亨廷頓·英格爾斯工業 (HII) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Q1 of 2013 Huntington Ingalls Industries earnings conference call. My name is Sandra, and I will be your operator today. At this time, all participants are in a listen-only line. We will conduct a Q&A session towards the end of the conference.

(Operator Instructions)

As a reminder, this call is being recorded for replay purposes.

I would now like to hand the call over to Dwayne Blake, VP of Investor Relations. Please go ahead.

Thank you, Sandra. Good morning, and welcome to the Huntington Ingalls Industries first-quarter 2013 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 laws. Actual results may differ. Please refer to our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results.

Also in the remarks today, Mike and Barb will refer to certain non-GAAP measures, including 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 will turn the call over to our President and CEO, Mike Petters. Mike?

Thanks, Dwayne. 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 2013. Today we reported sales of $1.6 billion, essentially unchanged from last year, and diluted earnings per share of $0.87, a 30% improvement over the same period last year. Pension-adjusted earnings per share was $1.17 for the quarter, compared to $0.89 last year. Segment operating performance continues to improve. First quarter segment operating margin was 7.7%, up 124 basis points from 6.4% last year. The margin expansion was driven by improved operating performance at Ingalls and risk retirement at Newport News. We received $3.2 billion in new business awards during the quarter, including the refueling and complex overhaul of CVN-72, USS Abraham Lincoln, resulting in a backlog of $17.2 billion at the end of the quarter.

And before I address our major programs, I will make a few comments on the defense budget and sequestration. The failure to pass a Defense Appropriations Bill for 2013 in a timely fashion delayed the start of the refueling and complex overhaul of the USS Abraham Lincoln at Newport News by six weeks. And it also delayed the award of the DDG-51 multi-year contract at Ingalls. The Congress subsequently approved and the President signed into law the 2013 Appropriations Act in late March, and the Lincoln has now arrived at Newport News, although later than we would have liked.

In addition to funding the Lincoln RCOH, the 2013 Appropriations Act also includes funding for construction of CVN-79, three DDG-51 destroyers -- which is one more than the Navy requested -- advance procurement funding for a second Virginia Class Submarines in FY '14, and advance procurement funding for continuation of LPD production. The Act also funds the cost to complete LHA-6, LPD-25, and the CVN-71 RCOH. Within the Homeland Security Title, the Act also funds construction of NSC-6, and added funding to buy long lead material for NSC-7.

From HII's perspective, all of our 2013 priorities were supported by the 2013 Appropriations Act. Regarding the President's budget request for FY '14, support for our programs generally remains favorable. The budget request includes a second year of funding for CVN-79 Kennedy construction; two Virginia Class submarines, with authorization to incrementally fund the second VCS in FY '14, allowing the Navy to fund the submarine over two years; one DDG-51; a third year of funding for the CVN-72 RCOH; and full funding for construction of NSC-7.

With regard to sequestration, as most of you know by now, shipbuilding is more insulated in the near term than many other defense programs due to the long-term nature of our contracts and our backlog. However, sequestration does present increased risk to our supply chain, which consists of nearly 5,000 companies in all 50 states. Long-term sequestration could thin this shipbuilding supplier base if procurement schedules are stretched out, and make the construction of ships and submarines more expensive. In an effort to support the long-term health and viability of our industrial base, we will continue to communicate this impact to our customers and elected officials.

Now I will hit a few highlights of our major programs, beginning with Ingalls. LPD-25 Somerset continues to perform well at the Avondale shipyard, and successfully completed main engine light-off, a key milestone that supports delivery this your. At Pascagoula, LPD-26 is in the unit construction and erection phase of production, and LPD-27 is on track for keel laying in the second quarter. LHA-6 America continues to progress through the test program, and is experiencing typical first-in-class issues that put pressure on the delivery schedule. However, the team is taking the necessary steps to mitigate the impact of these issues, in preparation for successful acceptance trials and completion of the ship this year. LHA-7 Tripoli is in the early stages of construction and continues to make steady progress.

In the National Security Cutter program, NSC-4 and NSC-5 are progressing well. On May 1, we were awarded the construction contract for NSC-6, with construction to begin in October. Also, the contract award for procurement of long lead time material for NSC-7 is expected this quarter. Construction of DDGs 113 and 114 continues to progress well, and we expect the Navy to announce the next DDG-51 multi-year ship award of either 9 or 10 ships split between ourselves and our competitor very soon. On the DDG-1000 destroyer program, construction of the aft PVLS modules, hangar, and deckhouse for the DDG-1001 is progressing well. Ingalls demonstrated considerable improvement for the first set of class products to the second set, and we plan to complete our work on DDG-1001 by the first quarter of 2014.

