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Edited Transcript of HII earnings conference call or presentation 1-Aug-19 1:00pm GMT

Q2 2019 Huntington Ingalls Industries Inc Earnings Call

- Aug 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Huntington Ingalls Industries Inc earnings conference call or presentation Thursday, August 1, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* C. Michael Petters

Huntington Ingalls Industries, Inc. - President, CEO & Director

* Christopher D. Kastner

Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO

* Dwayne B. Blake

Huntington Ingalls Industries, Inc. - Corporate VP of IR

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Conference Call Participants

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* Carter Copeland

Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense

* David Egon Strauss

Barclays Bank PLC, Research Division - Research Analyst

* Douglas Stuart Harned

Sanford C. Bernstein & Co., LLC., Research Division - SVP and Senior Analyst

* Gautam J. Khanna

Cowen and Company, LLC, Research Division - MD and Senior Analyst

* George D. Shapiro

Shapiro Research - CEO and Managing Partner

* Jonathan Phaff Raviv

Citigroup Inc, Research Division - VP

* Joshua Ward Sullivan

Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst

* Myles Alexander Walton

UBS Investment Bank, Research Division - Research Analyst

* Noah Poponak

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Robert Michael Spingarn

Crédit Suisse AG, Research Division - Aerospace and Defense Analyst

* Ronald Jay Epstein

BofA Merrill Lynch, Research Division - Industry Analyst

* Seth Michael Seifman

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Q2 2019 Huntington Ingalls Industries Inc. Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference Mr. Dwayne Blake, Vice President of Investor Relations. Sir, you may begin.

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Dwayne B. Blake, Huntington Ingalls Industries, Inc. - Corporate VP of IR [2]

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Thanks, Jimmy. Good morning, and welcome to the Huntington Ingalls Industries Second Quarter 2019 Earnings Conference Call. With us today are Mike Petters, President and Chief Executive Officer; and Chris Kastner, Executive 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 laws. Actual results may differ. Please refer to our SEC filings for descriptions 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 is posted on our website.

We plan to address the posted presentation slides during the call to supplement our comments. Please access our website at huntingtoningalls.com and click on the Investor Relations link to view the presentation as well as our earnings release. With that, I'll turn the call over to our President and CEO, Mike Petters. Mike?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [3]

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Thanks, Dwayne. Good morning, everyone. Thanks for joining us on today's call. So let me share some highlights from the quarter starting on Slide 3 of the presentation. Sales of $2.2 billion for the quarter were 8% higher than 2018 and diluted EPS was $3.07. New contract awards during the quarter were approximately $1 billion, resulting in backlog of approximately $39 billion at the end of the quarter, of which $19 billion is funded.

Regarding activities in Washington, both the House and Senate recently passed their respective versions of the fiscal year 2020 National Defense Authorization Bill and they are now postured to begin conference. We are very encouraged by our strong support for Navy shipbuilding in both measures, which enables the continued procurement of destroyers, submarines, aircraft carriers and amphibious warships. Both bills also authorize and accelerate the purchase of LPD-31 in 2020 to best leverage the hot production lines and supply chains for the LPD Flight II ships.

Regarding the appropriations process, we're very pleased that a bipartisan budget agreement for fiscal years 2020 and 2021, which raised the budget caps for defense and non-defense discretionary spending, passed the House last week, and we await final approval of the legislation and look forward to the Senate's markup of respective appropriations bills after the August recess, followed as quickly as possible by conference on defense and other appropriation measures so as to minimize the need for a continuing resolution.

We were also encouraged that the administration announced its intention to proceed with the Refueling and Complex Overhaul of CVN 75 USS Harry S. Truman, and we look forward to having that ship arrive at our Newport News shipyard in the next decade.

So now I will provide a few points of interest on our business segments.

At Ingalls, the team delivered NSC 8 Midgett in April and the ship sailed away in June.

DDG 119 Delbert D. Black was relaunched after completing exterior structural repairs resulting from the incident that occurred during contractor delivery of the new floating drydock in March. The team is now focused on completion of interior damage repairs as well as integration and testing activities. Delivery of the ship originally scheduled for the end of this year is still under review but is likely to be in the first half of next year.

LHA-7 Tripoli completed builder's trials in mid-July. The team is now focused on acceptance trials later this year with delivery coming into focus in the late 2019, early 2020 time frame. And finally, the team received a final frigate RFP and is preparing its technical and pricing proposals for submission to the customer in accordance with their prescribed schedule.

At Newport News, the team completed the upper bow section on CVN 79 Kennedy last month. This unit is the last superlift to be erected and complete the ship's primary hall. Kennedy is approximately 94% structurally complete and approximately 62% complete overall.

Outfitting and painting activities remain on track and do support launch planned for the fourth quarter of this year.

CVN 73 USS George Washington achieved a 55% complete milestone during the second quarter and is on track with undocking planned this quarter. Following undocking, the team will be transitioning into the reinstallation and test phase of the RCOH. On the submarine program, SSN 791 Delaware remains on track with delivery also planned this quarter. SSN 794 Montana, our first Block IV delivery is on track to achieve pressure hull complete later this year, with delivery planned for late next year.

And finally, the Block V contract award is expected later this year.

