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Huntington Ingalls Industries Inc
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Ladies and gentlemen, thank you for standing by and welcome to the Q1 2020 Huntington Ingalls Industries, Inc. Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Mr. Mike Petters, Chief Executive Officer. Thank you. Please go ahead, sir.
Thanks, Messy. I am Dwayne Blake, Vice President of Investor Relations. Good morning, and welcome to the Huntington Ingalls Industries first quarter 2020 earnings conference call. With us today are Mike Petters, our President and Chief Executive Officer; and Chris Kastner, our Executive Vice President and Chief Financial Officer.
As a reminder, statements made in today’s call that are not historical 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 a description of some of the factors that may cause actual results to vary materially from anticipated results. Also, in the 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?
Thanks, Dwayne. Well, good morning, everyone and thanks for joining us today on the call. So before getting into my remarks on the quarter, let me first provide a COVID19 update. As this national emergency began, we established three very important objectives.
Our first objective was to minimize the impact to our workforce and to provide a work environment that is as safe as possible. Now this resulted in some benefit changes and some actions designed to give each individual employee as much flexibility as possible to help them navigate through these uncharted waters and make arrangements that they needed to make.
In doing this, we assured them that their job was safe. We also made adjustments to ship schedules to facilitate social distancing and we enhanced cleaning activities in our shipyards and since taking these actions, we are approximately 25% of our employees working remotely and are experiencing about a 70% to 75% attendance rate at both shipyards.
Our second objective was to protect the national asset that is Huntington Ingalls industries. We've been identified as critical and mission essential by the Department of Homeland Security by the Department of Defense and by the U.S. Navy. So we took action during the quarter to enhance liquidity and strengthen our balance sheet and Chris will discuss those actions in more detail during his remarks.
And importantly, our supply chain is a critical part of the industrial base and our ability to help our suppliers especially those small businesses will reap benefits as we come through this pandemic. To this end, we've accelerated more than $50 million of payments to our critical supply chain partners. This not only helps them but it also help their communities as our supply base resides in nearly every state in the union.
Now our third objective was to be the reliable source of information for our employees and to that end, we've kept a very frequent and steady drumbeat of communications to our employees and to our community through multiple vehicles including social media. We've kept them informed,. We've answered many of their questions and provided them the resources and guidance they need to help keep them and their family safe.
Now additionally, I've been personally engaged in multiple strategic efforts centered around this pandemic and I participate in weekly calls along with the other defense industry's CEOs, with the Assistant Secretary of the Navy for research development acquisition James Hondo Gertz. Now I would be remised if I did not add that the U.S. Navy has really leaned forward during this crisis, ensuring uninterrupted contractual payments and the continuation and even acceleration of contract awards such as LP 31 that was awarded in early April.
These efforts are a great help to our industry and provide stability, liquidity and business continuity and I credit assistant sector Gertz for his immediate action to these kinds of issues. As a nation I believe we need to focus and adapt to what is being rightly called the new normal. We knew early on that this crisis was not going to be over in a few weeks or even months. So we have worked to change our business to effectively operate in that new environment.
For example we have now over 11,000 people working remotely to tenfold increase from where we were just eight weeks ago actually we had already started transforming our business. So this crisis has provided us a catalyst to accelerate this transformation and we believe we will be able to weather this storm and continue to provide our critical products and services to our customers around the nation.
Now let me share some highlights from the quarter starting on Slide Four of the presentation. Sales of $2.3 billion for the quarter were 8.8% higher than 2019 and represent record highs for the company and diluted EPS was $4.23 for the quarter. New contract awards during the quarter were approximately $900 million resulting in a backlog of approximately $45 billion at the end of the quarter of with approximately $21 billion is funded.
Regarding activities in Washington, our actions in early February supported congresses' consideration of the budget in regular order, but our focus rapidly shifted mid-quarter to mitigating the impact of COVID19 on our workforce and supply chain and we will continue to work with Congress and the administration to support authorities and investment that will enable our nation's economic recovery through the entire defense industrial base, which is uniquely postured through tens of thousands of suppliers across all 50 states to be the engine for that recovery. We also look forward to congressional consideration of the fiscal year 2021 budget request in the coming months.
Now let me share a few business segment highlights from the quarter. At Ingalls, the team delivered LHA 7, Tripoli in February and wants two ships in the quarter; DDG 123, Lenah H. Sutcliffe Higbee in January and LPD 28 Fort Lauderdale at the end of March. DDG 119 Delbert D Black completed acceptance trials during the quarter and then delivered on April 24. NSC 9, Stone is progressing through final assembly and test activities and is expected to deliver later this year. And finally DDG 62 USS Fitzgerald completed sea trials and plan production work during the quarter and is scheduled for sale away this summer.
