亨廷頓·英格爾斯工業 (HII) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Huntington Ingalls Industries, Inc. Second Quarter 2018 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would like to introduce your host for today's conference, Dwayne Blake, Vice President of Investor Relations. Sir, you may begin.

Thanks, Brendan. Good morning, and welcome to the Huntington Ingalls Industries Second Quarter 2018 Earnings Conference Call. With us today are Mike Petters, President and Chief Executive Officer; and Chris Kastner, Executive Vice President of Business Management and Chief Financial Officer.

As a reminder, statements made in today's call that are not historical facts 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 their remarks today, Mike and Chris will refer to certain non-GAAP 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 and CEO, Mike Petters. Mike?

Thanks, Dwayne. Good morning, everyone, and thanks for joining us on the call today.

We -- this morning, we released second quarter 2018 financial results that reflect solid performance across all 3 business segments. So let me share some highlights, starting on Slide 3 of the presentation. Sales of $2 billion for the quarter were 8.7% higher than the second quarter of 2017. Diluted EPS was $5.40, and included the benefit of a claim for prior year research and development tax credits. And Chris will provide some additional color on taxes during his remarks. We received approximately $1.1 billion in new contract awards during the quarter, resulting in a backlog of approximately $21 billion at the end of the quarter, of which $15 billion is funded.

Regarding activities in Washington, both the House and Senate recently passed the 2019 national defense authorization conference agreement and the bill is now ready for the President's signature. We are very encouraged by the support for Navy shipbuilding in the final measure, which includes the following. It authorizes the purchase of a fourth Ford-class aircraft carrier, CVN-81. It supports the purchase of CVN-80 and 81 under a single contract, if anticipated savings can be confirmed. And it supports advance procurement for LPD Flight II amphibious warships to leverage hot production lines and supply chains. We're also pleased with the progress of the defense appropriations bills in each chamber that are also very supportive of Navy shipbuilding. And we remain hopeful that the appropriations process will continue to proceed expeditiously.

Now I will provide a few points of interest on our business segments. At Ingalls, the team is continuing to drive DDG-117, the Paul Ignatius, NSC-7 Kimball and LHA-7 Tripoli toward completion, with trials and deliveries for these ships expected to span the fourth quarter and first half of next year. On the LPD program, LPD-28 Fort Lauderdale, reached 25% vessel complete during the quarter and is performing well on both cost and schedule. On the DDG program, the team has started fabrication on DDG 125, the Jack H. Lucas. This is the first Flight III ship that incorporates a new air and missile defense radar system. And Ingalls also recently launched DDG 121, the Frank E. Petersen Jr. At Newport News, CVN 79 Kennedy is approximately 47% complete overall, and 81% structurally complete, with 361 of 448 lifts joined together in the drydock. At this stage of construction, the team is focused on efficient execution of each super lift, and that includes increased levels of pre-outfitting work.

Importantly, we are seeing the benefits from these actions and from the capital investments in covered workspaces on the assembly platen. I am very pleased with the progress on this ship. There's still a lot of hard work ahead of us, but the team is meeting our performance expectations and is continuing to drive toward an early launch of the ship at the end of next year. On the submarine program, SSN 789 Indiana delivered to the Navy at the end of June, and SSN 791 Delaware, the final Block III boat to be delivered by Newport News, is on track to deliver in the first half of next year.

Now turning to Technical Solutions. We continue to realize the benefits of having a business segment that is focused on non-shipbuilding activities, but has reach-back to our entire portfolio of capabilities. For example, in just the past 15 months, we have significantly expanded our Department of Energy portfolio, previously concentrated at the Savannah River site. The portfolio now includes contracts for managing the Nevada National Security Site, the remediation of certain areas of the Los Alamos National Laboratory site and the management and operation of the Los Alamos site. At each of these sites, whether we are the lead, minority partner or significant subcontractor, we bring an unmatched level of nuclear expertise and complex project management skills to the team. And we are proud to be a trusted partner of our DOE customer.

