Huntington Ingalls Industries, Inc.
Q4 2013 Earnings Call Transcript

Published: 27 Feb 2014

[Operator:]

Good day, ladies and gentlemen, and welcome to the Huntington Ingalls Industries Q4 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Dwayne Blake, Vice President, Investor Relations. You may begin.

[Dwayne B. Blake:]

Thank you, Nicole. Good morning, and welcome to the Huntington Ingalls Industries Fourth Quarter 2013 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?

[C. Michael Petters:]

Thanks, Dwayne. Good morning, everyone, and thanks for joining us on today's call. As most of you know by now, we have a straightforward business philosophy at Huntington Ingalls Industries. We do what we say and we say what we do. When we spun off from Northrop Grumman almost 3 years ago, 2013 was viewed as an inflection point in our margin expansion story. And I am pleased to report to you that our financial results for 2013 are right in line with our expectations and keep us on track to achieve our target of 9-plus percent operating margin by 2015. Sales for the quarter of $1.9 billion were up 6%, and for the full year, were up 2% to $6.8 billion. Adjusted operating margin for the quarter at our Ingalls segment improved by 73 basis points to 6%, continuing a trend of improving performance, while our Newport News segment continued to deliver solid performance at 9.1% for the quarter. Adjusted diluted EPS was $1.66 for the quarter and $5.36 for 2013, up significantly over last year. Additionally, during 2013, we increased our backlog by 16% to $18 billion, of which $12 billion is funded. Our entire team has remained focused on safety, quality, cost and schedule, and achieved several significant milestones during the year, including

[Barbara A. Niland:]

Thanks, Mike, and good morning to everyone on the call. Today, I'm going to focus my discussion on key highlights from the fourth quarter and year-end results. I will also provide some information on our outlook for 2014. Please refer to the slides posted on our website for more information. Before we get into the detail, during last quarter's call, we discussed hurricane insurance recoveries and the Gulfport closure that had a significant impact on sales and the operating margin at our Ingalls segment. We had additional adjustments in the fourth quarter related to the hurricane insurance proceeds. These fourth quarter adjustments were refinements of our estimate, not changes in our position on the accounting treatment. All of the numbers that I discuss today will be adjusted for these third and fourth quarter events, where applicable. Please refer to the presentation on our website or our earnings release for reconciliations. Moving to consolidated results, shown on Page 4 and 5 of our presentation, we ended the year with a strong quarter at both Newport News and Ingalls. Total revenues increased 5% for the quarter, bringing full year revenues to $6.8 billion, a 2% increase over prior year. The growth in the fourth quarter was mainly driven by the Ingalls segment, related to increased volumes on DDGs and NSCs. Fourth quarter total operating income was $156 million, up 47% over prior year, which drove full year operating income to $465 million, up 30% over last year. These results were mainly driven by increased operating income at both segments and favorable variances and deferred state income taxes and the FAS/CAS Adjustment. Deferred state taxes are different from the estimate that we provided to you on the third quarter call. During the fourth quarter, we finalized our 2014 planned pension contributions, and our estimate was reduced. Since for tax purposes, pension contributions were pulled forward a year, the change impacted deferred state income taxes in the fourth quarter. We generated $238 million of free cash flow in the quarter and $97 million for 2013. This year included an increase in cash taxes and higher pension contributions that were somewhat offset by improved program performance and the hurricane insurance proceeds we received in the third quarter. Additionally, working capital is burdened by closure costs related to Avondale and Gulfport facilities, which will not begin reversing until we reach final agreement with the Navy. Capital expenditures for the quarter were $54 million and were $130 million for the full year, which were in line with our expectations. During the quarter, under our share repurchase program, we purchased over 800,000 shares at a cost of $64 million. Looking ahead, we expect our operating margin to continue to show improvement towards our 2015 target of 9%. Our expected increase in free cash flow in 2014 has shifted to the right due to the delay in the recovery of Avondale closure costs and the additional working capital related to the Gulfport shutdown. Capital expenditures are expected to be in the 3% of sales range. The increase in CapEx is related to investments in Newport News that will increase efficiency. Moving on to segment results on Pages 6 and 7, Ingalls had strong sales and operating income growth for the quarter. Sales were up 9% due to the increased volumes from DDGs and NSC. Operating margin was up 73 basis points over the prior year quarter, primarily due to continued risk retirement on the NSC program. For the full year, Ingalls' adjusted operating margin increased by 123 basis points over last year to 4.6%, in line with our expectations. This increase is mainly attributable to lower volume on underperforming contracts that we were working out of our portfolio and risk retirement on the NSC program. Turning to Page 8. Newport News fourth quarter sales increased 2%, primarily due to higher volumes in aircraft carriers. Operating margin for the quarter was consistent with last year at 9.1%. For the year, Newport News performance was strong, with $4.1 billion in sales, an increase of 5.1% over last year, with all product lines supporting the growth. 2013 operating margin was 9.5%, up 33 basis points from last year, largely driven by program performance improvements and risk retirement on the VCS program. If you'll turn to Slide 9, I'd like to make a few comments on pension. We are expecting a favorable 2014 net FAS/CAS Adjustment of $92 million, based on an increase in the pension discount rate from 4.24% to 5.27%, holding our long-term return on asset assumption of 7.5%. 2014 cash contributions, net of CAS recovery for pension and postretirement benefit plans, are expected to be a benefit of $65 million, mainly due to our pension plan's steadily improving funded status and the phase-in of harmonization. For 2013, our actual return on pension assets was 10.5%. Regarding some of the other income statement items in 2014, deferred state taxes should provide a benefit of about $5 million, based on current 2015 pension assumptions. Interest expense should be roughly $115 million and our tax rate should be close to 34%. Lastly, beginning in 2014, AMSEC and CMSD, approximately 10% of Ingalls' revenue, will be part of our Newport News segment. The change will be reflected in the financial statements starting in the fourth -- the first quarter. That wraps up my remarks. And with that, I'll turn the call over to Dwayne for Q&A.

