Huntington Ingalls Industries, Inc. Q1 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the First Quarter 2021 Huntington Ingalls Industries Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to turn the call over to Dwayne Blake, Vice President of Investor Relations. Mr. Blake, you may now begin.

Thanks. Good morning, and welcome to the Huntington Ingalls Industries first quarter 2021 earnings conference call. With us today are Mike Petters, President and Chief Executive Officer; Chris Kastner, Executive Vice President and Chief Operating Officer; and Tom Stiehle, Executive Vice President and Chief Financial Officer. As a reminder, statements made in today's call that are not historical fact are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Actual results may differ. Please refer to our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results. Also in the remarks today, Mike, Chris, and Tom will refer to certain non-GAAP 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'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. I trust that everyone is staying healthy and safe. Now, let me share some highlights from the quarter starting on Slide 3 of the presentation. Sales of $2.3 billion for the quarter were slightly higher than 2020. Diluted EPS was $3.68 for the quarter and pension adjusted EPS was $3.56, up from $2.43 in 2020. New contract awards during the quarter were approximately $5.3 billion resulting in a record backlog of approximately $49 billion, of which approximately $25 billion is funded. Chris will provide some color on a few of the key awards for the quarter during his remarks. Shifting to activities in Washington, we were pleased that the recently released summary of the fiscal year 2022 President's budget request affirmed that maintaining U.S. Naval Power is critical to reassuring allies and signaling U.S. resolve to potential adversaries. Of note, the budget summary cited continued recapitalization of the nation's strategic ballistic-missile submarine fleet, investment in remotely operated in autonomous systems, and funding for the next generation of tax submarine program, and we look forward to understanding budget details for these and other national security priorities when that information becomes available, as well as funding levels requested for the Department of Energy and the Department of Homeland Security. We also look forward to working closely with Congress as the FY '22 President's budget request is considered during the current legislative cycle. Regarding portfolio shaping actions during the quarter, we completed the previously announced sale of our oil and gas business and also completed the contribution of the San Diego shipyard to tighten acquisition holdings in exchange for a non-controlling interest in this leading provider of ship repair and fleet sustainment services. Completion of these transactions sharpens the focus of our Technical Solutions business into areas where we believe unique capabilities and close customer relationships will drive strong organic revenue growth and margin expansion. And as I prepare to close, I'm very pleased with the operating rhythm the team is achieving, which led to the third consecutive quarter of solid program execution and financial results. I am very confident that our strength, agility, and positive momentum resulting from enduring the impacts of COVID-19 will serve as a key catalyst to help us leverage our historic backlog to generate strong free cash flow and create long-term sustainable value for our shareholders, customers, and employees. Now before I turn the call over to Chris, let me make a few comments about our recent leadership change. After serving as President of Ingalls since 2014 and with more than 40 years of service, Brian Cuccias retired on April 1. Brian's career at Ingalls has been remarkable, and HII has truly benefited from his leadership. Effective April 1, Kari Wilkinson succeeded Brian as the new President of Ingalls and will report to Chris. Kari has proven herself to be a strategic and visionary leader that is focused on operational excellence, and I am extremely confident that Ingalls is in very capable hands. And now I will turn the call over to Chris for some remarks on the operations. Chris?