For the Technical Solutions segment, results for the quarter were impacted by a $12 million forward loss on a fixed price maintenance availability at our San Diego shipyard for the cruisers CG 65 USS Chosin. The loss was primarily due to unanticipated additional cost required to complete aluminum repair work in the superstructure and topside area of the ship.

This issue was discovered during our quarterly EAC process and that process also revealed that the team was not making the operational progress consistent with the remaining work scope on the ship. So we sent some of our most experienced ship builders to review the situation, and we discovered a deficit in the capabilities to manage and execute the work. As a result of that review, we recognized the forward loss, and we are restructuring and adding talent to the program and execution teams in order to ensure that the work is performed with the highest quality and that the ship is returned to the fleet as soon as possible.

The Technical Solutions team continues to move forward and achieve success on its key growth initiatives across several business fronts. In unmanned systems, for example, we continue to support Boeing as their teaming partner on construction of the first 5 XLUUVs, a program, which we believe will dramatically change the market for unmanned undersea vehicles. Our G2 and Fulcrum acquisitions have been operationally integrated. And we are already starting to see benefits from adding these new capabilities to our existing businesses. In fact, we have already begun developing and submitting proposals as an integrated entity, which we believe will translate into additional growth opportunities going forward.

And in our nuclear services division, our Department of Energy business continues to perform very well. And we remain actively engaged on several large new business pursuits in this space.

In summary, our programs continue to be well supported as authorization and appropriations bills work their way through Congress. Award of the VCS Block V contract later this year will further expand our backlog and help insulate the business from any future debate in the Washington around defense spending levels. At Ingalls and Newport News, we are poised to achieve several key milestones in the second half of the year that set the foundation for a return to 9% -- 9% to 10% shipbuilding margins in 2020.

And a Technical Solutions team is focused on capturing growth initiatives across their business portfolio and achieving margins of 5% to 7% in 2020. I am confident that our team will accomplish these objectives and continue producing long-term sustainable value for our shareholders, our customers and our employees. So now I will turn the call over to Chris Kastner for some remarks on the financials. Chris?

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [4]

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Thanks, Mike, and good morning. As I'll review our second quarter financial results, you may follow along with the slide presentation we posted this morning on our website.

Beginning with our consolidated results on Slide 4 of the presentation, our second quarter revenues of $2.2 billion increased 8.3% compared to the same period last year, primarily due to growth in our Technical Solutions division due to the acquisitions of G2 and Fulcrum and higher volumes in Aircraft Carriers and Navy nuclear support services at Newport News.

Operating income in the quarter of $175 million decreased $82 million or 31.9% from second quarter 2018, and operating margin of 8% decreased 472 basis points. These decreases were primarily driven by an unfavorable change in the operating FAS/CAS Adjustment compared to the prior year, performance in Newport News on the VCS program and the recognition of a forward loss on a contract at Technical Solutions.

Turning to Slide 5 of the presentation. Cash used in operations was $44 million in the quarter and net capital expenditures were $91 million or 4.2% of revenues compared to cash provided by operations of $239 million and $85 million of net capital expenditures in the second quarter of 2018.

During the quarter, we contributed $14 million to our pension and postretirement benefit plans, of which $4 million were discretionary contributions to our qualified plans.

We also repurchased approximately 246,000 shares at a cost of $52 million and paid dividends of $0.86 per share at $36 million, bringing our quarter end cash balance to $29 million.

At quarter end, we had drawn $414 million on our revolving credit facility. The lower cash generation in the quarter was simply a function of timing with some receipts delayed until early third quarter. As we look forward for the full year, we expect free cash flow to be just north of last year's free cash flow of $512 million.

Moving on to Slide 6 of the presentation. Ingalls revenues in the quarter of $622 million decreased $7 million from the same period last year.

Ingalls operating income of $69 million and margin of 11.1% in the quarter were down from second quarter 2018, mainly due to lower risk retirement on the LPD program as well as recoveries related to a settlement agreement in 2018.

Turning to Slide 7 of the presentation. Newport News revenues of $1.3 billion in the quarter increased 7.1% from the same period last year, mostly due to higher volumes in aircraft carrier construction, aircraft carrier RCOH programs and Navy nuclear support services. Newport News operating income of $70 million and margin of 5.5% in the quarter were down year-over-year, primarily due to lower performance on the VCS program and pending contract actions for Block V boats.

Now to Technical Solutions on Slide 8 of the presentation. Technical Solutions revenues of $336 million in the quarter increased 38.3% from the same period last year, mainly due to the acquisitions of G2 and Fulcrum, which collectively contributed $66 million of revenue in the quarter as well as growth in oil and gas, fleet support and nuclear and environmental services. Technical Solutions operating loss of $1 million in the quarter compares to operating income of $7 million in the second quarter of 2018. The decline is primarily a result of the forward loss related to the fleet support contract that Mike discussed earlier.

Lastly, let me provide some thoughts on how the year is developing. With our strong start to the year for revenue, we expect year-over-year shipbuilding revenue growth of approximately 5% in 2019 and expect Technical Solutions revenue between $1.2 billion and $1.3 billion.

Also, we expect our shipbuilding business to achieve approximately 8% return on sales for the full year. In this regard, we expect shipbuilding margin will improve sequentially in the third and fourth quarters of 2019 as we ramp to margins of 9% to 10% in 2020.

