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Executives

Mike Petters – President, Chief Executive Officer

Barb Niland – Chief Financial Officer

Andy Green – Vice President, Investor Relations

Analysts

Sam Pearlstein – Wells Fargo

Robert Spingarn – Credit Suisse

Doug Harned – Sanford Bernstein

George Shapiro – Shapiro Research

Pete Skibitski – Drexel Hamilton

John – Citi

Myles Walton – Deutsche Bank

Brian Ruttenbur – CRT Capital

Mayur Manmohansingh - Barclays

Huntington Ingalls Industries Inc. (HII) Q2 2012 Earnings Call August 8, 2012 9:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the Second Quarter 2012 Huntington Ingalls Industries Earnings conference call. My name is Chantele and I will be your facilitator for today’s call. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference, at which time you may press star, one to enter into the question queue. If at any time during the call you require assistance, please press star followed by zero and an operator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today’s call, Mr. Andy Green, Vice President of Investor Relations. Please proceed.

Andy Green

Thanks Chantele. Good morning and welcome to the Huntington Ingalls Industries Second Quarter 2012 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 non-GAAP measures, including segment operating income and segment operating income. 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 www.huntingtoningalls.com and click on the Investor Relations link to view the presentation, as well as our earnings release.

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 am pleased to report Huntington Ingalls Industries’ results for the second quarter of 2012. Today we reported sales of $1.72 billion, up 10.1% from the same period last year, and diluted earnings per share of $1.00, up from $0.80 in the second quarter of 2011. Second quarter segment operating margin was 7.4%, a significant improvement from 6.3% last year, and we ended the quarter with $669 million of cash on the balance sheet. Total backlog was $16.2 billion, of which $12.6 billion is funded.

During the second quarter, we continued to execute well on all major programs at both Ingalls and Newport News, including achieving several milestones. At Ingalls, we launched two ships – the amphibious assault ship LHA-6 America, and LPD-25 Somerset. We successfully completed acceptance trials for LPD-23 Anchorage, a ship that will be delivered to the Navy next month, and we announced the construction contract for the newest amphibious assault ship, LHA-7 Tripoli. Subsequent to quarter-end, we announced the $1.5 billion construction contract for LPD-27, the 11th ship in the San Antonio class of LPDs.

At Newport News, the submarine and carrier programs continued to perform well and our outlook for these programs remains positive. In fact, we are in the preparation phase for a significant amount of new business, including the next block buy of submarines, the inactivation of CVN-65 Enterprise, the refueling of CVN-72 Lincoln, and the construction of CVN-79 Kennedy.

Overall, our programs continue to perform in line with our expectations and we remain confident that we can deliver 9%-plus total operating margin by 2015. In the near term for the second half of 2012, we expect segment revenue and margins to be similar to the first half.

Regarding the threat of sequestration, I don’t have much more to say on the subject as the potential negative impacts it will have on the industry, our workforce and our supply chain have been well-publicized, and while we hope that an alternative is found to avoid the automatic and indiscriminate spending cuts triggered sequestration, it is the law of the land. What we are doing is communicating to members of Congress and other leaders, along with our industry partners, about how this could impact us and we’re telling them that our supply chain – nearly 5,000 companies that span all 50 states – is at risk. They are likely to feel the impacts of sequestration much more rapidly than HII because their contracts and orders tend to cover much shorter periods than our longer term contracts.

Our formula for success is continuing to perform well on our contracts and meeting all of our commitments on safety, quality, cost and schedule; and that’s what we focus on each and every day.

Now to hit a few highlights of our major programs at Ingalls. As I mentioned earlier, LPD-23 Anchorage, constructed at our Avondale shipyard, has successfully completed acceptance trials and delivery should occur in September, about one month later than previously planned. The delay is due to the insulation of non-compliant bolts associated with certain propulsion system components. Although I am disappointed with the delay, I am proud that one of our own people identified the issue and that we are correcting it ourselves. We estimate the total cost of inspection and replacement to be less than $1 million.

LPD-24 Arlington, being built in Pascagoula, is nearing completion and is scheduled to go to builder’s trials the week after next. Following builder’s trials, the ship will complete acceptance trials and then deliver to the Navy by the end of the year. LPD-25 Somerset, the last Navy ship scheduled to be built at the Avondale shipyard, was christened a little over a week ago and is scheduled to deliver next year. As Pascagoula, we continue to ramp up construction on LPD-26 John P. Murtha, and we just announced the construction contract award for LPD-27, the latest ship in the San Antonio class of LPDs.

In June, we successfully launched LHA-6 America and we expect to deliver the ship in 2013. Performance on this program has been trending well, reflecting the outstanding efforts by the program team to improve efficiency and maintain high quality while controlling costs, and although significant risk remains as we move through the outfitting and testing phase, overall we are pleased with the progress on the ship.