Thanks, Mike, and good morning everyone. Operationally we had a solid quarter making consistent progress across our shipbuilding and Technical Solutions programs. With that, let me share a few key contract awards and programmatic highlights from the business segments for the quarter. At Ingalls, the team was awarded a lifecycle engineering and support services contract for the LPD program with a cumulative value of approximately $214 million. The scope of work includes engineering change management, supply chain management, training for new shipboard systems, and the execution of post-delivery availabilities. Regarding program status, LHA 8 Bougainville achieved the 25% complete milestone during the quarter. And the team remains focused on maintaining strong cost and schedule performance in support of their planned production milestones. On the DDG program, the team remains focused on preparations for the launch of DDG 125 Jack H. Lucas, and sea trials for DDG-121 Frank E. Petersen Junior, both planned for the second half of this year. On the LPD program, LPD 28 Fort Lauderdale remains on track to complete sea trials later this year, and LPD 29, Richard M. McCool Junior, remains on schedule for launch early next year. Ingalls is also working closely with the Navy to put LPD 32 and 33 along with LHA 9 under contract. This bundled acquisition approach is the most affordable method by the ship, and when complete affords predictable savings for the Navy. At Newport News, the team was awarded a $3 billion contract for the refueling and complex overhaul of CVN 74 USS John C. Stennis, and also received a contract modification for construction of the 10th Virginia-class Block 5 submarine. These key awards are additional building blocks for our record backlog, which now stands at nearly $49 billion. Shifting to the program data, CVN 79 Kennedy is approximately 81% complete. The team is finalizing plans to support the single-phase delivery requirements while continuing to focus on compartment completion and key initial test milestones. CVN 73 USS George Washington is approximately 87% complete and continues to make progress with the crew recently beginning to move back onboard the ship. This is another key milestone in support of re-delivery to the Navy planned for next year. On the VCS program, SSN 794 Montana continues to test program activities in preparation for delivery to the Navy planned for later this year. In addition, SSN 796 New Jersey remains on track to achieve the float-off milestone as planned in the second half of this year. Our Technical Solutions booked several key awards during the quarter; this included a $175 million fleet sustainment recompete and its position on a Naval Information Warfare Center Pacific ISR and cyber security IDIQ contract. Additionally, production of the first Orca XLUUV modules is now underway at our Unmanned Systems Center of Excellence. Approximately 75% of our structural components have been fabricated, and assembly has commenced with final unit delivery to Boeing planned later this year. Finally, our nuclear and environmental services business continues to perform very well with strong performance across our Department of Energy contracts on Los Alamos, Nevada, and Savannah River. Now I will turn the call over to Tom for some remarks on our financials. Tom?

Thanks, Chris and good morning. Today, I will briefly review our first quarter results. For more detail on the segment results, please refer to the earnings release issued this morning and posted to our website. Beginning with our consolidated results on Slide 4 of the presentation, our first-quarter revenues of $2.3 billion increased less than 1% compared to the same period last year. This was primarily due to growth in Newport News and Ingalls that was largely offset by a decline in Technical Solutions due to divestitures associated with our portfolio shaping actions we have taken. Segment operating income for the quarter of $191 million increased $35 million from the first quarter of 2020 and segment operating margin of 8.4% increased by 149 basis points. The improvement was driven by higher risk retirement at Ingalls and improved performance at Technical Solutions. Operating income for the quarter of $147 million decreased by $68 million from the first quarter of 2020, and operating margin of 6.5% decreased by 305 basis points. These decreases were primarily driven by less favorable operating FAS/CAS adjustment, partially offset by the strongest segment operating results compared to the prior year. The tax rate in the quarter was approximately 15% compared to approximately 20% in the first quarter of 2020. The decline in tax rate was primarily due to the divestiture of our oil and gas business, as well as the recognition of R&D tax credit for the current year and prior periods. Net earnings in the quarter were $148 million compared to $172 million in the first quarter of 2020. Diluted earnings per share in the quarter were $3.68 compared to $4.23 in the first quarter of 2020. Excluding the impacts of pension, diluted earnings per share in the quarter were $3.56 compared to $2.43 in the first quarter of 2020. Turning to Slide 5 of the presentation, cash from operations was $43 million in the quarter and net capital expenditures were $59 million or 2.6% of revenues, resulting in free cash flow of negative $16 million. This compares to cash from operations of $68 million and net capital expenditures of $66 million and free cash flow of $2 million in the first quarter of 2020. Cash contributions to our pension and other post-retirement benefit plans were $72 million in the quarter, of which $60 million were discretionary contributions to our qualified pension plans. During the first quarter, we paid dividends of $1.14 per share or $46 million. As noted on our fourth quarter earnings call, we did reinitiate share repurchases earlier this year and continue to view the return of excess free cash flow via share repurchases as an integral part of our capital allocation strategy over the long term. During the quarter, we repurchased approximately 292,000 shares at a cost of approximately $50 million. Moving on to pension, with the passage of the American Rescue Plan Act, we have reviewed the 5-year pension outlook that we provided on our last earnings call and continue to believe that remains the most appropriate deal. Due to the limited nature of our projected contribution and the impact of lower cash activity with Safe Harbor implementation, the passage of the legislation does not have any meaningful impact on our outlook. We plan to provide an update to near-term pension expectations on our Q3 call, consistent with our product cadence. Moving on to Slide 6 of the presentation, Ingalls revenues of $649 million in the quarter increased $20 million or 3.2% from the same period last year, driven primarily by higher revenues on the DDG program. Ingalls' operating income of $91 million and margin of 14% in the quarter were up from the first quarter of 2020 mainly due to higher risk retirement on LHA 8, which was related to the 25% completion milestone that Chris mentioned earlier. Turning to Slide 7 of the presentation, Newport News revenues of $1.4 billion in the quarter increased by $66 million or 4.9% from the same period last year due to higher revenue in both aircraft carrier and submarine construction, as well as fleet support services. Newport News operating income of $93 million and margin of 6.6% in the quarter were down slightly year-over-year primarily due to lower risk retirement on CVN 73 RCOH, partially offset by higher risk retirement in VCS Block IV boats. Now to Technical Solutions on Slide 8 of the presentation, Technical Solutions revenues of $259 million in the quarter decreased by 18.3% from the same period last year, mainly due to the divestitures of both our oil and gas business and the San Diego shipyard on February 1 of this year, partially offset by a full quarter of results from Hydroid which was acquired at the end of the first quarter of 2020. Technical Solutions operating income of $7 million in the quarter compared to a loss of $7 million in the first quarter of 2020. This was driven primarily by improved performance in defense and federal solutions and nuclear environmental services, as well as a gain related to the sale of our oil and gas business. Turning to Slide 9, we continue to expect we will finish the year with shipbuilding operating margin in the 7% to 8% range with the significant remaining risk retirement events weighted towards the end of the year. In addition, we expect shipbuilding margin for the first half of 2021 to be around the midpoint of our annual guidance range. We continue to view the remainder of our 2021 guidance as appropriate with the exception of the effective tax rate which we now expect to be approximately 18%. Now I'll turn the call back over to Dwayne for Q&A.

