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Huntington Ingalls Industries, Inc. (NYSE:HII)

Q3 2011 Earnings Call

November 10, 2011 9:00 AM ET

Executives

Andy Green – Vice President, Investor Relations

Mike Petters – President and CEO

Barb Niland – Corporate Vice President, Business Management and CFO

Analysts

Jason Gursky – Citi

Rob Spingarn – Credit Suisse

George Shapiro – Access 342

Heidi Wood – Morgan Stanley

Sam Pearlstein – Wells Fargo

Noah Poponak – Goldman Sachs

Dan Barsi – Sanford Bernstein

Brian Ruttenbur – Morgan Keegan

Mayur Manmohansingh – Barclays Capital

Pete Skibitski – SunTrust

Yilma Abebe – JP Morgan

Operator

Good day, ladies and gentlemen. And welcome to the Third Quarter 2011 Huntington Ingalls Industries Earnings Conference Call. My name Chenille, and I’ll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions)

As a reminder, today’s conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today Mr. Andy Green, Vice President of Investor Relations. Please proceed.

Andy Green

Thanks Chenille. Good morning. And welcome to the Huntington Ingalls Industries third quarter 2011 earnings conference call. With us today are Mike Petters, President and Chief Executive Officer; and Barb Niland, Corporate Vice President, Business Management and Chief Financial Officer.

As a reminder, statements made in today’s call that are not historical fact are considered forward-looking statements and are made pursuant to the Safe Harbor provisions of Federal Securities Law, actual results may differ. Please refer to our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results.

Also in their remarks today, Mike and Barb will refer to certain non-GAAP measures including segment operating income, adjusted segment operating income, adjusted segment operating margins, adjusted total operating income, adjusted total operating margin and adjusted diluted EPS in the third quarter of 2011. All adjusted figures exclude a non-cash goodwill impairment charge. Reconciliations of these metrics to the comparable GAAP measures are included in a schedule that accompanied our earnings release and is posted on our website.

We have posted presentation slides on our website today that we planned to address during the call to supplement our comments. Please access our website at www.huntingtoningalls.com and click on the Investor Relations link to view the presentation, as well as our earnings release and reconciliations.

With that, I’d like to turn the call over to Mike.

Mike Petters

Thanks, Andy. Good morning, everyone, and thanks for joining us on today’s call. I’m pleased to report Huntington Ingalls Industries results for the third quarter of 2011. Today we reported sales of $1.59 billion, down 4.3% from the same period last year.

A $300 million non-cash goodwill impairment charge which was driven by adverse equity market conditions and not a change in our outlook resulted in a reported net loss of $248 million for the quarter and a loss of $5.07 per share. Barb will have more to say on the charge in her presentation.

Excluding the impact of the charge, total operating margin was 6.9%, up from 4.6% last year and diluted earnings per share was $1.05 for the quarter up from $0.86 in 2010. Total backlog at the end of the quarter was $17.3 billion, up about $400 million over the second quarter.

Third quarter was a very successful quarter for the company. We booked $2.1 billion of new awards including new construction contracts for DDG-114, the second ship and the DDG-51 restart and NSC-5, the Coast Guards latest National Security Cutter.

We also booked several sizable maintenance and repair contracts at AMSEC and Continental Maritime and Newport News Shipbuilding won a large maintenance contract to support the Navy’s Nuclear Propulsion Program in upstate New York. We delivered two ships during the quarter, the Submarine California and NSC-3 Stratton and we began to ramp up production of Virginia-class submarines to two per year.

Overall, the third quarter demonstrated the strong momentum we’ve generated since the spin-off last spring. We continue to perform in line with our long-term expectations and we are excited about our prospects going forward.

Now, I’d like to review each program in a little more detail starting with Ingalls shipbuilding. For the DDG-51 restart as I just mentioned, we receive the award for DDG-114, our second DDG award in just over three months.

Obviously, we were very disappointed that we did not win the DDG-116 competition. Keep in mind that of the 62 ships to-date under the original program, Huntington Ingalls built 28 of them and we’ve been awarded two of the first four in the restart.

Historically, we have a strong track record for quality and efficiency on this program and looking ahead, we strongly believe that with the management team and operating system we have in place and with a continued focus on cost reductions and efficiency, we will be competitive in position to win a substantial share of future DDG awards.

On the LPD program, we successfully completed builders’ trials of LPD 22 San Diego and we expect to complete acceptance trials and deliver the ship to the navy by the end of the year. We continue to make progress on LPD’s 23 through 25, have begun construction of LPD 26 and are working under our long lead material contract for LPD 27.

We remain on schedule to deliver LPD’s 23 and 24 next year, and LPD 25 in 2013. We are currently negotiating for the construction contract for LPD 27 and expect to have it in place some time next year.

In the LHA program, we continue to make progress on LHA 6 with the successful translation of Modules 1 and 2 along with the past record 571 ton lift to erect the deckhouse superstructure.

We expect the ship to be 75% structurally erected by the end of the year. And as I have said before, while we are pleased with the progress on the ship, we recognize that the majority of the risk lies ahead in the outfitting and testing phase of construction. We anticipate a contract on LHA 7 the next America Class Amphibious Assault ship by early next year.

The third quarter saw a couple of key milestones for the national security cutter program, including the delivery of NSC-3 Stratton and the construction contract award for NSC-5 the fifth ship in the program.

