Huntington Ingalls Industries, Inc.
Q3 2015 Earnings Call Transcript

Published: 5 Nov 2015

[Operator:]

Good day, ladies and gentlemen. And welcome to the Huntington Ingalls Industries third quarter 2015 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct at question-and-answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mr. Dwayne Blake, Vice President, Investor Relations. Please go ahead, sir.

[Dwayne Blake:]

Thank you, Amanda. Good morning and welcome to the Huntington Ingalls Industries' third 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. As a reminder, statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the Safe Harbor provisions of federal securities law. Actual results may differ. Please refer to our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results. Also in their remarks today, Mike and 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?

[Mike Petters:]

Thanks, Dwayne. Good morning, everyone and thanks for joining us on today's call. This morning, we released third quarter 2015 financial results that reflected solid operational performance. For the quarter, revenues of $1.8 billion were approximately 5% higher than last year and diluted EPS was $2.29, which included one-time cost of $0.06 per share for the full repayment of our term loan. Backlog at the end of the quarter was approximately $23 billion, of which $12.5 billion is funded. Demonstrating continued confidence in the free cash flow generation of the business, our Board of Directors recently approved a 25% increase in our quarterly dividend to $0.50 per share and doubling our share repurchase program from $600 million to $1.2 billion. These decisions reaffirm our commitment to continue returning cash to our shareholders. Since our Q2 earnings call in August, Congress passed the fiscal year 2016 National Defense Authorization Act, but the bill was vetoed by the President and returned to the Congress. Last week a budget compromise was reached between the executive and legislative branches which provided temporary relief to sequestration by raising the budget caps in fiscal years 2016 and 2017 for defense and nondefense discretionary accounts. We believe that the budget levels in the agreement paved the way for a corresponding adjustment in defense authorization levels that will ultimately enable enactment of a revised bill. Similarly the budget agreement should allow for final passage and enactment of defense and nondefense appropriations measures. We remain hopeful that authorization and appropriations bills will be enacted in a timely fashion to minimize disruption to the industry. At the same time, our team remains engaged with Navy and congressional leadership on all of our programs. Now I will provide a few points of interest on our business segments. At Ingalls, the NSC program continues to perform extremely well as the team launched NSC-6 Munro in September and is expected to be delivered by the end of next year. In addition, fabrication started in July for guided missile destroyer Delbert D. Black DDG 119, the 32nd Arleigh Burke-class destroyer to be built at Ingalls. At Newport News, the Virginia-class submarine program continues its outstanding performance as the team achieved the pressure haul complete milestone on Washington, SSN-787 in September, signifying that all of the submarine's hull sections have been joined to form a single, watertight unit. Washington will be the U.S. Navy's 14th Virginia-class submarine and the seventh to be delivered by Newport News. On Gerald R. Ford, CVN-78, the overall test program continues to support delivery in the first half of 2016. However, increased vendor service costs required to support troubleshooting and repair of various systems during the test program causes to increase the estimated cost of completion and recognizing negative cumulative adjustment in the quarter. While it is a bit disappointing that we had to recognize a cost increase for the second quarter in a row, we are less than a year from delivery and the Newport News team is focused on completing the work on this first of its class ship in a safe and high-quality manner. And regarding UniversalPegasus, weakness in the oil and gas market remains a challenge. But we are continuing to make difficult decisions to position the business for the market turnaround. In closing, the relentless focus on program execution, risk retirement and cash generation continues to serve us well and remains a top priority. As a result, the team produced solid financial result this quarter that keeps us on track to maintain 9% plus operating margin in our shipbuilding business. Now that concludes my remarks and I will now turn the call over to Barb Niland for some remarks on the financials. Barb?

