亨廷頓·英格爾斯工業 (HII) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Huntington Ingalls first-quarter 2014 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the call over to Dwayne Blake, Vice President of Investor Relations. Please go ahead, sir.

Thanks, Jamie. Good morning and welcome to the Huntington Ingalls Industries first-quarter 2014 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 huntingtoningalls.com and click on the Investor Relations link to view the presentation, as well as our earnings release.

With that, I'll turn the call over to our President & CEO Mike Petters. Mike?

Thanks, Dwayne. Good morning, everyone, and thanks for joining us on today's call. I am pleased to report strong first-quarter 2014 financial results that are right in line with our expectations and keep us on the path toward our target of 9% plus operating margin in 2015.

For the quarter, sales of $1.6 billion were up 2% from last year and segment operating margin was 8.6%, up from 7.7% last year. Operating margin at our Ingalls segment improved from 4.4% last year to 7.9%, continuing a trend of improving performance, while our Newport News segment continued to deliver solid performance at 9% for the quarter.

Diluted EPS was a $1.81 for the quarter, more than double last year. Additionally, we received $2.2 billion in new contract awards during the quarter, which increased our backlog to $18.7 billion of which $13 billion is funded.

Regarding the defense budget, there is continued uncertainty about whether sequestration will remain and it becomes clearer each day that this is not the best way to run our government. The debate over performing a refueling and complex overhaul or inactivating CVN-73 George Washington remains unresolved. And this mid-term issue could become a near-term issue.

We are concerned that the lack of funding in the FY15 budget proposal for the CVN-73 RCOH will impact the planning necessary to execute the RCOH in accordance with the current plan of record. This is not the ideal situation as it creates unnecessary churn and makes it difficult to plan and schedule the work on all of our other contracts.

However, our team remains engaged with the Navy and congressional leadership, and our suppliers, to ensure that potential implications to the industrial base, our workforce, and other programs are communicated and understood.

Now, I will hit a few highlights of our major programs, beginning with Ingalls. LPD-26 John P Murtha achieved stern release in March. The ship is 55% complete, and the team is completing the erection phase of production in preparation for launch in the fourth quarter. LPD-27 Portland achieved a 25% structurally complete milestone at the end of March as it continues to progress through the shop and unit-manufacturing phases of construction.

I am very pleased with our progress on the LPD program. We are seeing improved efficiencies and are leveraging lessons learned in the benefits of serial production from one ship to the next. These are the primary reasons you hear us making the case for continuing the production of LPDs as a bridge to the LXR program.

LHA-6 America was delivered to the Navy in early April, marking yet another milestone for HII as we completed the last of the underperforming contracts. She will remain in the yard for completion of postdelivery work and depart in the third quarter. I want to publicly thank the LHA-6 team for producing such a high-quality ship while keeping the costs within the parameters we established last year.

The keel laying for LHA-7 Tripoli occurred as planned in March, and the team continues to make steady progress. The ceremonial keel laying is scheduled for June. Regarding LHA-8, we are pleased that funding was included in the FY15 budget submission to continue design development in support of awarding a detailed design and construction contract in FY17.

In the national security cutter program, NSC-4 Hamilton completed engine light off in early April and remains on track for delivery to the Coast Guard later this year. NSC-5 James is 100% structurally erected and was launched this past week. NSC-6 Munroe early fabrication is continuing to progress well. And we were awarded a contract for construction of NSC-7 Kimball at the end of March.

On the DDG-51 program, DDG-113 John Finn is making steady progress through the unit manufacturing and erection phases of construction and remains on track to be delivered to the Navy in 2016. Early fabrication work for DDG-114 Ralph Johnson is progressing, and we are preparing for construction to begin in the fall of DDG-117 Paul Ignatius. In addition, we received full funding for construction of DDG-119, the second of five DDG-51 destroyers we were awarded last June.

Regarding the DDG-1001 we remain on track to deliver the deck house from our Gulfport facility in the second quarter. Following completion of this work and the composite mass for LPD-27, we will proceed with the shutdown of the Gulfport facility.

