亨廷頓·英格爾斯工業 (HII) 2019 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Q4 2019 Huntington Ingalls Industries Inc. Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Dwayne Blake, Vice President of Investor Relations. Please go ahead, sir.

Thanks, Josh. Good morning, and welcome to the Huntington Ingalls Industries Fourth Quarter 2019 Earnings Conference Call. With us today are Mike Petters, President and Chief Executive Officer; and Chris Kastner, Executive Vice President 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 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 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 today's call. 2019 was a great year for HII, and I want to personally thank each of our 42,000 employees for continuing to execute their daily activities with an unwavering commitment to our core principles of safety, quality, cost and schedule.

I would characterize 2019 as a year of positioning for the future. We captured major contract awards that resulted in a record backlog of $46 billion at the end of the year. We enhanced our shipbuilding facilities by bringing new projects online to improve efficiency and affordability as we completed the fourth year of our 5-year generational CapEx program. And we challenged our employees to remain focused on execution while driving continuous improvement, innovation and creativity.

Now specifically, during 2019, we delivered 3 ships, the guided missile destroyer USS Paul Ignatius, the National Security Cutter Midgett and the attack submarine USS Delaware and we redelivered the USS Gerald R. Ford following her post shakedown availability.

We were awarded an historic $15 billion contract to build 2 more Gerald R. Ford class aircraft carriers as well as an $8 billion contract for the Virginia-class Block V submarines. And we successfully navigated through the second year of our shipbuilding program maturity transition and achieve shipbuilding return on sales that were in line with our expectations.

We expanded our portfolio by acquiring Fulcrum in early 2019. And additional portfolio shaping activities are continuing with the pending acquisition of Hydroid that was announced last week as well as the recent decision to divest our oil and gas business.

Additionally, yesterday, we announced agreement to contribute our San Diego shipyard assets to a recently formed fleet sustainment venture backed by the Carlyle Group and Stellex Capital Management. All of our 2019 activities as well as the recent portfolio-shaping activities were approached with 3 key outcomes in mind, driving growth, managing risk and generating strong returns.

So now let me share some additional highlights from the quarter and full year, starting on Slide 3 of the presentation. Sales of $2.4 billion for the quarter and $8.9 billion for the full year were approximately 9% higher than 2018, and represent record highs for the company. Diluted EPS was $3.61 for the quarter and $13.26 for the full year. Adjusted EPS, which excludes the impact of a noncash impairment charge related to the pending sale of our oil and gas business, was $4.36 for the quarter and $14.01 for the full year.

Chris will provide more details on this charge in his comments. New contract awards during the quarter were approximately $10 billion, including the aforementioned VCS Block V contract, resulting in backlog of approximately $46 billion at the end of the year, of which $18 billion is funded.

And regarding activities in Washington, we are very pleased that the House and Senate passed and the president enacted the National Defense Authorization Act as well as all 12 appropriations measures for fiscal year 2020. These measures strongly supported ship construction and repair as well as other national security imperatives, including acceleration of both LPD 31 and LHA 9 and approval of incremental funding. The legislation also restored the refueling complex overhaul of CVN 75 USS Harry S. Truman and supported investment in submarines, surface combatants, unmanned platforms, Department of Energy, nuclear and environmental programs and cyber defense.

Now with the release earlier this week of the President's fiscal year 2021 budget request, trade-offs were made across various accounts, including shipbuilding to fit within the administration's budget top line. Even so, we are pleased to see investment for priorities, including destroyers amphibious ships, Columbia class ballistic missile submarines and restoration of the CVN 75 refueling complex overhaul as well as increased integration of critical capabilities such as unmanned underwater vehicles and C5ISR.

We look forward once again to working with the administration and Congress in support of outcomes that best leverage our hot production lines, our supply chains and our service expertise to deliver the ships and capabilities that our nation requires.

Now let me share a few business segment highlights from the quarter. At Ingalls, LHA 7 Tripoli is essentially complete, and the team is working towards delivery in the next few weeks. LPD 28 Fort Lauderdale is approximately 70% complete and is on track for launch in the first half of this year. DDG 119 Delbert D. Black completed builders trials in December and is preparing for delivery in the first half of this year. NSC 9 Stone is progressing through final assembly and test activities and is on track for delivery later this year. And finally, DDG 62, the USS Fitzgerald completed sea trials last week and is on track for redelivery in the first half of this year.

At Newport News, CVN 79 Kennedy was christened and subsequently launched in December and has successfully transitioned into final assembly and test activities at the pier as we bring the ship systems to life. The ship is approximately 69% complete, and performance remains in line with our expectations.

CVN 73 USS George Washington has transitioned into its final outfitting and test phase, the refueling and complex overhaul is approximately 68% complete and the ship is scheduled for redelivery to the Navy in late 2021.

