play out in the P&L in the sense that if there are no issues, do we see a reserve likely gets released? Or, is it more a matter of if there is an issue, we might see further charges?

Yes, I think it's more the latter than the former. But, I would say that, again, the milestones to look for are on the heels of the launch of 25 which we just came through. We have coming up the sea trials on the 23, launch of America, and sea trials on the 24. All of those are major milestones for us. What they are -- they are the times where we can step back with quality launches and quality trials -- we can step back with a sense that we retired some risk associated with these programs. That's kind of the way we are managing it, and that's why we keep bringing people back to these milestones. To get through to those milestones in whatever fashion that we do as clean as we can, then continues to confirm and validate our overall long-term outlook.

Okay. If I can just follow up on the Virginia class, just as you've ramped up the two boats. I'm surprised to see revenues down year-over-year. Can you talk a little bit about that, and maybe size the performance improvements that we would have seen in the quarter on that program?

Okay. Let's start with the performance improvements. There wasn't anything significantly material on there. But, as far as the revenue, it only dropped a little bit, and that was really related to we had a huge fourth quarter of material come in. So, a big ramp up on material on Block 3 in the fourth quarter that we didn't have in the first quarter. So, that was what's driving it.

Okay. Thank you.

Our next question comes from the line of Brian Ruttenbur of CRT. Please proceed.

Thank you very much. Hi, Mike, and Barb. Stumbling this morning. What kind of bill delays do you see versus procurement dollar delays in the near-term and long-term?

I don't really see any. Right now, we're funded. We don't have any issues in terms of funding. So, I don't really see any issues.

We don't have issues with invoicing and payments on contracts that we have. If your question is really to are we concerned about the delays in appropriations and procurements going forward, I think that's in the cloud of what ultimately happens with sequestration. You are starting to hear people talking a little bit about unobligated dollars in prior years, and what does that mean. We are not -- most of our dollars are obligated. So, it's not clear that that's a big issue for us, but it certainly is a big issue for the industry.

One of the biggest confusions around sequestration I think today is that nobody really knows how it's going to be implemented. Even if you just said, okay, this is what the law says, and let's go implement the law. Is it going to be a 10% across the whole business of everything that we do? I think one of the senators pointed out that how do you do that and buy three-quarters of a submarine? That becomes a real problem. Then there's a question of can you take sequestration and do vertical cuts to get to the numbers, and I don't know that anybody knows. I know there are a lot of opinions, but I don't know that anybody knows. We certainly aren't qualified to even have an opinion on that. That just continues to add to the uncertainty of our 5- to 10-year outlook.

As a follow-up, let me see if I can be a little clearer on my questions. Skepticism exists out there in terms of you being able to expand margins in a real questionable environment. I'm not a skeptic because it's basically you are still coming up to what would be less than what your biggest peers are in terms of margins. Can you address that? Where your peers are? And, why you don't think that you can get up to as high as the peers? Or, do you think you can get as high as what your peers are? And that wouldn't mean much higher than 9%.

I think in the ship building business, the history has been in the 9% to 10% range. And, we believe that we can operate sustainably in that range. But, we're coming through a period of time here where we have got to retire substantial risk to get to that. We have the workload in our backlog today to do that. The thought that somehow the budget debate is affecting our ability to improve our margins is a bit specious as far as I'm concerned. I think that we are focused internally to continue to drive the margins up to that normal operating range for the history of ship building. You know what happens in ship building is that mature programs book more than 10% because they are successful, and you're in serial production, and you're doing really well. Brand new programs book less than that. It's the blend that you are looking for in the business. The healthy business has a handful of new programs and has a handful of mature programs, and you blend that together to get to the overall long-term, sustainable run rate. I see no reason why this business cannot be operating as well as anybody in the industry.

Thank you.

Our next question comes from the line of George Shapiro of Shapiro Research. Please proceed.

A couple of other questions. Can you disclose what the EACs were in the quarter? Because I assume you probably put it out in the Q anyway.

Are you just asking for the cumulative adjustments, George?

I think that's all you will disclose in the Q, right?