At Avondale, unit construction for LPD-27 will continue through the third quarter of 2014. As you know, we recently announced the establishment of a joint study group with Kinder Morgan Energy Partners. The study group has been tasked to evaluate best use opportunities for redeveloping Avondale.

If an economically viable best use of the facility is determined, the companies may pursue the formation of a joint venture to redevelop the Avondale site together. However, as I have said before, if we are unsuccessful in these efforts, we will proceed with our plan of record and close the facility.

Now turning to Newport News. CVN-78 Ford is approximately 75% complete and continues through the final outfitting and test phases of construction. Delivery remains on track for 2016.

For CVN-79 Kennedy, we received an extension of the construction preparation contract which continues engineering and design, material procurement, and advanced unit-construction activities prior to award of the detail design and construction contract that is expected later this year.

In submarines, SSN-785 John Warner, our first Block III delivery boat, reached pressure hull complete, which is the last major milestone before the submarine's christening this summer. As announced last week, the $17.6-billion Block IV contract for 10 additional submarines was awarded. This program has already proven itself to be one of the best -- if not the best -- performing shipbuilding programs in the country. And we look forward to continuing our important role in building these submarines.

CVN-72 Lincoln has completed the first 13 months of a 44 month RCOH. The team has accomplished a tremendous amount of work thus far and remains focused on activities to support undocking in the third quarter.

CVN-65 Enterprise has completed the first 10 months of her 38-month contract for the inactivation and the defueling of its eight nuclear reactors, with a continued focus on building the shipboard defueling complex, completing temporary systems, and personnel training and qualification.

In closing, now that all of the five Ingalls ships associated with the underperforming contracts have been delivered to our customer, our team is focused on continued program execution and risk retirement to drive operating margin to 9% plus in 2015. I am extremely pleased with our overall progress thus far, and I want to thank the Ingalls and Newport News teams for maintaining the drive and focus over the past three years to get HII to this point.

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. Today, I will discuss key highlights from the first quarter and, as a reminder, starting in January, our CMSD and AMSEC businesses were realigned under our Newport News segment, and prior-year results reflect this change.

Moving to consolidated results shown on page 4 of our presentation, we had a relatively straightforward quarter, with modest sales growth and a strong operating margin performance, which was primarily driven by risk retirement at Ingalls.

Total revenues increased 2% for the quarter, due to increased sales at Newport News. Total operating income was $159 million, up 67% over prior year, which was mainly driven by increased operating income at Ingalls and a favorable FAS/CAS adjustment.

Consistent with prior year, we were cash users in the first quarter. Cash used at operating activities was $214 million, bringing our quarter-end cash balance to $742 million. During the quarter, we made $39 million of our $123-million qualified pension contribution for 2014. We expect to contribute the remaining amount in the second quarter.

Capital expenditures of $24 million were $6 million less than the same period last year. However, we continue to expect capital expenditures for the full year to be in the 3% of sales range. Under our share repurchase program, we purchased approximately 250,000 shares at a cost of $25 million.

Before I get into segment results, I want to give a quick update on the Avondale restructuring proposal. We recently submitted an updated proposal to the Navy which included total restructuring costs of $284 million, up from the previous total cost of $256 million. The primary driver of the increase is the exclusion of potential recovery from the sale of assets in line with customer guidance.

Now, moving onto segment results on page 5, Ingalls had slightly lower sales but significant operating income growth for the quarter. Sales were down less than 1% due to lower volume on LHA-6 and LPD-25. Operating margin was up 350 basis points over prior-year quarter, primarily due to continued risk retirement on the NFC and LPD programs.

Turning to page 6, Newport News first-quarter sales increased 3.5%, primarily due to higher volume in aircraft carrier and the acquisition of Stoller, which contributed approximately $25 million in Q1 revenue. Operating margin for the quarter was 9%, down 51 basis points from last year, mainly due to lower risk retirement on the VCS program and the risk retirement on the execution contract for the Roosevelt RCOH, partially offset by risk retirement on Ford.

