Huntington Ingalls Industries, Inc. (NYSE:HII)
Q4 2015 Earnings Conference Call
February 18, 2016, 09:00 AM ET
Dwayne Blake - Vice President, Investor Relations
Michael Petters - President and Chief Executive Officer
Barbara Niland - Corporate Vice President, Business Management and Chief Financial Officer
Christopher Kastner - Corporate Vice President and General Manager, Corporate Development
Gautam Khanna - Cowen
Pete Skibitski - Drexel Hamilton
Jason Gursky - Citi
Doug Harned - Bernstein
Sam Pearlstein - Wells Fargo
George Shapiro - Shapiro Research
Joseph DeNardi - Stifel
Darryl Genovesi - UBS
Kristine Liwag - Bank of America Merrill Lynch
Roman Schweizer - Guggenheim
Good day, ladies and gentlemen, and welcome to the Huntington Ingalls Industries fourth quarter earnings conference call. [Operator Instructions] I would now like to introduce your host for today's conference, Mr. Dwayne Blake, Vice President of Investor Relations. You may begin, sir.
Thanks, Ranya. Good morning, and welcome to the Huntington Ingalls Industries fourth quarter 2015 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; and Chris Kastner, Corporate Vice President and General Manager of Corporate Development.
As a reminder, statements made in today's call that are not historical fact are considered forward-looking statements and are made pursuant to the Safe Harbor provisions of federal securities law. Actual results may differ. Please refer to our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results.
Also in their remarks today, Mike and Barb will refer to certain non-GAAP measures, including certain segment and adjusted financial measures. Reconciliations of these metrics to the comparable GAAP measures are included in the appendix of our earnings presentation that is posted on our website.
We plan to address the posted presentation slides during the call to supplement our comments. Please access our website at huntingtoningalls.com and click on the Investor Relations link to view the presentation as well as our earnings release.
With that, I will turn the call over to our President and CEO, Mike Petters. Mike?
Thanks, Dwayne. Good morning, everyone, and thanks for joining us on today's call. This morning we released fourth quarter and full year 2015 financial results that reflect solid operating margin performance and cash generation at Ingalls and Newport News, while our UniversalPegasus operations continue to be negatively impacted by extremely unfavorable market conditions.
2015 was a year of inflection, marking achievement of our goal of 9%-plus operating margin in the ship building business and the end of the first five years of operations since spin-off. I want to thank each one of the 36,000 employees of Huntington Ingalls for their hard work and dedication that produce these results and for their continuous commitment to safety, quality, cost and schedule.
Now, during the quarter we had two events that reduced our GAAP earnings. First, we absorbed the $40 million one-time cost to refinance our 10-year notes, which will significantly reduce our interest cost going forward. Second, we recorded a $16 million non-cash goodwill impairment charge and a $27 million non-cash intangible asset impairment charge in our other segment.
The impairments were driven by continued low crude oil prices and a deterioration of market fundamentals in the oil and gas services industry. Note this fourth quarter 2014 results included similar impacts of $37 million to refinance our seven-year notes and a $47 million non-cash goodwill impairment charge.
2015 full year results also included cost from early payment of our term loan in the third quarter and a non-cash goodwill impairment charge in our other segment, and favorable resolution of an insurance litigation matter in Ingalls in the second quarter. All comparative data that I discussed today are adjusted for these items as well as the FAS/CAS adjustment.
So for the quarter, sales of $1.9 billion were consistent with last year and segment operating margin was 8.8%, down from 9.4% last year. For the full year, sales of $7 billion were 1% higher than 2014 and segment operating margin of 9% was consistent with 2014. Diluted EPS was $1.95 for the quarter compared to $2.19 last year, and diluted EPS for the full year was $7.33, up from $7.14 last year.
Additionally, we received $700 million in new contract awards during the quarter, resulting in backlog of $22 billion at the end of the year, of which $11 billion is funded. Cash generation was particularly strong, again, in the fourth quarter with $309 million of free cash flow, which was down slightly from last year, and we ended the year with approximately $900 million of cash on the balance sheet.
Since our third quarter earnings call in November, the fiscal year 2016 budget has been authorized and appropriated, and the President's fiscal year 2017 budget request has been released. Within the 2016 budget, I want to point out a few highlights.
The final portion of funding was authorized and appropriated to support construction of the 12th LPD, LPD 28, and accelerate by two years construction of the next-generation amphibious warship LXR that will be based upon the LPD. Funding was also authorized and appropriated for a ninth National Security Cutter. All of these actions are reflective of the broad support for the capabilities that these ships provide and our ability to execute within the cost and schedule expectations of our customers.