In unmanned systems, we continue to strengthen our partnership with Boeing during the design phase of XLUUV, the Navy's flagship UUV program. A down-selected initial prototype production contract award is expected early next year. Additionally, we were one of several companies that recently received a contract to support research and development activities for the Navy's UUV family of systems. And finally, in the oil and gas business, we have seen a rebound in project activity in the United States and Canada that is driving increased hiring in both markets. As a result of our strong project execution and an unrelenting commitment to customer success, we are well positioned to take advantage of improving energy market conditions and are doing just that.

In closing, we have had a very solid first half of the year and look forward to maintaining this momentum in the second half. Our path to 2020 strategy is on track and our near-term focus remains on executing existing contract work and capturing quality new contracts. These actions, combined with our well-trained and engaged workforce, keep us on a path to continue creating long-term sustainable value for our shareholders, our customers and our employees.

And that concludes my remarks. And I'll now turn the call over to Chris Kastner for some remarks on the financials. Chris?

Thanks, Mike, and good morning. As I review our second quarter financial results and provide a few updates to the full year, you may follow along with the slide presentation we included with our earnings release this morning.

Beginning with our consolidated results on Slide 4 of the presentation. Our second quarter revenue growth was particularly strong, as this marks the first time since we spun that we generated revenues in excess of $2 billion in a given quarter. Revenues in the quarter of $2 billion increased 8.7% over second quarter 2017, driven by higher volumes in aircraft carriers and Navy nuclear support services at Newport News.

Operating income in the quarter of $257 million increased $16 million or 6.6% from second quarter 2017. The increase was primarily driven by a favorable operating FAS/CAS adjustment in the quarter compared to the same period of 2017, partially offset by lower segment operating income. Operating margin in the quarter was 12.7%.

Turning to Slide 5 of the presentation, cash from operations was $239 million in the quarter, after contributing $60 million to our pension and postretirement benefit plans, of which $50 million were discretionary contributions to our qualified plans. Year-to-date, we have contributed $84 million to our qualified plans. And as discussed previously, we expect to make a total of $508 million in discretionary contributions to our qualified plans in 2018 with the balance occurring in the third quarter.

Free cash flow in the quarter was $154 million. Net capital expenditures in the quarter were $85 million or 4.2% of revenues compared to $79 million in the same period of 2017. We continue to expect capital expenditures for the year to be between 5% and 6% of revenues. We returned almost $280 million to our shareholders in the quarter by repurchasing approximately 1.1 million shares at a cost of $247 million and paying $32 million in dividends, bringing our cash balance at the end of the quarter to $398 million.

Now to segment results on Slide 6 of the presentation. Ingalls revenues in the quarter of $629 million decreased 1.6% from the same period last year, driven by decreased volumes on the NSC program and surface combatants, partially offset by increased volume on the LPD program. Ingalls operating income of $83 million and margin of 13.2% in the quarter were down $15 million and 214 basis points year-over-year, respectively, mainly due to lower risk retirement on LHA 7 and the NSC program, partially offset by higher risk retirement on the LPD and DDG programs and $12 million of income from recoveries related to a settlement involving a legacy commercial contract.

Turning to Slide 7 of the presentation. Newport News revenues of approximately $1.2 billion in the quarter increased 18.2% from the same period last year, mostly due to higher volumes in aircraft carriers and Navy nuclear support services. Newport News operating income of $91 million in the quarter was up $11 million year-over-year, primarily because of higher revenues. Newport News operating margin in the quarter of 7.7% was 30 basis points lower than the same period last year, primarily due to changes in contract mix.

Now to Technical Solutions on Slide 8 of the presentation. Technical Solutions revenues of $243 million in the quarter were relatively flat to revenues in second quarter 2017. Technical Solutions operating income of $7 million and margin of 2.9% in the quarter, decreased $2 million and 81 basis points year-over-year, respectively, primarily because of lower performance in fleet support services.

Before I turn the call back over to Dwayne for Q&A, let me address our lower-than-expected effective federal income tax rate for the quarter and the expectation for the full year. Our effective federal income tax rate for the quarter of 8.8% differed from the statutory rate because the claim for higher research and development tax credits for the post-spin-off 2011 through 2015 tax years. We now expect our 2018 effective income tax rate to be approximately 17.5%.