Thanks, Tom. 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. Operator, I'll turn it over to you to manage the Q&A.

The first question comes from Carter Copeland from Melius Research. Please go ahead.

Mike, I wondered if you could expand. I mean it's been quite a string of challenges thrown out over the last several quarters. But the comment you made around the operating rhythm and finding I guess more of a better cadence there. I wondered if you could expand on that, and specifically what sort of operating metrics you're looking at that give you conviction that that's a trend you're going to stay on.

Okay, I think first of all, Carter you're right. We've had a lot of challenges thrown at us in the last 12 months. And we took a pretty significant hit back a year ago with attendance relative to the pandemic and the impact that had on our ability to retire risk. We recognized that in Q2, but what came out of that was the stabilization of our employment levels and scheduling. We've actually created the mechanisms in our risk register so that we know where we are, where we're going, and where we need to get. It helps a lot that we have this backlog that we're working off of. Now we are at a point where, when you come through a crisis like this, the connectivity, the tools that you've put in place, and the innovation that has happened, it becomes beneficial. As we move forward, we start to look at what we actually accomplished. While we started at the beginning of the pandemic thinking that we needed to preserve 25,000 people, we have just hired over the last five years in our workforce. We've done that. We actually have hired between 5,000 and 6,000 people since the pandemic started. That's pretty creative and innovative. We still have robust hiring plans going forward. Our case rates today are lower than they have been since last summer, and the quarantine volume today is lower than it's been since this began. We have administered vaccines to about a third of our workforce on top of where they are widely available to the rest of the employees who are getting them. So, we're seeing a steady rhythm, our folks are at work, they're engaged. We understand what needs to be done, and we're actually getting it done. The change where we moved Chris over to be the Chief Operating Officer and really create more management bandwidth on how we manage that risk going forward and make sure that we're doing what we said we would do has helped significantly. I don't know if that answers your question, but I feel really good about where we are right now in terms of performing to our commitments.

Okay. And then just as a quick follow-up is, obviously a lot of talk macro-wise about inflation and inflationary impacts, when you look at your fixed-price work, is there any cost exposure that you watch there to be aware of, or is it not significant at this point? How should we think about that?

Yes, I may let Tom take that one. And let him talk to you about what we're seeing there.

