Huntington Ingalls Industries - Earnings Call - Q1 2020

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by and welcome to the Q1 2020 Huntington Ingalls Industries Inc. earnings conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Mr. Mike Petters, Chief Executive Officer. Thank you. Please go ahead, sir.

Dwayne Blake (VP of Investor Relations)

Thanks, Missy. This is Dwayne Blake, Vice President of Investor Relations. Good morning and welcome to the Huntington Ingalls Industries First Quarter 2020 earnings conference call. With us today are Mike Petters, our President and Chief Executive Officer, and Chris Kastner, our Executive Vice President and Chief Financial Officer. As a reminder, statements made in today's call that are not historical facts are considered forward-looking statements and may fall into 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. Reconciliations of these metrics to the comparable GAAP measures are included in the appendix of our earnings presentation that's 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.

Michael Petters (President and CEO)

Thanks, Dwayne. Good morning, everyone, and thanks for joining us today on the call. Before getting into my remarks on the quarter, let me first provide a COVID-19 update. As this national emergency began, we established three very important objectives. Our first objective was to minimize the impact to our workforce and to provide a work environment that is as safe as possible. Now, this resulted in some benefit changes and some actions designed to give each individual employee as much flexibility as possible to help them navigate through these uncharted waters and make arrangements that they needed to make, and in doing this, we assured them that their job was safe. We also made adjustments to shift schedules to facilitate social distancing, and we enhanced cleaning activities in our shipyards.

Since taking these actions, we have approximately 25% of our employees working remotely and are experiencing about a 70%-75% attendance rate at those shipyards. Our second objective was to protect the national asset that is Huntington Ingalls Industries. We have been identified as critical and mission essential by the Department of Homeland Security, by the Department of Defense, and by the U.S. Navy. We took action during the quarter to enhance liquidity and strengthen our balance sheet, and Chris will discuss those actions in more detail during his remarks. Importantly, our supply chain is a critical part of the industrial base, and our ability to help our suppliers, especially those small businesses, will reap benefits as we come through this pandemic. To this end, we have accelerated more than $50 million of payments to our critical supply chain partners.

This not only helps them, but it also helps their communities as our supply base resides in nearly every state in the union. Now, our third objective was to be the reliable source of information for our employees. And to that end, we have kept a very frequent and steady drumbeat of communications to our employees and to our communities through multiple vehicles, including social media. We've kept them informed. We've answered many of their questions and provided them the resources and guidance they need to help keep them and their families safe. Now, additionally, I have been personally engaged in multiple strategic efforts centered around this pandemic, and I participate in weekly calls along with the other defense industry CEOs with the Assistant Secretary of the Navy for Research Development Acquisition, James "Hondo" Geurts. Now, I would be remiss if I did not add that the U.S.

Navy has really leaned forward during this crisis, ensuring uninterrupted contractual payments and the continuation and even acceleration of contract awards such as LPD-31 that was awarded in early April. These efforts are a great help to our industry and provide stability, liquidity, and business continuity, and I credit Assistant Secretary Geurts for his immediate action to these kinds of issues. As a nation, I believe we need to focus and adapt to what is being rightly called the new normal. We knew early on that this crisis was not going to be over in a few weeks or even months, so we have worked to change our business to effectively operate in that new environment. For example, we have now over 11,000 people working remotely. That's a tenfold increase from where we were just eight weeks ago.

Now, fortunately, we had already started transforming our business, so this crisis has provided us a catalyst to accelerate this transformation, and we believe we will be able to weather this storm and continue to provide our critical products and services to our customers around the nation. Now, let me share some highlights from the quarter starting on slide four of the presentation. Sales of $2.3 billion for the quarter were 8.8% higher than 2019 and represent record highs for the company, and diluted EPS was $4.23 for the quarter. New contract awards during the quarter were approximately $900 million, resulting in a backlog of approximately $45 billion at the end of the quarter, of which approximately $21 billion is funded. Regarding activities in Washington, our actions in early February supported Congress's consideration of the budget in regular order.

But our focus rapidly shifted mid-quarter to mitigating the impact of COVID-19 on our workforce and supply chain. And we will continue to work with Congress and the administration to support authorities and investment that will enable our nation's economic recovery through the entire defense industrial base, which is uniquely postured through tens of thousands of suppliers across all 50 states to be the engine for that recovery. We also look forward to congressional consideration of the fiscal year 2021 budget request in the coming months. Now, let me share a few business segment highlights from the quarter. At Ingalls, the team delivered LHA-7 Tripoli in February and launched two ships in the quarter: DDG-123 Lenah Sutcliffe Higbee in January and LPD-28 Fort Lauderdale at the end of March. DDG-119 Delbert D. Black completed acceptance trials during the quarter and then delivered on April 24th.

NSC 9 Stone is progressing through final assembly and test activities and is expected to deliver later this year. Finally, DDG-62 USS Fitzgerald completed sea trials and planned production work during the quarter and is scheduled for sail away this summer. At Newport News, CVN-79 Kennedy is approximately 72% complete, and the team remains focused on compartment completion and preparation for primary system testing. Newport News is working closely with the Navy to pursue a single-phase delivery approach on CVN-79. Now, this change from a two-phase delivery would extend the Newport News' performance duration while supporting the Navy's plan for efficiently delivering a completed ship in 2024. Initial indications are that incorporating a single-phase delivery will increase the scope of work under the contract and stretch the construction schedule and the test program to the right.

However, the ultimate financial and schedule implications will not be clear until we definitize the change with the Navy. CVN-73 USS George Washington is progressing through its final outfitting and test phase and is approximately 74% complete. On the submarine program, SSN-794 Montana is expected to launch in the second half of the year and remains on track to deliver in the first half of 2021. We anticipate SSN-796 New Jersey achieving the pressure hull complete milestone in late 2020. In our technical solutions segment, we received several contract awards across the Department of Defense for manned and unmanned airborne intelligence and ISR support and secured recompete business with the U.S. Postal Service for enterprise IT operations.

