Huntington Ingalls Industries Q3 2022 Earnings Call Transcript

Quartr
Provided by Quartr
November 3, 2022

There are 13 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2022 High Earnings Conference Call. At this time, all participants are in a listen only mode. And after the speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to hand the call over to Christy Thomas, Vice President of Investor Relations. Ms.

Operator

Thomas, you may begin.

Speaker 1

Thank you, operator, and good morning, everyone. Welcome to the HII Third Quarter Joining me today on the call are Chris Kastner, our President and CEO and Tom Steele, Executive Vice President and CFO. As a reminder, any forward looking statements made today that are not historical facts are considered our company's estimates or expectations and are forward looking law. Forward looking statements are subject to risks and uncertainties that could cause Refer to our SEC filings. Also in their remarks today, Chris and Tom will refer to certain non GAAP measures.

Speaker 1

For reconciliations of these ii.com. With that, I would like to turn the call over to our President and CEO, Chris Kastner. Chris?

Speaker 2

Thanks, Christy. Good morning, everyone, and thank you for joining us on today's call. I would like to begin today by highlighting the HII teams that work hard And survivable naval ships ever built, engineers and technology specialists developing critical capabilities and mission driven solutions, All aligned with supporting our customers' priorities and pressing national defense needs. Thank you to the entire HII team. Now let's turn to our results on Page 3 of the presentation.

Speaker 2

In the Q3, we had sales of $2,600,000,000 which were 12% higher than 2021 And diluted EPS was $3.44 for the quarter, down from $3.65 in 2021. New contract awards during the quarter were approximately $2,100,000,000 which results in backlog of approximately 46,700,000,000 at the end of the quarter, of which $23,200,000,000 is currently funded. We continue to make progress across all of our shipbuilding programs. At Ingalls, we recently completed acceptance trials on DDG-one hundred and twenty three, Lena, Sutcliffe, Higbee. And during the 3rd The keel was authenticated for DDG-one hundred and twenty nine, Jeremiah Denton.

Speaker 2

In our amphibious ship product lines, began on LPD 31 Pittsburgh and last week we were awarded a $2,400,000,000 detail design And construction contract for LHA-nine. Also, we have commenced the work to complete the combat system installation and activation on the Zumal Class destroyer Lyndon B. Johnson, DDG 1,002. At Newport News, CBN 79 Kennedy Is moving further into the test program and began testing of the electromagnetic launch system. And on the other side of the shipyard, the keel was laid In the drydock for CVN-eighty Enterprise, the RCOH program continues to make progress with CVN-seventy three, USS George Washington On track to redeliver next year.

Speaker 2

Also, we continue to see progress on the Virginia class submarine program and expect to deliver SSN 796 New Jersey and float off SSN 798 Massachusetts next year. In the quarter, we experienced continued challenges from the broader macroeconomic environment, most notably a persistent tight labor market with really no material improvement in general economic conditions. Through the Q3, we have hired over 3,600 craftsmen and women against our full year plan of approximately $5,000 and we continue to utilize the levers of outside lease labor and over In addition, supply chain challenges continue across our Supplier Ecosystem, resulting in longer material lead times and inflation pressure. As we've discussed previously on inflation, we do have some contractual mitigation And we continue to actively manage the supply chain and our production schedules to minimize impacts. To address our shipbuilding labor challenges, To bring in more shipbuilders, we are also expanding our very successful apprenticeship programs, including revised curricula, Reduction in completion time lines, a focus on pre apprenticeships and youth apprenticeships and expansion to underserved populations And women in the industry.

Speaker 2

Moving to our Mission Technologies business, our pipeline remains very strong with $4,000,000,000 in proposal or evaluation and $17,000,000,000 in capture. Our 3rd quarter book to bill was 2.2 and was a healthy 1.1 year to date. Integration of operations and business systems following the Alliant acquisition is largely complete, and we are already seeing Strong synergies such as the recently announced VMASS and MASS DMO awards totaling over $900,000,000 in total contract value. We also received a couple of major contract actions in our Nuclear and Environmental business that were driven by Staying strong performance. At Savannah River, our joint venture received an extension for 4 years, plus an additional option year.

Speaker 2

And at the Nevada National Security site, our joint venture received a simultaneous early exercise of all five of its option years. These are significant wins, and we are very proud to support DOE across the complex. Despite headwinds earlier in the year Due to the delayed omnibus spending bill and the ongoing intense competition for talent, we continue to gain momentum and see strong growth potential going forward. This includes both domestic and international markets, where we are expanding our presence in regions consistent with the national security strategy. In summary, I'm confident that our presence across all the combatant commands, coupled with an increasing demand signal for Advanced Technology Solutions from our DoD customers positions Mission Technologies well going into FY2023.

