亨廷頓·英格爾斯工業 (HII) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Huntington Ingalls Industries, Inc. Q4 2014 earnings call.

(Operator Instructions)

As a reminder, this conference is being recorded. And I would now like to introduce your host for today's conference, Mr. Dwayne Blake, Corporate Vice President, Investor Relations. You may begin.

Thank you, Sam. Good morning, and welcome to the Huntington Ingalls Industries' fourth-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 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. Before we start, I want to express our deepest condolences to the family of Joe Nadol, our friend and colleague from JPMorgan. As you all know, Joe was insightful, accurate, and fair, and he had a keen understanding of our business and our industry, and he will be sorely missed.

This morning we released fourth-quarter and full-year 2014 financial results that reflect excellent operating margin performance and cash generation at Ingalls and Newport News. We also had some pressure from UniversalPegasus due to extremely dynamic market conditions and some operational challenges. So I want to personally thank each one of the 38,000 employees of Huntington Ingalls for the hard work and dedication that produced these results, and for their continuous commitment to safety, quality, cost, and schedule.

During the quarter, we had two events that reduced our GAAP earnings. First, we absorbed the $37-million one-time cost to refinance our seven-year notes, which will significantly reduce our interest costs going forward. Second, our annual goodwill evaluation led to a $47-million non-cash impairment charge in our Other segment. This was driven by the recent drop in oil prices and the decline in industry market multiples.

In addition, fourth-quarter 2013 sales in operating income at Ingalls included the benefits of the favorable resolution of hurricane-related insurance claims. 2013 full-year results also included the charge for closure of the Gulfport facility. All comparative data that Barb and I discuss today are adjusted for these items, as well as for the FAS/CAS adjustment.

For the quarter, sales of $1.9 billion were consistent with last year and segment operating margin was 9.4%, up from 7.9% last year. For the full year, sales of $7 billion were 2% higher than 2013, and segment operating margin of 9.1% was up from 7.6% in 2013. Diluted EPS was $2.19 for the quarter, up from $1.66 last year. Diluted EPS for the full year was $7.14, up from $5.36 last year. Additionally, we received $500 million in new contract awards during the quarter, resulting in a backlog of $21 billion, of which $12 billion is funded.

Cash generation was particularly strong and we ended the year with approximately $1 billion of cash on the balance sheet. Since our Q3 earnings call in November, the FY15 budget has been authorized and appropriated, and the President's proposed FY16 budget has been released. Within the FY15 budget, the Navy has decided to move forward with the refueling and complex overhaul of the George Washington CVN-73.

As a result, Newport News was recently awarded a $224 million contract modification for advanced planning of the RCOH, as well as for the procurement of long-lead materials, and this will support award of a contract for execution of the RCOH in the summer of 2017. Also within the FY15 budget, an additional $1 billion was authorized and appropriated to support construction of the 12th LPD, LPD-28. In addition, $550 million is proposed in the President's FY16 budget, bringing total potential funding to approximately $1.8 million. Clearly, there is broad support for the Navy/Marine Corps team, and the critical industrial base that is required to support it. However, the cloud of sequestration remains on the horizon, and Congress and the administration have difficult decisions to make in the near future in order to restore the normal -- restore normal order to the process.

Now, I will provide a few points of interest on our major programs, beginning with Ingalls. The LPD and NSC programs are performing very well, and are continuing to reap the benefits of serial production. I appreciate the progress made in securing funding for LPD-28, but our team will not rest until that ship is under contract. In the LHA program, LHA-7 Tripoli is continuing through the early phases of construction and is leveraging the lessons learned from LHA-6 America.

In addition, efforts continue on the affordability design contract to reduce the construction and lifecycle cost of LHA-8. On the DDG-51 program, DDG-114 Ralph Johnson is preparing for launch late this year and work on the other ships remains on track. Regarding our Gulfport facility, Ingalls and the Mississippi State Port Authority entered into a purchase agreement in January of this year. The agreement allows the port to begin a due diligence process that may lead to the ultimate sale of the property.

And now turning to Newport News. On CVN-78 Ford, the test program on this first-of-a-class ship is still going well, and delivery remains on track for the first half of 2016. For CVN-79 Kennedy, activities under the construction preparation contract are progressing very well, and we expect a detailed design and construction contract to be awarded in the first half of this year.