As outlined on Slide 9, the shipbuilding margin ramp-up will be supported by the achievement of key program milestones later this year, with significant risk retirement weighted towards the fourth quarter.

For Technical Solutions, we continue to expect margins between 5% and 7% in 2020. Finally, for 2019, we now expect depreciation and amortization to be approximately $220 million, which now includes the recent Technical Solutions acquisitions and we expect interest expense to be approximately $65 million.

That concludes my remarks. I'll turn the call back over to Dwayne for Q&A.

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Dwayne B. Blake, Huntington Ingalls Industries, Inc. - Corporate VP of IR [5]

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Thanks, Chris. (Operator Instructions) Jimmy, I'll turn it over to you to manage the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Myles Walton with UBS.

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Myles Alexander Walton, UBS Investment Bank, Research Division - Research Analyst [2]

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Mike, I was going to lead off with now that the budget deal looks like it's going to take place and sequestration is going to be erased from the vernacular. Can we take a -- are you ready to take a more constructive view on the growth trajectory of the shipbuilding business at this point? And I know Chris, you said in the remarks, you actually gave the sales guidance for the year, which again is obviously above that 3% you guys have been talking about. So Mike, where are you in your heads at -- from a growth perspective, given now that the budget outlook seems to be forming more positively?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [3]

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Well, I guess, number one, we're very happy that this deal has come together. We're hopeful that the Senate will take it up and it will become the framework for an appropriations process and we can minimize the impact of any CR. As far as the shipbuilding Myles, I mean, the growth is really based on the way the work flows through the business. We're sitting here today with a $39 billion backlog, we have a Block V out there, there's a frigate competition going on. The way that all of that volume of work is going to flow through the business is still -- it's going to give us a 3% CAGR through the next 3 to 5 years. Wherever the budget process goes, that's where that's going to end up, I think. So there may be a year or a quarter, where it's a little bit higher or lower than that. But I think that it's -- the main thing about it is that we're locking the contracts in, and so if there's a right turn in the budget process and -- after '21, then we've already got our work under contract. So that's for us is the way we're thinking about the business. We're not really going to change the growth rate based on the budget deal.

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Myles Alexander Walton, UBS Investment Bank, Research Division - Research Analyst [4]

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So just to clarify though, the last couple of years of 11% and now 5%, obviously, above that 3% growth rate, I mean you're expecting a pretty sharp deceleration implied?

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [5]

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Well, yes. Obviously, with the growth over the first -- this is Chris, over the first half of the year. And what we're looking at the second half getting to a 5% growth for the year, there could be a deceleration going forward. I think that 3% is a pretty good baseline to use going forward. That being said, as Mike indicated, with the budget deal and with the backlog in Block V, hopefully, getting negotiated in the second half of the year, we'll be going through our planning process. And if we think, it's north of that, then we could update that at the end of the year. But I think the 5% this year and then using 3% beyond, that's probably a pretty good baseline to set at this point.

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Operator [6]

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And our next question comes from Carter Copeland with Melius Research.

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Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [7]

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Mike, I wondered if I could just ask a kind of overarching question about execution, just given the importance that execution is going to have on the next couple of years' margin targets or expectations that you laid out. When you just look at the -- some of the lower performance you called out on VCS or some of the stuff that's in the public domain on delays there and then the performance in TS in the quarter, I just wonder, if you take a step back and look at where you guys have come in terms of performance, if this is kind of a couple of one-offs before you hit your groove again. Or should we be -- is there something systematic in some of the challenges you've had, albeit small, that we should be mindful of?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [8]

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Carter, that's a great question. And actually it's something that we're spending some time on here. The activity of the past couple of -- first of all, let's step back. Historically, in my career in the shipbuilding business, we're executing today at a level that is as high or higher than I've seen in my career across the business. Having said that, you're exactly right. We have had a couple of hiccups along the way that really are -- have been concerning to us. And as a result, we're at a place today where we now have been able to go and because of the execution, we've been able to go and capture the largest backlog we've ever had.

The task in front of us now is to go and execute that better than we ever have done before. To that end, I've asked our business leaders to take another turn on execution and risk management in their business to make -- to ensure us and by that extension, you, that we're going to execute that backlog as well as it can be executed. And so I actually think that this is one of the greatest value opportunities for us because we have this backlog. And we have an opportunity now that we have the visibility and the horizon in front of us. We actually now have the opportunity to go execute this in an even more robust way than maybe we've seen in the past.

So we -- the first piece of business is eliminating these little refinements and hiccups that we've had along the way. And so -- that's why the issue that we had this quarter in San Diego is -- that's just another indication of what you're talking about and where we need to tighten up our performance. But I'm confident that the team will turn it out and set some records going forward.

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Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [9]

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Is there -- just as a quick follow-up to that, is there any commonality in the hiccups? Or are they each idiosyncratic?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [10]

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Yes. I think each one stands on its own. I think that the challenge that we've given ourselves is that usually these things are not new. The root cause of any particular hiccup is something that we've seen in the business before. So one of the things we have to do is take the places where we're executing excellently and make sure that, that's the standard for the whole business. And that's where a lot of our energy is going to be.