Good morning, Carter. Yes, so relative to inflation, our contracts are much longer term. We have the benefit here with long lead contracts from a planning horizon and the backlog that we have to plan our work out. So, we have a site as far as the materials that we need. Additionally, we put together our proposals and the contracts that we bring home. We generally want to see those POs in place before we move forward. So what we're seeing, I've talked about yards just this week, and at that point, we're not seeing a tremendous amount of inflation across the purchases that we have. We're not having a problem feeding yards from a material perspective. We do see going forward as we're getting new quotes that the span of the validity of the quote is short. I think the contractors are staying light on their feet as far as what they are committing to, but relative to our contracts and our performance, we don't see an impact right now.

We take the next question from the line of Myles Walton from UBS. Please go ahead.

I was hoping, Chris you could clarify that LPD bundled contracts you mentioned the size, timing and if that is more to just generate efficiencies or could there actually be increased levels of work versus your medium-term plan as well?

Yes, so that's all kind of contained in the 3% guidance that we talked about from a growth standpoint. The benefits of the bundle are pretty clear; when you can order those three ships together and sequence the work in an efficient manner, you're absolutely going to get savings. It's something we support, it's something we're working very closely with the Navy. If we are not able to get that, we'll get those ships under contract incrementally it just will not be as efficient.

What would be the size of the bundle of those three?

5.5 billion potentially.

Okay. And there is a clarification for Tom. The sequential margin in 2Q given the 1H is expected to be at the midpoint of the range. Can you point to maybe why the step down is so significant to six mid-sixes or so?

Sure, as I related in my comments, opening comments there, there's not a tremendous amount of milestones that we have in Q2, Q3, it's just a pacing year right now. So we're watching the volume come through at the present booking rates that we have right now. We think the first half of the year will come in around the midpoint of the guidance. And then we have milestones in the back half of the year that, if retired, have some potential there, but obviously we have to burn that off as the year goes by.

The next question is from the line of Doug Harned from Bernstein. Please go ahead.

We've seen a whole lot of Navy shipbuilding plans at the 500 plus versions and the C&L appears to have gone back to kind of 355 ship goal, but even that goal has been not easy to get to and the mix appears very uncertain. So Mike when you think about planning in this environment, how do you think about long-term investments and where you want to sit given all of the flux around these shipbuilding plans?

Thanks, Doug. That's a great question when we actually kind of kick around a lot; are we thinking about this the right way? I think at a macro kind of at the higher level what we see is that the shipbuilding execution plan is on a much longer rhythm than the shipbuilding theoretical plans; like a 30-year plan comes out every couple of years. But the contracts we have—ships right now that are under contract to deliver—Doris Miller deliveries in 2032. So, we look at these plans not so much as the precision of the plan, but more about what's the intent of the plan. What we're seeing in the intent of the plan you've acknowledged that they move around a little bit, but what we see in those movements is maybe wants to move to a Navy that has many ships, faster ships, maybe smaller ships, cheaper ships. So our investments are aimed in that direction. That doesn't mean they are not going to build aircraft carriers or submarines, because we believe they are, but they're going to want to build aircraft carriers more efficiently. They're going to want to build submarines more efficiently. They want to build more submarines more efficiently. In the non-nuclear ships, amphibs, destroyers, and frigates, those kinds of platforms go through class change or block changes, and our challenge is to be agile enough to respond to the customers' requirements, and do that as effectively and efficiently as we can. So the investments we make in our facilities are designed to be able to do that. There are multipurpose, multi-product kinds of investments. We'll do a capital investment at Ingalls that will apply to four classes of ships. We'll do capital investments at Newport News that you can use for carriers or submarines. That's kind of the way we think about that as opposed to making a big investment for a program that three years from now may evaporate. We don't do that. So that's our perspective on the generational investment we made over the past five years or so, a couple of billion dollars in our shipyards. We think that positions us very well for the direction that we believe the Navy is going to end up. We'll probably have lots of discussions about whether it's one more submarine or one less destroyer, but it means our investments were still the right thing to do.

When you look forward, as you're saying, more faster ships, it can open it up to other competitors rather than just you and General Dynamics. Do you foresee a time—obviously it's a ways away—when the competitive structure of this industry could change because of smaller, faster, different ships?

