亨廷頓·英格爾斯工業 (HII) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2012 Huntington Ingalls earnings conference call. My name is Stephanie and I will be your coordinator for today. At this time, all participants are in listen-only mode. Following the prepared remarks, there will be a question-and-answer session.

(Operator Instructions)

I would now like to turn the presentation over to Mr. Andy Green, Vice President of Investor Relations. Please proceed, sir.

Thanks, Stephanie. Good morning and welcome to the Huntington Ingalls Industries third 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 certain non-GAAP measures, including certain segment and adjusted financial measures. Reconciliations of these metrics to the comparable GAAP measures are 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'd like to turn the call over to Mike.

Thanks, Andy. Good morning, everyone, and thanks for joining us on today's call. We know that a great many of you listening in this morning on the East Coast have suffered and are still dealing with the devastating effects of Hurricane Sandy, and we want you to know that our thoughts go out to each and all of you.

I am pleased to report Huntington Ingalls Industries results for the third quarter of 2012. Today, we reported sales of $1.6 billion, flat from the same period last year, and diluted earnings per share of $0.26 compared with a loss of $5.07 in the third quarter of 2011. After adjusting for non-cash non-operating items in both periods, adjusted EPS was $0.74 compared with $1.05 last year. Third quarter adjusted segment operating margin was 7.1%, or flat compared to last year. And we ended the quarter with $766 million of cash and total backlog of $16 billion, with $13 billion of that funded. Our results for the third quarter contain non-cash workers compensation and tax expenses that were unrelated to the core operating performance at both Ingalls and Newport News.

In addition to these expenses, Ingalls' operating margin was also negatively impacted by $20 million in EAC adjustments related to the LPD program. This charge was largely driven by performance on LPD-24, which just completed its final sea trials and is expected to be delivered by the end of the year. Following the delivery of LPD-24, the remaining two underperforming ships at Ingalls, LPD-25 and LHA-6, are scheduled for delivery in 2013. As I've stated on previous calls, delivery of these underperforming ships is critical to achieving our 2015 target of 9-plus percent operating margin, and we are making steady progress toward that goal.

Reflecting our confidence in the performance of our programs and the ability to achieve our 2015 goals, today we announced our first quarterly dividend of $0.10 per share and a $150 million, three-year share buyback program. Our quarterly dividend will provide a stable and recurring component of total return for shareholders, and we expect our share repurchase program to be more than offset the dilution from employee equity compensation over the next three years. Distributing cash to shareholders is one element of our balanced capital allocation strategy that we believe will maximize shareholder value. In addition to the distributing cash to shareholders, we are continuously evaluating all options across the cash deployment spectrum, which include looking at organic growth opportunities, such as investment in facilities and equipment that enables us to expand existing product lines or improve efficiency and affordability.

Our substantial investments over the past several years in expanding capacity for Virginia class submarines and the build out of facilities for the Enterprise inactivation are typical of organic growth opportunities that are available in naval shipbuilding. Exploring other growth opportunities, including partnerships, joint ventures, and acquisitions that can make sense for us, if they are in adjacent markets, or otherwise leverage our unique strengths and provide a clear path for us to create value. Our highly successful joint venture with Flour and Honeywell at the Savannah River nuclear side is a prime example. Managing our liabilities, including funding of our pension plans, which is a very important responsibility and an obligation that we have to our greatest asset, our talented workforce, and reduction of debt, which can enhance our credit profile and reduce our cost of borrowing.

Now to hit a few highlights of our major programs, beginning with Ingalls. LPD-23 Anchorage, constructed at our Avondale shipyard and the second of the original five underperforming ships, was delivered during the third quarter. LPD-24 Arlington, nearing completion in Pascagoula, has completed builders and acceptance trials and should be delivered to the Navy by the end of the year. LPD-25 Somerset, the last Navy ship under construction at the Avondale shipyard, remains on schedule to deliver in 2013. And at Pascagoula, we are ramping up construction on LPD-26 John P. Murtha and LPD-27, the newest ship in the San Antonio class of LPDs. On the LHA program, during the third quarter we christened LHA-6 America and it remains on schedule for delivery in 2013. In the National Security Cutter program, NSC-4 and NSC-5 are under construction, and we are under a long lead material contract for NSC-6. We expect an award for the construction of NSC-6 in 2013.

We are in the early stages of construction of DDGs 113 and 114, in support of the DDG 51 program restart. We expect contracts to be awarded for another 9 or 10 ships in 2013, split between ourselves and our competitor. On the DDG-1000 destroyer program, we have delivered the deck house for DDG-1000, the first ship of the class, construction of the aft PVLS modules, hangar and deck house for DDG-1001 is underway, and we are working with the Navy toward a contract for similar work on the third ship in the class, DDG-1002. At Avondale, we continue to wind down Navy shipbuilding at the facility, which we expect to complete by the end of 2013. And although closure is still our baseline assumption, we are also assessing the possibility of keeping the facility open as a manufacturer of industrial products other than naval ships.