NSC-4 is also under construction and is progressing well. These ships have been well received by our customer the U.S. Coast Guard and we are very proud to be part of this important homeland security program.

For the DDG 1000 program the team and our manufacturing facility in Guilford employs some of the most advanced composites fabrication technology in the world for the deckhouses and hangers for DDG 1000 and 1001. This proven technology combined with a highly skilled work force positions us to continue the program strong performance on the DDG 1002 contract expected to be awarded in early 2012.

At Avondale, the work force there continues to perform very well and we are continuing with our plan of record to wind down operations. That being said, when we first announced this decision we emphasized that we deliberately decided to complete construction of the two LPDs being built at Avondale, LPD 23 Anchorage and LPD 25 Somerset to enable us time to work with federal state and local officials to explore redeployment opportunities for the skill and talented workforce at Avondale.

In fact we just recently announced an agreement with the State of Louisiana, whereby the state would provide some very attractive incentives for joint venture. This agreement enables us to aggressively seek out a credible partner and a sustainable market and we will leave no stone unturned in this effort.

Now turning to Newport News, in aircraft carrier constructions CVN-78 Ford is 29% complete and is over 50% structurally erected. During the quarter we erected the ships turn as a single 825-ton superlift one of the largest of the 162 major sections of the ship. The program remains on track and the ship is on schedule for launch in 2013 with expected delivery in 2015.

On CVN-79 Kennedy, structural manufacturing, material procurement and design and planning are underway under the construction preparation contract. Although, there has been much speculation regarding the 2013 budget and the procurement of Kennedy, the current plan is to begin full construction of the ship in 2013.

The RCOH for CVN-71 Roosevelt continues to go very well and due to expanded repair work scope from the navy under the contract the ship is now schedule to be the – to be redelivered in mid 2013. Advanced planning continues for the refueling of CVN-72 Lincoln and execution should begin in early 2013.

For carrier inactivations, we are currently in the fourth year of the five-year planning contract as we prepare for CVN-65 Enterprise to enter the yard in mid 2013 for defueling of its eight nuclear reactors.

On the Virginia-class submarine program, during the third quarter we delivered SSN-781 California, the latest submarine in the program more than eight months early. Commissioned two weeks ago California was described by the navy as the most combat ready of any Virginia delivery to-date.

The first four of the block 2 boats have been delivered and the first four boats of block 3 are under construction. This includes SSN-787, marking the beginning of the programs two submarine per year build plan.

For the company as a whole, our long-term outlook remains unchanged and we are on-track to achieve the targets we’ve discussed since the spin-off. All of our programs continue to perform inline with expectations. We continue to make progress on LPDs 22 through 25 and LHA 6, but risk remains on these programs.

We are also seeing strong performance out of our other programs, such as the refueling overhauls, national security cutters, DDG-51s, LPD 26 and 27, aircraft carrier construction, fleet services and the Virginia-class submarine program.

In the near-term, based on our third quarter results and what we’re seeing so far in the fourth quarter, we expect to finish out the year at a run rate of sales and earnings similar to what we’ve seen in the first nine months.

Although, it is still early to comment in any detail on 2012, we still expect to post year-over-year improvement in segment operating margin as we begin to replace legacy contract revenue at Ingalls with revenue from new business.

By the end of 2012, we expect to have delivered LPDs 22, 23 and 24, and do have made substantial progress ramping by VCS, DDGs 113 and 114, NSCs 4 and 5, and LPD 26. Margin improvement should continue into 2013 after we’ve delivered LPD 25 and LHA 6, the last of the underperforming contracts. Beyond 2013, we continue to expect our margin expansion to accelerate significantly on our way to our 2015 target of 9 plus percent.

Before I turn the call over to Barb for a more detail on the financials, I’d like to make a few comments on the defense budget and the future of ship building. First, I wanted to emphasize that we have no crystal ball. We have no way of knowing exactly what the super committee might or might not do. While we do know however, is that the Navy and Coast Guard have missions all over the globe protecting America’s vital strategic interest.

The fleet including the ships and personnel is already stretched to its limit in the effort to fulfill those obligations and to maintain the fleet and its mission profile going forward, our customers are going to have to do more with fewer dollars.

We’ve heard the same speculation you have concerning defense budget cuts. Unfortunately in today’s deficit reduction environment, virtually every program is being closely evaluated and its cost is under the microscope.

In the past few months, for example there has been wide spreads public speculation regarding various naval shipbuilding programs. But I encourage you to remember that is just that speculation. Until we see a final budget, we won’t know for sure the impact on our programs if any.

One thing I will note however is that the discussions around the defense budget over the past several months have become significantly more thoughtful with respect to the broader implications of the cuts.

What began as a sweep hypothetical strokes all depend to cut large programs looking primarily at the dollar amount directly tied to those programs has now evolved into more rational discussions that include the significant tangential effects of large program cuts.

And although, I won’t comment on specific programs, rest assured that we are closely engaged with the Navy and Coast Guard during this process and we will continue to work with them to support their program needs in the most cost efficient manner possible.

Lastly, it’s important to remember the context of today’s discussions and how from a timing standpoint, the resulting decisions may or may not impact our business. There are three distinct timeframes, the first zero to five years are already established, these are the contracts that are already in the backlog or that we are negotiating today. The debate right now is about the budget for 2013 and the results of that debate will become relevant in the next five to 10 years.

Yeah, beyond all of that what is really being debated today is the question of what kind of Navy well we will have in 10 to 50 years. I’m confident, however, that HII is well-positioned to continue to support the Navy’s mission as we have done for more than 100 years.