Newport News, CVN 79 Kennedy is approximately 72% complete and the team remains focused on compartment completion and preparation for primary system testing. Newport News is working closely with the Navy to pursue a single phase delivery approach on CVN 79. Now this change from a two phase delivery would extend the Newport News performance duration while supporting the Navy's plan for efficiently delivering a completed ship in 2024.
Initial indications are that incorporating a single phase delivery will increase the scope of work under the contract and stress the construction schedule and the test program to the right. However, the ultimate financial and schedule implications will not be clear until we definitize the change with the Navy. CVN 73 USS George Washington is progressing through its final outfitting and test phase and is approximately 74% complete.
On the submarine program SSN 794 Montana is expected to launch in the second half of the year and remains on track to deliver in the first half of 2021 and we anticipate SSN 796 New Jersey achieving the pressure hall complete milestone in late 2020.
In our Technical Solutions segment, we received several contract awards across the Department of Defense for manned and unmanned airborne intelligence and ISR support and secured recompete business with the U.S. Postal Service for enterprise IT operations. In January, we announced our largest award of the quarter, a task order to support the U.S. Air Force Europe's ISR operations with a total potential value of $954 million over five years.
In addition, we closed the Hydroid acquisition at the end of the quarter which significantly expanded our capabilities in the important and rapidly growing autonomous and unmanned maritime systems market. So in summary, I am encouraged by what we've been able to accomplish during these unprecedented times. Our leadership team is demonstrated flexibility and agility to respond to new developments, while continuing to achieve a number of key milestones and finally our $45 billion backlog, unprecedented program visibility, strong balance sheet and thoughtful leadership through the COVID19 crisis allowed us to remain confident in the long-term financial targets and value creation strategy we provided at our Investor Day in February.
Now I'll turn the call over to Chris Kastner for some remarks on the financials, Chris?
Thanks Mike and good morning. Today I will briefly review our first quarter results and also provide some comments on our 2020 and long-term outlook in light of the current COVID19 pandemic. For more detail on the segment results, please refer to the earnings release issued this morning and posted to our website.
Beginning with our consolidated results on Slide Five of the presentation, our first quarter revenues of $2.3 billion increased 8.8% compared to the same period last year, driven by growth across all three divisions. Growth at technical Solutions was driven primarily by mission-driven innovative solutions where results included a full quarter for Fulcrum which was acquired in late February 2019.
Revenue Newport News was due to higher submarine construction volume and growth at Ingalls was driven by higher volume on the LPD and DDG programs. Operating income increased by $54 million or 33.5% to $215 million when compared to the first quarter 2019 and operating margin increased to 176 basis points to 9.5%. These increases were primarily driven by a more favorable operating FAS/CAS adjustment and higher risk retirement at both Newport News and Ingalls.
Net earnings in the quarter were $172 million compared to $118 million in first quarter 2019. The increase in net earnings for the quarter was mainly the result of higher operating income and a more favorable FAS nonservice pension benefit, partially offset by a $16 million loss recorded in other income as a result of lower returns on marketable securities related to our nonqualified benefit plans.
We are pleased with the operating results for shipbuilding in the quarter including the 5.7% sales growth compared to the first quarter of 2019 and a 8.3% return on sales. In Technical Solutions, our core nuclear and MDI businesses are performing as expected. In the quarter, Technical Solutions achieved a very strong book to bill ratio of 1.6, which included a significant new window to support the U.S. Air Force, Europe's ISR operations.
As Mike mentioned, closing the acquisition of Hydroid in the first quarter positions us as a leader in the strategically important autonomous and unmanned maritime systems market. We continue to make progress on the other portfolio shaping activities that were highlighted at our Investor Day in February, including the contribution of our San Diego shipyard to a new ship repair partnership, which we expect to complete this summer and the divestiture of our oil and gas business.
Turning to Slide 6 of the presentation, cash from operations was $68 million in the quarter and net capital expenditures were $66 million or 2.9% of revenues compared to cash from operations of $11 million and $74 million of net capital expenditures in the first quarter of 2019. Additionally, we contributed $30 million to our pension and postretirement benefit plans in the quarter of which $20 million consisted of discretionary contribution to our qualified plans.
We also repurchased approximately 391,000 shares at a cost of $84 million and paid dividends of $1.03 per share or $42 million bringing our quarter end cash balance to $28 million. As the COVID19 situation evolved and a high level of uncertainty that came with it, we thought it was prudent to hold share repurchases, which we did on March 11. Through the end of Q1, we've returned to shareholders 107% of free cash flow generated from 2016 through the end of the quarter. Share buybacks will continue to be an integral part of our capital deployment strategy once volatility related to COVID19 subsides.
