Good day, ladies and gentlemen, and welcome to the Huntington Ingalls Industries’ Second Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session and instructions will follow at that time. [Operator instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today’s conference Mr. Dwayne Blake, Vice President of Investor Relations. Sir, you may begin.

Thanks, Derrick. Good morning and welcome to the Huntington Ingalls Industries’ second quarter 2017 earnings conference call. With us today are Mike Petters, President and Chief Executive Officer; and Chris Kastner, Executive Vice President of 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 Chris 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 slide 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’ll 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. We released our second quarter results this morning that reflect solid performance across the enterprise. So let me share some highlights from the quarter starting on Page 3 of the presentation. Sales of $1.86 billion were up 9.3% from last year. Diluted EPS was $3.21 and operating cash was $186 million for the quarter. Additionally, we received $3.4 billion in new contracts, including $3 billion for detail design and construction of LHA 8 Bougainville, and $218 million for long lead material in advance construction activities for LPD 29. As a result, backlog was approximately $21.1 billion at the end of the quarter of which $14 billion is funded. Regarding activities in Washington, we were honored to participate in a shipbuilding hearing before the Senate and Armed Services Committee, Seapower Subcommittee, this past May, where we advocated for stable and predictable funding for shipbuilding as well as an end to sequestration. The hearing also afforded an opportunity to highlight the inherent efficiencies and cost savings of leveraging high production lines and multiship procurement strategies for Ford-class Aircraft Carriers, LPD 17 class amphibi ships and DDG 51 Class Destroyers. We are pleased with the progress being made by the defense authorizing and appropriating committees in Congress with regard to the fiscal year 2018 budget and I encouraged by the support for Navy shipbuilding in various builds. As the administration complete its national defense strategy review this summer, we look forward to seeing how results will shape the fiscal year 2019 President’s Budget as well as the future year defense program. However, looming over all of this is the Budget Control Act, which remains a lot of land as well as the need to determine how Columbia-class submarines will be…

Thanks, Mike, and good morning. Today, I will review our second quarter consolidated and segment results as well as provide you with a few updates for the second half of the year, starting with our consolidated results on Slide 4 of the presentation. Revenues in the quarter of $1.86 billion, increased 9.3% over second quarter 2016 due to higher volumes at Ingalls and acquisition of Camber, which contributed approximately $85 million. Operating income for the quarter of $237 million, increased $20 million or 9.2% for the second quarter of 2016, primarily driven by the FAS/CAS Adjustment. Operating margin of 12.8% was similar to second quarter 2016. Turning to Slide 5 of the presentation. Cash from operations was $1.86 million in the quarter and free cash flow was $107 million. Capital expenditures in the quarter were $79 million or 4.3% of revenues, compared to $48 million in second quarter 2016. We continue to expect capital expenditures for the year to be between 4.5% and 5.5% of revenues. Additionally, year-to-date we’ve made $91 million of discretionary contributions to our qualified pension plan, and we plan to contribute the remaining discretionary balance in the third quarter. We also repurchased approximately 708,000 shares in the quarter, at a cost of $138 million. Bringing the balance remaining in our share repurchase program to approximately $306 million and paid dividends of $0.60 per share or $27 million bringing our quarter end cash balance to $553 million. We remain committed to returning substantially all our free cash flow to shareholders through 2020. Before I go to into the segment results, let me briefly discuss our credit rating. During the quarter, Fitch, affirmed its BB+ corporate credit rating of HII and raised its outlook from stable to positive. Following Moody’s affirmation of its Ba1 corporate credit rating and…

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 for the queue as possible. Derrick, I’ll turn the call over to you to manage the Q&A.

Thank you. [Operator Instructions] And our first question comes from Robert Spingarn from Credit Suisse. Your line is open.

Good morning. Hey, guys.

Good morning.

Good morning.

Quick follow-up on what you just said on Avondale. Is there particular cash impact we should expect if and when that closes? And then I have a question Mike, for you on LCS.