In January, we announced our largest award of the quarter, a task order to support the U.S. Air Forces in Europe's ISR operations with a total potential value of $954 million over five years. In addition, we closed the Hydroid acquisition at the end of the quarter, which significantly expanded our capabilities in the important and rapidly growing autonomous and unmanned maritime systems market. So in summary, I am encouraged by what we have been able to accomplish during these unprecedented times. Our leadership team has demonstrated flexibility and agility to respond to new developments while continuing to achieve a number of key milestones.

And finally, our $45 billion backlog, unprecedented program visibility, strong balance sheet, and thoughtful leadership through the COVID-19 crisis allow us to remain confident in the long-term financial targets and value creation strategy we provided at our investor day in February. Now, I will turn the call over to Chris Kastner for some remarks on the financials. Chris.

Christopher Kastner (EVP and CFO)

Thanks, Mike, and good morning. Today, I will briefly review our first quarter results and also provide some comments on our 2020 and long-term outlook in light of the current COVID-19 pandemic. 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 five of the presentation, our first quarter revenues of $2.3 billion increased 8.8% compared to the same period last year, driven by growth across all three divisions. Growth of Technical Solutions was driven primarily by Mission Driven Innovative Solutions, where results included a full quarter for Fulcrum, which was acquired in late February 2019. Growth at Newport News was due to higher submarine construction volume, and growth at Ingalls was driven by higher volume on the LPD and DDG programs.

Operating income increased by $54 million, or 33.5%, to $215 million when compared to first quarter 2019. And operating margin increased 176 basis points to 9.5%. These increases were primarily driven by a more favorable operating FAS/CAS adjustment and higher risk retirement at both Newport News and Ingalls. Net earnings in the quarter were $172 million compared to $118 million in first quarter 2019. The increase in net earnings for the quarter was mainly the result of higher operating income and a more favorable FAS non-service pension benefit, partially offset by a $16 million loss recorded in other income as a result of lower returns on marketable securities related to our non-qualified benefit plans. We are pleased with the operating results for shipbuilding in the quarter, including the 5.7% sales growth compared to the first quarter of 2019 and the 8.3% return on sales.

In Technical Solutions, our core nuclear and MDIS businesses are performing as expected. In the quarter, Technical Solutions achieved a very strong book-to-bill ratio of 1.6, which included a significant new win to support the U.S. Air Force Europe's ISR operations. As Mike mentioned, closing the acquisition of Hydroid in the first quarter positions us as a leader in the strategically important autonomous and unmanned maritime systems market. We continue to make progress on the other portfolio shaping activities that were highlighted at our investor day in February, including the contribution of our San Diego shipyard to a new ship repair partnership, which we expect to complete this summer, and the divestiture of our oil and gas business.

Turning to slide six of the presentation, cash from operations was $68 million in the quarter, and net capital expenditures were $66 million, or 2.9% of revenues, compared to cash from operations of $11 million and $74 million of net capital expenditures in the first quarter of 2019. Additionally, we contributed $30 million to our pension and post-retirement benefit plans in the quarter, of which $20 million consisted of discretionary contribution to our qualified plans. We also repurchased approximately 391,000 shares at a cost of $84 million and paid dividends of $1.03 per share, or $42 million, bringing our quarter-end cash balance to $28 million. As the COVID-19 situation evolved and the high level of uncertainty that came with it, we thought it was prudent to halt share repurchases, which we did on March 11th.

Through the end of Q1, we had returned to shareholders 107% of free cash flow generated from 2016 through the end of the quarter. Share buybacks will continue to be an integral part of our capital deployment strategy once volatility related to COVID-19 subsides. Moving on to slide seven, we have recently taken a series of actions to enhance our liquidity and further solidify our balance sheet. After the quarter closed, we issued $1 billion in new senior notes and also entered into a 364-day revolving credit facility with $500 million of capacity. We are fortunate that our primary customer, the Navy, has taken steps to accelerate cash flow under our contracts, which we have passed down to our supply chain partners primarily for small and disadvantaged businesses. Given these changes to our debt profile, we now expect our 2020 interest expense to be approximately $104 million.

To summarize, the hard work and dedication of our employees during this difficult time has been truly tremendous. We have incurred and will continue to incur additional costs related to our COVID-19 response in order to keep our employees safe. Additionally, as Mike noted, we have experienced staffing levels at about 70%-75% over the past several weeks. These lower staffing levels will likely impact program schedules and efficiency and increase ship estimates to complete, the materiality of which we will not know until we get greater clarity regarding the return to normal staffing levels and have a full reconciliation of supplier material delivery schedules. We are confident the costs incurred for COVID-19 response are allowable costs under our contracts.

Further, we continue to evaluate these impacts to programs against our contractual terms and current and pending legislation for the potential to obtain equitable adjustments to target cost, target price, and program schedules. We are working closely with our customers concerning the treatment of cost, and we will be able to provide additional details on COVID-19 cost treatment and recovery as we move through the year. However, as of today, we expect a modest impact of sales in Q2 due to reduced attendance in the shipyards. We also see shipbuilding sales growth for the year to be at the lower end of the previously provided range of 3%-5%. We will gain more clarity as we move through the year and plan to provide a more comprehensive update during our second quarter earnings call.

Finally, we continue to believe that our strong balance sheet liquidity and high degree of visibility and stability provided by our backlog make us well positioned to minimize the impact of COVID-19 on our business. We also do not see changes to our long-term financial expectations we communicated in February at our investor day, including our expectation to generate approximately $3 billion of free cash flow from 2020 through 2024. Now, I'll turn the call back over to Dwayne for Q&A.