That concludes my remarks. I'll turn the call back over to Dwayne for Q&A.

Thanks, Chris. (Operator Instructions) Brendan, I'll turn it over to you to manage the Q&A. Brendan?

(Operator Instructions) Our first question comes from Doug Harned of Bernstein.

I wanted to get a little better understanding of the margin profile at Newport News. And particularly, when you look at CVN 79, can you give us a sense of the risk profile on that program? In other words, if things go according -- just according to plan, do you foresee, next year, that we could see some improvement in margins at Newport News?

Yes, Doug. We've talked about this before. The really -- the next major event on 79 from a risk -- while we do quarterly EACs, our risk retirement milestone is going to be launch. And the nominal schedule for launch is the beginning of 2020, but the team is pushing hard to get the launch done in the fall of next year. And at this point, we seem to be on track for that, and we're happy about that. But we're probably not going to do any sort of major risk reassessment between now and launch.

Okay, so if I think of Newport News more broadly, I mean, you're well into Block IV on Virginia class. I'm just trying to understand if we should start to see some potential for margin improvement there as Block IV matures? And if you -- and I would think, if you get launch early on CVN 79, that would also be some potential for upside. I'm just trying to understand what levers there are there?

No, Doug that -- this is Chris. That's a really good point. Block IV will be maturing, 73 will be maturing as well. So along with 79, you have both of those programs maturing. But we're still pretty comfortable with the 7% to 9% return on sales. It could fluctuate some quarters, but we're comfortable with 7% to 9% for shipbuilding, excuse me.

Our next question comes from Carter Copeland with Melius Research.

Just a couple of quick ones. One, Chris, can you clarify for us the gross favorable, unfavorable cumes? And then, Mike, I just wondered if with the MDAA supportive of many of the things you've been looking for, how does that play into your updated thoughts around timing on contracting of some of these opportunities? How far out will that take us, now that you've got some very clear support for what you've been looking for?

Sure. I'll take the adjustments first, then I'll kick it over to Mike. There were $50 million of positive adjustments, $13 million negative, for a net $37 million. 70% of that net was Ingalls.

Carter, on the -- as far as the MDAA goes, as I mentioned, we're very encouraged and pleased with the way that the bill came out and we look forward to the President finally signing that bill. There is still an appropriations process that has to work itself through. I think I said before, this is the most exciting time that I've seen in shipbuilding in 30 years. And if you step back and just look at what we're doing right now, we actually have an offer in to the Navy to build 2 aircraft carriers. Our team has an offer in to the Navy to build 10 submarines. And we are in a competition for a share of 10 destroyers, and that's right now. There's support for multi-year procurement of LPDs, so we're all very encouraged by all of this.

But the way the nation makes its decisions to go and actually execute these requires both authorizations and appropriations. We're engaged in the appropriations process, but we're not through that process yet. And so we're at a place where all the things that need to be happening are happening, but we are not across the goal line and have been around long enough to know that you don't get points until you get across the goal line. So as far as the longer-term view, I do think that we're going to -- I'm encouraged to think that we're going to be able to get contracts for all of these ships over the next year to 18 months and get that done. And that's going to set the shipbuilding piece of our business up for the next 5 to 10 years. And I'm very encouraged about that, but we're not done yet. And before we look at the scoreboard, we're going to keep trying to get first downs.

Our next question comes from George Shapiro of Shapiro Research.

Yes. I wanted to know, Mike, for the first half of the year now you have had 7% revenue growth, and you were suggesting more like 3% over the next several years. Can -- you want to change that estimate or what's going on here? And do you expect this kind of growth in the second half?

Yes, George, I think that when we talked about the 3%, we talked about it over a several year period. Yes, we've had a couple of good quarters, but we're comfortable with our 3% estimate over a longer time frame.

George, this is Chris. I may add, we have 3 submarines in Newport News right now in availabilities. That's really not work that is consistent over the long term. It will be lumpy over time. But we're still comfortable with the 3% CAGR at this point.