So regarding Avondale, the terms of that deal, that purchase and sale agreement are not disclosed at this point. We have a long way to go in the due diligence process, it could take a few months here. So that’s going to take a bit of time to resolve. It’s a positive first step. But we really will know that will be done until it’s done. From a cash standpoint, as you know to Avondale sale is part of the restructuring proposal that we have going on with the Navy. So whether could be some initial cash pickup before the end of year based on the terms of the deal, we would be obligated to provide some of that back to our overhead rates.

Right, okay. Thanks for that, Chris. Mike, on LCS, it looks like there is going to be a follow-up program here at FGX. That sounds like it will be a single winter 2020 timeframe for the award. Is this something that you guys are interested in? And how should we think about that opportunity?

I a word, yes, we are interested in that program. We participated in the industry discussions that have been going on so far. We have advocated that the National Security Cutter could be a good small frigate. That’s a possibility. We’ll have to see if that’s how the requirements shape out and if that even make sense. The Navy program looks like it’s going to be driven by how quickly you can get a ship to the fleet. And so we’re actually pretty good at getting ships to the fleet. So we think we have a fighter’s chance and we’re really interested in the program.

Okay. And then just lastly Chris, one other thing, on Ford, was there a profit pickup in Q2 or is that Q3 or is just wasn’t one? Just given the margin its important is?

There was no material adjustment within the quarter related to the Ford.

Okay, and you don’t expect one?

No, I don’t.

Okay, thank you.

And our next question comes from David Strauss from UBS. Your line is open.

Thanks, good morning.

Good morning.

Mike, could you give us a bit of more of an update on Kennedy, you talked about being 50% structurally complete, but some stuff out there in the news this quarter around cost production on it, just an update there?

Sure. We are 50% structurally complete, if you look in the dry dock you can make out kind of a whole bottom key area of ship, it’s looking like a ship now. We will start building skyline here before too long. In the quarter, you referenced some news. I mean what happened during the quarter is that GAO put out a report, which really compared 79 Kennedy to the Ford in terms of the way the cost was allocated in the shipyard. I think that’s a pretty useful report from the standpoint of saying here is a way to look at what’s happening on Ford – between what happens on Ford and what happens on Kennedy. The fact is that when we went to contract on Kennedy, we took a pretty significant reduction in the man hours between Kennedy and Ford. And we can go and kind of quibble about which hours are in there report or not. But I think it’s useful to think in the main they got that right. There is a pretty significant reduction of man hours between Ford and Kennedy. And I think their perspective was that this is bigger than anything we’ve ever seen in carriers. And we agree in the main, we agree with all of that. It is bigger than anything we’ve ever seen before. We did take that reduction in the target. And now let’s talk about why took that reduction and why we have confidence in what we’re doing. As we went into Ford, we were operating for the first time. We were operating with a digital design and a 3D product model. But it was not complete when we started that ship. As we started the Kennedy, the model was complete. When we started the Ford, as we went…

Right, thanks that’s terrific color. As a follow up just wanted to ask about how you’re thinking about the growth in the shipbuilding business going forward as a whole. I think this quarter you did about 4% growth in the shipbuilding businesses. As I look at the account SCN account it is grown by 25% or so over the last couple of years. I think last, I heard from you guys, you were still talking flattish, just how you’re thinking about the revenue profile from here? Thanks.

I think if you, if you buy into the 355 ship Navy, you can talk yourself into a pretty aggressive growth profile. We’re at the place where we’re saying until sequestration is taken care of and we’ve its a kind of show us the money sort of perspective. And without that and without that getting sorted out, we are going to stick to our guns and say the history of SCN account that it’s reasonably flat. My concern is that if you find another way to pay for the Columbia class, then it won’t be flat. Then there will be growth in the profile. But if you don’t find a way to pay for the Columbia class, you’re going to take it out of hide and you are going to take it out of other ships. So our view is that we’re making pretty significant capital investment in our business and we’ve talked about how generational that is. That capital investment is to support the flat plan. If we see a break loose on heading up towards 355 ships and we get some confidence in that, we will be talking about more capital investment. So our view is that we are optimistic, we are hopeful, everybody’s saying all the right stuff. But we got some real tough things to get over. The budget control act is a big deal that we’ve got to get over, before everybody can go about and do this the right way. So that’s – we’re going to stick to our guns and say plan on flat. Hope for the best.

