Huntington Ingalls Industries Q2 2024 Earnings Call Transcript

Presentation

[Operator]

Ladies and gentlemen thank you for standing by and welcome to the Second Quarter 2024 HII Earnings Conference Call. [Operator Instructions].

I would now like to hand the call over to Christie Thomas Vice President of Investor Relations. Mrs. Thomas you may begin.

[Christie Thomas, Vice President of Investor Relations at Huntington Ingalls Industries]

Thank you operator and good morning. I'd like to welcome everyone to the HII Second Quarter 2024 Earnings Conference Call. Joining me today on the call are Chris Kastner our President and CEO; and Tom Stiehle Executive Vice President and CFO. As a reminder statements made today that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to future events or our future financial performance and involve known and unknown risks uncertainties and other factors that may cause our actual results to be materially different from future results expressed or implied by these forward-looking statements.

Please see our SEC filings for important factors that could cause our actual results to differ materially from expected results. Also in the remarks today Chris and Tom will refer to certain non-GAAP measures. For reconciliations of these metrics to the comparable GAAP measures please see the slides that accompany this webcast which are available on our website's Investor Relations page at ir.hii.com.

With that I would like to turn the call over to our President and CEO Chris Kastner. Chris?

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Thanks Christie and good morning everyone. The HII team remains focused on executing on our programs and meeting our commitments to our customers. In the second quarter our shipbuilding division delivered two ships and our Mission Technologies business achieved another quarter of strong performance. The alignment of our products and services to the United States national security strategy continues to provide strong visibility to our long-term revenue forecast.

To start I'd like to discuss our results. Record second quarter revenue was $3 billion up 6.8% from a year ago and diluted earnings per share was $4.38 for the quarter up from $3.27 in the second quarter of 2023. New contract awards during the quarter were $3.1 billion which resulted in backlog of $48.5 billion at the end of the quarter of which $27 billion is currently funded.

At Mission Technologies we had the seventh consecutive quarter of record revenue with sales of $765 million 19% over the second quarter of 2023. In addition to very strong revenue Mission Technologies trailing 12-month book-to-bill is 1.15% and its new business opportunity pipeline is over $83 billion. Mission Technologies continues to offer leading-edge technologies aligned with the capabilities our customers need and this growth in a competitive sector confirms for us that our technology portfolio is ideal for today's market requirements.

In shipbuilding we remain focused on directing our resources toward meeting our delivery commitments to the Navy. Significant efforts continue in each of our shipyards to create labor stability improve proficiency and increase capacity all aimed at meeting our throughput goals. The long-term investments we are making in capital and employee development coupled with Navy industrial-based investments will stabilize and improve performance as our portfolio shifts towards new contracts and our ability to meet scheduled projections and performance goals will support achievement of our financial commitments to our shareholders.

In the second quarter at Ingalls we delivered LPD 29 Richard M. McCool Jr. and are looking forward to launching LPD 30 Harrisburg later this year. Other milestones including the launch of DDG 129 Jeremiah Denton and the delivery of LHA eight Bougainville have been adjusted based on workforce availability the most efficient utilization of shipyard facilities and levels of system completion to support predictable downstream execution of future milestones.

At Newport News in the second quarter we delivered SSN 796 New Jersey and continue to make progress toward our remaining milestones that are planned for later this year. During the quarter SSN 798 construction team experienced a minor disruption to Massachusetts test program due to some equipment replacement identified during testing. The disruption has been resolved and the team is back into the test program making steady progress. It does however shift delivery from late 2024 to early 2025. We are reaffirming our shipbuilding margin outlook for the year. And as we've discussed we are already in negotiations and expect several significant contract awards by the end of this year including Block VI Virginia class submarines build two Columbia class submarines and additional amphibious ships.

Turning to activities in Washington. We continue to see bipartisan support for our programs reflected in the fiscal year 2025 defense appropriations and authorization bills as they progress through both chambers of Congress. We are pleased that the two authorization committees have shown strong support for shipbuilding including support for additional advanced procurement funding authority for CVN 82 additional funding authority to support Virginia class construction and a multi-ship procurement of amphibious ships.

The Senate authorizers also included additional funding authority for LPD Flight II and DDG 51 Flight III ships. The House Appropriations bill continues to support our major shipbuilding programs and notably includes investment of $4 billion into the submarine industrial base. We await Senate appropriations positions and the final outcomes will depend on eventual respective conference negotiations by the appropriations and authorization committees.