In submarines, our fifth delivery of the Virginia-class SSN-785 John Warner is preparing for sea trials and delivery in the second quarter of this year, while work on the remaining Virginia-class boats remains on track. CVN-72 Lincoln remains on track for redelivery to the Navy in the fourth quarter of next year, and the inactivation and defueling work on CVN-65 Enterprise is ongoing.

Last month, we announced that the S.M. Stoller Corporation and Newport News Nuclear joined together to form Stoller Newport News Nuclear Incorporated, or SN3. This entity combines the strength and experience of both companies to form a highly capable, full-service nuclear operations and environmental services company, focused on US Department of Energy and US Department of Defense clients. We are very excited about the opportunities SN3 can pursue and capture in this space by leveraging our core competencies in nuclear operations, heavy manufacturing, and engineering and program management. In addition, we recently acquired the Columbia Group's Engineering Solutions Division, which supports our growth into the US Navy unmanned submersibles market. ESD, which was renamed Undersea Solutions Group, will report under the submarine program at Newport News.

As I mentioned earlier, our Other segment recognized a non-cash goodwill impairment charge of $47 million in the quarter, as a result of the recent drop in oil prices and its impact on current and future business. To address these factors, as well as some of the operational challenges, we are taking specific actions, including changes in the management team; workforce reductions; consolidation of office space; and other overhead cost reduction initiatives to rightsize our operations for this changing environment. With our eye always on long-term value creation, we are taking the necessary steps now to create a healthier business during this downturn in order to position UPI for long-term success when the market turns.

In closing, I want to recap some of the things our team accomplished in 2014: we delivered LHA-6, the last of the underperforming ship contracts; Ingalls and Newport News generated segment operating margin above 9%; operating and free cash flow were the highest since the spinoff in 2011; and we were awarded $10 billion in new contracts, including the Virginia-class Block IV and continued construction preparation for CVN-79 John F. Kennedy. We positioned ourselves in the energy market with the acquisitions of Stoller and UPI, and also in the unmanned submersibles market with the recent closing of the Undersea Solutions Group acquisition.

Looking ahead, we expect that there will be competitive or sole-source Navy shipbuilding contract awards of approximately $40 billion for Ingalls and Newport News in the next five years. These contracts are expected to lead to approximately $60 billion of follow-on work over the next 20 years. We will be making discretionary capital investments at both facilities in order to prosecute this work. Further, the Department of Energy will be re-competing over $66 billion of work in the next 10 years, and we expect SN3 to be well positioned to capture a share of those market opportunities.

And, finally, UPI will emerge from the downturn in the oil and gas market as a stronger, healthier business, well positioned for the inevitable rebound in that market. With all that being said, I remain very confident in our ability to achieve 9%-plus operating margin in 2015. With our focus on creating long-term sustainable value, HII is positioned for a long and prosperous future.

That concludes my remarks. I will now turn the call over to Barb Niland for some remarks on the financials. Barb.

Thanks, Mike, and good morning, everyone. Today, I'm going to review our consolidated and segment results for the fourth quarter and full year, then wrap up with some information on our outlook for 2015. Please refer to the slides posted on our website for more information. As Mike mentioned, all of the numbers that I discuss today will be adjusted for the goodwill impairment charge and the one-time interest expense for the early extinguishment of debt in 2014, and for 2013, the hurricane insurance recoveries and Gulfport closure. Please refer to the presentation on our website or the earnings release from this morning for the respective reconciliations.

Now, turning to the consolidated results shown on pages 4 and 5 of the presentation, we ended the year with very strong operational performance in the fourth quarter at Ingalls and Newport News. Total revenue in the quarter of $1.93 billion increased 1% over the same period in 2013, bringing 2014 revenue to just under $7 billion.

Total operating income in the quarter was $191 million, and the operating margin was 9.9%, compared to $156 million and 8.2% in the fourth quarter of 2013. These increases were due primarily to higher operating income at Ingalls and Newport News, as well as favorable variants in the FAS/CAS adjustment, which was partially offset by lower deferred state income taxes and an operating loss in the Other segment.

Cash flow from operating activities and free cash flow were very strong in the quarter and for the full year. We generated $402 million of cash from operating activities in the quarter, and $716 million for the full year. Free cash flow in the quarter was $328 million, and $551 million for the full year. These increases were primarily due to decreases in accounts receivable and lower pension contributions.