[Dwayne B. Blake:]

Thanks, Barb. [Operator Instructions] Nicole, I'll turn it over to you to manage the Q&A.

[Operator:]

[Operator Instructions] Our first question comes from the line of Joe Nadol of JPMorgan.

[Christopher Sands:]

It's actually Chris Sands on for Joe. Mike, I was wondering if you'd give us some color on the impact if George Washington were to be retired instead of the RCOH, both financially and operationally.

[C. Michael Petters:]

Well, it's -- I mean, let's step back and recognize that whether the ship is refueled or inactivated, the work would be done at the Newport News site. And so the discussion around George Washington has some -- would have a little bit of impact in Newport News in the -- really, in the timeframe of the inactivation, the RCOH, may affect the planning, although that's not really clear yet. It looks like we may be planning either way right now. But the bigger issue is that this is really a debate about how big is the Navy going to be. And interestingly enough, if you follow this very closely, you'll have a front row seat at how the nation makes that decision. You'll see all the opinions come out in the blogs. You'll see lots of viewpoints on how many carriers we need and where they need to be. There will be some discussion about industrial-based impact, but I don't expect the industrial base to be the driving force in the decision around how many carriers we have. And so at Newport News, it's going to be how much is the planning affected over the next couple of years. We don't know that yet. What does it do to the volume if there's an inactivation instead of an RCOH? I think we said before that an RCOH is about half the volume of a new construction job, and the inactivation is about half the volume of an RCOH. So the actual execution volume would be impacted a little bit, which would then have some effect on rates and things like that in the shipyard. But the real issue around 73 is going to be the much broader strategic issue of how does the nation decide how big a Navy it wants.

[Christopher Sands:]

But if you were to skip an entire RCOH, I mean, would you expect that to be pretty disruptive to future RCOHs, just in terms of the skills being lost?