I don't know, Doug, I guess maybe, but I would caution anybody from thinking about that question as a binary question, that it's either one or the other. It's going to be a transformation that's going to be product line specific. Most of the shipyards in this country build a product. Our shipyards build several classes. We build four classes of ships at Ingalls. We build carriers and submarines at Newport News and refueling and all that sort of things. We do multiple classes of ships in our shipyards. We think that serves us well for whatever direction the future is going to be, and if the environment becomes more competitive, so be it. We're happy to compete.

The next question comes from Ron Epstein from Bank of America. Please go ahead.

Can we talk a little bit or maybe about the services business; the margins in the quarter were maybe about 2.7% and the target margins were 3% to 5%. What drives the upside there? How are you thinking about that?

Yes, I'll take that, hey Ron. It's Tom here. So a couple of things; we have got it from 3% to 5%. You're right; it is 2.7% this quarter. Right now, we saw a little bit of volume shortfall there as we're waiting for awards and the sales to come along with those awards for the year. Just with COVID and the announcements, where we are and some recompetes, it's just a little bit behind relative to guidance of 3% to 5%, but the year is still in front of us, and we haven't changed our guidance. We think TS will meet the guidance by year's end.

Ron, I can add to that. There is—in our equity accounting relative to the nuclear space, the timing of some of those awards are slated toward the second and fourth quarters. So you don’t generally see that happening in the first quarter. So it's a bit lumpy, and we usually start light.

Then a question for Mike. When you're looking out medium term, what are the biggest opportunities that you're trying to plan for now? I mean this is a follow-on to Doug's question, as you're positioning the business, what's the big fish out there that you want to catch say call it three, four, or five years out?

In shipbuilding, I think we'll start with that. If there's an expansion of a product line, there has been some discussion about what the industry's ability to support expansion of the submarine product line. We certainly want to be able to take full advantage of that. In the same way, if the Navy wants to expand in the frigate space, we want to be able to assist with that. Engagement on the planning and design piece for what happens to the future of amphibs is probably a mid-to-long-term issue, probably not near to mid-term. And what happens with the carrier space? Are there going to be CVN 82, and is there going to be some design for affordability put to it, and how are we going to engage in that? CVN 82 is coming up; I mean it's—you’ve got a contract in 27 or 28. So making sure that that stays on track is how we think about it in shipbuilding. In the Technical Solutions space, we've made a big investment in unmanned and expansion of the unmanned business is something that we think is important. Now that we've made that investment, we have a portfolio that we need to capture expansion on. Of all the budget items that I see out there, the unmanned budget item is probably going to have the largest percentage growth over the next five years in my view. We’ve established our position as a Department of Energy prime, and there is a lot of work over there that needs to be done, and we are pursuing all of that very aggressively. We think that’s a really great spot for us to be in, taking advantage of capabilities that we have in our shipbuilding business, but also gaining access to another customer. We've done very well with that and we look to continue to expand that. Finally, ISR space, where we've really done well, and we expect to do well going forward. We kind of look at that as capability dependent based on what our customers' needs for capability are, but that's kind of how we think about our strategy in the coming years.

Thank you. The next question comes from George Shapiro from Shapiro Research. Please go ahead.

Yes—Tom, if you could provide the EAC’s and is it fair that the pickup on the LHA 8 was probably $35 million or so?

So a little bit; good morning, George—a little bit of color on that is, 86 was the up—was the favorable adjustment, 36 is down net 50 across the yards about 9010 at Ingalls. Only significant drivers on the upside there were the LHA 8; we usually don't give guidance or information on the specific ship, so $35 million is kind of heavy there. Ingalls had a good quarter on top of the LHA 8 hitting the 25% vessel complete milestone where they reevaluate the risk and they re-strike the EAC. Overall, it was a good quarter for Ingalls. There were no significant upsides or downsides that I'd highlight here.

Tom, if $35 is a little bit heavy, I mean just on the rough numbers you gave, it would imply about $45 million of favorable at Ingalls. So was there anything else you can specify or is it all spread across the board for say another $20 million if 30 was the LHA 8?

Yes, the Q has the information on LHA 8. So we’re not— you’ll see that you're about $10 million heavy. But as I say, the other aspects of it were change management. We’ve definized the change there and have been focused on cost management. So overall, it was a good quarter for Ingalls.