Thanks appreciate the color.

And our next question comes from George Shapiro from Shapiro Research. Your line is open.

Yes, good morning, first quick one for you Christy. The Ingalls margin seems abnormally high. You know it was about last year, and last year you got a big benefit from LPD delivery. So can you give us what the EACs were or and/or if there is something unique in the EAC for Ingalls this quarter?

Yeah George thanks for the question. The unique thing that happened at Ingalls, this quarter, it’s becoming less unique and more run rate is they had a very high quality launch related to LHA-7. It’s actually ahead of schedule and they were able to retire about $30 million of risk. So it was driven by high-quality LHA-7 launch.

Okay and could you just tell us how much – what the favorable and unfavorable EACs were I guess, we’ll see it in the Q in a little while.

Well, I’ll just tell you. It is positive 88, it negative 28 for a net of 60. And about 85% of that net is driven by Ingalls.

And then one for you Mike, can you tell us where you think we are in terms of what you have talked about as the Newport News best up for this year.

I don’t think, I think Newport News is in a phase right now that’s more than a year. I think Newport News is at the beginning of CVN-79. We go to launch that ship in 2020. So that’s really the first big major milestone on 79 that effects the way that we rationalize our risk registers. We are just now going to be this quarter, we are going to be the beginning the next refueling overhaul. We are beginning construction on the Block IV. We’re going to be heading into negotiations on Block V for the Virginia Class. And we’re beginning Columbia. So if you look across Newport News, they’ve got, those are all really good solid great programs with long-runs, ahead of them. But this next time period at Newport News is going to be starting up. And in the middle of that, we are going to be digitizing the shipyard. And so to give us a chance to really be successful on these long, long runs that we have in front of us and takes some significant cost out. So this is not just a one year event at Newport News, this is going to be a phase that they are going to go through. And I’m really happy with the team that’s there, the way they are working on their programs, and executing exceptionally well on all of their programs. And three deliveries in 19 days is pretty phenomenal. So I’m pretty excited about where that business is going to go. And it’s going to be set up for a very, very bright future. But we got to go through some through a little phase of time here that’s going to be a grind.

Okay thanks very much.

And our next question comes from Sam Pearlstein from Wells Fargo Securities. Your line is open.

Hi good mornings, you recently got the DDG contract for the Flight 3 upgrade. I guess just trying to think about what do you do differently to make you think differently about the starting margin on that ship versus other DDG starts?

Sam this is Chris, we assess the risk on each ship when we start out. And the risk on that is a bit different, obviously, from the Flight 2. So the beginning margin rate could be less. But that’s an assessment we make on each ship when we start the program.

Okay, and now with the LPD-29 advanced construction, does that get you the bridge to LXR, or do you still need anything more in order to fill that gap?

That depends on when LXR happens. If the assumption is that it’s going to happen in 2019, then we’re probably getting pretty close. If you take LXR and you build a write-off of LPD-29 and it’s next one, the optimum time would be sooner than that. But I think to me this is part of the discussion around how do you find Columbia. Because I think unfortunately, I think LXR becomes one of those things that could be affected by the failure to figure out how to fund Columbia. And that’s why we keep bringing that up as – you can’t just go and throw all these programs out there. They’re going to start bumping into each other unless you figure out how to get through sequestration.

Thank you.

And our next question comes from Peter Skibitski from Drexel Hamilton. Your line is open.

Yeah Mike, wondered if you could, ringing into the DC debate a little bit, and just discuss, in terms of your discussion there, how would you handicap the likelihood of getting the BCA work around deal, because it seems like some of the Senate Democrats have kind of pulled up a flag to say hey, here is one potential work around. So is that a positive thing? Would you handicap it at better than the 50% that we do get a workaround?