Changes in trade working capital were a source of cash in 2014 of $120 million. However, working capital continues to be weighed down by the closure costs of Gulfport and the Avondale facilities. As I mentioned before, we estimate the closure cost for Avondale at $284 million, of which $212 million is capitalized in inventory. The estimated closure for Gulfport is $57 million, of which $37 million is in accounts receivable. We continue to work with the Navy to reach final agreements on the treatment of these costs, and we also hope to reach final agreement in the first quarter with the Mississippi State Port Authority on the sale of the Gulfport facility, which will help alleviate some of the burden in working capital.

Capital expenditures were $74 million in the quarter and $165 million for the full year, which were in line with our expectations. In 2014, our cash contribution to our pension and post-retirement benefit plans was $159 million. Our actual return on assets was 10.1% and discount rates fell over 90 basis points, to 4.34% at the end of the year. After a review and comparison of the new mortality tables to our actual experience, the updated mortality assumptions increased our pension liability by roughly 1%, which equates to less than $60 million.

We repurchased over 271,000 shares during the quarter, at a cost of $26 million, bringing the total number of shares repurchased in the year to over 1.4 million, at a cost of $138 million. In the quarter, we also paid dividends of $0.40 per share, or $19 million, bringing the total dividends paid in 2014 to $49 million.

Interest expense in the quarter was $66 million, and $149 million for the full year. This included $37 million of one-time expense for early extinguishment of debt. Excluding this one-time expense, interest expense was also in line with our expectations. Our effective federal income tax rate in the quarter was 34.2% and 33.3% for the full year.

Moving on to segment results on pages 6 and 7, revenues at Ingalls of $608 million declined 13.5% from the fourth quarter of 2013, due primarily to the deliveries of LHA-6, LPD-25, NSC-4, and the DDG-1001 Deckhouse. The decrease was tempered by increased volumes on the NSC and DDG programs.

Operating margin in the quarter was 11.8%, up 530 basis points, driven by performance improvement and risk retirement on the LPD program. For the full year, Ingalls generated operating margin of 10% on revenues of $2.3 billion. Operating margin increased 518 basis points over 2013, primarily due to performance improvements and risk retirement on both the LPD and the NFC programs.

Turning to page 8, revenue at Newport News increased 4.8%, to $1.3 billion, in the fourth quarter, primarily due to higher volumes on the VCS program and the acquisition of S.M. Stoller. Operating margin in the quarter of 9.2% increased 47 basis points over the fourth quarter in 2013, due to performance improvement and higher risk retirement on the VCS program. For the full year, Newport News generated revenues of $4.5 billion, a 3.5% increase over 2013, and operating margin of 9.1% for the full year was consistent with 2013.

Now to the Other segment, revenues in the quarter were $56 million, bringing 2014 revenues to $137 million. The segment had an operating loss of $54 million in the quarter, which included a $47 million non-cash goodwill impairment charge as a result of the recent drop in the oil prices. Excluding the goodwill impairment, the operating loss in the quarter was $7 million and $12 million for the year. The losses were driven primarily by lower volumes on existing contracts, contract delays and cancellations as oil prices dropped during the quarter, and the non-cash amortization of purchase intangibles.

Turning to slide 9, I'll provide an update on our pension assumptions for 2015. We are expecting a favorable net FAS/CAS adjustment of $111 million for the year. This is based on higher CAS recovery, as we hold our long-term return on assets assumption of 7.5%. We expect 2015 CAS recovery to exceed our cash contribution for both the pension and post-retirement benefit plans, due to the phase-in of harmonization.

Now, let me provide you some additional insight for 2015. We expect our normal sustaining and maintenance CapEx spend to be about 2% of revenues. In addition, as we prepare to compete for the new programs that Mike talked about that are up for bid over the next five years, we are looking at spending up to another 2.5% to 3% of revenues on discretionary CapEx. So, in total, CapEx spend for 2015 could be in the range of 4.5% to 5% of revenue.

As Mike mentioned, we remain on track to achieve our 9%-plus segment operating margin goal. As a reminder, this is a full-year objective, and the quarters can sometimes be lumpy due to timing of risk retirement events. We expect deferred state income taxes to be a benefit of about $20 million, interest expense of approximately $100 million, and the income tax rate in the 33% to 34% range.

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. Sam, I'll turn it over to you to manage the 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. Sam, I'll turn it over to you to manage the Q&A.