Regarding 2014, we are still expecting interest expense to be roughly $115 million and our tax rate to be between 33% and 34%. With respect to deferred state taxes, we maintain our estimate at a $5-million benefit for 2014. However, know that our estimate of deferred state taxes can fluctuate due to timing of contract income for tax purposes.

Finally, I want to briefly mention the new mortality tables released in January. Because the tables reflect increased life expectancies, the general consensus is that costs and liabilities will increase for FAS/CAS and cash. We do not expect this to have an impact on 2014 pensions cost, and we'll provide more specific guidance for 2015 at the end of the year.

That wraps up my remarks. And, with that, I'll 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. Jamie, I'll turn it over to you to manage the Q&A.

(Operator Instructions)

First question comes from Robert Spingarn from Credit Suisse

Good morning

You know Mike, as we think about Ingalls and the strength there you've now essentially delivered all of the zero margin ships so congratulations on that. Are we, as we go forward, going into positive cume cash territory now that you're focused on the more profitable clean sheet ships?

I think what you'll see is that Ingalls will start to behave as everyone else in the industry from a financial perspective as the ships that we have mature and we get back to our blended rate of more than 9%. It shouldn't be -- the five under-performing ships created an outlier situation for Ingalls there for the last several years. It's good to be behind us. Now we need a little bit of time to get the newest contracts that we have matured so that we're performing just like basically what everybody else in the industry does.

Okay, and given the way the ramp that you previously characterized as conservative on these newer ships, it would seem to me that the 9% target is actually not a final point. Because at the 9% target you have for next year, has these ships still in the early stage margin. So, essentially I'm asking you what the upside or is there upside to that number as those ships mature?

Well, I think we've gone through this before, Rob. It's actually the nine -- my view is that shipyards that are operating well, operate, especially when you have multiple platforms and multiple maturities, basically operate somewhere you know north of 9% and less than 10%. It's that 9% to 10% band is kind of where you are.

Our view is that we'll be in that band with the right blend and the right maturities next year. And the idea, the hope would be that we'd be able to sustain that. We've got some challenges in terms of sustainment right now around our amphib program that we've been pretty vocal about.

So you see us being very vocal about pushing for a bridge between LPD's and LXR's. What's really driving that, first of all, is that's the most efficient way for the taxpayers to get the ships that they want to buy. Secondly, the effect of that is that creates a sustainment bridge for us and we're able to sustain the performance at Ingalls and so --

When does this bridge, the timing on the bridge, when do you have the volume issue?

Well, it starts to play out over the next three probably next three to five years so you know it's a midterm issue for us which is why we're on it right now.

Okay.

Then I was going to ask you the same question on carrier overall and maintenance. The bridge question, you brought up that the overall, the RCOH on 73 could be a near-term issue. As we think about 72 and the inactivation of 65, given the uncertainty in 73, at what point do we start to see a whole?

You know you could argue that there's a bit of a whole right now because we're not really planning for it. We're doing a little bit of planning on the 73 but we're not really planning for an RCOH or the inactivation.

We're kind of caught in between right now and we'd really like to get on with it a little bit. So there's a little bit of a decline, you probably can't see much of it, but there's a little bit of decline on the planning side right now.

You know, this thing pushes out more than a year and it starts to become a problem relative to how it affects the rates in the yards as well as the volume in the yards. I think this is a 12 month decision for us really for how we're going to proceed.

Thank you.

Next question comes from Omar Khalid from Goldman Sachs

Good morning

The positive you've already discussed but wanted to ask a little bit about M&A here. I understand that the MP Stoller acquisition adds to the nuclear servicing capabilities in Newport but wanted to focus a little bit on any potential commercial opportunities. Especially as they relate to utilizing Avondale. Have you guys seen anything? Are you guys actively looking on that front?

Well we're not going to comment on any of the activity. I would just say at this point that what we've said before is that our aperture is wide open as we think about the capabilities that we have and how best to deploy those in a moderate risk environment. Our balanced cash flow strategy remains intact.