During the quarter, we also were awarded the $2.4 billion construction contract for LHA-7 Tripoli, the next America-class amphibious assault ship. Tripoli will be identical in all major respects to LHA-6, meaning it will have the same hybrid electric propulsion system and instead of a well deck will have additional hangar space and fuel storage in order to optimize its marine aviation capabilities.

The National Security Cutter program continues to perform well and is a powerful example of the cost benefits of serial production. Construction is underway for the next two ships- NSC-4 and NSC-5 – and we are under a long-lead material contract for NSC-6. A construction contract for that ship is expected in 2013. Our Coast Guard customer is very pleased with the performance of the National Security Cutters and we look forward to supporting their future requirements as part of the recapitalization of the aging fleet.

In the DDG-51 program, we are in the early stages of construction of DDGs 113 and 114, and we expect these ships to perform well. Like the NSC program, the DDG-51s are another good example of serial production and we expect these and subsequent ships to reflect the cost benefits of the Ingalls operating system. The next contract award of DDG-51 should be nine or ten ships split between us and our competitor with the final award likely in 2013.

On the DDG-1000 Zumwalt class destroyer program, we have delivered the four aft PVLS modules and the composite hangar for DDG-1000 and expect to deliver the composite deck house later this year. Construction of the aft PVLS modules, hangar and deck house for DDG-1001 is underway and we are working with the Navy toward a contract for similar work on the next ship in the class, DDG-1002.

At Avondale, we are proceeding with the plan to wind down the facility by the end of next year. The dedicated and highly skilled shipbuilders at Avondale have performed well on LPDs 23 and 25, and we are continuing to look for alternative ways to preserve those highly skilled jobs.

Now turning to Newport News, CVN-78 Ford was 80% structurally erected and 43% complete at the end of the second quarter and is on pace to launch next year with delivery in 2015. Like every lead ship program, we’ve had to deal with labor and supply chain inefficiencies and issues around the development and insertion of new technologies; however as I’ve said before, Ford is the best lead ship program that I’ve seen during my career in shipbuilding. When Ford joins the fleet, it will be the most advanced and powerful warship ever constructed and will be a symbol of our nation’s commitment to a strong Navy. On CVN-79 Kennedy, the next carrier in the Ford class, we are ramping up construction preparation activities and anticipate having a construction contract in place sometime in 2013.

In submarines, performance on the Virginia class submarine program remains strong, making VCS one of the most successful DOD procurement programs. The close cooperation between us and our teaming partner coupled with the ramp-up to two submarines per year build rate has driven steady improvement in productivity and affordability. More efficient production also means these highly capable platforms join the fleet earlier than planned, which enables the Navy’s fleet commanders to better fulfill their missions. SSN-783 Minnesota, the last Block 2 submarine, and the next submarine to complete construction should launch late this year and deliver in mid-2013. The eight submarines of Block 3 are fully funded, and we expect a Block 4 contract award next year for at least nine additional submarines.

The CVN-71 Roosevelt refueling and complex overhaul is on pace to meet its revised redelivery schedule of mid-2013. CVN-72 Lincoln, the next carrier scheduled for refueling, just completed its transit to Naval Station Norfolk and should come into the shipyard early next year. Similar to carrier and submarine construction, our COHs provide substantial long-term visibility and predictability as each carrier is refueled about 23 years after delivery. This facilitates better long-term planning and helps us to optimize our manning levels and material procurement.

CVN-65 Enterprise, the world’s first nuclear aircraft carrier, was built at Newport News and for more than half a century has demonstrated the significant power projection of an aircraft carrier, having participated in virtually every major military action since the Cuban Missile Crisis of 1962. She is currently on her final deployment and is expected to enter the yard in 2013 for inactivation and a defueling of its eight nuclear reactors. Overall, we are very pleased with where we stand on all of our major programs and our second quarter results reflect the steady progress our team is making toward achieving our long-term financial objectives.

Before I turn the call over to Barb for more commentary on the financials, I’d like to make a few comments on how we manage our business in a way that maximizes value for our shareholders. As I’ve said before, in the near term we are focused on three primary mechanisms for creating value. First, to lock in key contracts. At the time of the spend, I mentioned that it was imperative that we finalize five key contracts critical to sustaining the business through 2015: LPDs 26 and 27, DDGs 113 and 114, and LHA-7. We have now been awarded all of these contracts plus an additional National Security Cutter – NSC-5 – which was awarded early.

Second, to retire risk on existing programs, specifically risk related to our five underperforming contracts at Ingalls. In 2011, we delivered LPD-22 and we expect to deliver LPD-23 and LPD-24 in 2012. The remaining underperforming contracts – LPD-25 and LHA-6 – are on track for delivery next year. And third, to complete the closure of Avondale or, if possible, find an alternative use for the shipyard and its workforce. While we continue down the path of closure, we are still investigating other opportunities.

As we successfully execute on these three levers, we improve our financial flexibility and strengthen our ability to deploy assets in a way that makes sense for our shareholders, our customers and our employees. And 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 would like to briefly review our consolidated and segment results as disclosed in the press release.