Speaker 2

Shifting to activities in Washington, the federal government began the new fiscal year under a continuing resolution, which funds government operations through December 16th. We continue to urge Congress to proceed expeditiously and remain optimistic that the annual defense appropriations and authorization processes will be completed in the months ahead. While final outcomes will depend on eventual respective appropriations and authorization include recommendations for new DDG-fifty 1 multiyear procurement authority, additional funding for amphibious ships and requirements for not less than 31 amphibious warfare ships. The strong shipbuilding demand driven by our national defense requirements is shown on Slide 5. These critical customer needs spanning destroyers, amphibs, submarines and aircraft carriers and including new construction overhaul And maintenance and modernization will result in significant contracts.

Speaker 2

And now I will turn the call over to Tom for some remarks on our financials. Tom?

Speaker 3

Thanks, Chris, and good morning. Today, I'll briefly review our Q3 results. For more detail of the segment results, Please refer to the earnings release issued this morning and posted to our website. Beginning with our consolidated results on Slide 6, our 3rd quarter revenues $2,600,000,000 increased approximately 12% compared to the same period last year. This increased revenue was attributable Income for the quarter of $131,000,000 increased by $13,000,000 or 11% from the Q3 of 2021, And operating margin of 5% was essentially flat from the prior year period.

Speaker 3

The increase in operating income was primarily due to more favorable non for new shipbuilding. Other net expense was $13,000,000 in the quarter, which was primarily driven by losses on equity investments given market volatility in the quarter. Our effective tax rate in the quarter was approximately 14.8% compared to negative 4.3% in the Q3 of last year, which included research and development tax credits for tax years 2016 through 2020. Net earnings in the quarter were 138,000,000 compared to $147,000,000 in the Q3 of 2021. Diluted earnings per share in the quarter was 3.44 in the quarter decreased to $5,000,000 or less than 1% from the same period last year, driven primarily by lower revenues $50,000,000 and margin of 8% in the quarter declined from last year primarily due to lower risk retirement on the DDG program, partially offset by higher LPD risk retirement by $91,000,000 or a robust 6.7% from the same period last year due to higher naval nuclear support services as well as the submarine and aircraft carrier revenues compared to the previous year.

Speaker 3

Newport News operating income of $102,000,000 and margin of 7.1% were up from the last year due to contract incentives on the Columbia Class Submarine Program, partially offset by lower risk retirement on the VCS program. The Columbia class contract incentives are related to Newport News support of continued growth in the submarine construction enterprise. At Mission Technologies, revenues of $595,000,000 increased $201,000,000 compared the Q3 of 2021, primarily driven by the acquisition of Align in the Q3 of last year. Mission Technologies operating income of intangible assets compared to $8,000,000 in the Q3 of last year. Mission Technologies EBITDA margin in the 3rd was 8.4% and 8.7% year to date.

Speaker 3

Turning to Slide 8, cash used by operations was $19,000,000 in the quarter and net capital expenditures were $77,000,000 or 2.9 percent of revenues, resulting in $73,000,000 or 3.1 percent of revenues and free cash flow of $277,000,000 in the Q3 of 2021. While Q3 free cash flow was below the projection we provided on our last earnings call, this is simply a function of timing as well as the tax payment of approximately $80,000,000 that we elected In the Q3, given the lower probability of delay and deferral of changes to the R and D tax treatment, in fact, we are increasing our overall free cash flow outlook for fiscal year 2022, which I'll discuss in more detail in a moment. Cash contributions to our pension and other Plans were $11,000,000 in the quarter, of which less than $1,000,000 were discretionary contributions to our qualified pension plans. During the Q3, we paid Dividends of $1.18 per share or $48,000,000 We also repurchased approximately 66,000 shares during the quarter at an aggregate Cost of approximately $14,000,000 Moving on to Slide 9 and our updated outlook for the 2022 2023 1st, I would like to highlight that our funded status remains strong and has improved year to date.

Speaker 3

Additionally, I will note that the cash flow impacts related to the pension changes remain muted. For 2023, the FAST benefit has come down considerably from our last update given the more immediate recognition of the negative asset returns experienced thus far in 2022. While the increase in the discount rate does partially offset the impact of asset returns, the magnitude of the impact related to lower asset returns is clearly more significant. Please remember that pension related numbers are subject to year end performance and measurement criteria. We will provide a multiyear Update of pension estimates on our 4th quarter earnings call in February.