Understood.

Just a brief follow-up on the margin front to the prior question. Now that you have delivered LHA-6, how should we think about the quarterly margin profile here in Ingalls in the near term or at least for the back half of this year?

Well if you're thinking about quarterly margin profile about this business, you're not really looking at the business the right way. We are not a quarter to quarter kind of business. We have products that take four to eight years to build and we have a customer that puts out a 30 year plan.

What we've said is that wherever we are today we're on track to get to something in the 9% plus range next year. That's our path.

Understood.

On the EAC profile there's nothing specific on the EAC's that can be released in the back half here or anything along those lines that you guys are looking at?

We have our normal course of risk retirements and that's about all I'm going to say.

Alright, thank you

Next question comes from Myles Walton from Deutsche Bank

Hi, good morning. This is [Emmett Morarter] here for Myles Walton.

Your first question is on the update on Avondale that was provided last month. I'm sure there's not a whole lot you guys can offer given the study is ongoing but maybe can you give us some color on just how you are thinking about the scope of the company's potential participation? Is there a potentially completely new business opportunity there for the company or is it something more -- actually less capital intensive like a lease? Can you just offer some thought there on how you are thinking about that?

I think the first thing is obviously Kinder Morgan is a very credible partner to be working on this with. These are folks who have a wide range of interest and capabilities and so they clearly bring a very wide aperture to possibilities around that site. We're open to that.

The point of this is to actually try to turn over, as we said all along, we want to turn over every rock and see what we can find. Our effort to do that now is really with Kinder Morgan and we'll see where it takes us over the next several months.

Okay, and if you would were to find an alternative for the shipyard, how would that impact the recoverability of the closure cost? And the most relevant, with respect to that, is the cost that are already capitalized. Can you just offer some help there in terms of how we can think about that?

I'll let Barb answer that.

Sure.

The human capital cost that we've incurred in everything would still be recoverable under restructuring. What would happen is we would contribute the assets into a --potentially contribute the assets into the JV. Any assets that wouldn't go into that JV would also be recoverable under restructuring.

Okay that's really helpful.

You know, I just have one question, sort of high level margin question and I know you talked about this before. You've done a remarkable job with respect to margins at Ingalls. You're pretty close to that 9% target and even though I know it's going to be fluctuation from a quarter-to-quarter basis.

Can you talk about, are you still thinking about the longer-term operating margin potential of the business at 9% or are you seeing some incremental opportunity given the performance to date that there some opportunity to go beyond that on a sustainable basis?

Well, I think that on a sustainable basis a shipyard that has many product lines and many maturities has a blended rate in the 9% to 10% range. That's my experience for many years and that's what the industry has told us and I think that's where we've been -- Ingalls has been an outlier to that for many years.

They're moving back into that range and we're very proud of the work that they've done. We think that's what that business is capable of.

That's very clear I just thought I'd ask that question.

Just the third and last question for Barb. Can you provide some cash flow expectations for the year? Either an absolute number maybe more from a conversion of net income basis?

No, we don't give guidance on our cash. Part of it is because of the lumpiness and I know you don't like that word. But a lot of it has to do with timing at collections at the end of the year. If I gave you a pinpoint number and I miss collection by one day and I can be off $200 million on one day collections. So not going to provide that.

Okay, thanks guys. Great quarter

Thank you

Next question comes from George Shapiro from Shapiro Research

Yes good morning.

Barb, I wanted to pursue the cash flow from a different angle. The free cash flow conversion last year was pretty poor at like 37%, and I know you've talked in the K about a lot of it being higher pension contribution. But the thing that has struck me is you've also seen a big increase in receivables, up $176 million in Q1, up $218 million last year.

So if you could pursue a little bit more what's causing that? Because I also know in the K you mentioned that some of these receivables aren't collected until 2015, some more not until 2016. So, if you could just kind of, [explain] what's going on there?

Sure, no problem.