[C. Michael Petters:]

No, because, I mean, certainly we have teams today that are bringing new construction ships to life at the same time that we're doing the RCOHs. And so you think about an RCOH, it -- the RCOH is probably the most complex work that we do, because you're doing the defueling of the ship, you're doing the refueling and startup of the ship, you're repairing the ship after 25 years at sea, and you're doing modernization work. As far as the nuclear test program, the refueling and the startup of the ship and the RCOH is comparable to the work that we do on the new construction carriers and in the submarines. And so the folks that do that, you have to make sure their training and qualification is all aligned, but the basic principles are essentially the same. Where it comes to the modernization and repair packages, those are basically driven by the amount of planning that you do and how detailed the planning is. And so I don't see it as being -- I see it as being a volume impact. I don't see it as being any specific critical skill that would decay away and be a problem for future RCOHs. I don't really see it that way at all. I do think that you have to make sure that you keep a sequence going, because the facilities that are available to do these RCOHs and inactivations, they're very, very limited and very tightly scheduled, for as far as we can see. And so what will matter is that if we decide to inactivate the ship, it needs to be inactivated on time. If we decide to refuel it, we need to refuel it on time so that we can do the next refueling on time.

[Christopher Sands:]

Right. And then, Barb, just one on cash flow. You mentioned that the working capital reversal related to the closures slipped to the right. Do you anticipate that you'll recover anything related to Avondale this year in Q4? And just, generally, if you could provide more color if you think that free cash flow conversion could be below 100% again this year?

[Barbara A. Niland:]

I think that it is unlikely -- we will attempt to start recovery in the fourth quarter, but it is unlikely that will occur. I believe it will move into next year. And as far as the free cash flow conversion, like I said, you have to look at us over a 5-year period, a much longer period. I can't guarantee we'll have 100% cash conversion in any given year.

[Christopher Sands:]

Okay. And then would Gulfport recovery start this year?

[Barbara A. Niland:]

We are working that to start recovery this year. Again, that has the potential to slip into next year, but we're doing every effort that we possibly can to make it begin this year.

[Operator:]

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

[Samuel J. Pearlstein:]

I just wanted to follow up on that free cash flow question, which was just -- I know you highlighted the pension piece, which looks a $212 million swing year-over-year. Can you just talk about cash taxes, the closing costs, any other big swings from '13 to '14 in terms of just cash flow?

[Barbara A. Niland:]

From '13 to '14, so I haven't really given specific guidance into '14. I mean, we have given you what we think the pension would be. In terms of cash taxes, I really don't want to give specific guidance for '14, so...

[Samuel J. Pearlstein:]

Okay. And Mike, if I can ask you just a question. I know you mentioned the Virginia-class sub multiyear could come mid-year. I don't know if I caught it, but did you talk about when the next Ford-class carrier timing could be and where you are on the cost to get a better estimate in order to price that ship?

[C. Michael Petters:]

Yes. Our -- the 79 contract, Kennedy, is the one that is kind of in play now. Our desire was actually to have that contract before the end of 2013. For a lot of reasons around the fiscal issues, as well as the cost caps on the Ford itself, the decision was made that before we can actually go to a contract for 79, we need to actually have further progress on the 78. Now we are doing extensive construction preparation work on the 79 today in the shipyard. There are units that we are working, very high-volume, frankly, through getting that ship ready to be constructed. We have been working with the Navy to move towards a contract. Our expectation is that we can get to a contract this year that -- probably later in the year, and we'll just have to see how this plays out, I think. This is not -- I mean, it's a little bit hard to talk about, but it's really not unusual. This is what we went through when we actually went to contract on the Ford. The original Ford construction contract was set for 2006. We ultimately did not get to that contract until 2008. In that case, we were coming through the design, and we needed to make sure that the design matured before we went to the contract. Now we're coming through the construction of the lead ship. And we expect this contract to be, as opposed to the cost-type contract that we have on Ford, we expect the contract to be a price-type contract on the Kennedy. And so everybody, the Navy and the company, everybody wants to make sure that we understand what the risks are associated with the construction when we go to that contract. And so we're working very closely with the Navy to get that done. The delay in the contract is, it's not the optimum way to do this. On the other hand, it's not slowing down construction on the ship today.

[Operator:]

Our next question comes from the line of Doug Harned from Sanford Bernstein.