In summary, Huntington Ingalls posted another quarter of improvement in operating income, operating margin and free cash flow. Although, risk remains in the LPD and LHA six programs, we continue to make progress on these ships, as well as ramping up new business and we remain firmly on track to achieve our stated sales and margins targets.

At Huntington Ingalls, our goal is to provide U.S. warfighters with high quality ships at the lowest possible costs and on or ahead of schedule, objectives that we believe will create substantial value for all of our shareholders.

With that, I’ll turn the call over to Barb Niland for some remarks on the financials. Barb?

Barb Niland

Thanks, Mike, and good morning to everyone on the call. I’d like to briefly review our consolidated and segment results as disclosed in the press release then wrap up with some comments on pension.

Before I get into our operational results, I’d like to discuss the goodwill impairment charge we took during the quarter. As you are aware, we normally perform a goodwill impairment test at the end of November or more often if certain criteria are met. We performed our last goodwill test at the time of the spin and we determined there was no impairment.

However, as a result of the decline in our stock price and market capitalization in the quarter, we were required to take a closer look at goodwill to evaluate for impairment. We performed the relevant evaluations and although, our internal cash flow projections suggested a value above that implied by our stock price, the sharp decline in our market capitalization and decline in equity market multiples required an adjustment to goodwill.

The $300 million non-cash of goodwill charge does not have an impact on our liquidity or debt covenants. And keep in mind that this is an estimate and is subject to adjustment in the fourth quarter as we finalize our testing.

I want to emphasize what Mike said, our long-term outlook as not changed. This non-cash goodwill impairment charge was strictly driven by adverse equity market conditions.

Now turning to the financials on slide four of the presentation, reported third quarter sales decreased $72 million from the same period last year and I will provide more details when I discuss each segment results.

Including the $300 million non-cash goodwill impairment charge taken during the quarter, GAAP reported segment operating loss for the quarter was a $187 million. Total operating loss was a $190 million and diluted loss per share was $5.07.

Adjusted for the goodwill impairment charge, segment operating income was $113 million and total operating income was $110 million. Total operating margin was 6.9%, compared to 4.6% for the same period last year. Adjusted for the goodwill charge diluted EPS was $1.05, compared to $0.86 last year.

Cash from operating activities for the third quarter was $232 million, up $59 million over last year. Capital expenditures for the quarter were $36 million flat from last year. For the full year we continue to expect capital expenditures to be approximately 3% of sales.

Turning to slide six, Ingalls revenue for the three months ending September 2011 decreased $19 million or 2.5% from the same period in 2010, primarily driven by lower sales in the DDG-51 program partially offset by higher sales in the National Security Cutter Program.

Excluding the non-cash goodwill impairment charge, Ingalls operating income for the quarter was $19 million, compared with an operating loss of $1 million in the same period in 2010. Ingalls adjusted operating margin was 2.6% for the quarter, up from essentially zero last year.

Turning to slide six, Newport News revenues for the quarter decreased $52 million or 5.6% from last year, primarily driven by lower sales volume on the Roosevelt RCOH and the Ford, partially offset by higher sales volume on the advanced construction contracts for Kennedy and the advanced planning effort on the Lincoln RCOH.

Newport News operating income for the quarter was $94 million, compared with $90 million last year. The increase was primarily due to performance improvements realized on the VCS program, offset by risk retirement on the Toledo DMP in 2010 that did not occur in 2011. Newport News operating margin was 10.7% for the quarter, up from 9.7% in 2010.

If you’ll turn to slide seven, I’d like to make a few comments on pension. Please note that pension related numbers are subject to year end performance and measurement criteria. So what we’re showing you here is simply to give you an idea of what 2012 pension could look like under certain conditions.

This chart shows the sensitivity of our 2012 estimated FAS/CAS pension adjustment to the discount rate assumption and actual asset returns for 2011. And assumes an 8% long-term return on assets going forward, which is slightly lower than last year’s assumption of 8.5%.

Given where we are today, our discount rate assumption would likely fall in the 5.25% to 5.5% range. With regard to cash funding and based on today’s conditions, we expect net pension contributions of roughly between $75 million to $100 million in 2012.

That wraps up my remarks and with that, I’ll turn the call over to Andy for Q&A.

Andy Green

Thanks Barb. Chenille, we’d like to start the Q&A and just as a reminder to all the participants, please limit yourself to one question and one follow-up, so we can get as many in as we can.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Jason Gursky of Citi.

Jason Gursky – Citi

Hello. Can you hear me?

Mike Petters

You bet. Great. We can hear you, Jason.

Jason Gursky – Citi

Yeah. Thanks for taking the call guys.

Mike Petters

Yeah.

Jason Gursky – Citi

Mike, I’d love to just get some qualitative commentary from you if possible on why you think the DDG-51 award went away from you and what impact this might have on your ability to sustain flat revenue outlook over the five year period out to 2015?

Mike Petters

Well, as far as the outlook goes, we’re not changing the outlook based on this first competition. As I said, we’re very disappointed that we didn’t win that competition. On the other hand, this was the very first competition that we’ve had since Katrina happened. And we’ve been doing a lot of work over the last three and half years getting ourselves ready doing the things that we thought were important and we did measure up.

But what we have now is we actually have a stake in the ground on a target to shoot for, before that we were doing what we thought was right and what we thought would make value and we made a lot of progress, we just didn’t get all the way to where we need to be.