[Barb Niland:]

Thanks, Mike and good morning, everyone. Today, I will review our third quarter consolidated and segment results as well as provide you with a few updates for the full year. Please refer to the slides posted on our website for more information. Turning to the consolidated results on slide four of the presentation. Total revenues in the quarter of $1.8 billion increased $83 million or 4.8% from the same period last year due to increased volumes at Newport News and Ingalls. The increase was partially offset by lower volumes at UPI. Segment operating income of $172 million increased $21 million and segment operating margin of 9.6% improved 76 basis points from the third quarter last year, due to strong performance at Ingalls. Total operating income of $200 million increased $29 million and total operating margin of 11.1% improved 115 basis points from the same period last year due to performance improvement at Ingalls and an increase in the FAS/CAS adjustment. Cash from operations was $254 million and free cash flow was $217 million, which was consistent with the third quarter of 2014. Capital expenditures in the quarter were $37 million compared to $40 million in the same period last year. As I mentioned during last quarter's call, we have been seeing lower than expected capital spending this year. Some of our larger projects started later and slower than planned and so now we expect capital expenditures as a percentage of revenues to be approximately 2.5% for the full year. We will provide you with more details on our capital expenditure expectation during our Investor Day on November 10. During the quarter, we repurchased approximately 915,000 shares at a cost of $103 million and paid dividends of $0.40 per share or $19 million. As I mentioned on last quarter call, we repaid our outstanding term loan bringing our third quarter cash balance to $671 million. Moving on to the segment results, beginning on slide five of the presentation. Ingalls' third quarter revenues of $593 million increased $34 million or 6.1% from the same period last year. The increase was driven by higher volumes on the DDG and LHA programs, partially offset by lower volumes on the LPD and NSC programs. Operating margin for the quarter was 13%, a 315 basis point increase over the same period last year due to performance improvement on the LHA, NSC and LPD programs. Turning to slide six. Newport News third quarter revenues of $1.2 billion increased $80 million or 7.3% over third quarter 2014 due to higher volumes on the VCS program and in-fleet support services. This increase was partially offset by lower volumes on the CVN-72 RCOH and the construction contract for CVN-78. Operating margin for the quarter was 8.5%, a 71 basis point decrease from the third quarter last year due to lower performance on CVN-78. Moving on to the other segments. Revenues in the quarter were $30 million with an operating loss of $5 million due to the prolonged weakness in the oil and gas services market. Now to update you on some items for the full year. We are now estimating a FAS/CAS adjustment of $106 million which is slightly lower than our previous estimates due to updated census data. Additionally, we now expect deferred state income tax expense of approximately $3 million, instead of the $5 million benefit I provided on the first quarter call due to timing of contract income for tax purposes and the impact of the true-up of 2014 estimated taxes to actual filed returns. We still expect interest expense excluding the one-time cost associated with the bond refinance and the term loan repayment to be approximately $95 million. Turning to slide seven, where we have included some sensitivities around 2016 FAS/CAS adjustment. Please remember that pension related numbers are subject to year-end performance and measurement criteria and therefore we will provide you with a better estimate for 2016 on our fourth quarter call. But this chart shows the sensitivities of 2016 estimated cash FAS/CAS adjustment to discount rate assumptions and actual asset returns for 2015 and 7.5% long-term return on assets going forward. At the end of the third quarter, our discount rate was approximately 25 basis points higher than last year and year-to-date actual asset return was negative 3.3%. Therefore, depending on the year-end performance, the measurement criteria and the discount rate, 2016 FAS/CAS adjustment may vary significantly from the sensitivity shown on this chart. But again, we will provide you with an update during our fourth quarter call. To summarize, this was a good quarter, led by strong performance at Ingalls. However, as I often try to remind you that from quarter-to-quarter shipbuilding can be operationally lumpy due to the portfolio mix of the new and established programs, the timing of milestones, risk retirements and deliveries. With that being said, we remain on track to meet our full year 9% plus segment operating goal in our shipbuilding business. That concludes my remarks for the quarter, I will turn the call back over to Dwayne for Q&A.

[Dwayne Blake:]

Thanks, Barb. 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. Amanda, I will turn it over to you to manage the Q&A.

[Operator:]

[Operator Instructions]. Our first question comes from Gautam Khanna from Cowen and Company. Your line is open. Please go ahead.

[Gautam Khanna:]

Thanks. Good morning and great results.

[Mike Petters:]

Thank you.

[Barb Niland:]

Thank you.

[Gautam Khanna:]

I was wondering if you could just comment on, in the defense compromise, the bill that's pending, what you saw that may have been upside or a positive development in the future on anything that was a little bit less positive?