Turning to the financials on Slide 4 of the presentation, consolidated second quarter revenues were up 158 million or 10.1% compared to the same period last year. This increase was driven by higher volume across multiple business lines, including carrier construction, submarines and amphibious assault ships, which was partially offset by lower volume on carrier RCOH and fleet support service revenue at Newport News. I will provide more revenue detail in each segment report.

Second quarter segment operating income was 127 million and total operating income was 106 million. Segment operating margin was 7.4%, up from 6.3% in 2011. Total operating margin was 6.2%, up 34 basis points from the same period last year. Total operating margin was impacted by 15 million higher pension expense offset by a slight decline in deferred state income taxes in 2012.

Diluted earnings per share for the quarter was $1.00 compared to $0.80 for the second quarter 2011. The increase in EPS was driven by sales volume at both segments and margin improvement at Ingalls. We ended the quarter with a $669 million cash balance. Cash provided by operating activities was 151 million, a decline of 35 million over the same period last year. Capital expenditures were 30 million, up from 20 million in the second quarter last year, and are expected to fall in the high end of the 2 to 3% range for the year.

Similar to last year, 2012 cash flow was significantly negative in the first quarter and is now trending positive. We expect this trend to continue for the remainder of the year, with the largest variables being timing of collections, timing of deliveries, and pension contributions compared to last year.

Moving on to pension, the expected qualified pension contributions for the year have increased by 24 million to 236 million due to updated demographic data and our practice of maintaining our plans funded status to avoid benefit restrictions. During the first half of the year, we contributed 183 million to our pension plans and the remainder is expected to be weighted towards the third quarter. In addition, we have updated our FAS/CAS adjustment for 2012 to negative 74 million, down from negative 77 million we estimated at the end of last year.

I will have more to say about 2013 pension expense on the Q3 call, but I did want to mention the pension funding relief legislation, which was recently signed into law. We expect this will provide significant flexibility to us regarding contributions starting in 2013, but it will not affect our expected 2012 contributions. We are currently analyzing all of the variables related to the legislation and should have more detail next quarter regarding our future pension contributions.

Turning to Slide 5, Ingalls’ revenue for the second quarter increased 48 million or 6.8% from the same period last year, driven primarily by higher sales on LHA-7 offset by lower sales on LHA-6. The LPD program remained constant for the quarter as higher sales on LPD-27 and LPD-25 were offset by lower sales on LPD-24 and LPD-22 following the deliver of LPD-22 in Q4 of 2011. The NSC program remained flat due to lower sales following the delivery of NSC Stratton in 2011 offset by higher sales on the construction of NSC-4 and NSC-5, as well as the advanced procurement contract on NSC-6.

Ingalls’ operating income for the quarter was 38 million compared with 19 million in the same period of 2011. Operating margin was 5% for the quarter, up from 2.7% last year. The increase was the result of lower net unfavorable performance adjustments in the LPD program for the quarter as compared to 2011, and during the quarter Ingalls received 7 million for the resolution of a contract dispute with a private party which was a direct contribution to operating income.

Turning to Slide 6, Newport News’ revenue for the quarter increased 107 million or 12.3% from the second quarter 2011. It was primarily driven by higher volume on CVN-78, CVN-79, the Lincoln RCOH, the advanced planning efforts on the Enterprise inactivation, and the VCS program as it transitions to building two boats per year. These increases were partially offset by lower sales on the Roosevelt RCOH and lower fleet support services primarily due to the redelivery of the submarine USS Albany in 2011.

Newport News’ operating income for the quarter was 89 million compared with 79 million in the second quarter last year. Operating margin was 9.1% for the quarter, flat to prior year. The increase in operating income was driven by higher sales volume and the impact of performance improvements on the VCS program.

Last, interest expense for the second quarter was 29 million and the effective tax rate was 35.1%. For the full year 2012, we now estimate deferred state tax expense should run about 8 million, interest expense should be roughly 118 million, and our tax rate should be close to 35%.

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

Andy Green

Thanks Barb. Just a reminder to everyone – if you could limit yourself to one initial question and one follow-up, and then get back in the queue so we can accommodate as many people as possible. And with that, Chantele, I’d like to turn it over to you to manage the Q&A.

Question and Answer Session

Operator

Sure. [Operator instructions]

Your first question comes from the line of Sam Pearlstein of Wells Fargo. Please proceed.

Sam Pearlstein – Wells Fargo

Good morning.

Mike Petters

Morning, Sam.

Sam Pearlstein – Wells Fargo

Mike, you said that you thought the second half of this year would be relatively similar in terms of revenue and earnings as the first half. I’m just looking—if I look last year, you saw much steeper step-up in the second half of the year where the second half was much stronger. What’s different there as to why we’re not going to see a pickup in the second half? I know the pension steps up a little bit, but just trying to think about the moving pieces there.