On the submarine program, SSN 794 Montana achieved the pressure hull complete milestone in December, and remains on track to deliver in the first half of 2021, and SSN 796 New Jersey is on track to achieve the pressure hull complete milestone in late 2020.

In our Technical Solutions segment, performance remains healthy across the business. For example, our teams continue to do a great job supporting the Air Force with training and ISR activities, both domestically and abroad. Performance is strong at key Department of Energy sites, including Los Alamos, Savannah River and the Nevada National Security Site with more Department of Energy new business opportunities on the horizon. And we continue to need to support Boeing as their key partner in the production of the extra-large unmanned undersea vehicle and with the acquisition of Hydroid, we are well positioned to compete for future unmanned, undersea and surface vehicles.

TS ended the year with a lot of momentum heading into 2020 and their recent portfolio shaping activities create a sharpened focus for the business which will allow them to create innovative solutions for growing and evolving customer requirements.

In summary, I am very excited about where we are as a company. Our shipbuilding programs continue to be well supported in Washington, and we have captured a record $46 billion backlog that provides unmatched stability and visibility. We are creating modern recapitalized facilities to efficiently execute our contracts, and we are seeing improving operational performance that produce shipbuilding return on sales that was right in line with our expectations in 2019. And we have a well-trained workforce that is laser-focused on execution while driving continuous improvement, innovation and creativity.

In addition, our recent portfolio shaping activities create a sharpened focus in the Technical Solutions business and positions the team to capture growth opportunities in unmanned systems, defense and federal solutions and nuclear and environmental services.

The acquisition of Hydroid is particularly exciting as we combine this entity with our unmanned maritime systems business unit to form one of the leading autonomous and unmanned maritime systems companies in the world. I firmly believe that we are taking the right steps to drive growth, manage risk and generate strong returns, which will, in turn, continue to create long-term sustainable value for our shareholders, our customers and our employees.

So now I'll turn the call over to Chris Kastner for some remarks on the financials. Chris?

Thanks, Mike, and good morning. Today, I will review our fourth quarter and full year consolidated results and provide some additional information on how we view 2020. For more detail on the segment results, please refer to the earnings release issued this morning and posted to our website.

As Mike mentioned earlier, we continued to refine our areas of strategic focus within the Technical Solutions division. We recently announced the acquisition of Hydroid, which we expect will close by the end of the first quarter. The total purchase price is $350 million. This represents a multiple of approximately 16x expected 2020 EBITDA when adjusting for approximately $50 million of related tax benefits.

Moving on, our oil and gas business, UPI is now considered an asset held for sale and is reflected as such on our balance sheet. During the fourth quarter, we recorded a $35 million noncash asset impairment charge, primarily related to goodwill associated with the valuation of UPI as we prepare to divest that business. UPI had a very good year in 2019, and they have a strong backlog moving forward. Excluding the impact of the impairment of UPI, adjusted EPS for the quarter was $4.36 and $14.01 for the full year. GAAP diluted EPS was $3.61 for the quarter and $13.26 for the full year.

Turning to our consolidated fourth quarter results on Slide 4 of the presentation. Revenues in the quarter of $2.4 billion increased 9.7% over fourth quarter 2018, primarily due to higher volumes in submarine construction for Virginia and Columbia class boats in Newport News, and growth in our Technical Solutions division, due primarily to the acquisitions of G2 and Fulcrum. For the quarter, G2 and Fulcrum contributed revenues of approximately $55 million.

Operating income for the quarter of $186 million decreased $27 million or 12.7% from fourth quarter 2018 and operating margin of 7.7% decreased to 197 basis points. These decreases were primarily driven by a less favorable operating FAS/CAS Adjustment and an asset impairment charge related to our oil and gas business.

Moving on to consolidated results for the full year on Slide 5. Revenues were $8.9 billion for the year, an increase of 8.8% from 2018. This increase was primarily driven by higher volumes in aircraft carriers, submarines and Navy nuclear support services at Newport News, and growth in our Technical Solutions division, due primarily to the acquisitions of G2 and Fulcrum as well as higher fleet support and oil and gas revenues. For the year, G2 and Fulcrum contributed revenues of approximately $201 million.

Operating income for the year was $736 million and operating margin was 8.3%. This compares to operating income of $951 million, and operating margin of 11.6% in 2018. The decreases were primarily due to a less favorable operating FAS/CAS Adjustment compared to 2018, an asset impairment charge related to our oil and gas business and losses on fleet support services contract as well as lower risk retirement at Ingalls. These were partially offset by contract changes on submarine support services, higher volume at Newport News and higher-risk retirement on the CVN 73 RCOH contract.