Now turning to labor. Positive trends continue in talent acquisition as we have hired over 3800 craft personnel year-to-date which keeps us on track to achieve our full year plan of approximately 6000. In summary I'm confident that the team's focus on the execution of the fundamentals in our programs positions us positively for the future and look forward to the second half of the year as we meet more milestones and deliver on our commitments to our customers and shareholders.

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

[Thomas E. Stiehle, Executive Vice President and Chief Financial Officer at Huntington Ingalls Industries]

Thanks Chris and good morning. Today I'll briefly review our second quarter results. 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 six of the presentation our second quarter revenues of approximately $3 billion increased 6. 8% Compared to the same period last year and represent a record second quarter result for HII. This increased revenue was attributable to very strong year-over-year revenue growth of nearly 19% at Mission Technologies as well as growth at Ingalls and Newport News shipbuilding.

Operating income for the quarter of $189 million increased by $33 million or 21.2% from the second quarter of 2023. And operating margin of 6.3% compares to operating margin of 5.6% in the same period last year. Net earnings in the quarter were $173 million compared to $130 million in the second quarter of 2023. Diluted earnings per share in the quarter were $4.38 compared to $3.27 in the second quarter of the prior year representing a year-over-year growth of approximately 34%. Backlog increased slightly to end the quarter at $48.5 billion up approximately $100 million from Q1's close.

Moving to slide seven. Ingall's revenues of $712 million in the quarter increased $48 million or 7.2% from the same period last year driven primarily by higher volumes in amphibious assault ships and surface combatants partially offset by lower volumes in the National Security Cutter program. Ingalls operating income for the quarter was $56 million and operating margin of 7.9% compared to $65 million and 9.8% respectively from the same period last year. The decreases were primarily due to lower risk retirement on surface combatants partially offset by a delivery contract incentive on LP 29 Richard M. McCool Jr.

At Newport News revenues of $1.5 billion were up $26 million or 1.7% from the same period last year. Newport News operating income for the quarter was $111 million and operating margin was 7.2% compared to $95 million and 6.3% respectively in the prior year period. The increases were primarily driven by favorable contract adjustments incentives and volume on the RCOH program partially offset by lower performance on aircraft carrier construction and the VCS program. Shipbuilding operating margin in the second quarter was 7.4% up from 6.8% in Q1 of this year. We are pleased to exceed the shipbuilding margin guidance we previously provided for the quarter and we continue to see significant opportunity in the second half of the year for margin enhancement.

At Mission Technologies revenues of $765 million increased $120 million or 18.6% compared to the second quarter of 2023 primarily due to higher volumes in C5ISR and cyber electronic warfare and space. A portion of Mission Technologies overperformance in the quarter was driven by material and work that may not reoccur on a consistent basis and we have factored that into our guide going forward. We are obviously very pleased with the growth in the quarter and we are raising the Mission Technologies revenue guidance range for the year by $50 million.

Mission Technologies operating income for the quarter was $36 million and operating margin was 4.7% compared to $9 million and 1.4% respectively in the second quarter of last year. The increases were driven primarily by higher volumes I just mentioned as well as stronger performance in fleet sustainment. In addition in the second quarter of 2023 we recorded a $6 million loss related to the sale of a joint venture interest which also helps the year-over-year comparison. Second quarter results for Mission Technologies included approximately $25 million of amortization of purchased intangible assets. Mission Technologies EBITDA margin in the second quarter was 8.5% compared to 6.7% in the second quarter of 2023 and 7.7% last quarter.

Turning to slide eight. Cash used in operations was $9 million in the quarter. Net capital expenditures were $90 million or 3% of revenues. Free cash flow in the quarter was negative $99 million consistent with the guidance we provided on the first quarter call. Cash contributions to our pension and other postretirement benefit plans were $14 million in the quarter. Also during the quarter we paid dividends of $1.30 per share or $51 million in aggregate. We also repurchased approximately 250000 shares during the quarter at a cost of approximately $65 million.

Moving to slide nine. We have summarized our expectations for the third quarter and the year. For the third quarter we expect shipbuilding revenue of approximately $2.2 billion and shipbuilding margin of approximately 7.8% with margin continuing to ramp in the fourth quarter. For Mission Technologies we expect revenues of approximately $650 million and operating margin of approximately 2.5%. For the year we are reaffirming our share building revenue and margin expectations and as I previously noted we are raising Mission Technologies revenue guidance range.

We are also updating our interest expense expectation to $95 million based on the phasing of our latest cash flow forecast. We are reiterating our free cash flow outlook for 2024 of $600 million to $700 million as well as our five-year free cash flow outlook of $3.6 billion. As we have noted we expect free cash flow to be weighted towards the latter part of the year which is not unusual. We currently expect third quarter free cash flow to be near zero preceding expected strong cash collections in the fourth quarter.