Mike Petters

Yeah, I’d say first of all, last year and this year are a little bit different in that the risk profile that we were working our way through last year was very different than it is now. You know, we’ve retired—as we’ve been going quarter by quarter, we’ve been retiring some of that risk that was in front of us last year, and frankly the second half of last year was when we retired some of that risk, so that opportunity may not necessarily be quite the same this year.

Secondly, I think if you look at what happened in the first half of this year, I think Barb always talks about the lumpiness of our business. I think if you look at the first two quarters of this year, you see the lumpiness of our business. The second quarter, we achieved several significant milestones in the second quarter and it made it a very, very high-end kind of quarter for us; but if you look back over the last six months and we look forward for the next six months, we think that they’re pretty similar at this point.

Sam Pearlstein – Wells Fargo

Okay. And then Barb, you mentioned the $7 million receipt in the quarter. Can you just sum up the other (inaudible) adjustments just in terms of what the benefits were in this quarter?

Barb Niland

Sure. You’ll see when the Q comes out that the positive adjustments were 60 million, which includes that 7, and the other positive things were we had a couple of the boats on VCS performance adjustments there, and also on LPD-23 and 25 we were seeing favorable performance there to the prior adjustments we had made. And then on the negative adjustment side, that’s $26 million and that’s primarily driven by LPD-24 and a little bit of LPD-22.

Sam Pearlstein – Wells Fargo

Okay, thank you.

Barb Niland

You’re welcome.

Operator

Your next question comes from the line of Robert Spingarn of Credit Suisse. Please proceed.

Robert Spingarn – Credit Suisse

Good morning. So Mike, I have to say you sound good. There’s a lot of confidence I detect there, having known you for a long time, and I can see the pride in the progress that’s been made down in the Gulf Coast. So that being the case, should we think about this, based on what you just said to Sam about the second half, when we strip out the 7 million you did 4.1% down there. Is that at this point a sustainable margin?

Mike Petters

Yeah, I think that I’ll just stay with what I’ve already said – that the first half is reflective of how the second half is going to go. I think that what you have to really look at, Rob, is that we are ticking off the events that we laid out and said that these are the risk retirement events that we have to accomplish. We really accomplished several of those events in second quarter. You know, we had a couple of launchings in there, a couple of trials. Second quarter was a very high paced activity, and so to go so far as to say that we’ve got it completely contained and sustainable, I’m not ready to go do that yet. But I am very, very pleased with the way that the team has rallied over the last—I mean, we’d say year and a half, but Barb and I sometimes think that this has been a four and a half year journey for us. We’re in a good place right now and we fully expect to continue to retire the risk and move ahead over the next 18 months.

Robert Spingarn – Credit Suisse

Okay, well that’s helpful. Barb, maybe from just the way you book these favorables and unfavorables, is your methodology to take a (inaudible) catch and then recognize all of that in the current quarter, or do you something more akin to what we’ve seen from your competitor which is to take a modest amount of that favorable and the remainder of it through the end of the contract, in other words spreading it more evenly, meaning that is this quarter a little—I think to what Mike just said, perhaps this is the peak for the year because these events happen now.

Barb Niland

Well, no. When we do a (inaudible) catch-up, that same booking rate continues for the remainder of the program unless we have another milestone that affects our booking rate up or down. We have a very rigorous process with a schedule of events and costs associated—cost performance associated along the way with those events, and so we very deliberately make changes in our booking rates.

Mike Petters

Yeah Rob, I would add that one of the key tenets of the systems that we’ve put in place at Ingalls over the last four and a half years is we’ve taken the entire risk register and we’ve attached all of the items in the risk register to specific key events, and when we come through that key event, we do a hot wash on did we retire the risk, did we mitigate it. If we didn’t retire it, is there another opportunity to do that? And so that’s why the events are important to us because that’s our chance to do a real-time update on where do we stand on the risk in that program.

Frankly, that’s why Ingalls has—in my view, that’s why we feel so good about where we’ve been, and we are optimistic about where we’re going. But it also is we still have real clear line of sight on the risk that’s still out there between now and the delivery of the last four ships and the closure of Avondale. We are keeping our eye on all of that.

Robert Spingarn – Credit Suisse

Okay. And then just to finish up on Avondale, if you stick with your plan to wind down and nothing happens differently, and understanding that you’re hoping for a different outcome, but if it goes this way, Barb, are there any events we should be looking out for the remainder of this year and ’13 that hit the books?

Barb Niland

No. You will see when the Q is filed that we reduced our restructuring costs from 271 million down to 265, and that difference is actually a reduction in our estimated cash outlays and we talked about that, that it would be negotiated based on actual. So as we’re incurring the actuals, we update our proposal so that’s about the only thing you’ll see. But right now, everything is on schedule as planned.

Robert Spingarn – Credit Suisse

Okay, thank you both.

Barb Niland

You’re welcome. Have a good day.

Operator

Your next question comes from the line of Doug Harned of Sanford Bernstein. Please proceed.

