Huntington Ingalls Industries Executive Insights: Sequestration, Operational Metrics in the Gulf

On Wednesday, Huntington Ingalls Industries Inc (NYSE:HII) reported its first quarter earnings and discussed the following topics in its earnings conference call. Here’s what executives shared.

Sequestration

Carter Copeland – Barclays: Just, I know this is a tough topic to address, but I wondered if you could talk a little bit about sequestration and scenarios you are evaluating and how ship building may differ from other programs that we’d see your peers and things like overhead flexibility or the lack there over, how we should think about the impact of long-term funding and perhaps unspent funds that you could live on a little bit longer than programs that are incrementally funded? And lastly, if there are scenarios in your mind that could push programs into a (indiscernible) position where we could see stop work orders or anything like that, anything you are evaluating as you kind of think of about scenarios any color you could provide would be really helpful.

Mike Petters – President and CEO: Sure, it is a wide open question so let me see if I can bring a little bit of color to it, thanks for the question. We have said from the beginning that this prospect of sequestration, it’s out there, but the vast majority of the work that we need to do in the next three to five years to achieve the objectives that we have been talking about for the last year, we have under contract. We really have two more contracts to get, the LHA 7 and the LPD 27 contract, we are close on those we just got to get those finished. Those are really the last two of the original set of contracts that we talked about a year ago that really pushes out to the three to five year time frame. Our focus in that body of work is to retire the risk that we have in some of our heritage work, the LPD 22 delivery was a big milestone for us at the end of last year. This summer is going to be a big risk retire summer for us with the launch of the America, the sea trials and ultimate deliveries of LPD 23 and 24, we are in a place now we are a big part of what we have been working on to retire risk, we are heading into the zone where it is time to get it retired. Relative to the law in the sequestration, I don’t know that I have any other particular insight in it than anybody else does. A whole lot of folks say that ultimately this is not going to happen, but a whole lot of folks also say they have no idea how it may not happen or if it does happen it is going to have some different effect or maybe a reduced effect there is a whole host of initiatives but it doesn’t appear to me anyway that there is any sense that there is some kind of an arrangement that’s going to come out before the election that’s going to bring anymore clarity to this. In our view we step back, in our business we have the advantage of really seeing the whole might of America come to bare in our shipyards. We have to invest in our workforce, we have to invest in our facilities and our tooling and our plants and we have to support our supply chain. Our workforce comes to us and we make significant investments in them over time. The prospect of sequestration gives us pause as to what kind of investment we would need to be making over a period of time. When you step back and say that it might take eight years to create a nuclear pipefitter in Newport News, the question you have to ask yourself as you are starting that process today is what’s the real prospect there and what’s the return on that. So, we are thinking our way through that sort of thing. When you step back and think about capital investment in our facilities, now you’re thinking about how do you invest in your core business when you’re not really sure what the core business is going to look like the day after tomorrow. So, we are thinking very carefully about that. When you start taking look at our supply chain, we have 5,000 suppliers across – in virtually every state. This supply chain already in shipbuilding has been thinned over the past several years. Roughly on the order of about 60% of our supply chain now is in bit of a sole-source position. If you step back and think about what sequestration could do to that? The 60% that are sole sourced, that number could go up. So, at the end of the day, we step back and we look at all of those things and the one thing we know for certain is that if sequestration happens the cost of the programs that we are providing to the Navy and the Coast Guard will go up. Not necessarily the cost of the programs that we are executing today, but the cost of the future programs that will go up. You want to go buy another aircraft carrier, you want to compared it to the cost of the forward – my forecast would be that it would be more expensive in the environment that gets created under sequestration. So, from my standpoint it is a terrible way to run the country and I think that it’s something that cooler heads are going to have to come together and find a solution to, because we’re just the shipbuilders, I am sure that the entire industry is wrestling with this in the same way. We have the advantage of actually being able step back and say that there’s a day after sequestration, there is three to five years of things that we’ve got to go do to get right and to meet our financial plans and we can work on whatever the impact the sequestration is after it’s over. A lot of the folks in our industry do not have that ability and a lot of the folks in our supply chain do not have that ability. So, for us it’s important that strategically we get this right. As far as particular scenarios because of the cycle time of what we’re doing, we’re not evaluating any particular scenario, quite frankly because I think the Pentagon may actually have this right. As soon as you start to evaluate any scenario it becomes the straw man against which all other scenarios get measured, and I don’t know that anybody particularly wants to be the straw man right now. So, that’s about as candid as I can be about it. We are watching it. We’re engaged. We are talking about the impacts, the challenges in our industrial base, in our shipbuilding industrial base. We’re working it very hard, but we are focused on retiring the risk in our business, driving this business to where it needs to be over the next three to five years and we have the tools in our hands today to do that.

