Welcome to Huntington Ingalls Industries Inc. Q4 2014 Earnings Call. [Operator Instructions]. I would now like to introduce your host for today's conference, Mr. Dwayne Blake, Corporate Vice President Investor Relations. You may begin.

Thank you, Sam. Good morning and welcome to the Huntington Ingalls Industries' fourth quarter 2014 earnings conference call. With us today are Mike Petters, President and Chief Executive Officer and Barb Niland, Corporate Vice President, Business Management and Chief Financial Officer. As a reminder, statements made in today's call that are not historical 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 their remarks today, Mike and Barb will refer to certain non-GAAP measures, including certain segment and adjusted financial measures. Reconciliations of these metrics to the comparable GAAP measures are included in the appendix of our earnings presentation that is posted on our website. We plan to address the posted presentation slides during the call to supplement our comments. Please access our website at www.huntingtoningalls.com and click on the Investor Relations link to view the presentation as well as our earnings release. With that, I will turn the call over to our President and CEO, Mike Petters. Mike?

Thanks, Dwayne. Good morning everyone and thanks for joining us on today's call. Before we start, I want to express our deepest condolences to the family of Joe Nadol, our friend and colleague from JPMorgan. As you all know, Joe was insightful, accurate and fair and he had a keen understanding of our business and our industry and he will be sorely missed. This morning we released fourth quarter and full year 2014 financial results that reflect excellent operating margin performance and cash generation at Ingalls and Newport News. We also had some pressure from UniversalPegasus due to extremely dynamic market conditions and some operational challenges. I want to personally thank each one of the 38,000 employees of Huntington Ingalls for the hard work and dedication that produced these results and for their continuous commitment to safety, quality, cost and schedule. During the quarter we had two events that reduced our GAAP earnings. First, we absorbed the $37 million one-time cost to refinance our seven year notes which will significantly reduce our interest costs going forward. Second, our annual goodwill evaluation led to a $47 million non-cash impairment charge in our other segment. This was driven by the recent drop in oil prices and the decline in industry market multiples. In addition, fourth quarter 2013 sales and operating income at Ingalls included the benefits of the favorable resolution of hurricane related insurance claims. 2013 full year results also included the charge for closure of the Gulfport facility. All comparative data that Barb and I discuss today are adjusted for these items as well as for the FAS/CAS adjustment. For the quarter, sales of $1.9 billion were consistent with last year and segment operating margin was 9.4%, up from 7.9% last year. For the full year, sales of $7 billion were…

Thanks Mike and good morning everyone. Today I'm going to review our consolidated and segment results for the fourth quarter and full year, then wrap up with some information on our outlook for 2015. Please refer to the slides posted on our website for more information. As Mike mentioned, all of the numbers that I discuss today will be adjusted for the goodwill impairment charge and the one-time interest expense for the early extinguishment of debt in 2014 and for 2013, the hurricane insurance recoveries and Gulfport closure. Please refer to the presentation on our website or the earnings release from this morning for the respective reconciliations. Now turning to the consolidated results shown on pages 4 and 5 of the presentation, we ended the year with very strong operational performance in the fourth quarter at Ingalls and Newport News. Total revenue in the quarter of $1.93 billion increased 1% over the same period in 2013, bringing 2014 revenue to just under $7 billion. Total operating income in the quarter was $191 million and the operating margin was 9.9%, compared to $156 million and 8.2% in the fourth quarter of 2013. These increases were due primarily to higher operating income at Ingalls and Newport News, as well as favorable variants in the FAS/CAS adjustment which was partially offset by lower deferred state income taxes and an operating loss in the other segment. Cash flow from operating activities and free cash flow were very strong in the quarter and for the full year. We generated $402 million of cash from operating activities in the quarter and $716 million for the full year. Free cash flow in the quarter was $328 million and $551 million for the full year. These increases were primarily due to decreases in accounts receivable and lower pension…

[Operator Instructions]. Our first question comes from George Shapiro with Shapiro Research. Your line is open.