Now turning to Newport News. CVN-78 Ford was 87% structurally erected and 46% complete at the end of the third quarter and is on pace to launch next year, with delivery in 2015. We continue to ramp up construction on CVN-79 Kennedy, the next carrier in the Ford class, and anticipate having a construction contract in place sometime in 2013.

In submarines, we just christened and launched SSN-783 Minnesota, and expect delivery in the spring of next year, 11 months ahead of schedule. We expect a block 4 contract award next year for nine or 10 additional submarines, with construction beginning in 2014. CVN-71 Roosevelt is scheduled to complete it's refueling and complex overhaul and redeliver in mid-2013, and we expect CVN-72 Lincoln to arrive at the shipyard in February to begin its RCOH. CVN-65 Enterprise is expected to enter the yard in 2013 for inactivation and the defueling of its eight nuclear reactors.

In summary, despite some difficulties in getting LPD-24 prepared for delivery, we are very pleased with where we are on all of our major programs and we remain confident in our ability to reach our anticipated 2015 targets. Newport News is now entering a period over the next 12 to 18 months where it will establish its business base for the next several years, including CVN-79 construction, the CVN-72 RCOH, block 4 submarines, and the Enterprise inactivation. Ingalls has already been awarded several key contracts, including LHA-7, NSC-5, two LPDs and two DDG-51s, and is well on its way to delivering the remaining legacy underperforming ships that we expect will drive margin expansion back to the 9% range. Of course, the defense budget and sequestration remain uncertainties, but the nature of naval shipbuilding probably insulates us from immediate impact.

Now since the spin, I have consistently emphasized the issues we face and why it is critical that we retire risk and replace underperforming contracts with new business that can perform at more typical shipbuilding margins. And although we still have several years before we reach our 2015 targets, I am extremely proud of what our team has accomplished and I am highly confident that we will achieve our goals. We are steadily retiring risk, we are getting critical new business funded and under contract at both shipyards, we are streamlining our operations, we are executing well on new business, we've created and are reinforcing a culture based on safety, quality, cost and schedule, which drives affordability, and we have a management team that is highly focused on maximizing shareholder value. All of these things give us the confidence in our outlook to begin distributing cash to our shareholders long before we originally expected, which reflects strongly on the performance of our shipbuilders and the entire Huntington Ingalls team.

Now looking ahead to the remainder of this year, we continue to expect second half earnings to look like the first half, excluding the third quarter non-cash items I mentioned earlier. And with that, I'll turn the call over to Barb Niland for some remarks on the financials. Barb?

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

Before I get into our operational results, I'd like to discuss the two non-cash non-operational items that affected our income statement this quarter. First, we took a non-cash workers compensation charge of $24 million, which resulted in lower segment operating income at both Ingalls and Newport News. In the third quarter of every year, we update our self-insured workers compensation liability, as based on factors including actuarial data, recent claims history, and prevailing interest rates. The charge included in this quarter was primarily driven by the decline in the discount rate assumption used in computing the workers compensation liability from 3.05% to 1.59%. The other operational item was an $8 million tax expense related to our spin-off tax agreement with Northrop Grumman, which reflects the portion of the final Northrop Grumman 2011 tax return filing attributable to the HII for the pre-spin period. This tax expense increased our effective tax rate for the quarter to 65%. These adjustments are difficult to predict, and we may be subject to both positive and negative adjustments in the future.

Now turning to this financials on slide 4 of the presentation. Third quarter sales were flat from the same period last year, and included higher sales in carriers, surface combatants, and the NSC program, offset by lower sales volumes on amphibious assault ships. GAAP reported segment operating income for the quarter was $89 million, total operating income was $66 million, and diluted EPS was $0.26. Adjusted for the non-cash workers compensation charge and tax expense, segment operating income was $113 million, total operating income was $90 million, total operating margin was 5.6%, and adjusted diluted EPS was $0.74. We ended the quarter with a $766 million cash balance. Cash provided by operating activities was $137 million, a decline of $95 million over the same period last year.

During the quarter, we contributed $47 million to our qualified pension plans, and in October we contributed $6 million, which completed our expected contributions for 2012. Capital expenditures for the quarter were $35 million, down $1 million from the third quarter last year. For the full year, we continue to expect capital expenditures to be at the high end of the 2% to 3% of sales range. As we said earlier in the year, we expect 2012 cash flow to be similar to 2011, with the exception of the pension funding fling of a little more than $200 million. As you know, cash flows are driven by timing of collections and ship deliveries, so a difference in just a few days can make a material difference in year end reported cash balance.

Turning to slide 5, Ingalls' revenue for the third quarter were $670 million, down 9.5% from the same period in 2011, primarily driven by lower sales in amphibious assault ships following the delivery of LPD-22 and LPD-23. These declines were partially offset by increases in surface combatants and the construction of DDG-114 and the NSC program. Excluding the non-cash workers compensation charge in 2012 and the non-cash goodwill impairment charge in 2011, Ingalls' operating income for the quarter was $10 million, compared with $19 million in the same period in 2011. Ingalls' adjusted operating margin was 1.5% for the quarter, down from 2.6% last year. Included in Ingalls' operating income for the quarter were $20 million of unfavorable adjustments related to the LPD-22 through 25 contract, with the majority of it related to performance issues on LPD-24, which is expected to deliver in the fourth quarter.