The President's fiscal year 2017 budget request marks the beginning of the process for Congress to consider shipbuilding priorities and investment for the next fiscal year. We were very pleased to see that the President requested funding for all key shipbuilding programs of record, including advanced procurement for the Ohio-class Replacement Program, continuation of CVN-79 Kennedy and advanced procurement for CVN-80 Enterprise, which is the third Ford-class aircraft carrier.
The President also requested investment for the refueling overhaul of CVN-73 George Washington and advanced procurement for the refueling overhaul of CVN-74 John C. Stennis; as well as two Virginia-class submarines; two DDG-51 class destroyer; LHA-8, which is the next big deck amphibious warship; and T-AOX, the next generation fleet oiler. We were also pleased to see substantial investment requested for a new Coast Guard icebreaker. We look forward to Congress considering all of these requests over the next several months.
Now, I'll provide a few points of interest on our business segments. At Ingalls, the LPD and NSC programs continue to perform very well and are reaping the benefits of serial production, while the DDG and LHA programs remain on track. We expect contract awards for LPD 28 and NSC-9 later this year, and we look forward to continuing our outstanding track record of performance on these very important programs.
At Newport News, CVN-78 Ford achieved the milestone, recognizing installation of over 14 million feet of electrical and fiber optic cable in January. This team is working through the test program and preparations for builder's trials in the second quarter with delivery to follow. The Virginia-class submarine program continues to perform at a high level, while CVN-72 Lincoln and CVN-65 Enterprise continue on their paths to redelivery to the customer, expected at the end of this year and in the first half of next year, respectively.
As I mentioned earlier, UniversalPegasus recognized non-cash goodwill and purchased intangible asset impairment charges in the quarter. As you know, this is a tough time for the oil and gas industry, but we are continuing to take specific actions to right-size our operations for this dynamic environment to position UPI for long-term success when the market turns.
So in closing, I want to recap some of the accomplishments by our team in 2015. We delivered NSC-5 James at Ingalls and SSN-785 John Warner at Newport News. Ingalls and Newport News generated segment operating margin above 9% for the second year in a row, operating and free cash flow were the highest since the spin-off in 2011 and we were awarded $8 billion in new contracts including detail design and construction for CVN-79 John F. Kennedy and construction of NSC-8 Midget.
Looking ahead, we laid out the path to 2020 at our first Investor Day this past November. The path includes investing $1.5 billion in capital to strengthen and protect our core shipbuilding business, returning substantially all of our free cash flow to shareholders via dividend increases of at least 10% annually and share repurchases, and leveraging our deep technical services competencies and nuclear operations expertise to optimize and expand our services portfolio.
I am excited about the possibilities these strategic initiatives provide for our employees, our customers and our shareholders, as we continue to create long-term sustainable value. And I am confident that we have the right team in place to provide the leadership and focus necessary to execute these initiatives.
Now, I have one other important duty to perform as part of this call, that is formally recognizing Barb's contribution to Huntington Ingalls, as she leaves us for retirement. Barb has been a full partner in all that we have accomplished, and someone I have had the pleasure of working directly with for the past 12 years. Her professionalism and pragmatism have been at the heart of our planning and execution. And while we have great confidence in Chris, we will definitely miss Barb.
So that concludes my remarks. And I will now turn the call over to Barb Niland for some remarks on the financials. Barb?
Thanks, Mike, for the kind words. It's been a privilege working for you and representing the 36,000 employees of Huntington Ingalls Industries, so good morning everyone on the call. Today I am going to review our consolidated and segment results for the fourth quarter and full year. Then I will hand the call over to Chris Kastner, who will be taking the reign as the new CFO on March 1, to wrap up with some information on 2016.
As Mike mentioned, all the numbers that I discuss today will be adjusted for the insurance litigation settlement, the non-cash goodwill and purchased intangible asset impairment charges and the one-time expenses related to early extinguishment of debt. Please refer to the presentation on our website or the earnings release from this morning for more information and the detailed reconciliation.
Turning to the consolidated results on Slide 4 and 5 of the presentation, and starting with the quarter, total revenues of $1.9 billion decreased 1.1% from the same period last year due to lower volumes at UPI and Ingalls, partially offset by higher volumes at Newport News.
Segment operating income of $167 million decreased $14 million from the fourth quarter 2014 and segment operating margin of 8.8% decreased 63 basis points due to lower risk retirement at Ingalls and lower performance at UPI.
Total operating income of $187 million decreased $4 million from the fourth quarter 2014 and total operating margin of 9.8% was down 10 basis points, as favorable FAS/CAS adjustment was offset by the lower segment margin at Ingalls and UPI.
For the full year revenue increased 1.1% to just over $7 billion, driven by higher volumes at Newport News. Segment operating income of $633 million and segment operating margin of 9% were in line with 2014, as improved performance at Ingalls and Newport News was offset by the continued pressure at UPI.