Question on -- Mike you say margins will be over 9% but effectively Ingalls in Newport News made 9.4% this year. So are you figuring you'll see a decline in that margin in '15? If you could explain that a little bit further.

As we said many times here George, the healthy business operates in the 9% to 10% range based on the blend and mix and the maturity of the work that we have going on. We had a great year in retiring risk in 2014. We have to do that again. At Newport News we have a lot of cost type work and we’re doing the delivery of the Ford. Most of that work will be done this year as we get ready for delivery next year. We’re going to be heading down the path of delivery of the RCOH and a lot of that work is going to be done this year and the enterprise also. We have three carriers in a cost type environment at Newport News that is going to make it -- it's a little bit out of balance in terms of the blended rate, so we'll be working our way through this year at Newport News. At Ingalls, the question really is how does with future workflow to support the risk retirement that we have going on, whether it's LPD 28 or the next LHA. How does that work flow in fit into our work? And so that's why we're not going to try to handicap whether it's higher or lower than 9.4%. We're just going to continue to say that to be healthy in this business you ought to be able to operate sustainably in the 9% to 10% range.

Thank you. Our next question comes from Robert Spingarn with Credit Suisse. Your line is open.

Barb, I wanted to come back to what you just said on CapEx and your comments on working capital and just see if we can get to the endgame on free cash flow for '15. So CapEx could go up by a couple hundred million, it sounds like. Assuming and I guess one question would be is that already in the plan or is that dependent on which programs you decide to pursue so how much variability is in that or do we just build in call it 4.5% to 5%. And then how does working capital behave? You obviously had that big drop in receivables. And that was -- is that going to be a headwind going into next year? Because if you take that and you take the CapEx it seems like free cash could be $300 million lower but I want to make sure I'm not forgetting to put in the positives such as the sale of assets and etcetera.

So let's start with capital. And that's exactly why I explained capital and split out the maintenance and sustainment pretty steady at 3%. The discretionary capital are individual projects based on engineering studies that prove out the concept can improve efficiencies and reduce future cost to help us be more competitive. So we're not releasing all that capital and giving everybody a blank check to move forward. We're releasing it incremental and engineering studies to look at the items and determine if they make sense for us. Okay. So in a perfect world if all the projects that everybody wanted to do this year -- the range would be in that total capital 4.5% to 5% range right? At each project will be let out incrementally. And each quarter I'll let you know if I'm getting closer to that amount or not. So that covers the capital. On the working capital side we continue to work on working capital and yes -- we’re successful in the sale of Gulfport that will help a little bit but we assumed in some of what is in receivables today that we would sell Gulfport. So it will depend on the exact value we sell it for whether we will see an improvement due to that sale. And then the other thing we will be timing of completing the negotiations with the customer on that accelerated depreciation that's sitting in accounts receivable right now. So I believe though we have made a great effort to sell the property for -- and that the customer should recognize that and negotiations on that particular issue should go okay and move forward quickly once we get that sale complete. On the Avondale restructuring piece, remember we just recovered that over five years. So part of that would be recovered. And then since you're worried about what cash is going to be at the end of the year I would say 2014 we had an outstanding collections. We pretty much collected every single invoice we had outstanding, that's my first time in 10 years I've seen that. So it can be lumpy just because of timing. We might get paid January 2nd versus December 29th. So it's really tough to predict what it will end up at the end of the year.

So just to close this off, you had a source of $100 million from working capital in '14, it's been a use in a couple of years prior to that, what's the right way to think -- I know they are moving pieces. Is there a good range we should use for '15?

I think it's going to be tough to call on that one. My famous word lumpy it could be. It could be the same as 2014. It could be worse. So I promise you my entire team is working that every day. We have a relentless focus on improving working capital in this business.