At Avondale, although closure remains our baseline assumption, we are pursuing commercial energy infrastructure contracts and other opportunities. While we pursue alternatives, we are sending some LPD-26 and 27 units to Avondale to efficiently manage the base at both Ingalls and Avondale. However, as we have communicated previously, if we are unsuccessful in our pursuit of commercial energy infrastructure and other industrial manufacturing opportunities, we will have to close the facility. This is our least desired outcome, and we are taking reasonable steps to try to prevent this from happening.

Now turning to Newport News, CVN-78 Ford has reached several significant milestones in 2013. In fact just yesterday, NNS performed the last of 162 superlifts, which completes more than three years of structural erection work, and makes the ships primary hull structure 100% complete, with overall ship progress at 60%. Outfitting of the ship has included coatings applications in approximately 500 tanks, voids, and spaces; installation of over 4 million feet of cable; and installation of a significant amount of machinery in preparation for launch this year.

On the Kennedy, the next carrier in the Ford Class, efforts continue under our construction preparation contract to ramp up engineering design, planning, long lead time material procurement, and advanced construction; and we anticipate having a construction contract in place later this year.

In submarines, the final Block II boat, SSN-783 Minnesota, recently completed very successful alpha sea trials, and remains on track to deliver this Spring, 11 months ahead of schedule. We expect a Block IV contract award this year for up to 10 additional submarines, with construction beginning in 2014.

CVN-71 Roosevelt remains on track to complete its refueling and complex overhaul and redeliver midyear; and the CVN-72 Lincoln which arrived at the shipyard on March 28, is under contract for its 44-month RCOH. CVN-65 Enterprise is expected to enter the yard later this year for inactivation and the defueling of its eight nuclear reactors.

In summary, I am very pleased with the progress that Ingalls and Newport News continue to make on our major programs. And while risk remains as we work through the test programs on LPD-25 and LHA-6, we remain confident in our ability to expand the margins at Ingalls and reach our anticipated 2015 targets. I am also very proud of the efforts of our 37,000 shipbuilders during the first quarter. In spite of the uncertainty surrounding the 2013 budget, they remained focused on the work at hand, and continued to maintain an emphasis on safety, quality, cost, and schedule because they know that these areas are vitally important to our customers, our shareholders, and the men and women who will be serving on the ships.

Now that concludes my remarks. And I will now 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 would like to briefly review our consolidated and segment results as disclosed in the press release, then wrap up with some clarifying comments on pension.

Turning to the financials on slide 4 of the presentation, first quarter sales were flat from the same period last year, and included higher sales on submarines, the NSC program, and fleet support services, offset by lower sales on amphibious assault ships. GAAP operating income was $95 million; pension-adjusted operating income was $118 million, up 22% over 2012. GAAP diluted earnings per share for the quarter was $0.87, pension-adjusted diluted earnings per share was $1.17, up 32% over 2012, driven primarily by additional risk retirement on the VCS program at Newport News and the absence of unfavorable adjustments on the LPD program at Ingalls.

Consistent with prior years, we were cash users in the first quarter. Cash used in operating activities was $362 million, bringing our quarter-end cash balance to $652 million. For the full-year, we expect to be a free cash flow positive. However, as I said before, cash flows are primarily driven by timing of collections and ship deliveries. So a small shift can make a material difference in year-end reported cash balance.

During the quarter, we purchased approximately 4,000 shares for a total of 35,000 shares since we announced our $150 million share repurchase program last November. Additionally, we paid our second dividend of $0.10 per share on March 15. Capital expenditures for the quarter were $30 million, up $3 million from the first quarter last year. For the full year, we continue to expect capital expenditures to be in the mid 2% to 3% of sales range.

Turning to slide 5, Ingalls' revenues for the first quarter were $631 million, down 8.8% from the same period in 2012, driven by lower sales on amphibious assault ships following the delivery of LPD-23 and LPD-24, and lower volume on LPD-25 and LHA-6. These declines were partially offset by an increase in the NSC programs from the continued construction of NSC-4 and NSC-5, and the advance procurement contract on NSC-6. Ingalls operating income for the quarter was $26 million, compared with $20 million in the same period in 2012. Ingalls operating margin was 4.1% for the quarter, up from 2.9% last year. The increase was primarily due to the absence of unfavorable adjustments on the LPD program.