To summarize we delivered another quarter of strong year-over-year revenue growth and met our shipbuilding expectations while Mission Technologies portfolio continues to perform very well. Additionally we are pleased to raise our Mission Technologies revenue guidance and reaffirm our shipbuilding financial outlook for the year.

With that I'll turn the call back over to Christie to manage Q&A.

[Christie Thomas, Vice President of Investor Relations at Huntington Ingalls Industries]

Thanks Tom. [Operator Instructions] and one follow-up so that we can get as many people through the queue as possible.

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

Questions and Answers

[Operator]

Thank you, Christy. [Operator Instructions]. The first question is from the line of Myles Walton with Wolfe Research. Please go ahead.

[Myles Walton, Analyst at Wolfe Research]

Thanks. Good morning. Chris could we start with labor. It sounds like you continue to have good traction on the hiring front but it's not clear to me if your net-net increase in your head count to where you want. So maybe just touch on attrition hiring goals I guess are good but attrition goals for the year at both shipyards and if that's a meaningful driver to some of the milestones wipeouts.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Yes sure. Thanks Miles. Thanks for the question. Yes we are achieving our hiring goals in both shipyards. So we think we've made significant progress on ensuring that we can get the people to execute the work. Attrition is not materially improving but we're thinking about it more broadly from a labor standpoint or execution standpoint. Attrition excuse me attendance and over time both have recovered. We're performing well there. Our outsourcing programs are executing well and the industrial-based funding is being applied where it's necessary to increase the industrial base.

So it's not just labor. We need to execute on our programs independent of how attrition is working. We'll continue to work on our attrition issues. We'll work on salary flexibility recruiting in the right places. But we're having to go where labor is. We've got some interesting stuff going on in Hampton Roads where we're actually creating manufacturing footprint in areas we hadn't before to attract labor. So we're thinking about it more holistically now. It's not just simply labor and attrition in order to meet our throughput goals.

[Myles Walton, Analyst at Wolfe Research]

In terms of its effect on the milestones I understand the Massachusetts sounds more like a technical discovery are the Ingalls milestone slippages more workforce limitations driven?

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Well it's both actually. It's on LHA it's just a significant amount of volume and labor and application of the labor to achieve those milestones. So we move that. DDG-129 is a little different there's sequencing involved in getting to that launch but also some impact related to labor. Now all of that is included in our financials and in our guidance and we're comfortable with where we are.

[Myles Walton, Analyst at Wolfe Research]

Okay. Thank you.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Sure.

[Operator]

The next question is from the line of Robert Spingarn with Melius Research. Please go ahead.

[Scott Mikus, Analyst at Melius Research]

Good morning. This is Scott Mikus on for Rob Spingarn. Tom or Chris I wanted to ask based on the guidance you need to generate about $1 billion of free cash flow in the fourth quarter. So I'm just wondering if you could talk about your level of visibility into that cash generation? And then if possible can you quantify how much of the fourth quarter free cash is tied to working capital that could move into early '25?

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Yes. Thank you for the question. I'll start and then Tom can finish it off with some details here but I hate to give the answer of timing because it's just not specific enough for you all but there is a lot of timing in the back half of the year for margin and cash. In order to achieve that progress over the back half of the year we need to make our milestones on our ships we need to achieve contract incentives and it's not just one. It's we risk adjust all of our programs over the back half of the year to ensure that we can make guidance and we have a line of sight to it. So yes it is over the back half of the year. There is some timing. There's some unwind in working capital but we do have line of sight to it. Tom?

[Thomas E. Stiehle, Executive Vice President and Chief Financial Officer at Huntington Ingalls Industries]

Yes I'll provide some more color on that too. Scott I appreciate the question. It's not uncommon from where we are right now. I mean we usually use cash at the beginning of the year. We have guided both minus 200 and minus 100 for Q1 and Q2 respectively. We find ourselves right now through the quarter through the first half of the year at minus $274 million. Honest is broken there was about $100 million that moved from Q1 to Q2 in a payment and then we closed Q2 kind of missing a $75 million of payment. So I mean from performance and where we thought we'd be we're kind of right where we guided.

From a perspective the year had to shape to it it was back end and loaded anyway. It was more back-end loaded in '24 than it was in 2023. When you get the Q and you can take a look at this comparison in there from '23 over to '24 and we're down operationally in cash about $284 million and then we have another $54 million of capex that we're spending in '24 over '23. So that constitutes about $330 million down in '24 over '23. But again in line with where we thought we'd be in the plan the portfolio.