Turning to slide 6, Newport News revenues for the quarter increased $68 million, or 7.8% from last year, primarily driven by higher sales volume on Ford, the construction preparation on Kennedy, higher sales volume from the advanced planning on the Lincoln RCOH, and a $15 million favorable resolution of an outstanding contract adjustment on Enterprise EDSRA from 2010. This contract adjustment also favorably impacts operating income for the same amount. Adjusted for the non-cash workers compensation charge, Newport News' operating income for the quarter was $103 million, compared with $94 million last year, primarily due to volume, including the Enterprise EDSRA resolution. Newport News' adjusted operating margin was 10.9% for the quarter, up from 10.7% in 2011.

If you'll turn to slide 7, I'd like to make a few comments on pension. As always, a reminder that pension-related numbers are subject to year-end performance and measurement criteria. So we've change the chart from last year so that the FAS/CAS adjustment shown here includes other post-retirement benefits expense and is comparable to the FAS/CAS adjustment we report in our financials. This chart shows the sensitivity of our 2013 estimated FAS/CAS adjustment to discount rate assumptions and actual asset returns for 2012, and it also assumes a 7.5% long-term return on assets going forward, which is slightly lower than last year's assumption of 8%. At the end of the quarter, our discount rates are running approximately 100 basis points below last year, and year-to-date actual returns were around 10.6%.

With regard to 2013 pension funding, we continue to assess our options in light of the recent pension relief legislation bill passed as part of the highway bill. Although our 2013 required contributions are likely to be very low, our discretionary contributions could be higher than this year, depending on interest rates, actuarial assumptions and other funding strategies. Lastly, for the full year 2012, we estimate deferred state tax expense should run about $11 million, interest expense should be roughly $118 million, and our tax rate should be close to 42%. The FAS/CAS adjustment is still expected to be $74 million.

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

Thanks, Barb. Just a reminder to everyone, if you could limit yourself to one initial question and one follow-up, so we can get as many people through the queue as possible. Stephanie, I'll turn it over to you and let you manage the Q&A.

Thank you. Ladies and gentlemen, we are ready to open the lines up for your questions.

(Operator Instructions)

Your first question comes from the line of Robert Spingarn with Credit Suisse. Please proceed.

Good morning, guys.

Hello, Rob.

Mike, when we think about your revenue flow at Ingalls, with the delivery of the zero margin LPDs continuing and then the new wins you talked about on the other surface ships, and within the context of the insulation that you mentioned when you were talking about the budget uncertainty, how many quarters of revenue visibility do you think you have at this time, at this $700 million-type average? How long can you do that? How do we think about that?

Bob, I can answer little bit of that, and then I'll let Mike add to it, if that's okay.

At Ingalls, we're sitting with about $7.6 billion in backlog. So when you think about how long it takes to deliver those ships and everything, you can do the math. You have a minimum of 10 quarters, but I think that we won't have all those ships delivered in 10 quarters.

Okay.

Right. So there's a big chunk of it is near term, and then you add on, it kind of gracefully falls away and you bring new work in on top of that.

I think the real challenge at Ingalls -- we are excited about the destroyer competition that is already in play. The bids have been submitted, and frankly, we expect that award to be in the first half of 2013, which would add substantially to that backlog. And in fact, the Navy is even talking about the possibility of having 10 ships awarded as opposed to 9, and so that would be -- we think would be very positive.

I think I've said before, I think the whole question of where amphibs sit is something that will be very public and a lot of discussion over the next couple of years. Our amphib business is going to tail off by plan. And I think that as we work our way through the resource allocation and the fiscal discussions, I think amphibs and the role that the Marines have, and the role that the Navy has in forward deploying and being expeditionary are going to be very front and center for all the stakeholders, and we expect to be very prominent in that discussion.

Okay. And then just as a follow-up on the same topic -- Barb, what percentage of Ingalls' revenue in the quarter was represented by the zero margin contracts?

We don't usually provide that. We provide generalities by year, but not by quarter.

Can you talk about it on an annual basis?

Yes. We talked about it in the past. We've said that 25% was what we were burning off -- over the entire year.

But remember, Rob, the reflex here is to say, okay, if it's whatever the percentage, 25% or whatever, is not performing, then you want to say, okay, the rest of it must be performing at the top of the -- at the right rate. But what we are doing here is, we are retiring the ships that should be performing at the top rate, and we are filling in with work that the blend is low. And so it takes time for us to walk our way back up to 2015, where we will achieve the 9-plus objective there.

Fair enough. And we know that there are adjustments that are made in there. But when I think about the fact that you had an underlying run rate of $30 million, as Barb said, on roughly $670 million in revenue, and as we go forward more and more of that revenue -- of that zero margin -- is going to go away, as long as it's replaced by profitable ships -- you understand where I'm going?

Yes, absolutely. And that's very fair.

Okay. Thank you.

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

Good morning

Hello, Doug

I wanted to see if you could give a picture of your longer-term capital spending plans. If you look at Newport News, it seems like you've gone through the transitions related to Virginia class CVN-78 decommissioning; and then Pascagoula seems to be pretty modern at this point. And how are you thinking about CapEx, longer term?