Total operating income of $735 million increased $33 million, primarily due to favorable FAS/CAS adjustment. Total operating margin was 10.5%.
Moving on to cash flow. Cash from operations was $411 million in the quarter and free cash flow was $309 million. For the full year, cash from operations increased $112 million to $828 million and free cash flow of $640 million increased $80 million over 2014. The increase was primarily due to the after-tax effect of the insurance litigation settlement in the second quarter and lower pension contribution.
Capital expenditures in the quarter increased $28 million to $102 million from the same period last year. And for the full year capital expenditures increased $23 million to $188 million from 2014.
Cash contributions to our pension and post-retirement benefits plans were $136 million in the year, of which $99 million were discretionary contributions to our qualified pension plans. Asset returns for the year was a negative 1% and pension discount rates increased almost 40 basis points to 4.73% at the end of the year.
During the quarter we repurchased over 332,000 shares at a cost of $38 million, bringing the total number of shares repurchased in the year to over 1.9 million and at a cost of $234 million. In addition, we paid dividends in the quarter of $0.50 per share or $24 million, bringing the total dividend paid for the year to $81 million.
Interest expense in the quarter was $64 million and $137 million for the full year and included $40 million and $44 million, respectively, of one-time expenses related to the early extinguishment of debt. This compares to interest expense in the fourth quarter of 2014 of $66 million and $149 million for the full year, which also included $37 million of one-time expense for the early extinguishment of debt in both the quarter and the full year.
Our effective income tax rate in the quarter was 37.5% compared to 34.2% in the fourth quarter of 2014. The increase was primarily driven by lower domestic manufacturing deductions year-over-year. For the full year, the tax rate was 36.1% compared to 33.3% in 2014. The year-over-year increase was driven by the lower domestic manufacturing deductions and higher portions of goodwill impairment that were not amortizable for tax purposes.
Moving on to segment results, and starting with Ingalls on Slide 6 and 7, revenues at Ingalls of $580 million in the quarter declined 4.6% from fourth quarter 2014 due to the deliveries of NSC-4 and NSC-5 and lower volumes on LPD 26. The decline in revenues was partially offset by higher volumes on the DDG program. Operating margin of 10.2% in the quarter decreased 167 basis points from the fourth quarter 2014, driven by lower risk retirement on the LPD program.
For the full year, Ingalls generated revenues of $2.2 billion, which decreased 4.3% from 2014. Operating margin of 11% for the year increased 102 basis points from 2014, driven by higher performance on both the LHA-6 America-class and NSC programs as well as the favorable resolution of outstanding contract changes.
Turning to Slide 8. Revenues at Newport News of approximately $1.3 billion in the quarter increased 2.6% from the fourth quarter 2014, due to increased volumes on the VCS program and in-fleet support services. Operating margin in the quarter of 9.3% was in line with the fourth quarter 2014. And for the full year, Newport News revenues of $4.7 billion increased 3.6% and operating margin of 9% was similar to 2014.
Turning to the other segment on Slides 9 and 10. UPI generated an operating loss of $12 million on revenues of $29 million in the quarter compared to an operating loss of $7 million on revenues of $56 million in the fourth quarter of 2014. The decreases were driven by the prolonged decline in oil and gas services and the effect of restructuring cost during the quarter. For the full year, UPI generated an operating loss of $32 million on revenues of $134 million.
Overall, it was another good quarter and good year. As Mike said earlier, we are proud of what our employees have accomplished since the spin. That wraps up my remarks for the quarter and the full year.
I will now turn the call over to Chris Kastner to provide you with some information on 2016. Chris?
Thanks, Barb, and good morning. Turning to Slides 11 and 12, and starting with the income statement. For the full year we expect revenues to be relatively similar to 2015. Segment operating margin in our shipbuilding business to be in the 9%-plus range. As a reminder, there can be variation in margins between the quarters, but for the full year we expect to achieve a 9%-plus margin.
We are expecting a favorable net FAS/CAS adjustment of $137 million for the year and we expect deferred state income tax expense to be in the range of $10 million to $15 million. We expect the interest expense of approximately $75 million for the year and the income tax rate to be in the range of 33.5% to 34.5%.
Now, a couple of items that will impact cash flow. We plan to contribute $210 million in cash to our pension and post-retirement benefit plans, of which $167 million is discretionary contribution to our qualified pension plan. We also expect capital expenditures to be in the range of 3.5% to 4.5% of revenues for the year. That concludes my remarks on 2016.
I'll turn the call back over to Dwayne for Q&A.
Thanks, Chris. As a reminder to everyone on the call, please limit yourself to one initial question and one follow-up, so we can get as many people through the queue as possible. Ranya, I'll turn it back over to you to manage the Q&A.
[Operator Instructions] And our first question comes from the line of Gautam Khanna from Cowen.