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Operator [11]

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And our next question comes from Doug Harned with Bernstein.

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Douglas Stuart Harned, Sanford C. Bernstein & Co., LLC., Research Division - SVP and Senior Analyst [12]

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Mike, when you talked about the budget, one of the things that's also happened in parallel is we've got a new Marine commandant. And he's talked about a very different, I would say, in his planning guidance, sort of a very different structure for the amphib force. Potentially moving away from LHAs, LPDs, LSDs and so forth. Could you talk about your thoughts around that? And where you see the evolution of the Navy going and shifts like this? I mean, these things obviously take quite a while. But is this something you need to think about now? Or is this something that's really far off in the future?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [13]

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Well, thanks. That's a question we ask ourselves every day. The world is changing, the Navy is changing in response to that. And we are changing in response to the Navy. I just would point to the effort that we are putting into the unmanned space right now in support of really primarily in support UUVs. But overall, we think that the unmanned space is going to fundamentally change the Navy going forward. The intent to try to make ships more lethal from the Navy standpoint is something that we're paying closer attention to. We're engaged with the Navy now to think about what's the next version of the Ford-class look like? This 2 ship contract that we have is a great contract. But if you don't spend time thinking about what that ship should evolve to today, when it comes time to go to a new contract, you'll be late. It'll be too late to think about it then. And the same sort of thing happens with the commandant and the Marines. As they rethink their way of how they plan to engage on the nation's behalf, we plan to be right there with them in support of what they need to do. You're right. These are not light-switch changes. It's not a course change where you're going to go a hard left or hard right turn, these things have to kind of -- they have to evolve from an operational concept perspective and then from a technology and platform perspective and then all the way down to a training and recruiting perspective. But I think, the commandant has kind of laid it out there and said, look, that over the horizon, the way we've always done business may not be the way that we need to do business in the future. And I think that's true for everybody. And we are very actively engaged in trying to support that.

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Douglas Stuart Harned, Sanford C. Bernstein & Co., LLC., Research Division - SVP and Senior Analyst [14]

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Just as a follow-on, in the priorities that the Navy has looked at, I mean readiness has obviously been a big one. So sort of on the shorter end here, I mean, you've benefited from a lot of the work you've been doing on Los Angeles-class ships, which just helped revenue. When you look forward, I mean this a short-cycle part of the business, so it is an area that could give you some upside from that, I would think, from that 3% depending how it plays out. How do you see the outlook for fleet support here and repair work going forward, given this focus on readiness? Is this is an episodic event with the Los Angeles-class work? Or is this something we could -- you expect to see continue to build?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [15]

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Well, you're right that it's a short-cycle business and the visibility that we have in that business is significantly limited compared to what we have in the construction business. There is no doubt that the Navy today is rethinking its overall approach to readiness and how do they get more readiness for the dollar. They're looking at ways to be more efficient. I mean I would point back to San Diego again, not to keep bringing that up, but that was in a contract change-type on the government's part to move to a fixed-priced contract, and our team was a little slow to respond to that. And so as they are pursuing efficiency in the readiness space, we have to be agile enough to respond to it. The history of that space, though, Doug, as you probably know, is that there's a lot of variability in it and most of it gets pushed out to the private sector. So the government yards and the government activities there are a primary source of providing that readiness. And when there's overflow or where there's dynamics that go beyond that capacity, it moves to the private sector, which means that the private sector fluctuates a lot more than readiness budgets in general.

I know that, that's something that the Navy is trying to address and fix and they believe that addressing that issue, creating some more predictability in the private sector would then create opportunities for more efficiency. We support that. We are not through that process. I mean I think that we're in the middle of that to try to see how all that plays out. So a result, we've got some good submarine repair work that we've been doing at Newport News that -- but we don't have great visibility into what's out there and how that's going to play out. And so to the extent that, that gets sorted out, it'll become more predictable and we can make it a more predictable part of our business space.

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Operator [16]

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And our next question comes from Robert Spingarn with Crédit Suisse.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [17]

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Mike, I wanted to ask you about the timing on some of these deliveries. So you talked about DDG 119, I think, previously -- or you showed that you've moved that into 2020. But also LHA-7, the Tripoli, that's now late in the year or early next year. I wanted to ask you what's going on with that ship. Why is it being pushed to the right? And then to what extent do pushed-out ships into 2020 get you to your margin expectation of 9% to 10%? Meaning is that a sustainable margin from 2020 on? Or does it benefit from a high cluster of risk retirements from deliveries?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [18]

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Well, so first question around LHA 7. We had a very successful builder's trial on LHA 7 and the ship is in really good shape. Where we are is we're working through a couple of technical design issues where we're working and discussing with the Navy about are these life-of-the-ship issues that need to be resolved before we deliver the ship? Or are they issues that we resolve -- we deliver the ship and because the systems are working today, it's just a question of whether they will work for the life of the ship. So we're in that sort of discussion with the Navy. They're fairly complicated, and -- but we see -- we think that'll come to a resolution around the end of the year and predicting whether it's the end of this year or the beginning of the next year, we don't want to put up -- we don't want to put any sort of extra pressure on that. We want to resolve that the right way. Relative to your second question about things moving into '19. I mean we've got actually pretty significant work in '19 before we go to '20, the delivery of Delaware, the launch of 73. The launch of 79 in the fourth quarter is on track, and that's a big event for us. And in fact, we're beginning the process of planning the christening ceremony before the end of the year. So that -- we feel very positive about that.

