Huntington Ingalls Industries, Inc. (HII) Earnings Call Transcript & Summary

Okay. I think we're all set here and ready to go. First, I'm really happy to have with us again, Mike Petters, Chairman and CEO of Huntington Ingalls. I know -- before we get started, I know you want to say a little bit. You got -- I know there's a forward-looking statement message here. We said -- go ahead and do that, yes.

Thanks. Good afternoon, and thanks for having us. 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 materially from those projections. Please refer to our SEC filings for a description of the factors that may cause actual results to vary materially from anticipated results. With that, I'll turn it back to you, Doug.

Okay. Great. Well, Mike, thanks for being here. And it would be great to start out with budget since we just saw the new budget on Friday. Perhaps you could give us your thoughts on how that looks and what it means for Huntington Ingalls?

Yes, Doug, it seems like every year at this conference you and I talk, and the first question is what about the budget. And I get to remind you that the budget submission is like the very first step in a long process, and the ultimate final budget only looks coincidentally like the submission. So there's a process that's going to go through here. I think this year is really one of the more interesting years just from the standpoint of most of this budget was prepared in the last administration. And you had a change of administrations. You've had the new administration trying to put some of it -- trying to highlight some of its priorities in this budget. But this is the first of a 3-step process, right? I mean you have the FY '22 budget submission, but then you have the update to the National Defense Strategy. And then after that, you're going to have the FY '23 budget submission. So I think if you're trying to read the tea leaves and understand what the priorities of the new administration are going to be, you kind of have to let all 3 parts of that process play itself out. Now there's a lot of talk about the top line of defense and all that sort of thing. I would just point out, for Huntington Ingalls, the majority of our business is in the shipbuilding account, and we look very closely at that. We see that as being -- has been well supported over the last 3 or 4 years. And this first cut on this budget is that it's fairly well supported again. And our sense is that you go through that 3-step process, we think that shipbuilding budget is going to be fairly well supported throughout that process. Relative to the other parts of the budget, the things that we think that will matter like unmanned platforms and autonomous platforms, ISR, training and simulation, cyber, those kinds of things that we have presence in and capability in we think are going to be well supported, and we're looking to continue to work in those areas. So first cut, 1 week, and 1 week after the submission, we feel pretty good about where it came out, and we'll see how the process plays itself out.

Yes. I know it's always hard to know at the beginning. And when we look at this, we always think of Congress as very supportive of shipbuilding, perhaps more supportive than the administrations are. And so we sort of looked at this, we thought, well, one, DDG, could we see an add to that? I mean when you look at these, do you -- where do you see room here that what -- where you might see -- you have the submission, but then where are the places where there's possibility you might get more out of this?

Yes. I mean you kind of highlighted DDG. Our overall role here, Doug, is as we engage in the processes, we always take the position of if that's -- if this is what you want to do, here's the most efficient way to do it from the industry standpoint. So when you start kind of mixing and matching ships here and there, taking some out, putting others in, we can -- we talk with the administration and with the Congress about what are the respective efficiencies or inefficiencies to that. Relative to that DDG, it's to maintain the cadence in the industrial base in support of surface platforms that DDG is pretty important. Taking it out is a way to disrupt that cadence. And if I've learned anything in this business over a few years is that you get the industry into a rhythm and you get them into a cadence and you get the acquisition system in that same cage. When those 2 things sync up, you have a great opportunity to build very efficient platforms with -- and be very successful for both the Navy and for the industry. So when you start kind of pulling these one-offs, it does create inefficiencies, and we'll talk to the Congress about that. Broader, I would say that there's -- we're kind of in an environment now and I -- my safe harbor here is I used to be a submarine guy a long time ago when I was in the Navy. I think that no matter how many submarines the nation decides to build, we're going to wish we had built more. And so I think if there's upward pressure, it's going to be around the submarine program. But having said that, I think that, in the grand scheme of things, the investment in Columbia and Virginia-class is a pretty heavy investment already. So I'm not sure how much appetite there is to go forward there. But I think that's -- there's going to be some pressure upward there.