Carter Copeland – Barclays: I know it’s a tough topic to address, but I appreciate the color.

Mike Petters – President and CEO: It’s a little long-winded too I know.

Carter Copeland – Barclays: That’s okay. It’s a tough topic.

Operational Metrics in the Gulf

Douglas Harned – Sanford Bernstein: If you look at the margins at Ingalls, they were improving, but could you talk a little bit about what operational metrics you are looking at in the Gulf right now and how we should think of this margin improvement as fitting on some kind of trajectory towards the goals that you’ve described.

Mike Petters – President and CEO: Well, first of all I think the way to think about what’s happening in the Gulf, I’ll go back to what we just talked about. We’ve done a lot of work over the last four years to put ourselves in position to retire substantial amount of risk and the work that we’re going to do in the next few months is going to be a culmination of that. Going to builders trials on 23 and 24 are significant milestones, launching LHA 6 is a significant milestone. We just launched LPD 25 another significant milestone and so over the next four months, you’re going to see these milestones go by and you’ll see us be able to step back with a little bit more certainty about, okay, these things just like with LPD 22, we were able to move past another big piece of the risk. As we’ve said all along, the year 2013 is really the inflection point for any sort of trajectory in performance at Ingalls. Our operating system is full of metrics where we do hot washes after every phase and do all kinds of things like that. But it’s really going to be the ultimate delivery of LHA 6, the delivery of 23, 24 and 25 and that the closure of Avondale. Getting those things out of our system and getting them behind us then puts us in a place to accelerate. So, as we said earlier today, you should see a little bit of an improvement year-over-year at Ingalls this year, but after that I think that 2013 becomes the inflection, the new work comes in and we accelerate that into our goal of the 9% plus in 2015.

Douglas Harned – Sanford Bernstein: Related that when you think of LPD 25 over at Avondale and would describe any progress in the thinking about the ultimate disposition of Avondale and then also how you ensure if that’s the last piece of work that may be done there that you make sure that goes smoothly to the endpoint and gets delivered with the kind of quality and cost that you’re targeting?

Mike Petters – President and CEO: Sure, it’s something we think about every day. The plan of record today still is to close that shipyard. We do not have an alternative plan today. We continue to explore alternatives, but our plan is we are marching down the path of closure. 25’s launch was a significant milestone, because it was a high-quality launch. The ship was in great shape when it went into the water. LPD 23 is in great shape as it gets ready to go out on sea trials. The workforce at Avondale has done a magnificent job since the announcement when we were part of Northrop Grumman in 2010 that of the plan to close Avondale. They have done an absolutely tremendous job on these last two ships. The things that we’ve done, we tried to step back and think about the things that you just asked about, what’s going to happen when you only have two ships left and you are going to close it, what’s the disruption, what’s the potential for that to be, how do you manage your cost, how do you make it as variable as you can? We’ve thought our way already through that. We put some incentives, for instance, for attendance and productivity in our labor contract and our union leadership worked with us to do that in a very constructive way. All of those incentives have been met to-date. We have another year to go on that and we continue to be optimistic about how that’s going to turn out, but as we’ve said along, this is a bit uncharted territory. So, we go into this with our eyes wide open.