As we move into 2020, however things shake out at the end of the year with LHA 7, what happens in 2020 is we get back, we start to get back to that normal blend that we've always talked about that's pretty healthy. We will now have a really large backlog of new work, but we will have work now moved into the mature level where we believe we can sustain the 9% to 10% range that we think is healthy for the business. We do have 4 deliveries at Ingalls next year, including the Fitzgerald. But I think that's going to become a persistent drive across the business going forward. So I don't think that we're moving things into '20 to make '20 feel better -- or the things that move into '20 are not going to make '20 feel better at the expense of '21. I think that we're in -- I think we're in a pretty good place to have a pretty sustained run in the healthy range of this business, given that the work is under contract.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [19]

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Okay. Well, that's really helpful. And I wasn't really suggesting that you were doing it deliberately but just the -- maybe the timing got you there. And then I also wanted to thank you all for the extra color you provided here, particularly these milestones.

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [20]

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Yes. And I -- and we're not -- and obviously, ships go when they need to go. And if we can get 7 done this year, we will. But we will -- it's going to done the right way. Whatever we work with the Navy, it'll be ready to go. And it'll be done the right way. And everybody can be confident that, that's going to happen. But that doesn't impact the range that we've been talking about. We're confident of the 9% to 10% range. We're confident of that, given that we have the backlog and we have the teams in place to go execute it.

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Operator [21]

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And our next question comes from Jon Raviv with Citi.

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Jonathan Phaff Raviv, Citigroup Inc, Research Division - VP [22]

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On cash flow, kind of a -- it's a double-parter here. So first of all, what drives the second half pickup after a pretty weak 1 half? And then also where is the shortfall this year? It just seems like the 2019 message or target, if you will, continues to ratchet down? You've said only modest free cash flow growth. That's a limited operating growth but you assume CapEx is up this year. So where is that weakness or softness coming from? And do we pick it up next year?

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [23]

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Yes. Thanks for that, Jon. It's really simply timing. Unfortunately, we had some invoices slip into Q3. Probably the largest example is we had an $84 million delivery invoice from NSC-8 that moved from Q2 to Q3. So it's simply timing. Obviously, the back half of the year will be much stronger. We have some contract mods that we're waiting on, specifically at Newport News. So it's unfortunate the first half of the year started as it did. But it's simply timing and I fully expect to recover over the back half of the year.

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Jonathan Phaff Raviv, Citigroup Inc, Research Division - VP [24]

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Well, can you -- Chris, can you speak more to -- about the 2019 target? I mean having basically flat free cash flow year-over-year, despite what I assumed was a tension tailwind this year, is a bit down. I mean just given -- so bigger picture question is really, given the huge backlog, the budget deal in place, I appreciate there's a lot of moving pieces. But can you give a sense of the organic cash flow generation opportunity in this business going forward with or without tension, with or without working capital flows. Just the level of setups, just because that 2019 numbers continue to melt down over the last 6 to 18 months.

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [25]

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Well, I think it's a pretty good question, Jon, that we are -- we did have this excellent Q4 2018, where working capital was at really the lowest level I think we've ever been at. So that's impacting it a bit. I don't think you'd get back to a normalized free cash level until 2021, when our capital program is complete and tension normalizes and we get back to maybe 100% free cash flow conversion. So I think 2021 is really kind of the best place to look when we get to a more normalized level of cash flow.

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [26]

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I do think it's fair to say that the excellent cash we had in Q4 created a bit of a headwind for 2019. And we've been talking about that through the year.

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Operator [27]

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And our next question comes from Gautam Khanna with Cowen and Company.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [28]

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Two questions. First, I was wondering, on the elision that happened, did that have any knock-on productivity drag in the quarter or will it, as you move forward, as you move teams to assess the damage? And just wondering like what the knock-on effect was in Q2, if it was, and if not, might there be one on the comp?

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [29]

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Yes. So we have insurance to protect us against that. There's an immaterial deductible that we have to deal with related to insurance, but we have insurance that protects us -- protects that, Gautam.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [30]

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Okay. So there was no impact in terms of cume catch-up or anything of that nature...

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [31]

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Other than the deductible, no.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [32]

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Okay. And then could you actually give us what the cume -- the profit adjustments were? And how they skewed by segment?