Turning to slide 6, Newport News revenues for the quarter increased $55 million or 6.1% from last year, primarily driven by higher sales on the VCS program, as well as higher fleet support services. Newport News operating income for the quarter was $94 million, compared with $81 million last year, primarily due to VCS program risk retirement, and the favorable resolution of outstanding contract changes, also on VCS. Newport News operating margin was 9.9% for the quarter, up from 9.1% in 2012.

If you turn to slide 7, I would like to make a few comments on pension to give you an update from the ranges provided on our last call. After the evaluation of the recently completed collective bargaining agreement negotiation at Newport News, we expect the 2013 FAS/CAS adjustment to be $85 million. We also expect our qualified pension contributions to be $301 million for the year, of which $32 million was contributed in the first quarter, with the remaining contribution planned in Q2.

That wraps up my remarks. And with that, I will turn the call over to Dwayne for Q&A.

Thanks, Barb.

As a reminder to everyone on the call please limit yourself to one initial question and one follow-up, so we can get as many people through the queue as possible. Sandra, I will turn the call over to you to manage the Q&A.

Thank you.

(Operator Instructions).

And your first question is from, apologies for pronunciation, Joe Nadol from JPMorgan. Please go ahead.

Thanks, good morning.

Good morning, Joe.

Mike, just on the LHA-6, you mentioned that there is some pressure on the schedule. Could you maybe give us more specifics on what you are seeing there, and just how you are feeling about the situation with the accrual rates on the contract?

Well, in terms of what is happening on the ship, I feel really good about what is going on the ship, and we had a really good quality launch. We are moving into the test program now. I just walked the ship myself last week. And now we are at the point, where we are bringing this brand-new ship through the test program, to get to builders trials and acceptance trials. And we see ourselves being on track to get through all of that this year. But it is going to be, as we have said all along, we have to sleep with one eye open on this, until we get it across the finish line. So, and I will let Barb talk about accruals.

Yes, we are doing a very thoughtful approach to how we are going to deliver the ship. And at this point in time, we don't see any issues with our current booking rate.

Okay. If we look sequentially from Q4 to Q1, Ingalls margin was down a touch. I know there is all kinds of mix shifts, and the margin was up a lot year-on-year as you pointed out. But Barb, could you maybe give the comparison from Q4 to Q1 at Ingalls?

Yes, sequentially, what happened in Q4, is we had several favorable adjustments, none of which were individually significant. But the types of adjustments, we had some small risk retirement on NSC-4. We had some retirement -- risk retirement on LHD-8 for some material. We also quoted out some old contracts on DDG-51, so that helped us get to the 5.3% in Q4. And then in Q1, we actually had some downward pressures related to overhead rates, and the EPA indices going down on our contracts. Again, it affected multiple contracts, but none of which were individually significant.

Okay. Thank you.

Thanks, Joe.

Thank you. Your next question, apologies again for pronunciation, this one is from Noah Poponak from Goldman Sachs, please go ahead.

Good morning. This is [Omir] in for Noah.

Good morning.

A couple of quick ones for me. Mike, just following up on your comments regarding the new business development initiatives you have. You had mentioned previously that some newly announced energy projects in Louisiana and Texas were specifically creating some demand for your workforce with some incoming requests. Any updates or any progress there specifically? And also, when should we be expecting some sort of news one way the other, from you on whether this is a viable endeavor for you, or will you will not be pursuing it further?

Well, I don't know that the -- first of all, the news is the same. I mean, the projects are moving along, and the phone keeps ringing in terms of, are there ways that we can work with you, or with your facility or with your workforce. And so, we are being fairly deliberate here. Because we have got some scars around, trying to do things that we have never done before. And so, we are trying to find the right arrangement with the right partner, that takes full advantage of what we do. In terms of -- I have resisted the challenge of -- what is the drop dead date on this.

The clock is ticking -- is that the workforce continues, as we finished LPD-25, the workforce will continue to draw down. And at some point, if there is no workforce there, then the conversation that we start to have with the industry becomes very different. We mentioned that we have actually, to balance the workload at Ingalls, to support the work we are doing on LPD-26 and 27 there, we are actually doing some unit work at Pascagoula -- I am sorry at Avondale. And that unit work is actually helping us maintain the workforce a little bit longer than we would have otherwise, with just the draw-down of LPD-25. But, we are -- the workforce basically draws down pretty fast over the next 12 months. And so, that is kind of the window that we are in right now. And if we get the point, where there is no workforce left, I guess my view is that we still have an asset, and we just move to a different phase of discussion with that industry.