[Mike Petters:]

Well, first of all, I would say, remember the horizon of this business is pretty long-term and so any particular movements in any particular piece of legislation are probably less significant to us, rather than and instead I would say the fact that they have got to a compromise and the fact that they are moving towards a regular order process to get through revise the authorization bill and get these appropriations bills done. We are optimistic that that's going to happen. We believe that the more the legislative process can be in a regular order process, the better chance we have to make the case for the long-term investments that need to be made to support our programs. When we are in a sequestered environment that's a very short term, very narrow focus and it can have some long-term affects. And so we are very, very happy that we have a compromise and we are optimistic that we will get through the appropriations process. But we are paying very close attention to make sure that that happens. In terms of our programs, they are all very well supported, they were very well supported in the first authorization bill and we expect that to continue.

[Gautam Khanna:]

Okay. And if I could just ask a follow-up. At Ingalls, obviously you have had terrific results for a while now. And I just want to get sense, I mean is there anything that gives you pause that would potentially slow that down as we move forward in terms of just how the ship flows through? How unusual would you say this quarter was relative to what we could expect going forward?

[Mike Petters:]

Well, we have talked before about these businesses, our balance between work that's happening on mature programs and work that you are starting up on. And we are very, very pleased. I am really proud of the team at Ingalls and what they have accomplished since we have spun the company, but even going further back. They have really rebooted that business to where it is today. But I think the balance between work and retiring risk on mature programs and starting up new programs causes what Barb calls the lumpiness in the business. And that's why we say, the healthiest range for the business is to operate in the 9% to 10% band. Where we are today, as opposed to where we were in 2011, where we had a significant number of mature programs at Ingalls that were performing way below our standards. Where we are today is that our programs that we are executing on, are performing to our standards. The challenge at Ingalls is how do you parlay that into the future work. And the real challenge that we see at Ingalls over the next five years is going to be, what's next. The LPD-28 is an example of, let's keep the production line hot, let's get that program moving, let's bridge the LPD program's success that we have created into the next class of amphibs, let's keep the destroyer program on track, let's keep the NSC program moving. There is talk of an NSC-9 and we are very supportive of that. So the thing that I would say, on the horizon for Ingalls is number one, continue to focus on superior execution, number two, let's go capture that new work that's out there.

[Barb Niland:]

I would also add, for this quarter, we had some favorable adjustment on the LHA-6, which was previously delivered that we cleaned up contract changes and better performance on deferred work. So that also helped increase the Ingalls margin for the quarter.

[Gautam Khanna:]

Got it. Thank you very much, guys.

[Barb Niland:]

Thank you.

[Operator:]

Thank you. Our next question comes from Peter Skibitski from Drexel Hamilton. Your line is open. Please go ahead.

[Peter Skibitski:]

Good morning, guys. Nice quarter.

[Mike Petters:]

Good morning. Thank you.

[Barb Niland:]

Good morning.

[Peter Skibitski:]

Hi Mike. On this news out there in the quarter that kind of postulated a work ship you guys of, call it roughly 40%, I think on SSBN(NYSE

[Mike Petters:]

The short answer is, no, I don't have a comment on that. The broader answer is what we have said before. We are working closely with the other members of the Submarine Industrial Base and the U.S. Navy to try to find the very best way for the nation to produce the Ohio replacement program at the same time that it is producing Virginia-class program. The Submarine Industrial Base has shown that is able to do that in a very, very efficient and effective manner and we are working our way through that now. And so more to come, we will negotiate that and then come back and let you know how it all turned out.

[Peter Skibitski:]

Okay. Great. Just one follow-up. On DoD's decision to do live fire testing on the Ford, is there any financial impact to you guys from that, either positive or negative?

[Mike Petters:]

Not that I would I would hazard to put any sort of programmatic estimate on it, we would probably be involved in trying to set up and also trying to evaluate. But the bigger issue there, I think fundamentally the bigger issue there is, when is the ship going to be ready to deploy. And this is going to change that schedule. And just in the past few days we have we members of the Navy telling Congress that they are short aircraft carriers and so I think that's a bigger issue for the Navy than it is for us.

[Peter Skibitski:]

Okay. Got it. Thanks guys very much.

[Barb Niland:]

Thank you.

[Operator:]

Thank you. Our next question comes from Sam Pearlstein from Wells Fargo. Your line is open. Please go ahead.