Now we have a target to shoot for, we look forward to the next competition. We congratulate the team at there, we wish them well and we’ll see them in the next competition, we’re energized to go get it.

Jason Gursky – Citi

Okay. Great. And then there was, I don’t know if you’ve had a change yet to see this report out today out in the press, but there seems suggestion that you’re going to a see 5% withholding on progress payments related to the DDG-114, due to some deficiencies and it sounded like management processes or something to that effect. I was wondering if you have any insights on that and what that means from perhaps an earnings and a cash flow perspective?

Mike Petters

Well, we have ongoing in all of our contracts we usually end up with some -- with several kinds of disputes with our customers over various issues. And this particular one, I think has to do with our earned value management systems, but we have range of them and those disputes and withholds are spelled out in our filings.

Again, this is something we will engage with -- have engaged, frankly, with our customers on and we will continue to engage on. But as far as our outlook and flows for the business we don’t see this is having any effect.

Jason Gursky – Citi

Just to confirm there is no impact to cash flows or earnings driven by this in the near-term?

Mike Petters

Not to our outlook, no.

Jason Gursky – Citi

Okay. Thank you.

Operator

Your next question comes from the line of Rob Spingarn, Credit Suisse.

Rob Spingarn – Credit Suisse

Good morning.

Barb Niland

Good morning, Rob.

Mike Petters

Hi Rob.

Rob Spingarn – Credit Suisse

Mike you talked about LPDs 22 through 24 delivering by the end of ‘12 and you also mentioned 9% margin in the Gulf by ‘15. Are there any timing changes here, was LPD 22 do this here and then the target on the margin, is that slipping to the right?

Mike Petters

No. There is no change, I mean 22 is, we do expect 22 to deliver this year and 23 and 24 next year. And our target has always been 9 plus percent in 2015, so no change there. The team is performing right on line and right on track with the plans that we’ve laid out.

Rob Spingarn – Credit Suisse

Okay. Would you be able to give us some sense of how the margin plays out in ‘13 and ‘14, you’ve been clear that we shouldn’t look for much in ‘12, ‘13 is really where we see a bit of a jump just given the number of zero margin ships that depart in ‘12? But how do we think about ‘13, ‘14, ‘15 then?

Mike Petters

Well, without being terribly specific what we said is that 2013 is a point of inflection for margin improvement. And what will happen is these, by 2013 all of the underperforming contract work will be behind us and Avondale situation would be behind us at that point too.

The new contracts will be coming on. Our bias towards conservatism on the front-end of new contracts, we’ll be ramping up on those contracts in terms of margin recognition, which is why we see this getting up to the run rate in 2015. So you think of 2013 is a point of inflection.

Rob Spingarn – Credit Suisse

And how do you think about 2012 guidance and timing on that guidance?

Mike Petters

At this point, I’m not sure that it makes a lot of sense for us to try to guide into this environment at all.

Rob Spingarn – Credit Suisse

Is that largely due -- is that more due to what’s going on in Washington or is it the uncertainty around the Avondale closure situation, what?

Mike Petters

I would say, yes. I would say, yes.

Rob Spingarn – Credit Suisse

I mean is it...

Mike Petters

Yeah. I mean any one of these things would be completely assumption driven and so to have three of these things -- these three things, all of them being so assumption driven that, pick your set of assumptions you get a set of numbers.

So from our standpoint that’s not effective in our communication plan and what we’re trying to communicate is that, we are – we’ve got our eyes wide open on what the risks around these different issues are.

Rob Spingarn – Credit Suisse

Okay. And then just to finish up, to sustain you just had a great margin at Newport News in the quarter, I think everybody sees that? How sustainable are those performance improvements on Virginia and what else should we think about there and how do those margins go forward?

Barb Niland

Well, this is Barb. And I would say is, we have multiple ships under construction on the Virginia-class program and I don’t believe 10.7% is sustainable and ratable, but during the third quarter we had an unusual amount of favorable risk retirement primarily related to the delivery of California and then New Mexico completing the warranty period.

But because we have ship -- six subs under construction at any point in time, we have different risk retirements across each one of their ships. So you will see some lumpiness in our return on sales on that program.

Rob Spingarn – Credit Suisse

Okay. Thanks very much.

Mike Petters

You bet.

Operator

Your next question comes from the line of George Shapiro of Access 342.

George Shapiro – Access 342

Yes. Barb, I saw the loss for -- provision for losses went down $21 million in the quarter, so you’re at $31 million now, so probably runs out in the first quarter next year except that LPDs don’t finish delivering till the end of next year. So, why won’t there be the risk of another charge that needs to be taken there?

Barb Niland

Well, we’re talking about risk associated with getting those programs out of the yard. But right now as we see it both LPD 23 and 24 are over 85% complete at this time and they are going to deliver in the latter part of the first half of next year, so we feel at this point in time those provisions are about where they need to be.

George Shapiro – Access 342

Okay. And then one question on inventories, they certain were better and your cash flow is very good this quarter. But they’re still seeing like they are too high. Can you just go through what’s happening there on a year-to-date is still up close to a couple of hundred million dollars?

Barb Niland

Sure. Not a problem. Yeah. Our cash performance was actually pretty good but that was really due to accelerated cash collections and just timing. Inventory is higher than the end of last year and part of it’s due to the – clearly Avondale restructuring costs.