Gautam Khanna, Cowen. So guys, I was wondering if you could elaborate on the budget comments, the budget request comments you made in the opening remarks. With respect to the icebreaker, can you give us a sense for how that might be procured and when that might actually be awarded? Also, any color on the LXR program? And maybe some updated milestones on the Ohio-class?
So we'll start with the LXR program, because I think that's kind of centerline of good news here. The Navy in their budget request they've identified LXR as a program that stays inside the fit-up, and they've actually -- I think they've got it set for the first ship procurement in 2020 I think.
But the main thing there is last year we went through a decision process, the Navy made a critical decision to say that the LXR program is going to be based on the LPD haul. And then last year we had the first round of funding for LPD 28. We've now gone through and completely funded LPD 28, which is sort of a transition, if you will, from the production run of LPDs on a path to the LXR.
So from my standpoint this is all really good news, because we have a very efficient path to keep the amphibs moving. I've said for five years now that the amphibs are in the scrum, really when it comes to some of this funding. And I think the Navy and the Marine Corp have shown their commitment to the program and we're excited about that, and when it shows up in the President's request, that's a further validation of the importance of the program.
It's consistent with the Navy's plans for making it proceed in an efficient way, and it aligns with the way that we're thinking about the business in terms of that production line. So we're excited about that. We have the opportunity to really capture the efficiencies of serial production, which we've been trying to do across all of our programs.
On the Ohio Replacement Program, I've been pretty vocal about, we've got the find a separate source of money, we got to find more money for the shipbuilding budget to handle the Ohio Replacement Program, because it could and it's big enough, so that it would crowd out other shipbuilding.
I think this is going to be a discussion that we're going to have for the next five to 10 years, really, is how we're going to pay for the program and how comfortable can we do it inside of the Navy's budget. But this first-go round is a great indication that it's going to happen, that it's going to happen and that the other programs are going to stay on track. And so we are very pleased with the way that came out.
Now, there's a lot of discussion about different kinds of mechanisms to fund this and from our standpoint we're somewhat agnostic about whatever the mechanism is. What we really need to see is that the funding is there without affecting other programs, and that's what happens in this budget and that's what looks like is happening in the Navy's plan by and large.
With regard to the icebreaker, we're on the front-end of that program. We're still at the point of our customers that are out there, trying to set their requirements. And setting their requirements and setting the pace for the program are things that are always kind of influx right now.
It's clear there is a commitment to the program. It's a program that we're very interested in and we've been in dialogue to understand what those requirements are and to position ourselves to be able to participate in that program and support the Coast Guard's plans when they go forward. So all of that is good news for us.
And our next question comes from the line of Pete Skibitski from Drexel Hamilton.
A couple of questions, I guess. On the pension, contributing the pretty large discretionary amount, can you help walk us through the calculus on that? You talked about returning most of free cash flow to shareholders, where you're making the decision to make a pretty large discretionary contribution to the plan. What led you to kind of down that path to putting that kind of money into the plan?
Our practice is to fund 90% of our plans on a pre-met basis. And in order to maximize our cash recovery across our multiple plans calls for that contribution. So simply maximizing our cash recovery.
And then just one more, I guess. You're excluding the impairments at UPI, I guess, the ongoing operating loss is kind of sharp still. How you guys think about 2016? Do you feel like that business is sized right until it's breakeven in 2016 or is that kind of a quarter-by-quarter issue that you have to manage?
Yes, it's going to be quarter-by-quarter. I mean the dynamics in that marketplace have been pretty volatile just in the past 30 days. And our commitment here is to maintain the relationships we have with those critical customers out there that are in that space. And that means that we've got to preserve capabilities that those customers are going to need.
We are winning our share of the work that is out there, but it's not going to be worked, it's going to kick-in until the end of this year or next year. And so the time facing of that is something that we just got to fight our way through quarter-by-quarter. I wish it were different, I wish it were a different way, but our commitment here is to those customer relationships and we're going to do what we have to do to make sure we get that right.
And Pete, in Q4, slightly over half of the UPI loss adjusted for the PI and the Goodwill was related to restructuring cost associated with leases and severance.
So the ongoing operating loss was kind of in the single-digit millions, is that maybe what should we kind of run out for next year?
Yes. We think that's about right.
There is still pressure in that range.
And our next question comes from the line of Jason Gursky from Citi.
Barb one last question for you on [ph] Litton on Avondale. Can you just update us on the progress of recovery at Avondale, and given all of the moving parts? And that's being handed over to Chris at this point to just take care of.
Yes. So Chris started this now, he's going to go finish it here. But we continue to evaluate opportunities including sale. So we did competitively bid and selected a brokerage service to assist in the potential sale of real estate and other assets, while we continue to pursue restructuring. So we have had a few interested parties, so that continues to move along. In addition to that, we've been in discussions on a regular basis with our customer regarding our proposal and those discussions continue.