[Sam Pearlstein:]

Good morning.

[Mike Petters:]

Good morning.

[Barb Niland:]

Good morning, Sam.

[Sam Pearlstein:]

Can you talk a little bit about capital? And where I am going with this is, one is what should we think about as the ongoing quarterly interest expense now with the refinancing? And then secondly, given that you have got probably a better than expected rate, why didn't you borrow more buyback stock more aggressively? How are you thinking about capital? Because it seems like you certainly could have borrowed more to do something like that?

[Barb Niland:]

Okay. So I will start with the interest expense. After this year, we will expect to see about $12.8 million savings related to that bond refinancing going forward, so for the year, okay. As far as you asked about capital expenditures or do you just want to talk about --?

[Sam Pearlstein:]

No. Capital allocation. Like why not take advantage of the lower rates and maybe do more in terms of the repurchase? I know that the Board just added the authorization, not capital expenditures, but thinking about the capital of the business.

[Barb Niland:]

So we are going to talk more about that on Tuesday at our Investor Conference. So can we hold that question till then?

[Sam Pearlstein:]

Okay.

[Operator:]

Our next question comes from Robert Spingarn from Credit Suisse. Your line is open. Please go ahead.

[Robert Spingarn:]

Good morning.

[Mike Petters:]

Good morning.

[Barb Niland:]

Good morning.

[Robert Spingarn:]

Barb, could you just go through what you said a moment ago about the puts and takes or EACs, if you will, in the two businesses? You talked about LHA-6, the magnitude of that and any other major positives or negatives at either business?

[Barb Niland:]

Sure. So we had $82 million of gross favorable adjustments and $20 million of gross unfavorable adjustments and net adjustments were $62 million for the quarter. So some of the usual suspects. VCS positive adjustment or favorable adjustment. I talked about LHA-6. NSC programs, some favorable adjustments and on CVN-71, we had some outstanding contract regulations. And on the unfavorable side, it was the CVN-78 and a couple gnits and gnats, none individually significant.

[Robert Spingarn:]

Okay. Thanks for that. Mike, with CVN-78, it sounds like there are some cleanup items ongoing. Barb just mentioned them. How much longer might we expect to see that at this stage, given that you are so close to the end.

[Mike Petters:]

Yes. I mean the ship is essentially built and where we are now is, we are taking all of that as new systems and we are testing the systems, testing each of the systems out but we are also testing the integration of the systems with each other. Significant amount of new technology in the programs, significant amount of software associated with these systems. Some of it is contracts that are furnished that we have been responsible for. Some of it is government furnished that the government has brought the system to us and now we have to integrate it into the ship and test it. This is the romance of our business is that the test program is designed to iron all of the stuff out. It's really hard to predict how these things are going to go. The team is working really hard to work its way through that. The main thing though is that the schedule is holding and we are on track to deliver this ship in the first half of next year. And so from that standpoint, I think that that sort of puts a boundary on the timeframe of the impact of this program to where we are. We are really disappointed that we this has played out the way that it has. But at the same time, we recognize that it's a lead ship and it's still the best lead ship program I have ever been associated with. So from that standpoint, it's still going pretty well.

[Robert Spingarn:]

Okay. And then just, Barb, a clarification. You talked about the volatility in the margins. We understand that. But the implied fourth quarter for Ingalls is pretty low at that 9% full-year numbers. Anything we should interpret from that?

[Barb Niland:]

Well, I just wanted to remind everybody, the LHA-6, the big adjustment that we made the quarter made the margins pop.

[Robert Spingarn:]

Do we go back to normal? Or do we go back to lower than normal?

[Barb Niland:]

You are killing me.

[Robert Spingarn:]

Not trying to.

[Barb Niland:]

I will get back with, hey, by the end of the year, we will be at 9% plus in our shipbuilding business. How about that?

[Robert Spingarn:]

Okay.

[Mike Petters:]

And I will go back to what we have always talked about. If you try to predict where anyone of these things is going to be in any particular quarter, that's a bunny trail that we really don't recommend you go down. You have to look at the aggregate of the business over a four quarter period and see how that all smoothes itself out. Ingalls is doing really well. There is no doubt about that. That's not to say that Ingalls is going to always have every quarter be like this quarter has been. We are trying to make sure that you understand that there is some one-time things in this quarter that they have earned, but they show up in our accounting this quarter.