And one quick one for Mike, can you update us on the Block V submarines? I mean that was the one that you've had some problems with, where do we stand right now?

Actually, the challenge we had in Q2 was on Block IV, George. And we've got a rhythm in Block IV that's going to carry through and help us do really well on Block V. I don't know, Chris, if you want to add to that.

I can add on Block IV; we hit some important milestones in the first quarter with Montana floating off and New Jersey getting pressure hull complete through important milestones on the balance of the year. We're optimistic about the rhythm and momentum on the Block IV contract right now.

The next question comes from Richard Safran from Seaport Global. Please go ahead.

I've been reading about the work being done on the Ford. Is Newport still doing work on things like the weapons elevators and other maintenance items, etc.? I just want to know if you could discuss how the work on the Ford is progressing relative to your expectations, when you expect completion, and if there's been any commentary from the Navy about the level of satisfaction with your efforts so far.

Yes, this is Chris. And I'll let our ex-aircraft carrier program manager Mike talk about it after me. But yes, we have really positive interaction with the Navy on the Ford; we have weekly interactions on the Ford, especially on the weapons elevators. We got seven of those turned over. Ford will be done this summer, so really positive interaction. That work will go on for a while, but nothing really material going forward; but yes, it's been positive. The Newport News team is performing very well, and I think the Navy is very pleased with the performance of that ship right now.

I'll just add that Ford is at sea as much, if not more than any other ship in the fleet last year. It's the training carrier for the East Coast, and the Navy would say, and they have said, they can quote you the number of traps, the number of launches. The number of tons of ordnance that they've moved on the weapons elevators, how easy it is to operate, how much power density changes from the Nimitz-class. I mean, it is a centerpiece of the design and a centerpiece of the Navy strategy moving forward, and the ship is coming together really well, getting ready to go towards their shock trial, so all systems are green and moving ahead.

I’d like to revisit your comments about the future Navy fleet. There was one program I think that was omitted, and maybe it was deliberate; there was talk of a replacement for the Ticonderoga. I was kind of wondering if you could just comment on the status of that program? I mean, do you think that will ever materialize to a real opportunity? Or for example, do you think Flight III is what is going to replace the Ticos?

I'm not sure I know how to handicap that. One of the first things I learned at the Academy 40 years ago was that there are countermeasures and then there’s counter, countermeasures, and there’s counter, counter, countermeasures. What happens is technology races ahead at a speed that’s a lot different than the build cycle of a ship. The question is what kind of platform you’re going to need to work with technology. If you look at the Flight III destroyer and what they're trying to do, that ship is pretty full. So is there a need to create something different to carry it forward? The Navy is in dialogue with the industry about that right now, and I'm not ready to handicap how it’s going to turn out.

The next question comes from Noah Poponak from Goldman Sachs. Please go ahead.

Just going back to the pace of margin through the year, the risk retirement, and how they flow through. The shipbuilding margin if I take out the net positive EAC in a lot of your history is in the zone of 6.5%, and the different guidance comments you've provided for first half and full-year sort of imply second half 2Q, 3Q, and then stepping up in 4Q? So I guess, it implies essentially no risk retirement events in 2Q, 3Q, actually maybe even embedding something slightly negative. Just want to make sure that's what you're looking for, and I have that correct?

Yes, I'd tell you that we are in the zone, Noah. So between 6% and 7% will be the norm; a 6.5% is a good estimate on your part. I tell you that the mix moves around at both yards as far as where the ships are. So as ships get either sold off or mature, when they take a step up and/or you have new ships that are spotted with lower booking rates, that mix changes. I wouldn't read too much into that regarding where we need to be from a plan perspective against our guidance that we gave you. So yes, I think you got that right.

Makes sense, and Tom when you look to next year in 2022, do you have more risk retirement events or less or a similar amount?

So we told you 7% to 8% this year, low 8% next year. We had mentioned that. I can go forward, and then Chris gave the guidance for Q4 in February, had mentioned that, hey this is a pacing year. As we get into 2022 and 2023, we expect to see more ship deliveries. There is potential there, and the plan has this moving upward. As the quarters click off or burn down that risk, we'll realize those margin expansions we discussed.

Just a clarification on the ARPA into pension, cash flow inputs; do the contribution and CAS recovery numbers you provided previously literally not change at all, or is it just that those had come down enough that the change is going to be small relative to your total cash flows?