But also we talked about the performance on our LPDs and LHA 6 and that manifests itself in inventory with the retentions and the progressing on those ships. And so you’ll see a big change in that inventory as we deliver the ships. So right now we are just paying the price for that.

George Shapiro – Access 342

Okay. Thanks very much.

Mike Petters

Thank you, George.

Operator

Your next question comes from the line of Heidi Wood of Morgan Stanley.

Heidi Wood – Morgan Stanley

Yes. A couple of questions to circle back on Newport News. Can you breakout what were the contract cumulative adjustments in the quarter and maybe talk about the driver of these 22% services margins in the quarter that was pretty impressive.

Barb Niland

Heidi, we are not going to break amount the numbers. But what I can tell you is, the biggest, the unusual events were just the delivery of California and then New Mexico coming out of the warranty period. So we had some pickups because we retired risks there.

But across the program, we have different incentives, we have material incentives, scheduled incentives, small business incentives, as we retire all that risks we will have cumulative pickups there. When we make the complete modules and deliver modules, we’ll retire risk there. We will retire risk based on our cost performance, our labor performance. So it’s a constant watch across each of the ships.

Heidi Wood – Morgan Stanley

The services margins, can you talk to us about that uptick?

Barb Niland

The services margins -- there was a little bit of pickup related to a very tiny amount related to the Toledo DMP. And then in addition to it is just all of our Savannah River, the way we do that margin with no sale comes in and it’s just timing. I don’t expect to see that continue.

Heidi Wood – Morgan Stanley

Should we think that the services margins is being more in the mid-teens on a sustained basis thus far?

Barb Niland

I think it will be a little less than that because of the aero funding that we received on the Savannah River contract and then that will start to be declining.

Heidi Wood – Morgan Stanley

Okay. Mike a quick question for you and then I’ll turn it back over, a bigger picture as you sort of talked about the skyline and heading into kind of ‘13 and beyond and obviously the rollout of the previous port program. You’re sort of intimating more favorable contract terms versus the past, but help us understand across the industry we’re seeing evidence of much tougher contract terms going out of Pentagon?

You have the F-18 multi year it has prior margins, KC-X signed fixed price development at zero and F-35 LRIP 5 which is at this stage not signable it should cost review by a half of -- share your thoughts, so what’s happening specifically in your contracting environment that is enabling you to drive your confidence that you’re going to be able to be seeing higher margins and better regencies through a defense budget down cycle?

Mike Petters

Yeah. It’s a great question Heidi. I think to answer that, lets go back and remember why we have underperforming contracts in the first place. The contracts that were signed on the LPDs and the LHA were signed in the aftermath of Katrina when the yard was being rebuilt, but the culture of the yard had been broken. And so the cost baseline that was assumed in those contracts was not correct.

What we are doing, while we absolutely recognized the points that you made that there are certainly going to be different kinds of risk sharing, there is going to be different kinds of terms and conditions out there. The fundamental issue for us is, if we can get the cost baseline right that’s going to be a major improvement in where we’ve been over the last five years.

And the contracts that we are negotiating today, we are negotiating those off of the cost baseline that we’re actually performing to today rather than, so we know what the cost baseline is for us to go get this work under contract.

As I said you’re exactly right there are other pressures out there that if we were running at a full rate, I would say we would be in the same boat as everybody else. But we’re resetting the cost baselines right now in all of our contracting and so that overwhelms the effect that you talked about.

Heidi Wood – Morgan Stanley

Okay. Good. Thank you so much.

Mike Petters

You bet.

Operator

Your next question comes from the line of Sam Pearlstein of Wells Fargo.

Mike Petters

Hi Sam.

Sam Pearlstein – Wells Fargo

Good morning. Barb you had mentioned 3% of sales for CapEx, which if you do on the order of $6.5 billion, I guess gives you about a $190 million of CapEx that’s a pretty big step up from where you’ve been running. Can you talk about what we might see in the fourth quarter there and why it’s going up?

Barb Niland

Well, you calculated about right and really it’s just kind of a normal phenomena vendor here all your vendors are going to getting their invoices and want to get paid by the end of the year, but also some of our work is completing towards the end of the year. So, we’ve talked about we were finishing that inactivations facility, we have the extension on [NLF] going on getting ready for the two subs a year.

We’re buying equipment getting ready for the two subs a year because we’ve already started that second one. So, a lot of it it’s just timing at the end of the year and somehow the suppliers always get their invoices in at the end of the year to make their sales numbers to and as they complete the work. So, I look forward to be real.

Sam Pearlstein – Wells Fargo

Okay. And then when you mentioned the $75 million to $100 million of pension contributions how does that compare to this year?

Barb Niland

This year we just had a small amount of pension contribution so it is significantly more, the discount rates are driving that.

Sam Pearlstein – Wells Fargo

Okay. And I just one follow-up it’s just in -- I know you don’t want to talk about the Virginia class positive adjustment in terms of the size, but it looks like in the first quarter you had 7%, 9% now a 10% margin in Newport News which is a business that I would have thought would be generally more stable. And so when should we start to see something where there aren’t these big swings on a quarterly basis?

Barb Niland

Well, that’s the problem when you look at your business -- at our business on a quarterly basis it’s a little harder because of the lumpiness those with cash as well as risk retirements on the program. So, you really need to look at this business more instead of quarter-over-quarter but more year-over-year type look at the total year.

Sam Pearlstein – Wells Fargo

Okay. Thank you.