I think first of all, I think you're right. The major projects at Newport News -- and it was the Virginia-class program to get facilities for two submarines per year production capability, as well as the inactivation business for the Enterprise, and then the follow-on aircraft carrier inactivation business. We are the back end of that. We are thinking about the next round of investments for the Navy, relative to future programs out there, whether it's Ohio replacement programs or something like that, or maybe even thinking more about how do we retire the risk on certain programs to make them more affordable so that we can strengthen their position in the budget debate that's going on. So we think about that as well.

We think the same way at Ingalls. Ingalls' future is probably a bit more dynamic than the Newport News one. The ships are smaller and come a little bit faster. And so being able to invest to support or kick-start the next program and help make that affordable to help the taxpayers find their way to support it, is something that we are very interested in doing. And so we are always thinking about that.

Having said that, inside of our Navy shipbuilding business today, we are on the back end of a pretty substantial investment. And we are very proud of the facilities and capital that we have in place today.

And then on Ingalls -- after having lost the DDG-51 competition, the last one, to GD, when you look ahead now, what's the timing of competition for future DDG-51s? And are you where you want to be at Ingalls, in terms of your competitive position, when you look at those awards?

Well, we have -- the next round of competition is actually underway right now. Both teams have submitted bids. It's nominally for nine ships. There's discussion that the Navy might actually try to find a way to award 10 ships in this discussion.

The answer to your question about are we where we want to be -- we will not be where we want to be unless we win. And so we have taken a lot of steps. We got a lot of good feedback from that last round of competition. We have been driving our competitive posture, and we look for ways to continue to improve our competitive position. But at the end of the day, no matter how good we feel about it, if we don't win, we have more work to do. So that's the way we are approaching it.

Okay. Thank you.

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

Good morning.

Good morning, Sam.

I wanted to find out and understand a little bit more about the adjustment on the LPD-22 to 25. And I guess a couple parts is -- number one, the 22 has been delivered for a while, so why would that still be going on? And then, just trying to think about how the typical ship would go out, is I would think you would have some contract closeouts when the 23 was delivered, but until the 24 gets delivered, you wouldn't have that next milestone. So can you talk a little bit about that aspect of it?

Sure. Across all four of those contracts, we had a change in our escalation that affected the targets on those contracts downward. So that's just a fact of life of how the contracts work with escalations, so we had a small piece of it with that. The majority of it was actually performance on LPD-24 and getting that ship to sea.

Okay. And then the performance in terms of the 24 -- are there any lessons learned that help you with 25? Or are there changes that you have to make in terms of the production or anything that you can ensure that you wouldn't see a repeat with 25?

Well, as we've said all along, these four ships, 22 through 25, are challenges for us. Two of them are being built, or were built, in Pascagoula; two of them were being built in Avondale. The challenge specifically to LPD-24 was that LPD-24 was the last ship in the production line while the shipyard was going through the trials and tribulations of LHD-8, LPD-22, the DDG-1000 swap, the start up of the NSC program, the other things that were going on there in the aftermath of the storm. So the 24 had a variety of issues associated with reallocating resources to those other programs.

On the other hand, LPD-24 had the full benefit -- or had the most benefit of the operating system that we put in place. And so as we approach delivery, the lessons that we learned from LPD-22 and 23 to get the ships to delivery, we absolutely applied and benefited from. But on the other hand, we still had to work through some of these long-standing issues that were out there.

And the other thing I've said from the beginning is that the number one issue for these ships is, we have to deliver them. It's unfortunate and concerns us greatly when we have to do something like we've done this quarter, but we are very excited that we got the ship out to acceptance trials. We got across that threshold; the ship performed very well on acceptance trials, and we are very strongly committed to getting that ship delivered before the end of the year.

And the number one issue for us is getting these five ships delivered. This will be the third one. LPD-25 and LHA-6 deliver next year. The delivery of LPD-24 just enhances our confidence in our plan to get those two ships delivered next year. Certainly, things that we learned from LPD-24 are rolled forward into 25 and LHA-6.

Okay. Thank you.

Your next question comes from the line of Peter Skibitski with Drexel Hamilton. Please proceed.

Good morning, guys.

Good morning.

I guess there's obviously still some risk remaining on 25 and LHA-6. Can you guys talk about some of the other programs, the destroyer restarts? I know there's been talk of a lot of new technologies inserted there. Ford, I think, has the EMALS. And then, the next Virginia contract, if we expect to have any changes in booking rates there. Can you talk about those three areas and just how we should think about profit risk on those programs?

Well, I think the first thing is, let's step back. How do we do this? The way that Barb and I have set this to be done in this organization over the last five years is, we are very conservative on the front end of the program. We identify what we think the risks are and we don't take credit for retiring the risk until the risk is actually retired. So on all of the new work that we've started in Pascagoula -- the two destroyers, the two LPDs, and the LHA-7 -- we are being fairly conservative there at this point, given that when you sign the contract, you have a risk register. And as we retire those risks, then we will adjust the rates accordingly.