[Robert Spingarn:]

Okay. Thanks guys.

[Operator:]

Our next question comes from Doug Harned from Bernstein Research. Your line is open. Please go ahead.

[Finbar Sheehy:]

Good morning. It's actually Finbar, here for Doug.

[Mike Petters:]

Hi Finbar. Good morning.

[Barb Niland:]

Good morning.

[Finbar Sheehy:]

Good morning. A couple of things, sort of short. On Newport News, you announced layoffs earlier in the year because of the phasing and scale of the work coming up. Are you at the right level now? Or done with that? Or where do we stand with that?

[Mike Petters:]

No. This is just the first phase of that. And remember the cause of this that it's because we have three aircraft carrier deliveries in a very narrow window, I think it's now we are down. I think it's about 15 months now we are going to be delivering three carriers. And truthfully some of that was caused by the budget battle back about three years ago when the arrival of the overhaul was delayed due to a congressional dispute. But because we are going to be working through that over the next year-and-a-half, we are going to have another round of this next year that we are going to have to recognize. The saddest part of it all is that, on the other side of this, when we start heavy work into the buildup of the Kennedy workforce and the buildup of the Ohio replacement workforce, we are going to want to hire a lot of the folks back. And that's the problem that we have when we get a little bit out of phase is that, this coming and going is not healthy for the business. And it tears our heart out that we have to go through this sort of thing and we try to move mountains to prevent it. And our legislators try to do that too and it's incredibly unfortunate that we are going to actually have to go through this little dance over the next couple of years.

[Finbar Sheehy:]

And given the pressure on volumes, the presumed either layoff costs associated with that and then rehiring and retraining, are we looking at pressure on the margins there for some time to come from this?

[Mike Petters:]

Well, I think it's fair to say that the blended balanced shipyard operates in the 9% to 10% range. I think all-in-all across the industry, Newport News has a very bright future but they are going to have to work through some pretty tough issues in the next 18 months.

[Finbar Sheehy:]

Okay. Thanks.

[Operator:]

Our next question comes from Myles Walton from Deutsche Bank. Your line is open. Please go ahead.

[Mike Petters:]

Hello.

[Barb Niland:]

Myles?

[Mike Petters:]

Okay. It looks like we lost him. Move onto the next question.

[Operator:]

Our next question comes from Jason Gursky from Citi. Your line is open.

[Jason Gursky:]

Good morning, everyone.

[Mike Petters:]

Good morning.

[Barb Niland:]

Good morning, Jason.

[Jason Gursky:]

Congrats on the retirement, by the way. Can you just give us a quick update on the Avondale negotiations with the Navy? Expected timing and whether you have gotten any feedback from them on your proposal?

[Barb Niland:]

Yes. We did get a feedback with lot of question cost this past quarter and we are working with them. We have answered all of their questions and we are waiting to hear back from them. So as I said before, this will be a process and it's a continuous negotiation and providing more data to support costs on our proposal. So no real big change other than they gave us some questions. We answered the questions. We are waiting to hear back.

[Jason Gursky:]

And Barbara, are there are statutory timelines on this? Or is this just an open ended negotiation and it is done when it is done?

[Barb Niland:]

Actually we have a statutory requirement at the next year, sometime next year. And so we will either have to extend it or settle it or if we are in total disagreement take a decline. But I am optimistic that we will work together with our customer, have a resolution that meets our expectations.

[Jason Gursky:]

Okay. Great. And then, Mike for you, on the CapEx side of things, we are running a little bit lower than what was expected for this year. What does that say about margin rates over the next couple of years? I know that some of this CapEx was going to go towards things that were going to help improve your cost structure and your ability to perform over the longer-term. There is lack of a ramp in CapEx this year, push out the potential positive impacts of that capital?