(Operator Instructions)

George Shapiro with Shapiro Research.

Good morning. Question on -- Mike, you say margins will be over 9%, but effectively Ingalls and Newport News made 9.4% this year. Are you figuring you'll see a decline in that margin in 2015? If you could explain that a little bit further.

As we said many times here, George, the healthy business operates in the 9% to 10% range based on the blend and mix, and the maturity of the work that we have going on. We had a great year in retiring risk in 2014. We have to do that again.

At Newport News, we have a lot of cost type work and we're doing the delivery of the Ford. Most of that work will be done this year as we get ready for delivery next year. We're going to be heading down the path of delivery of the RCOH and a lot of that work is going to be done this year, and the Enterprise also. We have three carriers in a cost type environment at Newport News that is going to make it -- it's a little bit out of balance in terms of the blended rate, so we'll be working our way through this year at Newport News.

At Ingalls, the question really is, is how does future work flow to support the risk retirement that we have going on? Whether it's LPD 28 or the next LHA. How does that work flow and fit into our work?

So that's why we -- we're not going to try to handicap whether it's higher or lower than 9.4%. We're going to continue to say that to be healthy in this business you ought to be able to operate sustainably in the 9% to 10% range.

Okay. I'll stick with my one question and get back in the queue.

Robert Spingarn with Credit Suisse.

Good morning. Barb, I wanted to come back to what you just said on CapEx and your comments on working capital, and just see if we can get to the endgame on free cash flow for 2015. So CapEx could go up by a couple hundred million, it sounds like. Assuming-- and I guess one question would be, is that already in the plan or is that dependent on which programs you decide to pursue? So how much variability is in that or should we just build in, call it 4.5% to 5%?

And then how does working capital behave? You obviously had that big drop in receivables. And that was -- is that going to be a headwind going into next year? Because if you take that and you take the CapEx, it seems like free cash could be $300 million lower, but I want to make sure I'm not forgetting to put in the positives, such as the sale of assets and et cetera.

Right. All good questions. Let's start with capital. And that's exactly why I explained capital and split out the maintenance and sustainment pretty steady at 2%.

The discretionary capital are individual projects based on engineering studies that prove out the concept can improve efficiencies and reduce future cost to help us be more competitive. So we're not releasing all that capital and giving everybody a blank check to move forward. We're releasing it incremental in engineering studies to look at the items and determine if they make sense for us. Okay.

So in a perfect world-- if all the projects that everybody wanted to do this year -- the range would be in that total capital 4.5% to 5% range, right? But, each project will be let out incrementally. And each quarter, I'll let you know if I'm getting closer to that amount or not. So that covers the capital.

On the working capital side, we continue to work on working capital and yes -- if we are successful in the sale of Gulfport that will help a little bit, but we assumed in some of what is in receivables today that we would sell Gulfport. It will depend on the exact value we sell it for, whether we'll see an improvement due to that sale.

And then the other thing will be timing of completing the negotiations with the customer on that accelerated depreciation that's sitting in accounts receivable right now. So I believe though we have made a great effort to sell the property for -- and that the customer should recognize that. And negotiations on that particular issue should go okay and move forward quickly once we get that sale complete.

On the Avondale restructuring piece, remember we just recover that over five years. So part of that would be recovered. And then since you're worried about what cash is going to be at the end of the year, I would say 2014 we had an outstanding collections. We pretty much collected every single invoice we had outstanding. That's my first time in 10 years I've seen that.

So it can be lumpy, just because of timing. We might get paid January 2 versus December 29. It's really tough to predict what it will end up at the end of the year.

So just to close this off. You had a source of $100 million from working capital in 2014, and it's been a use in a couple of years prior to that, what's the right way to think -- I know they are moving pieces. Is there a good range we should use for 2015?

I think it's going to be tough to call on that one. My famous word, lumpy, it could be. It could be the same as 2014. It could be worse. I promise you my entire team is working that every day. We have a relentless focus on improving working capital in this business.

Alright. Thank you, Barb.

Rob, if I could just pile on here, I know you didn't quite ask this question but if you think about what's going to happen on the Navy business in the next five years and just take a look at the programs that are going to be awarded, and then the tail that comes with those programs, CVN 79, the construction contract, the CVN 73 RCOH, CVN 74 RCOH, the next block of submarines, the Ohio replacement program, LHA 8, and whatever might come after LHA 8, LPD 28 and the LXR program, a competition on the DDG program again. Whatever the Navy path -- whatever they choose for some future small surface combatant is out there.