Moving on to Slide Seven we have recently taken a series of actions to enhance our liquidity and further solidify our balance sheet. After the quarter closed, we should $1 billion in new senior notes and also entered into a 364 day revolving credit facility with $500 million of capacity. We are fortunate that our primary customer, the Navy, has taken steps to accelerate cash flow under our contracts, which have test down to our supply chain partners, primarily for small disadvantaged businesses. Given these changes to our debt profile we now expect our 2020 interest expense to be approximately $104 million.
To summarize the hard work and dedication of our employees during this difficult time has been truly tremendous. We've incurred and will continue to incur additional cost related to our COVID19 response in order to keep our employees safe. Additionally, as Mike noted, we've experienced staffing levels at about 70% to 75% over the past several weeks. These lower staffing levels will likely impact program scheduled and efficiency and increase ship estimates to complete, the materiality of which we will not know until we get greater clarity regarding the return to normal staffing levels and have a full reconciliation of supply material delivery schedules.
We are confident the cost incurred for COVID19 response are allowable cost under our contracts. Further, we continue to evaluate these impacts, the programs against our contractual terms and current and pending legislation for the potential to obtain equitable adjustments to target cost target price and program schedules. We're working closely with our customers concerning the treatment of cost and we will be able to provide additional details on COVID19 cost treatment and recovery as we move through the year.
However, as of today we expect a modest impact to sales in Q2 due to reduced attendance in the shipyards. We also see shipbuilding sales growth for the year to be at the lower end of the previously provided range of 3% to 5%. We will gain more clarity as we move through the year and plan to provide a more comprehensive update during our second quarter earnings call.
Finally we continue to believe that our strong balance sheet and liquidity and high degree of visibility and stability provided by our backlog make us well positioned to minimize the impact of COVID19 on our business. We also do not see changes to our long-term financial expectations, we communicated in February at our Investor Day including our expectation to generate approximately $3 billion of free cash flow from 2022 through 2024.
Now I'll turn the call back over to Dwayne for Q&A.
[Operator instructions] Thanks Chris. As a reminder to everyone on the call, please limit yourself to one initial question and one follow-up, so we can get as many people through the queue as possible. I'll turn it over to you, Messy, to manage the Q&A.
[Operator instructions] Your first question comes from the line of Jon Raviv with Citi.
Hey, good morning, everyone. Just a question on the performance in the margin, which I know heading into the year is going to be a lower margin year for a variety of reasons and also backloaded. You reiterated the number for the year at 9%. We did mention there's could be similarities from COVID. Just give us a sense for what kind of relation we should see now with Coronavirus. Then I've a follow-up.
Ready for the next question?
Hi this is Jon Raviv. Can anyone hear me?
We have a technical difficulty, if you will remain online. The conference will resume. And your next question is from the line of Carter Copeland with Melius Research.
We're back. Sorry about that. We got dropped there for a little bit. So I'm -- three or four questions and you guys have already answered them. So we'll catch up as we go along.
It was just John's question but we've got your back. I fumbled with the mute button many times. So no worries I wondered if you could give us a sense on the most up-to-date data you have on the headcount levels in the yard. I can imagine that something you're monitoring day-to-day just like we're monitoring any of these other COVID related curves them and the impact that that has on your estimates for what the disruption will be and productivity.
Have you seen any change since the end of the quarter in the month of April, have you bottomed out, has it improved, any kind of up-to-date color that's beyond the month of March that you can provide?
Thanks for the question. It's been pretty steady. The initial disruption for our folks to figure out what sort of disruption they had in their lives, well they had family members that lost their jobs or they had kids at home, they had to work their way through that. They've worked their way through that and I think as we said the aggregate, the attendances is about 75%.
You can parse that a lot of ways but basically where folks who have to be present in the business inside of the shipyards, that number is lower than 75%, but the rest of our workforce either they're working remotely or while we've changed the conditions that they're working in on-site have been able to support at a higher level than that. So we've been pretty steady for the last I would say the last two or three weeks anyway. So the number you have is the number we've got.
Okay. If you try to parse it between the two yards, what's the difference?
It's pretty much the same in both places. So the number one driver in attendance right now by far is the schools are closed and folks have to decide how they're going to take care of their kids and all the usual mechanisms for people to take care of their kids are not available either. So that's our biggest driver in attendance. I continue to argue that we've got to find a way to get schools back to where parents are going to be comfortable to send their kids to school. That's got to be at the top of everybody's list. If that happens, we see this moving ahead.
We're removing -- we're shifting our posture as well. Now that we've kind of stabilized this, we're starting to look now to how do we expand our employment and fill it back in. So we're moving ahead and leaning forward on this.
We'll come to the estimates on our shifts in the quarter and incorporate that reduced attendance on the schedules and the impact on the touch labor on our shipbuilding programs, but we're assessing the opportunities. Our expenses have changed right. So the most obvious one is travel essentially zero, but less obvious is stuff like Teladoc, which is something we put in place a while ago, and in spite which means our people are not in the emergency rooms and that's much less expensive for us.