And so maybe just a couple of quick comments about the pipeline of business that you are bidding on outside of the core shipbuilding business. What kinds of things might we look forward to hear in the next, call it, eight-and-a-half, nine months, 10 months here in calendar '16? What are the key programs that you're out there bidding that we all ought to be paying attention to as to who is going to be the winners and losers, and what that will help us understand about future growth opportunities?
Sure. We talked in November about both the commercial nuclear space as well as the government services space. And in government services, there is both support of the fleet around the world as well as participating in the Department of Energy areas.
So commercial nuc, and let's start with that, we're supporting the project that Southern Company and Westinghouse are constructing down at the Vogtle plant. And so we're proud of the performance that we have there. And our hope is that as that market starts to expand, we have an opportunity to do some more in that space.
We're navigating our way through the creation of the design and the regulatory oversight of the NRC to make sure we get all that right. And so we've done great work there so far and we're hoping that can turn that into something bigger than what we've got today.
In the Department of Energy space, I think the biggest thing that's on the horizon right now is out of Hanford. But there the Nevada National Security site is coming up, we've made a bid on that and we're partnered with Honeywell and Jacobs. And of course in the DOE space there is always a lot of those things going on and a lot of different teams be informed and moving around.
So that's a little bit tricky to try to handicap the timing of some of these things in the way that they get awarded. But we're very happy with the way that SN3 has kind of stepped into that market space now and is creating the alliances we need to be successful in that space.
And then supporting the Navy around the world; we're watching and participating as the Navy continues to be on call. Longer deployment cycles are putting pressure on maintenance cycles, and support from both an engineering and planning perspective that our folks at AMSEC are very deeply involved in, and so especially as the Navy continues to be forward deployed, we are forward deployed with them.
And today, we have a 100 people supporting the Navy in Japan, for instance, and so we're around the world there doing those kinds of things to support them, and that's really a services as the need comes up kind of business. Our expectation is that the demand for that is going to go up. And so I'm not sure, I can put a specific target out there as in terms of a date on that space or a specific program in that space, but I am a believer that the demand for the Navy is going to drive that market.
And our next question comes from the line of Doug Harned from Bernstein.
First, Secretary Carter in his pre-budget statement, he made some comments about CVN-78 construction and that it was undisciplined, and that there would not be another carrier like that or construction process like that. How do you interpret those remarks? And what implications do they have for the approach to the CVN-79 and future carriers?
Well, I'm not sure I would use the word undisciplined, but I would say that the next carrier will not be, from a cost and schedule performance perspective, will not be like Ford. Ford was a lead ship. We've talked many times about the challenges that lead ships have. This was a particularly challenging project because of the major insertion of technology into the platform.
We basically kept the haul and redesigned everything else in that ship. And so today, what we have is we have ship that's built. The ship is completed. We're in a test program now that's going to drive us through the first half of this year.
What we have done though, when you build a lead ship, as we've talked about, that lead ship is it's your first production unit, but it's also your first prototype. That is the prototype, and that's where you -- in prototypes you test out your build plans, your test out your training plans for your employees, you test out the tooling that you have, you test out your supply chain. You're basically testing everything.
In the course of that testing, you learn things. And what we have is a very extensive process for capturing those lessons learned and applying them to CVN-79. And Doug, as you know, we signed a contract for CVN-79 in the middle of last year, which frankly reflected, a lot of that learning. Some of that learning is capital that we need to invest to drive the efficiencies. And so that's part of our capital plan going forward is to invest to support that program. But there will be a substantially fewer man hours required to build CVN-79 than what we took on CVN-78.
The other thing I would say is that there is a broader discussion going on about capability and capacity, which is really interesting to see part of. In the Navy's parlance, this isn't a light switch where you go from one to the other, it's really -- these things take a long time. If you go back a decade ago, CVN-78 was not the only lead ship program out there. The carrier was a new design program.
We, at 10 years ago, we were coming through the first new submarine at Newport News. Texas was our first delivery of a submarine in 10 years. So we were kind of on just at the very beginning of clearing up the lead ship kinds of issues in the submarine program. The LHD program was a new design program. The LHA program was a new design program. The DDG-1000 was a new design program. The LPD program was a new design program.
So 10 years ago, the navy was basically redesigning all of the shifts in its fleet. Every one of those programs on the front-end went through the first ship of a class kind of perturbations that you got to work through when your first ship is a -- your first production unit is also your prototype. Ford actually is the biggest of those ships and has taken the longest to come through that.
But now if you go and look at the sequence of things that are in the Navy's budget today, the carrier is not a new design ship anymore, the Virginia-class program is a gold standard for serial production and technology insertion into a mature platform. The DDG-51 program has been restarted and we're back into serial production on that program.