Yes, it seems significant as far as the change if you do the math—there is something there. But we really don't want to chase it on a quarter-by-quarter basis. Since we moved over to Safe Harbor, we have really kind of mitigated the CAS variability, and really we are at limited contributions over the projection that Chris provided in February. The mac contribution was $80 million, half of that post-retirement benefits. The projections on pension going forward will be a function of the discount rate that changes and the plan performance; between those three variables, we won't update as recorded here. We will give you a look-see at Q3; that's the normal cadence for the remainder of the year and 2022. As 2021 closes out, we will give you a fresh look at a five-year projection next February.

The next question comes from David Strauss from Barclays. Please go ahead.

Mike, you touched on the unmanned portfolio and the potential growth there in a couple of your comments. Could you size the revenue now that sits within TS and what a reasonable kind of target for that business could be over the next couple of years? And when you would think about actually breaking it out so we can see what's going on there?

Yes, we haven't broken that out yet. So, we'll just let you know when we're ready to break it out.

Okay. I guess in the first quarter you did, you had 5% growth at Newport, 3% at Ingalls. You're forecasting shipbuilding relatively flat top a little bit this year and 3% from here. How should we think about the relative growth rate of Newport versus Ingalls both this year and into the future?

Yes, this is Chris. We don't break out the growth rate by the two shipyards. We have historically said that Ingalls is more flattish moving forward and a lot of the growth is coming from Newport News, but we don't give specific growth rates.

Okay, see if I can hit on one here. The R&D amortization, Tom, what potential impact could you guys be looking at there if that holds?

Yes, so the opinion that we have on that is not constructive from an investment standpoint. We have to amortize it over five years. We have run some models on that; it's not a tremendous impact. It does, obviously, affect the cash on it. Our model says it could be in the range of $50 million to $100 million, and we will have to see how that legislation unfolds.

Our next question comes from Gautam Khanna from Cowen. Please go ahead.

I have a question on the National Security Cutter program; any change in the Biden administration to keep buying these? What should we be looking for in the 2022 request? What's on your contract if you could just refresh us on that?

Yes, we're pushing hard to get NSC 12 appropriated. I think it's kind of like the Navy side where we're living off of the works done on the FY 2022 budget, before this administration got here. I think the administration now is doing a top-to-bottom review of all of that stuff. That's why frankly for DoD, you've just seen the top-line number come out with not any details behind it. Our view is there is a lot of strong support for the National Security Cutter. The Coast Guard is gainfully using that platform around the world and we're proud to partner with them to get it done, and we're going to continue to pursue it.

Yes, Gautam, I could add we've delivered through nine, as you're probably aware, ten is coming in 2023 with eleven deliveries on the 2024 timeframe. It's a very capable ship, and we're working with the Coast Guard for potentially getting twelve under contract.

Okay, understood. Any discussion of additional Block V resources, is 12 sort of the end of the line on that program?

I think we'll see. A lot of new players are coming to the table to have a discussion around it. We're happy to provide whatever requirement the nation needs in that platform.

Okay. And I may have missed it in your opening remarks, but where are we in terms of staffing at the shipyards? Are people showing up? Like the level of absenteeism and/or from COVID, how are we doing?

Yes, we are at normal levels now. I mean, we have our lowest case rates since last summer. We have the fewest number of people in quarantine since last summer. About one-third of our workforce have been vaccinated. The workforce is getting vaccinations in other places as well. What that’s doing is driving our case rates down pretty dramatically. We hired about 6,000 people during the pandemic, and our hiring plans continue. We expect that by the first of June, the people in our shipyards who want to get the vaccine will have had access to get it. So, we're moving ahead.

Last one from me; just curious, is there any precedent for the bundled purchase that you were talking about? Which maybe LHA and LPD been put together as a bundle across different ship classes contracting?

We had a competition a few years ago where the competition was around an LHA and a TAO. We won the LHA, and our friends at NASCO won the TAOs. We've been building ships in this country for over 200 years. I would say that there is probably precedent for just about everything that's out there.

The next question comes from Robert Spingarn from Credit Suisse. Please go ahead.