Dwayne Blake (VP of Investor Relations)

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 through the queue as possible. I'll turn it over to you, Missy, to manage the Q&A.

Operator (participant)

At this time, if you would like to ask a question, press star one on your telephone keypad. Again, that is star one for any questions. Your first question comes from the line of Jon Raviv with Citi.

Jonathan Raviv (Analyst)

Hey, good morning, everyone. Just a question on the performance and the margin this year. I know heading into the year is going to be a lower margin year for a variety of reasons and also backloaded. You reiterated the number for the year at 9%, but you did mention there could be some moving pieces from COVID. Can you give us a sense for what kind of progression we should see now with coronavirus? Yes, please. That'll help follow up. Anyone there?

Operator (participant)

Are you ready for the next question?

Jonathan Raviv (Analyst)

Hi, this is Jon Raviv. Can anyone hear me?

Operator (participant)

Ladies and gentlemen, it looks like we're having technical difficulties. If you will remain online, the conference will resume.

Dwayne Blake (VP of Investor Relations)

Looks like it was on our end or their end, apparently.

Jonathan Raviv (Analyst)

Didn't touch it.

This has happened a lot.

Operator (participant)

Okay. And your next question is from the line of Carter Copeland with Melius Research.

Dwayne Blake (VP of Investor Relations)

Our first question.

Carter Copeland (Analyst)

Hey. Hey, guys. Can you hear me?

Dwayne Blake (VP of Investor Relations)

We're back. Sorry about that. We got dropped there for a little bit. So I imagine there's already been like three or four questions, and you guys have already answered them. So we'll catch up as we go along.

Michael Petters (President and CEO)

What were they? Yeah.

Carter Copeland (Analyst)

No, it was just Jon's question. That's it. But yeah, we're glad you're back. Trust me, I get it. I've fumbled the mute button many times, so no worries. I wondered if you could give us a sense on the most up-to-date data you have on the headcount levels in the yards. I mean, I can imagine that it's something you're monitoring day to day, just like we're monitoring any of these other COVID-related curves and the impact that that has on your estimates for what the disruption will be and productivity and whatnot. Have you seen any change since the end of the quarter in the month of April? Have you bottomed out? Has it improved? Any kind of up-to-date color that's kind of beyond the month of March that you can provide?

Michael Petters (President and CEO)

Yeah. Thanks for the question. It's pretty steady. The initial disruption for folks to figure out what sort of disruption they had in their lives, whether they had family members that lost their jobs or they had kids at home, they had to work their way through that. They've kind of worked their way through that. And I think, as we said, the aggregate attendance is about 75%. You can parse that a lot of ways, but basically, where the folks who have to be present in the business, inside of the shipyards, that number is lower than 75%. But the rest of our workforce, either they're working remotely or we've changed the conditions that they're working in on-site, have been able to support at a higher level than that. So, we've been pretty steady for the last, I'd say, the last two or three weeks anyway.

So, the number you have is the number we've got.

Carter Copeland (Analyst)

Okay. And if you try to parse it between the two yards, what's the difference?

Michael Petters (President and CEO)

Not much. Pretty flat.

Yeah. It's pretty much the same in both places. The number one driver in attendance right now, by far, is that the schools are closed, and folks have to decide how they're going to take care of their kids, and all of the usual mechanisms for people to take care of their kids are not available either, so that's our biggest driver in attendance. I continue to argue that we've got to find a way to get schools back to where parents are going to be comfortable to send their kids to school. That's got to be at the top of everybody's list. If that happens, we see this moving ahead. We're shifting our posture as well. Now that we've kind of stabilized this, we're starting to look now to how do we expand our employment and fill it back in, so we're moving ahead and leaning forward on this.

Christopher Kastner (EVP and CFO)

This is Chris. We'll come through the estimates on our shifts in the quarter and incorporate that reduced attendance on the schedules and the impact on the touch labor on our shipbuilding programs, but we're also assessing the opportunities. Our expenses have changed, right, so the most obvious one is travel. It's essentially zero, but less obvious is stuff like Teladoc, which is something we put in place a while ago, and it's spiked, which means our people are not in the emergency rooms, and that's much less expensive for us. So when we come through the quarter and the year, it's going to be we're going to assess the risk on our ships related to reduced attendance, but also the impact on our expenses, so it's more of a holistic approach than just what's the attendance in the yards and what's happened to productivity on the ships.

Michael Petters (President and CEO)

Yeah. In fact, I'm encouraged. The key milestones for our production, we're essentially meeting the key milestones that we have to meet. And just off the top, delivery of the destroyer in the last couple of weeks is evidence of that.

Christopher Kastner (EVP and CFO)

Yeah. 119, 62 is on schedule. NSC 9 is on schedule. Really comfortable with how we're performing in shipbuilding.

Michael Petters (President and CEO)

Yeah. It's going well.

Carter Copeland (Analyst)

All right. Great. Thanks for the color, guys.

Michael Petters (President and CEO)

Check.

Operator (participant)

Your next question is from the line of Myles Walton with UBS.

Hey, everybody. Good morning. This is actually Emily on for Myles. So, hi, everybody. On the recent result of the frigate competition, given the contract value for the ship, would you have been able to sign up for that aggressive of a price? And then additionally, what is on your radar now for potential awards at Ingalls? And does the recent award for LPD-31, how does that impact Ingalls' production line?