So when we come through the quarter and the year it's going to be -- we're going to assess the risk on our ships related to reduced attendance, but also the impact on our expenses. So it's more of a holistic approach than just what's the attendance in the yards and what happened to productivity on the ship.
In fact I am encouraged the key milestones for our production were essentially meeting the key milestones that we have to meet and just of the top delivery as a destroyer in the last couple weeks is evidence of that.
119 62 is on schedule and it's on schedule, very comfortable with how our performance on shipbuilding.
It's going well.
All right. Great. Thanks for the color guys.
And your next question is from the line of Myles Walton with UBS
Hey everybody. Good morning. This is actually Emily on for Myles. On the recent result of the competition given the contract value for the ship, which you have been able to sign up for that aggressive of the price and then additionally what is on your radar now for potential awards at Ingles and is the recent award for LPD 31 how did that impact Ingle's production line?
Well a lot of questions there. Recognize that everybody in the competition was pricing at different ship and so almost impossible to do an apples-to-apples comparison of price to what happens. So I think the Navy try to run a best value competition and selected a winner. We're obviously very disappointed with the way that it came out, but we'll get a debrief from the Navy on what happened and how could have gone better and we'll go forward from there.
Relative to other opportunities at Ingalls, we still have a very strong presence and production line right now in the large deck amphibs that Phase 2 LPD program evidenced by the contract just signed for LPD 31. We're building destroyers and we're still building national security cutters and so the Ingalls future is bright as far as I can tell. This is a disappointment but the thing about competition is you get up off the field and you go learn your lessons and get better the next day and so that's kind of the way we're taking it.
The Navy is starting to rethink -- starting to think about what the future hold and we're going to be part of that future and so we're excited about that.
Your next question is from the line of Jon Raviv with Citi.
I'll not to break everything this time I suppose. You guys hear me though? So my question has been I don’t know if you have heard it was just on margin progression through 2020 and 2021. I know this year has going to be somewhat backloaded in terms of that 9% that you reiterated that number. What is the progression and how do you achieve that with various unknowns around COVID19. And then related to that you what is the potential menu of outcomes from the new one phase carrier plan.
No real change to margin progression at this point Jon. We have to come through Q2. No doubt it's going to be a complicated quarter, but I wouldn’t change the way we're thinking about margin in 2020 or in 2021 actually.
I think it's too early. There is as Chris said earlier, there's certainly some risk now that's in our risk register that we didn't have in our risk register two months ago, but on the other hand there's opportunities out there that our business is actually transforming itself organically kind of just doing it and so there's some real opportunities for us in terms of efficiencies and new ways of doing business and moving ahead.
So it's way too early for us to try to back away from anything that we might said earlier. As far as single phase delivery for 79 what the original plan was, was the Navy and the company had decided to split the delivery to finish the platform and then use the post-delivery time to upgrade the actually install the sensors and those state-of-the-art things that change three, four, five generations while you're building to ship and you want to make sure it's as current as possible.
The Navy has come back and said it's going to be better to do this in an integrated fashion because that way we can get a more complete ship sooner and be able to get the ship ready to deploy faster that way as well. Now what will do is that will change the schedule for -- if we're able to work through this and we haven't, but if we work our way through this it will change the schedule for how the test program proceeds throughout the ship because we'll line that up with the new schedule.
It will change the way the Navy mans the ship which is part and parcel to our test program and delivery schedule. So at this point, there will be more scope. It will probably move the schedule around a little bit and until we get through it, I'm not sure we can say exactly how much impact it's going to have, but we think it's actually the right answer for getting that ship to the fleet and into operation as fast as possible.
Just a follow-up on that point Mike, I appreciate the perspective there. Is it not the case that the late 2020 improvement in margin and I get that 9% on what rely on some of those things happening on the carriers that you just outlined, if those things don't happen then that one of the risk items to the 9% this year perhaps.
Yeah, I would say that's true but that's why I've said we actually think again we got to kind of work our way through the weather we're going to do contractually go account for this and then we look at what are the opportunities we're seeing in the rest of the business from the impact of this virus. So that's -- we just don't know enough right now to back away from them.
Your next question is from Doug Harned from Bernstein.
Thank you. Good morning. I wondered Newport News I wanted to talk about Virginia Class and Columbia Class because in addition you're going to see some significant block five work on Virginia Class. I know you highlighted in the release that Columbia Class the amount of work there is starting to grow and can you -- could you talk first about what you see the impact for those two programs they're growing on your margins in Newport News?