That has been the approach that we've used at Newport News for many years. And it shows itself in all of the performance, in all of the programs that we have at Newport News. We've had quarters where we've had step ups at Newport News due to a delivery of a ship, which is the ultimate retirement of risk on that ship, and that creates a little bit of the lumpiness quarter to quarter that you see. But over the long term, it's a very solid way to recognize the profitability of the program. It is always stepping forward. It's paced, I guess, is the right way to say that.

So relative to the specific programs that you mentioned -- the destroyer program, this is a restart of the DDG- 51 line. There was a five-year gap in that line, and we were given the opportunity to be the first two ships in production. We're very pleased with the way that production has started, because we are actually bringing the operating systems that we put in place and the discipline and the culture to bear on these ships at the very beginning of the program. And so we are performing as we expect to perform on those programs. I would say the same for the LPDs and the LHA. They are -- particularly the LHA-7, probably not quite as far along as the destroyers are, but in all of those programs, the things that we have done to improve our operating system and improve our culture and enhance the caliber and quality of our leadership team, are all paying off for us there.

At Newport News -- with regard to technology insertions, I'm not sure exactly what you mean by technology going into the DDG-51 program. This was really designed to be a restart of a mature product line. There's always some technology being inserted in the warfare systems and in the sensors, but in terms of building the ships, those are -- the earlier we know about those, the more we can accommodate them, but they're not big drivers in the process that we use to fabricate the ships.

Over at Newport News, in the carrier program, we've talked a lot about the Ford over the past several quarters. The Ford continues to be on track. It continues to be the very best lead ship that I've ever seen. We do have some of the standard issues that go along with lead ships. You have new technology that doesn't develop as fast as you need to, and so you have to figure out how you're going to work your way around that, in the course of the contract. Our contract structure recognizes that risk, and we have the appropriate sharing mechanism with our customers so that both of us get the real value for the taxpayers there. And so that's proceeding apace.

The submarine program's going very well. In fact, the submarine program's another program where the Navy is considering -- would really like -- I won't speak for the Navy, but I would like to see the contract go to 10 ships. There's an effort in the Congress today to try to expand that 9 ship offer in block 4 to make that a 10 ship block. And so we are excited about that and we are leaning forward to it. And I think that's just a testament to the caliber of the team and the quality of the work that's being done.

Okay. Very helpful. I appreciate that.

And last question -- on pension -- I guess for Barb. Barb, it looks like on a net basis year over year, it looks like maybe you guys are thinking only, call it a $15 million incremental pension headwind for 2013. Does that sound about right?

You're looking at that pension chart that we showed?

Correct.

It's about that, maybe a little higher.

Okay. Great. Thank you.

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

Good morning, guys.

On Hurricane Isaac, was there any impact in the quarter from that, either financial, in the quarter, or otherwise?

Yes, in the quarter we lost about $23 million of sales volume and about $1 million of OM on that. So we looked as that as not material.

Okay. And then it looks like you guys have been -- on the debt, you've been chipping away at it, $7 million, $8 million a quarter. Is that something that we should expect now, with the repurchase and the dividend, for you guys to stay on that same kind of debt paydown rate?

Yes, I think that's fair. We're comfortable with the pace that we are on right now, relative to our debt structure.

Thank you.

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

Good morning

Good morning

Mike, Barb, I wanted to pursue a little bit -- at the end of the second quarter you had like a $6 million reserve on the balance sheet for completing the LPD stuff, and now you've got $4 million. So what happened in the quarter that necessitated the $20 million incremental charge? It sounds like this is longtime stuff, but there must've been something that happened in the quarter.

It was a combination of all the things we've already talked about, George. There was no major single event.

It was -- we're in the same quarter where we're trying to get LPD-23 delivered. We are trying to take LPD-24 from builder's trials to acceptance trials. So there's a big press on that to get that done.

There's things that happen day in and day out, but then there's things that we are doing to recover from things that were a couple years back. So I can't say that there was any single event on that. I think Barb talked about how there was the overall effect on the whole -- remember, these four ships are all part of the same major contract, and so the overall effect of the whole contract was impacted, as well.

And then, what gives you confidence that LPD-26 and 27, which are also being made at Pascagoula, will be that much better than the 24 at Pascagoula? You've got a better learning curve? Did you get better pricing on 26 and 27? If you could just explore that a little bit.

Sure, sure. Thanks, George.

I'd say the first thing is that -- remember, we've talked before, this four ship contract was -- it assumed a serial production line with a very steep learning curve in it, and it was signed post-Katrina, and it assumed a pre-Katrina cost baseline. And that's what we've been dealing with; really from the day the contract was signed, we've been -- Barb and I got there a couple years later, and we've been dealing with that ever since we got there.

When we go to contract on LPD-26 we, number one, are taking advantage of the operating system that we've put in place, which includes class plan build plans, serial production assumptions relative to how we are going to build things. We are going to do things the same way over and over again. It includes the full-scale risk register that we've created. It includes the phased construction program with the hot washes and the phase start discussions that we do. All of those things are there and it reflects the cost baseline that we have experienced post-Katrina. So all of those things in tandem give us great confidence that these ships are not anywhere near to the same path that the four ships in the previous contract were on.