My, this is just one man’s opinion here. I think the first of all the discussion that’s going on around the BCA, of what’s the real requirement for security. What are the things we need to be able to do? What’s the world look like? All of the things are driving folks to recognize that the budget control act is not helpful. You kind of look at, any dimension you look at it through, any lens you look at – you kind of come to that conclusion. And just about everybody I talk to says, we really shouldn’t be operating this. But now how do you get it changed? And how do you get it get undone? My guess is, it probably looks a little bit like what we’ve done in the past. That there will be some kind of another Ryan Murray deal. I don’t think that’s the right answer. Let me be clear about that. When you only do these two year fixes, you’re not able to do the strategic decision-making that this country needs to make on behalf of any dimension, whether its security or some other dimension that you’re looking at. You can’t think strategically when you have basically a two-year deal. Having said that, a two-year deal is better than no deal. So I would say right now, if I had to lay a wager, as we get to the end game, there’s going to be some discussion of some way to put together a deal, that’s going to make some of this happen. And we’ll see and will stay engaged.

Okay got I got it. Thank you for that. And then can you give us some details on that Nevada test site when just in terms of what’s your participation in the JV? What kind of margin or even just the level we should model in?

Well, its 23%. It could be – it’s a 10-year program, $500 million or – excuse me, $5 billion over 23% of that. So on an annualized basis, it’s probably south of $10 million a year.

All right, thanks guys.

And our next question comes from Jason Gursky from Citigroup. Your line is open.

Hey, good morning, everyone.

Good morning.

Good morning.

Hey Mike, Mike, I just wondering if you could spend a few minutes talking about unmanned undersea. Where your capabilities are at this point? And then kind of what you view the future to be in unmanned undersea, kind of the – this potential size of the opportunity there? And maybe talk a little bit about some of the key milestones that you’re looking for either from your technical capabilities or from the customer? And when we might begin seeing this become a bit more of a meaningful portion of your revenue stream?

Yes, good question. Conceptually, we’ve had a view towards this space for a while now. And a couple of years ago, we acquired the undersea group from Columbia, that had a working manned and unmanned undersea vehicle called Proteus. And we’ve shopped that around and we showed folks that, that was a very small acquisition, but that opened up a whole lot of doors to customers that we really didn’t great access to before that. And it’s created an opportunity to partner in ways that may be we couldn’t partner before. We have tremendous undersea capability in our submarine construction program. Then I would say that second to none. But building submarines, where you are going to take people into the environment of the sea is different than building an unmanned vehicle. That’s just a – it’s a very different thing. The physics are all the same, but the difference between carrying a person and not carrying a person is dramatic. And it really creates a whole different set of customers and whole different set of requirements. So we felt like we needed to get some more knowledge in there. And so bringing those guys on from Panama City was a huge even though as a small acquisition on our part, it was a huge change in our company. Because it gave us chance to go and really engage in that space. And so we’ve been engaging in that space as the programs have come through. The first go around on the LD UUV, we were very involved in that, when that program moved to the side. And now, the Navy’s gone forward with this XL UUV program. We’ve actually been – we’ve actually teamed with Boeing to participate in that program. And we are very, very excited about the…

Okay, that’s great. Thanks. And then as the follow-up question here on the Technical Solutions side of things. Over the past couple of years, you’ve talked about some of the growth opportunities there. Can you maybe just provide us quick update on the various initiatives that you had going on there from a growth perspective? Thanks.

Sure. The first thing to understand about Technical Solutions is that when we acquired Camber, we actually didn’t felt we had the critical mass or we have separating this business away from the shipbuilding business and creating the third business unit. The reason we wanted to do that was because the way those, everybody that’s in the Technical Solutions division, the way that they compete is fundamentally different than the way we compete in shipbuilding. The style of competition is very different, the magnitude and the quantity of the customers that are out there are very different. And so how you go to the market is very different. It’s consistent across that division now. They fundamentally go to market the same way but this slight of customers is tremendously large compared to the customers that we have in shipbuilding. And the style of contracts and the style of competitions are very different. Behind that though is there is a fundamental reliance on the shipbuilding business to support the Technical Solutions team. We believe that there is great – we’ve had a historic relationship between our fleet support group the folks at AMSEC historically and the folks at Continental Maritime, their relationship back to shipbuilding kind of make sense. I mean big navy customers, big navy support around the world and that continues. But then you turn to our effort in the DOE space and we talked about being, we’ve been working with floor at the Savannah Riverside floor over a decade now. But we’ve never really been able to kind of grow that business in any way. And we’ve now moved this to the place where we have been part of the winning team in the Nevada test site. And we see the Department of Energy has a lot of…

That’s great. Thank you.