Okay. And then, Chris, just to follow-up. You had said before that at Ingalls, we would see probably lower margins later on in the year as we see more new ships coming -- starting, so you'll you have less EACs. Is that still an accurate statement?

Yes, I think, over time what we've said is that as we get new ships at Ingalls, that there should be less opportunity for the higher margins that they've had over the last couple of years. I still think we're comfortable with the 7% to 9% return on sales for shipbuilding.

Our next question comes from Jon Raviv of Citi.

On free cash flow for this year, Chris, can you just revisit some of the targets you've intimated for the year? I think, $100 million down year-on-year, which would implied $350 million in 2018. And then what are the building blocks on the 2019 beyond the mechanical $400 million year-on-year swing from pension?

Yes, we don't provide free cash flow guidance. But I have discussed $100 million of pressure to where we finished last year, and we finished last year around $450 million. And then just the significant swing based on our accelerated pension contribution of net pension cash of about $400 million in 2019. There are other puts and takes that will go into '19 cash and we're coming through our plan now. So as things evolve through the year and when we get into the year-end call, I'll be able to provide you more color.

And then sort of related to that question on sustainable -- almost, like, thinking about sustainable cash flow. Obviously, the net pension inflow is pretty significant right now. When that starts shrinking just due to essentially mechanics, is there anything you can do to fill that hole, so to speak?

Well, don't necessarily think of it as a hole, right? The major swings for cash for us, right now, are our capital program, which we think makes great sense, that is $1.8 billion through 2020. And then pension driven by CAS, cash and FAS. So over time, as we become more fully funded, all FAS, CAS and cash should come down. We provided the information on where we directionally think that is in '18 and '19. We'll come through the plan and we'll provide you additional guidance or additional direction for '19 and '20 for pension. So there's not a lot of moving parts when you think about cash in shipbuilding. It's really capital, net pension and working capital, and working capital is fairly consistent. So we really don't think of it as a hole we need to fill. It's just a normal operation of the business.

Our next question comes from Sam Pearlstein of Wells Fargo.

I wanted to go back on the 3% outlook that you have, because you mentioned -- this is for the sales growth, you mentioned a couple of different competitions or things that are out there. And I guess, I'm trying to just think about how do things like the frigate and icebreaker in terms of how those break, or how we buy the DDG 51 Flight IIIs in terms of the split. How do you think about those and that profile in that longer-term growth rate?

It's a good question. The 3% CAGR is really a risk-adjusted viewpoint on how things could evolve between now and 2022. If things fall perfectly, it could be more than that. But it's really a risk-adjusted look at shipbuilding revenue, taking into consideration all of those competitions and all of those programs.

And Mike, the Flight III competition, is this similar to prior ones or where you might have the loser get some of the winner's price? Should we expect a 50-50 split? Anything different about this competition versus other ones we've seen in the destroyers?

Yes. I think in the main, it's a -- I'd say, it's in the same box, but it's in a different part of the box. Because I think, the Navy came to this solicitation -- this is my perspective -- but they came to this -- this time around, they came with a view that they're trying to figure out how to get quantity as well as value out of this block buy, considering that it also is a radar upgrade. And so we actually had to price several different scenarios of schedules and quantities of ships complementary between our yard and our competitor's yard. And I can't speak to the Navy's evaluation process, but I think they were looking at all of those different scenarios and trying to figure out how to optimize their return.

For us, we -- it created a circumstance in the proposal that, basically, if you want the ships faster, there's an opportunity to do that. And so it's just going to be interesting to see how this all turns out on the back end. But I think where we're going to be, like I said, we're going to be in the same box. But I think this is going to be a case where the industrial base is trying to support the Navy from a quantity standpoint. And I think that's going to be pretty good however it turns out. And it'll be -- and it's going to be pretty good for -- at least for us, it's going to be pretty good no matter how it turns out.

Our next question comes from Gautam Khanna, Cowen and Company.

I was wondering if you could give us any flavor on the gross unfavorable [cume] catch ups year-to-date, whatever it is, $37 million? Is that skewed to NNS? And how has that mix changed, if you look kind of, first half versus first half of last year?