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [33]

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Sure. So the gross favorable were $63 million. 40% of those were Newport News and 60% Ingalls. The unfavorable was $44 million, 50% Newport News, 30% TS and 20% Ingalls.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [34]

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Okay. And just related to an earlier question about once you get behind on a VCS program or any program, just curious about the curve to catch up. I mean the word, obviously, is once you fall behind, you stay behind. I'm just curious about your confidence on recovering. And if you can just give us any color as to what gives you that confidence?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [35]

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Sure. Yes, I mean, the -- especially when you're in a serial production line like we are with Virginia-class, if you start to have issues with schedule, it does start to affect the synchronization of the line. We've been working pretty hard to reset that this year, given kind of where we started last year fourth quarter. And we've made great progress on that. This is really a Block IV issue that we're working through to get units out of our steel fab facility into the production. We've created -- we've taken advantage of space. We've created some new construction sites for our teams to go work on. We changed the leadership team to be more engaged in the process of taking advantage of the tools. So we have the digital tools so we have to drive the productivity. And we've seen that. Again, not a light-switch kind of thing where you say you wake up one day and say, "Great, everything's fixed." But we are making good progress to getting back towards the schedule that we need to have and we're pretty optimistic about that. Beyond that, it informs the way that we set the schedule for Block V. And so as we're coming to get to that contract under our belt, that will be factored into the Block V. So all-in-all, I'm optimistic about the progress that we've made. We still got work to do. But the team is -- we got the right team in place and they're doing the right things, and we're making the right kind of progress.

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Operator [36]

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And our next question comes from Ronald Epstein with Bank of America.

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Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [37]

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Maybe just one big-picture question. When you're thinking about capital deployment now, how are you thinking about stuff like M&A? Is there any adjacencies out there, bolt-ons, that sort of thing? Or are you just focused on returning capital to shareholders?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [38]

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Well, we've -- our strategy Ron for the last 3 or 4 or 5 years, we've been talking about, is that we want to invest in our core business with capital projects and we're coming towards the end of that. We're going to return substantially all of our free cash flow to our shareholders. But we're going to invest in ways to grow our services business. And you've seen us do that with some acquisitions. If you look at our Technical Solutions division today and you look at the businesses that we're in, I really like those businesses. I think there's opportunities in the unmanned space for further expansion. I think that the DOE business, in the last 5 years, we've become a Department of Energy prime contractor, and there is a significant amount of work in that space. And so how that plays and where it goes, those are 2 critical areas for us to be prosecuting. The opportunity to do -- expand our footprint in cyber and Intel is always out there as we think about where those customers and what capabilities they need. And so we're opportunistic on this, and if we see the right opportunity, we're going to engage and we have engaged. And I expect that will continue.

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Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [39]

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Okay. And then maybe can you give us a quick update on where we stand on Virginia-class because in the quarter, it seemed like you took a charge or something there?

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [40]

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Yes. Let me add on the Virginia-class the language in the script and then on the -- in the earnings release. The vast majority of that reduction from last year is related to the reduced booking rate and the Q4 charge that we took. So there was fine-tuning in the EACs as we always do quarter-over-quarter but nothing material that we can mention. Most of that was just a reduction in the base-level booking rate on the program.

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Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [41]

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Okay. But nothing new?

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [42]

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No. No.

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [43]

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No. Nothing. Again, as I said before, we're -- the team in -- on the Virginia-class program right now is making some really good progress to get Block IV set up for success.

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Operator [44]

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And our next question comes from Seth Seifman with JPMorgan.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [45]

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Definitely appreciate that it's too early in the year to be making predictions about pension for next year or anything like that. But I guess just to give us a sense of what the sensitivities are around for the P&L, FAS/CAS and on the cash flow statement? If the year ended today, I assume you had some good asset performance, which helps and then interest rates, which are negative. And so how does all that shake out?

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [46]

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Yes. So Seth, thanks for that question. It took a while before I got to a pension question. But asset returns -- as you would expect and as you indicated, asset returns are up over 14% through the end of Q2 and discount rate down about 70 basis points. So those are opposing forces in the calculation. Unfortunately, you calculate FAS/CAS and cash differently. So it's tough to get to a real answer. I think it's -- you're right, it's early in the year to do that calculation and forecast into 2020 and 2021. So I think it makes sense to wait a bit. The sensitivities are in the K, in the year-end K. So you can find them there and try to estimate it. From a cash standpoint, CAS and cash tend to move together, so that should help out a bit when you think about it. But you're right. It is early in the year and I indicated what the asset performance was and what the discount rate performance was. So that should help you out a bit.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [47]

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Great. And maybe just to follow up on the Jon's question from earlier, when we think about the cash flow outlook for the business, working capital came down considerably for a number of years. We saw a very good working capital performance. As a percentage of sales, where should we think about where -- just to -- you've got to make an assumption and so on a go-forward basis, can working capital be 6% of sales consistently for this business? Is it more of a high single-digit number, just in terms of thinking about where cash flow can go in the out years?

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [48]

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Yes. I think that 6% performance was outstanding performance and something closer to 8% or 9% makes a lot more sense on a run rate basis on where we tend to fall out. Remember, over the last few years, we did have restructuring in the working capital. So it should definitely come down from there. But the end of last year was kind of an outlier.

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Operator [49]

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And our next question comes from George Shapiro with Shapiro Research.

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George D. Shapiro, Shapiro Research - CEO and Managing Partner [50]

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One for you Chris, and then one for Mike. The one for you is probably a simple one. The implication of the 5% revenue growth for the year is a little under 3% in the back half. Is that primarily going to be at Newport News or Ingalls? Or how should we look at how it splits between the 2 businesses?

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [51]

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Yes, I think it's primarily Newport News.