[Operator Instructions] And our next question comes from Myles Walton from Deutsche Bank. Your line is open.

Thanks, good morning.

Good morning.

Good morning.

I was hoping that follow-up, I mean maybe a clarification on TS first. I think, Chris, you said that there was a $3 million reversal. I’m just kind of thinking sequentially, the margins in TS or EBIT contribution in TS, looks like clean extra charge in 1Q would have been $11 million clean ex-reversal I guess would have been $6 million sequentially despite a higher volume. Can you talk to the mix there and also where you are relative to the 5% to 7% long range margin target?

Yes, so notwithstanding what’s going on with the Westinghouse bankruptcy and how that eventually shakes out. We still think 2017 could be low single-digits, subject to the bankruptcy and how that flows through. And then, we believe we are on page to get to 5% to 7% by 2020.

Okay. And then Mike or Chris I don’t know which, in terms of the Avondale restructuring and shut down the claim. I know that you’re going through the DOD side of contracts claims at this point. How key is this P&L to that process and kind of a pathway to recovering that $300 million or so in the restructuring and shutdown?

It really isn’t. There’s an assumption made within the restructuring proposal for an ultimate disposition. So while it may modify the ultimate value of debt, it doesn’t really impact it.

What’s the timeline of your current claim?

That could carry on 12 to 24 months. We are still negotiating informally with the navy to try to get resolution. But that could take a year to year and a half to year or two years.

Oaky, I’ll leave it with you. Thanks.

Thanks, Myles.

And our next question comes from Doug Harned from Bernstein. Your line is open.

Yes, good morning.

Good morning.

Good morning.

If we go back to CVN 79, the Kennedy, let’s – if you think about most of your mature programs on fixed price contracts, these sent to be double-digit margins. And this is obviously the first fixed price contract of this class. But if you look at it and think about if you stay on plan, is this a ship that you could do a double-digit margin on?

Well, let me just say, Doug, we are talking about a program that’s going to play out over the next six years or so, five years anyway. And could we? Sure. Are we retargeting that? You bet. Is there a lot of work to do between now and then? Absolutely. So we’re watching it, we’re working it, we are engaged in it. We certainly are pushing hard for that outcome.

And this is so – that’s good to hear. So this is something that you’re going to see how this evolves over time as you reduce risk and hopefully you can get there on this one.

Just like we do on every other program.

I just also wanted to ask on the budget, we have obviously as you described a whole range of scenarios here with some pretty attractive budgets, I would say, from a shipbuilding standpoint, if you look at what’s in the house committees down to what if we have no debt ceiling relief, what if, you can’t do anything about BCA. When you look forward to the investments that you would need to make, should we ramp up the shipbuilding outlook, what do you look for as the trigger or when you can start to make some of those investments looking at some possible growth?

Yes, I’m not – yes, Doug, that’s a really good question. I’m not sure there is a single light switch that I’m going to say, if they fix that then we are often running. I would tell you that if they were to and the best of all universes, if somebody decided to just figure out how to make sequestration go away. That will be a pretty big indicator because the driver for that would be the requirements are just getting to be so loud that we got to go do something different than we are doing. But that’s probably the biggest indicators, watching how – how do we maneuver our way through that. If we do another two-year deal, that’s probably – that’s not as good as making it go away, but that’s better than not doing it. How this discussion goes on the debt ceiling will be watching that. And all of that goes into the soup as we start to make our decisions. The advantage we have is that we can actually start to deploy our capital ahead of the navy’s decision to buy ships. And so because we get to watch and see how these other things happen in the appropriations process. And we’ll be able to stay ahead of that. And we can throttle that and measure that based on our assessment of the terrain at that point in time. Our assessment right now is, it’s too early for us to get out in front of our headlights and start investing again from 355 ship Navy. It’s not too early to continually investment that we’re making to support the 300 ship Navy.