Our effective income tax rate was 13.4% for the quarter and 19.6% for the full year. This compares to 3.2% and 13.9% for fourth quarter and full year 2018, respectively. The lower tax rates in 2018 were driven by higher estimated research and development tax credits for the 2011 through 2018 tax years.

Turning to cash flow on Slide 6 of the presentation, cash from operations was $566 million in the quarter, and free cash flow was $408 million. For the full year, cash from operations was $896 million and free cash flow was $460 million. Fourth quarter capital expenditures were $158 million. And for the year, capital expenditures were $436 million or 4.9% of sales.

Cash contributions to our pension and postretirement benefit plans were $59 million in the year, of which $21 million were discretionary contributions to our qualified plans. Additionally, we repurchased approximately 254,000 shares in the quarter at a cost of $58 million, bringing the total number of shares repurchased in 2019, to approximately 1 million at a cost of $214 million. We also paid dividends of $1.03 per share or $42 million in the quarter, bringing total dividends paid for the year to $149 million.

Now turning to Slide 7, let me provide an update on pension. As we announced in late January, we will adopt the safe harbor methodology for CAS pension cost accounting beginning in 2021. The transition to safe harbor method reduces CAS pension cost volatility and improves program cost predictability. While the transition does create an unfavorable impact to GAAP EPS starting in 2021, it is cash flow neutral over the long term. As you can see on the pension table provided on Slide 7, cash recoveries and cash contributions become fairly well matched beginning in 2021 and moving forward. For ease of analysis, we'll expect -- or we expect to begin providing EPS adjusted for FAS/CAS Adjustment, starting with first quarter 2020 results.

Now let me provide you with an update on some additional 2020 items, as shown on Slide 8. We expect shipbuilding revenue to grow between 3% and 5% in 2020. We expect shipbuilding return on sales to be 9% in 2020, with the majority of significant risk retirement events weighted towards the latter part of the year, resulting in shipbuilding return on sales averaging 8% for the first 3 quarters.

Regarding Technical Solutions and given the recent portfolio shaping events underway, we expect revenue to be approximately $1 billion in 2020. This figure excludes results from UPI and the San Diego shipyard and assumes the Hydroid acquisition closes in the first quarter of 2020. Also for Technical Solutions, we expect return on sales to be in the 5% to 7% range.

On Slide 8, we've also provided 2020 modeling considerations for your reference, including taxes, interest expense, depreciation and amortization and capital expenditures.

Finally, on Slide 9, we have provided an updated view of anticipated major shipbuilding program milestones for 2020 and 2021.

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

Thanks, Chris. (Operator Instructions).

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

(Operator Instructions) Our first question comes from Myles Walton of UBS.

I was wondering on the free cash flow for '19, kind of where did that come out versus your expectations? And then maybe as you look at capital deployment, you didn't really pick up the repurchase effort in the fourth quarter. And wondering if that reverses significantly in 2020?

Yes. So cash in Q4 was a little bit below expectations, $50 million to $60 million below. It was only time with some receipts primarily at Newport News that weren't paid that shifted into 2020. So not really concerned about that. That is normalizing.

Relative to capital deployment, we really don't see a change. We're going to invest in our shipyards, continue to comply with our commitment relative to dividends and analyze that throughout the year, but still the 10% increase -- at least a 10% increase this year and then continuous share buyback. It's pretty consistent in 2019 with previous years in share buyback, obviously, in '18, we're pretty opportunistic, but really no change there.

But still the band-aid is their return versus all free cash flow to shareholders?

No, there's no change in that commitment. That commitment through 2020 definitely stands.

Our next question comes from Carter Copeland with Melius Research.

Two quick ones. One, Mike, if you could just speak to the Hydroid acquisition and unmanned and the longer-term growth opportunity, maybe in a little bit more detail. How you see the competitive landscape in that part of the market evolving? I realize there's a lot going on, but any color there would be helpful.

And then just on a housekeeping. Chris, I wondered if you might give us the EACs gross and net?

Let me do the housekeeping first. Yes. So positive is 89%, negative 50%, net of 39%, about 90% of that was Newport News.

Okay. Relative to Hydroid. We began, I guess, we identified the Navy's potential to move towards more unmanned systems several years ago, and we recognized that while we had engineered out a lot of manpower on the Ford design that was not what -- that was not where the Navy was talking about. They were talking about unmanned vehicles, in particular, and we didn't really have a footprint there. We -- you recall, we invested in a small company in Panama City that had a platform called Proteus, which was a 2 manned or unmanned or it was both, either or could be operated with 2 people or be unmanned platform. That was actually in the water and being tested and being used by many customers, not just the Navy. We acquired that group. And the first thing we found out was that there's a whole set of technologies and customers and people and processes that we were not very familiar with. And so not only did we get some technology there, we got some access.