We are now coming through the -- we're in the second ship of the LHA class. Have come through all of the design challenges that LHA-6 had and LHA-7 is performing fine. The LHA-8 is in the budget. And you can just take down every one of the programs that Navy has today are all mature programs that are basically in serial production. And the most important thing that we have to do is keep that moving.
So from my standpoint, the capability versus capacity discussion is the really interesting one, but it's different for the Navy because the horizon is so much further way in ship building than it is in anything else, and that's why I am so happy about where we are with the budget, because it definitely shows the Navy's commitment to preserving these production lines and keeping not just the capacity out there, but the capability out there as well.
But if I can just follow-up on this from the capital plan, because if I look at capital spending involving CVN-79, CVN-80, and then also you mentioned before that the LXR plan it is being built off of LPD-17, but you also have the T-AO-205 plan, which seems to be building off T-AKE and T-AO-187, so if I look at, you've got investment for CVN-79.
The Navy is trying to make both of those two other programs competitive, yet one seems just totally tied to NASSCO and one seems totally tied to Ingalls. How do you think about investment across those programs, it looks hard to compete on T-AO-205, do you invest in that? What does this mean for the CapEx profile over the next year?
That's a great question, Doug, and pretty insightful. Without commenting on the competition what I would say is that remind you that in our shipyards we build multiple classes of ships and so when we think about putting capital investment in the shipyards, most of the capital investment that we put in is designed for multiple classes of ships and so we're focused on those processes and those things that are going to be common across different classes.
It's not uncommon, but it's lesser and it's a lesser investment for us to turn around and say we're going to invest in a facility that can only be used for A platform or A class of ship. And so given that, we step back and we don't look at necessarily -- we are investing and improving the performance in the LPD program and we are investing in those kinds of facilities that would help us to be successful in the T-AO program, should that be our program, but it's not. We're not looking at making a specific investment to chase a specific program at this point.
So that's kind of the way we think about it and that's why we talked about this investment over the next five years, this $1.5 billion. This is a generational reset for our businesses and we're going to end up building classes of ships in these capital facilities that are not even on the drawing board right now.
And our next question comes from the line of Sam Pearlstein from Wells Fargo.
Mike, I just wanted to follow up. You mentioned the builders' trials for CVN-78 in Q2 and delivery to follow shortly thereafter, does that mean the delivery has slipped out of the first half? And then I am just trying to think about is, is there an impact to P&L, like the Ingalls ships went like a reserve release or anything like that upon delivery?
Well, on the second issue, it's a cost type contract, and so in terms of reserve release it's going to be pretty insignificant. As far as the schedule goes, I don't even want to put any sort of a stake on the ground in terms of saying this is what we're going to go do. The bottomline is that we're testing the ship, and the ship as I was told 20 years ago when I was doing career construction, the ship will leave when it's ready.
We're doing everything we can to get the ship out. We expect that to happen in the middle of the year. There is a sequence from builders' trials to delivery that we go through, and so the team down there is committed to getting it done as quickly as possible.
As I said earlier, the ship is complete. We're testing systems now that have been installed, and not only are we testing the systems themselves, kind of, is the system working the way that it was designed to work, we're also testing does it work with the other systems the way its supposed to work too.
And as a lead ship, all of this integration is a big challenge for us. And the Navy and the company are working through this with probably the best team in the business to get it done. And so like I said, I don't want to commit to any specific date on the schedule, what I'm going to tell you is it's going to go as quick as we can get it out.
Thank you. And just a follow up, the employment reductions you had announced last year were effective in February. So I'm just trying to think about how did that affect the P&L for the period expenses in Q1. Is it then recoverable? Just trying to think about how it's going to impact the first quarter?
For the last year, the reserve was booked for that and it's all recoverable because it's part of our normal benefits package.
And our next question comes from the line of George Shapiro from Shapiro Research.
My questions on trying to get a little more hands on free cash flow for '16, so the way I rough it out, tell me where I maybe wrong, CapEx could be a $100 million higher than what it was in '15. You had the $150 million insurance payment in Q2, which I assume you don't get something like that in '16.
And then it looks like the pension payment, maybe is $110 million higher than '15. I don't know whether you made a payment in the fourth quarter or not. So when kind of put all that together and net income after FAS/CAS is probably comparable. I figure that maybe free cash flow is going to turn out to be somewhere around $300 million in '16 versus '15. I was just wondering if that's correct or what might be wrong with it?
Yes, I think you have all the essential elements there, George. Those are the large drivers. I don't see much moment in working capitals. It's fairly balanced through the year. So I think you have it. We don't provide guidance, of course, and payments could move beyond the quarter and through yearend, which would drive it a bit on some of our larger contracts, but I think you have the essential elements.
And our next question comes from the line of Joseph DeNardi from Stifel.