Sure. Thank you, that is helpful. Just a last one for me, a higher level margin question. It seems like you are obviously making reasonable progress here towards the 9% goal for 2015. If you look out beyond that, do you see any upside to margins above and beyond there? And if so, what would the drivers of that upside be potentially?

Well, I think I have said before, that this kind of business operates normally in the band of between 9% and 10% over period of time. And I think you get high in the band when you are projects are very mature, and you are in serious production. And you are low in the band, when you are doing lead ships, and doing a lot of engineering and trying to start programs up. And so, I would expect that we would stay in that band going forward. A lot of that will depend on how the workload plays through in terms of sequestration, and what happens with ship procurements and the on-time procurement of things, particularly -- as I have said before, I think that the carrier schedule, the submarine schedule, and the destroyer schedule is a pretty good schedule, and I feel pretty good about that. I -- we are putting a lot of energy right now into shoring up the amphib schedule, because I think that is where the -- that is the challenge will be in the three to five year timeframe.

Thank you.

Yes.

Thank you. Your next question is from Robert Spingarn from Credit Suisse. Please go ahead.

Mike, on the margin, long-term margin outlook, just following up on the last question. I think you and Barb have consistently said 9%-plus across the Company for 2015. And Barb, I think you have clarified that that is a full-year number.

Correct.

That is right.

How do we think about the mix between the two businesses in that margin? I -- clearly, it depends on what you just talked about, the maturity of programs in 2015. So are we in a situation where we are at parity between the two yards? Or should we think of one being, maybe Newport News is higher and Ingalls is still sub 9%? How do we think about that?

No, I think our objective is to be at parity. I mean, we believe that to attract capital to this business, and to attract talent to this business. Whether it is a nuclear business or a non-nuclear business, you have got to have that kind of a return. And so that is our objective, is to get both of these business up above that threshold. And I feel really confident about that. As I have said, beyond that, we have got to go shore up the amphib base. But I feel very confident that both of these businesses will be operating in that range.

And Rob, it is important to look at it on an annual basis, because you will have, quarter over quarter, you will have tick ups for risk retirement, so you have different things going on. So, it is very important, like he said, to look at it for the year. Quarter over quarter isn't really a way to look at our business, because you will have risk retirement at different periods during the year.

How, Barb, on that note, how does the risk retirement look in the early stages here, on some of the newer programs that are moving through Ingalls? So, moving the focus away from LP, Somerset and LHA-6, et cetera, to the newer ships?

Yes, I would just look at it across all programs. We look at a lot of different things. We look at how we are forecasting overhead, what our actual labor rate rates are on each program. And then we have events that occur, and it could be percent complete while we are meeting our performance criteria. It could be launched. It could be, we achieved different incentives in the contract. Like on submarines, it can be pressure hull complete. Of course, at delivery, you have retired a lot of the risk, but you still have to go through warranty periods and things like that. So there is various stages of testing. So we look at a lot of different things across all the programs.

And what I would say, Rob, is that two years ago we said that we needed five contracts. And we talked about, not only did we get all five contracts, we got six. We got an extra NSC contract in there that wasn't on our first list. All of those contracts, at the early stages are performing in the range of where we want them to perform to support our long-term objectives. Every single one of those programs is where we want it to be.

And then just as a final question, on the sequester and to the extent that you have some maintenance exposure or short cycle exposure here and there in the business, if we end up with this $41 billion coming home so to speak, we are -- and what magnitude might you see some impact in '13 and '14?

If there is any impact, it is going to be in our AMSEC business I believe, or maybe a little bit at Continental in San Diego. But in the grand scheme of things, we expect that to be relatively minor to the overall size of the business.

And is that next year, because you are largely booked through in those businesses for this year?

Well, I think still -- it is mostly next year, because you don't know where next year is going right now. I think there is still decisions to be made about this year. So, and I feel pretty good about where we are this year, and I think we may have a nick here or there. But I think that it's, -- again this is such a smaller piece of our overall business that it -- at the macro level it is not something that is driving us at this point.

Okay. Thank you.

Thank you. Your next question comes from Doug Harned from Sanford and Bernstein, sorry.

Good morning.

Good morning, Doug.

I wanted to see if we could get a better understanding of the amphib outlook. And this -- once you get past LPD-27, how are you thinking about this portion of the business? I know that -- we are looking at, at least in the current shipbuilding plan that I have seen, we are looking at LX off in the future, and no more LPDs. What do you see happening here, and how does that affect the way you manage that business?