[Douglas S. Harned:]

I'd like to understand a little bit more about The S.M. Stoller acquisition, and the things you're doing outside of the core Navy shipbuilding business. As -- I mean, we're looking ahead at quite a bit of cash generation over the next few years. And can you give us a sense of the scale of effort that you're undertaking, or if you are diversifying into new areas? And sort of at what scale this is? And how much cash might end up going into something outside of the core?

[C. Michael Petters:]

Well, without trying to predict any certain amount, what I would say is that we're taking a hard look at what our capabilities are and what are the markets that we think we can address those capabilities to. We are a company that has a very strong engineering background. We're very solid in managing a very deep and expensive supply chain and we have a long history of doing modular manufacturing construction. We have already, before the Stoller acquisition, we had already formed a partnership with Fleur to operate at the Savannah River nuclear site, and that's been going on for several years. We have explored partnerships with other firms in pursuit of potential opportunities in the DOE space. Because, quite frankly, that's one of our key areas of capability. We do very solid -- we're best in class when it comes to nuclear operations. And so there are a lot of companies out there that have wanted us to be part of their teams for different opportunities. In the course of that effort, we found ourselves partnering with S.M. Stoller on a number of different occasions and meeting with them and finding that they have a set of skills that are very complementary to us. One of the things that I like the most about this company is that they have a customer intimacy that we would take, frankly, years to develop. They're located in dozens of sites around the country for the DOE. And I liken that to our operation in the Navy side at AMSEC, where AMSEC has a couple of dozen offices around the world. Wherever the Navy is, that's where AMSEC is. While wherever the DOE is, it seems that Stoller is there as well. And this is an opportunity for us to work with them to leverage the unique capabilities that we have to better address the DOE space. Going forward, it is my view that we have some unique capabilities to offer to other customers. And we have talked pretty extensively about we do think that we can bring our engineering skill set and our modular construction skill set, we can successfully deploy that towards the oil and gas sector, so we've opened an office in Houston to do that. And we are taking a hard look at how do we take advantage of our skill sets, who do we partner with, and how do we do that in a way that is moderate risk, but has a great chance to be successful. And so we'll continue to evolve. I don't see this as being something that's going to double the size of the company in a year. I see this as being something that's going to evolve over time. And as we build a record of success, we can -- just like we've done over the last 3 years since the spin, but in the last 6 years since Barb and I first got responsibility for all of shipbuilding, we have evolved the business to a place where we're ready to go and achieve more of our full potential. So this is a walk down a path to see how do we redeploy the tremendous capabilities that we have.

[Douglas S. Harned:]

I know you're well aware of the risks associated with diversification from defense-oriented businesses. And it's just something that, I think, if there's a way to describe sort of the scale of this activity and how you would minimize the risk, and I think that will be very important for people to understand here. I mean, it just -- it tends to raise a red flag, and so I'm just trying to get an idea from you about what that path will look like and how people who own the stock for Navy shipbuilding and what that -- and the potential that has, can get comfortable with this as a use of cash?

[C. Michael Petters:]

Well, I think that, Doug, the challenge that I would suggest that every defense company is dealing with today is how to, in this environment, how do you articulate the way that you're going to grow the value of your business. A lot of the companies, as I look around, I see that -- and hear that they're talking about international opportunities or commercialization of products and those kinds of things. We don't really believe that international is a really solid way for us to try to enhance the value of this business. But we do have 5,000 engineers and designers in this company. We are an engineering company, and engineering is a great way to see a window into a new space. I don't know exactly what the path will take us, I don't exactly know how it's going to go down, but I have to tell you that I feel like I'm obligated to pick up every rock and look under it and see if we can find some value there. It's going to be an incremental approach at this point, because we certainly recognize that a big bang opportunity would be fraught with risk. And if you know anything about us, you know that we are very, very thoughtful about the risk that we consider.

[Operator:]

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

[Carter Copeland:]

Just a quick couple of clarifications, Barb. On the cash, with respect to 2013, can you help us size what the headwind for cash taxes was? And then with respect to the pension, you gave us the net number, but I wondered if you might tell us what the gross contributions and reimbursements were behind that number and whether or not that number is net of tax?