Michael Petters (President and CEO)

A lot of questions there. Recognize that everybody in the frigate competition was pricing a different ship, so almost impossible to do an apples-to-apples comparison of price to what happened. I think the Navy tried to run a best value competition, and they selected a winner. We're obviously very disappointed with the way that it came out, but we'll get a debrief from the Navy on what happened and how it could have gone better, and we'll go forward from there. Relative to other opportunities at Ingalls, we still have a very strong presence and production line right now in the large deck amphibs, the phase two LPD program, evidenced by the contract just signed for LPD-31. We're building destroyers, and we're still building national security cutters. The Ingalls' future is bright as far as I can tell.

This is a disappointment, but the thing about competition is you get up off the field and you go learn your lessons and you get better the next day, and so that's kind of the way we're taking it. The Navy is starting to rethink or is starting to think about what's the future holding. We're going to be part of that future, and so we're excited about that.

Thanks so much.

Operator (participant)

Your next question is from the line of Jonathan Raviv with Citi.

Jonathan Raviv (Analyst)

Thanks. I'll try not to break everything this time, I suppose. Can you guys hear me, though?

Christopher Kastner (EVP and CFO)

Yes, we can hear you.

Jonathan Raviv (Analyst)

Oh, okay. Glad to confirm that. So my question had been, I don't know if you heard it, was just on margin progression through 2020 and 2021. I know this year is always going to be somewhat backloaded. You talked about 9% this year. You reiterated that number. What is the progression, and how do you achieve that with the various unknowns around COVID-19? And then related to that, what is the potential menu of outcomes from the new one-phase carrier plan?

Christopher Kastner (EVP and CFO)

I'll handle margin progression. You can handle phase one. No real change to margin progression at this point, John. If we have to come through Q2, no doubt it's going to be a complicated quarter. But I wouldn't change the way we're thinking about margin in 2020 or in 2021, actually.

Michael Petters (President and CEO)

Yeah. I think it's too early. As Chris said earlier, there's certainly some risk now that's in our risk register that we didn't have in our risk register two months ago. But on the other hand, there's opportunities out there that our business is actually transforming itself organically. Kind of it's just doing it. And so, there's some real opportunities for us in terms of efficiencies and new ways of doing business and moving ahead. So, it's way too early for us to try to back away from anything that we might have said earlier.

As far as the single-phase delivery for the 79, what the original plan was, was the Navy and the company had decided to split the delivery, to finish the platform, and then use the post-delivery time to upgrade or actually install the sensors and those state-of-the-art things that change three, four, five generations while you're building the ship. And you want to make sure it's as current as possible.

The Navy has come back and said, "It's going to be better to do this in an integrated fashion because that way we can get a more complete ship sooner and be able to get the ship ready to deploy faster that way as well." Now, what that will do is that will change the schedule for if we're able to work our way through this, and we haven't, but if we work our way through this, it will change the schedule for how the test program proceeds throughout the ship because we'll line that up with the new schedule. It will change the way the Navy mans the ship, which is part and parcel to our test program and delivery schedule. So, at this point, there will be more scope. It will probably move the schedule around a little bit.

Until we get through it, I'm not sure we can say exactly how much impact it's going to have. We think it's actually the right answer for getting that ship to the fleet and into operation as fast as possible.

Jonathan Raviv (Analyst)

Just to follow up on that point, Mike, I appreciate the perspective there. Is it not the case that the late 2020 improvement in margin to get that 9% did somewhat rely on some of those things happening on the carriers that you just outlined? If those things don't happen, then is that one of the risk items to the 9% this year, perhaps?

Michael Petters (President and CEO)

Yeah. I would say that's true, but that's why I say we actually think that there's again, we got to kind of work our way through what are we going to do contractually to account for this, and then we look at what are the opportunities we're seeing in the rest of the business from the impact of this virus, so we just don't know enough right now to back away from that.

Jonathan Raviv (Analyst)

Thank you. I'll hand it off.

Michael Petters (President and CEO)

You bet.

Operator (participant)

Your next question is from Douglas Harned from Bernstein.

Douglas Harned (Analyst)

Thank you. Good morning.

Michael Petters (President and CEO)

Hey, Doug.

Douglas Harned (Analyst)

On the important news, I wanted to talk about Virginia-class and Columbia-class because this year, you're going to see some significant Block V work on Virginia-class. I know you highlighted in the release that Columbia-class, that the amount of work there is starting to grow. And could you talk, say, first about what you see the impact of those two programs now growing on your margins at Newport News?

Michael Petters (President and CEO)

Well, Doug, it's going to be the beginning of these programs. And by now, you know that when we're at the beginning of the program, we're reasonably conservative in terms of that. Now, truth is that we know a lot about submarines. And the arrangement on Columbia-class is just a little bit different than the teaming arrangement we have on Virginia-class. And so how that works and how the expansion works and goes forward, I think, is we've got that factored into. It's part of the way we were thinking about the year and the next several years when we talked to you guys in February. So, there's not really much change in all of that. It's just that it blends right in to get us to where we want to be.

Douglas Harned (Analyst)

When you look at Columbia-class, as we looked at this, we were assuming you'd really start to get production growth taking off kind of in the 2023 timeframe. For Newport News, how do you see that trajectory of work? How much of a contribution do you expect Columbia-class to be making over the next couple of years?

Christopher Kastner (EVP and CFO)

Yeah. Doug, this is Chris. We don't have a specific number for you, but it does start to ramp from here and then really start to get some momentum in 2021. But we don't have a specific number for you.

Douglas Harned (Analyst)

Okay. Well, that's good. Thank you.

Christopher Kastner (EVP and CFO)

Oh, sure.

Michael Petters (President and CEO)

Thanks, Doug.

Operator (participant)

Your next question is from David Strauss with Barclays.

Hey. Good morning, guys. This is actually Matt Akers on for David. Thanks for the question.