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George D. Shapiro, Shapiro Research - CEO and Managing Partner [52]

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Okay. And then for you Mike, in general, over the last number of years, you've had an impeccable record of executing in a business that's notoriously been pretty risky. And now all of a sudden, we've started to see some issues crop up. What do you think has changed from those years of terrific execution to what we're seeing now? And admittedly, you had forecasted some of this to occur, but I just wanted your thoughts on that.

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [53]

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Yes. Thanks, George. I mean we are putting a lot of energy into this right now because as I said before, we are -- we believe and my experience is that we're executing at a very high level. But we are fraying on the edges and it's time now to go and take another turn to clean that up. And so we've got some new people, we've got some new leadership. We are getting into executing new work. It's not lead ship kind of work but for instance, we had a contract-type change in San Diego that we didn't react to fast enough. Across the business today, we have pockets of superior execution. The challenge that I put in front of the team is that, that needs to be the standard and not just the pockets that we have. And so the team has taken a turn on how do we go and do that. And as I look across the business today, I see -- I already see some evidence that, that's going to benefit us in the future. We talked a little bit about Block IV, today. I see the things happening in Block IV to rectify and get that set up, that piece of that program for success. Clearly, the launch of 79 before the end of the year, if we go back a couple of years, we were talking about a launch of 79 in the spring of '20. We're at a place now where we're going to be launching that ship here at the end of 2019, and it is going to be the heaviest ship we have ever launched, which is an indication of how well they'd outfitted the ship, how well the pre-outfitting has gone and how well the program management team is running. So in the main, we are executing well. But we've got -- you're right, we've got a couple of little clean-up area that we got to go pay attention to. And we need to make this superior execution where we have it, we need to make that our standards. And that's the task that's in front of us, and we're ready to go get it.

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George D. Shapiro, Shapiro Research - CEO and Managing Partner [54]

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But I guess, what's caused that to change? Because for a number of years, you must have always had some potential issues, but they didn't seem to surface themselves till now.

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [55]

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It's almost on a case-by-case basis. But if I were to step back and say what's the kind of the macro thing is, as our programs have expanded, we've had new people put into places of leadership and we haven't supported them very well. And -- whereas, in -- you go back 6, 7, 8 years ago, we may have had pretty senior leaders in places that they knew all the ins and outs of the business. And so that's the challenge is how do we take someone who is going to be walking into a program for the first time and make sure that they have the structure of support for success around them that will set the standard for where we're going. And I don't think that we've been as tight on that over the last couple of years as we should have been. But that's certainly something that we can put our arms around and fix in pretty short order.

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Operator [56]

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Our next question comes from David Strauss with Barclays.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [57]

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The free cash flow guidance or help you gave us implies obviously a lot of cash coming in, in the second half of the year. Chris, what do you plan to do with that? Would you delever some from having levered up in the first half of the year? Or should we expect most of that going towards a step-up buyback?

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [58]

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Yes. So we'll stay with our commitment to return substantially all our free cash flow through 2020 back to shareholders. I do expect that we'll be out of the revolver, so some deleverage makes sense. But our commitment to return substantial free cash flow to shareholders remains. We think it's a good strategy. We're going to keep to it.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [59]

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Okay. And then Mike, just going back to this ramp to 9% to 10% shipbuilding margins in 2020, are there specific programs or milestones that are -- really stand out here and been able to achieve that, that we can monitor or watch for?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [60]

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Yes. I think the milestones that we have been laid out already are the ones to pay attention to. Obviously, getting 79 to launch this year is a big deal for us. And then getting Delaware out and getting the VCS program back on track for next year is also going to be pretty important. The 119, while we've talked about the financial impact and the insurance of 119, the resetting of the production line and the destroyers were that -- we had a -- obviously hadn't planned for the rework we've had to do there, getting that back into sequence and getting that back into phase so the destroyer line doesn't get impacted by that is the work that Ingalls is on right now that will set us up for success in 2020. So I think the milestones that you have in front of us, the things that we need to get done here at -- between now and end of the year set us up very well for next year.

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Operator [61]

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And our next question comes from Josh Sullivan with Seaport Global.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [62]

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Just a question relating to the execution strategy and you touched on it. But these technology efficiency initiatives you're working on, shipbuilding would appear to be an area that could benefit. Can you detail any early success with these initiatives? Or maybe how any pilot programs are progressing?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [63]

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We have lots of pilot programs going on across the business. And I'm a little reluctant to put any sort of particular number there because any number you put in it you extrapolate across the volume of the business and it becomes eye-watering. But we are very excited about the ability to bring digital technology, digital work instructions, visual build tools to a workforce that is younger than we've had in a while that is used to working with these kinds of tools, who are empowered to talk about how they think things could go better and a leadership team that is engaged and looking for ways to do things better. And we are seeing improvements in both cost and schedule in the pilots. And we're seeing that in both yards. And so we are -- we made significant capital investment over the last 5 years that we talk about that being a generational improvement. The fact of the matter is we're seeing benefits from those capital investments today in terms of efficiencies. And that's -- all of that goes into giving us the confidence that the business is going to accelerate into the normal range of where the business should be by next year. So that's kind of, I think, that's about all I really want to say about it. It's -- we have a fairly young workforce at Newport News today. And I remember the days 10 years ago, when we had some tough contracts but a very young workforce at Ingalls. And in 3 years, Ingalls' workforce went from being the youngest in the industry after Katrina caused a major change and disruption in that workforce. Three years later, they were still the youngest in the industry but they were the most experience because they'd delivered 10 ships. I think that, that sort of success is sitting in front of Newport News today in terms of they've got work under contract, they've got a young leadership team, they've got a young workforce and they are engaging in very constructive and productive ways. And it just creates excitement every time I walk through the yard.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [64]