Right. So, Q1 '12, our cumulative adjustments were $14 million favorable versus Q1 last year of $4 million unfavorable adjustments. If you will recall, Q1 last year, we recorded the negative adjustments for the retention grants issued as part of the spend and the continued risk evaluation on the 78 contract plus LPD 22 and 24. So, this quarter we had, like I said, the $14 million cumulative favorable adjustment. Basically, it was across multiple programs. Those milestones were achieved. Shipboard test program on the RCOH. We finished the PSA on one of the submarines. It was really across the board, and there was no single item that was material.

Okay. And then, just another quick one. The $240 million jump in receivables in the quarter. Is that -- that usually happens in the first quarter. It happened last year. Is there anything unusual in that? Can you detail what specific programs it might have been on?

That's across the board. It was really accruals driving [that]. That's what happens -- like you said, it happens every year.

Okay. Thank you very much again.

You're welcome.

Our next question comes from the line of Jason Gursky of Citigroup.

Barb, just a couple of quick tactical questions for you. Can you update us on what your expectation is for both pension expense for the entire year as well as Cap Ex?

Okay. Let's start with Cap Ex. Cap Ex, I expect to be in the 2% to 3% range like I've said. First quarter, if you took out the $36 million we paid last quarter -- or last year, first quarter for the closure of Avondale with Louisiana, we are about the same quarter-over-quarter. $27million. I expect the year to be just a little but less than last year, but in that 2% to 3% kind of in the high end of the 2% to 3% range like I've said before. That's the Cap Ex. On the pension, basically, we expect the net FAS CAS adjustment to be in the $77 million range. If you go back to what we talked about in March, we put together a pension assumptions chart, and none of those assumptions have changed.

Okay. That's great. Just wanted to make sure that there wasn't any changes there. Then, could you discuss a little bit about labor down in the Gulf, and how labor retention is going down there? And, how the labor force down there is progressing along the various learning curves? Just another way of trying to explore some the potential risks at Ingalls in the margin ramp down there?

You bet. One of the things that we set out to do when we first started bringing all this together about four years ago was we had to build a constructive relationship with our various labor unions, and we have done that. Just several months ago, we signed an extension to the labor agreement down there. It's going to carry us out for the next couple of years. And, it was approved pretty solidly by the work force. There is a belief in the work force that we have the right approach to improving the business. Our people want to be part of something that is successful, and they see that we are on a path to be successful. What we have seen in particular -- I've already spoken a little bit about the folks at Avondale They really have taken on the challenge of if these are the last two ships we are going to build, they are going to be the best two ships we ever build. And, we are very, very proud of that. They have every right to be very proud of that. I think that's a testament to Irwin and his team in the way that they partner constructively with the organizations that handle our production, and we are very -- we consider that an asset. We continue to look forward to working with them in the future.

Great. Thank you.

Our next question comes from the line of Myles Walton of Deutsche Bank. Please proceed.

Good morning.

Good morning, Myles.

Maybe Barb first, on the first quarter of last year negative adjustments affecting Ingalls margins, can you quantify what that was? We can get a clean compare in terms what the margin was year-on-year?

Myles, they weren't material so they weren't significant. There was small adjustments on LPD 22 and 24. So, we haven't been giving amounts out.

If you excluded those from both periods, would you have had margin expansion?

Well, we have margin expansion because we delivered LPD 22. So, you are going from the 2.2% to the 2.9%.

Right, so the 2.2% though had a negative adjustment in it?

It did, small.

So, even if you added it back you would still have shown margin expansion?

Right.

Good. Mike, on the pathway to 9% by 2015? Obviously, a piece of it is a mix shift of the backlog and a piece of it's the productivity improvement. As you look at the glide slope, it sounds like 2012 is a slight improvement. '13 has the benefits of the mix shift. Is the glide slope from '13 to '15 relatively linear at that point?

I think -- I'm not exactly -- know what relatively linear actually means. What I would say is, it will be accelerating. '13 will have -- you will have deliveries and the closure of Avondale all in there. '13 is going to be a bit of a mix. '14 will be clean. And then, as we retire risk on new programs, '15 will be where we need to be. I would hesitate to say that it's a stair step linear thing from '13 to '15. I would hesitate to say that because we are going to be working through the startup of a new programs and the retirement of the risk on the front end of those programs, and that's what we will really be doing in '14.

But, I guess if I understand it right, the move from '13 to '14 and '14 to '15 is really about your ability to drive the productivity improvements through the base business as opposed to any type of mix shift or [programmatic] specific issues being delivered.