Christopher Kastner (EVP and CFO)

Good morning.

So now that Hydroid is closed, excuse me, I wonder if you could give us sort of an update on your thoughts of the opportunity there for unmanned ships and sort of how that business is handling it.

Michael Petters (President and CEO)

We're obviously very excited that we were able to close this deal. It took us. It was a long process with Kongsberg working through what would make the most sense for both of us. Now that it's in the portfolio, we've come basically in the last five years. We've come from not really being present in this space to being as capable as anyone in this space. We're excited about that. The Navy will continue as it thinks through what they want the fleet of the future to look like. They're going to continue to look at how do you do more missions with less people. We think that's a critical element of what they're going to be doing. Hydroid certainly gives us a step into that. There's a range of programs that the Navy's already announced that we're actually part of.

Boeing has the lead on the XLUUV program, and we are working with Boeing to manufacture that product for them. The Navy's announced the large diameter UUV program, and we're very excited about the opportunity for that, and then Hydroid, as a business, before we ever got involved with them, they were a dominant player in programs smaller than that, so this gives us now a full range of capability in the portfolio of platforms and missions and capabilities that we believe the Navy's going to need in the UUV space.

It also then gives us an opportunity to expand into the unmanned surface space because a lot of the capability that you're going to need relative to autonomy or manufacturing and advanced manufacturing and those kinds of things are going to be the things that you're going to need to be able to be successful in the unmanned surface space. My assessment is that the unmanned surface space is lagging the undersea space, but I don't know that that lasts. And I am excited about where this whole program's going to go. It's going to be a great business for HII to be in because it's going to be a critical mission for our customer, and that's where we want to be.

Great. Thanks, it's helpful, and then I guess, can you comment on the sale of UPI business and just given kind of the volatility in oil markets right now? Is that still on track and sort of any changes to your thought process there?

Christopher Kastner (EVP and CFO)

Yeah. Sure, Matt. This is Chris. Yeah. No doubt. It's a volatile market out there right now. The good news is that UPI, they've got some really stable long-term customers that are hanging with them, and we have a strong management team. So, that process will continue. We expect it to complete this year.

Okay. Great. Thanks, guys.

Sure.

Operator (participant)

Your next question is from Robert Spingarn with Credit Suisse.

Robert Spingarn (Analyst)

Hey, good morning.

Michael Petters (President and CEO)

Morning, Chris.

Robert Spingarn (Analyst)

Chris, I got a couple for you. First, Newport News and then Ingalls. But following up on Jon's question on CVN-79 and the single-phase delivery, but more from a cash perspective, that delivery in 2024, are you able to comment at all on what the impact of that would be on 2023 cash flow and kind of the slope of free cash flow you pointed to back at the investor day? I think you reiterated the cumulative target of $3 billion, but just wondering if this could make it more back-end weighted. So, that's the first.

Christopher Kastner (EVP and CFO)

I don't think so. We don't know yet exactly because we haven't definitized that change. But I don't think it materially changes the slope. A little more detail on cash. I think with all we know right now on free cash flow and everything moving around, we're still north of $500 million this year, and then we start to ramp.

Robert Spingarn (Analyst)

Okay. And then just switching to Ingalls, I was wondering if you could provide any color on the EBIT profile of the NSC program as it exists today, just so that we can get a better idea of how that program eventually ending might impact the business?

Christopher Kastner (EVP and CFO)

Yeah. I don't want to get-.

Jonathan Raviv (Analyst)

Mike.

Michael Petters (President and CEO)

I don't want to do an analytics program review right now. We don't really get detailed estimates of margin rates by ship. I will say from Ingalls' perspective in the quarter, the LPD program is performing very well. Pleased with LPD-28 and LPD-29, the award for LPD-31. So, Ingalls had a really good quarter.

Robert Spingarn (Analyst)

I was just going to ask Mike if there's any customer interest in a 12th NSC hull.

Michael Petters (President and CEO)

Sure. There's been a lot of talk about it. I think the question at this point is, where does the budget go? And I think that that's kind of the big question mark out there for everybody. But the Coast Guard continues to operate the NSC at a high tempo with lots of mission success and lots of very positive and favorable feedback to us. And so it has been a program that has been funded and supported both from the Coast Guard and from the Congress over the years. So, I'd say, sure.

Robert Spingarn (Analyst)

Okay. Thank you both.

Michael Petters (President and CEO)

Sure. That.

Operator (participant)

Your next question is from Peter Skibitski with Alembic Global Advisors.

Peter Skibitski (Analyst)

Hey, good morning, guys. Hope everyone's doing well.

Michael Petters (President and CEO)

Yes. You as well.

Peter Skibitski (Analyst)

Mike, I had a top-level question about the Navy Marine Corps' outlook for ships, kind of in light of the commandant's guidance and budget pressures connected. I think there's a new shipbuilding plan in the works in the building also that isn't complete yet. I don't know if it's connected. I think it's connected to this idea of a light amphibious warship. So, kind of the next question is, do you think the requirement for amphibious lift is going to be reduced or modified over the next couple of years in any way? And is it kind of maybe shift to smaller amphibious ships? Can you compete effectively there? So, just kind of interested in your thoughts overall about what looks to be a lot of change that might not impact it in the near term, but maybe in the mid to long term.

Michael Petters (President and CEO)

Yeah. That's a good question, and that's certainly something that we're thinking a lot about. Look, at the very top level, there is always a challenge of if you want to change direction, if you want to go in a different direction, the question is, how quickly can you do that? And recognize that if you're going to trade off current capability for potential future direction, that's got lots of unimplied risk there that hasn't really been. We haven't been able to kind of break that mold of you can't really go in a new direction by trading off current capability. And I would offer that one of the things that we continue to stress is that current capability actually includes the infrastructure and the industrial base that you have created. We've hired more than 25,000 people at HII over the last five years.