[Mike Petters:]

We have not ever really said that this capital was going to improve near-term margins. This is really, I think I have characterize it is a generational investment in our business. And it's really about the long-term support of programs over the next couple of decades. So the time phasing that you are seeing now is really driven by our analysis of the project, where it stands and then how you bring that project into --how do you start that project up in a way that's not terribly disruptive to the work that you have already got going on. And so it's a pretty massive planning job to think your way through. I am building the most complex warships in the world and now I am going to redo the facilities or create new facilities while I continue to build the most complex warships in the world. And so you know we are very thoughtful about that before we cut the money loose to go and invest in a project because once we cut it loose it's too late to go back at that point. So we are doing a lot of analysis. We are doing a lot of study, a lot of planning, a lot of interaction with all our program folks and with our customers to make sure that we keep everything that we have got on track but that we can effectively and efficiently cut in the programs or cut in the projects in a way that they will support programs as best they can. So there is a lot going on here, but I think it's evidence of the thoughtfulness that's going into these investments.

[Jason Gursky:]

That's great. Thank you.

[Operator:]

Our next question comes from Ron Epstein from Bank of America. Your line is open.

[Ron Epstein:]

Hi. Good morning, guys. Good morning, Mike.

[Mike Petters:]

Good morning.

[Barb Niland:]

Good morning.

[Ron Epstein:]

A big picture question for you. As you think about the future of the business, you guys make one move to diversify into the oil engineering services stuff that didn't really play out. Do you think about other ways to take the business and to diversify some away from just the large shipbuilding or for evermore is the business a shipbuilding business?

[Mike Petters:]

Well, Ron, we are going to talk about this at some length on Tuesday. Let's just say that I still think that there is a lot of capability in our business and there are customers out there that need it. And so trying to find the right business arrangement that allows that kind of access to happen is something that we believe needs to happen. And so like I said, we will talk on Tuesday a lot about who we think those customers are and how we plan to think our way through that. But yes, I still think it's really important for this business to not be so focused in on one single customer and one single approach because frankly there are a lot of people out there that do a lot of great things that we can learn from and we do a lot of great things that they can learn from us. And so that's what's going to, I think ultimately create more value in this business.

[Ron Epstein:]

Okay. Great. And maybe just one follow-on, kind of related. When you look out over the next year or so, what other opportunities are there right now within the core business that you are looking to chat or they are on the horizon?

[Mike Petters:]

Well, if you take a look at this business over the next five or 10 years, the single most important issue in front of the industry, not just us, but the industry is how is the Navy going to pay for the Ohio replacement program. If the money for that program is going to be paid out of the traditional shipbuilding account at the traditional levels, then a lot of other programs are going to be affected. On the other hand, if there is a way for that program to be funded, either outside of shipbuilding account or above the shipbuilding account, then you have a chance for the industry to remain healthy in support of all these programs that the Navy needs. And so you know when I step back, there is probably a lot of things that we have done some technology investment in undersea warfare. We bought an undersea systems group that brought some technology to us and we are interested in those kinds of things. And you can stack all of those programs up. But at the macro level, the most important issue facing the industry today is how is that Ohio replacement program going to be funded. It has to be done. It's a national priority. I am a little biased. I was a boomer sailor myself when I was back in the Navy. But it is something that the nation is going to do. And so the question now is, how do you do that and still do all of the other things that we need to be able to get done.

[Ron Epstein:]

Okay. Great. Thank you so much.

[Mike Petters:]

You bet. Thank you.

[Barb Niland:]

Thank you.

[Operator:]

[Operator Instructions]. Our next question comes from Darryl Genovesi from UBS. Please go ahead.

[Darryl Genovesi:]

Hi guys. Thanks for the time.

[Mike Petters:]

You bet.

[Barb Niland:]

Good morning.

[Darryl Genovesi:]

Barb, when I look at your presentation slide on page seven, it shows a downward variation of the FAS/CAS income [indiscernible] and the discount rate, I think that's opposite to what we are accustomed to seeing. Can you explain what's going on there?

[Barb Niland:]

Right. Well, what we did on this chart is, we assumed that FAS and CAS move equally so we probably should have footnoted that on there. So when you think about it, when the discount rate goes up, your expense goes down. So well that's the nuance here. We just assumed that FAS and CAS moved equally.

[Darryl Genovesi:]

Okay. And Mike, if I could just ask you a bigger picture question, that admittedly is probably better save it for Tuesday. You have talked a few times about, in fact you have talked very frequently about shipbuilding business is doing 9%, 10% EBIT margins through the cycle. When I compare this with other defense businesses, we have seen margins at other defense primes move up pretty significantly over the course of lifecycle. A lot of them are doing 12%, 13% EBIT margins these days. And I just wondered if there is something that's sort of structurally different about shipbuilding that you think makes it an inherently lower margin business than, say, aircraft or other vehicles or whatever the case maybe.