So George, down at Ingalls our contracts have retention clauses. So it's not performance related it's just part of the contract. Depending on what ship, the retention clause calls for 1.5% to 7% of billings to be withheld on your contracts. So for example LHA-6, the retentions on LHA-6 got to be about $200 million.

So, until you deliver those ships, those high retentions aren't released yet. You'll start seeing a little bit of that change. In addition to that, you have some pressure related to Gulfport closure that you're not billing, and you have pressure related to issues from Katrina that we still haven't resolved that we're not billing some of the rates.

So those are the types of things that you're seeing. But the biggest drivers in the end are really just AR timing.

So when you say like in the K that you'll get $150 million of receivables in 2016, that's when whatever ship that's related to where your withholding these billings gets delivered?

Yes. And it's constant pressure though. Because as the ships are maturing those retentions increase. So -- part of shipbuilding

So over time we'd expect this disparity between cash and receivables or a weaker free cash flow conversion to continue, effectively.

Well, I think two things will happen George, and I've said this before. As we resolve restructuring, as we recall resolve Gulfport, as we resolve Katrina issues, and I expect them to make significant progress by next year, that all that will come out of AR. So you'll see a pickup there. I've been saying that, I said it last year, in 2015 you'll see some improvements there.

One last thing on that. Could you provide the CAS reimbursement you are expecting this year?

The CAS reimbursement for the pension side? Let's see. I cannot remember that number off the tip of my head. I will have to get that for you

Okay thanks very much.

Thank you

The next question comes from Doug Harned from Sanford Bernstein.

Good morning.

I'm interested in the Ohio class replacement and a GE contract. But as you look forward, I don't know what extent your involved in it today, but do you see a likely path here that this could turn out to be something like Virginia class? That it could be a split, a good contract ultimately when it goes into production? So what's the path on that?

Thanks, Doug.

I'm not sure that there is a path at this point yet. I think that the best way to think about Ohio replacement program in the industry is that today there is a submarine industrial base comprised of our friends at Electric Boat and the folks here at Newport News and all the suppliers that are out there, today we are supporting the Virginia class program. At some point in future that submarine industrial base will be supporting the Ohio replacement program and the Virginia class program.

I think there's going to be a lot of discussion around how is the best way for the industrial base to do that in an efficient and effective way. I don't think it's clear yet, whether you're talking about capital investment or technology investment or any of that, it's not quite clear yet how that's going to sort itself out.

So we remain committed to supporting these important programs. We'll see what the path, how it plays out.

Then Newport News. I'm just interested in to some extent risk profile. When you look at CVN-78, you're 75% complete, how do you look at -- at the same time you're being funded CVN-79 on an incremental basis, in a sense. How do you look at the risk profiles going forward here?

Are we heading into a higher risk for the final stages of completion of the Ford? Is it harder to perform well when you're being funded on an incremental basis on 79? How is this working?

That's a great question.

78 is a lead ship. So we have moved, now that the ship is launched and is here at our pier three, we are moving into the test program for all of the new technology that we put onto the ship. The ship has come together very well. I've said it before that from a construction standpoint it's the best lead ship I've seen ever come together.

Now we have to go test it and I think that while we have a lot of confidence about that I think that the proof is in the test. So given that, I think that everybody kind of walks through a test program on a lead ship with a whole lot of awareness of where things can go.

I think the challenge is that as your -- when you think about the follow-on ship, the 79, I think everybody has been struggling with how do you go to a price type contract on the second ship when you haven't gone all the way through the first ship? I think the Navy was struggling with how to budget for that. I think that we have worked our way through what we think the risk of the test program is on 78 and how we could accommodate that in a pricing package for the 79.

The decision that's been made is that let's hold off and retire some more of that risk before we go to that final contract. Now doing that classically adds cost to the second contract and adds -- you're not able to cut everybody loose. You're not able to kind of turn the entire supply chain loose.

The Navy's worked with us very well to try to minimize that cost. So that's why you're seeing some pretty substantial incremental funding, both from a supply chain and from a unit construction phase, to try to minimize the effect of the delay in a full up detailed design and construction contract.