[Barbara A. Niland:]

Okay. So let's start with the cash taxes side. And on the cash taxes, that was $126 million, okay? And then on pension, the CAS piece of that is $227 million for the recovery side, and the FAS piece of that is $135 million, okay? And that includes PRB -- I don't know if you want that. PRB is our...

[Carter Copeland:]

Post Retirement, yes. Do you have just the pension?

[Barbara A. Niland:]

Sure. From a pension standpoint, the CAS piece is $192 million, and the FAS piece is $118 million. Okay, so that net for just pension is $74 million.

[Carter Copeland:]

Okay. And then to move away from the pension, and get to a bigger picture question. Mike, I wondered if you might tell us what you're thinking about the language around a new surface combatant that the secretary is talking about as part of a smaller LCS buy. What opportunities might you guys have to play in that and what might that mean from your standpoint?

[C. Michael Petters:]

Well, it's very early. I mean, you heard the same things that we heard. And ultimately, this will depend on how the requirements get set and how you can match up against those requirements. But we have -- we have been building the National Security Cutter for the Coast Guard for several years now. And we have a -- this ship is proving itself at sea for the Coast Guard. If the requirements align with that kind of a platform, then I think that we have a great opportunity. If the requirements align around some other set of missions and facts, then I think we'll have to take a hard look at that. But that's a platform, that's the size of a ship and a platform's capability set that we have been executing on for the last several years, and we've been doing that very successfully. So we look forward to the chance to understand it better and to engage with our customer to see how we match up with what it is they're looking for.

[Carter Copeland:]

Okay, great. And one final one. Barb, you said very quickly at the end that AMSEC was moving from one segment to the other? Was that correct? And what was the rationale behind that?

[C. Michael Petters:]

I'll take that one. When we -- AMSEC was -- and Continental were originally part of Newport News back in when Newport News was acquired by Northrop Grumman. They followed -- when we put all of shipbuilding together in 2008, we decided to keep -- to let AMSEC and Continental go with the nonnuclear side of the business, because all of the work that's done at Continental is -- at their yard, is nonnuclear shipbuilding. And frankly, Irwin had been responsible for AMSEC before that, and we just let him take that with him. The rationale today is that we're bringing them back home to where they were, primarily because the alignment between what AMSEC is actually doing out servicing the fleet and what Newport News does with the carrier support, there's a high degree of alignment there. And Continental plays an important role in resourcing the work that we do in support of the carriers at North Island in San Diego. And at Ingalls, the issue, the primary issues for Ingalls going forward, are really in capturing new business related to the amphib business, which we've talked about extensively here before. With the transition of the leadership team, as you know, Irwin is stepping down and Brian Cuccias will be taking over. With that transition, we felt it was appropriate to realign to get the priorities for each of those leadership teams better aligned with the folks that we have running it. So that's really why I wanted to do that. And I think it sets both Newport News and Ingalls up for a higher degree probability of success going forward.

[Operator:]

Our next question comes from the line of Jason Gursky of Citigroup.

[Jason M. Gursky:]

Barb, you mentioned that CapEx this year was going to be 3% of sales, and you mentioned that it was going to result in some efficiencies. So I was hoping that Mike and Barb, if either one of you could comment a little bit more about what the spend is going on and what those efficiencies might look like and whether that doesn't allow for potentially higher margins, either in the near term or over the longer term.

[Barbara A. Niland:]

So okay, the intent is that they will help us achieve higher margins longer term, not near term. But one of the capital projects that's included is we're replacing very old weld equipment. And with that replacement, it will be easier for the welders to get the equipment to where it needs to go, more efficient use of it. We expect that we'll see headcount reductions, as well as gain significant efficiencies in the new processes with this new equipment. And I believe this equipment is like 30, 40 years old. It is ancient. And so it makes the welders have a very difficult time. So that's one of the projects that we have. We have some other projects to gain efficiencies on the Virginia-class program, as well as for CVN-79 that we're looking at.