Well Doug, it's going to be the beginning of these programs and by now you know that when we're at the beginning of the program, we're reasonably conservative in terms of that. Now truth is that we know a lot about submarines and the arrangement on Columbia is just a little bit different than the teaming arrangement we have on Virginia Class and so how that works and how the expansion works and goes forward I think we've got that factored into. It's part of the way we were thinking about the year and the next several years when we talked to you guys in February. So there's not really much change in all that. It blends right into to get us to where we want to be.
When you look at Columbia Class as we look at this, we were assuming it really start to get production growth taking off kind in the 2023 timeframe. For Newport News how do you see that trajectory of work? How much of a contribution do you expect Columbia Class to be making over the next couple years?
Doug, this is Chris. We don't have a specific number for you, but it does start to ramp from here and then really start to get some momentum in 2021 but we don't have a specific number for you.
Your next question is from David Strauss with Barclays.
So now that I know it's closed, I was wondering if you could give us sort of an update on your thought and opportunity there for unmanned ships and for how that…
We're obviously very excited that we were able to close this deal. It took us -- it was a long process with Kongsberg working through what would make the most sense for both of us. But now that's in the portfolio we've come basically in the last five years we've come from not really being present in the space to being as capable as anyone in the space and we're excited about that.
The Navy will continue as it thinks through what they want the fleet of the future to look like. They're going to continue to look at how do you more missions with less people and so we think that's a critical element of what they're going to be doing and Hydroid certainly gives us a step into that.
There is a range of programs that the Navy's already announced that we're actually part of. Boeing has the lead on the XL UUV program and we are working with Boeing to manufacture that product for them. The Navy's announced a large diameter UUV program and we're very excited about the opportunity for that and then Hydroid as a business before we ever got involved with them, they were a dominant player in program smaller than that.
So this gives us now a full range of capability in the portfolio platforms and missions and capabilities that we believe the Navy is going to need in the UUV space. It also then gives us an opportunity to expand into the unmanned surface space because a lot of the -- a lot of the capability that you're going to need relative to autonomy or manufacturing and advanced manufacturing and those kind of things are going to be the things that you're going to need to be able to be successful in the unmanned surface space.
My assessment is that the unmanned surface basis is lagging the undersea space but I don't know that that last and I am excited about where this whole program is going to go. It's going to be a great business for HII to be in because it's going to be a critical mission for our customer and that's really want to be.
And then I guess can you comment on sale of UPI business and just given kind of the volatility in oil markets right now, that contract and so if there was any changes to your thought process there?
No doubt it's a volatile market out there right now. The good news is that UPI they've got some really stable long-term customers that are hanging with them and we have a strong management team. So that process will continue. We expect it to complete this year.
Your next question is from Robert Spingarn with Credit Suisse.
Chris, I got a couple for you first, Newport News and then Ingalls, but following up on John's question on CVN 79 and the single phase delivery from a cash perspective that delivery in 24, are you able to comment at all of what the impact of that would be on 23 cash flow and kind of the slope of free cash flow you pointed to back at the Investor Day.
I think you reiterated the cumulative target of $3 billion but just wondering if this could make it more back weighted. So that's…
I don’t think so. We don’t know yet exactly because we haven’t definitized that change, but I don’t think it materially changes the slope. A little more detail on cash. I think with all we know right now on free cash and everything moving around we're still north of $500 million this year and then we start to ramp.
Okay and just switching to Ingalls I was wondering if you could provide any color on the EBIT profile, the NSC program as it exists today, just so that we can get a better idea of how that program eventually ending might impact the business?
I don’t want to do an program review with you right now. We don't really give detail on estimates of margin rates by ship. I want say from Ingles' perspective in the quarter, the LPD program is performing very well. Pleased to 28 and 29, the award for 31, so Ingalls had a really good quarter.
I was just going to ask Mike if there's any customer interest in the 12 Tennessee Hall?
Sure. There has been a lot of talk about it. I think the question at this point is where does the budget go and I think that that's kind of the big question mark out there for everybody, but the coastguard continues to operate the NSC at a high tempo with lots of mission success and lots of very positive and favorable feedback to us and it has been a program that has been funded and supported both from the Coastguard and from the Congress over the year. So I would say sure.
Your question is from Pete Skibitski with Alembic Global.
Mike, I have a top level question about the Navy and Marine Corps outlook for ships. Kind of in light of the commandants guidance and budget pressures connected and I think there is a new shipbuilding plan in the works in the building also that isn't complete yet and I don’t know what's connected but I think it's connected to this idea of a light amphibious warships. So, kind of the net question is do you think the requirement for amphibious lift is going to be reduced or modified over the next couple of years in any way and is it kind of maybe shift to smaller amphibious ships, can you can compete effectively there, just in your thoughts overall about what looks to be a lot of change that might have impacted them in the near-term or maybe in the mid to long-term?