Mike, I wonder if could just talk about kind of the relative revenue contribution from $78 million and $79 million this year and kind of what your assumptions around the margin impact of that, just on the 9% plus guidance you gave for the year. Just any help with that?
Yes. We don't break anything out by program and so probably not going to do much to help you with the trade-off between $78 million and $79 million. But our commitment is that our core ship building business, over the year, is going to perform at 9%-plus. As Chris pointed out in his comments, there is going to be some lumpiness there and the Ford in the first half of the year is going to have pressure in it. There is no other way to say it. But across the whole business for the whole year, we're going to be at 9%-plus.
And then just on the M&A side, I think we've talked quite a bit about this at the Investor Day, but what are you seeing there? Are you guys active in kind of looking at other assets to build out the other segment or is it just kind of wait and see approach at that time?
Well, we won't comment specifically about any particular opportunity. We've got our radar up and we're looking around, the question is how do you value anything and how does it fit in with the strategic view of the organization? As I again, have said from time to time, the first question we ask ourselves is that why would we be a better owner of that business?
I mean you got to get through that before you can do anything else. We laid out at the Investor's conference, we laid out some very specific filters that, or hurdles, if you will, that you have to get over for any transactions. And we're insistent that we're going to stick to that.
And our next line comes from the line of Darryl Genovesi from UBS.
I guess, similar question to George upon accrual basis. Mike, I know you don't like to give a lot of forward guidance, but maybe perhaps expansion broadly speaking, do you think you guys could grow earnings this year?
I'm sorry, do I think what -- to grow earnings?
You think you can grow earnings expansion?
Yes, I mean, I think the challenges that our core ship building business is right now, even though, there is good things in the budget, the things that are in the budget don't manifest themselves for a few years on our program. And I think we've said for five years that the best way to think about the core ship building business that we have is that it's flat.
And so I think that if you want to do the math, our commitment to buyback shares and those kinds of things are out there. But our basic business is a flat ship building business with an opportunity to do some things on the services side from time-to-time. And the earnings are going to be 9%-plus.
And then maybe just on, one more on the kind of competitive situation. I mean, in your opinion does the decision to use a LPD haul form on LXR still leave an opportunity for sort of a meaningful competitive bidding process? And I guess, similar question on SSBN-X with having kind of gotten into the meat of the next budget cycle now, has there been any clarity offered by the Navy on what your role versus GDs might be on that program?
Well, I'll let you to talk to the Navy about what there acquisition strategy for LXR might be. I do think that we are in a place in ship building where there is really a lot more allocation than there is competition, and in some cases competition actually slows down the process and/or stifles the innovation somewhat. So I think you have to kind of think our way through that a little bit. I don't exactly know how LXR will come out.
We do think the decisions that have been made on LXR so far have been very smart decisions on the part of the Navy to take advantage of all the challenges that we had to fight our way through a decade ago to get these programs up to where they are today. And I think it's a really key decision not to go and start over with a clean sheet of paper and redesign that ship, and so all of those are really good.
I want to make sure that I catch -- I think I might have said that LXR was a 2020 program, but I think it's really a 2021 program. And so whatever it is, it's inside the fit up and that's the most important thing is that it's not one of those bowriders that sits right outside the fit up forever. I mean it's actually in the program and the Navy is moving forward on it. So we're excited about that. If the Navy chooses to compete we'll compete. If the Navy chooses another path, we'll partner into that path and we'll go execute it, so more to come, I guess.
And our next question comes from the line of Ron Epstein from Bank of America Merrill Lynch.
It's actually Kristine Liwag calling in for Ron. Can you guys discuss how much is lost in Goodwill and intangible assets related to your oil and gas business? And also what are the trigger points for possibly more impairments and write downs?
So for UPI, the Goodwill balance is around $29 million and the purchase intangible balance is around $4 million. At the end of the year, when oil prices continue to drop, we went back and triggered another look at our forecast. And when we look at our forecast, we decided that, hey, this has been prolonged. And originally we thought we were going to see a recovery sooner, so we look at it with a more delayed recovery. I'm not saying it can't happen, it's possible. If oil prices continue to drop, we could have a problem. But right now, I think we're in a fairly reasonable place on as far as Goodwill and purchase intangibles.
And switching gears, it seems like the Navy study on potential alternatives to the CVN-78 class is back on the table and with possibly smaller carriers in the long-term. Can you discuss what this would mean for you?
Well, I think first of all, let's talk about the analysis of alternatives. And one thing that I think it's really important for folks -- and the Navy is going to go off and do their study, and I don't know how that's all going to turn out. However, the Navy works their way through that, we see ourselves as their principal partner in shipbuilding and we will be there to help them do whatever it is that they believe that they need to go do.