And Rob, if I could just pile on here, I know you didn't quite as this question but if you think about what's going to happen on the Navy business in the next five years and just take a look at the programs that are going to be awarded and then the tail that comes with those programs CVN-79 the construction contract, the CVN-73 RCOH, CVN 74 RCOH, the next block of submarines. The Ohio replacement program, LHA 8 and a whatever might come after LHA 8, the LPD 28 and the LXR program, a competition on the DDG program again. Whatever the Navy pass, whatever they chose for some future small surface combat is out there. You see an awful lot of activity not just in awards in the next five years but in terms of programs that are going to go out for 20 to 25 years are going to be decided here in the next five years and so our decision is that we want to invest against that to make sure that our competitive posture is where it needs to be. The Navy has got pressures on the budget side of this and so in some programs where we’re sole-source, our competition is with the budget and not necessarily with someone else and so our investment here is going to be about driving the efficiency into the business that our customer needs. In a way that will be sustainable, will create sustainable value for us longer than a year or two but really talking about a 20 to 25 year kind of return.

Thank you. Our next question comes from Doug Harned with Sanford Bernstein. Your line is open.

You mentioned Ohio class replacement and right now I mean that's a General Dynamics program but as you look forward to the opportunity to participate in that, what are the points in which the Navy or sort of the timing when the Navy would typically make a decision with respect to sharing work across different parts of the industry. In other words when could you start to see you might be playing a role in that?

Well Doug I think first of all we've been doing some work on that program already, but as I've said before I think the way you have to think about that program. It is a major national construction effort and the entire submarine industrial base will be involved in trying to produce that program at the same time that it's still producing the Virginia class program. You'll have to ask the Navy on what their timing for their decisions on different pieces of this will be. But our expectation is that there will be a whole lot of discussions going forward about what's the most optimal way for the submarine industrial base at the national submarine base to produce the nation's demand for submarines. And so we expect that that will be played out over the next couple of years.

And then I guess separately we've had this fall in oil prices. I think it's fair to say the oilfield services sector looks much less attractive than it did six months ago. How are you now looking at your efforts? You bought UniversalPegasus, as you go forward how do you think about that sector now given the change?

Well there is no doubt that there has been a major change in that space from where we were a year ago. Our challenge today is to manage the reduced flow of capital. We see companies in that space that are delaying their projects. For the most part projects are not been canceled. We have really good customers that are working with us on delaying these projects to match their capital expenditures. They're changing their CapEx based on the oil price. The challenge for us is that there is definitely going to be less volume. We have got a size of the business to be successful at a lower volume. We have got to do that in an environment where we maintain the relationships that we have with these -- we have a superior group of customers and we're very proud of that customer set. We've got to maintain that relationship that we have with them. We bring to those customers some unique skills today and it's very important for us that we preserve and maintain those capabilities going forward because when this market terms and I believe it's inevitable that it will just don't ask me when. When it turns we are going to be positioned to benefit from that and the first order of business is we've got to be successful at a lower volume. Now as far as going forward and how you think about investing in that space, certainly growth rates have changed from where they were a year ago. A little bit different way to think about how do you value something in that space and so we're giving all of that another view. Certainly our view of the space has changed since where we were a year ago. But the bottom line Doug is that if we have a lot of capability and we’re interested in creating channels to those customers who need our capabilities and we think that that's a way to create new value for our business that wasn't there before.

Thank you. Our next question comes from Pete Skibitski with Drexel Hamilton. Your line is open.

Mike one for you. For the '15 budget approved, we've got the 16 proposal out there. A lot of shipped things seem to be clarifying a bit. I want to ask you, as your kind of midterm revenue profile kind of clarified at all or is there still kind of too much floating out there in terms of the unknown with sequestration and whatnot?

I think the sequestration is the elephant in the room, frankly. I'm an optimist and I believe that somehow someway we will find a way to move into 2016 in a non-sequestered way. I can't tell you what the mechanism for that will be and I don't know what the catalyst for it is. But I do think that somehow this great country will find a way to do that because the alternative is just so bad. Relative to our specific programs, sequestration is -- in the midterm is a real challenge because when you start to look at some of the programs that I talked about over the next five years sequestration will directly affect some of those programs. I think the Navy has provided their list of how -- which programs get affected and by what volumes. The carrier program gets affected. The RCOH has been playing out on the front pages for the last couple of years. And I don't think that changes even though we have this contract now and we're racing towards an RCOH I think if we're in a sequestered environment I think that all gets debated again. And so I'm not sure that I would say that it's all cleared up. I think that I'm optimistic that we will find a way through it but there is still a lot of moving parts.