And in the course of that access, we then realize that we can bring some of our own core capability to this area that might actually accelerate the adoption of the technology as well as create a business for us. And that led to an arrangement with Boeing, who had invested in their large unmanned vehicle. They had actually put it at sea, but they needed somebody to build it. So we could bring our manufacturing expertise to bear on that. We did that. We've -- and in the course of that, we kind of realized that okay, we're starting to really get an understanding of these large unmanned undersea vehicles.

But when we looked around, we saw there's a lot of activity on the smaller side. And Hydroid was a company that we noticed was really, really a big player in the smaller UUV space. And so we began a journey and a process with Kongsberg to walk our way through and resulting in the acquisition -- we hope. We've signed the agreement, and we hope to close that deal. But that gives us a footprint in basically the full range of unmanned undersea capability, and it speaks to a larger kind of belief that I have personally is that, I mean the Navy can have lots of things that they say they need and lots of things that they want to do. But they need to do that. When the industry can get there and provide it for them, they can go a lot faster.

And so our view is let's bring some of our capability, our ability to build workforce, our technology, our manufacturing expertise our contact information. Let's bring all of that to bear in this space to accelerate the development of the unmanned space on behalf of our customer. And so we think that this is a step in that direction. As you say, there's a lot going on in there. And -- but I would say that there's a lot of folks, who could talk about this scientifically. What I would tell you is that if you're in the water, you're learning about it, and we're in the water. And so we're really happy about that. And we're optimistic about where this business is going to go.

Yes. I would also add that, that business just, organically, post the transaction getting complete within HII, it'll grow at high single digit. So that's the near-term growth rate we see in that business. So we believe it can only get better beyond that.

Our next question comes from Jon Raviv with Citi.

On the cash -- just following up on the cash flow question. I know you mentioned $50 million to $60 million will lie on Newport News receipts slipping into 2020. Any other big building blocks we should think about heading into this year? CapEx comes down a bit, perhaps. Anything else you should keep in mind thinking about underlying cash flow?

Not really, as you're aware this is the last year of our major capital program, and we get back down to 2.5% of sales in 2021. What you're going to see, over the near term, is us start ramping our free cash such that we become $700 million a year cash flow story. Now I can't tell you whether that happens in '21, '22 or 23, we're going to ramp towards that. But at the end of the day, $700 million becomes the new normal for HII for free cash flow.

And just to clarify, Chris, that's with or without pension benefit?

That's all in.

That's all. Okay. And then just a quick follow-up on margin cadence. Can you talk a little bit more on the back-loaded nature of this year? I know on the last call, you mentioned that there could be (inaudible) what's the comp?

Yes. The major items -- sure, the major items, the back half of the year, our delivery of NSC 9, 796, getting to pressure hull complete and then bringing to life, CVN 72 -- excuse me, CVN 73 and CVN 79 through their test program.

Our next question comes from Doug Harned with Bernstein.

I want to go back to Mike, the discussion about unmanned systems. And last week, Secretory, Esper talked about moving to a very different kind of 355 ship Navy in 2030, which is, I think, it's pretty aggressive with smaller platforms, lower manning, including optionally manned. I mean I asked you a while back about this as it related to the Marine Corps strategy that had been laid out. But if the Navy moves aggressively in this direction, how might that affect your core programs, the larger ships and your business mix? And what's your understanding of how the Navy is looking to proceed here?

Well, Doug, I think this is -- this continues to evolve. The Navy is trying to match up the requirements that they see out in the world that they feel like they need with the ability of the industry to support it. And so our view of that is that we need to be on the front edge of that and trying to help them evolve that.

Relative to our core business, though, I mean our strategy for the last 3 years, if you go back over the last 3 years, the shipbuilding accounts have been historically high, doesn't actually talk about how high they've been. I mean my whole career, they've been in the $14 billion to $16 billion a year, year in and year out. And for the last 3 years anyway, we've been just short of 20 -- $25 billion. Even this year, for all of the discussion over the past few days about what's going on with the shipbuilding budget and all that sort of thing, it's still at $20 billion. And so I think that where you're going to see is, you're not going to see a hard left turn here where we're going to say, okay, we don't need big platforms with people on them anymore, and we're going to make -- we're going to have a Navy that's completely unmanned. I think what you're going to see is an evolution. You're going to see the unmanned space become amplification of presence and platforms that the Navy needs.

And so I don't know how the accounting works and all that sort of thing because that's -- that becomes an interesting discussion about what actually counts as a ship, and I just kind of stay out of that. I think about it more in terms of capability to provide presence for the Navy and the ability of the industry to bring technology to bear on the problems that they have. I think that the Navy is going to be moving towards more unmanned systems to amplify the platforms that they have and then see where that goes from there. And we want to be -- as their principal partner, we want to be right there with them and help them make that successful.