Speaker 3

Turning to Slide 10, we are narrowing our 2022 Shipbuilding and Mission We are now expecting shipbuilding revenue to be between $8,200,000,000 $8,300,000,000 and expect Mission Technologies revenues to be approximately $2,400,000,000 The narrowing of the shipbuilding revenue guidance is a function of the challenging labor environment that we have frequently discussed as well as our expectations for the timing of the material as we near year end. The Mission Technologies revenue is a reflection of the slower start of the year as well as the current hiring environment. As Chris noted, 3rd quarter book to bill ratio exceeded 2.0, a very positive indicator as we move forward, and we remain very Yes, thinking about the growth opportunities at Mission Technologies. We are reaffirming our shipbuilding operating margin guidance range of 8% to 8.1%. For Mission Technologies, we are slightly revising our margin guidance to approximately 2.3%, which is largely a function of the lower volume of work in the year.

Speaker 3

Moving to free cash flow. We are increasing our guidance to 2022. Under current Section 174 R and D tax law, the midpoint of our prior guidance $225,000,000 which has now been raised to approximately $350,000,000 The most significant driver of that increase is the COVID progress Repayment, which we initially expected in 2022 moving to 2023. Given our free cash flow through the Q3, we are expecting very strong free cash flow generation in the 4th quarter. On Slide 11, we have provided an update view of our free cash flow expectations.

Speaker 3

This outlook assumes the current R and treatment for tax purposes remain in place. And given that adjustment, our 2020 through 2024 free cash Our expectation is now approximately $2,900,000,000 As we have noted before, the impact of the R and D treatment is approximately $50,000,000 over the 2022 through 2024 timeframe. We are reaffirming our capital Allocation priorities, including our commitment to This is particularly in 2024 after we have reached the desired debt level. I will also note that we have recently announced and increased our quarterly cash We are pleased to reaffirm our share building margin guidance and increase our free cash flow expectations as we aggressively manage through current business conditions. Regarding year 2023, we plan to provide detailed guidance on our Q4 call consistent with our normal cadence.

Speaker 3

With that said, We continue to view a long term shipbuilding revenue CAGR of 3% as appropriate, and we are pleased to reaffirm our long term free cash flow target through 2024 as I have We would normally expect incremental shipbuilding operating margin improvement in 2023. However, given the current economic environment, We'll need to close out the year to assess risk retirement and operational efficiencies before we can provide more insight. We will finish The year just as we started focused on execution and we provided more comprehensive update on our view for 2023 in February. With that, I'll turn the call back over to Chris for some final remarks before we take your questions.

Speaker 2

Thanks, Tom. Before wrapping up, I would like to highlight on Slide 12 That we will release an updated HAI sustainability report in the coming days, which will be available on our website. We are focused on the alignment of the program with our mission, values and purpose and structuring our strategy around securing our business, building our community and protecting our resources. We have enhancements in process for future sustainability reporting and expect another update to be released in the spring of 2023. Finally, turning to Slide 13, we remain focused on successfully executing on our strong backlog and positioning for long term growth, which will generate value for our employees, customers and shareholders.

Speaker 2

Now, I will turn the call over to Kristi for Q and A.

Speaker 1

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. Operator, I will turn it over to you to manage the Q and A.

Operator

Absolutely. Your first question comes from the line of Doug Harned with Bernstein. You may proceed.

Speaker 4

Good morning. Thank you.

Speaker 5

Good morning, Doug. Good morning, Doug.

Speaker 4

Yes, on Newport News, can you give us a sense of how things are progressing on Virginia Class? And that's been I know

Speaker 3

you had

Speaker 4

less risk retirement this time around, but you've talked a lot about this and the importance of getting labor back and trained. Where does that stand now in terms of your outlook? Yes.

Speaker 2

Thanks for that, Doug. Some Definitely some stability in the Virginia class program right now. The Block 14 and 796, which is the next boat to be delivered, Some positive developments from a schedule standpoint there, very stable and looking towards beginning of next year to Get that vote delivered. So I'd say stability in the schedule, still working very hard on the fundamentals of cost and efficiency. But I

Speaker 4

think Well, yes, so in terms of cost and efficiency, I guess What I'm trying to get at is if there is a if you're seeing kind of a clear path to a point where you're Really happy that you've got everything under control in terms of cost and so forth. I mean, I'm just trying to get a picture for what that trajectory Looks like you now over the next few quarters say.

Speaker 2

Yes, sure. So fundamentally, When you have stability in your schedules and stability in your planning documentation and you know what work is in front of you, You're going to have a better chance to have an efficient performance from a cost standpoint. So first things first, let's get the schedule right. We've got the labor, they are fully staffed on Block IV and Block V, and they're making progress on their milestones. And now it's just knocking down that work, getting through the test program on 796 and progressing on 798.