Chris, I wanted to ask in your new role. I think one of the things you're tackling is just moving up the best practices from one yard to the other, maybe across all three businesses. I was hoping you could expand on that a little bit and talk about where the opportunities are within that?

Yes, no, that's a really good question. I have had the opportunity to work at Ingalls as a CFO there. In my corporate CFO role, I reviewed all the processes at Newport News. There are significant things that happen within each of the yards and even internal solutions that can be shared. One example I can give is supply chain; the supply chain teams work very closely with each other. They bundle procurements, they look at capacity across the spectrum, and they do a very good job at that. Their operating systems are a bit different, but they learn from each other, and we bring best practices in the operating systems as well. I could talk for days about the things we're working on across shipbuilding and within Technical Solutions to learn from each other, but those are just a few of them.

I think on one of our visits, one of the things we saw at Newport News was the implementation of VR to sort of replace physical blueprints as an example of where technology can come in. Is there an update on how well that's been implemented, and if you're actually using that yet or if there are other technologies we’re talking about?

Yes, another good question. Digital is absolutely being utilized within Newport News and building CVN 80—it's preparing for utilization on the Columbia-class. It's an investment we're making, and it's paying off the craft and the trades like the new product. We're hopeful for really great things to come from that.

Is anyone quantified the benefit? Have you seen at least in testing percentage of man-hours reduced or anything like that?

We have definitely seen a percent increase in savings. We haven't published anything to that regard. It's just at the beginning stages of CVN 80. So we don't want to get ahead of ourselves, but we are achieving savings, yes.

The next question comes from Joseph DeNardi from Stifel. Please go ahead.

Just to clarify Carter's question, maybe more specifically when you think about an inflationary environment, what protections do you have, and then where are the risks? I understand you're not seeing anything right now, but to the extent we do see that, where are you protected and where are the risks?

Thanks, Joseph. So, I just said early on that our contracts are a little bit more long-term than in other industries. We do have long lead contracts. We make sure we have as much material understood on the quote by the time we go for award; the risk of inflation hitting our handshake values is low. Additionally, as contracts run out, there are contracts with the carriers six to seven or eight years, and we bought the material much further out, and it’s tough to get that quote. We still have EPA indices and pricing bands with the customer that we share options. Right now, we don’t see inflation impact on our execution of the contracts that we're working today. There may be pockets here and there—a piece of material may be late—but on the whole, material is flowing into the yard at expected times and costs.

Okay, yes, that's helpful. And then Mike, when you look at 80, 81, and 82, can you talk about the degree of commonality you're expecting from those ships? Does the Block Buy ensure greater commonality so that maybe you can benefit more from serial production? When you think about the opportunity to improve margins on carrier construction, how important is more commonality or is it something very different than that? Thank you.

Yes, so 80 and 81 are the two ships under contract. 82 is the ship that's out there. Chris alluded to my ancient history as being a program manager. I was actually a program manager for the Stennis and Truman, which was the last time we built two ships at the same time. I can tell you that the second ship absolutely benefits from the first ship in the way that the teams move from one platform to the next. The learning curves are there. It's hard to think about learning curves on ships that deliver four or five years apart, but they are real. As you get to the second ship, you have well-trained crews who have gone through this, who are capturing lessons and carrying them into that platform. The trick is how to take what we've learned at 81 and ensure that we do that with 82; and what that means is 82 has to be on time. If you delay 82, you start spreading these things back out, and you start breaking those learning curves. 80 and 81 means you'll get great efficiency there. The Navy advertises $4 billion of efficiency across the enterprise, which is significant. If you push that out and delay 82, you're going to start to cut into that efficiency pretty dramatically.

Thank you. I'm not showing any further questions at this time, and I would now like to hand the call back over to Petters for any closing remarks.

Thanks for that and thanks for joining us today. We certainly hope that you and your families are all staying safe and healthy in this environment as we come through the pandemic. I'd like to direct your attention to our Investor Relations page on our website and take a look at our corporate sustainability report. We've been doing a lot of work over many years around these kinds of issues related to sustainability. We've collected all of that and created a virtual report for you to take a look at—it’s a pretty dynamic presentation, and I'm very proud of what this company does relative to our communities, employees, customers. I appreciate your interest in our company, your engagement with us, and any feedback that you have. We look forward to seeing you again soon. Thanks.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.