We've spent $500 million training them, and we spend $3 billion-$4 billion a year on our supply chain where they've been doing the same thing. And so, we have an industrial base that's ready to support the direction that you want to go. If you want to go in a different direction and be successful with it, I think you got to think your way through, how do I get the industrial base to move in that direction? And so clearly, the Marines are thinking about a concept of operations that's a little bit different than what they've been talking about. I don't think in the end, I don't think it changes their near-term requirement for heavy lift. And this discussion is not something that's going to say, here's how we're going to get there in the next two years.

I mean, you're really talking when you start talking about new shipbuilding plans, you're really talking about what does shipbuilding, what does the Navy look like 10-15 years from now? Because the Navy that we're going to have five years from now, you're building it today, and it's at sea today. So, the timeframes have to be kind of thought their way through. I think that there's an opportunity here for the industry and the Navy to work together to take advantage of all of the assets that we have to create a capability that would support going forward. Now, the other piece of what you said is something that we're thinking really hard about is that there is a bit of a floor for us in terms of as you get smaller in ship size, the market becomes a lot more competitive.

And so we got to think our way through that just as a business. How do we improve our competitive position if this is a direction that our customer's going to want to go? And we're looking hard at that.

Peter Skibitski (Analyst)

Okay. Thanks a lot for the color, Mike.

Michael Petters (President and CEO)

You bet.

Operator (participant)

Your next question is from Gautam Khanna with Cowen.

Gautam Khanna (Analyst)

Hey, guys. Good morning.

Christopher Kastner (EVP and CFO)

Good morning.

Gautam Khanna (Analyst)

So, I have a couple of questions, and forgive me if these were obvious. But first, just to be clear on the COVID impact on profit accrual, are you assuming I guess percentage of completion accounting, right? So, you accrue less revenue as there are fewer people making progress on ship. But the margin rate you're assuming is as though there is no COVID impact. Is that right, assuming there'll be some relief down the road? So, you just kind of.

Michael Petters (President and CEO)

No.

Gautam Khanna (Analyst)

How does that?

Michael Petters (President and CEO)

It's a good question. In Q1, there's really no COVID impact. There was no way to estimate that impact in Q1. We're going to have to assess that in Q2 as we understand the comprehensive impact and the opportunities related to it. So, it's a good question, Gautam.

Gautam Khanna (Analyst)

So, meaning in Q2 right now, a month and a couple of days have passed in Q2. There is a COVID impact, fewer people showing up at the yards. So, you're accruing less revenue, but you're accruing cost at the same margin that you otherwise would? Or again, I want to be very clear.

Michael Petters (President and CEO)

That's right. And you don't change your estimates until you come through comprehensive EACs on your ships, which we will do in the quarter in Q2, and then assess that in the quarter and deal with that in Q2.

Gautam Khanna (Analyst)

Okay. So, right, but let's just say that the Navy hasn't given you guidance on what form that equitable adjustment will be. Would you then take a negative cum catch-up in Q2 and then just wait and hope that you do come to a resolution and then take a positive?

Michael Petters (President and CEO)

Well, yeah. You're getting to claim accounting there. I don't think you should from a claim accounting standpoint, you would not assume that they're going to give you an equitable adjustment to these costs. So, without opportunities, you would potentially have to do a negative adjustment. That's correct.

Gautam Khanna (Analyst)

Got it. Okay. Shifting to technical solutions. So, there was a reference in the release to lower performance on a host of items, oil and gas, I think, some fleet repair work, etc. Could you just elaborate on what's happening in those? And I think it was nuclear and environmental as well. So, was this just, again, COVID inability to execute, or was it something else? And what are the plans on the oil and gas side?

Michael Petters (President and CEO)

Yeah. So, actually, in the quarter, the major impact was the San Diego shipyard, and some performance issues there. Oil and gas and nuclear were okay, but compared to last quarter, the performance was a bit less. Nuclear ships timing and very comfortable with where they are and still comfortable at the 7%-9% EBITDA. I commented previously on oil and gas. We still think that'll get divested this year.

Gautam Khanna (Analyst)

Last one, cum catch-ups by segment, if you could give us the net.

Michael Petters (President and CEO)

I've got positive 61, negative 29, net 32, and two-thirds of that net is Ingalls.

Gautam Khanna (Analyst)

Okay, and was TS a negative, I imagine?

Michael Petters (President and CEO)

It was pretty flat, little negatives.

Gautam Khanna (Analyst)

Thank you very much, guys. I appreciate it.

Michael Petters (President and CEO)

Sure, Gautam.

Operator (participant)

Your next question is from Ronald Epstein with Bank of America.

Ronald Epstein (Analyst)

Hey, good morning, guys.

Michael Petters (President and CEO)

Good morning.

Christopher Kastner (EVP and CFO)

Morning, Ron.

Ronald Epstein (Analyst)

Could you speak to in the 2021 budget, there's not a second Virginia-class, and there's been a lot of back and forth that there could be a second Virginia-class. And I think your friends over at BWXT are building a reactor for a second Virginia-class. So, how do we think about is there going to be a second Virginia-class or not? I mean, what's your latest read on that?

Michael Petters (President and CEO)

Thanks, Ron. Look, you've been doing this as long as I have. You know that the budget comes over, and then there's a process that the Congress goes through to get the budget squared away and passed and appropriated. There were some late-moving items in the budget, frankly, from last year to this year that, I guess my assessment is that the Congress was surprised about. And so when that happens, it takes a lot more work from the administration and from all the stakeholders to work their way through it. My sense of this, though, is that the outlook for that second Virginia is pretty bright. I think the Congress has pretty much made its intentions pretty clear. And so I don't know how all the pieces move around, but I'd say I'm pretty optimistic about it.