Speaker 2

So I'm not going to give you a trajectory on margins on the VCS program. I will say the best indicator Within the submarine program is, are you making your milestones? Are your schedules stable? And if they are, you're going to meet your cost objectives. But there's a lot of fighting that team.

Speaker 2

They're working very hard to get that done. I know that the team is working very hard on the fundamentals and the operating system. If they get that right and they work on that every single week, which they are, they're going to be successful.

Speaker 4

If I can squeeze just one more in here Related to cost, you mentioned inflation in the last quarter. And historically, I felt that your view has been that you can handle inflation. You've got enough opportunities in terms of escalators So forth to deal with that. But can you talk about what may be different this time because we're seeing in a lot of defense Companies know that inflation in the short term is more difficult than we've seen in prior periods.

Speaker 2

Yes. Well, so as I said previously, we do have some protection. The biggest issue for inflation for us is going to be in our really On our new contracts, in ensuring that we get the bids right from the supply chain and ensure that the cost and schedule is correct When we bid those new contracts. So that's probably the greatest risk for us. We do have some inflation area issues within Some of our piece parts in the supply chain where we didn't have those under contract.

Speaker 2

But as I said previously, we have some protection For that, although not fully protected. So the real issue for us related to inflation is getting the bids right on our new contracts and we're working very hard to ensure we do that.

Speaker 6

Okay, great. Thank you. Sure.

Operator

Thank you for your question. The next question comes from the line of Robert Spingarn with Melius Research. You may proceed.

Speaker 5

Hey, good morning.

Speaker 2

Good morning, Rob.

Speaker 6

Good morning, Rob.

Speaker 7

Tom, what was the organic growth for Mission Technologies in the 3rd quarter since you have A partial inclusion last year in Q3. And then I know, Alliant has a lot of cost plus work, but how much might Wage inflation have contributed to the top line growth there.

Speaker 3

Yes. So when I look at that, you are right. We closed August 19 last year. The Q3 last year was incomplete. So the organic growth for the quarter specifically was about 1.5%.

Speaker 3

But I look at it for the year. It could be choppy because of the CR at the beginning of the year. We've talked about the slow contracting environment, the wins and then the supply chain issue a little bit on the operational Side of that, the overall Mission Technologies growth for the year is 4.3%, Alliance up grew 8%, Q2, we told you about 6% for Mission Technologies as a whole. Mission Technologies revenue top line is a little light. Usually that 3rd quarter for us or the 4th fiscal quarter is a sweep up quarter for both Alliant and legacy MDIS.

Speaker 3

We had anticipated when we told you about an 8% growth against the Q2 top line, we would see about $650,000,000 and that didn't materialize there. As I said, factors were that we didn't Sweep up as much as we thought we would in funds, have open seats we've talked about in hiring professionals there and then just Some material some minor material didn't hit in the quarter. So that's where we stand with growth.

Speaker 2

I would all connect you with that. Sorry, Rob, but I don't recall if you just said that Tom, but I think that we had pro form a growth of 8% year to date within Mission Technology. Real good wins And DMATs and the Air Force training contract, which is very positive. The book to bill is positive. So I think that team has a lot of opportunity Moving into

Speaker 7

23. Okay. And then just a high level one, Chris. But on this potential 5 unit block buy for the Columbia class. Could you talk about what that might be opportunity?

Speaker 2

Well, we assume that the Columbia class will Kind of orderly from the Navy and electric boat, that's been included in all our capacity planning And how we think about the business going forward on our 3% growth rate now. I think the Navy has been very thoughtful And how they order material and how they're thinking about bundling procurements to ensure they get the best Economics relative to ordering material from the supply chain. So, I think it's a smart way to do it. We're just in the initial stages of kind of talking about it, but it will definitely be involved a part of Our growth rate going forward, it will be a source of growth in Newport News, and I think the team is smartly working on it.

Speaker 7

Is it fair to think that's better visibility than normal, 5 bows?

Speaker 2

Absolutely. But you think Jeez, if you think about the defense strategy and you think about the CNO NAV plan and the amount of The visibility we have right now into what our backlog will be and the demand signal we're going to get in shipbuilding, we have very good visibility and high confidence In years from a visibility standpoint, the important thing we need to do is focus on execution, make sure we get these bids correct and then get these delivered because the Navy needs them. Okay. Fair enough. Thank you.

Speaker 3

Yes. I'd comment too on the back end of that. We added a new slide to kind of hit the strong demand for shipbuilding. You can see a backlog chart on Slide 5 there, It shows that backlog at the $46,000,000,000 range. That's sustained itself through at least 2026.