Because I don't know that anybody's smart enough to know where the cross over is between the extra cost of delaying that contract and the risk retirement of that you get because you delayed it. That's been the dance that we've been working through here for the last, really for the last 18 months. We're going to be working our way through that for the rest of this year.

But given that, we're very confident about where we are on 78 and we're excited by the chance to move out and get moving on 79.

Do you think they'll have -- it's really, is it 2014 -- you'll have more clarity you think by year-end then on this?

Well certainly the test program on 78 will have come through some of the bigger items in that program by the end of this year. Our ambition is that we would get to the detail design and construction contract by the end of the year. I would say that's probably not carved in granite, but that's the plan.

I think that's the Navy plan. That's our plan. And I think we have to see how the year unfolds to see whether that still makes sense or not.

Okay great thank you

You bet

The next question comes from John Godyn from Morgan Stanley.

Thanks a lot for taking my question.

Mike, I wanted to ask a broader question about commercial opportunities. I appreciate some of the earlier questions and the reluctance to talk about any specific opportunity but we continue to see some progress with the Kinder Morgan deal. I'm just curious from where you stand today, should we have more confidence that commercial will be a part of this business as we look out the next couple years? Is that how we should be interpreting what we're seeing here?

Well, I think that what we've said all along is we're going to look for ways to achieve the full potential of this business. One of the things that we've come through since 2010, is that in 2010 when we were part of Northrop Grummen, we announced that we were going to close Avondale. We began a very detailed engagement with folks who could talk to us about the redeployment of that site and ways to go use it.

We have a very mature risk management process and at this point we still haven't found the right way to redeploy that. But in the course of that work, what we've come to understand is that we have a significant engineering capability that complements our pretty significant manufacturing capability. The risk profiles of engagement in those areas are a little bit different.

If we're able to engage in an area where our engineers can lead our manufacturers into that space, we think we can do okay with that. If we are trying to engage in an area where our manufacturers are going to try to lead our engineers into that space, that can be a real problem for us.

I think that in the history of Navy only shipyards trying to do commercial work, I think that's what you've seen is that the commercial business becomes a real challenge when the manufacturing side is leading the equation. It gets to be possible and achievable if the engineering side is leading the equation. So we're thinking really hard right now about, how do we take better and fuller advantage of the engineering capability that we have to lead our manufacturing capability to achieve the full potential of the business.

I think you can think about Stoller as an example of that. Stoller is a company that has tremendous access to a couple of dozen DOE sites. We have tremendous depth of capability with no access.

The marriage of Stoller to our engineering and technical support at Newport News creates potential for us in a space that we were not in before. We were there but we were not able to really break through. So we're excited about that possibility.

If we can find other opportunities in other spaces where we can do things like that, we will seriously consider it. I think you see in our industry today, I think you see everybody wrestling with how do we create growth in an environment where the Pentagon is not advertising a lot of growth.

Some folks are talking about international. We're not talking about international. Some folks are talking about commercializing and leading. We are cautious about that.

We do believe there are some things that we can do and some customers that we can engage with that would enhance the value of this business. So we're going to keep our eyes open for that moving forward

That's very helpful.

When we define commercial broadly to include shipbuilding, energy and any other opportunities, how should we think about capital allocation in that context? Investments in potential commercial opportunities over the next few years versus maybe rising capital returns?

I think it just depends on the opportunity at this point. Again, we're interested in the access to the markets and bringing the depth of our capability towards that. Depending on a particular opportunity we would then take a hard look at whether the capital investment made sense or not

Okay thanks a lot

The next question comes from Carter Copeland from Barclays

Hey, good morning and good quarter

Thank you

Good morning, Carter

Just a couple of quick ones. Mike, with respect to the post delivery work I think you mentioned on LHA-6. Could you give us some color on the scope of that and if that has any kind of implications for risk or risk retirements?

No, this is just routine. After we deliver the ship to the Navy, the Navy they actually, the crew will work the ship. Take ownership of it, if you will. It's kind of the normal course of business that we stay engaged with them.