And then just one follow-up, one thing I saw during the quarter is this idea of the Navy I think assembling plan where it was kind of compete altogether the fast oil or and LRX and I think maybe LHA-8 as well. And I was pretty confused about it in terms of what would a winning scenario look for HII and get a timeline during which this plays out. Can you add any light on that whole plan? And how it might play out for you guys?

We’re at the very front end of the Navy's acquisition strategy for a range of programs and I think that that like a lot of things if you look at it before the cake is done sometimes that affects the cake. So I'm not going to comment too much on this except to say we're engaged with the Navy to figure how is the best way for them to successfully acquire the platforms that they need going forward.

[Operator Instructions]. Our next question comes from Jason Gursky with Citi. Your line is open.

It's actually Jon [inaudible] for Jason. I just want to confirm Mike, your language and you always say 9% plus margins in 2015. Is that still just a shipbuilding number or do you see some opportunity to turn other around a little bit faster with the cost actions you outlined?

We think about that and we use that to set the stage four years ago for driving efficiency in our shipbuilding business. Over the long-term where we really want to be is we want to be driving the return on invested capital in our business up and we’re making some big investments right now and so that’s going to be, we’re still kind of going to be going through this phase is that return on sales or segment margin or is it return on invested capital? I think about that in terms of specifically I think about shipyards in being -- a healthy shipbuilding business operates in that 9% to 10% range. Relative to other segment that we’re talking about today, as I said we expect that to be successful at a lower volume and that's what our efforts going to be. Overall I think we still be in the 9% to 10% range.

The other segment in a healthy business, remember it's a services business so it's in the 5% to 7% range, okay, with no capital investment. And then in the shipbuilding side where Mike talked about the healthy range of 9% to 10%, what you have to remember is we have services also in the shipbuilding side with our businesses and AMSEC and continental maritime that are -- we’re absorbing it at a much lower margin rate because those contracts are all time and material or cost plus with much lower margin rates. So it's all about being a healthy business and having a good mix of programs.

Just a quick follow-up on segments, Mike I think in reference in response to George mentioned some mix shift headwinds at Newport News. Similar question at Ingalls, it sounds like you -- feel like you have opportunity to potentially repeat what you did this year even though fourth quarter was so strong. Could you add a little more on Ingalls sustainability going forward?

Where we are at Ingalls is the execution side of Ingalls is going very well right now. Across all other programs that I went through and our comments -- I'm very, very happy with the way that we are executing. But part of being the healthy shipyard is that you have to bring in the future work to balance the volume. And so -- how does the Navy acquire the platforms and how does Ingalls participate in those acquisitions over the next few years is part of the equation as to whether they can be sustainable or not. And so really four years ago the focus at Ingalls was on execution. Today the focus at Ingalls -- it always remains on execution but we then have to use our performance to make sure that we preserve and capture the work that's in front of us. And so that's what our effort is. If that work starts to move around even though we will be executing well it will drive our rates and that will negatively affect the business. So our overall approach is to let's get this work done. That's why we're particularly pleased with where the LPD 28 came out. The Congress step forward and put a $1 billion up against that program and the Navy came back in the '16 budget and added more money to the program and basically now there is a commitment to go and execute that program. We think that that is the right decision but it also is very, very helpful to Ingalls around the sustainability of their future.

And John, I would like to add when you -- Jason I'm sorry, when you talked about the fourth quarter being pretty big at Ingalls. It was because we launched LPD 26 and as we go into 2015 we will have the launch of NSC-6 and the launch of one of the DDGs. And much smaller ships so we had big risk retirement on 26 that affected the fourth quarter. And the risk retirement on a smaller ship will be a little different next year or this year, as we are in this year.

Thank you. Our next question comes from George Shapiro with Shapiro Research. Your line is open.