Well, when you think about growth, I think the shipbuilding is a fairly predictable business because -- on top line, because of the very long contracts. You've talked about a 5-year growth rate of around 3%. But this year, you're giving revenue guide dance of 3% to 5%. What factors create that range of outcomes? Is this repair work or uncertainty about the timing of milestones? I mean how do you get that broader range this year in guidance?

There's really some minor timing issues that could move it between 3% and 5% on some of our programs as not really new programs drive that, although timing of some material on some of the new awards would help us out a bit. But the majority of that, as you indicate, is already under contract.

Our next question comes from Ron Epstein with Bank of America.

Could you give us a little more, maybe background or color on the $950 million contract that you guys got in ISR work for -- with the tech services division, right? I mean that's doing support work for the Air Force in Europe, right? So if you could give us some more background on that? And then I have a follow-on question.

Yes. So that's -- Ron, this is Chris. That's Air Force contract, persistent multi role operations, ISR contract. That's split over 4 or 5 years, all that revenue. And we're really excited about it. We've done similar work through one of our acquisitions. So this is essentially a follow-on with different scope. I can't really go into too much detail of what they're doing. I got to be careful on the call, but we're really excited about that. We think it's an important area going forward.

Okay. And then, Mike, just maybe a broader question. One of the things that's come up in some of the conversations that we've had around naval strategy. Do you -- are you of the view -- do you see a future where there's more underwater operations beyond just kind of the typical Virginia-class, Columbia-class, that there's going to be a need for broader underwater infrastructure and that this unmanned underwater play is part of potentially building out broader underwater infrastructure?

Well, Ron, I remind you that you're talking to a former submarine officer. So I need to kind of do my safe harbor on that. But the thing about the undersea environment and platforms in the undersea environment is that they're very asymmetric. There's lots of history of a single submarine can bottle up an entire fleet in port and the fact that you can look out across the harbor and can't see it gives it an advantage. And so being undersea is a multiplier, just that, just the simple fact that your underwater is a multiplier for the -- your capability.

There's a lot of things that you can do under water that you may not want to send a Virginia-class submarine with a bunch of people on it to go do. And so being able to -- on the other hand, there's a significant amount of things underwater that you want to be able to do that you want to have a Virginia-class submarine or so something like that, fully manned, fully capable of complying with rules of engagement and all that sort of things. You want to be able to do that too. And so what we see is that this asymmetry that comes from being under sea is going to be something that Navy has to find a way to take advantage of.

And if you just go back, gosh, it's getting to be close to 30 years now, but if you go back and start to look at how did the -- how did the unmanned aerial systems take off, right? There was a technology that was being developed, and we were kind of doing this. And then suddenly, there was a knee in the curve where nobody could get enough of it. Everybody wanted more, and there wasn't enough capacity. And I mean literally, the curve just shot almost vertical.

We've been talking in the unmanned space for probably 10 years or 15 years about when is the knee in the curve going to come for the unmanned space -- undersea -- the unmanned undersea space. I would say the undersea space is a much harder environment in terms of the physics of it. And I'm not sure the knee in the curve is going to look like the unmanned aerial vehicle space did. But I believe you're starting to see now the maturation of technologies, more and more folks are getting in the water, and they're getting to understand what the art of the possible is. And so there -- whether it's a knee in the curve or if it's just an acceleration, I think we're kind of getting there now. And so it's really important for us just to be in the middle of all of that. And I think that 15 years from now, you could see a Navy that is talking a lot more about what they can and want to do undersea. I just think that's where it goes.

The final thing I'd say, Ron, is this is just my own personal amateur historian view, is that when countries can no longer afford the full Navy that they want, they buy submarines because they're asymmetric for the money that you put into them. So I mean, I think, we have history that says that. I don't know that it will quite play out that way here, because presence is important and presence actually keeps conflict from becoming hot conflict. And so I think the Navy has a great understanding of that. But in marriage, I think it's marrying undersea capability with the presence is a way for us to go.

Our next question comes from Robert Spingarn with Crédit Suisse.

I wanted to ask you for a little more detail on shipbuilding margin, both forward and also Q4 '19 from the perspective of CVN 79. So trying to understand, you book that very conservatively in the beginning of the program. I think we were looking for some kind of write-up upon launch. So Chris, can you tell us anything about CVN 79 EACs in Q4? And then maybe other way to look at this is, how does the 9% in 2020 divide between Ingalls and Newport News? And what's happening with the carrier relative to plan?