Now having said that, one of the things that gets lost when you do all of these alternatives and you do this analysis is that there is a lot of metrics that get thrown around like cost per ton and things like that to try to drive more affordable solutions to a mission set. The thing that people don't get sometimes is that the cheapest thing we do is create volume. Building volume in the ship is what actually creates -- that's the cheapest thing we do, so making it large actually suddenly creates a whole lot of flexibility in the platform that you didn't have before.
I'm not the metric guy, but I don't believe you can buy two-thirds of a carrier for two-thirds of a cost, two-thirds of the capability for two-thirds of a cost, I don't believe you can do that. Because the first thing you do is you start to reduce the volume, you significantly change the flexibility and the capability of the ship.
And so this has been looked at many, many times. Every time it gets looked at it that we come back to this decision that we really do need the volume at sea, so we have the flexibility to go do those missions that we don't even know about right now, that we're going to need to perform for 50 years. So I'm a strong advocate for the big deck carrier. And now having said that, if the Navy chooses to go in a different path then we'll be right there and we'll help them be successful in that path.
And our next question comes from the line of Roman Schweizer from Guggenheim.
And, Barb, fair winds and following seas, wish you the best.
So my first question just regarding Newport News, I was wondering if there was any opportunity or discussions with the Navy to pull forward possibly any work on CVN-73 or any other projects there to kind of help smooth that workload out in '16.
There have been a lot of discussion with the Navy on how do we manage this workload valley challenge. But the real challenge that we have is that we have these three carriers to deliver now, starting in a middle of the year and carrying over to the first part of next year. And you can do a lot of things and you can move a lot of work around, and the Navy's work with us to do that. But having said all that, we still have -- this is pretty disruptive. And so we've got to fight our way through it.
The most discouraging thing about this, and I'm sure the Navy's is just discouraged about it as we are, is that on the backend of this we're going to start hiring back. Two years from now we're going to be coming right back up towards the levels where we were before we started laying people off. And the Navy works with us very closely to try to prevent those kinds of situations from happening. But this happened because of the sequester environment in Washington and the disruptions that created in long-term planning.
And until we get out of that environment, we're all just doing the best we can to fight through it and preserve our skills to the best of our ability. It's no way for the greatest country on earth to run its business. And we've got to do better than that.
And just one more follow-up related to Newport News, but on the submarine side, you sort of talked about the impact of Ohio-class and Virginia-class, really the submarine industrial base and how that workload is sort of spread and shared as those two programs go simultaneously? The Navy's fit up will cut Virginia-class in 2021, the ramp would drop till one per year. And I was just wondering, when you look at that total workload available, would one Ohio-class and one Virginia-class still be sort of net additive to that industrial base?
Well, I think that you need to recognize that the Ohio-class submarine is a significantly different larger volume of work than a Virginia-class submarine, and so it might be one and one equals two, but one Ohio-class plus one-Virginia class is a significantly higher level of work for the industrial base than two Virginia-class submarines.
And the other thing I would point out is that you're looking at the appropriations documents, the real question in the business is not what happens in the years when the money gets funded, what you have to work your way through is what's happening in the business as the ships get build, what do the volumes look like, what do the delivery teams look like and how do those line up.
So your really 2021 is only a forecast of where you might be in '26 or '27 or '25 even, so that's kind of complexity of the challenge, but I think, it's easily, it's not even close, one Ohio-class plus one Virginia-class is significantly more work than two Virginia class.
And we do have a follow up question from George Shapiro from Shapiro Research.
Oh yes, I just wanted to pursue, maybe Barbara and Chris, what the adjustments were in Ingalls, where you said there was lower risk retirements. Could you just quantify what they were because we probably won't get to see them same until the K comes out?
Right, well, for the quarter, we had $71 million favorable risk retirement and that was primarily related to the Virginia-class, and across the program. And in 2014 of fourth quarter, we had a lot of risk retirement related to the LPD programs that we didn't have in 2015 in this quarter. So we had $51 million in the quarter of net favorable adjustments, so none of the downers were individually significant, the uppers were primarily related to Virginia-class programs.
End of Q&A
Well, I think that's it on our call list, so we'll wrap up here. I would like to thank everybody for joining us today. And I, again, would like to thank, Barb, I believe this is our 20th call together, so thank you for that, for all of your support and hard work over all these years.
We had a great year in 2015. That captures and culminates nearly five years of really hard work by our team. So we'll celebrate that a little bit, but we know that we're not ever done. We have mapped out our strategy for the next five years, so that in essence positions our company for the next 25 to 35 years.
In order for those plans to become reality, our focus on program execution, risk retirement and cash generation will not change. So thanks for your interest in HII and we look forward to seeing you soon.
Ladies and gentleman, thank you for participating in today's conference. This concludes today's program. You may now all disconnect. Everyone have a great day.
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