You see an awful lot of activity, not just in awards in the next five years, but in terms of programs that are going to go out for 20 to 25 years. They're going to be decided here in the next five years. So our decision is that we want to invest against that to make sure that our competitive posture is where it needs to be.

The Navy's got pressures on the budget side of this and so in some programs where we're sole-source, our competition is with the budget and not necessarily with someone else. And so our investment here is going to be about driving the efficiency into the business that our customer needs. In a way that will be sustainable -- will create sustainable value for us longer than a year or two, but really talking about a 20 to 25 year kind of return.

Thank you Mike.

Doug Harned with Sanford Bernstein.

Good morning. You mentioned Ohio-class replacement, and right now, that's a General Dynamics program. But as you look forward to the opportunity to participate in that, what are the points in which the Navy -- sort of the timing when the Navy would typically make a decision with respect to sharing work across different parts of the industry. In other words, when could you start to see you might be playing a role in that?

Well Doug, I think first of all, we've been doing some work on that program already. But as I've said before, I think the way you have to think about that program, it is a major national construction effort and the entire submarine industrial base will be involved in trying to produce that program at the same time that it's still producing the Virginia-class program.

You'll have to ask the Navy on what their timing for their decisions on different pieces of this will be. But our expectation is that there will be a whole lot of discussions going forward about what's the most optimal way for the submarine industrial base, at the national submarine industrial base, to produce the nation's demand for submarines. And so we expect that that will be played out over the next couple of years.

I guess separately, we've had this fall in oil prices. I think it's fair to say that the oil field services sector looks much less attractive than it did six months ago. How are you now looking at your efforts? You bought UniversalPegasus, as you go forward, how do you think about that sector now given the change?

There's no doubt that there's been a major change in that space from where we were a year ago. Our challenge today is to manage the reduced flow of capital. We see companies in that space that are delaying their projects. For the most part, projects are not being canceled.

We have really good customers that are working with us on delaying these projects to match their capital expenditures. They're changing their CapEx based on the oil price.

The challenge for us is that there's definitely going to be less volume. We have got to size the business to be successful at a lower volume. We've got to do that in an environment where we maintain the relationships that we have with these -- we have a superior group of customers and we're very proud of that customer set. We've got to maintain that relationship that we have with them.

We bring to those customers some unique skills today. And it's very important for us that we preserve and maintain those capabilities going forward. Because when this market turns, and I believe it's inevitable that it will, just don't ask me when; when it turns we are going to be positioned to benefit from that. And the first order of business is we've got to be successful at a lower volume.

Now as far as going forward and how you think about investing in that space, certainly growth rates have changed from where they were a year ago. A little bit different way to think about how do you value something in that space, and so we're giving all of that another view. Certainly our view of the space has changed since where we were a year ago. The bottom line, Doug, is that we have a lot of capability and we're interested in creating channels to those customers who need our capabilities, and we think that that's a way to create new value for our business that wasn't there before.

Thank you.

Pete Skibitski with Drexel Hamilton.

Great quarter.

Good morning. Thank you.

Mike, one for you. For the 2015 budget approved, we've got the 2016 proposal out there. A lot of shipped things seem to be clarifying a bit. I wanted to ask you, has your kind of midterm revenue profile kind of clarified at all, or is there still kind of too much floating out there in terms of the unknown with sequestration and whatnot?

I think the sequestration is the elephant in the room, frankly. The -- I'm an optimist and I believe that somehow, someway, we'll find a way to move into 2016 in a non-sequestered way. I can't tell you what the mechanism for that will be, and I don't know what the catalyst for it is. But I do think that somehow this great country will find a way to do that, because the alternative is just so bad.

Relative to our specific programs, sequestration is -- in the midterm, is a real challenge because when you start to look at some of the programs that I talked about over the next five years, sequestration will directly affect some of those programs. I think the Navy has provided their list of how -- which programs get affected and by what volumes. The carrier program gets affected. The RCOH has been playing out on the front pages for the last couple of years. And I don't think that changes even though we have this contract now and we're racing towards an RCOH, I think if we're in a sequestered environment, I think that all gets debated again.

And so I'm not sure I would say that it's all cleared up. I think -- I'm optimistic that we'll find a way through it but it's -- there's still a lot of moving parts.