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I appreciate that. And then just switching gears, is there any update on the Columbia program progress? What are the major gating factors for the program? Is there anything in the supply chain or design side that remains a hurdle at this point?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [65]

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Yes, for our work, our work is on track. We're supporting General Dynamics in that program. Our capital projects that we've put in place to support that and create the efficiencies that we need to capture are on track. And we're already -- we're actually using some of those facilities for work in the Virginia-class program and we're capturing efficiencies there. So from our standpoint, the program is essentially on track. We're getting to the point where it's going to be gets -- where lead ships get really interesting. Can the design stay in front of the construction? I think we got a really good schedule. I think our partners at Electric Boat have got a really good schedule and a really good leg up on that. But it's time to go perform.

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Operator [66]

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And our next question comes from -- a follow-up of Robert Spingarn with Crédit Suisse.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [67]

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I was just wondering, are the public Navy yards able to service the Ford-class carriers. I was reading somewhere that they weren't outfitted to be able to accommodate this class. I just wasn't sure if that was the case and if this might present different sustainment opportunity versus the Nimitz?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [68]

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I think the -- it's a good question, Rob. The -- there are clearly differences between Ford and Nimitz, the power requirements, those kinds of things. I think those are all things that can be addressed and will be addressed by the government shipyards. And so I don't really see a major, fundamental change in the way that the Ford-class is going to be supported from the industry. It's a little bit early on that. But we're -- I know that everybody knows what you have to do to get a shipyard ready to receive the Ford. Remember the hull is the same. And so those physical things like piers and docks, those kind of things don't need to change much. But the -- some of that -- some of the support things will just have to be upgraded and that's just a matter of doing it and they'll be able to do it.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [69]

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Just on this topic, have you seen this opportunity anywhere else across the fleet, whether we're talking about surface ships or submarines?

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [70]

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In terms of trying to expand the...

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [71]

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Service opportunities. In other words, yes, where maybe the Navy itself is changing the scope of what it does, which creates opportunity for you and your peers.

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [72]

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Well, as, I think, I said before, the Navy is taking a hard turn on how do you do readiness in a more efficient way. And that's being led from the secretary's office. I mean it is really a -- we talked about readiness in my career for a long time. This is a no-kidding effort to go get it sorted out. And they've had some success in the aviation community that they are looking to translate into the ship repair business. My perspective on it and I think that they're working hard to try to figure this out is that the history is that a lot of variability in that space has been pushed to the private sector. And they're looking to try to create more predictability there, predictability from a standpoint of scope, predictability from a standpoint of price performance and contract type and considering bundling contracts and things like that. All of those are good ideas and all of those things need to play out. I think we're on the kind of the front end to that to see whether we can actually create more efficiency there. We certainly want to participate in that. And so far, we've kind of got our toe in the water with the Virginia-class support. And we'll see what other opportunities it presents. It's a little early for us to try to predict how that's all going to shake out.

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Operator [73]

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And our next question comes from Noah Poponak with Goldman Sachs.

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Noah Poponak, Goldman Sachs Group Inc., Research Division - Equity Analyst [74]

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I wondered if a month into the third quarter you had a sense for how the net cumulative catch-ups at Ingalls were shaping up for 3Q, even if just kind of broad strokes directionally versus more like 1Q or more like 2Q? And then my second question is on the working capital, on the cash flow statement topic, could you just tell us what you're assuming either back half or full year for change in working capital in your statement of where you expect the cash flows to shake out for the year?

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Christopher D. Kastner, Huntington Ingalls Industries, Inc. - Executive VP of Business Management & CFO [75]

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Yes. So -- thanks. No, I absolutely think the risk retirement events are more tailored towards Q4. So while I won't give Ingalls or Newport News separately is it's absolutely positioned to sequentially get better Q2, Q3 and Q4, so Q4 will be better. From the working capital standpoint, we don't have a specific target. I guess you could probably do the math relative to just north of where we finished last year. But that's where we are thinking we'll end up at this point.

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Operator [76]

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And I'm showing no further questions in the queue at this time. I'd like to turn the call back to Mike Petters, CEO, for any closing remarks.

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C. Michael Petters, Huntington Ingalls Industries, Inc. - President, CEO & Director [77]

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Well, I just want to thank everybody for joining us on the call today. As you can see, across the business, things are -- we're executing pretty well and we're -- we have the opportunity to execute somewhat even better. And milestones for the rest of the year and shipbuilding set us up very well for where the shipbuilding business needs to be next year. And our Technical Solutions division is performing -- all of the Technical Solutions division is performing well across the board and those are businesses that we really value and like to be in. So thanks for being with us. And we look forward to seeing you around the Street.

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Operator [78]

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Ladies and gentlemen, thank you for your participation on today's conference. This does conclude your program. And you may all disconnect. Everyone, have a great day.