Doug Harned – Sanford Bernstein

Good morning. On LHA-6 and LPD-25, could you update us on the timing next year when you expect those deliveries? And then related to that, since you’ve launched these ships, would I be correct to assume that the risks that you’ve been talking about – either upside or downside – that band should be narrowing somewhat now that these ships are in the water?

Mike Petters

Okay. First of all regarding schedule, I would at this point just say second half of next year for both of those ships. We just christened the Somerset and will be christening the America on October. And so the second half of next year is when we’re looking at the delivery of those ships, and they’ll go through the whole trial sequence and everything else.

Doug Harned – Sanford Bernstein

That’s later than you had thought, isn’t it, before?

Mike Petters

You know, I think that what we’ve been doing is we’ve—I think it is later than we had originally laid out a couple of years ago; but again, I think as we’ve been working our way through this, we’ve been adjusting the schedule to reflect our better understanding of what the risk profile is. That’s part of what our challenge over the past couple of years has been.

Both of those ships are in pretty good shape. I mean, I’m pleased with the quality of the launch on Somerset and I’m particularly pleased with what the team on America is doing. They’re basically working through a new design program there with a significant engineering change, and they got the ship in the water early. It was a quality launch, and so I’m excited about where that’s going.

Doug Harned – Sanford Bernstein

And then if I can on Virginia class, as you move through Block 3, I would assume that you would expect margins to improve as you move down the learning curve. I’m curious where you are today on Block 3 Virginia class relative to your plan of margins.

Mike Petters

We’re basically on our plan. I would point out that the learning curve on these programs is starting to get pretty flat ship-over-ship because doubling the volume now takes a whole lot more ships than it used to in the learning curve. But in terms of our financial plan, we are performing very well against our financial plan on all of those programs, on all of the Virginia class program.

Doug Harned – Sanford Bernstein

Okay, great. Thank you.

Operator

Your next question comes from the line of George Shapiro of Shapiro Research. Please proceed.

Mike Petters

Morning George.

George Shapiro – Shapiro Research

Good morning. Question for you - is about 40% of the revenues at Ingalls now still at zero margin?

Barb Niland

It’s a little less than that. It’s less than that.

Mike Petters

Yeah, we think it’s a little less than that.

George Shapiro – Shapiro Research

Okay. So then it would appear that the margin of the core business was improved a little bit this quarter from what you’ve had in the past. If you could explain—well, I guess you kind of explained where you took the improvements, but is that a sustainable thing?

Barb Niland

Well George, you know, as we talked before, on all our new programs we are starting at a lower margin rate until we see progress on each of those ships and performance, like Mike talked about, against each one of those milestones. But like we said, the first half of the year is going to look like the second half.

Mike Petters

I guess what I would say, George, in the same way that we allocated all of the risk registered to key events on our five underperforming programs, we do that on all of our programs and so as we’ve been saying for a while, we expect the blended rate of this business across the portfolio of all of our programs to be operating in the 9%-plus range. Our challenge at Ingalls is that the ships that should be operating above that are not performing, and so that’s created a hole in the blend As we retire the risk and deliver those ships, you will see the margins improve at Ingalls in the rest of the business but they’re only going to improve at the rate at which we retire risk on the new programs and get them up to the level of maturity that they need to be. And so that’s going to be a bit lumpy because it’s about when does the program start, when do you start fab, when did the contract get signed, when is the material coming in. And so it’s going to be a little bit more bumpy than you would think, and you’re going to have a lot more visibility on that than you usually do because you won’t see the full blended rate. So that’s kind of what you’re seeing right now.

George Shapiro – Shapiro Research

But specifically, Mike, did it go up a little bit this quarter if you look at the aggregate of the profitable programs?

Barb Niland

Well, that’s because of the delivery of LPD-22, so you took one of the ships and a forward loss out of there.

George Shapiro – Shapiro Research

Okay. Okay, thanks very much.

Operator

Your next question comes from the line of Pete Skibitski of Drexel Hamilton. Please proceed.

Pete Skibitski – Drexel Hamilton

Good morning. Mike, just wonder if you could add some more color in terms of your thoughts on the potential impact of sequestration to HII. Do you think they would sort of spread the cuts out over all of your programs, or would you expect to have one large program outright cancelled? Just wondering what your thoughts are there.

Mike Petters

Well, first of all I think that a core part of our view on sequestration is that obligated prior year funds, the ships that are on contract today, are going to stay on contract. I just don’t think—and maybe I’m the naïve one in the room, but I just don’t think that there’s any practical way for there to be any savings generated by trying to go in and reduce scope or cancel or terminate any of the programs for contracts that have already been signed, and so that’s why we, frankly, have focused so hard on getting those five big contracts signed so that we could get those under contract going into next year.