Yes. I don't -- so this year, I don't believe there was anything materially -- that we would address. And I don't have the specific cume adjustments for the first half, 6 months of the year, last year versus this year in front of me. Gautam, I could walk you through that later today, if you'd like?

Okay. No, that would be helpful. I'm just trying to get at -- on CVN 79, have you -- are you sort of on plan with the cost estimates over the last couple of quarters? Or is that been a source of gross unfavorables?

No. We're comfortable with where we are on 79.

Okay. Chris, I was hoping you could give us some directional color, perhaps even a floor on where pension trends, you know FAS/CAS recovery beyond 2019. I mean, what sort of -- you've given guidance on CapEx, it appears that it would drop something like $200 million in 2020 based on your 5-year plan. Do you have any sort of lower bound on pension recovery that you can give us so we have some framework for the range of outcomes?

Gautam, I don't right now. We're going through our planning process. And I'll be able to update our analysis for pension for both '19 and '20 and provide that to you on the year-end call.

Okay. And just last one. Based on the deliveries you have forecast in Q3 and Q4, should we expect that Newport's margin this quarter is sort of the high watermark for the year? Or do you have any sort of color you can give us on sort of the sequential cadence of margin at NNS?

Yes. Gautam, we don't -- as you know, we don't provide margin guidance. What we have said is, it will be 7% to 9% return on sales in shipbuilding for the next 2 years.

Our next question comes from David Strauss of Barclays.

Wanted to ask about cash return. So far year-to-date, you've had a heavy amount of share repurchase. You've got the pension funding coming due in -- or you're planning on doing that in Q3. How should we think about it from here? Are you going to increase debt or raise debt to fund the pension, given where you stand today? And how should we think about share repurchase through the rest of the year?

Yes. Share repurchases is an essential part of our strategy that we kicked off in '15, where first we invest in our shipyards, and we're investing $1.8 billion in our shipyards through 2020. And then returning substantially all free cash flow back to shareholders. What we did in Q2 is consistent with that strategy and we're going to continue to execute it. Relative to raising debt, we don't necessarily need to do that for our pension contribution in Q3. We have a -- our cash balance, was I think $398 million, and we have a $1.3 billion revolver. So we have a strong balance sheet that we can deal with that.

Okay, and a follow-up on TS. I think in the past you've said that you've targeted that business as a 5% margin business in the 2020 time frame. How does Nevada and Los Alamos kind of change -- potentially change that story?

It's all part of that story. It's an essential part of the strategy within TS, was to be successful in the DOE space. Team has done an excellent job there. I think Mike has done a tour of the facilities here. So if he wants to comment on it, that would be...

Yes. I would just -- as Chris said, this is an essential part of our TS strategy. And I would kind of offer that in my over 30 years in the business, I've watched us over 30 years try to chase down some of this business, with really only one success and that was at Savannah River. At the end of '16, we reorganized the business and we created a separate division and we've created and established new leadership lines. And we became much more focused on going after that business. And since that time, we have become -- we're on the team at the Nevada test site. We are a subcontractor to the team at Los Alamos on the M&O contract. And we're the prime for the Los Alamos Legacy Cleanup. So in basically 18 months, we've won 3 awards, where after 30 years we had only won one. So I'm excited about where we're going with that business. And as I said, and Chris has said, it's an essential part of the -- of where the TS business profile is going to go, not just over the next couple of years, but really over the next several decades. We're a principal partner now with the Department of Energy, and we're proud to be there and very supportive.

Our next question comes from Ronald Epstein with Bank of America Merrill Lynch.

Maybe two questions. Back to that revenue growth assumption of 3%. Mike, per your comments, if some of that stuff that is being talked -- about potentially a 2 carrier block, the 10 submarines, so on and so forth -- and it being, in your own words, the best environment you've seen in 30 years, it's hard to believe that's a 3% growth environment if any of that actually comes through.