Ronald Epstein (Analyst)

Okay. Great. And then when you think about the current pandemic, what opportunities has that opened up for you in terms of when you think about the Technical Solutions group? Are there potential M&A opportunities out there now that might not have been or are potentially more attractive now? I mean, one of the things you guys articulated at the investor day is that scenario where you want to have some growth. Is this an opportunity to try to grow that business?

Michael Petters (President and CEO)

I think that the issue right now is that valuations are just, I'd almost say, mythical. To try to get to a fair value of a business is, I mean, that's a hard read. I mean, we are still interested. We haven't changed our posture. But let's just take, if Acme is out there and suddenly Acme got wiped out by their share price got wiped out by this volatility, the board of Acme still would think that they're worth a lot more than their share price is. And so trying to engage in that is really pretty challenging. But we're going to keep looking, and we're kind of leaning forward to try to find ways to make something out of it, so.

Ronald Epstein (Analyst)

And then finally, you might address this before, but just to dig maybe a little deeper, how is your supply chain doing, right? I mean, when you think about where there could be more serious stress points, and in particular, some of your smaller suppliers, if you're dealing with the sole-source, mom-and-pop kind of shops, I mean, how are they handling this? And what are you doing to try to help them through the situation, particularly those that might have more exposure to industrial or aerospace markets?

Michael Petters (President and CEO)

Thanks for the question. We're in direct contact with our entire range of suppliers, several thousand across the country. I'd say at first cut, we have reached out to everyone and said, "Let's talk about what impacts you're seeing and what impacts that might have to our programs." The vast majority of our suppliers are saying, at this point, no impact. Now, I would say, because of where we are right now, I would say we put the word yet on the back end of that. They say no impact. We say no impact yet. There's a group of suppliers that are saying that they're seeing impact, but no impact to our programs.

I would say, "Okay, no impact to our programs yet." And then there's a handful of suppliers that are saying, "Hey, we've got real impact here, and it is going to impact our programs." I think what I'm encouraged about, Ron, is that in the near term, we're actually supporting the key milestones that we need to support, whether it's ship construction activity or supporting the fleet. We have the information and material we need from our supply chain to do that. What's harder to evaluate is what's going to be the impact around the corner, not in the near term. I think in the near term, we're working our way through that. But I think in the medium term, the stuff that needs to be going on today to support us at the end of this year or into next year, how is that going?

That's why I say we put yet next to that because I don't know that anybody has a very clear view of that. The last thing I would say is that one of the advantages that we have, besides having the $45 billion backlog to go work through and support our supply chain, is that our supply chain is domestic. We're not dealing with suppliers in Mexico or suppliers in India or anything like that. I mean, where there have been some disruptions that I've seen across the industry has been as much about trying to reach across the borders as it has been about trying to reach and find the small folks. So, we're keenly engaged in this. We're working this every single day. But at this point, I'd say near term, not in effect. Medium to long-term, wait and see.

Ronald Epstein (Analyst)

Got it. All right. Thank you very much.

Michael Petters (President and CEO)

You bet.

Operator (participant)

Your next question is from Noah Poponak with Goldman Sachs.

Noah Poponak (Analyst)

Hey, good morning, everyone.

Michael Petters (President and CEO)

Morning, Noah.

Noah Poponak (Analyst)

Hey, Chris. Just back to the question on your margin rates and how the EAC recognition and accounting will work as you go through the year and there's potentially disruption. But you're sort of telling us you're able to hold to what you thought before this disruption. My understanding from what some of the other defense companies that had reported already and spoke to this said was that amongst the handful of things that your customer was doing to help the industry get through this, that one of them was to the extent you were underperforming cost in what you had contractually signed up for, if you were able to display that it was attributable to the coronavirus pandemic, that you would actually be made whole back to your original assumptions.

Am I correct that that is going on and that's part of your ability to hold the margins, or did I totally misread that from somebody else?

Christopher Kastner (EVP and CFO)

I think you may have misread it a bit. Now, that being said, it's an evolving situation a bit. But I think there's a lot of news and a lot of discussion out between government contractors and the government on the appropriateness of getting equitable adjustments through different legislation. The way we read it right now, based on current legislation, you do not have the ability to recover equitable adjustments for delay and disruption on your contracts. So, we're not operating under that assumption. That doesn't mean it might not. We might not get there. And there are some types of costs where we think you will get adjustments and recovery for, stuff like quarantining or if a government facility is shut down, you can't go into work. You're not going to be harmed for that.

But equitable adjustments and delay and disruption, we don't think that is fully understood yet or fully dealt with under legislation yet. So, I would not make that assumption, no.

Michael Petters (President and CEO)

I would add there is intent, but there's not coverage. And so, where we are from an accounting standpoint, at the risk of practicing accounting without a license, where we are with an accounting standpoint is we're just not assuming that. We are engaged in the discussion about how do we make this happen and what changes need to be made from an appropriation and from an authorization standpoint. But that has not happened yet. And so, that's where our engagement is, and we'll see how it goes.

Noah Poponak (Analyst)

So, assuming that doesn't happen then, would I then need to model that your shipbuilding margin in the second and third quarter declines sequentially from the first and then is more back-end loaded to the fourth quarter? Or how do you hold the margin with the amount of disruption you're seeing?

Christopher Kastner (EVP and CFO)

Yeah. So, I wouldn't change anything at this point. No, I think it's just too early. I think it's just too early. There's going to be a modest impact to sales for sure in Q2, but there's risk that we're going to have to deal with relative to reduced attendance in the yards. But there's also opportunities because our expenses are fundamentally changing right now, and you need to deal with all of that when you do your EACs.