Yes, I just wanted to clarify some of your earlier comments, Barb. So based on the higher CapEx and receivables being flat it doesn't seem like you could get free cash flow equal to net income in '15. It's going to be somewhat below. Is that a fair statement?

It could be. Yes. That's a fair statement.

Okay and then just if you could comment, could you project what CAS might be for '16 at this point?

I don't have that crystal ball here. Of course we have projections where we think they'll be but -- George, I hate to go out on a limb on that one, but thanks for asking me.

Thank you. Your next question comes from Doug Harned with Sanford Bernstein. Your line is open.

Just one more question, when you talk about 4.5% to 5% CapEx -- I found this a little surprising and the reason is it seems that in many ways that you've moved from a situation of going into new programs to a more steady -- it what appears to be a more steady-state of similar ships going forward. So I was surprised to see CapEx go up to these levels. If you look at say GD Marine Systems they've operated pretty consistently between 1% and 2% for CapEx for some time. I'm just trying to understand what's different at Huntington Ingalls right now and -- where this -- what is this going to basically, the CapEx?

The perspective that we have is that we've taken advantage of the serial production in the LPD program and the restart of the destroyer program. And the lessons learned on the LHA's. We've taken advantage of that to fix the returns on our Ingalls business. And we look out ahead and we see the LXR program out there which is a new program, we see the next competition for the destroyers which will be -- that's coming up in about three years. We see the next -- we see LHA-8 is under some significant budget pressure at this point and we see the question is what happens after LHA-8 out there. We see the need to reset the competitive posture at Ingalls and so that's our objective here is to first of all reset that from a capital investment perspective and the facilities perspective, I’ve been working on process for quite a while but it's time for us to go and align the facility and our process there to be even more competitive. I think the one way to think about that Doug is that we’re building multiple classes of ships in the shipyards, in each of our shipyards and so we’re building facilities that tend to be multi-platform flexible which makes it a little bit different kind of investment profile than say other folks might have. At Newport News there is a lot of budget pressure as you well know in the carrier program there is a cost cap on CVN-79, the challenge of getting to a contract. I mean we've been working on trying to get to a contract for quite a while. How do you invest in the process efficiencies they are going to allow that to happen? I do think that there will be -- as…

So is it fair to say when I look at Ingalls for example you had post-Katrina there was a lot of work down there to modernize those shipyards at that point in time. When you look at today's situation, I think of Ingalls -- LXR is still a few years you know particularly with LPD-28 assuming that all goes according to plan. Do you invest this early for an LXR are you investing specifically for a LXR program or specifically for Ohio class replacement at this point in time or are these things that you do to modernize the shipyard to make you better positioned for each of those?

I think Doug that's great insight and I think that that's some of both. First of all in the aftermath of Katrina what we did is we rebuilt the shipyard. I can't say that we actually modernize the shipyard in the sense of bringing it to where the state-of-the-art is in terms of shipbuilding production. We were changing the team that was there was changing the wheel on a car that was going around a curve at 60 miles an hour and a lot of what was done was just rebuilding what we already had. This is a much different thought process on what is the process that we're going to use for building ships? Some of the investment that we’re going to make are going to be generic in nature that will support all of our ship building programs. Some of them will be conditional based on the Navy's plan for acquisition and you bring up the timing of the program that may certainly affect the timing of some of our investments. But all in all our overall approach here is there is so much in play over the next 3 to 5 years that has such a long impact on the business that we want to be out in front of that.

Thank you. And we have a question from Pete Skibitski with Drexel Hamilton. Your line is open.

I have a couple more free cash questions, actually. Bob I think just so I'm clear on 2014 you had a pretty large retention release on LHA-6 correct?

That’s correct.

We don't have anything similarly that could happen in 2015?

No you do not have anything that will offset that.

Okay. And just an housekeeping D&A I think came in at close to $195 million. Should we expect that up by any meaningful amount because of the CapEx ramp or will that impact more over time?

That will have an impact more over time.

Okay. And then last one I guess on the debt refinancing I think you have one more kind of high rate trend, the 7 and 8 they are doing 20-21?