Well, we are advocating that -- and first of all, I think you are looking at exactly the same things we are. There is an LXR program out there that is fairly far away. And there is LHA-8, which is a follow-on to LHA-7, which is very important to us. But our view is that, there are ways to be creative here, that could actually be more efficient for the taxpayers, the Navy and the Marine Corps, and also support our objectives. So trying to move those programs around or bridge from the program that we have, the LPD program that we have, to a future LX program is something that we are advocating very loudly.

We have been proposing that you could use the LPD hull for a variety of missions, besides just LPDs. And so we are taking that case forward. And if you go and look at the Appropriations bill, there was money set aside in the '13 budget to go down that path. Whether it is a transition ship, or a bridge ship from an LPD program to an LX program, we had to work our way through that. But the Congress believes that you can't just stop building amphibs and then restart it. That is what the book of law says. So we are engaged in that process in a very robust way.

I am not sure, because of the way we are pushing on this, I am not sure I can actually predict exactly how it is going to turn out. But I do feel pretty good about the reception that we are getting, an attraction that we are getting. Because I think everybody now understands that when you stop a shipbuilding production line, it becomes very expensive to restart it. And so folks are trying to find a way to -- in this environment, it is not easy. But to try and find a way to get us from where we are today, to where we want to be in the future.

And if you overlay the budget situation, sequestration and the potential for future automatic cuts on this -- I mean right now, you have got a lot -- you did well, I would say in the '13 budget. You have got a lot of contracts in place for shipbuilding. But when you look out -- if we have a next year of say, automatic cuts, are you looking at some risk there on the construction side of the business? I know it is -- I think it's important.

Yes, I think it is really just about timing, Doug. I mean, once we have the contract, I don't believe there is any -- there is not going to be any movement to go back in and try to adjust the contract there, based on anything that happens. So it is a matter of what is the timing of the ships, and what is the timing of the contracts. I have described to some folks that -- as I have said before, I believe carriers, submarines and destroyers are pretty solid. I mean, those are the Navy's priorities. The Navy has a really good understanding of the symbiotic relationship between those high-performance platforms, and the industrial base required to support that. And I believe the Congress does too. And in fact, the Navy went forward and to the Congress, and the Congress has expressed a desire to add a destroyer, and add a submarine to what the Navy request.

So I think those programs are going to continue along, on the path, basically that has been laid out. But I think when you drop below those three programs. And let's set ORP off to the side here, because I think ORP ends up in that -- in that it becomes the fourth of those programs. But you set the rest of those -- you take the rest of the Navy programs and the amount of money the Navy has, I think there is going to be -- I would call it a scrum for lack of any other word. But it is going to be a scrum, to try figure out how do you -- how do you sort through this, so that you get the most capability at sea for the dollars that you have. We believe that you are going to be going into that decision with mature designs, not new designs. And we believe that volume at sea is going to be an important discriminator. And so that is why we have been pushing hard on the LPD hull form, as a mature design with an opportunity for putting volume at sea to support a variety of missions. And we are getting good reception with that. I am not sure how the scrum all plays out, but it is something that we are very focused on.

Okay, very good. Thank you.

Thank you. Your next question, apologies for pronunciation, this one comes from Peter Skibitski from Drexel Hamilton. Please go ahead.

Good morning, Mike and Barbara.

Hi, Pete. How are you doing?

Good, good. Yes, I wanted to follow up again on the 9% margin rate goal by 2015. I am just wondering with the two problems ships delivering later this year or expected to, why wouldn't you be able to hit the 9% goal in 2014? Is it an extra volume issue, or is there something else? Can you just add a little color there?

Yes. I mean, we have said this before that, what we have to do is, when we have new programs, we put all of the risk that we are aware of in the risk register. And then as the program matures we retire that risk. The new programs that we signed after we spun two years ago, won't be mature enough in 2014 to get us to the point -- and we just need the time to let those programs mature to the point where we can get Ingalls up into the band in 2015. It is that simple, really.

Okay, understood. Understood. And then in the quarter on the Virginia risk requirement and the contract change -- or can you [quantify] for us, the cum catch-up on the VCS in the quarter? And then maybe give us the net cum catch-up for the quarter also?