Speaker 3

We have excellent visibility From both the 30 year shipbuilding plan, the 5 year 5 year plan and then the more immediate FY 'twenty three budget of expectations what we see in the near term. And we have Tremendous visibility of the awards we expect to come in the next 3 to 5 years.

Operator

The next question comes from the line of Scott Deutschland with Credit Suisse. You may proceed.

Speaker 8

Hey, good morning. Thank you so much for taking my questions.

Speaker 3

Good morning.

Speaker 8

Tom, can you quantify the benefit of the Columbia Class incentives? And if just wondering if that's something that Could also help the business in the coming quarters or maybe if that's a one off? Thank you.

Speaker 3

Yes, sure. So you'll see that in the Q later this morning when it comes out. The Quantification, that's $41,000,000 of Columbia incentives. Over the last 2 or 3 calls, we've highlighted that as we're working closely with our customer, our needy Customer, on how the Virginia class and the Columbia class play out, both the additional boats of Block V, the Block VI boats and then the Bill 2, We're working closely with the program offices as far as what those requirements look like, what are the schedule requirements that both have to flow out here and that drives like a Capacity and capability requirements within Newport News. So, we've worked closely with the program office there and We see a need for additional capacity that we have in the yard.

Speaker 3

We've negotiated A position right now, and we've achieved those incentives in the quarter. So it's $41,000,000

Speaker 8

Got it. Thank you. And then Chris, apparently the Ukrainians recently used unmanned service vessels in combat, I think last Saturday. I think there were these kamikaze style USVs. If I recall correctly, you've said in the past that the CONOPS was something that still needed some work on

Speaker 2

the unmanned service vessels.

Speaker 8

So I guess Now that you've actually seen these in combat, do you think that's a big moment for the class of weapon systems broadly? And what does that mean for Huntington? Thank you.

Speaker 2

Yes, Scott. I don't want to comment on the specific mission, but I think Getting these assets in the water, executing missions for the customer is very important because it's going to demonstrate How positive and productive these can be as a force multiplier. And we think it's The most positive thing we can do is get these in service, so they can demonstrate their pretty impressive capability. Now, I don't know if we've hit an inflection point from a revenue standpoint as of yet, but there's definitely momentum That's being gained both subsea and on the surface and a number of different con ops and Missions that are being contemplated for these type of vessels. So we only think it's a positive development and we think it will Continue to gain momentum and we really like where we're positioned.

Speaker 2

Got it. Thank you so much.

Speaker 6

Sure.

Operator

Thank you for your question. The next question comes from the line of David Strauss with Barclays. You may proceed.

Speaker 9

Thanks. Good morning.

Speaker 6

Good morning, David. Good morning, David.

Speaker 9

Tom, could you just go through the rundown of EACs

Speaker 3

on the quarter? Cumulative adjustments that we had there, so it was 84% favorable, 57% unfavorable and net of $27,000,000 And a proportionate of that was about half of that was on Newport News and then 25% each for Englewood, MT.

Speaker 10

Great.

Speaker 9

And then as we think about the opportunity for improved Shipbuilding margins next year, I mean, you obviously talked about that there potentially could be some leverage on the volume side. But What about, Chris, I guess, from a milestone perspective, how do you see the milestones in 2023 relative to 20 22 giving you an opportunity for To enhance margins.

Speaker 2

Yes. So we'll give you a comprehensive update on the milestones on the next call. About the 5 deliveries in 2023, we're still very positive on those schedules are holding and we're pacing towards delivery on those ships and the balance of Those milestones are in process. We're going to assess the risk and opportunity every quarter. It's definitely still a tight labor market.

Speaker 2

There's been some positive indicators here As of late, but I don't think 2 data points is necessarily a trend.

Speaker 5

So we're

Speaker 2

going to be measuring how we deal with that, Assess our risk and opportunities, and then provide you comprehensive update at the end of the year. But The milestones in 23 are holding. We're very comfortable with that. We need to get these assets delivered and the team is working very hard to do that. Thanks very much.

Speaker 6

Sure.

Operator

Thank you for your question. The next question comes from the line of George Shapiro with Shapiro Research. You may proceed.

Speaker 7

Yes. I just wanted to pursue, you raised the long term assets for the pension to 8%. I guess that's maybe just Based on how bad it is this year, but if you could give some color on it? And then also what how that affected your not the contribution, how it affected Your adjustments for next year.

Speaker 3

Yes, sure, George. I appreciate the question. Yes, so we did raise that. When we look at the company as a whole in business now, 11 full years, The 12. 9 and the 11, we've exceeded the target of 7.25 that we've had.