I would tell you a couple of the milestones that we had at the end of '23 that dragged into '24 although it's only a couple of ships LPD 29 the SSN 796 and then the launch of 788 all just brought that work into 2024 and created just a little bit of a draw on making kind of cost and progress and headway on the existing portfolio we have here. But the guides that have we provided zero on free cash flow for Q3 which has some variability to it. There's a lot of activity that milestones that you have on major milestones smaller milestones underneath.

Capital incentives the capital is a little bit slower than we guided. We guided 5.3% for the year. It was 2.6% in Q1 and 3% for Q2. But as that comes online in the back half of the year the progress that we want to make to close out the work packages that are in play right now will allow us to fully build all the costs that you see on the balance sheet. You can see the contract liabilities and the arap in there. So there's some net working capital that's going to burn itself down.

We finished last year at 5% of working capital at the end of 2023. We said just under 9% right now. And I kind of foreshadow at the beginning of the year that we were going to have this shape and by the end of the year because the capital incentives we'd actually have a little bit of an advancement we'll work ourselves down to the 2% to 3% range in working capital. And that's aligned with our plan. It's aligned not only with the free cash flow perspective we gave you to $600 million to $700 million this year. But in the five-year goal I told you that had some shape into it too. And net working capital level exiting 2024 into 2025 is planned in the guidance that I gave you for $3.6 billion kind of going forward.

So I think we have we understand where we are. We aligned with the plan that we had this year. The increases on the back half of the year between the progressing milestones incentives capital incentives. And then we have some new contract awards that introduced some alignment with the business environments that we have here that that itself it was just at the beginning of those contracts we anticipate them to be awarded if not at the end of Q3 and Q4. a little variability of the effect. Is that going to be like show up in Q3 or Q4. But it will by the end of the year we'll have new avoids that will assist both in margin and cash as well.

[Scott Mikus, Analyst at Melius Research]

Okay. That gets into my next question. So I wanted to ask just high level a big part of the margin story at least for shipbuilding is putting new ships and boats on contract that have better pricing compared to some of your older contracts. So can you give us an update on how many ships and boats you put on contract so far this year? And how many you expect to put on contract in the next 12 to 18 months?

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Yes. So we expect to put under contract over the next six to 12 months and probably before the year expires actually another 21 boats with pricing that reflects the current macroeconomic environment. So it's a significant amount of work that we intend to put under contract over the back half of the year.

[Scott Mikus, Analyst at Melius Research]

All right, thanks. I'll stop there.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Sure. Thanks, Scott.

[Operator]

The next question is from the line of Pete Skibitski with Alembic Global. Please go ahead, Pete.

[Pete Skibitski, Analyst at Alembic Global Advisors]

Pete. Hey. Good morning, guys. I did have a question on Ingalls margin. I know you've touched on it a little bit just because it's dipped here for the first time in almost a couple of years. The release talked about lower risk retirement on service combines. And I wasn't sure if that's kind of you've got some early DDG 51s in the yard and you're booking conservatively or I wasn't sure if that was if the DG 129 push out next year impacted this quarter. Could you maybe talk through that a little bit with us a little more deeply.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Yes sure. Sure. Sure. I can start. I think you probably have a little bit of a compare issue from last year in that language. But obviously you moved to two milestones cost goes with schedule so that impacted the quarter. And then 129 had a bit or excuse me LPD 29 at delivery had a little bit less risk retirement than we usually have. So Ingalls is going to continue to execute. This is just a bit of a quiet quarter for them and I expect them to recover very quickly here.

[Pete Skibitski, Analyst at Alembic Global Advisors]

Okay. I appreciate it. And just one follow-up. I know some of the there's been some supply chain issues on the Virginia I think and the carriers but I think one of the issues has been development of the new electric generators do you guys have a time line of when that new system is expected to arrive in the yard?

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Yes. So I'm probably not the right person to talk about that depending on what program you're referencing. We have our estimates have not changed for 80 if that's what you're referencing. And our schedules have not changed materially either. They're making good progress on 80. They're doing some very interesting things relative to ensuring that we hold on to the schedule for 81 and how we're going to build those. But I'm not really comfortable because there's been no material change between Q1 and Q2 relative to those delivery requirements or expectations.

[Pete Skibitski, Analyst at Alembic Global Advisors]

Thank you.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Sure. Thank you.