Well, I'll comment on margin. And then, Mike, you can talk about CVN 79, if you like. But Q4, 79 met their milestone. We evaluated the risk, and I've previously indicated that there's a lot of risk in front of us on that ship. So it just simply wasn't material enough, I think material enough was an issue to mention. But we did have a very good Q4 in shipbuilding, both Ingalls and Newport News actually. In 2020, I expect both Newport News and Ingalls to be at 9%. I expect them both to get there.

Okay. And then just on the carrier, I mean was I wrong in thinking that the launch would release a fair amount of positive EAC? Or is it next year's Q4 with the system build out milestone that you're talking about?

Yes. I think that was our view of this is that the risk that we incurred on the Ford was really in the test program, which is kind of -- we're walking into the test program now on Kennedy. And we just -- we're going to be conservative about this. The Ford actually for a lead ship came together better than any lead ship I've ever seen. But as we tested systems, which we had to work our way through a whole bunch of new technology there. So this is our next goal on that. And we're going to continue to be pretty conservative on that until we actually retire those risks. And I don't think we ever really expected that launch would be open the floodgates on risk retirement. We just -- frankly, the early launch of the program team put together was a way for us to mitigate downstream risk, and that's -- it was a part of a step, but not a floodgate.

Are you on plan with 79?

We are.

Our next question comes from George Shapiro with Shapiro.

I just want to follow-up a little bit on the last question from Rob. Can you just give us the specific EACs in the quarter? And then also, can you explain, -- you just mentioned that you got a pick up in margin on the Block V contract. So that assumes that the contract was more favorable than what you might have thought before. If you could comment on that? And then also, the other benefit that you had there on the LA-class ships. The support services increase in margin.

Yes. So Block V in Columbus, neither one is material enough to mention the number. It's in the -- it's all included in the Newport News results. I can't get back to you for your first question, George, I don't even recall it. What was the first question again?

Like, what are the EACs?

I already gave that to tomorrow's beginning. It was gross favorable of 89%, unfavorable of 50%, 90% of that being Newport News.

Okay. And then how about the support contract changes for the LA-class that you referenced. I mean can you be a little more specific what they were?

No, they were all embedded in Newport News performance in the quarter.

Okay. And then just one more general one, Mike. You looked in detail at the '21 budget for shipbuilding. Do you think that Congress leaves it as is. I mean there are quite a bit of changes, right? 1 less destroyer, 1 less Virginia-class to all this to support Colombia.

Well, George, I'm going to suggest that I'm not sure that I've ever seen the Congress leave any part of the administration's budget as is. And so I think that the budget submission is a beginning of a process, it's a long process to go from submitting the budget to appropriating the bills. And I'm not talking about just defense. I'm talking about all of the areas of the budget. So I think it's going to -- our role in this is typically to talk to how is the most -- if that's what you want, what's the most efficient way to do it. So that's kind of the way we work this, and we've worked at it over the years. And sometimes it works out, and sometimes, it's not necessarily the way we would like. But I think we're just at the very beginning of the process right now, and it's going to play out over the next several months.

What in it would you like to have changed?

Well, I think the biggest issue is the one that we've been talking about here all along. And that is that you got to find a way to pay for Columbia. If you decide that you're going to pay for Columbia inside the shipbuilding account then it's going to squeeze ships out unless you're going to push the budget up. And in the last 3 years, I think that we -- at the very beginning of the ramp up into Colombia, at a time when our strategy was take advantage of the budget and get as much stuff under contract as you possibly can, because there's going to come a time where you're going to have a lot of arm wrestling over the budget. And I think we've done that very well, and that's how we ended up with the backlog that we have. But I think the uncertainty about how you're going to pay for Columbia is going to show up. And I think that's what really showed up here. The pluses and minuses were really squeezed out because you have to go pay for Columbia. And I absolutely think we have to go pay for it. And I think that's a national priority. But I just think it's going to be -- it's the elephant in the room that has to be dealt with, if you want to keep all the other programs going. So I think that's where this ultimately goes. Each ship, certainly, we'd like to see -- more ships are better, and they're better, not just for us, but they're better for the whole industry. So we'll continue to advocate for that, but that's a way to keep the industrial base healthy and happy.

Our next question comes from Pete Skibitski with Alembic Global.

Bit of a follow-on. Mike, how are you feeling about the outlook for big deck amphibs at Ingalls right now? I know you've been trying to kind of bring one of the ships forward and the Navy's plan and Congress has helped out a little bit, I think, and we've got the new budget. But how are you feeling about that right now?

Well, I feel pretty good about it, frankly. The Marine Corps wants it. The Congress is trying to find ways to push it through. I just think it's an example to some of the pluses and minuses. I think what you see in the budget is really the squeezing of -- there's only so much air that can go into the balloon from the budget submission standpoint. So I feel pretty good about it. I think that there's a lot of support for what the big deck amphibs can do and what they are doing out there today. And so I remain optimistic about where that's going to ultimately end up. There's going to be days when we feel really good about and days when we kind of wonder what's going on. But I think in total, it's going to be -- it's -- we're going to end up in a good place and a good outcome.