And then just one follow-up. One thing I saw during the quarter is this idea of the Navy, I think, ship bundling plan where it would kind of compete altogether, the fast oiler, and LRX, and I think maybe LHA 8 as well. And I was pretty confused about it in terms of what would a winning scenario look like for HII and get a timeline during which this plays out. Can you add any light on that whole plan, and how it might play out for you guys?

We're at the very front end of the Navy's acquisition strategy for a range of programs, and I think that -- like a lot of things, if you look at it before the cake is done, sometimes that affects the cake. So I -- I'm not going to comment too much on this except to say that we're engaged with the Navy to figure out how's the best way for them to successfully acquire the platforms that they need going forward.

Okay thanks. I'll hop back into the queue.

(Operator Instructions)

Jason Gursky with Citi.

Good morning. It's actually Jon on for Jason. Thanks for taking the question. I just want to confirm your language, you always say 9%-plus margins in 2015. Is that still just a shipbuilding number, or do you see some opportunity to turn other around a little bit faster with the cost actions you outlined?

We think about that and we used that to set the stage four years ago for driving efficiency in our shipbuilding business. Over the long-term, where we really want to be is we want to be driving the return on invested capital in our business up, and we're making some big investments right now, and so that's going to be -- we're still going to be kind of going through this phase is it return on sales or segment margin, or is it return on invested capital? I think about that in terms of -- specifically I think about the shipyards and being -- a healthy shipbuilding business operates in that 9% to 10% range.

Relative to the other segment that we're talking about today, as I said, we expect that to be successful at a lower volume. And that's what our efforts going to be. Overall, I think we'll still be in the 9% to 10% range.

The other segment in a healthy business, remember it's a services business, so it's in the 5% to 7% range, okay, with no capital investment.

And then in the shipbuilding side, where Mike talked about the healthy range of 9% to 10%, what you have to remember is we have services also in the shipbuilding side with our businesses and AMSEC and Continental Maritime that are at -- we're absorbing a much lower margin rate, because those contracts are all time and material or cost plus at much lower margin rates. It's all about being a healthy business and having a good mix of programs.

Understood. I appreciate that. Just a quick follow-up though, on segments. Mike, I think in reference or response to George, you mentioned some mix shift headwinds at Newport News. Similar question at Ingalls, it sounds like you feel like you have opportunity to potentially repeat what you did this year even though fourth quarter was so strong. Could you add a little more on Ingalls' sustainability going forward?

Where we are at Ingalls is the execution side of Ingalls is going very well right now. Across all other programs that I went through in our comments, I'm very, very happy with the way that we are executing. But part of being the healthy shipyard is that you have to bring in the future work to balance the volume. And so -- how does the Navy acquire the platforms and how does Ingalls participate in those acquisitions over the next few years is part of the equation as to whether they can be sustainable or not.

And so really four years ago, the focus at Ingalls was on execution. Today, the focus at Ingalls -- it always remains on execution, but we then have to use our performance to make sure that we preserve and capture the work that's in front of us. And so that's what our effort is. If that work starts to move around, even though we'll be executing well, it will drive our rates and that will negatively affect the business.

So our overall approach is to let's get this work done. That's why we're particularly pleased with where the LPD 28 came out. The Congress stepped forward and put $1 billion up against that program, and the Navy came back in the 2016 budget and added more money to the program, and basically now there is a commitment to go and execute that program. We think that that is the right decision but it also is very, very helpful to Ingalls around the sustainability of their future.

John, I'd like to add when you -- Jason, I'm sorry. When you talked about the fourth quarter being pretty big at Ingalls. It was because we launched LPD 26 and as we go into 2015, we'll have the launch of NSC 6 and the launch of one of the DDGs, and much smaller ships. So we had big risk retirement on 26 that affected the fourth quarter. And the risk retirement on a smaller ship will be a little different next year -- or this year. As we are in this year.

Thank you.

George Shapiro with Shapiro Research.

I just wanted to clarify some of your earlier comments, Barb. Based on the higher CapEx and receivables being flat, it doesn't seem like you could get cash -- free cash flow equal to net income in 2015. It's going to be somewhat below. Is that a fair statement?

It could be. Yes. That's a fair statement.

Okay and then just if you could comment, could you project what CAS might be for 2016 at this point?