Like as Chris said, Ron, this is -- the 3% is kind of risk adjusted. We are not home on the 2 carriers. We're encouraged, but we're not there. On the submarine business, the 10 ship Block 5 contract is one we're working on. Congress is considering adding a couple of ships to that, but not sure how that's going to play out. The destroyer business is a 10-ship competition. So there's a share of 10 ships with an option for 5 more. Not really sure how that's going to play out. There is desire to go to multi-years on the LPD, the LXR program, the LPD Flight II. But we're not at that point yet either. And the frigate competition is an end of next year RFP and maybe a 2020 award, so we're really way up in front of that. And so our view of it is that, as Chris said, if all of those things break our way, it's definitely more than 3%. But as we step back and handicap where we think that things are going to go with some confidence from a risk standpoint, we think 3% is a good number to work from right now. If some of these things start to break our way and we see a different number and see it -- and make an adjustment, we'll be happy to let you know.

Okay. Yes. Fair enough. And then maybe another question, when we were down visiting the shipyard a little while back and walking around CVN 79 and seeing all the super lifts and what's going on with that ship. Can you maybe just talk to everyone on about some of the lessons learned that you guys have had on that ship that you can apply to CVN 80 in terms of efficiency? So as we think about the transition to the next carrier, how we could maybe see maybe more margin stability or even potentially margin uplift?

Sure. We -- and you saw it when you were here. We made -- have made pretty significant capital investments to reduce the cost of 79. And we targeted a pretty significant man-hour reduction just in the labor side of that contract between 78 and 79. We see opportunity to continue to advance those reductions when you go to 80 and 81. Especially if you happen to have it in a 2-ship contract, where you are able to just have the teams move from doing the work on 80 and going right over and doing the work on 81. Shift gears, if you're able to do that inside of the shipyard, you ought to be able to do that in the supply chain as well. And approaching the market and approaching our suppliers and talking to them about buying 2 shipsets worth of material, as opposed to 1, should create some efficiencies for us there. And then, as we go through, and I think, Ron, when you were here, we talked with you all like we've talked with everybody about the digital transformation that's going on in Newport News, and how you bring the technologies that are out there to bear on this pretty complex manufacturing enterprise. We believe there's opportunities there as well.

And the real push for the 2-carrier contract is to create that stable floor so that we can then go and prosecute all of those efficiencies and opportunities. So as I keep saying, we're very encouraged about where we are today. If we had -- if you were able to do a time lapse and say a year ago today, we were preparing a 1-ship proposal for the Navy for CVN 80. Today, we have a proposal into the Navy for CVN 80 and 81 and we are seeing and encouraged by a lot of broad support, both inside the Navy and across the river in the Congress for proceeding down that path. We set -- we think that sets the foundation for affordably producing and delivering aircraft carriers in the future and we're really excited about what that means for us.

Our next question comes from Krishna Sinha of Vertical Research.

On the Indiana 789, given that you delivered in the quarter and you completed sea trials, I would have expected a little bit more of a risk reserve to be taken this quarter. Is that something that's still yet to be booked? Is that like a 3Q event? Or did you take most of the risk reserve on that at launch at an earlier date?

Well, thanks for the question, Krishna, and welcome. We assess our EACs on a quarterly basis. We have adjusted those previously on the Indiana. I don't anticipate material adjustments related to that boat going forward. And I still believe that 7% to 9% is the right way to think about the business over the next couple of years.

Yes. And then on future sort of risk events, risk reserve events, EAC events, can you just talk about -- I think that the 789 was the major launch this year. Are there any other milestones -- major milestones on other programs that we should be aware of in 3Q and 4Q?

We do have delivery of NSC-7 this year. And then we're moving down the path on delivery of the other two boats, DDG-117 and LHA-7, towards the back half of this year, the first half of next year. And then we have incremental milestones on a number of ships that we'll assess on a quarterly basis.

Are the EAC adjustments typically -- in looking at a single program, when are the bulk of EAC adjustments sort of taken? Are they more towards the launch date or the delivery date?

Well, you have to assess each program and each program and each ship will have its individual risk register. So there's not a pat formula that's determined for each of the milestones. It's all based on the risk register on the specific ship, on that specific program, as it runs through the manufacturing cycle.