Operator

Your next question comes from the line of Noah Poponak of Goldman Sachs.

Noah Poponak – Goldman Sachs

Hi. Good morning.

Barb Niland

Good morning Noah.

Noah Poponak – Goldman Sachs

Is there something that makes your third quarter margins seasonally strong relative to the other three quarters of the year?

Barb Niland

Well, what we were just talking about on the Virginia Class, just the fact that we delivered California, we came out of...

Noah Poponak – Goldman Sachs

Well, I’m not talking about this year specifically, I mean on an ongoing basis every year. It looks like historically there has been some seasonal strength in the third quarter relative to the year, although it doesn’t happen every year. I’m just wondering if there is something that would drive that for the company?

Mike Petters

There is -- I would say no in general. I think you could note that the -- our third quarter is the end of the government’s fiscal year. And so there may be on a kind of a random basis there may be some effect of that that might have a little bit of an effect. But in this particular case, the fiscal calendars had nothing to do really with this. This was about work that we finished and risks that we retired.

Noah Poponak – Goldman Sachs

Got it.

Mike Petters

It just happened -- it just happened to be this quarter.

Noah Poponak – Goldman Sachs

Okay. Following up on the question before about tougher terms of trade with the Pentagon where you’re kind of saying that, your starting point for your cost basis is in a substantially different place. How do you think Mike about the risk that as you improve when you go back to the negotiating table at the Pentagon, they seem in a lot of other cases very willing to strongly suggest that they need to then reset the bar again on you and sort of have you shared a lot of the improvements you’ve garnered with the customer?

Mike Petters

I mean -- as we’ve talked many, many times when we go to negotiate a contract, we’re in that end of the business where we’re either our sole source supplier or we’re in a head-to-head competition with one other supplier. We are not in that end of the business where there 8 competitors out there who our and they’re in a pretty strong competitive environment which drives -- which drives the negotiations.

So typically in our negotiations where we go into is, it’s usually less about price and it’s more about how we’re going share the risk that’s here. Neither one of us the government wants to buy the ships that we’re offering. We want to sell the ships that we’re offering, we want to try to find a way to share the risk, because by sharing the risk we are creating value for shareholders and we’re saving money for the tax payers.

And so I think that -- that’s discussion of how are you going share the risk is what our negotiations all about. We get lost in all of this is that, if you sign a cost-type contract with the government the reality is, even if you only retire 80% of the risk and you have to increase the cost by some dollars for the 20% you didn’t retire.

You save the tax payers in contracts you save that tax payers hundreds of millions of dollars, because if they had signed a price-type contract the price would have been 30% to 40% higher.

Noah Poponak – Goldman Sachs

Right.

Mike Petters

So, that’s what discussion is all about for us really it’s less about the price and its how do you craft the contract in a way that makes sense for the tax payers and make sense for the shareholders. And, for me the center of that conversation is, do we have a common view of what the risk is, do we have a view and can we create a common view of how we’re going to share that risk.

Noah Poponak – Goldman Sachs

Okay.

Mike Petters

They want to put all the risk on me they have to pay me more for it.

Noah Poponak – Goldman Sachs

Okay.

Mike Petters

If they -- if we decide to share it then that can be mutually beneficial to both of us.

Noah Poponak – Goldman Sachs

That’s helpful. If I could just sneak in one other quick one for Barb, if I -- I might be looking at the math incorrectly here, but it looks like you’re saying the ‘12 discount rate would be down 30 to 60 basis points versus ‘11. If I just look at the Moody’s AA it’s done 125 basis points year-to-date, how do I put that?

Barb Niland

Yeah. Well, we take our discount rate-- we use a discount rate based on AA bonds where the duration matches the timing of our pension flow. So, I -- based on where discount rates are today and everything untitled get the lower end of our range we’re given you.

Noah Poponak – Goldman Sachs

Okay.

Barb Niland

So if -- I will know that from the end of the year, end of year we do our measurement and it’s every body’s guess what the market is going to do and where we’re going to be.

Noah Poponak – Goldman Sachs

Okay. Thank you.

Operator

Your next question comes from line of [Dan Barsi] with Sanford Bernstein.

Dan Barsi – Sanford Bernstein

Good morning.

Mike Petters

Good morning.

Dan Barsi – Sanford Bernstein

Just to go back to contract awards again, I mean you booked over $2 billion in awards for the quarter, but something we’ve been hearing elsewhere is that there has slowing progress on moving contracts forward. Are you seeing any signs of order flow being delayed or of orders you expected taking longer to be finalized?

Mike Petters

I can’t say, I mean what we’re talking about at this point in our contract negotiations are contracts or ships that have been authorized and we were and either been fully appropriated or mostly appropriated and we’re working our way through that. The negotiations are tough, but we don’t see that the things are being held back. If that’s what you mean.

Dan Barsi – Sanford Bernstein

That’s what I was asking, yes.

Mike Petters

Yeah. And we’re not seeing the effect of that. We’re seeing that things are taking a little bit longer just because of the -- the as I said before, trying to get this -- trying to get a common view of what the risk in the program is and then trying to find a way to make sure it makes sense for everybody. That takes a little bit -- that’s taken a little bit longer now, but that’s not a flow issue I don’t think.

Dan Barsi – Sanford Bernstein

And then, just turning to the next opportunity on DDG-51, when would that come up and when would you expect to be awarded?