Speaker 3

Obviously, this is down year. It's 2 years we've less than 7.25. And as we've highlighted To The Street, where as our peers are too, we're in the double digit negative returns against the pension plan that we have here. So We do think it's prudent when we looked at it going forward that at least for next year, we have an expectation that the return on assets could be 8%, so we raised Three quarters a point. Relative to the pension, you can see from our table that we gave you that updated the parameters for 2023, the The stat rate has changed.

Speaker 3

It's gone from 3% to 4.90 percent, so that's up 190 bps. We gave you the returns on what we saw through the Year to date at minus 15%. And you can see that flows through the fast cash adjustment goes down about $102,000,000 So That's some headwinds on EPS next year. But I will keep you updated and at the next call we give you the entire table for a 5 year projection going forward.

Speaker 7

Okay. Thank you.

Operator

Thank you. The next question comes from the line of Seth Seifman with JPMorgan. You may proceed.

Speaker 11

Thanks very much and good morning.

Speaker 2

I'd actually just say that

Speaker 11

I was going to ask a question about the asset returns and I figured no one else would ask that question, but if someone did, I knew it would be George. Maybe thinking about A different kind of bigger picture question. I apologize if this is a little bit squishy, but I was looking for something on your website recently and You go on the side and I think initially there's a picture of like a soldier, like an army soldier holding got kind of sea, cyber, land, air, joint all domain. When you think long term, Chris, about how you want to Position the company during your tenure. Is there a point by I know it's far out there about 2,030 or whatever where you want to see shipbuilding be a certain percentage of sales and Much lower than it is right now?

Speaker 2

Well, it's going to be a lower percentage simply because we think we've made really good investments In growth markets, when you think about the technology markets that we're in Mission Technologies, they really directly I'll relate to the national priorities when you think about AIML, cyber, unmanned, ISR, Live virtual constructive training and advanced synthetic training, those directly relate And apply to the defense priorities moving forward. So they will naturally grow And so shipbuilding will be a lesser percentage of the portfolio, but make no mistake, shipbuilding will always kind of be at the heart of this company And we're focused on it, but I think they'll naturally reposition a little bit based on the technology. And it's interesting, the Navy is asking for this, right? These are Navy priorities and I can think of no better way to serve your customers and to answer their call relative to additional more complicated missions that they need to execute. So It's a good question.

Speaker 2

It's one we think about a lot and we think we're making the appropriate investments in these technology areas.

Speaker 3

Cool. Thank you very much.

Speaker 6

Sure.

Operator

Thank you for your question. The next question comes from the line of Gautam Khanna with Cowen. You may proceed.

Speaker 12

Wanted to ask just to be clear, the labor shortfall this year, How does that impact the timing of any milestones in the next couple of years? Does is everything are the 8 milestones you cited last quarter for 20 3 still on for 23. Is there any Q4 weight to those, etcetera?

Speaker 2

They're still on for 23. And we assess labor situation are and this Gautam, thanks for the question. This is Chris. And we assess our labor plans and our program schedules on a quarterly basis. So All of the labor situation that we've seen this year, what we expect for next year is all included in those program schedules and we're still comfortable With those

Speaker 12

milestones. Okay. Could you quantify so what do you anticipate your labor Hires to be this year relative to the 5,000? And then what is the impact on an annual basis from The delta between $5,000 and whatever it's likely to be.

Speaker 2

Well, we're on pace to get to $5,000 I'm Still comfortable with that number. We're going to have to see how it goes. We've had a couple of good indicators here. So we're still comfortable with that. As we said previously on this call, we'll give you a better highlight on what we think about 2023 in February.

Speaker 12

Okay. And do you have a preliminary view on what you need to add next year

Speaker 2

In terms of what? Not at this time. We're working on that now. We're coming through our plans and we'll provide you that information in February, Galen.

Speaker 6

Thank you, guys. Sure.

Operator

Thank you for your question. The next question comes from the line of Myles Walton with Wolfe Research. You may proceed.

Speaker 10

Good morning. On the topic of

Speaker 2

Miles, welcome back. Sorry.

Speaker 3

Hey, thanks, Chris.

Speaker 10

Glad you noticed my brief absence, albeit. Yes. On the topic of milestones, I was hoping you could touch on the 2 that were still on the slate for 2022, DDG-one hundred and twenty three and then EMALS.

Speaker 2

Sure. So, 123 is on schedule, has some really good trials. They're on to get delivered before the end of the year. And then EMALS has been initiated. I was actually down in the spaces last month, maybe 2 months ago, All the equipments installed doing localized testing, starting that test program, so some positive developments there.