[C. Michael Petters:]

And I would just add that we do look at these projects in terms of what they might mean for reducing the risk of a program. Whether it's the risk register of a program that we have in place or the acquisition cost risk of a future program, we look at it both ways. I'm not sure that I'm ever going to be in a place where I'm going to let anybody convince me that a capital investment in something this quarter is going to change our margins next quarter. I just don't see that being this kind -- this is not that kind of business.

[Jason M. Gursky:]

Okay, fair enough. And then, Mike, you had -- I was wondering if you could make some bigger picture comments about the outlook for the amphibious shipbuilding plan? As we move now into the fiscal '15 budget process, we had the opportunity to listen to Secretary Hagel and Chairman Dempsey earlier this week talk about priorities going into this next budget cycle. What's your updated view on the outlook for the amphibious shipbuilding plan?

[C. Michael Petters:]

I'm not sure that it's changed that much. We have said that the Navy's hierarchy of priorities is carriers, submarines, destroyers and then amphibs and then auxiliaries after that. And that we've described that the resources seem to be running thin at the amphib line, and so that's where the scrum is for work to go. We are still advocating that a follow-on LPD be bought as a way to bridge from the current LPD production line, which is going very well, to a future program that the Navy has identified as LXR, which is a smaller version -- basically the small version of an amphib and it's a replacement of the, I think, it's the LSD 41 class. The gap between the end of our production in Ingalls and the beginning of that program is fairly lengthy. And so unlike the carrier discussion we had earlier, which is a -- I really think is a major, big strategic issue of how big does the Navy need to be, I think the amphib discussion is really a pure industrial -- it's not a pure industrial-based issue, because it is about how much lift do the Marines need and those kinds of things, but the industrial-based issues play a much bigger role in how you think about the amphibs. The Congress has appropriated $260 million for a follow-on amphib. They did that a year before last. Last year, they directed the Navy to come forward with what's your plan for continuing to support the industrial base around amphibs. We still believe that a follow-on ship makes good sense. The Navy plan does call for a follow-on large-deck amphib, LHA-8, and we're engaging and excited to engage with the Navy on how does that program, how's the best way to successfully execute that program. So there's a lot of interaction right now in the area of amphibs, and a lot of it is being driven by how do we get the capability that we need for the cost that we can afford. And we are happy to be part of that discussion.

[Operator:]

Our next question comes from the line of George Shapiro of Shapiro Research.

[George Shapiro:]

Barb, for 2013, receivables went up over $200 million, of which $68 million of that occurred in the fourth quarter. Now I'm assuming that's all due to the recovery you're looking forward to for Avondale and Gulfport. My question is, how much higher that receivable goes in '14, since it sounds like you're not expecting any recovery in '14? And for you, Mike, if you can just go through what the issues are in terms of the negotiation you have with the Navy in terms of getting that money back?

[Barbara A. Niland:]

Okay, George, let me start with the receivables. Some of that's also timing on that, okay? But as far like an increase for Avondale and Gulfport closure, it will be small. The majority of it is sitting there now, so less than half. So probably in the $20 million range.

[George Shapiro:]

Okay. So you would expect those receivables not to increase very much more in '14?

[Barbara A. Niland:]

Right.

[George Shapiro:]

Okay. And then, Mike, if you'd just go through kind of what the issues are with the negotiations with the Navy.

[C. Michael Petters:]

You're talking about the recovery on the restructuring?

[George Shapiro:]

Yes. For the recovery of the costs -- or the receivables that are there from Gulfport.

[C. Michael Petters:]

So George, the way that, that works is that the recovery becomes part of our billing base, and it's not a separate payment by the Navy over a period of time. The negotiations kind of move around a little bit. If you're thinking about what we're doing at Avondale as we continue to think about how do we redeploy it, there's the part of the recovery that's associated with the asset that's there, but there's also the part that's associated with the workforce that's there. We've incurred a lot of the workforce cost, and depending on how we move forward with the asset probably affects the way that, that negotiation goes. I don't know that anybody has a lot of experience with these kinds of events and negotiations. But what you, I think, typically -- where I think where we're headed is we're going to be negotiating around a set of actual costs over a period of time. And I think that, that in the meantime, I think that we'll be talking about what's our rate base look like.