Yes. I mean the Columbia looks extremely well supported. And Virginia-class, that -- there's been speculation, could you take that up, I'm sure they -- I know there are people in the Navy that would like to do another one. But I guess when you look at this budget as a whole, one thing that struck me are all of -- if you look at all of these different Navy shipbuilding plans that are coming out there, I would say one thing that comes through is, to your point, all of them have strong support for submarines.

Right. Yes. The longer-term trend kind of -- we try not to get too laser beam focused in on any particular budget to use that single data point to glean a long-term trend out of that one budget. We look at 30-year plans. We're in the think tanks, trying to understand what's going on there. We kind of build a view of where is this going over the next 10 to 20 years. And our sense of it is that the Navy going to get bigger, and it's going to have -- but it's going to get bigger with smaller ships. It's going to get bigger with faster ships. And the hope would be that -- that would be an efficient way to do that, so they would be cheaper ships. So a larger Navy with many smaller, faster ships that are cheaper is kind of where we think it's going in the long-term trend. So I think you're going to -- and that's how we've invested. We've invested against unmanned. We're -- we think that it's not either/or, we think the submarines and the carriers are the centerpiece of that future Navy. And so at Newport News, we're investing in how do we improve productivity with digital tools and the kinds of things you're seeing in manufacturing around the world. At Ingalls, it really is about how do you improve and increase your competitiveness as the platforms get smaller. And so that's kind of the way we're thinking about our businesses as we go through. And we've got a $50 billion backlog to go figure that out on.

Well, one of the things that always feels challenging is it's very hard to change quickly in these strategies. I mean I remember back when Gates was the SecDef. And I think, at early Obama administration, he said, "I want to cut the number of carriers from 11 to 10 in 2040." And Congress went insane and said that has to be struck from the budget. And when you look now at this movement toward smaller ships, more autonomous ships, is there a way to think about the time frame when that actually could happen and have an impact on your business? Because I can't -- it's hard for me to imagine any strategy that changes the course of what you're going to be doing over the next 5 or 6 years.

Well, I 100% agree with you. The way I say that, Doug, is that all of this talk is it's presented as if it's a binary choice, but it's not binary. As I said, the carriers and the submarines are going to be the centerpiece of the Navy of the future. It's hard to imagine a Navy that does not have a Ford-class and a Virginia-class and a Columbia sitting right in the center of what it does. And you pick any time frame, 5 years, 10 years, 25 years, I think 25 years from now, you're still going to see the Virginia-class, the Ford-class, the Columbia-class as the centerpiece of the Navy. And then around that, you're going to see -- you may -- you'll see the LPDs and the LHA, you'll see the DDGs. You may see some perturbations in some of that, but it's going to be on the edges. You may see more frigates. I think that's a great example of how you get there. We were disappointed not to be in the frigate program but -- at this point. But the frigate program is -- that's a smaller ship, so let's go figure out how to do that as a nation, and we can build more of those and move in that direction. The other thing, though, I think we do see is that there's going to be a lot more reliance on unmanned platforms. And so that's been our investment: to build our unmanned platform portfolio. We're very pleased with how far we've come in the undersea area. There is some kind of still turbulence, I think, on the surface side in terms of what direction is that going to go. But in the meantime, we've been investing in our capability there so that as the Navy starts to expand its unmanned appetite and budgets, I think the unmanned budget -- Doug, I would tell you 5 years from now, the unmanned budget is going to be 3x to 5x what it is today. Now that's a pretty expansive growth rate, but it's a small number. So it's a small number that's going to grow 3x to 5x. It will still be a small number relative to carriers and submarines. So the end of the answer to your question is I don't see any change that the Navy is going to make that causes us to not be able to turn inside of that.