It will be new contracts that will have opportunity in it, and it will have risk in it. As we retire the risk, we step up.

Okay.

That's what we'll be doing.

And, I would say on the productivity improvement, we're seeing productivity improvement today. So, when we bid those new contracts, we bid those contracts based on how we're performing today. So, there isn't this whole leap we have to take to achieve those targets.

That's fair. Just wanted to understand the slope. Thanks.

Good question. Thanks.

Our next question comes from the line of Matt Vittorioso from Barclays. Please proceed.

Hi. Thanks for taking my call. [Gobi] in for Matt. Just a quick question on working capital here. Obviously, a pretty significant use of cash for working capital in the first quarter. Do you expect similar to what we saw last year, an unwind throughout the year with the bulk of that coming in the fourth quarter? Or, can you just give us a little guidance on what we should be looking for there?

That's exactly what I'm looking for. I expect it to look very similar to last year, and then December will be the month that will tell where we end up for the year just like last year. I reminded everybody in the last call that in the last week of the month, we collected the majority of that cash. So, I'm banking on the same thing to happen this year.

And then, just as a quick follow-up,. Can you give us a sense of how you intend to manage the cash balance going forward? We have that -- that puts you back toward $1 billion in cash on the balance sheet. Would you look into potentially paying down some term loan? Or, are there other things out there that -- acquisitions or other opportunities that you are looking at that you want to keep the cash on the balance sheet for?

Yes, certainly. We are considering all of the potential uses of cash today. But, our number one priority is to make sure that we get through the risk retirement of the four ships that remain and the closure of Avondale. So, all of the other things we are considering the things that you can do with cash. We're working very hard on what's the right use of that cash today. But, the first thing that we have to do is we have to get through the closure of Avondale.

Okay. Great. Thank you. That's helpful.

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

Hi. Thanks for taking my follow-up. I just wanted to get an update on -- you have this estimate of $271 million out there that you thought it was going to take to close Avondale of which $128 million was an asset write-down, the remaining $143 million was cash. I was just wondering if there has been any change to that, and if any of that cash has actually gone out the door yet?

Yes. Like Mike talked about. One of the reasons why we feel like our estimates on 23 and 25 should be in the range of reasonableness is we are paying incentives, and we are also paying retentions to our employees. So, we've spent about $74 million to date of the -- my recollection is there's $150 million of facility expenses and human capital expenses. So, we've spent $74 million so about half of that to date. Part of that was also the payment we made to Louisiana for the cooperative endeavor agreement.

Thank you.

You're welcome.

Our next question comes from the line of [Yoma Atty] of JPMorgan. Please proceed.

Thank you. Good morning. As you look out in several years, and then your margins improve and so forth, how does credit ratings fit into the picture? Any thoughts around financial policy? And then, perhaps the working toward investment grade in the out years?

Again, all of that is part of our thinking today is just what do we want to look like when Avondale closes. And, what's the right way for us to be deploying the cash that we will be able to generate. If we are able to, and we were very confident that we will be able to achieve our 2015 objective, how do we redeploy that cash to create the most value for the business. And, we are taking a hard look at that. At this point, all we were prepared to say is we have got to get through Avondale first.

Granted, there is the Avondale work that is so in front of you. Does the investment grade rating make sense for the Company? Is that something you would like? Or, are you comfortable in this BB ratings category?

Again, I think we're considering all of the possibilities at this point. We are not uncomfortable where we are. We also recognize that there are values to be somewhere else. And so, we are looking at all of that. We are not prepared today to cite that we have any particular objective.

Thank you. That's all I had.

You bet.

Thank you, sir. At this time, we have no questions. I would now like to turn this call over to Mr. Mike Petters for closing remarks.

Thank you, and thanks to all of you for being part of the call today. As we said in the beginning, this call is six weeks since our last call, and so it's not much as changed since then. But, it's good to have another quarter under our belt. Another quarter where we've retired some of that heritage risk that's out there. The next few months are going to be very important for us in that regard with the potential sea trials we have coming up and the launch of America. And, we are excited about that. We think about that in terms of -- in a football analogy -- we've driven this all the way down into the opportunity to score. Now, we have to get the ball across the goal line, and that's where we are on all those programs. We have done a lot of hard work to get here, but we aren't done yet and we are very focused on that. Thank you all for being part of this, and we will talk to you next quarter.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.