Mike Petters

I see, I think that’s probably about this time next year is what I think the plan is at this point. But we’d have to I guess, we have to confirm that. I think that’s what it is and I think that the most important thing for our team right now is, the feedback loop that we got from this last competition allow us to go in and see what the opportunities are for us to be more competitive.

Dan Barsi – Sanford Bernstein

Great. Thanks.

Operator

Our next question comes from the line if Brian Ruttenbur with Morgan Keegan.

Mike Petters

Hey Brian.

Brian Ruttenbur – Morgan Keegan

Hi. Just a question just a follow-up to some of the other questions to get clarity, on G&A, can you talk about it in the fourth quarter you had a drop from quarter -- two quarter from second quarter to third quarter, can you talk about that just in the fourth quarter kind of near-term looking at your toes?

Barb Niland

Yeah. I mean, I hate to use the word lumpy all the time, but that’s just kind of the aware our businesses. I would look at not a significant change in the fourth quarter to the third quarter.

Brian Ruttenbur – Morgan Keegan

Okay. And then, most of your pension expense is going to be in the G&A line in 2012, because you are going to have that increase?

Barb Niland

We will have an increase yes.

Brian Ruttenbur – Morgan Keegan

And most of it will be in the G&A line?

Barb Niland

It will show, yes, yes.

Brian Ruttenbur – Morgan Keegan

Perfect. Thank you very much.

Operator

Our next question comes from the line of Carter Copeland from Barclays Capital.

Mike Petters

Hi, Carter.

Mayur Manmohansingh – Barclays Capital

Hi. Good morning, guys. This is [Mayur] in for Carter.

Mike Petters

Good morning.

Mayur Manmohansingh – Barclays Capital

My call dropped earliest so I apologize if the question I’m going to ask is -- was asked earlier.

Mike Petters

Not a problem.

Mayur Manmohansingh – Barclays Capital

Mike you talked about you captured 2015 long-term guidance the same in terms of flat revenues and 9 plus percent margins. With the loss of DDG well not winning DDG 116 we are just wondering, does this or were any other question that you may have had or that something else so that’s please as we look towards the sort of longer term forecast?

Mike Petters

Our general presumption in the DDG line is that we will win about half of those. And there is four ships have been awarded so far and we’ve won -- and we’ve got of them. We’ve obviously got another competition coming up and we’re getting ready to go do that.

But the loss of this specific ship while it’s very frustrating, it’s also very helpful to my team will allow us to be even more competitive for the next, for the next go round. And all of that’s not going to have at this point -- at this point there is not, we don’t see any change, any reason to change our outlook for 2015.

Mayur Manmohansingh – Barclays Capital

Okay. And then you mentioned that most of the risk on LHA six lies ahead? I was just wondering...

Mike Petters

Right.

Mayur Manmohansingh – Barclays Capital

…if you can kind of give us some color in terms of how should we think about the freezing of risk on this ship? Where do you typically see kind of most of the risk is it the last 25% as most of that’s going to come up probably let’s say in the next quarter?

Mike Petters

Yes. I mean, I think that when -- on these kinds of programs particularly the LHA six program, you are going to -- you are going to recognize it from when you fight it on the ship and when you fight it on the ship is when you are in the test program. If you done the work, if things have come together the way they -- the way you plan for then the test program will validate the work that you have done. The uncertainty comes in because of the -- the nature of the new design work and the nature of the -- the way that we put in.

Now we’ve work hard to improve our first time quality in the business and we’re doing very diligent work, the program team on that ship is working very hard to define the scope of work as they are going through the construction process. But its really when you get into the testing program that you can validate either a) we’ve retired that risk or b) we’ve got more work to go do before we’re done with the work. So that’s kind of why -- that’s kind of why its back-end loaded the way that it is.

Mayur Manmohansingh – Barclays Capital

Okay. And if I can sneak in one, final one for Barb, did you mention by any chance what you expect free cash flow to be for the full year?

Barb Niland

Okay. Good question. I talk about this all the time our invoices are pretty big and at the end of the year have a lot of invoices outstanding and its all based on timing. So very hard to give you a point estimate on that.

If all goes well, I look for the trend to continue favorably, but we did have a great timing in the third quarter a lot of invoices were paid early. So I look at cash flow to improve a little bit.

Mayur Manmohansingh – Barclays Capital

Okay. Great. Thanks guys.

Operator

Your next question comes from the line of George Shapiro, Access 342.

Mike Petters

Yes George.

George Shapiro – Access 342

Just a follow-up Mike, it looks like revenue this year maybe coming at six or so, I mean is that going to be relatively flat next year and is there any color you can give it would seem like Newport should be up and the Gulf down if there is any color you could give on that?

Mike Petters

I mean, I consider that at this point to be relatively flat and we are going through a phase where you will see, the work ship from one side to the other. You’ll see -- in fact you already seen some of that. But over the long-term, we don’t see any reason to change the overall outlook for the business.

George Shapiro – Access 342

Okay. And next year you would expect the Gulf to be down and Newport to be up some to reach that flat kind of number?

Mike Petters

We haven’t provided any sort of guidance by division like that. We just kind of have kept it at the corporate level and said this looks pretty flat across the whole business.

George Shapiro – Access 342

Okay. Thanks.

Mike Petters

Yes. Thank you.

Operator

And your next question come the line of Pete Skibitski of SunTrust.

Pete Skibitski – SunTrust

Hey, good morning guys.

Barb Niland

Good morning Pete.

Mike Petters

Hello Pete.