You got it.

Any chance that you would refinance those sooner before maturity?

If we can get a good rate and the time is right it would be the smart thing to do. So we always look at it and when the numbers balance and the MPB is that the right rate we certainly will jump in if we have the opportunity.

Thank you. Our next question comes from Sam Pearlstein with Wells Fargo. Your line is open.

I wanted to ask you a question about some of the budget stuff in the fiscal '16 request. Just if I look at like CVN-78 it looked like it was a little bit less by few hundred million in '16 then you would've said in from the set up last year and I guess I'm trying to just think about, is that a sign of more spending in '15? Or is that a stretch out of development and does it have any impact in terms of the Kennedy or the next negotiation?

I think sometimes you need a program to try to decipher what you read in the budget documents. We're in a place where we are moving towards completion on CVN-78 and the program is funded. How the government is trying to do their housekeeping to make sure that they have the funding to get us to the end point, we're aware of that but that's really an internal to the government kind of discussion. We have the authorities, the processes, the people and the decisions to make to get the ship delivered and that's what we're really focused on. On CVN-79 we've been doing significant work on a construction preparation contract. We have been negotiating the detailed design and construction contract. We have talked for a while about the challenge of negotiating a price type contract when you're not finished yet with the first one which was in a cost type environment. And so we are still trying to work our way through that and get some common view of what's the risk in that program and make sure the government and the company have a view of the risk that looks the same. Overlying that whole negotiation though really is the cost cap on CVN-79 which is a number that was set equivalent to the cost cap on CVN-78 back in 2006 or so something like that. And so trying to figure out how do you get all the scope, how do you get the risk agreed to and how do you do that inside the box that the government is operating inside has made for a really challenging negotiation. As far as the funding goes and the way the budget request and the appropriations and the way the Navy is thinking about that -- we're pretty very confident that all the authority and funding that we need to get these ships done is in place.

And is that the same on the George Washington in terms of the overall? I know there is funding in this budget request but are you working I guess towards the dismantling step and then you still have to wait for the next contract to actually do the remainder of the refueling?

No what's happened here is we actually now have a contract to plan for the refueling. The contract mod that we just did cuts us loose to go and plan the work as if it's a refueling and to actually begin the procurement of long lead material to do that. What will be hanging over that is that there will be an execution contract to follow and the execution contract could be affected by whether or not we're in a sequestered environment. And so that's sort of the grey area out there. As I said I'm an optimist, I believe that we will find a path through there, I believe that ship will be refueled. I believe that we will get to the 79 under contract. I believe that these programs will stay on track and the timing will all be in place. But I don't know what the catalyst for removal of sequestration is, yet. So we'll see.

Thank you. And I do have a question from Jason Gursky with Citi.

It's [inaudible] again. Thanks so much for fitting me in on the follow-up. If you guys just [inaudible] a little more on the timeline perhaps of how long it will take to "reset" your competitive posture and then especially in this environment of heightened CapEx, what is the cash to point priorities specifically on returning cash to shareholders? Could we see share count come down? Do expect the low rates of dividend? Just what does that fall in this list of priorities you've offered today?

Well we certainly believe strongly in bringing our shareholders along with us as we go forward. I believe that our shareholders understand that we need to go and be successful in this resetting of the business and so we see that being pretty balanced going forward. This is not something that we will do at the expense of the shareholders. This will be done with them in partnership with us.

Okay. Thanks everybody for joining us today. I'd like to wrap things up by just saying how pleased I'm with where we are right now. Looking back over the past four years we have absolutely turned around the performance at Ingalls and we have maintained Newport News performance at the levels that you expect. In spite of our challenges at UPI we have produced the operating margin in cash at levels right in-line with our expectations. We have a clear view of the things we need to do to maintain a strong and competitive business for the long-term. Our relentless focus on execution will never change. We do recognize the importance of finding new paths to create additional value and we absolutely plan to bring our shareholders along with us. So thanks for your interest in HII and we look forward to seeing you soon.