[George Shapiro:]

So what's your confidence that all of what you have is receivables ultimately gets recovered from the Navy?

[Barbara A. Niland:]

Very confident.

[C. Michael Petters:]

Yes, very confident.

[Barbara A. Niland:]

Very confident. The reason why it's delayed, is one, we're doing work in Avondale for Ingalls. And so that is creating part of the delay. You can't close it down and start recovery. So that's part of the delay. And then part of the delay is just typical negotiations that we're going through.

[Operator:]

Our next question comes from the line of Bill Loomis with Stifel.

[William R. Loomis:]

Just looking at CVN-79, as you go into negotiations, what type of contract, fixed-price contract, does that look like it's going to be? Is that going to be something like a fixed-price incentive, where you basically contract, you share costs up to a target, and then have to assume all the risk beyond that? Or is it going to be a straight fixed-price program, is there going to be any cost-type elements involved in CVN-79?

[C. Michael Petters:]

I think that the top line answer is we expect it to be a fixed-price incentive contract. As we go to the table and as we think about where the different areas of risk are, I think that the team has the latitude to try to find the right way to build a contract around the risk that's there. There may be parts of this that are not fixed-price incentive, and they may -- and I think the whole range of different contract options are available. But in the main, at the highest level, we expect it to be a fixed-price incentive contract.

[William R. Loomis:]

Okay. But there will probably be some of the higher-risk elements. How about things that you're not necessarily fully in control with, like technology, radar, catapult, things of that nature, would that be potentially something that's not a fixed price for you?

[C. Michael Petters:]

Well, I think that, one of the big, one of the major discussions that we have going on today is there's a substantial amount of government-furnished equipment that comes to this ship and how is that scheduled and what does it look like. There's also a question of, what does the government want to buy for the next ship? What is the ship actually look like at delivery, and are they going to buy those pieces or are we going to buy those pieces? That's all part of the discussion. If it's something that's well proven and understood and they want us to go manage it, and we've managed it before, then we feel very comfortable with that. We can get an appropriate contract for that. Something that's brand-new that nobody has ever managed, and the risk register is very high, and you have a different kind of contract for that. So that's all part of the negotiations, and I think it's premature to try to say how that's all going to turn out. But I think that the headline of it will be that it's a fixed-price incentive contract.

[William R. Loomis:]

Okay. And then you protested the Offshore Patrol Cutter award. Can you tell us what were the key points that you are protesting on that?

[C. Michael Petters:]

Yes, I don't think I want to say too much about that, except that we view every -- we do everything we can to learn from every experience that we've got. And our view is that we want to understand this better. And so we've filed a protest so that we can have a better understanding of how the decision was made, so that we can go learn from this. And we'll see how the protest plays itself out.

[William R. Loomis:]

And just one final one, kind of a little bit longer term. But you've been trying to show how the LPD platform can be used for other things, like ballistic missile defense, much larger radars and so forth. Any chance that you've heard the Defense Secretary talk about a replacement for the littoral combat? Would that platform fit a role, or is it just not in the same ballpark?

[C. Michael Petters:]

A different kind of ship. I mean, a really different kind of ship. And the frigate that they're talking about for replacing the -- or the follow-on to LCS, or whatever it turns out to be, we need to set it. We don't know -- exactly know what the set of requirements are. But that's a small ship, a small surface combatant with a lot of capability. The LPD is a platform that is fairly large. And in my view, the reason it's so powerful is because it's incredibly flexible. It is -- I really think that the key to success going forward, when you're building platforms that last for decades and you're using technology that gets superseded every 18 months, I think the way that you are successful there is by putting survivable volume at sea. I think that Enterprise has lasted 50 years -- it was online for 50 years. The planes that flew off that ship at the end its life were not even on the drawing board at the beginning of its life. But the fact that the Enterprise was large and had large volume, gave that ship and gave the Navy great flexibility to do all kinds of missions. Whether it was power projection or humanitarian aid, whatever it was, that volume at sea was very important. What the LPD brings is large volume at sea. And so bringing survivable volume at sea is something that we think makes a lot of sense. We know that there are folks who actually understand that, that does make some sense, that we have a production line that's hot, and we continue to try to work that. But it's not related at all to whatever happens with a future surface combatant of some kind.