Speaker 2

So yes, Each of those are on schedule.

Speaker 10

Okay, got it. I was just going off the I think the release talked about few, if any, milestones in the Q4. So Those must be minor milestone releases or risk reserve releases?

Speaker 2

Well, we'll assess it. We'll assess them when they're complete and review the entire EAC risk and opportunities and Then deal with the outcomes at each. Okay.

Speaker 10

All right. And then maybe Tom on the progress payment rule Or Chris. Is there any legislative indication that that rule is going to be reversed at some point? Because I know it's favorable, but I'm imagining you're flowing it to your suppliers as well. I'm just curious, are you Anticipating a rule change or are you actually seeing legislative action or policy action that would suggest it's going to change next year?

Speaker 3

We think there's interest it's Tom here. Yes, thanks for the question. We think there's interest there up on the hill. I don't think it's a top priority right now. We'll have to see how it plays out as we get through the elections.

Speaker 3

Does it get inserted into a bill by year end or not? As the year progresses, since there's just one last tax payment I make kind of mid December timeframe, The benefit this year doesn't play out, but obviously as soon as that loss swings over, as we've been highlighting, it's a $250,000,000 Impact, a positive impact to the free cash flow. So we're eagerly awaiting that. I'm hopeful that it does It could change, but we'll just have to see how that plays out.

Speaker 10

So, Natan, I was referring to the progress payment rule shift That you thought it would be reversed in 2022, now it's going to be reversed in 2023. Oh, I'm sorry. Just the timing of progress statements.

Speaker 3

Yes, I got it.

Speaker 10

And I'm asking, do you actually see legislative Inertia there.

Speaker 3

So I would tell you that as I told you at the Q2 call that I believe it was going to be pushed to the end of the year right now, and that's a piece of the uptick that we have in our free cash flow guidance that we gave you. So we told you it was 225 was the midpoint. We now project to have to pay those payments back in 2023 time frame. So it's an uptick in for this year, it's an adjustment in the free cash flow bridge we gave you in the briefing. And we anticipate paying those back in the Q1 of 2023.

Speaker 6

Okay. All right. Thank you.

Speaker 2

Thanks, Miles.

Operator

Thank you. The next question comes from the line of Ron Epstein with Bank of America. You may proceed.

Speaker 6

Yes. Hey, good morning.

Speaker 5

Good morning.

Speaker 6

Looking at Mission Tech, do you still feel confident on that 6% to 8% Margin target by 24?

Speaker 3

Yes. So we're on cost right now. When we at the EBITDA right now, we've given you the numbers and where we finished the previous year in 8% range. If you notice, we just Adjusted the EBITDA NDA target down from 8.5% to 8.3% because of the volume pressures that we have, but we feel comfortable with that right now. As the in the briefing we have, we still have a robust pipeline.

Speaker 3

We feel comfortable that we're getting our momentum, The portfolio itself and the technology that we're going after are many opportunities at this. So I do. I think there's a little stress on it right now for 2022 just for the volume Sales as we adjust our base and overheads around that, but that's still a target that we've been highlighting and It's good for modeling on the call.

Speaker 2

Yes. Ron, remember a lot of that work is cost plus. There's a lot of we think there'll be a lot of stability in the margin rate moving forward. So we're still comfortable with that.

Speaker 6

Got it. Got it. And then if you look at Newport News and you back out to Columbia, right, the 41,000,000 That suggests the balance of the business was at maybe 4% margin in the quarter. Can you kind of walk through what was going on there?

Speaker 2

Yes. So we had minor adjustments or what I'll call tweaks in EACs within the quarter A few programs in Newport News, not material enough to be mentioned here and that it was offset by the Columbia class incentives. Now incentives and scheduled incentives, performance incentives are normal in our contracts. It's a normal way to incentivize performance. We think it's a good A method to incentivize performance.

Speaker 2

So it's not out of the ordinary, but we have to assess our EACs every quarter. We make Minor adjustments, where we see fit to the risk and opportunities and there was just some minor adjustments on a few of the programs there.

Speaker 6

Can you give any more color on like what programs?

Speaker 2

Yes, not material enough to mention. It was across a number of them.

Speaker 6

Okay. All right. Thanks. Sure.

Operator

Thank you for your question. The next question comes from the line of Noah Papanak with Goldman Sachs. You may proceed.

Speaker 5

Hi, good morning, everyone.

Speaker 6

Good morning.

Speaker 2

Hi, Noah.

Speaker 5

Why did you choose to exclude the milestone slide From the deck this quarter?