Okay. We don't break it down individually by program. But when I look at gross favorable adjustments for the quarter it was $45 million. And it was primarily risk retirement on Virginia class, as well as contract adjudication of a bunch of changes. But there was also some CVN-71 risk retirement as we are winding down on that ship. So that was the primary drivers in the $45 million. And then we had $15 million of cumulative unfavorable adjustments. And that was kind of across the board, and it was all related to downward pressure on overhead rates as well as the change in the escalation indices. So nothing individually significant, just all across the board, both at Ingalls at Newport News.

Got it.

And that is $30 million favorable adjustments.

Okay, got it. And then last one, Mike, the Navy going to Congress and asked for an increase in cost of the four, I think at 9% increase, any expectations in terms of Congress not approving that? And is that sort of in line with your expectations and planning?

Well, I am not going to try to predict what the Congress will do. They will certainly want to understand the issue, and we are prepared to walk through all of it with the Navy. Yes, this is -- this is as we have talked about before, the Ford is a lead ship, and we are going through while it is -- I still insist that this is the best lead ship I have ever seen come together. There are going to be -- we are going to be taking it to launch. We don't want to launch it until it is ready to be launched, just to make sure that we retire as much risk, and do this as efficiently as we possibly can.

I do expect that ultimately that, that the request will be honored, and that we will move ahead. And that is -- that is certainly part of our financial plan going forward. And frankly, what it will take to get that ship delivered. So it is part of the process. It is a healthy process. I believe that Congress will give it a full review, and after they have given it a full review, they will come to the same conclusions that we have.

Okay, very good. Thanks.

Thank you. Your next question comes from Jason Gursky from Citibank. Please go ahead.

Hi, good morning. It is Jon Raviv for Jason. Thanks for taking the question.

Good morning, Jon.

Just following up on Pete's question about Newport News margins, and Mike you talk about the business being 9% to 10%. Clearly, 9.9% is your best first quarter there in a while. Can we get just a little more detail on how you expect those to trend at least throughout the year? And then going forward, then in terms of the new business coming in, and how we could see margins trend in '13? And then sort of going forward from there?

So I will start, and then I will let Mike weigh in on my comments. First of all, I would say 9.9% isn't really sustainable. We had some ships -- some submarines come out of warranty. We had favorable rate performance. We had a couple different things going on in the VCS program that allowed us to make the favorable adjustment this quarter.

And all in all, we usually have -- if you look last quarter and you look first quarter 2012, we had favorable adjustments on VCS. And it is really just as we hit certain milestones in the program, we retire risk. So you -- we won't see it every single quarter, but you will see it on and off which drives that high rate. Overall, we are at the mix that Mike talks about. New contracts as well as more mature contracts in process and Newport News which allows us too have that blended rate of 9%.

Right. Well, over time you will see the Ford is a cost type contract. We expect that we will move to a -- some kind of fixed-price incentive contract on the Kennedy. Which means we will start that work, and as that work starts to ramp up, we will have our eyes on all of that risk, so the booking rates will be fairly low. And then as they mature, we will -- they will become part of the blended rate. But that is our expectation. And so, that is why I always think that the best place for this business to be, and the best way to think about a shipbuilding business is that, it is in the range of a 9% to 10% business. Because you need to have a blend of fully mature programs, plus new programs, so that you can sustain that over a period of time. That is certainly what our objective is, and that drives our overall -- the Navy strategy.

Okay, thanks for that. And a quick follow-up on Avondale. It sound like you are being a little more active in terms of pursuing projects, but also actively keeping the shipyard alive. How is that impacting your discussions with the government, in terms of what you expect to be able to recover or the timing of that recovery? Or if it is going to happen at all?

Well, our discussions with both the Navy and the state of Louisiana continue to be very positive. The Navy is very supportive of our efforts to redeploy, as opposed to close the facility. And obviously, the state of Louisiana is working very, very closely with us to find the right opportunity that make sense for -- first of all, make sense for Avondale and, but that would also make sense for them. And so, we maintain a very, very -- I would say high bandwidth of communication with both parties to make sure that everybody understands what we are doing. And we are very comfortable with the way that this is playing forward so far. Whether you want to talk about the incentives that the state has put on the plate -- on the table or the restructuring that we have in front of the Navy, we are very comfortable with the way this is working right now.

Great, thank you.

Your next question comes from George Shapiro from Shapiro Research. Please go ahead.

Yes, good morning.

Good morning, George.

One point of clarification, the way I read, in your release favorable resolution of outstanding contract changes, that strikes me as more one-time than the general risk retirement that you wind up seeing quarter to quarter. Am I correct in that or?