Okay, got it. Just one follow-up for me. On the sale of Continental Maritime to Carlyle. I don't think it's a lot of revenue, maybe $100 million or so, but I thought it was always viewed as a positive to have a repair yard on the West Coast for you guys. So I'm just wondering how you're thinking about that now?

Well, I mean it's -- we contributed, just to be clear, we contributed this asset so that now we're part of the joint venture. So our view is that the business model -- let me step back. I think I've talked about this before. There is more demand for repair activity in the Pacific area of responsibility than there is capacity to provide it right now. But the Navy is kind of trying to work its way through a business model that's going to allow for more efficient support for the requirements that they have. In our case, we've -- as the business model has changed, we've kind of struggled with that a little bit. Our view is, we needed to restructure this business anyway, here's a way for us to keep our hand in that business and be able to help the Navy figure out the right way to get the business restructured and get the business -- get the industry in a place where it can actually effectively support what the Navy is doing. I mean we've had cases where in a space where there is not enough capacity to do the -- to meet the demand, we've actually had operations that have been closed. And so you have to step back and say, there's something bigger going on here, and we need to be part of that. So we need to be part of that discussion. But we also have to make sure that we try to find a solution. And this is what we think is -- working with Carlyle and Stellex, and Vigor and MHI, the other assets that are there. We think this is a way for us to effectively engage and help the Navy find a solution.

Okay. So you're not losing all the EBIT from that? It's just because of the accounting change, you're losing the revenue from the guidance?

Correct.

Our next question comes from Gautam Khanna with Cowen and Co.

This is Jeff Molinari on for Gautam today. So just some cleanups, all the questions have been answered already. So TS sales was guided to be $1 billion, kind of few more moving pieces than normal. What are you kind of assuming for annualized sales, EBIT margins for Hydroid and the businesses to be divested or excluded because of the JV? Just of those 3 moving pieces, if you could just kind of size those for us, it'd be helpful.

Yes. So we haven't provided that. And we think given the $1 billion of sales, a 5% to 7% return on sales should probably get you there from a modeling standpoint, but we haven't provided that data as of yet.

Okay, fair enough. And then on the margins, we talked about shipbuilding margin is kind of 8% through the first 3 quarters and then bumping up substantially in Q4. How do you think about that momentum continuing into 2021 at that level?

Well, I think that if you look at this business quarter-by-quarter, you're bound to have good surprises and maybe not so good. But I think that what we know is that -- and our experience here is that over the long haul, this business executes -- the shipbuilding industry executes at around 9%. So I think over the long haul, that's where we are. And our ambition is to execute our backlog, as you see out there at that level or better. And so that's kind of the way we're seeing this. The driver that we're seeing for this specific year is still a little bit of the hangover of the maturation of the backlog. And we've gone through a couple of years where we've had a heavy-weighted portfolio towards brand-new work. We just added 2 more carriers and hope another set of submarines into that mix. And it takes a little while to start to accumulate the milestones that we need to get them up. But we think that we're pretty sustainable here over the long haul.

Our next question comes from Seth Seifman with JPMorgan.

So Mike, I wonder if you could talk a little bit about the frigate. And are you still expecting an award this July and kind of how you're thinking about the positioning there and how that could ultimately fit in with the kind of work in Ingall?

Well, I mean, the bids are in. And we've put our best foot forward. We have invested in some facilities, and we have a very robust execution plan to be able to build that platform. And we're just standing by to help the Navy decide what they want to do. Now the competition is tough, I'll say that. And -- but we're still expecting award in the first half of the year.

Okay, okay. And then maybe a real quick follow-up. Chris, the working capital is still pretty low as a percentage of sales, about 6%. And if you have the $50 million of receipts in the fourth quarter, probably even would have been down slightly as a percentage of sales year-on-year. Is that a maintainable level of working capital, that sort of 6%, so the business grows working capital dollars may be up slightly, but not significantly?

Yes, it will move around a bit from time to time, but I think 6% is a really good target for shipbuilding.

Our next question comes from David Strauss with Barclays.

So I think, previously, you had talked about 9% to 10% margin range for shipbuilding in 2020 is 10%, not doable anymore, and -- in 2020. And is 10% still kind of an aspirational target looking further out?

David, this is Chris. It was simply coming through our plan and seeing how the programs were going to unfold in 2020 and the risk retirement potential there, which allowed us to arrive at the 9%. We're going to have quarters that are better than 9% and worse than 9%. We always challenge the organization to do better, but I think the best way to think about it is 9% moving forward.