We do think that sequestration could have some effect on the timing of future work for us. The debate about whether it’s a budget authority cut or is it an outlays cut, and how is the government going to work their way through that, I’ve seen really smart folks argue both sides of that. There hasn’t been any real clear guidance provided as to how that’s going to go. It makes it really hard to plan. I would expect that programs could be moved around a little bit to adjust to whatever the law is, but I would remind you that if you stepped back and said, what are the Navy’s top four priority programs in terms of shipbuilding? It’s the four programs we’re involved in, and so I don’t really see today anybody stepping out and saying we’re going to go and terminate one of these whole classes of ships or stop or curtail production of anything, because these production lines are pretty warm right now and they’re working very well, and we know from history that if you ever curtail one of these programs, it will be too expensive to restart again.

So the timing of our future work may be something that gets caught up in the discussion. I don’t believe the actuality of any of the programs that are out there is at any greater risk than it normally would be anyway, and so that’s why we’ve been able to say that the work we have under contract carries us through the next three to five years of work and that the timing of future work over the next couple years, the contracts we have to sign, that’s really why the—that’s the time period in the five to 10-year time frame of work for us, and that’s really been the basis of our commentary on that altogether.

Beyond that, though, I’d say our supply chain and our suppliers, they have a little bit different view. They supply not just to us but they supply to the whole industry, and the supply chain has been dwindling and weakening, I’d say, over the last several years to the point where the vast majority of our supply chain now is either sole source or single source suppliers. Their ability to plan, their ability to forecast is even less—they have less visibility than we do, and so we expect the supply chain to be challenged over this next time frame.

Pete Skibitski – Drexel Hamilton

That’s great color. I appreciate that. If I could add just one follow up to Barb on pension – hey Barb, if you had your year-to-date, your return on assets and your plan and peg your discount rate, I was just wondering, number one, how much would your discount rate change by, and sort of directionally how you would expect your FAS and CAS expense to move for 2013.

Barb Niland

Okay, so I’m not going to give anything on 2013, but let me tell you what – our return on assets year-to-date for the end of the quarter were 5.5%. And then as far as—I’ll give you some sensitivities, though. From a discount rate standpoint, a 25 basis point increase would be about a $17 million increase, and if it goes the other way, it’s about $18 million, okay, on a 25 basis point. And then on return on assets, you’re about on a 25 basis point about $8 million of change in FAS.

Pete Skibitski – Drexel Hamilton

Okay. Okay, thank you very much.

Operator

Your next question comes from the line of Jason Gursky of Citi. Please proceed.

John – Citi

Hi, good morning. This is John (Inaudible) in for Jason. Thanks for taking the question. Just a question on cash flows. Operation cash flows came in a little bit light this quarter, lower than what you were expecting. I know Barb mentioned that you expect the trend upward over the year. I was wondering if you can give an idea of the outlook for the year in terms of magnitude, how—what kind of swing we can get over the course of the year, and then perhaps just some vision out to ’13, and then ’14 assuming that Avondale closure goes to plan.

Barb Niland

Okay, not going to provide anything on ’13 or ’14 yet – sorry about that. But I talk about this all the time – cash, I expect the same trend as last year, but again it will all be based on timing of collections because we have big invoices. One day makes a difference when you close the year. Timing of deliveries – again, the 23 and 24 out and get the DD-250 signed off and billing our customer and getting paid. They’re really the two biggest drivers, so I don’t expect any issues on the deliveries with 23 and 24. And then I’m not smart enough to call who’s going to pay us on the last day of the year and the first day of 2013, so you’ve got to bear with us on that. It’s just the way it is and hard to predict.

John – Citi

Fair enough. And then just a quick follow-up on CVN-79 negotiations. I wonder if maybe you could provide an update on the progress there and just address some of the risk, if there is any, on how a longer negotiation process might impact expected margins since it’s a growing business and one would assume that risk is coming off the table, even though you still don’t have that full contract.

Mike Petters

Yeah, I think everybody is kind of preparing for the negotiations right now. The Navy is working through their scope of the job that we’re coming through, the estimates we’re taking a look at, the cost returns we see on 78. The Navy is working through the budget issues, so all of that stuff is ongoing. It’s about where it typically is for this kind—you know, we’re probably a year away from really having that in the final stages of negotiation. So it’s kind of where it ought to be.

I think that the challenge that the 79 presents is going to be we’re moving from 78 to 79. We expect that we’ll move from a cost-type environment to a price-type environment and we will not have finished 78, and so there will be that kind of calculation that we’ll be going through as we go to contract. That will be a tough one for us with the Navy as well. I mean, they’ll have their constraints, we’ll have our constraints, and we’ll go into the room and we’ll try to figure out to get a contract wrapped around it. We’ve always been able to do that, and we fully expect to be able to do that again.

John – Citi

Great, thanks for the color.

Operator

Your next question comes from the line of Myles Walton of Deutsche Bank. Please proceed.

Myles Walton – Deutsche Bank

Thanks. Good morning.

Mike Petters

Hi Myles, how are you doing?