You are correct. When we are -- when we file the -- adjudicate all the changes and everything, you get the fee on top of the costs, you are changing your target. And so, you can recognize all that at the point you finalize. So that is one-time.

Okay. And then just to follow-up a question. If I back out what seems to be maybe 20% or so of zero margin programs this quarter, the margin at Ingalls is a little bit over 5%. Now, Mike, historically, I mean would you expect to get like a 400 basis point increase in two years for retiring some risk on some of these newer programs?

Well, remember, where we are, is that the new programs have to mature. They have got to come through their -- the keel events, the start of fabrication, the first few phases of construction. But, yes, I could see that.

I mean, is that historically kind of a normal kind of sequence that you would expect to see or is there more?

I think it is -- to be frank, George, it is a little bit hard to talk about the history here. I mean, the operating system that we are using at Ingalls is fundamentally not something that we have used at Ingalls. And we started this just a few years ago. So we don't really have the track record of what that provides to us. On the other hand, it does look a lot like the system that was in place back 15 years ago. And in15 years ago, if you took an individual ship program, and you looked at how it matures over its life, a ship that takes four to six years to build. And you are going to talk about what do you do with the booking rates, when you go from year two or three, to year five or six? Yes, 400 basis points is certainly within the range of reason.

Okay. Thanks very much.

You bet.

Thank you. Sorry, your next question comes from Myles Walton from Deutsche Bank. Please go ahead.

Good morning.

Morning, Myles.

Barb, could you -- maybe start on the free cash flow. I think you mentioned that it would be positive. But I guess I am looking to flesh that out a bit. Because when I think about your S-curve chart for working capital, I think about the pension, year on year is a bit of a headwind, but after-tax not much, and your net income, cash earnings rising. What am I missing that free cash flow in '13 isn't as good or better than '12?

So what happens with, say the delivery of LPD-25. You have to think of deliveries have -- when you think about S-curve, the reason why you are on the upside is because you are delivering the underperforming ship. So you no longer have -- you collect the retentions with the exception of a little bit related to the warranty period and everything that they hold back. But that is usually big number, $50 million, $60 million. And also you can bill 100% of your costs, so you are not dealing with as lower of costs or progress, when you get to delivery. So you get a pickup there also. So you have a big cash bump with deliveries, and that creates that reversal on that S-curve.

Yes. So, but you are planning some deliveries for this year? So --?

We are planning the LPD-25 delivery. And we haven't given up on LHA-6 getting out of here. We just know that there is pressure, and we are going to do it in a very thoughtful, most methodical way to do it the most efficient and cost-effective way to make that delivery. So there could be some pressure on that. That is why I said, the lumpiness at year-end on the cash balance is related to timing of collections, as well as timing of deliveries.

Okay. All right. Mike, the other question I had for you was on supply chain. You mentioned it in kind of your opening remarks with respect to sequester, and your conversations with the Navy customer about of that being probably more of a concern to the health. I am curious from a financial perspective, how protected you are within your contract structures against the suppliers, the weakness under sequestration? Is this more of a customer heads up, that this could cause an issue to you, or is this also to help protect against your own contracts?

Well, gosh, with 5,000 suppliers in all 50 states, I would say the answer to your question is, it is probably all over the map. There are some suppliers that are probably in a place where, that they are -- they have their substitutes if there were problems from their standpoint. I think that they are looking at the same kind of thing that we have been looking at. It is just, we look at it in a very -- at a very broad level. They have a very narrow perspective. They have to decide whether they want to invest in the workforce or the tooling to support a program that they don't know exactly when that program is coming. However, they make that decision, it is possible that, that could lead to some inefficiency in the supply chain, could cause some people to decide not to make the investment, and not to stay as part of the team, depending on whether programs get delayed or not.

We take each case in our supply chain, both at Newport News and at Ingalls, we handle each one of these as an individual case. We evaluate how critical the technology is, how critical the supplier is, what is the risk to the program, what -- how important they are to the schedule? And we factor all that into the way we put a purchase order in place with them. We go so far as, in some places we put our own people in their plants, to make sure that we are helping them retire risk to support our schedules. And so, so we believe that we do this really well. It is one of the core competencies that we have.