Having said that, we still -- we manage this exactly the way we manage all of our other programs. We are conservative on the front end. We only take credit for risk retirement when it's actually retired. And so we are ramping up on those programs today. We go into the start of fabrication or the start of a major milestone, and we don't take credit for that until we've actually accomplished it. I think that, that's a tribute to the leadership team there in Pascagoula, the way that they've started on these programs. Irwin and his team are doing a fine job of getting these programs started the right way, and I think that will serve us very well over the next couple of years.

Okay. And then, if I might, just one nitty one for Barb. How come last year you didn't have any charge for workmen's compensation, because I'm sure the discount rate would've also come down last year in this quarter?

We use a risk-free rate, and it wasn't as significant as the drop when we look at it this year. And so basically, that was the driver.

Okay. Thanks very much, guys.

You're welcome.

Your next question comes from the line of Jason Gursky with Citigroup. Please proceed

Good morning, everyone.

Hello, Jason.

Just a quick question on the cash deployment. We've got now a dividend and the share repurchase program. Just wondering if you could talk a little bit about other potential uses of cash and your outlook now going forward with regard to acquisitions?

Sure. Overall, our number one challenge in this business is to achieve the full potential of this business. And that is to look for opportunities to create value, and cash deployment is the way that we consider that.

We are not completely focused in on any single approach. I think what we've described here is a very balanced approach to how we're going to deploy the cash. But, we've talked about investing in the businesses that we are in to enhance new businesses, like the carrier inactivation or the Virginia class program; or retire risk on programs to make them more affordable and maybe help make them come to fruition. But we also highlighted that we are interested in doing those things that are -- that we are uniquely qualified to do for maybe other customers who may have a need for that. I think the team that we have at Savannah River is a good example of how we are there to do nuclear operations. We are best in class when it comes to doing that kind of work, and there are customers out there that need us to do that.

You know, we certainly want to bring the shareholders along, and I think that from my standpoint, today's an historic day, really, in this company. Today's the day we initiated the dividend. So we are very excited about that. And we want to bring everyone along. We think that's a way for communicating and enhancing the value of this business, as well.

And so going forward, we are thinking hard about how do we take advantage of the assets that we have. You know, we mentioned Avondale -- we are executing the path to close Avondale and remove it from our Navy shipbuilding footprint. But we are certainly interested in, if there's an opportunity to use that unique skill set, we are certainly interested in finding ways to deploy that in a way that would create value for our business and for our shareholders.

And then speaking of Avondale -- when is the date of no return on making a decision on what to do with that yard?

What I'd like to say is that we've already made our decision. We are closing the yard to Navy business. The point of no return is really a discussion about the workforce. The delivery of LPD-23 means that LPD-25 is the only work that's left there. And so over the next year, we will be delivering LPD-25. And as we go through that in the normal course of a ship delivery, the level of the workforce, the number of the workers that are on that ship, will decline, has been declining and will continue to decline.

We do see that in that area of the country, there are significant projects being planned or announced that would require a skill set that's not unlike the skill set that we have at Avondale. It's modular construction. It's high energy systems. It's high density systems that we know how to go do. The challenge for us is, what's the schedule for those projects? Would we still have a workforce, if we decided to deploy in that direction?

And the second challenge is, can we be competitive? And what does it take for us to be competitive in that environment? The fact is that having a qualified workforce and a skilled workforce in today's economy and in today's environment is a great asset, and we are really working hard to try to figure out a way to take advantage of that.

Okay. That's great. Thank you.

Your next question comes from the line of Joe Noto with JPMorgan. Please proceed.

Thanks. Good morning

Good morning, Joe.

I just have one more question on LPD-24 and the implications for later ships. I don't want to put words in your mouth, but is it fair to characterize this as, you were already at zero margin and the biggest reason for the impact this quarter is just because you were already running so tight. And if we look at 26 and 27, if something similar had happened close to delivery for those ships, you probably -- the way you're accruing things now, you would have had a risk contingency that could have handled that?

Joe, you got it exactly right. That's exactly right. The issue here is that these programs have been underwater really for quite a while now. And so whatever we do, as we've said from the beginning, whatever we do on these programs is going to be very visible. The fact that we would be not actually taking credit on LPD-26 or 27 until we retire the risk means that you shouldn't see this kind of thing as we approach delivery on the new contracts.

Okay. Fair enough.

And then just a couple of little nits. I was wondering if you could provide what the EACs were, positive to negative in the quarter, that will be in your Q? And then any commentary on what we might expect in terms of near term share repurchase -- should we think about this ratably over three years, and so -- like you're chipping away at the debt, you'd be chipping away at your share base? Any color you can give on that? Thanks.

Let me start with what you'll see when we file the Q. The gross favorable adjustments are $46 million and the gross unfavorable adjustments are $55 million. So that $55 million includes the workers comp and then the LPD-22 through 25; and the $46 million includes that Enterprise EDSRA $15 million that we talked about earlier.