Myles Walton – Deutsche Bank

Good, good. Just maybe a follow-up on the CVN-79 question. Is it still looking—I think from your slide, you’re still looking at a 2020 delivery, and I think from the most recent (inaudible) it would suggest that 2022, and obviously we’re talking way out there in time and space. But how does that look to you – is it a stretch-out, or is there something else that’s going on?

Mike Petters

Well I’d say there’s probably two things that are going on there, Myles. One of them is how does it fit with the fleet requirements, and so when does the Navy need the ship in the fleet to maintain their four structure in 11. I think they’ve got a little bit of flexibility around that. You know, they’re operating at 10 right now, and so all the carrier deployments are being stretched out. We just saw a carrier on the west coast get accelerated to deploy a few months early to meet its requirements, and so the op tempo is really high right now and I think there is just some trying to figure out how are we going to maintain when we get back to 11 after Ford delivers, how are we going to operate and keep the four structure at 11, and how does 79 fit into that discussion. So I think that’s part of what you see in some of those documents.

I think the second thing you see in those documents is a bit of a reflection on the lead ship nature of 78. While it’s come together better than any lead ship I’ve seen, we’ve got significantly more pre-outfitting when the units go into the dock. The team is—you know, the whole thing has gelled a whole lot better than we usually see on a lead ship at this point.

We’ve had some challenges with the usual kind of churn that you see in lead ships around material, particularly valve suppliers and things like that, and there are some pressure and some thought in some quarters that maybe what we do as we stretch it out, we allow ourselves to get some of those technical issues completely sorted out in order to support a better schedule.

My own view of it is that a shipbuilder always has to make the trade-off between are we ready to go to the dock with the unit that’s missing valves, or do we wait for the valves. Typically we get to a point where we need to put the unit in the dock even if we don’t have the valves, and so that’s sort of the discussion that’s going on and I think that’s why you see some of that band of when the ship might be needed by the fleet and when it might be delivered, and how do we retire some of the risk associated with the new technology we’re seeing coming through on 78, so.

Myles Walton – Deutsche Bank

The one thing I’m curious about is at this point, though, it would seem like there is no risk to learning curve loss as a result of the potential delays from here. Where does that become a risk? If it’s 2024, then we have kind of a learning risk erosion potential, or--?

Mike Petters

Well, I guess in my experience the optimum gap between carriers is between three and a half and four years. Once you move past that, you start to lose a little bit. I mean, think about what you’re talking—even at four years, if you carry the bal unit of the ship into the dock and then four years later you’re going to do that again. Now, the bal unit is a very irregular shaped unit, very precise craftsmanship goes into that. A team forms to go do that. They go do it, and then they’re going to do it four years again—four years later, we’re going to do it again. Even in that, it might be a bit of a stretch to say that there is a substantial amount of learning carryover from one ship to the next.

And so yeah, there’s a lot of pieces that you can kind of go from one ship right into the next piece of it. I think once you go—I think five years that the Pentagon has cited as how they want to build these things is something we can manage. I would point out that the gap between 77 and 78 was—I believe it was six years, and that did—you know, we had some challenges there. The best carriers in terms of learning that we ever built were when we built them on two-ship contracts. We had two two-ship contracts. It was—let’s see, 72 and 73 were on one contract, and 74 and 75 were on another contract, and they were two ships over ten years and we could go right from one to the next. The supply chain was lined up. It was serial production of aircraft carriers and it was at its best. I think that every time you put another year in to delay the contract award or you do something, you are absolutely affecting the efficiency of the operation and you are raising the price to the taxpayers.

Myles Walton – Deutsche Bank

Okay, and then just two clean-up questions. One – Barb, you gave us some of the sensitivities for FAS/CAS for ’13, but where is the starting point if all else were being held constant for ’13 to those sensitivities?

Barb Niland

We’re going to talk about that in Q3.

Myles Walton – Deutsche Bank

All right. I figured camel’s nose was already under the tent; might as well put the whole body in there.

Mike Petters

Nice try!

Myles Walton – Deutsche Bank

Yeah, sure. And then the other clean-up one is, Mike, you mentioned still pursuing alternate uses for Avondale, but curious what kind of timeline you could continue to evaluate those alternatives, given the time to the end date of closing it down is a year, 18 months away.

Mike Petters

Yeah, Myles, the most important asset we have in that facility is the workforce that’s there, and every week that goes by, every month that goes by, the volume of workforce, the number of people that are working is going down. And so the value of that asset in terms of how much we can go, that sort of creates a clock that’s ticking, as you point out.

I don’t know that we’ve come and said that there’s an absolute—we have to close if we get to this point if we don’t have any other option. I don’t think we’ve made that call yet. I think that we are hopeful that we will be able to drive this thing to some other outcome. But the reality is that if we end up continuing to execute the plan that we have for closure, once it’s closed we won’t stop looking for ways to redeploy that asset, and so it will just shift to a different –we’ll just move to a different phase.