(Laughter) I don't have that crystal ball here. Of course, we have projections of where we think they'll be but -- George, I hate to go out on a limb on that one.

Okay.

But thanks for asking me.

Thanks.

Doug Harned with Sanford Bernstein.

Hello, thanks. Just one more question. When you talk about the 4.5% to 5% CapEx -- I found this a little surprising and the reason is, is it seems that in many ways that you've moved from a situation of going into new programs to a more steady -- what appears to be a more steady state of similar ships going forward. So I was surprised to see CapEx go up to these levels.

If you look at, say, GD Marine Systems, they've operated pretty consistently between 1% and 2% for CapEx for some time. I'm just trying to understand what's different at Huntington Ingalls right now and -- where this -- what is this going to basically, the CapEx?

That's a great question. The perspective that we have is that we've been -- we've taken advantage of the serial production in the LPD program and the restart of the destroyer program, and the lessons learned on the LHAs. We've taken advantage of that to fix the returns on our Ingalls business. And we look out ahead and we see the LXR program out there, which is a new program, we see the next competition for the destroyers which will be -- that's coming up in about three years.

We see the next -- we see LHA 8 is under some significant budget pressure at this point and the question is what happens after LHA 8 out there. We see the need to reset the competitive posture at Ingalls, and so that's our objective here is to, first of all, reset that from a capital investment perspective and a facilities perspective. Been working on process for quite a while, but it's time for us to go and align the facility and our processes there to be even more competitive.

I think the one way to think about that, Doug, is that we're building multiple classes of ships in the shipyards, in each of our shipyards, and so we're building facilities that tend to be multi-platform flexible, which makes it a little bit different kind of investment profile than, say, other folks might have.

At Newport News, there's a lot of budget pressures, as you well know, in the carrier program there's a cost cap on CVN 79. The challenge of getting to a contract. We've been working on trying to get a contract for quite a while. How do you invest in the process efficiencies that are going to allow that to happen?

I do think that there will be -- as a submarine industrial base tries to figure out how to support the Virginia-class and Ohio replacement programs at the same time, there's going to be need for capital investment at Newport News to support that. And we stand ready to go make those investments.

And I think when you step back and look at capital investment in the shipbuilding space overall, we tend to think of capital as something that's going to play out over the next three to five years, but in fact, the capital investments that we make today will be generational. And so -- I kind of think of this as this may be a little bit more like the investment that a drug company makes before they bring a drug to the market.

We make a big investment in the space and then we go and we use that to capture the programs, and then we drive the serial production in the programs to capture the returns that we need. And so that's kind of where the phase is, and if you look at the -- as I've gone through the list of the things that the Navy is going to be settling in the next five years, this is the time for us to go and reset the competitive posture of our shipbuilding business.

So is it fair to say that when I look at Ingalls, for example, you had post-Katrina there was a lot of work done there to modernize those shipyards at that point in time. When you look at today -- at today's situation, if I think of Ingalls -- LXR is still a few years out, particularly with LPD 28, assuming that all goes according to plan.

Do you invest this early for an LXR, or are you investing specifically for an LXR program or specifically for Ohio-class replacement at this point in time, or are these things that you do to modernize the shipyard to make you better positioned for each of those?

Doug, that's great insight and I think that it's some of both. First of all, in the aftermath of Katrina, what we did is we rebuilt the shipyard. I can't -- I can't say that we actually modernize the shipyard in the sense of bringing it to where the state-of-the-art is in terms of shipbuilding production. We were changing -- the team that was there was changing the wheel on a car that was going around a curve at 60 miles an hour and a lot of what was done was just rebuilding what we already had.

This is a much different thought process on what's -- what is the process that we're going to use for building ships? Some of the investments that we're going to make are going to be generic in nature that will support all of our shipbuilding programs. Some of them will be conditional, based on the Navy's plan for acquisition, and you bring up the timing of the program, that may certainly affect the timing of some of our investments. But all in all, our overall approach here is there is so much in play over the next three to five years that has such a long impact on the business that we want to be out in front of that.

Okay. Thank you.

Pete Skibitski with Drexel Hamilton.

I have a couple more free cash questions, actually. Barb, I think, just so I'm clear, on 2014 you had a pretty large retention release on LHA 6, correct?

Correct.

We don't have anything similarly that could happen in 2015?

No, you do not have anything that will offset that.