As they come on board the ship and -- kind of like when you move into your new home and they find that something is not the way they would like to have it or they figure out something, we're right there to support it. But there's no issues along those lines. This is just a normal course of getting the ship ready to sail away

Okay, great not anything nonrecurring in nature.

Then on the delayed delivery on the first block for Virginia class, does that have any from your vantage point any impact on you guys? Or are you too far removed for that to have any financial implications or planning implications?

I think the financial implications are less than the thickness of a pencil. So I wouldn't say there's any issue there. It has had an impact on us in terms of the way that we -- we found this issue, we're working our way through all of the other places and risk pieces of our supply chain to make sure that, you know, in a classic nuclear submarine way you find the one problem so convince me that you don't have a problem somewhere else.

We're doing that. So in that sense is has had an effect but not in a financial way.

Okay, great.

Lastly Barb, on the pension mortality comment you made, is there any way you can help us conceptually understand how to think about what some of these impacts might be? I mean, maybe comment on what sort of vintage mortality assumptions you've got baked in today or how we should think about how that impacts the liability. Any color you can help us with there?

We looked at it and we haven't come through our complete study with the actuaries and everything. But basically if the mortality tables go up, your costs are going to go up. I think that everybody's in a kind of panic stage that it's going to be a big number. It doesn't appear to be a huge number.

I think what happened was with everybody looking at CAS harmonization as this huge opportunity. It will eat a little bit into that. But it's not material.

Okay, great. Thank you both

The next question comes from Darryl Genovesi from UBS

Hi, good morning guys. Nice quarter.

My first question is on Ingalls. Should be -- the revenue run rate there now hold pretty steady at this $550 million a quarter level now that the under-performing ships are all out and Avondale's mostly playing a support role? Or is there another leg down on the overall level of effort as Avondale eventually gives up that support role and Gulfport gets closed?

I think that the overall I think will go back to the original issue of, we're trying to make sure that we have some sustainable effort there around the amphibs. So, whatever fluctuations you might see quarter-to-quarter over the next couple years, I think the big issues are going to be how do you bridge from the LPD-27 to the LXR. ¶ How is that going to work through in terms of the size of Ingalls and the scope of the work that they have on? I don't know if you want to add any more to that Barb, but that's why that transition is so important to us.

Okay. I guess I was just thinking maybe a little bit nearer term than that. But if that's the way you're -- if you're, I guess the way to think about it is what we're seeing now is, making sure that you don't hire too many people or drive the yard to too high of a level in front of a potential full on the LPD's. Is that the message?

You know, the work that's being done in Avondale, we use that as a bridge to continue looking at opportunities there. To help with the workload at Ingalls. So in terms of it going away, Ingalls will still have steady workload. There will be a tiny bit of pressure related to the Gulfport closure though

Okay.

Then also, I wanted to also ask you on Virginia class. It's been about four or five years now, I think, since you began the ramp-up to two a year. Are you actually producing and I'll say recognizing revenue at the full two a year rate now?

It's hard because of material and how we buy material. So if you want to go try to do a run-rate, there are fluctuations based on material. You know we have long lead material funding and things like that. If you're trying to go in and calculate the run-rate we're probably close, but again, it fluctuates.

Okay. I was just looking at this contract award from a couple weeks ago, and I know there's some price escalation in there and that sometimes these sideline numbers can be a little bit misleading. But if I just take that $18 billion or so award for 10 boats at two a year and say, your 50% share of that should be about $1.8 billion. It seems to me based on the pie chart you put in your 10-K that your revenue run rate is still 30% or 40% below that level? So just trying to figure out what the gap is and if it might close.

I think you're just looking at timing.

Okay. So I guess the implication is that there is still a little bit of a ramp ahead?

I think trying to straight line that is fraught with some challenges. Because you do buy a lot of material on the front end of these contracts and so that skews the program around a little bit.

Okay. Thank you.

The next question comes from Jason Gursky from Citi.

Good morning everyone.

Good morning.