And when you think about smaller ships, and the frigate being an example, that's one of the -- that's a situation where there are not many -- you are limited on who can build the Virginia-class submarine today. But when you go to the smaller ships, clearly, there are other people that would want to get into that market. Do you see any risk there when that eventually starts to build to your position?

Well, I mean my view is if you want competition, you're going to have to go below the barriers to entry, right? And so getting smaller is a way to do that. If you go smaller, guess what, we're going to go smaller, too. So we're not going to cede that marketplace to anybody. We're happy to go and compete. If the Navy wants competition, we'll go compete. And I have a lot of confidence in our ability to compete successfully.

Now all this -- when we think of the next 5 years or so, this ties back to a number that we've been talking about for years, which is sort of this 3% top line growth trajectory. I just wanted to ask, are we still talking about that? I mean this has kind of been [ at play ] and you have more visibility than most others in defense do into where your top line is going.

Yes. We have great visibility on that, Doug. I mean the vast majority of that work is already under contract. And that's -- in shipbuilding, that's the way we see it playing out. In services, we're projecting a little bit higher growth rate there, and we've got to go capture that work. But we feel very comfortable with that. We were never comfortable with the market kind of view that defense was a 5% or 6% kind of growth environment. And it's not that the folks who are saying that were wrong. In their spaces, they were probably right. But what we had a line of sight on was the shipbuilding piece was not going to grow that fast, at least we didn't expect it to. And so that's kind of the way -- our view was we're Steady Eddy on our 3%.

But the naval services business, I mean you've done -- you had these 3 Los Angeles-class ships come in. I mean the way that this administration decides to approach, in a sense, repair versus divestment, I think that seems to be pretty important here. In other words, there's a lot of work to make sure that our -- we have the readiness we need from the existing fleet. Can that -- can you get opportunities like those Los Angeles-class submarines, more and more of those, to add materially to the top line? Is that a possibility?

Support, yes, I think that it certainly will add more value to the business. We've kind of been in and out of that business a few times over the course of my career. I've seen us in it and then get moved out and moved back in and moved out. I think where we are today is -- I feel there's a real sense in the Navy that the private industry side of it, in support of the naval shipyards who do a lot of that work, the private sector actually is part and parcel needs to be predictable. It needs to be predictable, too. It's part of the team not just -- we're not just the overflow, if you will, for work that just needs to be done in these kind of interim windows. And I think the reason for that, frankly, is because I think the Navy is in a place where they need all the deployable assets they can get. They don't really want to take ships out of the fleet right now. And it's a little bit hard to go to Congress and say we need to build more ships when you're retiring ships. You want to be doing all you can to keep the ships that you have operating and keep them out at sea and in harm's way. And so we think that's a really important part of this. The pressure on the Navy right now from an operating standpoint is the highest that I've seen. In all my years of being in the Navy, even when I was in the Navy myself in the '80s, I don't think we did anything -- and the Navy was a lot bigger back then, so maybe that's why, but we have ships that are extending deployments. You see how thin we are when we have to move a ship from one theater to another, and it makes the front page of the major media journals out there because we're going to -- it's just there's a lot of stress. And so these deployable assets, you've got to be efficient at it, you've got to make the schedules and you've got to be a trusted partner with the Navy to make that happen. And so that's -- we're striving to do that. Start-up pain set aside, if you can get into it and make it a predictable business, then the industry can be a really strong asset for the Navy to make that happen.

Yes. Because it seemed like the -- in the new budget, maybe O&M was up a fair amount. And certainly, into the last administration, our sense was, in alignment with the Virginia -- I'm sorry, Los Angeles-class work, there was a real push to make sure that the assets we had could be deployed. But our sense has also always been that Congress gets more excited about funding the build of a new ship than they do about maintenance and repair.