It's a good a good question and it's certainly something that we're thinking a lot about. Look at the very top level, there is always a challenge of if you want to if you want to change direction, if you want to go in a different direction, the question is how quickly can you do that and recognize that your if you're going to trade-off current capability for potential future direction, that's got lots of unimplied risk there that hasn’t really been able to kind of break that mold of -- you can't really go in a new direction by trading off current capability and I would offer that one of the things that we continue to stresses is that current capability actually includes the infrastructure and industrial base that you have created.
We hired more than 25,000 people at HII over the last five years. We spent $0.5 billion training them and we spent $3 billion to $4 billion a year in our supply chain where they've been doing the same thing as we have a industrial base that's ready to support the direction that you want to go. If you want going to go in a different direction and be successful with that, I think you got to think your way through how do I get the industrial base to move in that direction.
And so, clearly the Marines are thinking about the concept of operations that's a little bit different than what they've been talking about. I don’t think in the end I don't think it changes their near-term requirement for heavy left and this discussion is not something that's going to say here's how we're going to get there in the next two years. I mean you're really talking when you start talking new shipbuilding plans, you're really talking about what the shipbuilding -- what does the Navy look like 10 to 15 years from now because the Navy that we're to have five years from now, you're building it today and that at that see today.
So the timeframes have to be kind of thought their way through. I think that there's an opportunity here for the industry and the Navy to work together to take advantage of all of the assets that we have to create a capability that would support going forward. Now the other piece of what you said is something that we're thinking really hard about is that there is a bit of a floor for us in terms of as you get smaller in ship size, the market becomes a lot more competitive and so we got to think our way through that as just as a business how do we improve our competitive position as if this is a direction that our customers is going to want to go and we're looking hard at that.
And your next questions is from Gautam Khanna with Cowen.
I have a couple of question and forgive me if these were obvious, but first just to be clear on the COVID impact on profit accrual, are you assuming percentage of completion accounting right, so you accrue less revenue as there are fewer people making progress on ship, but the margin rate you're assuming as though there is no COVID impact is that right assuming there will be some relief down the road?
It's a good question. In Q1 there is really no COVID impact. there is no way to estimate that impact in Q1. We're going to assess that in Q2 as we understand the comprehensive impact and the opportunities related to it. So it's a good question, Gautam.
So meaning in Q2 right now, you're a month and a couple days have passed in Q2, there is a COVID impact. Fewer people showing up at the yard, so you're accruing less revenue but you're accruing cost at the same margin that you otherwise would, again I just want to be very clear.
That's right and you don't change your estimate until you come to comprehensive VACs on your ships, which we will do in the quarter in Q2 and then assess that in the quarter and deal with that in Q2.
Okay So but let's just say that the Navy hasn’t given you guidance on what form that equitable adjustment will be would you then take a negative catch up in Q2 and then just wait and hope that you do come to a resolution and think of positive.
You're getting into claim accounting there. I don't think you should -- from a claim accounting standpoint, you would not assume that they're going to give you a equitable adjustment to these costs. So without opportunities you would potentially have to do a negative adjustment, that's correct.
Shifting to Technical Solution, there was a reference in the release to lower performance on a host of items. Oil and gas I think certain repair work etcetera. Could you just elaborate on what's happening in those and I think on environmental as well. So was this just again COVID inability to execute or was it something else and what are the plans on the oil and gas side?
So actually in the quarter the major impact was the San Diego shipyard and some performance issues there. Oil and gas and nuclear were okay, but compared to last quarter the performance was a bit less. Nuclear is just timing and very comfortable with where they are and still comfortable with the 7% to 9% EBIT. I commented previously on oil and gas, we still think that will get divested this year.
And then last one, catch ups by segment if you can give us the net.
I've positive of 61, negative of 29, net 32. And two thirds of that net is Ingalls.
And was TS a negative.
That was pretty flat, little negative.
Your next question is from Ron Epstein with Bank of America.
Could you speak to in the '21 budget, there's not a second Virginia Class and there's been a lot of back-and-forth that there could be second Virginia Class and I think your friends are building a reactor first second Virginia Class. So how do we think about. If there Virginia Class or not and what's your latest read on that?
You’ve been doing this as long as I have. You know that the budget comes over and then there is a process that congress goes through to get the budged squared away and pass and appropriated. There were some late moving items in the budget frankly from last year to this year, that I guess my assessment is that the Congress was surprised about and so when that happens, it takes a lot more work from the administration and from all the stakeholders to work their way through it.
My sense of this though is that the outlook for that second Virginia is pretty bright. I think the Congress is pretty much made its intentions pretty clear and so I don't know how the pieces move around but I'd say I'm pretty optimistic about it.
And then when you think about the current pandemic, what opportunities has that opened up for you in terms of when you think about the Technical Solutions group? Are there potential M&A opportunities out there now that might not have been or potentially more attractive now and one of the things you guys articulated at the Investor Day is that scenario where you want to have some growth. Is this an opportunity to try to grow that business?