[Operator]

The next question is from the line of David Strauss with Barclays. Please go ahead.

[David Strauss, Analyst at Barclays]

Thanks. Chris can you talk about where you are in terms of Block IV Block V work and then negotiating Block VI on ECS.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Sure. Sure. Block IV we're marching towards delivery on 798. We did have that minor move on the milestone but they're making progress on the test program now. And it's a good team on. It's a good crew. It's a good leadership. So I fully expect 798 will resolve at the beginning of next year. 800 is making progress. That milestone is holding to float off the back half of this year and then we have one more module that we have to deliver to General Dynamics. And then we're making progress on Block V and they'll start to fill in behind Block four in those getting into the integrated delivery in test of the Block V Virginia class boats.

Block VI we're in discussions with the government relative to negotiation of that block. I expect that to resolve this year. working closely I think it will be a fair deal dealing with this macroeconomic environment we talk about with inflation and supply chain insurance we have all that risk protected. The good news is we're making investments. The Navy is making investments in the industrial base in order to get at this throughput issue and we fully expected and when we do Block VI all of that will be wrapped into that deal and it will be a fair deal. So that's where we stand on Virginia class.

[David Strauss, Analyst at Barclays]

What is your revenue mix right now between Block IV and Block V?

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Yes. The vast majority of it Tom [Indecipherable] has the details but the vast majority of it is headed in the Block V now.

[Thomas E. Stiehle, Executive Vice President and Chief Financial Officer at Huntington Ingalls Industries]

Yes. So we're at 95% complete on Block V. And then Block I know it's not the exact answer to your question but we're at 95-plus percent of the contract completed on Block IV and Block V in the mid-20% range. And we're spending we crossed over about six quarters ago that Block V has higher revenue than Block IV.

[David Strauss, Analyst at Barclays]

Okay. And then a follow-up on working capital. Do I hear correctly? Now it's going to drop to you're saying 2% by the end of this year? Where does that go in 2025?

[Thomas E. Stiehle, Executive Vice President and Chief Financial Officer at Huntington Ingalls Industries]

A couple of things here. We got I think the last couple of calls we've been talking about that right? And the for the 600 to 700 guys and where the working capital is right now the capital incentives pop in here. We will burn down the 9% that we see through Q2 to that level going forward right lower than what we traditionally guided to between 4% and 5% because of what's going on on the capital front. We haven't guided both for free cash flow specifically for 2025.

And I would be I don't want to get into specific targets going forward. But I will tell you that we're kind of on plan on that front relative to its implications to the five-year free cash flow guidance. And as we close out the year for Q3 Q4 a lot of activity has to happen and how that's going to fall with everything I rattled off for? on how we're going to make the $600 million to $700 million. I'd prefer to hang on to the exact working capital guidance at the back half of the year as we set the trajectory and the targets for next year on the February's call.

[David Strauss, Analyst at Barclays]

All right. Understood. Thank you.

[Thomas E. Stiehle, Executive Vice President and Chief Financial Officer at Huntington Ingalls Industries]

Thank you.

[Operator]

The next question is from the line of Gautam Khanna with TD Cowen. Please go ahead.

[Gautam Khanna, Analyst at TD Cowen]

Yeah, thanks. I have two questions. First just on the Q4 cash flow. Was there are there any major like lumpy events that you could that might actually move that number materially if they were to slip out. And relatedly do the delivery milestone slips have any impact on that whatsoever. And then I have a follow-up.

[Thomas E. Stiehle, Executive Vice President and Chief Financial Officer at Huntington Ingalls Industries]

Yes. So I would tell you the ramp that we're going to see here between Q3 Q4 again we conservatively guided to zero for Q3 but that could be 100 to 200 higher. It could be 50 to 100 less there just depending on how everything that I said earlier kind of falls out. But the ramp from now where we are to Q3 and Q4 it's a composite there of improved trade working capital between AP and AR but progressing and closing a build you can see I have a cost in the balance sheet. So it's just getting the right progressing as we make headway on schedule to be able to build all the costs.

The major milestones add into that. We talked a bit at we have a slide on the PowerPoint briefing that you can see the ones that we have to hit there on the deliveries. And then we kind of work ourselves through both incentives and program contract incentives and then capital incentives. And then the new awards kind of contribute that rise and lift on the back half of the year too. So it's all of it. I don't think missing one milestone here or there is not going to drive the preponderance of the lift that we see kind of going forward. But we'll keep you informed and we'll give you an update on the November call. And the part two of your question?