Yes, we have a pretty disciplined process when we come off the contract, we map all of the risks that we see to the milestones in the program. And we evaluate at each milestone, we evaluate whether we actually retired that risk or not. And if not, can we continue to work to retire that risk at the next milestone or another milestone, or do we have to actually recognize that we didn't retire that risk. Every program has its own profile. We tend to be conservative in that regard. And so I'd say, it's a -- and that's sort of the blend that we've been talking about for almost 8 years now. That early in programs, we tend not to go and recognize risk retirement. We don't want to recognize it before we know for sure we have retired it. So there's probably a bias towards the back end of programs, but each one has got its own profile, as Chris said.

Yes. And then one quick one on revenues. You talked a little bit earlier about -- obviously, the positive shipbuilding environment and the subcommittee MDAA write-ups and how that's breaking your way as it stands right now. If things go to plan, even your risk-adjusted plan, is there a particular year where you'll see a surge in newbuilds? Or is it really spread out very evenly over, say, the next 10 years or some long period?

Yes, we actually think that we're in a pretty unique position right here, because if you step back just a little bit and look at what happened in the FY '18 process and now what's happening in the FY '19 process with regard to shipbuilding, there is a pretty good surge. That's why I say it's the most exciting time I have seen. In these 2 years, there's a surge for ship authorizations and appropriations. Each program has its own path and sequence for playing at -- for when you actually go to contract for the particular ships. But the issue that I think that makes us a little bit unique in the industry is that this 2-year window is really special for shipbuilding.

There is a big question, really, about what happens in '20. You know, sequestration kicks back in. What happens after that? Our view is that a lot of the work that we're going to get under contract before '20 puts us in a pretty unique place. If you see the same kind of activity in '20 and '21 and follow on, then that's just going to be even better for the business. But we're -- we think that -- I think I have described it before. Are we going to be at a new -- is this an indication of a new sustained level for the business or is this just going to be the rat and the snake where we have a lump in the business that we're going to work through over the next 5 to 10 years. The job right now is to get the lump under contract, and then we'll go figure out how do we keep it at that sustained level.

(Operator Instructions) Our next question comes from Joseph DeNardi with Stifel.

Mike, just on Columbia class, if you look at the workshare, it looks pretty similar just from our standpoint in terms of what you guys are doing on a Virginia class. So should we assume that maybe the margin profile on that business could actually be pretty good right out of the gate, because there is some commonality? Or are there actually some aspects that would lead to it being kind of more of a normal margin curve? And I know it's a ways out, but just curious how you think about that.

Well, I mean, the workshare is a little bit different than it is on a Virginia class. We will not be delivering any of those ships, whereas we deliver half of the Virginia-class programs. We will be building units and we're doing design work for those. Our scope on Virginia is about half. Our scope on Columbia is less than that. And we're going to be moving into a lead ship environment for a ship that's really 100% new. And so for the next period of time, next few years, we're going to be in the design phase, moving into construction. And we're going to be incredibly -- as supportive as we can be to make this program as much of a success from the gate -- from the opening gate as we can. But I don't think you want to just turn around and say, it's the same as Virginia and it's just an expansion of volume. I think that would be a misread. This is a new program and I think you need to treat it as a new program.

Okay. Okay. And then, Mike, you mentioned a couple of times, the risk-adjusted growth you see in the business, wondering if you could share kind of what the upper end of that range would look like if everything falls your way? And then what are some of the key risk items that you're looking at that will determined kind of how that plays out?

Yes. I think that's completely driven by whatever assumptions you want to pick. And it could be something as simple as, are there going to be any options picked up on the destroyers or not? Is the RFP for the frigate going to come out on time? Is there going to be only one builder and they're going to make that award on time? And I think you start getting into a top line guess based on -- and it's driven entirely by your assumptions. So I don't know that there's much value in trying to do that. Our view is that we have looked at all of that. We think that right now, the best way to position the business and to talk about where the business is going is from a risk-adjusted standpoint, 3% seems to make sense. As I mentioned before, if a couple things start to break our way and it changes our view, we would be happy to describe that with you and discuss it with you.