As far as the share repurchase program -- we are looking at it. I don't want to really say that we have a perfect schedule of exactly how we are going to do it. We'll watch and see what happens.

Okay. Thank you.

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

Thanks Good morning.

Maybe to go back to a couple questions. Mike, you talked about industrial products other than ships, and I guess two questions on that. Why would you ever want to get involved in something where you have the workforce, but maybe not the core competency for the end market? It would seem like that was something you'd leave to other companies and position the asset as such.

So that's kind of a topical question. And then, what would be the decision timeline for something like that?

Well, number one, there's no way we would get involved in something that was not in our core competency. The reason that we are looking at this is because we do actually think we have a core competency here for fabrication -- design and engineering and fabrication of complex systems. We do know how to do that. The question about the timeline -- so let me just put everybody at ease here. We are not charging out to go do something that we don't know how to do. We will only do something that we know how to do. We will do it in a measured way, so that we can prove to ourselves that we can be successful with it.

Relative to the timeline for it -- again, I think that the competition on the timeline is, we're not sure the demand for these products is going to be soon enough to support the workforce that we have in place. And so that's the balance that we are looking at. In the meantime, we will continue to execute our plan to close the shipyard.

Okay. I'm just reminded by commercial ships -- presumably that's something, obviously, we're not talking about but something that you have the capability to do, the workforce to do -- but a different market, a different customer sometimes is what dictates what's not in the core competency. So just reluctant to understand how you translate what you do to an end customer who's significantly different than your DOD customer and the risk profile that goes with. That's all.

You know what, Myles? I've got lots of scars on my back from those kinds of initiatives. So believe me, I'm treading very softly here.

On the other hand, we've said from the very beginning that if we are able to create a partnership along the way that can take advantage of our unique capabilities; where they would have an understanding of the role in the marketplace; if we are able to demonstrate the ability to be competitive -- then I would have to say that's an opportunity for us to achieve some potential that we otherwise wouldn't have achieved.

So I'm being open-minded about this, at this point. We are not charging off in a reckless fashion at all. We are being very thoughtful about this.

The reality is that the projects that are being planned or have been announced will require a manufacturing workforce that does not exist today. That is a reality. And so the question -- if you are sitting here with a manufacturing workforce, the question is, how do you engage in that? And can you engage in that? And we're weighing that.

Okay. And then, you mentioned both teams had submitted bids on the surface destroyers, with an expected decision for next year. Can you comment on the gates from a procedural budget process? And if those are limiting factors -- continuing resolution, sequestration -- are those limiting factors to the actual award of the ship in terms of what year money we're talking about?

I think the continuing resolution that goes through March does create an issue relative to the award of the contract before that. So this would be something after the March CR expires, assuming that there was a FY '13 bill.

Myles, you know that there's probably a range of possibilities there where you can have a normal bill, you can have a continuing resolution with anomalies, you can have a continuing resolution with no anomalies, and you can figure out which of those make sense for new starts and which doesn't. But in the situation we are in right now, we don't expect that award to be in the current situation. It would be after this is resolved to the next phase.

Okay. Got it. And then one last clean up one -- Barb, I think I got it that the workers comp is an EAC, so that's effectively profits from prior periods or expenses that should've flown through prior periods, based on what you know today. Is that an accurate representation?

Well, it works just like pension. When you adjust the discount rate, in this case the discount rate going down, you increase your liabilities. You've got to flow those, you've got to expense those through your contracts

But is it being expensed through the P&L today, based on a cum basis because --

Yes.

But pension wouldn't, unless you're already in a zero margin position. So that's what's driving that?

Right. It goes through your calculation or your percentage complete on your contracts.

So the only reason you're calling this out different than some of the escalators that may have come down, is because it's a specific item to workman's comp. Is that right?

Correct.

Okay. All right. Thanks.

Thank you.

Your next question comes from the line of Brian Ruttenbur with CRT Capital. Please proceed.

Thank you very much.

Just want to get a little bit more color on the return of cash to shareholders as a goal. Right now, it looks like you're paying less than a 1% dividend yield. And that's below, if you would say broadly, your peers. What the plan is -- just wanted to understand what the plan is for you guys down the road on the dividend.

Sure, Brian.

I think it's fair to say that we take small steps. And we wanted to start here in a very modest way. And as we go forward, we would evaluate our next approach. You know, our sense here is that we thought it would be better to start early than to wait; and let's get started with it and then see where it takes us. And again, no need to go jump into the deep end of the pool -- let's just start here at the beginning and start walking down the path.

Okay. And then for Barb, just a quick question on the tax rate, long term. I think you mentioned a tax rate in the 40's -- 42% this year. What you expect longer-term, in 2014, '15? When you're talking about your 9% operating margins, I think, in '15, what kind of tax rate are you looking at then?

Wow. You're going out a long way. I'd say it really depends on what happens with the domestic manufacturing deduction and your R&D credits and all the other sausage-making that goes into the taxes. But if you want to pick a number, I'd just go with the statutory rate of 35%.

Brian, I'd ask you what sort of tax rate are you looking at in 2015? (laughter)

It's going to be a heck of a lot higher, that's all I know.