[Gautam Khanna, Analyst at TD Cowen]

And Chris I was just wondering what's your appetite for acquisitions at this point? If you could just talk about that.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Yes. So capital allocation has been fairly consistent here for the last year after we started to pay down the debt. We like to be investment grade. We think that's where we need to be and where we want to be. We're going to continue to invest in our shipyards. We're going to pay a dividend. And then with excess cash we're going to provide it back to shareholders but we'll continue to evaluate M&A opportunities as they present themselves. And if it makes strategic and financial sense we'll evaluate it and entertain it. So there's not really a change in our capital allocation philosophy.

[Gautam Khanna, Analyst at TD Cowen]

Thank you.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Sure. Thank you.

[Operator]

The next question is from the line of Jason Gursky with Citi. Please go ahead, Jason.

[Jason Gursky, Analyst at Smith Barney Citigroup]

Okay. Good morning. Everybody can hear me.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Morning, Jason. Yes.

[Jason Gursky, Analyst at Smith Barney Citigroup]

Okay, great. Thank you all for struggling there. Chris just a quick question first on Mission Technologies. You mentioned the trailing 12 book-to-bill of 1.15% and the quantum of the pipeline that you have there. in that business. I'm wondering if you can step back for a minute and just talk a little bit about the 1.15% and when you can execute on that backlog and the pipeline that you have available to you? And what that means for growth rates beyond 2024. We are obviously off to a really solid start here in the first half of this year. I'm just kind of curious how this growth rate settles out over the next couple of years.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Yes. So thanks Jason. We're still comfortable with our 5% growth rate in Mission Technologies. It was a bit of a conservative guide. We've increased it for the year. And beyond that if we can execute on the $83 billion pipeline and the book-to-bill continues to be very good. It could be north of that. And it's really broad-based across the business that each one of those business areas is executing very well.

I would like to point out that there's a lot of interesting things going on in Mission Technologies. This is the first time that the Navy is going to deploy Virginia-class submarine with launch and recovery all autonomously of REMUS vehicle. And it's not just an exercise that's full deployment it's the Elmore. It's a great it's a great product and it demonstrates the kind of the man and autonomous and man teaming that we really think about provides a lot of value for our customer.

So if they continue to execute like this they continue to execute on that backlog and they take advantage of that pipeline. It could be north of that. But we don't want to get too far over our skis. We're going to be relatively conservative as you would expect for us to be but I'm very encouraged by how Mission Technologies is developing.

[Jason Gursky, Analyst at Smith Barney Citigroup]

Okay. Great. That's helpful. Appreciate that. And then secondarily just on labor productivity in the shipyards. I know you talked a little bit earlier during the Q&A session about attrition rates and hiring and all that kind of stuff is a good step which is great. But I think probably just as important maybe to those numbers is kind of the learning curve of the employees.

And I'm wondering if you have the ability maybe just from a big picture perspective to talk about labor productivity where you are today relative to maybe where you were pre-pandemic? Just wondering if we're still down relative to pre-pandemic levels from a labor productivity perspective? And kind of what you would back over the next couple of years and maybe when we can return back to kind of pre-pandemic productivity.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Great. So it's a great question Jason. So productivity is not as it was before the pandemic. There's no getting around that. And it's related to the experience level of the team. Now do I expect it do I expect it to improve? Absolutely. And both teams in Ingalls and Newport News are making investments to ensure it does. And the SIB investments that you see coming out of the Navy are focused on that as well it's not just infrastructure. It's targeted at the proficiency of the workforce as well. So I do expect it to improve. We're investing against it. We've done it before. We've seen it before and I expect it to continue to improve as we stabilize moving forward.

[Jason Gursky, Analyst at Smith Barney Citigroup]

Great. Thanks.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Sure.

[Operator]

The next question is from the line of Seth Seifman with JPMorgan. Please go ahead, Seth.

[Seth Seifman, Analyst at JPMorgan Chase & Co.]

Thanks very much and good morning. In the slides I think you talked about a reduction year-on-year in Virginia sub profitability. Should we attribute that to what's happening on Massachusetts? Or was there a reduction in expected profitability on Block V.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Yes. So I think that's probably a compare issue related to last year. There's no material issue that we can note related to that. It's kind of broadly across the blocks. We assess our ECs every quarter. We have to make an adjustment we do that plus or minus. So this is not anything individually material there.

[Seth Seifman, Analyst at JPMorgan Chase & Co.]

Okay. So and I think you mentioned earlier about the carrier. So with both the carrier and Virginia Block V there weren't meaningful changes to the estimated profitability.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

No not material enough to note. No. But we as I said we assess our issues every quarter when we make those adjustments dictated by our evaluation in that quarter.