Barb, you mentioned in your prepared remarks that the amount that you're going to try to recover on Avondale increased and is up at $35 million or $30 million based on your lack of ability to sell some assets in line with customer guidance. Can you provide a little bit more color on what exactly that means?

I didn't say lack of ability. That's your words. When we put that proposal together, the original proposal for $256 million, in there we had assumed we were going to sell some assets.

During our customer negotiations and discussions on the proposal, they recommended that we look at the whole -- all of the assets and everything associated with the closure of Avondale and then we would negotiate from there. So they didn't want us putting an estimate on asset sales. So that's what we agreed to do.

Okay.

Then just a quick follow-up to that. Where are we in this process? You got a proposal together.

When should we expect at this point for the negotiation on that proposal to come to an end and for you to begin raising your billable rates and recovering some of that?

I don't want to give away any strategy on that. But it would be very difficult for me to predict an end. When I think that we'll get in very deep discussions will be when we finish the units at Avondale and make a decision from there.

I mean it is both to our benefit and our customers benefit to find a redeployment approach. We all make out better for that. So we're balancing that right now and we're balancing that in this negotiation process.

Can you remind us when the last units will leave that yard?

They'll leave that yard in the third-quarter.

Third quarter of this year?

Yes.

Okay, that's great. Thanks for taking my questions.

Okay, thank you.

The next question comes from Joe Nadol from JPMorgan.

Hi, good morning guys. It's actually Chris Sands on for Joe.

Just wanted to follow up a little more on Avondale. Particular as it pertains to the timing of the study. Do you expect that will be complete before those units go out in Q3?

About the same time. It's a six month study and so we don't have a direct linkage there. We're not going to force the study to finish early if it's not ready.

They're on two different paths. They just happen to be coming -- probably come together about the same time.

So if the study comes back and says, yes we think there's a good use for this but it may take us a year to really start generating business, is it possible that you would do other support work for Ingalls in the meantime or would that not be satisfactory? Would you just go ahead and close at that point?

You know, you never say never. But I think it's most likely that once this production work is done, we'll be done.

Okay, so you would need the study to have a positive outcome and a very near term contract?

Yes. Or an approach. I think, that's why we don't want to try to prejudge what the outcome would be here. But the part of what we would see is a path to a market and then what's that path look like and play it out from there.

Value of economics of it.

Right.

In your last response, Barb, you mentioned that it obviously behooves the Navy to redeploy the asset as well. Have they offered any kind of support to kind of bridge you to other use in revenue?

No.

Okay, that was it. Thank you.

Alright, thank you.

The next question comes from Pete Skibitski from Drexel Hamilton.

Good morning guys. Nice quarter.

Good morning.

Good morning. I just wanted to verify on the Virginia Block IV award that was mentioned earlier, the $18 billion award. So you guys will book half of that, roughly half that, in the second quarter, that's there?

We'll book our portion of it in the second quarter.

Okay, and then Mike one for you. I missed your opening remarks. I'm not sure if you mentioned this, but the HAS? I didn't look into it in detail but it looked like the HAS was fairly supportive of shipbuilding. Then there was some language on the George Washington and on LPD-28. Did you read the same thing and do you have any insight into how that HAS is thinking?

The political process is a pretty convoluted one. We are generally overall pleased with the way that the HAS came through their mark. The process from here is a full contact sport through the end of the year so -- or through the end of the fiscal year. ¶ So we'll continue to stay engaged in that at this point. I don't know there's anybody who can actually handicap how any of the other committees are going to go forward and so I think I'll join them and not try to do that.

Fair enough. Thank you.

I show no further questions.

Okay, well thank you all for joining us this morning. It was a great quarter. It's actually this now marks three full years as an independent company and things we laid out at the beginning that we had to do. The delivery of LHA-6 is a major milestone in terms of moving down that road.

We continue to look forward to achieving the full potential of this business, working on the programs that we have and moving ahead. So we look to see you around and we'll be talking to you soon. Thank you very much.

Ladies and gentlemen that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.