But because we do it well, we have a lot of contact with these guys. And we know that if there is a lot of restlessness out there in the supply chain -- to out today, because they can't really figure out exactly when the next level of procurement is going to come, and when is the next ship going to happen. And that uncertainty is really creating some chafe in the supply chain if you will. In a supply chain that over the last -- in my opinion over the last 10 years has already been thinned out, because we have done so many lead ships. We are, I believe, in the submarine program, we are 80% sole-sourced. We will probably be -- I bet at least 60% sole-sourced on the Kennedy. And so you start to see, that there just is -- this is becoming a very important part of our business to manage. So I think it is -- there is not one size fits all answer here at, Myles, but it is kind of all over the map. But we do feel good that we -- this is something we do know how to go manage

Yes. And I mean, I don't want to diminish it, but it seems like your business would have some of the best visibility in certainly, your programs, some of the best visibility. And if you get that 51 and VCS multi-years this year, and maybe the CVN-79 this year, next year. I mean, it is hard for me to see what the supplier -- I can see if their business were touching other elements of the defense complex, but within your sub segments, the visibility is probably better than it has ever been.

Yes, I would agree with that. I think that even though that we are 80% sole-sourced in submarines, we have been able -- because that has been a very -- it has become a very predictable business, we have been able to manage that supply chain in a very efficient way. Because we have sustained demand there, and the suppliers know that, they can invest against it, and be very efficient to it. I think this is more of a problem for the non-nuclear side of the business, where the -- it's a bit more dynamic.

When is the next amphib coming? What is the story -- is there going to be a follow-on to LPD-27? The National Security Cutter, we basically have proposed that if we really want to save some money, we should do multi years on National Security Cutter. We have not had any commitment to that from the Congress. And so, those are one ship at a time. And so if you are a supplier in those programs, you are living a little bit closer to the edge, than you might be if you are say, on the submarine program or the destroyer program where you can kind of see the horizon a little bit better.

Thanks for the color.

You bet.

Thank you. We have a question from George Shapiro from Shapiro Research. Please go ahead.

Hello, George, again.

Hi. Well, I guess, there was -- nobody was in the queue, so it picked me up again. Mike, how do you manage the fact that you had mentioned you are going to move some work from Pascagoula back to Avondale on the LPD-26 and 27? I mean, how do you manage that efficiently? And then, on the LHA-6, you kind of raised a question here about potential delay in delivery and stuff. At what point would we -- would you be confident about that? And at that point, would that necessarily mean another charge or not?

Well, let's take the LHA-6 first. I don't see this being a charge to get the ship to delivery. I think this is really a matter of sequence. And the task for the team, as we sit here and we are walking to the sequence to get to completion and then delivery, we feel very confident that the ship will be completed this year. The question is, can you get beyond the acceptance trials, and get the close out done in time before December runs out? And I think that is really all we are up against.

And the one thing that we are going to make sure that we do, is we do this as efficiently as possible. If it delivers in December, that will be great. If the efficient way to do this, is to deliver it in January, that will be great too. And so, that is the kind of way we are looking at right now. We are pretty transparent about all of this. The team is doing some pretty incredible things to get that ship ready to go to sea, and I am very proud of what is going on there. It is just that the calendar and the schedule are intersecting a little bit at the end of the year, that is all.

Relative to the movement of units or the construction of units at Avondale, this is a pretty -- a pretty fluid process relative to -- we can build units at Avondale and transport them pretty efficiently. We have done that in the past. Frankly, we actually had folks that we outsourced these units to in the past, So we have kind of brought them in to do ourselves. And we can look at this, in terms of what of the skill trades that we are going to potentially need for a redeployed Avondale, and align that. The hull guys and the piping guys are folks that we really are going to need, if we are successful in redeploying Avondale, and that lines up with this work. And so, this is a very low risk way to buy some time on the clock. And that is kind of the approach that we are taking. But don't get me wrong, I mean, it is not going to going to buy us two years, it is going to buy us months.

Okay. Thanks again.

Thank you.

Thank you. I would now like to call -- to hand the call over to Mike Petters for closing remarks.

Okay. Well, thanks for -- thanks to everybody for joining us this morning. And again, we had a good solid first quarter. We are right on track to retiring the risk that we said we needed to retire by the end of this year. We feel very good about that, and we continue to be on track to obtain our objectives for 2015. We are very, very engaged in the process in Washington, relative to the strategic issues around shipbuilding schedules, and the best way to buy these ships, and how does that match with other priorities. And so, if you stick your head up and look around, you will see advertisements from us. You will see program stuff. And most of that is really going to be about, how do we transition the amphib production lines that are warm, to the future amphib lines that we need. So with that, thank you all for joining us, and we will be talking to you.

Thank you for joining today's conference call. Ladies and gentlemen, that concludes the presentation. You may now disconnect, and enjoy the rest of your day.