Different than what it is now. (Laughter)

I didn't want to say that. Great. Thank you guys very much.

Thanks, Brian.

Your next question comes from the line of Ron Epstein with Bank of America Merrill Lynch. Please proceed.

Good morning.

Just a bigger picture question. In the prepared remarks, you addressed it a little bit. But if we do run into some sort of sequestration scenario, who knows exactly how that would play out? How do you think about it, and how do you think about how it would impact your business, given that pretty much everything you do is multi-year in nature. How do we think about that?

Thanks for the question, Ron.

First of all, we made a decision very early on in this year that -- and I would say that it was a bit of a bet, but I think it's paid off for us -- and that is that prior year obligated funds are just not going to be part of this discussion. Prior year obligated funds for us are all the ship contracts that we have and the design contracts that we have, and the backlog that Barb has talked about. We've got the contracts signed at Ingalls that carries us out for the next few years. We've got contracts at Newport News that are going to carry us out for the next few years. And so the near-term effect of sequestration, as it exists -- our sense of it is it's not a near-term issue for HII.

We are watching very closely the impact to our suppliers. We have 5,000 suppliers in all 50 states, and those guys are -- they're very careful about this, trying to predict how things are going to go and what investments they need to be making to support us. And so we monitor that very closely, so any effect from that would have a little bit of an effect on us. But for the most part, we are just working our way through that in terms of the near term.

I do think that there needs to be, and there will be, a discussion about how do we allocate the resources that we have for the needs that we have. And I think that debate's going to play out over the next couple years, and that's really a discussion about what this company looks like in the 5- to 10-year timeframe. And so we are going into a phase here over the next couple of years where Newport News is going to be signing a series of contracts -- the new carrier construction contract, the next carrier refueling contract, the block 4 submarine contract, the inactivation of Enterprise. We believe that all of those things will happen. I'm not sure that I would go and place a large wager on exactly when are they going to happen, because I think the when is going to be the part that gets -- move the chips that get moved around some in this discussion.

But in the main, there's an understanding by the taxpayers and the Navy that these are capabilities that we have that are critical to our economic and national security. And so in that sense, we are engaged in the discussion about what is it that you need to do, when do you need to do it, and how do you get from where we are to where we want to be? And so that's a debate really about what does the company ultimately look like 5 or 10 years from now? And that's the way we've been approaching it.

We care deeply about our programs and our people and our supporting role for the Navy and its missions. We will care just as deeply about that on January 5 as we do on December 5, whether the law goes into effect or not. And the case that we are making now is the same case that we will be making after this law goes into effect or doesn't go into effect.

So that's the way we've been thinking about it. I think that it's turned out that we were probably right about the prior year obligated funds being not part of this discussion. So that served us well this year. It's kept our workforce focused in on the work that we've got, and it's given us a chance to breathe our way through this in a rational -- I'd say, unemotional -- way.

Great. Thank you.

You bet.

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

It's one more question. I wanted to follow-up on LPD-26 and 27. Because -- can you talk about the difference in the way those contracts look, compared to your earlier ones?

There's really not a big difference in the way the contracts work. It's really how we priced it; and we priced it based on our current experience. And then, because the contracts are very similar, they're both fixed price and they were both fixed priced incentive contracts. So we priced it based on current performance. And then, from a work standpoint, we put our operating system in place, and we have a more diligent process where we go through this phased construction. And then the third piece of that, as Mike's talked about, we conservatively book on the front end due to the risk in front of us; and then as we retire that risk, we improve the margin rates going forward.

My understanding was, on LPD-22 through 25, and even the earlier ones, that previous Management had signed up for some pretty aggressive learning curves. I was just curious how you were able to get to a point on 26 and 27? Is it by virtue of continued improved performance, or is it through better pricing -- in a sense, more realistic pricing -- on these newer ships?

You know, Doug, I'd say all of the above.

The fact is that when we go to sign a contract with the Navy, both parties are certifying that the pricing that is there is actually achievable. There's lots of data -- when we go to sign LPD-26, there's lots of data about what that pricing ought to be. So that's one part of it. But the other part of it is, you know, we are good stewards of the taxpayer dollars here. These operating systems that we put in place are serving us very well. The leadership team that has been built and is executing the programs on the Gulf Coast is doing a fine job. And we are very proud of the work that we are doing, and we are very optimistic about the targets we have set and our ability to achieve our long-term objectives.

Okay. Good. Thank you.

Thank you.

This concludes our question-and-answer session. I will turn the call over back to Mr. Mike Petters for closing remarks. Please proceed.

Thank you. I just appreciate everybody joining us on the call this morning. As I said, I think today for us, this is an historic day. We are initiating a dividend. We are initiating a stock buyback. In the history of the Company, today will be the day that we started that, and we are very, very excited about that.

We've said from the beginning that the number one objective over the next three years is to get those five ships delivered. We delivered another one this quarter. That's exciting. We also took another one to acceptance trials just last week, and that's very exciting. That would be three of the five ships by the end of this year will be out of the system.

We are looking forward to next year and finishing that part of our process, and then moving ahead and continuing to create more value for all of our stakeholders. So with that, thanks for being with us today.

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