[Seth Seifman, Analyst at JPMorgan Chase & Co.]

Okay. Okay. Great. And then just for Ingalls I guess should we expect profitability there to we've seen typically kind of solidly double-digit margin for Ingalls. Is that something kind of going forward that Ingalls can still be kind of at the high end of kind of good shipyard margins?

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Yes. So we don't guide by shipyard but I fully expect Ingalls to continue to execute on their programs very well. But yes we don't provide guidance by our shipyards.

[Seth Seifman, Analyst at JPMorgan Chase & Co.]

Okay, great. Thanks very much.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Sure. Thank you.

[Operator]

The next question is from the line of George Shapiro with Shapiro Research. Please go ahead.

[George Shapiro, Analyst at Shapiro Research]

Yes. Good morning. Tom I wanted to pursue a little bit the free cash flow needs for the fourth quarter. I mean obviously we can all do the arithmetic $973 million to $1.73 billion. Now if I look back that's nearly twice what you've ever done before the last highest year in the last five was $539 million in the fourth quarter of 2018. In addition you've never had three quarters in a row where no quarter generated positive cash flow. So my question is what has changed in the last five years in terms of contracts that you have or what to suggest such a dramatic swing this year from what we've seen before.

[Thomas E. Stiehle, Executive Vice President and Chief Financial Officer at Huntington Ingalls Industries]

Yes. So I think we have had a couple of quarters that were negative. So we can catch up offline on that George. But this isn't an odd year. I would tell you it's backloaded one. Two I would tell you that pre-COVID we're executing these contracts right now we have seen a draw in the schedules over the last three or four years. And that just changes the construct of a get progress and collect costs and what we're allowed to bill and creates a little bit of a draw on that. We still manage it annually. And as you know we've been pretty good at providing a five-year target back in 2019 providing the guidance annually for each of the years and we've met or exceeded that.

So I mean we're in the lane right now. We've actually increased that $2.9 billion to $3 billion so we threw another $100 million at it. We've given the next five years at 20% more. So we have pretty good visibility into the portfolio. It's a relatively I'm sorry? Yes. There was some feedback here. It's a relatively mature portfolio that's going on that we have here. So we have line of sight as far as what we have to build program plans the expected costs. And then all that rolls in once we come through our quarterly ACs into the guidance of free cash flow going forward here.

It is backloaded. And as I commented earlier I did a comparison you could take peak of the Q there on what's driving that? A little bit more capex that we've seen. Last two years have been 2.6% and 2.4% of sales respectively and already we saw the 3% quarter of last year and that's going to ramp in the back half of the year bought this capital incentives that come along with that.

As we continue to make progress the cost that you can see that's on the books and the balance sheet there we plan to liquidate that and really drive that working capital that's going to be the catalyst the working capital coming down milestones and deliveries and additional awards as well as on contract performance and capital incentives are going to drive the back half of the year.

The guide of 3% was probably on the conservative side. We didn't want to say it could be $100 million to $200 million higher or $50 million to $100 million less and we didn't want to provide a number that we leaned into for Q3. The events and criteria and milestones that we see have to happen are right in that end of September October and November time frame. So we guided conservatively which does make the Q4 look like it's a larger lift than it may be as it plays out.

[George Shapiro, Analyst at Shapiro Research]

Okay. Just one comment. What I said what I meant to say if I didn't say it properly on the cash flow was there hasn't been if you look at quarter-by-quarter there's been no time in the last five years where one quarter hasn't had at least positive cash flow of the three. There's been several quarters where two have been negative but not zeo in the third.

A follow-up I had was in Mission Technologies the guide for the second quarter was like $650 million you did $750 which is $765 million which was similar to the first quarter. And you had mentioned the material and that may drop down in the third quarter. Can you just be a little clear as kind of what actually drove in the materials comment that you made?

[Thomas E. Stiehle, Executive Vice President and Chief Financial Officer at Huntington Ingalls Industries]

Yes. So on the material comment that I said in my opening statements that was more applicable to Q1. So there was some sales that we had which are not in we don't envision to be on a recurring basis were not included in the Q2 or the guide kind of going forward. The Q2 revenue that we had at Mission Technologies was driven by strong performance in C5ISR and CEWS. And we believe that will continue going forward. We have normalized that for the book of business on contract right now. So we know what contracts we have and we're executing and we see the how we load that out and we have a clear sight on expectations of the revenues for the last two quarters as well as there is some there's still awards happen every month.