Myles Walton – Deutsche Bank

Okay, great. Thanks.

Operator

Your next question comes from the line of Brian Ruttenbur of CRT Capital. Please proceed.

Brian Ruttenbur – CRT Capital

Thank you very much. Great quarter. I have a question on G&A on the year, the dollar amount; and then book to bill for the year, if you could answer those, where you estimate both of those by year-end.

Barb Niland

Okay, so let’s talk about the G&A first. I expect it to look pretty close to where it is year-to-date, okay, so double it. And you know, the biggest thing in the G&A that’s driving it is really the FAS/CAS is in there for us, okay? So that’s the G&A.

And then your other question is the book to bill ratio – probably going to go—I’m thinking we got 27 after the quarter, and then if you look and you take our sales volume that we’ve talked about, doubling it, it will really depend on what happens with the continuing resolution and how all our engineering and services contracts get funded at the end of the year. It may go down slightly, but I think it all depends.

Brian Ruttenbur – CRT Capital

Okay. And then the Avondale – is there anything that the state can do at this point to stop you from shutting that operation down?

Mike Petters

I don’t have a contract with the state, you know? I mean, we have contracts to the state to build ships. If the state wanted to give us a contract to go do some other kind of work, I guess that they could stop us that way; but it would be because we had work to do. There’s no regulatory thing that they can do, there’s no legal thing that they can do that would stop it. Frankly, the State of Louisiana has been a very effective partner with us in trying to find ways to redeploy the asset. Last year, the governor and I came together and agreed that the State would come forward with a couple of hundred million dollars of incentives for any sort of potential partner to put into that asset, so this isn’t really about the political process trying to stop the loss of jobs. The political process has been a partner with us to try to find ways to redeploy the asset.

Brian Ruttenbur – CRT Capital

Great. Thank you very much.

Operator

Your next question comes from the line of Mayur Manmohansingh of Barclays. Please proceed.

Mayur Manmohansingh – Barclays

Hi, good morning guys. Good quarter. I just had one question – you maintained earlier the 9%-plus margin target by 2015, but in talking about the contract that you’ve won, that should carry your revenues to 2015. You were pointing out that you got an additional NCS – National Security Cutter – in addition to your sort of earlier plans. So I was just wondering – I mean, it sounds like this just—that there’s some upside to your prior revenue forecast for—I think it was for flat over the 2010 levels. Does that sound about right?

Mike Petters

I mean, we’re going to stay with that simply because if you take the National Security Cutter, the most important part of the National Security Cutter award was the Coast Guard recognized the value of serial production, and they wanted to keep the line moving so they could keep their price down. If you take the price of a National Security Cutter and you spread it out over the five-year period, it’s not going to substantially affect our outlook over the time frame, and in the main we have lots of pluses and minuses like this that are all going to average out, which is why Barb and I have said from the very beginning that the way to look at our business is that the revenue is flat but the earnings will expand. And that’s been our objective, that’s what we’ve been trying to get done, and so far we’ve been on track for that.

Mayur Manmohansingh – Barclays

Okay, great. And just one other follow-upon Avondale, just kind of coming back to Myles’ question earlier – just wondering, in terms of the closure of Avondale, are there any contentious items outstanding, I want to say with the Navy, in terms of what they will cover if you were to end up just closing the facility? I’m just wondering if there’s anything contentious left.

Mike Petters

No. I mean, the FARF spells out the allowability of the costs that we are putting into our effort, and all of that is pretty well defined. As Barb said, we started with estimates for what those costs would be. When this is all said and done, we’ll probably end up negotiating it around the actuals, but I would point out that the Navy has also been a partner with us in trying to find a way to redeploy the asset. We’ve said in order to redeploy this asset, we need four things: we would need the Navy to work with us, we would need the State and the political process to work with us, we would need a partner, and a sustainable credible market. Well, we’ve got the State and the Navy – they’re right there with us, helping us in every which way they can. We continue to look for a partner and a market.

Mayur Manmohansingh – Barclays

Great. Thank you very much.

Operator

At this time, I would like to turn the conference back over to Mr. Mike Petters for closing remarks. Please proceed, sir.

Mike Petters

Thank you, and thank you all for joining us this morning. As I said 18 months ago, I guess, we said we needed to get five contracts signed. We’ve gotten those five contracts signed. We told you that we needed to get five ships delivered. We’ve delivered one; we’re on the edge of delivering the second. We will have the third delivered by the end of this year and we’re on track to deliver the fourth and fifth ones next year, and so that’s on pace. And we said that we would be working our way through the closure and/or redeployment of Avondale, and the closure plan remains in effect and we continue to think about redeployment.

You know, we’re very excited about the steps that we have taken. We recognize that we still have a long ways to go. We’re very proud of the work that we’ve done, and we look forward to continuing to move ahead on our plan. Thanks for being with us this morning, and we look forward to seeing you on the street.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a wonderful day.

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