Also, timing is very important. You could have a 6-month delay on a ship, which could impact your revenue -- be very successful in acquiring a ship and building the ship, but that 6-month delay could impact your revenue. So the 3% is really a risk-adjusted answer based on knowledge of all of those factors.

Our next question comes from Rob Spingarn of Crédit Suisse.

I'm jumping in a little late. So I'm going to -- hopefully, these haven't been asked. One is -- the first one is on, for Chris, on the cash flow statement. There are some grant proceeds offsetting some of your CapEx. And I wanted to see if you have any color on what that relates to? Whether that's for Columbia or something else? And would something like this be recurring going forward? And is it net or gross relative to the CapEx guidance of 5% to 6% of sales? And then, Mike, I have one for you.

That's all included in the 5% to 6% of sales. And that's Shipyard of the Future proceeds from the State of Mississippi.

So that's -- okay, so it's, obviously, for Ingalls programs, therefore, nothing to do with Columbia.

Yes.

Is it program specific or just across Ingalls?

No, across Ingalls.

Okay. And then, Mike, on the -- just wanted to ask you, on the multi-year for DDG 51, what does winning this competition really mean? Do you have an indication on how the 10 ships would be split? How the priced options would be split? And then how we think about the price the loser would have to accept?

Actually, I have no indication. We've submitted our offer. What was unique about the proposal was that we actually priced several scenarios. And the scenarios included building more than half and building less than half of those program. So then the Navy will go and they'll make their choice. And since we priced all of that, I think that this is one of those -- it's a unique situation because I think the Navy did put quantity on a pedestal with cost in this competition and I think that's good for the whole industry. And we'll just -- we'll see how it turns out.

Does that mean it could be more than, let's say, 60-40 like 70-30 kind of thing or...

I don't -- no, I don't think there will be any more than what you've seen in the past. But I -- yes, let's just leave at that.

Okay, last question, actually, on the -- I just wanted to ask for your outlook on the cutter -- on the Coast Guard Cutter deliveries. How we should think about those since they often are strong ships from a margin perspective. What the delivery schedule looks like for the cutters?

Yes. NSC-7 back half of this year and NSC-7 -- excuse me, NSC-8, first part of next year.

Our next question comes from Jon Raviv of Citi.

I will not ask about growth, but I will ask about cash deployment. And understood that repo is an important part of the strategy, although we have seen other companies in this space, Defense broadly, contributing more to pension, we've seen sizable M&A. What's the current mindset on cash deployment beyond repo?

Well, our current posture is -- hasn't really changed since we came in a few years ago and described it. We're going to invest in our core business. So a large capital investment that we've been -- and we're in the middle of that right now. And then when you move from capital investment to the free cash, we're going to return substantially all of our free cash to the shareholders in the form of either share buyback or dividends, and we have a commitment to increase our dividends every year. As far as M&A goes, we believe that our balance sheet is strong enough to -- if we have opportunities to take advantage of, we would be able to do that. That's the path we've been on, that's the path we expect to be on through 2020. I think this quarter, we had a little bit more share buyback than we've had in the past, but that's completely consistent with what we said back in 2015. And we're not changing that posture at this point.

And on M&A, if you -- as you evaluate a pipeline or look at opportunities or evaluate them, are you focused more on core shipbuilding? Or could we see some interest in expanding the services market, which you seem to be -- which appears to be going well, thus far?

We're staying close to the core, right? And we'd always evaluate shipbuilding opportunities. But within TS, there are markets such as unmanned underwater vehicles, MODSIM, advanced training, agile software development, restricted work and then even environmental management in support of the DOE. So we're going to stay close to the core and utilize a fair -- a very disciplined process to evaluate this.

At this time, I'm showing no further questions and would like to turn the call back over to Mike Petters.

Well, thanks for everybody for joining us on the call this morning. As I mentioned, this is an exciting time for our business. Not only is it the most exciting time that we've seen in shipbuilding in 30 years, but we are feeling the growth now in our TS division that, with a couple of key wins in the DOE business and our footprint in UUV business, we really see that some of those seeds we planted a few years ago are starting to sprout. And we're very encouraged by that and we look forward to the rest of the year and for the years to come. Thank you all very much for joining us. Bye.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.