[Mike Petters:]

That's a really good question. I mean it is sometimes disconcerting to see the challenge for the businesses that are so capital intensive to be in a second tier of margin relative to some of the other programs in the business. But when I step back and think about why that is, I think there is probably two things that don't get a whole lot of attention. One is, a lot of those businesses that are at higher margin, they have actually done some of the same things that we do. They are in serial production of their product. They just have lots of products. And so even in shipbuilding, where we are able to get into serial production in our programs, we are able to drive our margins and drive our investment plans to perform very well. The challenge that this company has, is that a significant part of our businesses doesn't really can allow for serial production. I mean serial production in aircraft carriers is, yes, I mean we optimize that if we could build them three or four years apart, but that's not the way they are being bought right now. And so that creates risk in the program that doesn't exist if you are producing 100 planes or an assembly line kind of operation. So that's one part of it. But the other side of it is that the capital investment that we make in our business has a much longer life, I think than the capital investment that gets made in some of those other businesses. These great companies that build these high-performance platforms for the department, they are inserting technology in their assembly lines and into the product and they are making that investment and they are getting that return because they have multiple products. So they are getting that return pretty fast. For us, we are making a pretty substantial capital investment in our business, it's going to play out over the next 25 years. So there is a pace to this business that's a little bit different. And as a result, I think that you know, our customer is able to go and say here is where I want to go over the next 30 years. 30-year plans change sort of the risk profile of the industry. And so I think all of those things sort of conspire together to create a situation where the healthiest business for us is in the 9% to 10% range. We certainly are going to have quarters where we are above that. And we are going to have quarters where we are below that. But I think that over a 30-year period, if a shipbuilding enterprise operates in the 9% to 10% range, that's a pretty good business.

[Darryl Genovesi:]

That's great color. Thanks a lot.

[Mike Petters:]

You bet.

[Operator:]

Our next question comes from George Shapiro from Shapiro Research. Your line is open. Please go ahead.

[George Shapiro:]

Yes. Just a couple of quick ones. On the Ingalls margin Barb, would it be fair to assume that since the pickup came from primarily LHA-6 and that was one of your last underperforming ships that the likelihood of getting those kinds of pickups in the future is low and that's why you are saying a lot of it's nonrecurring?

[Barb Niland:]

I am not saying it's impossible that in the future you will see a large pickup or a pickup to that extent. But Ingalls, like we have said, is doing very well. All the ships are performing very well. We have a very methodical approach to risk retirement on all of our ships, both at Newport News and at Ingalls. And this just happened to be some contract changes, completing a couple things on LHA-6 that gave us a nice little pop there.

[George Shapiro:]

Okay. And then just to follow-up on the FAS/CAS, most of the other companies imply that the CAS does not move around as much as the FAS does. So is it really maybe just an overly conservative assumption to assume they will both move equally?

[Barb Niland:]

It was a conservative assumption. Really when you think about this, it's not only is at the expense side, but it's really moved the liability side and that's really where you want to see the discount rate go up for us.

[Mike Petters:]

Yes. I would point out, George, that overly was your word, not ours.

[George Shapiro:]

Okay. Again, Mike, when you talk about the 9% to 10% range for shipbuilding and then you talk about the difficulties of Newport over the next year or two. I mean, is it possible. Newport's margin would drop below the 9%, but Ingalls would be enough higher that you are still in the range that you are talking about?

[Mike Petters:]

Well, I think in the macro, that's certainly one possible future for us. Our targets are to keep both of our business in the 9% to 10% range. The challenge at Newport News has right now is that not only do they have those three carrier deliveries, but they are all cost type work. And so that is a little bit just the contract types are off balance for them as to where they normally are. The normal carrier construction business is a price type contract as opposed to a cost type contract. And so there is a little bit of imbalance in contract type at Newport News that they are going to be working through at the same time that they are working through these three contract deliveries. And so that's a little bit, in my experience, that's a bit unusual for them. And that's going to put some pressure on them. We have got a great team there and they are doing what they need to do and we have got some good targets for them. But in the aggregate, I think it's fair. You have got a good point. If you step back and look at the entire shipbuilding business in aggregate, we certainly believe that we are going to be in that range for as far as we can see.