And there's even though we're in the back half of the year there's several tens of millions of dollars of potential sales that happen on awards. So we have to execute our plan that we have in existing contracts. Those awards have to play out. And we've got it rightfully probably on the conservative side of where we stand. The run rate at Mission technologies between the first two quarters at $750 and $765 is 15.15 on an annual basis over $3 billion. We've conservatively taken the beginning of the year guide from $27 to $27.50 up to $27.50 to 2.80. So let's see how it plays out.

We don't want to get ahead of ourselves. Chris made a comment earlier about the growth. We saw some good growth in 2021 to '22 at 4% from '22 to '23 at 12.7% and now both Q1 and Q2 respectively has seen 20% and 18% growth. But we don't want to overly guide here. Obviously we've got to get the people in win those contracts and continue some good performance. But I'm feeling really strong about the allian acquisition the business proposition that we set that MT would be a $200 million cash generated which it is. And I feel really good about the portfolio of contracts we have and that pipeline growing.

[George Shapiro, Analyst at Shapiro Research]

So just one last one. So why guide to only $650 million in the third quarter?

[Thomas E. Stiehle, Executive Vice President and Chief Financial Officer at Huntington Ingalls Industries]

Well I'd rather say we have a lot of work to do going forward here. We don't want to over guide a miss and it's still a function of a couple of awards that will have a minor impact on the revenue for the rest of the year here.

[George Shapiro, Analyst at Shapiro Research]

Okay, thanks very much for all the caller.

[Thomas E. Stiehle, Executive Vice President and Chief Financial Officer at Huntington Ingalls Industries]

Yes, sir. Thank you.

[Operator]

The next question is from the line of Jordan Leone with Bank of America. Your line is now open, please go ahead.

[Jordan Leone, Analyst at Bank of America]

Hey. Good morning.

[Thomas E. Stiehle, Executive Vice President and Chief Financial Officer at Huntington Ingalls Industries]

Good morning, Jordan.

[Jordan Leone, Analyst at Bank of America]

On capex the sequential uptick that you guys had is there a percentage or a portion of that that you could give color on that you'd expect to get back from the Navy capex incentives.

[Thomas E. Stiehle, Executive Vice President and Chief Financial Officer at Huntington Ingalls Industries]

Yes we always invest with our partner with the Navy on this and depending on what the capex is and the timing and value equation what it adds and the design of getting in the yard whether it's for operational here or Navy sales and things like there's a mix there of investment. We don't get into that. I mean that's just part of the business case. And I will tell you that any capital projects that we do add value we get a return on that capital. and it goes into the business construct and how we choose which projects we bid we approve and we execute here. I leave it at that. It was 2.6% in Q1 3% in Q2. The guide is still 5.3% for this year with a 5% capex over the next three years.

[Jordan Leone, Analyst at Bank of America]

Got it. Okay. And then also to on the contract at Deloitte One that's for Navy ship building do you have any sense of the scope for it or why like Mission Tech wasn't picked or you guys in general?

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

I can't necessarily hear the question. There's some feedback. Can you repeat that?

[Jordan Leone, Analyst at Bank of America]

Yes. So Deloitte the one that was a $2.4 billion Navy contract for it seems like an HR contract on the Navy shipbuilding base.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Yes. I think they're supporting their identification allocation of investments to support where they should make investments. So yes we were we were not involved in that contracting process.

[Jordan Leone, Analyst at Bank of America]

Okay, got it. Thank you so much.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Sure. Thank you.

[Operator]

I am not showing any further questions at this time. I would now like to hand the call back over to Mr. Kastner for any closing remarks.

[Christopher D. Kastner, President and Chief Executive Officer at Huntington Ingalls Industries]

Thanks everybody for joining today. Before we go I'd like to extend my thanks to the entire HII team for their continued focus and we look forward to speaking with you on our next earnings call. Thank you.

[Operator]

[Operator Closing Remarks]

Participants

Corporate Executives

• Christie Thomas, Vice President of Investor Relations
• Christopher D. Kastner, President and Chief Executive Officer
• Thomas E. Stiehle, Executive Vice President and Chief Financial Officer

Analysts

• Myles Walton, Wolfe Research
• Scott Mikus, Melius Research
• Pete Skibitski, Alembic Global Advisors
• David Strauss, Barclays PLC
• Gautam Khanna, TD Cowen
• Jason Gursky, Smith Barney Citigroup
• Seth Seifman, JPMorgan Chase & Co.
• George Shapiro, Shapiro Research
• Jordan Leone, Bank of America Co.