Pete Skibitski – SunTrust

Mike, I was wondering if you kind of share with us how much incremental financial liability you could potentially incur with regard to this Avondale venture or the MOU with the State of Louisiana, because it kind of seems like it complicates the shutdown situation there and you start to think about the success the U.S. as had in commercial ship building. And so you wonder if you may be could incur a lot of liability there?

Mike Petters

Well, thanks for the question. We -- our plan -- our plan of record that we are executing today is that we are closing that facility. There are lots of reasons, lots of stakeholders who have hope for other outcomes. And we are very respectful of that. We purposely wanted to explore all of those other outcomes, because we’ve got great ship builders there and we owe them the chance to go and explore the possibility of other outcomes.

The State of Louisiana has stepped up and said if you’re able to find another path the state is willing to create some incentives and so you could think about this as, we’re on a path to closure, but if there is another way the state would be -- they’re trying to find a way to incentivize that.

What we’ve said from the beginning is that we got to have four things fall into place for us to do anything other than close the shipyard. The first is, we really do need a package of incentives from the state. And they come forward in a very big way and to compliment the State of Louisiana they are working very, very hard to try to help us find another outcome.

The second is, that we needed to have some agreement with the Navy that we were under the far that we would be able to go and explore these alternatives without giving up our rights on as far as restructuring costs and closure and we got that. So that’s the first two of the four things we need.

The last two things we need is, we need a credible partner and we need a sustainable market. Now, if you put those four things on the list you’d say, okay, which of these are the toughest things to get, the sustainable market and the credible partner are clearly the toughest things to get. And so and that’s where we are now.

I don’t think there is any chance that we would be able to get a partner if we didn’t have the state working with us and we didn’t have the Navy working with us on this. But having said that, just because they are working with us it doesn’t mean that we will get one and so, as far as the complication goes, until we have partner if we have one and until we believe that there is some sort of sustainable market that that partner wants to pursue that we could support.

We’re on path to closure and we’ve got that well scoped out, there is a program plan that we’re using, we’re -- unfortunately we’ve continue to layoff people and we’re closing shops there even as we go forward. So, it’s not the most elegant approach to the business, it’s what’s we owe to our fellowship builders at Avondale, the folks that are doing such great work we owe them.

It’s our responsibility to make sure that we turn over every rock looking for possibilities here and stepping all the way back what we’re seeing is that there are lot of folks out there who are looking for sites to do manufacturing. And so who knows, we may be able to make something out of nothing here.

Pete Skibitski – SunTrust

Can you envision a scenario in which you retained majority ownership of yard post 2013 or is that kind of a long shot and your preference maybe the likelihood is, you’ll wind down your ownership for the nothing yard closed or not?

Mike Petters

Yeah. I’m not sure, I want to be that specific yet, I mean our aperture is pretty wide open to possibilities, but the reason the fundamental reason we’re looking for a credible partner and a sustainable market is, this needs to be in a place that’s not in the Navy work that we’re doing today.

That means it’s going to be in some line of work that we’re not doing today, where we don’t have a whole lot of expertise and so we’re going to need somebody who understands the sustainable market that we’re looking for.

They don’t understand what the key to success are going to be there, they understand how to -- how to drive and orient the process, so they can be successful. And so we would -- think of that more as a follow roll for us as opposed to a lead roll. But, our aperture is wide open at this point.

Pete Skibitski – SunTrust

Okay. Got it. If I could just one last question on a separate topic, can you share with us why sales volumes on the forward would be down during the quarter, we sort of in a transition mode between phases or something or was an issue of number of days in the quarter?

Barb Niland

It’s really driven by the engineering content is starting to decline a little bit and the construction is picking up, but we had -- last year full fledged engineering and construction going on at the same time. So, it’s just overall little decline in the engineering side.

Pete Skibitski – SunTrust

I see, okay. Thank you.

Operator

Your next question comes from the line of Yilma Abebe with JP Morgan.

Mike Petters

Good morning.

Yilma Abebe – JP Morgan

Good morning. Thank you. One balance sheet question from me, given your cash balance and cash flow and expected cash flows going forward, can you comment on expectations for that pay down, even if you don’t want to talk about specific numbers and perhaps you can address generally your outlook on leverage?

Barb Niland

Well, right now what we are doing on the cash side is and we’ve been saying this all along, until we get these LPDs and LHA-6 out of here we are going to be conservative on our cash deployment strategy. We will look at starting next year we will start to take in a real hard look at a balanced approach and when we make that decision we will let you know.

Yilma Abebe – JP Morgan

Thank you. That’s all I had.

Barb Niland

Okay. Thank you.

Operator

Ladies and gentlemen that concludes the Q&A session. I’d now like to turn the call over to Mr. Mike Petters.

Mike Petters

Thank you. I just want to thank you all for participating in the call this morning. Again we -- this was another great quarter of improvement for us in operating income, operating margin and free cash flow. We do still have risk on the LPDs and LHA-6 programs, but we are making progress on those shifts and we are ramping up our new business and that means that we are still on track with the plan that we’ve laid out at the beginning of this year.

Our goal here at Huntington Ingalls is to provide our warfighters with the highest quality shifts at the lowest possible cost on or ahead of schedule. Those are objectives that we believe create value for all of our stakeholders. So thanks for joining us this morning and we look forward to seeing you in the future.

Operator

Ladies and gentlemen, that concludes the presentation. Thank you four your participation. You may now disconnect. Have a great day.

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