[George Shapiro:]

Okay. Thanks very much.

[Barb Niland:]

Thank you.

[Operator:]

[Operator Instructions]. Our next question comes from Myles Walton from Deutsche Bank. Your line is open. Please go ahead.

[Myles Walton:]

Thanks. Sorry about the technical issues last time. Mike, you talked about the 18-months delivery for the three carriers. And I wonder how much of a proxy of the headcount reductions we should think about as a proxy for the sales headwind that you are anticipating on the back of those leaving the shipyard? And then secondarily, can you size for us or maybe just rough order of magnitude or comments on the Ingalls towards the end of the decade, what kind of revenue profile headwinds there may or may not be that the authorizer seem to be looking to accelerate ships into to avoid?

[Mike Petters:]

Right. So certainly when you are at this point where we are reducing headcount at Newport News, that's going to have some effect on volume at Newport News. But as I pointed out, Newport News, you step back and look at this over a five or a 10 year period as we look at it. In my view, they have the brightest future of any of the businesses in the industry because the demand for the products that they have out there is higher. It's making headlines. And so there is a buildup of demand for the work that Newport News is doing. And it's just that we have got to get through this in phase of this last cycle, the new class of ships, the inactivation and the delay that we saw in the refueling that we have got to work through that turbulence to get to the beginning of that future. And so if you go out over five years, I think Newport News is going to be in great shape. At Ingalls. I think it's a little bit different in that, things are going really great there right now. We have got four different classes of ships under construction in that shipyard. But if you look down the sideline at each of those classes, you start to see that that follow-on programs are where all the risk is going to be. We are at the end of the LPD program, for instance. And so the decision to bridge from the LPD program to the LXR program via LPD-28 is a huge decision for Ingalls. And it does create some stability going forward, assuming the LXR program can be accelerated. And as we talked about before, the LXR program is going to be, I think, tied to what happens with the Ohio replacement program. So these things are all kind of intertwined. The destroyer program at Ingalls, I think, is in reasonably good shape going forward in terms of the outlook for destroyers. The large deck amphibs, we are building the seven today and we will be competing, we are in competition for the eight going forward with the LHA-8 and the TAOX. And so that needs to get settled. But then the question is, what happens after that. And then you are going to see, we are building six. The program of record was for eight. There is talk about ninth one. So that's kind of playing out there. There is discussion of an icebreaker out there that is in there. So Ingalls, it's a little bit harder to pin down where Ingalls is going to be in five or 10 years than it is to pin down Newport News. And a little bit more dynamic environment at Ingalls. And a lot of their success in the future depends on how well they do the work they are doing today. And we are very, very pleased with where we stand.

[Myles Walton:]

One other one, Mike, if I could. The shipbuilding account that you set aside are potentially set aside for the boomer and other items outside of the typical shipbuilding budget. In a scenario, what's the right size for that budget to be kind of on a go forward basis, as you think about it?

[Mike Petters:]

Yes. Well, that's a good question. And I guess I am less concerned about the mechanism for the funding. The legislative branch has created a mechanism for the funding. I think the Department of Defense is thinking about whether that's the right mechanism or if there is another way to do it or do we just bring it back into the shipbuilding account. I think what matters here is that you fund the design and you fund the early lead time procurement, you fund that on time. We have seen over and over and over again, what happens when you get yourself into a place where you need to move into production and the design is not done or the suppliers are not sorted out. And so I think what matters right now is that we keep the funding profile for the design and the early procurement, because that's going to set the stage for early success in that program. And that's going to be ramping up over the next over few years. I mean it's a pretty healthy requirement to keep that program on track.

[Myles Walton:]

Okay. Thank you.

[Mike Petters:]

You bet.

[Operator:]

Thank you. At this time, I would like to turn the call back over to Mike Petters for any closing remarks.

[Mike Petters:]

Well, I thank everybody again for joining us on today's call. And I want to wrap up by making sure that you know you could still sign up to come to our Investor Day, either in person or via webcast next Tuesday starting at 8

[Operator:]

Thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.