I think that the issue right now is that valuations are just -- are I'd almost say mythical. To try to get to a fair value of up of a business is it's a hard read. We are still interested and we haven't changed our posture, but let's just take a if Acme is out there and suddenly Acme got wiped out by -- their share price got wiped out by this volatility, the Board of Acme still would think that they're worth a lot more than the share prices and so trying to engage in that is really pretty challenging but we're going to keep looking and we're leaning forward to try to find ways to make something out of it.
And then finally you might address this before but just to dig maybe a little dipper, how is your supply chain doing right. When you think about where there could be more assertive stress points and in particular some of your smaller suppliers if you're dealing with sole-source mom-and-pop kind of shops I mean how are they handling this and what are you doing to try to them through the situation, particular or they might have more exposure to industrial or aerospace markets?
Thanks for the question. We're in direct contact with our entire range of suppliers several thousand across the country. I'd say at First Cut, we have reached out to everyone and said let's talk about what impact you're seeing and what impact that might have to our programs. The vast majority of our suppliers are saying at this point. no impact. Now I would say because where we are right now, I would say we put the word yet on the backend of that. They say no impact, we say no impact yet.
There's a group of suppliers that are saying that they're seeing impact but no impact to our programs and I would say okay no impact to our programs yet and then there is a handful of suppliers that are saying hey, we've got real impact here and it is going to impact our programs. I think what I'm encouraged about Ron is that in the near-term, we're actually supporting the key milestones that we need to support whether it's ship construction activity or supporting a fleet, we have information and material we need from our supply chain to do that.
What's harder to evaluate is what's going to be the impact around the corner, not in the near-term. I think in the near term we're working our way through that, but I think in the medium-term the stuff that needs to be going on today to support us at the end of this year or in the next year, how is that going and that's why we say put yet next to that because that I don't know that we have -- I don’t know that anybody has a very clear view of that.
The last thing I would say is that one of the advantages that we have besides having the $45 billion backlog to go work through and support our supply chain is our supply chain is domestic. We're not dealing with suppliers in Mexico or suppliers in India or anything like that. Where there have been some disruptions that I've seen across the industry has been as much about trying to reach across the borders as it has been about trying to reach and find the small folks.
So we're keenly engaged in this. We're working this every single day but at this point, I'd say near-term not in effect, medium to long-term, wait and see.
Your next question is from Noah Poponak with Goldman Sachs.
Hey Chris, just back to the question on all your margin rates and how the EAC recognition and accounting will work as you go through the year and there's potentially disruption, but you're telling us you're able to hold to what you thought before this disruption. My understanding from what some of the other defense companies that have reported already and spoke to this said was that amongst the handful of things that your customer was doing to help the industry get through this, that one of them was to the extent you were underperforming cost in what you had contractually signed up for if you were able to display that it was attributable to the Coronavirus pandemic that you would actually be made whole back to your original assumption. Is that am I correct that, that is going on and that's part of your ability to hold the margins or did I really misread that from somebody else?
I think you may have misread it a bit. Now that being said it's an evolving situation a bit. But I think there's a lot of news and a lot of discussion out between government contractors and the government on the appropriateness of getting equitable adjustments through different legislation. The way we read it right now based on current legislation, you do not have the ability to recover equitable adjustments for delay disruption on your contracts.
So we're not operating under that option. It doesn't mean it might not -- we might not get there and there are some thoughts across where we think you will get adjustments in recovery for stuff like quarantining more or if government facility is shut down, you can't go into work. You're not going to be harmed for that, but equitable adjustments and delaying disruption, we don't think that is fully understood yet or fully dealt with under legislation yet. So I would not make that assumption, no.
I would add, there is intent but there's not coverage and so where we are from accounting standpoint, at the risk of a practicing accounting with that on license. Where we are with an accounting standpoint we're just not assuming that. We are engaged in the discussion about how we make this happen and how do we -- what changes need to be made from an appropriation and from an authorization standpoint, but that has not happened yet and so that's where our engagement is we'll see how it does.
So assuming that doesn't happen then should -- what I then need to model that your shipbuilding margin in the second and third quarter declined sequentially from the first and then is more backend loaded to the fourth quarter or how do you -- how do you hold the margin with the amount of disruptions that you're seeing?
So I wouldn't change anything at this point. No, I think it's just too. I think it's just too early. There is going to be a modest impact on our sales for sure in Q2 but there's risk that we're going to have to deal with relative to reduce the tenants in the yard, but there's also opportunities because our expenses are fundamentally changing right now. They need to deal with all that when you do.
And whatever happens with the equitable adjustment is not going to happen in the second quarter.
That's just not going to be resolved in Q2.