Yes, I don't know about that. I mean, sure, the new ships, they're bigger jobs, right, typically. The maintenance and repair piece is hard. I mean it's -- that's hard because, typically, a lot of the work that needs to be done has been deferred. So you end up going into an availability with a scope that's somewhat undefined and a budget that's constrained. And that's a really tough working environment to be in. And so my sense of it is you have to be able to do both and you have to be able to do both well. And there's really no reason why you can't do that in a way where there's predictability on both sides. I mean the predictability from the industry in terms of what the industry is going to be expected to do and the Navy needs to have the understanding that if we give you that kind of predictability, we're going to get the platforms when we need them at the cost that we can afford. So that predictability thing goes both ways. And I don't think that's all sorted out yet. And I think that's the real issue is that, as we continue to work our way and refine that business in that space, I think there's going to be good opportunity for the industry. And I think that's going to, in turn, make the Navy that much more capable. I mean to that point, Doug, we contributed our -- we have a repair yard in San Diego. We contributed that to a joint venture where we have 10% of the venture, but it has several other repair activities in it. And that's designed to work through this: what's the business model going to be, how do we get through that and, once we understand the business model, what can we do with it. And that's kind of why we did it that way.

Well, when you look at margins, you've talked for a long time about the normal margin being in that 9% to 10% range for shipbuilding. As you look out, can you sort of refresh us on the basis for that view? And what can happen that pushes you to the high end of that or the low end of that?

Yes. Sure. Thanks, Doug. The -- I would first of all, say that, that came out of a sense as we were spinning out of Northrop. We were doing some work to figure out what kind of businesses have the chance to be. And Doug, you remember, we had several underperforming contracts. And so we had very low margins at that point in time. And really, the only solution to that was to work our way through those underperforming contracts and get our -- and move our work on to the newer contracts. Well, as we did that, we saw that if you're -- work that you have, you kind of want to have a nice balance between new work, newly contracted work and mature work that you have been working on for quite a while and retired a lot of risk on. If you get those in balance, what we've seen is that, over time, over the industry, in the history of the last -- at least the last 25 or 30 years, the margins can be in the -- frankly, they could be in the 8% to 10% range, but 9% is a good number. When you get a shipyard that's operating at 10% there's a good chance that the reason they're operating above 10% is because they're harvesting a lot of mature programs. They may not be filling up the front end, right? And if they're executing well and they're still operating below 9%, that's probably a sign that they've just got a whole lot of new work, and they don't have a balance on the other side. So we just sort of, as a mantra, said that when the workload is balanced, we ought to be as a business, given the range of products that we have and the types of contracts that we have, we ought to be in the 9% to 10% range. You know with a $50 billion backlog that we've captured over the last 3 years or so, we are way out of balance right now. We are way out of balance in terms of new work on the front end of our workload. And so -- and as I think Tom has pointed out, in our last call, he pointed out that we don't have a lot of milestones. When you're on the front end of a program, you don't have a lot of milestones to retire risk against. When you're on the back end of the program, if you have successfully retired the risk, you have a lot of milestones that you can take credit for. So as that backlog will mature, we'll see more and more milestones, which will give us a chance to move back into the kind of the normal band for the business. And that's -- we're executing well right now, and I think it's really being driven by the volume of the backlog.

And when you describe that and all of the work that you've won, I mean I think the focus of what you're talking about is heavily at Newport News because you've got so much there. And so if we roll back, a year ago, you had a number of issues there related to the Virginia-class and perhaps the complexity of the work that's going on at Newport News. But since then, margins have been much better. It looks like -- I mean it looked to us like a lot of those risks are behind you now. Can you talk about Newport News? And how the Virginia-class has proceeded?