Speaker 2

Yes. So we only do that twice a year. We kind of inserted that as a convention. So we've done it twice a year. I can comment on any one of them that you'd like.

Speaker 2

As I said previously to Some of the questions, the last 2 for this year are on schedule, deliveries for next year are on schedule. So it's just been our convention Twice a year, if you go back in time. Yes, sure.

Speaker 5

Okay. I had forgotten that. So yes, I wasn't sure if it was, Hey, something's happening with the milestones or it's nothing's changed, so it doesn't need to be there and I just had forgotten that it was twice a year or so?

Speaker 2

It's something that's happening with the milestones, I'd tell you. So, but they're on schedule. So thanks for that. It's just that that's our convention.

Speaker 5

Got it. Okay, perfect. With your discussion of inflation, I mean, I guess, at the highest level of addressing it, do you expect inflation to Actually negatively impact the margin in any noticeable way in the medium term? Or do you feel you have the contracting conventions to offset it?

Speaker 2

Yes, it could. I'll start and then Tom can chip in here. So do have some protections, right, from an inflation standpoint. We were very fortunate that with our relationship with the labor unions, we're able to Get long term arrangements there, which helps us mitigate it to some extent. Having suppliers under contract Before we entered into this mitigates it to some extent.

Speaker 2

And then our EPA clauses mitigates it some. But absolutely, when you think about our exempt workforce and some of the increases that we've had to provide from a salary standpoint For new hires, that impacts our labor rates a bit. And then some of the general inventory that you can't Put under contract could impact it a bit as well. So I would say it modestly impacts it. We've assessed all of it In our EAC process, and we think we have it, but we're going to have to be mindful of it moving forward.

Speaker 5

Okay. And then I guess your commentary about next year's shipbuilding margin, Do we need to consider the potential that it is down year over year? Or were you more just saying the plan was some expansion, That's still possible, but flattish is also possible.

Speaker 3

I think it's more of the latter there. Obviously, we want to come through. We're watching a risk Profiles, the risk registers, what gets burnt down this quarter, the performance and the cadence, are we maintaining schedule, the hiring and experience in the yard, The progress that we make with the experience and the material that hits into the yard, we'll run our ESG process. A piece of that ESG process The contract adjustments we get for EPA and other type of provisions that will handle for inflation. To piggyback on what Chris said earlier, Depending on the portfolio and the mix, Ingalls is more ninety-ten fixed price, Newport News is fifty-fifty cost type and fixed, Which contracts have EPA clauses, which contracts are being impacted.

Speaker 3

So a lot of things are moving around there between inflation, supply chain, interest rates, Performance, material receipt and progressing. So we really want to get a look see on where we stand right now. We told you 8% to 81%, and we still feel comfortable with that right now. We had a strong first half, which we kind of foreshadowed. We told you the back half would be about 7 for shipbuilding, we came in at 7.4% with those incentives.

Speaker 3

So you can do the math. We're still holding at 7% for the back half of the year. So you can do the math on that, what Q4 looks like, but I think 8 to 81 is still a valid endpoint for us. I'd like to see where we land on that, see our run rates and then we'll factor that into The baseline going forward is on the February call.

Speaker 5

Okay. Thanks so much.

Operator

We now have a follow-up question from the line of David Strauss with Barclays. You may proceed.

Speaker 9

Thanks for taking the other question.

Speaker 6

Sure.

Speaker 9

Just wanted to, Tom, maybe if you could run through on net working capital now. I think you had said I think right now we're at about 11%. I think you had said getting down 8% At the end of this year and then relatively flat on a percentage of sales basis from there, but coming down in absolute terms, if you could just give an update? Thanks.

Speaker 3

Sure. Yes. So for yes, that's exactly what I left here at 9.3%, about 9.3% was the working capital sales in 2, we are just about 11%, 11.1% for Q3, I anticipated that. We'll turn the corner a little bit as we exit the year here, as we kind of work ourselves through the work the trades, invoicing, payments and progressing. That will come down.

Speaker 3

And then we've talked about the milestones with the 5 deliveries next year, which are still in play here. So, I see 23 that drop dropping back to more traditional 6% to 8% range. And I would expect that we would run-in that rate over the next couple of years. And that's the plan and we're on that trajectory.

Operator

Thank you for your question. That concludes the question and answer session. I will now pass the line back to the management team, Chris Kastner, for final remarks.

Speaker 2

Thanks a lot. Thanks very much for your interest in our continued interest in HI. We welcome your continued engagement and feedback. Thank you.

Operator

That concludes the conference call. Thank you for your participation. You may now disconnect your lines.

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Earnings Conference Call
Huntington Ingalls Industries Q3 2022
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