Doug, I’d like to add tactically, the RFP for DDG 51 the quantity and the pace of those. And then the Block 5 DCS RFP should show up later this year. And that will give us some indication of how quickly they want to buy those ships.

Yes, that’s true. And if the Congress gave the Navy to the authority to procure more than one aircraft carrier, we see that as a really big signal. I don’t believe the Congress could do that without having some solution to the BCA. But if certainly, if we sit down and start negotiating with the Navy instead of the CV and 80 contract, we are negotiating two carriers or three carriers, we are going to be a whole lot more inclined to go and invest against the 355 ship Navy. And I will tell you, Doug, that our suppliers will be a whole lot more inclined to it than too.

Okay. That’s very helpful. Thank you.

And our next question comes from Noah Poponak from Goldman Sachs. Your line is open.

Hey, good morning, it’s Matt Porat on for Noah.

Good morning.

Good morning.

So I just wanted to sort of go back to TS for a moment. You have talked about some of the synergies from the sales standpoint. And I was looking to get a bit of better sense for some of the leverage you are looking to pull to sort of see those margins track a little higher?

Actually, there will be a natural growth in those margins based upon getting some result in the nuclear sector and winning deal, we were if you saw the first win within Nevada test site, so the investments we’re making within the TS, if those yield, some wins. And then, really getting the cost structure squared away in oil and gas, they had a fairly good first quarter where they essentially broke even. And if there’s a lift in that market that could potentially show some growth as well.

Got you. And what kind of growth are you kind of looking at from vessel package system Ford here?

We’re talking about low-single digit for the entire TS space.

Got it. Thanks so much.

Yes.

And our next question comes from Gautam Khanna from Cowen and Company. Your line is open.

Yes, thanks. Great results at Ingalls.

Thank you.

So you mentioned Ingalls has been kind of out performing for while now, which is obvious. I guess the question is, are there any other kind of major risk retirement events as you move through the rest of this year and into 2018 that we can look for as potential risk retirement events that could be a significant as what we saw in Q2?

That’s a good question. I’d indicated previously I thought margin would be a bit backend loaded for this year. Fortunately, Ingalls had a very good Q2 related to that quality launch in LHA 7. So I really think the best way to think about shipbuilding is 9% to 10% return on sales for the balance of the year.

Okay. And then when we look into next to previously guidance you talked about on CVN 79, that there’s no major risk retirement opportunities through 2020, I believe. Just want an updated view on that?

No, the launch for CVN 79 is 2020 and there is really no significant risk retirement milestone until then for CVN 79.

Okay. And then just any comments on where we stand with the icebreaker competition in RFP that, what you expectations for the program?

Well, I mean we are very interested in the program and we’re engaged in the studies that are going on right now to as the program begins to take shape. I think it’s going to take a little bit to work its way through. Obviously, the more complex the platform needs to be, the more likely we are to be a major player and trying to sort through it. We think icebreakers tend to be really complex platforms and so we are excited to be the part of the program. And we’re putting our best foot forward.

You have assumptions and timing of that program?

At this point, it’s moved a little bit faster than I would’ve thought. But I think that program is also going to be driven by from a timing perspective. It’s going to be driven by all of the other budget discussions that are going on. There’s a lot of stuff that could move faster if we get the budget stuff out of the way. This would certainly one of them.

Okay. And last one for me, Chris, any preliminary view on cash pension for 2018?

No. Gautam, thanks for the question. It’s a bit too early from contributions or cash pension in 2018. I’ll be able to provide you more color if we get towards the end of the year.

Thanks, guys.

You’re welcome.

And at this time, I’m showing no further questions.

Okay. Well, thanks to everybody for joining us on today’s call. We’re excited about what’s happening in our business. And we’re looking forward to creating more and more value doing hard stuff and getting it done right for a lot of customers. Thank you all very much.

Ladies and gentlemen, thank you for your participation in today’s conference. This conclude the program. You may now disconnect. Everyone, have a great day.