Yes. The process that we use, Doug, as you know, is it's a very disciplined EAC process that we do every quarter in every program. And what we do is we go and we look at the risk registers and we assess do we have a line of sight to continue on this path for this program to be successful. At the end of Q1 last year, our assessment in Newport News was Block IV was -- we had a line of sight to be successful there. It met all of our requirements. But remember, Block IV was a program that had some kind of handicaps at the beginning in terms of how long it took to negotiate the contract, the delay in procuring material, a lot of new hires during that time. But given all of that, the leadership team had led their way through and they had a line of sight on success. But then COVID hit. And when COVID hit, we had to -- I mean Newport News was operating between 50% and 65% of their workforce on the waterfront. We had to reprioritize the work and kind of to the point we prioritized the work towards those deployable assets, those submarine repair activities, the refueling. As we reprioritized those work, the back end of Block IV, we kind of lost the line -- we just lost the line of sight on success there in terms of what we could do relative to where we were on lock for at that time. Beyond that, COVID had -- I mean there was direct impact in terms of absences and all of that. But then you go to the indirect impact, which was you might have a job in the critical path on a submarine that requires a specific qualification, and the person that's qualified is being quarantined. And it delays that work for a couple of weeks. Or you have a team that's installing a new technology and the foreman is on quarantine. And so the makeup foreman is someone who's never done it before. We had that going on all over the place. And so as we tried to -- when we went to reset the register in Q2, we took a hard look at all of our risk registers and we felt like that -- and by the time we got to the end of Q2, we started to see -- we weren't at the end of the issue, but we started to see how the issue was going to play out. And we were able to reset the registers. And since then, we've had -- given those -- given that reset, we've had 3 good quarters from an execution standpoint, 3 clean quarters. And we're pretty -- we're proud of the team for fighting their way through 3 clean quarters at a time when you're suffering from a global pandemic in very human capital-intensive workforce. That -- I think that's a testament to the leadership team there.

Well, I remember -- I mean this is not a good parallel probably. But if you go back to those early days, well, the late Northrop Grumman days when you had the very serious issues in the Gulf, I remember you lost, out of Katrina, a huge portion of the workforce. But the problem -- so I know you did have some ships at the time where you had very inexperienced people doing things, and there were some mistakes made. But it sounds like that's not parallel to this because those experienced people are -- you may have had some inexperienced people, but the experienced people will -- are all back. You didn't have to...

Yes. So I kind of -- I got to go through both of those, Doug. And I came into Ingalls on the back end of Katrina. I wasn't there when Katrina hit. But when I arrived 2 years later, one of the things I looked at was that the pre-Katrina workforce at Ingalls had about -- 20% of the workforce had 25 years of experience. The workforce that was there when I showed up 2.5 years later had -- less than 5% of the workforce had 25 years of experience. So Katrina was a physical catastrophe because you had 8 to 10 feet of water across the shipyards, you had to recapitalize the shipyard, but it was also a human capital catastrophe because all of your experience left the area and didn't come back. When this started, I mean -- and that was -- I got to say that was a formative moment for me as a leader. So as we fought through -- you mentioned Irwin before. So Irwin and I fought our way through that in the last 3 years with Northrop, and then Irwin led for 3 more years after we came out of Northrop. I mean as we fought our way through that, we really came to appreciate even more deeply the value of that human capital part of our business. When this -- when we established our crisis management team in March of last year, the first thing that I said in the first meeting was this is not a hurricane. This is a human capital crisis that is happening in the living rooms of our employees. We've got to find a way to make sure that when we come out on the other side of this, we have the same workforce that we have right now. So here we are, 14 months later, we have a better workforce now than we had back then because we've hired 6,000 more people. We maintain that workforce that we had before that. And we use techniques and practices and technologies that we had to use during the pandemic to make this all work. Well, now they've become part of our DNA. And so I'm very excited about where we are right now because we managed to avoid the human capital crisis that Katrina was. And Chris Kastner is -- he was with us down at Ingalls. Tom Stiehle was with us down at Ingalls. We all learned some really tough lessons during those days, and we made sure that, that didn't happen to us here.

So I mean that, to me, it sounds like a very good news story than where you are now. So now when -- you're at Newport News and you look forward to that a 9% to 10% margin type window ahead of you, how do you see the path there? What are the puts and takes that is going to push you to the higher or lower end of that range at Newport News?