Is your comments of not changing anything more geared towards you don't think the numbers are going to change or more geared towards nobody has enough information at this point to really forecast what the number you're going to give?
Well I think more of the latter but also we're making critical milestones within our shipbuilding programs. We're delivering ships performing very well within Newport News and Ingalls. So it's kind of a combination of both.
Okay And then last thing on this as it pertains to revenue, it's I guess similarly a little bit hard to square if you're at 70% to 75% staffing and its presented to completion accounting business why that wouldn’t have a larger impact on revenue I guess to your last answer there it sounds like you have less of the cost there or less of a staffing there if you hit the milestones, that's a bigger piece than just what the staffing level is, but I don’t know I am surprised to see 70% to 75% staffing minimal change to revenue and a percentage accounting basis, how do our growth that.
Well we're going to recover right. The attendance is going to recover. So we talk about 3% to 5% for the year. So we're going to recover from the sales standpoint. As we get our tenants back for the year, there is going to be an impact in Q2 no doubt, no doubt, but we still think we're at the lower end of the -- but as of today, we still we still think we're lower in the 3% to 5%. If the virus goes on for a prolonged period of time, that could change, but today it's the lower end of the 3% to 5%.
Do you have visibility right now from sort of state and local economic reopening stay-at-home order revision as to when you'll start to be able to restart or bring people back on I should say.
Well we're at the first level, we're the largest employer in both Virginia and in Mississippi. So we're deeply engaged and connected to the Governor's office in terms of how do you go about reopening the state and what makes the most sense and how you do that and we come that conversation from with the standpoint of we benefit the whole time. So these are the issues that you're going to -- as you start to open these businesses these are the things you need to be thinking about.
You need to be thinking about employee safety, you need to be thinking about customer safety. I would just say the whole thing about reopening is it's voluntary. Businesses have to volunteer to open even if the Governor says to open, doesn't mean that you're going to open. The business has to volunteer to open. A business owner is going to say I can open because I'm confident that I can keep my employees safe and I can keep my customer safe and I can do that at a rate that makes sense for me to open.
And the second voluntary per action there is on the customer's part and they have to decide that it's safe for them to go out. I think I mentioned earlier it's the -- when are you feel safe to put your kids back in school I think is the number one question relative to all of this opening. So we're deeply engaged in all of that conversation.
How that plays for us is though is affects the employees that are staying home because they've to take care of their kids, it does affect them. So that's where the reopening affects them but our view is that we as I said, we're shifting our posture here to open we'll go higher, there is a lot of folks out there that are looking for work and there's a lot of qualified people that are looking for work and so we're looking to start expanding our attendance again to go and get back to the business of doing what we're doing.
So that's all going to play out in the second quarter and it's going to be as Chris said, it's just way too early to tell how that's all going to play out, but that's our view and that's somewhat independent of how the governors are going to open the states.
Really helpful and I appreciate it. Thanks guys.
And your final question comes from the line of Jon Raviv with Citi.
Thanks so much for the follow-up and I might just follow-up on that budget question. Can you just also talk about the carrier side of things? I know it's kind of comes up every few years and such but sectary office seems to be looking to reduce that footprint. So just can you give a little sense of your perspective given the current fiscal and political backdrop?
Jon thanks. I think the carrier conversation always comes up because it does -- it turns into a conversation about can we get more capability by changing structure or changing operations and things like that. There are lots of folks who have lots of opinions on this. I have been through this many, many times. The bottom line is you can't get 80% of the carrier for 80% of the cost. Volume is the cheapest thing that happens on the carrier making it -- actually making it larger is the way you capture the return on the investment that you’ve made.
And so the idea that you're going to go and do something smaller maybe have a small fleet which is a different kind up for the Navy which is something to think about, but in general if you're looking for a replacement platform, that hardly ever works out well in terms of the analysis. I do think the Navy and the Pentagon and Secretary Esper are thinking about and rightfully so they're thinking about what are the future capabilities that we need and how is the best way for us to get there and how do we found that without sacrificing too much of our current capability and you're going to see lots of options.
Some of them like that like the Marine Corps discussion that we had before. It's a very dynamic time in shipbuilding and we're going to be in the middle of that conversation as the principal partner for the Navy to help them achieve whatever it is that they want to do, but we come into that conversation with a $45 billion backlog of work that's going to be the foundation from which that conversation will take place.
The investments that we've made in terms of creating the agile workforce that we need and the agile supply chain that we made, I think are going to support whatever direction the Navy and the Pentagon want to go and we're happy to be part of that.
Okay. It looks like we have no more questions. I just want to thank you all for your interest today and we want to make sure that hope you all are safe and well and your families are safe and well. Please take care -- please take care of each other but we do appreciate your time for joining us and we look forward to speaking with you again. Thank you very much,
Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. You may now disconnect.