[Operator:]

Our next question comes from the line of Brian Ruttenbur of CRT Capital.

[Brian W. Ruttenbur:]

The dividend, as well as your buyback policy, you purchased $64 million in the quarter. And what is your plans going forward with your extra cash flow? Is it going to be equally weighted between dividend? Is it going to be more weighted towards buyback? What are the plans there?

[Barbara A. Niland:]

Well, right now, we have our buyback program in place. I don't see a huge change to that this year and we just have to see how things play out. No commitment, one way or another, except for with the current program, which is $300 million, and the current dividend policy that we have in place right now.

[Brian W. Ruttenbur:]

Okay. And then as a follow-up, G&A as a percentage of revenue going forward, what are you looking at as your ideal model with kind of flattish revenue, assuming flattish revenue going forward? Are you going to have a percentage of revenue or a dollar amount that you have in mind?

[Barbara A. Niland:]

I think it's tough to say that. I don't see any significant change, really. But you have to remember, a lot of things go into G&A. Every company is different. So in terms of thinking about that, you have, state taxes in there, you have group insurance, corporate leases, BMP, legal, all kinds of things in there. So I hate to give this answer, but it just depends, Brian.

[Brian W. Ruttenbur:]

Okay. So as a dollar amount though, it should be dropping in '14 versus '13, logically, as you...

[Barbara A. Niland:]

I think it's -- it should be about the same, but it really depends on what's going on.

[Operator:]

Our next question comes from the line of George Shapiro of Shapiro Research.

[George Shapiro:]

Just a different question. It looks like the 0 margin business this quarter was probably under 10%, which would imply that the underlying margin at Ingalls is like 6.5% or so. So what programs have that much upside to be able to get that to 9% by 2015?

[C. Michael Petters:]

So George, we have talked about this many, many times. The way that, that shipyard operates is that the 9% is a blended rate. The blended rate has to come from programs that are very mature, as well as programs that have just started. 3 years ago, we said we had to deliver 5 ships and we had to sign 5 new contracts. We have now delivered 4 of those 5 ships, the fifth one will deliver in the next couple of months. The 5 contracts that we signed, we signed all of those and we signed some extras to that. What you have to have, is you have to have a maturity, you have to have the time to mature each of those programs to a point where the risk has been retired to, so that their blended rate can bring the whole shipyard to 9%. And we have pointed out that the reason 2013 was the year of inflection was that our expectation was around the end of the year, around the end of the year of 2013, we would be pretty much through the 5 very mature ships that were not performing, which was driving the blended rate down, and we would have these new contracts. We actually don't get to 9% until 2015 because we need the new contracts to mature. And each one of those contracts has the opportunity to contribute positively to our overall assessment.

[George Shapiro:]

Okay. I know I asked this question a bunch of times. It just seems like to go from 6.5% to 9%, where you have effectively one year to do it, seems like a big jump, but maybe it's not.

[C. Michael Petters:]

Stay tuned.

[Operator:]

I'm showing no further questions at this time. I'd like to hand the call back over to Mike Petters for any closing remarks.

[C. Michael Petters:]

Okay. Well, thanks to everybody for participating in the call this morning. We do believe that we have achieved the things that we set out to achieve when we first spun the business 3 years ago. We'd identified 2013 as the year of inflection. We are at that point. The delivery of America is the last delivery of the 5 underperforming contracts. We're excited about the prospects for the future. We're committed to the 9% target for both of our businesses in 2015. We continue to think very carefully about how do we take full advantage and achieve the full potential of this business. And we're excited about everybody's interest in our business, and we're excited to engage with our customers as they plan their path forward. So we look forward to seeing you all. And thank you for your interest. Everybody have a good day.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Have a great day, everyone.