Okay. And then probably another one for you, Chris. The $700 million in free cash flow you talked about getting to. Can you, I guess, building off of what you did in '19 at $460 million, I know you've got CapEx coming down over the course of the next couple of years, probably helped by about $200 million, but it looks like pension, CAS less contributions about equivalent kind of headwind. So what takes us from $460 million to $700 million?

Well, it's growth, right? We're going to grow. Margin is improving as well. So you couple that with the reduced capital expenditures and pension normalizing and reaching milestones on ships, you get to $700 million. It's going to naturally float up to $700 million of free cash over the next few years.

Our next question comes from Joseph DeNardi with Stifel.

Yes, Mike, just on the margin profile of the business going forward. I get that there's a cost-plus component of your business that's probably greater than some of your peers. But if you look out over the next several years, it's more of the production, the fixed price side of the business that will be growing. And so longer term, why is it that a margin tailwind potentially such that maybe the margin profile can go from 9% to 10% to 10% to 12% at some point?

Well, I mean I wish I could say that you are right. But the fact is that the whole blend ends up and if you go now, and we've gone back and looked at this every which way you can look at it, you end up and -- you end up in a place where no matter where you are -- the first thing you want to do is you want to know that you're actually executing well. And that's where the whole discussion around 9% to 10% came from was, you're executing well if you're in that range and you have a good mix of new programs and mature programs. If you're out of that range high, that means that you're probably overweighted on mature programs. And if you're out of that range low, you're either not executing well or you have -- you're out of balance with new programs. So that's kind of where it came from. And right now, with a $46 billion backlog, our -- we're kind of on the heavy end on new programs. We've gone through a couple of years where we've been maturing programs, but we just added $20-some billion to the backlog last year. So we're going to continue to work our risk through that. But the other side of it is that if you just go and look at the entire industry over the last, I don't know, 10 or 15 years, the industry just tends to operate at 9%. And that takes into account of mature programs and new programs and everything else. And so we aspire to 10%. We push our teams to that level, and that's our ambition. But I think in terms of the way to think about our business is, this is a 9% business with a $46 billion backlog that plays out over the next 10 or 12 years.

Okay, that's helpful. Can you maybe quantify just given submarine growth and carrier transitioning from cost to fix. What the mix looks like as you see it 5 years from now in terms of cost versus fixed as a whole?

The way to think about that is the RCOH contracts are the cost-plus contracts moving forward. So I don't have a specific percentage, but that's really the majority of the cost-plus work in our base.

Our last question comes from Noah Poponak with Goldman Sachs.

Chris, just wanted to try the walk from today's free cash to $700 million again because it's sounded -- if I heard your answer to David's question correctly, it really comes down to just growth in the segment, but -- with CapEx and pension largely offsetting. But if it's a $9 billion business, growing top line, 3% to 4% with margins in the zone of flat. That's only kind of $20 million, $25 million share of free cash flow growth per year. Should I -- is there something in grant proceeds that have been large for you recently or something else outside of the segment? Or is it just more when you said it could be '21, '22, '23, that it's likely to the back end of that when you've had time to compound the segments?

Yes. So there's some compounding there. So it's also timing of the milestones and how that works through working capital. When you look at our plans and all our ships going through our plans over the next 3 years, it gets to $700 million. And that really becomes the new normal. So I think you've essentially got it right, Noah.

Okay. And then when you've stated that now pointing to 9% as a shipbuilding margin versus the prior comments of 9% to 10%. You stated that that's really just kind of honing in on the specific plan as you've moved into 2020 itself. Can you help us with the specific things that changed in the plan? What specific ship inputs are different versus what you thought previously?

No, there's really -- it was really nothing specific that I would draw up, Noah, there. It's just going through each ship, laying them out over the next few years and looking at the risk retirement opportunities and the risk on those ships that 9% was the best way to look at it.

Okay. So I should -- so it's more of just moving to a bottoms-up ship-by-ship plan versus a prior sort of directional, what the business is capable of type of framework?

And some of it is the fact that if we -- the previous plan had these -- a lot of these contracts we didn't have. So it is working through -- it is working through the large volume of contracting as it comes into our plan now. And how is that going to play out with our teams and our execution and all that. So we just felt like it's really important to kind of clarify that.

And I'm not showing any further questions at this time. I would now like to turn the call back over to Mr. Petters for any further remarks.

Okay. Well, thanks for joining us. I want to remind you that you can still sign up to participate in our Investor Day meeting next week via webcast. It's Tuesday morning, on the 18th, starting at 08:00. So just go to our website at huntingtoningalls.com, click on the Investor Relations page and follow Investor Day link to register. We're excited about the chance to meet with you all and share a lot more detail, what we think the next 5 years will bring. So we appreciate you joining us on today's call, and we look forward to seeing you soon.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.