Whatever happens with the equitable adjustments, not going to happen in second quarter.

No. That's just not going to be resolved in Q2.

Noah Poponak (Analyst)

Is your comments of not changing anything more geared towards you don't think the numbers are going to change, or more geared towards nobody has enough information at this point to really forecast what the numbers are going to be?

Michael Petters (President and CEO)

I think more of the latter. But also, we're making critical milestones within our shipbuilding programs. Right? We're delivering ships, performing very well within Newport News and Ingalls. So, it's kind of a combination of both.

Noah Poponak (Analyst)

Okay. And then last thing on this, as it pertains to revenue, it's, I guess, similarly a little bit hard to square if you're at 70%-75% staffing and it's a percentage of completion accounting business, why that wouldn't have a larger impact on revenue. I mean, I guess sort of to your last answer there, it sounds like even if you have less of the cost there or less of the staffing there, if you can hit the milestones, that's a bigger piece than just what the staffing level is. But I don't know. I'm surprised to see 70%-75% staffing, minimal change to revenue and a percentage of completion accounting basis. How do I square that out?

Michael Petters (President and CEO)

Well, no, remember, we're going to recover, right? The attendance is going to recover. So, we talk about 3%-5% for the year. So, we're going to recover from a sales standpoint as we get our attendance back for the year. There's going to be an impact in Q2, no doubt. But we still think we're at the lower end of the as of today, we still think we're at the lower end of the 3%-5%. If the virus goes on for a prolonged period of time, that could change. But right today, it's the lower end of the 3%-5%.

Noah Poponak (Analyst)

Do you have visibility right now from sort of state and local economic reopening, stay-at-home order revision as to when you'll start to be able to restaff or bring people back on, I should say?

Michael Petters (President and CEO)

Well, at the first level, we're the largest employer in both Virginia and in Mississippi. So, we're deeply engaged and connected to the governor's office in terms of how do you go about reopening the state and what makes the most sense and how do you do that. And we come to that conversation from the standpoint of we've been open the whole time. So, these are the issues that you're going to as you start to open these businesses. These are the things you need to be thinking about. You need to be thinking about employee safety. You need to be thinking about customer safety. I would just say the whole thing about reopening is it's voluntary. Businesses have to volunteer to open. Even if the governor says to open, it doesn't mean that you're going to open. A business has to volunteer to open.

A business owner is going to say, "I can open because I am confident that I can keep my employees safe and I can keep my customers safe, and I can do that at a rate that makes sense for me to open." And the second voluntary action there is on the customer's part, and they have to decide that it's safe for them to go out. I think I mentioned earlier it's the "When are you going to feel safe to put your kids back in school?" I think is the number one question relative to all of this opening. So, we're deeply engaged in all of that conversation. How that plays for us, though, is it affects the employees that are staying home because they have to take care of their kids. It does affect them. So, that's where the reopening affects them.

But our view is that, as I said, we're shifting our posture here to, we'll go higher. There's a lot of folks out there that are looking for work, and there's a lot of qualified people that are looking for work. And so, we're looking to start expanding our attendance again to go and get back to the business of doing what we're doing. So, that's all going to play out in the second quarter, and it's going to be, as Chris says, it's just way too early to tell how that's all going to play out. But that's our view, and that's somewhat independent of how the governors are going to open the states.

Noah Poponak (Analyst)

It's all really helpful, and I appreciate it. Thanks, guys.

Michael Petters (President and CEO)

You bet. You bet.

Operator (participant)

And your final question comes from the line of Jonathan Raviv with Citi.

Jonathan Raviv (Analyst)

Oh, thanks so much for the follow-up. And just to follow up on that budget question, can you also talk about the carrier side of things? I know it kind of comes up every few years and such, but Secretary Esper's office seems to be looking to reduce that footprint. So, just to give a little sense of your perspective given the current fiscal and political backdrop.

Michael Petters (President and CEO)

Yeah. Jon, thanks. I think the carrier conversation always comes up because it turns into a conversation about, "Can we get more capability by changing structure or changing operations and things like that?" There are lots of folks who have lots of opinions on this. I have been through this many, many times. The bottom line is you can't get 80% of a carrier for 80% of the cost. Volume is the cheapest thing that happens on a carrier. Actually making it larger is the way you capture the return on the investment that you've made. And so the idea that you're going to go and do something smaller, maybe you have a smaller fleet, which is a different conundrum for the Navy, which is something to think about. But in general, if you're looking for a replacement platform, that hardly ever works out well in terms of the analysis.

I do think the Navy and the Pentagon and Secretary Esper are thinking about, and rightfully so, they're thinking about, "What are the future capabilities that we need, and how's the best way for us to get there, and how do we fund that without sacrificing too much of our current capability?" and you're going to see lots of options. Some of them will, like the Marine Corps discussion that we had before. It's going to be a very dynamic time in shipbuilding, and we're going to be in the middle of that conversation as a principal partner for the Navy to help them achieve whatever it is that they want to do, but we come into that conversation with a $45 billion backlog of work that's going to be the foundation from which that conversation will take place.

The investments that we've made in terms of creating the agile workforce that we need and the agile supply chain that we need, I think, are going to support whatever direction the Navy and the Pentagon want to go, and we're happy to be part of that.

Jonathan Raviv (Analyst)

Thanks so much, Mike.

Dwayne Blake (VP of Investor Relations)

You bet. Okay. It looks like we have no more questions. I just want to thank you all for your interest today, and we want to make sure that I hope you all are safe and well and your families are safe and well. Please take care of each other. But we do appreciate your time for joining us, and we look forward to speaking with you again. Thank you very much.

Operator (participant)

Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. You may now disconnect.