Okay. And just on housekeeping, DNA, I think came in at close to $195 million. Should we expect that up by any meaningful amount because of the CapEx ramp or will that impact more over time?

It will have an impact more over time.

Okay. And then last one, I guess, on the debt refinancing, I think you have one more kind of high rate trend, the 7 and 8 that are due in 2021.

You got it.

Any sense that maybe you would refinance those sooner, before maturity?

If we can get a good rate and the time is right, it would be the smart thing to do. So we always look at it and when the numbers balance and the MPB is at the right rate, we certainly will jump in if we have the opportunity.

Okay, great. Thanks very much.

Sam Pearlstein with Wells Fargo.

Good morning. I wanted to ask you a question about some of the budget stuff in the FY16 request. Just if I look at, like CVN 78, it looked like it was a little bit less by a few hundred million in 2016 than you would've said from the fit up last year, and I guess I'm trying to think about, is that a sign of more spending in 2015? Or is it a stretch out of development, and does it have any impact in terms of the Kennedy or the next negotiation?

Well I think -- sometimes you need a program to try to decipher what you read in the budget documents. We're in a place where we are moving towards completion on CVN 78 and the program is funded. How the government is trying to do their housekeeping to make sure that they have the funding to get us to the end point -- we're aware of that, but that's really an internal to the government kind of discussion. We have the authorities, the processes, the people, and the decisions to make to get the ship delivered, and that's what we're really focused on.

On CVN 79, we've been doing significant work on a construction preparation contract. We have been negotiating the detail, design, and construction contract. We've talked for a while about the challenge of negotiating a price type contract when you're not finished yet with the first one, which was in a cost type environment. So we are still trying to work our way through that and get some common view of what's the risk in that program, and make sure the government and the Company have a view of the risk that looks the same.

Overlying that whole negotiation though, really is the cost cap on CVN 79, which is a number that was set equivalent to the cost cap on CVN 78 back in 2006 or so, something like that. So trying to figure out how do you get all the scope, how do you get the risk agreed to, and how do you do that inside the box that the government's operating inside of has made for a really challenging negotiation.

As far as the funding goes, and the way the budget request, and the appropriations, and the way the Navy's thinking about that -- we're pretty confident. We're very confident that all the authority and funding that we need to get these ships done is in place.

Is that the same on the George Washington in terms of the overhaul? I know there's funding in this budget request, but are you working, I guess, towards the dismantling step and then you still have to wait for the next contract to actually do the remainder of the refueling?

No, what's happened here is we actually now have a contract to plan for the refueling. The contract mod that we just did cuts us loose to go and plan the work as if it's a refueling, and to actually begin the procurement of long lead material to do that.

What will be hanging over that is that there will be an execution contract to follow, and the execution contract could be affected by whether or not we're in a sequestered environment. And so that's sort of the grey area out there.

As I said, I'm an optimist. I believe that we'll find a path through there, I believe that ship will be refueled. I believe that we'll get to the 79 under contract. I believe that these programs will stay on track and the timing will all be in place. But I don't know what the catalyst for removal of sequestration is yet. So we'll see.

Okay. Thank you.

I do have a question from Jason Gursky with Citi.

It's John again. Thanks so much for fitting me in on the follow-up. If you guys could just offer a little more on the timeline perhaps, of how long it will take to quote/unquote reset your competitive posture, and then especially in this environment of heightened CapEx, what is the cash to point priorities specifically on returning cash to shareholders?

Could we see share count come down, do you expect to still raise your dividend, where does that fall in this list of priorities you've offered today?

We certainly believe strongly in bringing our shareholders along with us as we go forward. I believe that our shareholders understand that we need to go and be successful in this resetting of the business. And so we see that being pretty balanced going forward. This is not something that we will do at the expense of the shareholders. This will be done with them in partnership with us.

Thanks.

Okay. Thanks everyone for joining us today. I'd like to wrap things up by just saying how pleased I am with where we are right now.

Looking back over the past four years, we have absolutely turned around the performance at Ingalls and we have maintained Newport News performance at the levels that you expect. In spite of our challenges at UPI, we have produced the operating margin in cash at levels right in line with our expectations. We have a clear view of the things we need to do to maintain a strong and competitive business for the long-term.

Our relentless focus on execution will never change. We do recognize the importance of finding new paths to create additional value and we absolutely plan to bring our shareholders along with us. So thanks for your interest in HII, and we look forward to seeing you soon.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect.