Huntington Ingalls Industries Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
February 9, 2023

There are 13 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the 4th Quarter 2022 HII Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded. To an operator.

Operator

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

Speaker 1

Thank you, operator, and good morning, everyone. Welcome to the HII 4th quarter 2022 earnings conference Joining me today on the call are Chris Kastner, our President and CEO and Tom Seeley, Executive Vice President and CFO. As a reminder, any forward looking statements made today that are not historical fact are considered our company's estimates or expectations and are forward looking statements made pursuant to the Safe Harbor provisions of federal securities law. Forward looking statements are subject to risks and uncertainties that could cause actual results to differ materially. For additional information regarding factors that could cause actual results to differ materially from expected results, refer to our SEC filings.

Speaker 1

Also in their remarks today, Chris and Tom will refer to certain non GAAP measures. Turn the call over to our President and CEO, Chris Kastner. Chris?

Speaker 2

Thanks, Christie. Good morning, everyone, And thank you for joining us on our Q4 2022 earnings call. First, I would like to thank the entire HII team for a solid year and express my gratitude for their outstanding contribution throughout 2022. It was through their dedication and commitment That we were able to deliver results that demonstrated consistent performance in a pretty tough economic environment. Now let's turn to the highlights for the quarter and the year on Page 3 of the presentation.

Speaker 2

In 2022, we reported record sales of 10,700,000,000 net earnings of $579,000,000 and free cash flow of $494,000,000 The demand for our products continues to drive a tremendous backlog of $47,000,000,000 and we grew sales and earnings across all 3 of our segments in 2022, setting the foundation for continued growth in 2023 beyond. At Ingalls, in the Q4, we delivered DDG-one hundred and twenty three LENA Studcliffe Higbee and completed builders trials on DDG-one hundred and twenty five, Jack H. Lucas, the 1st Flight 3 ship just 1 quarter after DDG-one hundred and twenty three completed her trials. Our DDG 51 team also started fabrication on DDG133, SAM NUN. In our Amphibia Ship product line, We were awarded a $2,400,000,000 detailed design and construction contract and started fabrication for LHA-nine Fallujah, the 4th Big Deck Amphibious Warship in the America class.

Speaker 2

Also at Ingalls, in January, we were awarded the advanced planning contract for the modernization period for Zumwalt class guided missile destroyers. At Newport News in the Q4, we authenticated the keel for SSN 8 100 Arkansas, honoring the ship sponsors, the Little Rock 9. We continue to remain focused on reducing risk And meeting cost and schedule objectives on the Virginia class boats. As for nuclear aircraft carrier, CVN 79 Kennedy is well into the test program. Distributed systems such as fire mains, potable water, air conditioning and ventilation are coming to life.

Speaker 2

The EMALS catapult system, which we began testing in 2022, remains on track and is progressing as planned through her test program, And we expect to enter into the combat systems test program later this quarter. And finally, for the refueling and complex overhaul of CBN 73 USS George Washington, we are 98% complete as we near planned redelivery later this year. At Mission Technologies, we achieved solid revenue growth for 2022 with all of the business groups growing year over year, And we ended the year with a robust potential business pipeline of $66,000,000,000 of which over onethree is qualified. Significant wins in 2022 included the decisive mission actions and technology services contract, Mobility Air Force's distributed mission operations contract and the Remus 300 selection is the U. S.

Speaker 2

Navy's small UUV program of record. From an operational perspective, we have integrated LION into our Mission Technologies and HII team. And with the integration complete, we can turn our full attention towards executing our growth strategy. Moving on to slide 4, we are providing the major milestones for 2023 And 2024. I'm proud to

Speaker 3

say that we met all

Speaker 2

of the shipbuilding milestones that we highlighted back in the Q2 of last year for 2022, and we are maintaining all of the 2023 milestones. This demonstrates growing confidence in our ship schedules and provide a solid platform to continue to improve our cost performance. Notable anticipated 3 milestones at Newport News include the planned delivery of SSN 796 New Jersey and planned float off of SSN 798 Massachusetts as well as the planned redelivery of CVN 73 and planned crew move aboard On CVN 79. At Ingalls, DDG-one hundred and twenty five, Jack H. Lucas, NSC-ten Calhoun and LPD 29 Richard M.

Speaker 2

McCool Jr. Are all forecast to deliver this year, while LHA-eight Bougainville is expected to launch. In addition to these shipbuilding milestones, Mission Technologies expects to see continued growth resulting from our large opportunity pipeline, including the several award decisions that we expect to be made in the first half of the year. Now, I would like to discuss our operational focus areas. Our top operational priority remains hiring and workforce development.

Speaker 2

I'm confident in our plans for hiring and as importantly, Our retention and training strategies. These strategies that center around employee skills and leadership development are gaining traction and we've had a good start to the year. After hiring over 4,900 craft personnel in 2022, We expect a similar hiring rate in 2023, while at the same time improving our productivity, attendance and overtime together to drive performance. Regarding inflation, we have some installation to our contracting terms and conditions. However, non programmatic elements of inflation have impacted us across all of our programs.

Speaker 2

And finally, the supply chain is stabilizing and we have worked closely with our customers and suppliers to achieve the best possible schedules. To summarize and notwithstanding being our most significant risk, as labor and Supply chain impacts continue to stabilize and inflation abased, we believe we have the opportunity for improved performance over the next few years. Turning to the budget environment. We are pleased with the passage and enactment of the fiscal year 2023 Defense Appropriations and Defense Authorization Both pieces of legislation strongly support shipbuilding, including funding and authority for an additional DDG 51 Flight 3 ship For a total of 3 DDGs, 2 Virginia class attack submarines, the Columbia class ballistic missile submarine program, Forward class nuclear aircraft carrier programs and the refueling and complex overhaul of CVN 74 John C. Stennis.

Speaker 2

Both appropriations and authorization bills continue funding for LPD 32 and LHA 9 and provide new advanced procurement funding for LPD 33, LHA10 and a third DDG 51 in FY 2024. The Defense Authorization Act also includes language requiring a naval fleet of no less than 31 operational Antibious warships, including a minimum of 10 amphibious assault ships. We continue to see bipartisan congressional support for our programs. We look forward to working with the administration and Congress on the President's fiscal year 2024 budget request. So with that, I will turn the call over to Tom for some remarks on our financial results and guidance.

Speaker 2

And then I have a few additional comments before we move on to Q and Thanks, Chris, and

Speaker 3

good morning. Today, I'll briefly review our Q4 and full year results and also provide an outlook for 2023. 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 4th quarter results on Slide 5 of the presentation, our 4th quarter revenues of $2,800,000,000 increased approximately 5% compared to the same period last year. This growth was driven by higher year over year revenue at all three segments Leading to record quarterly revenue for HII.

Speaker 3

Operating income for the quarter of $105,000,000 decreased by $15,000,000 or 12.5 from the Q4 of 2021 and operating margin of 3.7% compared to margin of 4.5% in the prior year period. The decrease in operating income was primarily due to lower segment operating income. Net earnings in the quarter were $123,000,002.99 in the Q4 of the previous year. Moving to our consolidated results for the full year on Slide 6. Revenues were $10,700,000,000 for the year, an increase of 12.1 percent from 2021.

Speaker 3

The increase was driven by year over year growth at All three segments along with a full year of Align revenue. Operating income for the year was 565,000,000 and operating margin was 5.3%. This compares to operating income of $513,000,000 and operating margin of 5 4% in 2021. The operating income growth was driven by year over year improvement at all three segments As well as a more favorable non current state income taxes and operating fast cash adjustments. Net earnings for the year were $579,000,000 compares to $544,000,000 in 20.21 and diluted earnings per share were $14.44 compared to $13.50 in the previous year.

Speaker 3

Moving on to Slide 7. Ingalls 20 revenues of $2,600,000,000 increased $42,000,000 or 1.7 percent from 2021, driven primarily by higher revenues in the LHA and DDG programs partially offset by lower NSE program revenues. Ingalls' 2022 operating income of $292,000,000 and margin of 11.4 percent both improved from $281,000,000 11.1 percent last year. These results were driven primarily by favorable changes in contract estimates and price adjustment clauses as well as higher risk retirement on the LPD program, Partially offset by lower risk retirement on the DDG program compared to 2021. At Newport News, 2022 revenues of $5,900,000,000 increased by $189,000,000 or 3.3 percent from 2021, Primarily due to higher revenues in both aircraft carriers and submarines, partially offset by a lower revenue in naval nuclear support services.

Speaker 3

Increased aircraft carrier revenues were driven by higher volumes on the refueling and complex overhaul of the USS John C. Stennis, CVN-seventy 4 and the construction of Doris Miller, CVN-eighty 1 and Enterprise, CVN-eighty, partially offset by lower volumes On the refueling and overhaul of the USS George Washington CVN 73 and USS Gerald R. Ford, CVN 78. Submarine revenue growth was due to higher volumes on the Columbia class and Block V boats on the Virginia class, partially offset by lower volumes on the Virginia Class Block 4 boats. Newport News 2022 operating income of $357,000,000 and margin of 6.1% were relatively consistent with the performance in 2021 of $352,000,000 and margin of 6.2%.

Speaker 3

2022 results included favorable changes in contract estimates from facilities capital and price adjustment clauses as well as contract incentives on the Columbia Class Submarine Program, partially offset by lower risk retirement on the VCS program And the refueling overhaul of the USS George Washington CVN 73 compared to 2021. 2022 shipbuilding margin of 7.7% was consistent with the performance of 2021, but below our expectations for year over year improvement as the back half of the year provided limited risk retirement opportunities. Continued labor challenges, including higher attrition rates, the impact of non programmatic inflation and supply chain disruption all contributed to slower margin progress. At Mission Technologies, revenues of $2,400,000,000 increased $911,000,000 were 61.7 percent from 2021, primarily driven by the acquisition of Align in the Q3 of 2021. Mission Technologies' operating income of $63,000,000 compares to operating income of $50,000,000 in 2021.

Speaker 3

Primary drivers of growth are the acquisition of Allian in 2021 as well as higher equity income from a joint venture, partially offset by higher amortization of purchase intangible assets in 2022 due to the Align acquisition. 2022 results include approximately $96,000,000 of amortization of Alliant related purchase intangibles compared to approximately 33,000,000 in 2021. I'll also note that the Q4 and 2022 results included a non cash downward valuation adjustment of approximately $10,000,000 or approximately $0.20 per share related to an equity method investment. Mission Technologies EBITDA margin in 2022 was 8.2% and adjusting out the one time downward valuation adjustment, EBITDA margin was 8.6 percent consistent with 2021 performance. Turning to capital deployment on Slide 8.

Speaker 3

We ended 2022 with a cash balance of $467,000,000 and liquidity of approximately 2,000,000,000 2022 cash from operations was $766,000,000 and free cash flow was 494,000,000 Free cash flow generated in the Q4 of 2022 was significantly above our prior expectations as we were able to accelerate Several large cash collection events. This has a direct impact on our expectation for 2023 Free cash flow, which I will discuss in more detail in a moment. I'm pleased to report that the net capital expenditures were 272,000,000 or 2.5 percent of revenues in 2022, at the very bottom end of the guidance range. Cash contributions to our pension and other post time and benefit plans totaled $41,000,000 in 2022. During the Q4, we paid dividends of $1.24 per share or 50,000,000 bringing total dividends paid for the year to $192,000,000 Over the course of 2022, We repurchased approximately 245,000 shares at an aggregate cost of approximately 52,000,000 Moving on to Slide 9 and our updated outlook for pension and postretirement benefits.

Speaker 3

Our outlook for 2023 Has improved modestly from the update we provided in November given the increase in discount rates since that time. Asset Returns for 2022 of negative 16.1 percent were about as expected compared to our update in the 3rd quarter. Expectations for 2024 through 2026 have been updated. And consistent with the Q3 update, The SaaS benefit has come down considerably from our last update given the more immediate recognition of the negative asset experienced in 2022. This is partially offset by the impact of higher discount rate.

Speaker 3

We also have provided An initial review of our 20 27 expectations. Turning to Slide 10 and our outlook for 2023. While we continue to expect shipbuilding growth of approximately 3% over time, our 2023 outlook Range of $8,400,000,000 to $8,600,000,000 acknowledges uncertainties around the current environment, particularly the labor challenges we have discussed. For 2023, we expect shipbuilding operating margin between 7.7% 8% as we continue to target incremental margin improvement, But acknowledge the current challenges have tempered the pace of that progress. For Mission Technologies, we expect 2023 revenue of approximately $2,500,000,000 or organic growth of approximately 5% year over year.

Speaker 3

We expect operating margins of between 2.5% 3% And EBITDA margins of between 8% and 8.5%. In 2023, amortization of purchased intangible assets is expected to total approximately $128,000,000 of which $109,000,000 is attributable to Mission Technologies. We expect 20 23 capital expenditures to be approximately 3% of sales. Moving on to expectations for the Q1 of 20 23, we expect overall revenue growth for the Q1 to be quite modest given normal seasonality in Mission Technologies and the strong 4th quarter performance for shipbuilding, Which benefited from favorable material timing. Additionally, given the timing of the shipbuilding program milestones and the mentioned Mission Technology seasonality, We expect Q1 segment operating results to be the weakest of the year with the shipbuilding operating margin near 7% and Mission Technologies The outlook we are providing today is based on the best information we currently have and assumes No further degradation in our supply chain, the non programmatic impacts from inflation continue to abate and most importantly, that we're able to continue to hire And retain employees at a pace that supports our staffing plans.

Speaker 3

Additionally, on Slide 10, we have provided our updated outlook For a number of other discrete items to assist with your modeling. On Slide 11, we have provided an Updated view on our free cash flow expectations through 2024. Consistent with how we presented this data in the Q3, this outlook The current R and D amortization treatment for tax purposes remains in place, and we are reaffirming the $2,900,000,000 target. If Section 174 is deferred or repealed, all else equal, there would be an opportunity of approximately 215,000,000 In total, over the course of 20232024. As I noted earlier, we significantly Performed our 2022 free cash flow expectation of approximately $350,000,000 by accelerating collections.

Speaker 3

This timing difference along with the delay of the planned COVID-nineteen repayment now into this year have impacted 20 3 free cash flow expectations. Consistent with our normal seasonality, we expect the Q1 of 2023 free cash flow will be the weakest of the year and given the pull forward of collections into the Q4 of 2022 is likely to be an out flow of $200,000,000 to $300,000,000 Our free cash flow expectation for 2024 remains unchanged as it will not be burdened by COVID-nineteen repayment, we'll benefit from continued top line growth and margin potential as compared to 2022. Additionally, we expect to see sub-six percent working capital levels as a percentage of sales in 2024. We are reaffirming our capital allocation priorities focused on debt pay down, which is on pace to retire both the $400,000,000 bond this year and the remainder of our line acquisition term loan in 2024 and our commitment to return substantially all free cash flow after planned debt repayment to shareholders through 2024. To close my remarks, it was no doubt a challenging year, but I'm proud of the entire HII team and the important work we accomplished across the business from successfully meeting all of our planned shipbuilding milestones to the critical integration work that was completed timely and under budget at Mission Technologies.

Speaker 3

Across the enterprise, we made meaningful progress in 2022, which resulted in growth across all segments And free cash flow results that were well ahead of our projections. We entered 2023 intent on driving execution and are well positioned to deliver profitable growth. With that, I will turn the call back over to Chris for some final remarks before we take your questions.

Speaker 2

Thanks, Tom. In summary, we delivered consistent results in 2022 and we believe we are well positioned to grow in markets of critical importance to our customers, While executing our almost $50,000,000,000 of backlog in 2023 beyond, we will continue to make long Now I will turn the call over to Christy for Q and A.

Operator

Thanks, Chris.

Speaker 1

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

Operator

Thank you. We're preparing to ask your question. Please ensure your line is unmuted. Our first question today comes from Myles Walton from Wolfe Research.

Speaker 4

Maybe at a high level, Is this still a 9% plus shipbuilding margin business?

Speaker 2

Yes, definitely. I believe that we've come through some challenging times with COVID and we've got some shifts that are still working through that. Ingalls is obviously north of that and Newport News is making great strides. And I think the biggest issue we can Work on the Newport News is simply working the operating system, getting the Block IV boats delivered over the next 2 3 years And transitioning to Block V. So yes, absolutely, it's a 9% business.

Speaker 2

I'm not going to give a forecast for when that's going to happen, But I do expect performance to continue to improve from here.

Speaker 4

Okay. And then Chris or Tom, I don't know, In terms of the plug for capital deployment for share repurchase, I guess it's $250,000,000 to $300,000,000 in 20 3, 20 24 is what you plan to do. Do you have any Sites on doing that a little bit earlier or do you have to wait until 2024's big cash flow comes through to have confidence to execute against it?

Speaker 3

Yes, Smiles, this is Tom. We haven't given you exact number. Obviously, if you work yourself through the math of where we are and expectations on the revenue, the margin expansion, the free cash flow Bridges that we've given you and then the capital expense as long as as well as with the working capital. The numbers fall out of that way. So as we work ourselves through the year, We the cash is generated.

Speaker 3

We anticipate to continue to buy back shares as we see value in the share price, But we haven't really guided on how that is going to be apportioned over 2023, 2024. We stand behind our commitment that all excess free cash flow will be given back to the shareholders Asset debt repayment schedule.

Speaker 4

And then just one clarification, what is non programmatic inflation? No.

Speaker 2

Yes. So I'll give you an example of that, Miles. It's related to expenses towards the end of the year that we didn't That the actuals are higher than what we forecast, stuff like medical benefits, insurance premiums, We just didn't get that right.

Speaker 3

And we've seen it as far as the market. Yes, sure. So it's overhead type expenses files.

Speaker 4

Thank you.

Operator

Thank you. Our next question comes from Robert Springen from Melius Research. Please go ahead, Robert. Your line is now open.

Speaker 5

Hi, good morning.

Speaker 2

Good morning, Rob. Good morning.

Speaker 6

Chris, you

Speaker 5

talked a lot about the labor constraint. And I wanted to see if you could Give us some granularity as to how that number splits between the 2 shipyards and Mission Technologies. One thing I've noted is if we look at your job postings, it seems like Newport News has 10x the openings of Ingalls and does that factor into the margins there?

Speaker 2

Not really. Mission Technologies is pretty stable adding Throughout the year with really industry standard attrition rates in a very competitive market. We plan to add about 5,000 shipbuilders throughout the year and there are some positive indications Not only hiring, but also over time, attendance and, attrition. So there are some positive indicators. I wouldn't necessarily relate it back to margin.

Speaker 2

Newport News will Higher more this year than Ingalls. We don't break that out separately, but I wouldn't necessarily relate that back to margin, no.

Speaker 3

Okay. And then just

Speaker 5

as a follow-up to that, could there be upside to the 3% top line growth if Congress appropriated more funds to Man shipyard capacity and the fund training and apprenticeship programs?

Speaker 2

Yes, but the constraint Is labor. Our shipyards are facilitated to grow in excess really Of that 3%. And but we need to be conservative in how we project, how we're going to add labor over the next few years. But is there upside? Yes, of course.

Speaker 5

Yes, I guess I'm asking you is can they help you attract labor faster and train labor faster?

Speaker 2

It benefits the ships. Yes. Interesting enough, there's a lot of initiatives, both at the state and federal level to help in workforce development. And we are actively communicating with both states that are involved in that and the federal government for Infrastructure and Workforce Development Support. Thanks, Chris.

Speaker 2

Sure.

Operator

Thank you. Our next question comes from Scott DeCher from Credit

Speaker 7

Tom, did CDN 79 book a net negative EAC in Q4? Just trying to interpret what's in the press release on the year over year comparison there. Thanks.

Speaker 3

Yes. So we don't provide the actual margin booking rates of step ups and step backs on any individual program. I would tell you, to Give you some color on that. On the adjustments, there was nothing significant at either your up or down on any individual programs. So the answer to The question is no on that.

Speaker 3

I would tell you that the effect that you're seeing at Newport News there is, although it's net down as far as The adjustments they had, it was really a function of not having the upside that we would normally see. So it's kind of range bound to what we saw on the downside of EC adjustments Because the timing on the milestones and just where they saw a little bit of a draw are short on labor, a little bit of pressure on overhead costs, Overhead absorption was a little bit higher on all the programs there, and CDN79 was not immune to that effect as well. But it was not significant enough. As you see, it's not called out in the case.

Speaker 2

Scott, I'd also add that CDN 79 had a pretty solid year. They met their compartment commitments for the year. Emalls is essentially build out. It's pretty amazing. I was up there last week And the equipment is in and they started that test program.

Speaker 2

The topside test program has begun. So they've got a bit of momentum. I hate to use A football reference, but the big game is this weekend, but, 79 is what I call 4 yards in a cloud of dust, right? Every week, they're executing on a lot of volume work. They met their commitments for last year.

Speaker 2

They've got a lot of work in front of them, But I have high hopes for success on that program.

Speaker 7

Great. And then Chris, what were the if you Sorry if I missed this, but what were the gross and net headcount additions in the shipbuilding business in 2022? And then just curious on how attrition trended in Q4 sequentially relative to Q3? Thank you. Yes.

Speaker 2

So attrition got better throughout the year. I don't have the specific number here. We added about 5,000 heads, But it did trend better as we move through the year and it's gotten better in January as well. It's pretty It's what I call it is a bit of stability showing up in the shipbuilding organizations from not only a labor standpoint, But also supply chain and inflation. It's not back to pre pandemic levels, but it's definitely stabilized and that's what we need to execute.

Speaker 8

Thanks guys. Appreciate it.

Speaker 3

Sure. Thanks Scott.

Operator

Thank you. Our next question comes from Pete Skibitski from Alembic Global. Please go ahead. Your line is now open.

Speaker 9

Hey, good morning guys. Good morning. Just going back to Kennedy, it's a big contract for you guys at Fixed price. And I was just wondering, my recollection was 23, 24, you guys are going to have some big Risk milestones on that project. It sounds like that's still going to happen.

Speaker 9

But has just the labor situation just kind of eaten up the upside On that potential risk retirement, is that the right way to think about it?

Speaker 2

I wouldn't necessarily say it's eating up all the upside. I would say that We're very conservative in how we deal with the EAC and there's a lot of really complex work in front of us. So I would not necessarily say it's eaten up all the upside. Okay.

Speaker 9

Okay. Just a follow-up. So at Newport News, is VCS Block IV the bigger muscle mover margin wise? Is that kind of The Block 4s kind of roll off over the next 2 years. Does that just give you a lot more relief than anything else?

Speaker 2

It will definitely give us a lot more confidence moving forward after we get those Block IV boats delivered and transitioned into Block V.

Speaker 9

Okay. And Chris, just on that, obviously, labor impacts all your programs, but Block IV had kind of the Unusually aggressive schedule. Is that combination why that's been such kind of a thorn in your side? Is that fair?

Speaker 2

Well, remember, Block 4 was impacted the most by COVID, Right. We had a pretty material impact back in 2020, which really reduced our profit expectations on those boats. So we just need to get through them. We need to get them delivered. The program schedules are pretty stable right now and a lot of cooperation between Electric Boat, Newport News And really Senior Navy to get through those program schedules.

Speaker 2

So we just need to get through them and then we'll transition into Block V.

Speaker 3

Chris, if I could hop on that too. Hey, Pete. So on that, to your question of 4 and 5, Block 4 has been with COVID hit 2020, 2021, 2022. So It's long run rate those contracts have had in the EACs with some additional costs. I think it's twofold.

Speaker 3

1, getting those Block 4 boats done Alleviates the mix in the portfolio at Newport News. So there's a lift that you talked about there. But then also it's just those both give us time to come down the learning curve, the lessons learned, Matrician, the operating system and the personnel that we have on board there, it truly is a production line. All the programs we have, it's the most serial production line with The modules go and then the boats are there. Some will go from unit to unit on with the same personnel.

Speaker 3

So getting through 4 and then that kind of benefit lifts the Block 5, which has Higher profit potential and then we'll take the preponderance of the portfolio's mix and new footprint. We crossed over the end of last year. So already now the Sales proportionate between Block 45 is now more in 5 than 4. So there's going to be a natural progression of improvement with learning, Four votes being accomplished and then that learning and higher profit potential on Block V is going to be affecting the Newport News portfolio.

Speaker 9

Got it. Thanks guys.

Speaker 3

Thanks.

Operator

Thank you. And the next Question comes from David Strauss from Barclays. Please go ahead, David. Your line is now open.

Speaker 10

Yes, thanks. Good morning.

Speaker 2

Good morning.

Speaker 3

Tom, so I had a

Speaker 10

similar question that I've asked in the past Around working capital, I mean, you obviously had a big improvement in working capital in the Q4. It looks like in your guide Cash, I guess, if I could back in, it looks like you're assuming relatively neutral working capital for 2024, is that correct? Or sorry, for 2023. And then could you help bridge us how you go from $400,000,000 $450,000,000 in cash to 23 is the number you're looking at in 2024. I guess maybe a little bit of CapEx help, but what else gets us there?

Speaker 3

Sure. Yes, I'll break that down. I have several points I want to hit. I'll hit the percentages on working capital last as I walk you through that. So we have updated on Slide 11 of the PowerPoint presentation.

Speaker 3

So we finished at 4.94 pretty healthy against an expectation of starting the year off at $3,000,000 to $3,000,000 We pulled that down at $2,000,000 to $2,500,000 kind of midyear with the reguide. And then Q3, we told you $3,500,000 We finished at $4,94,000,000 So healthy Free cash flow in 2022. Obviously, that pulls ahead a little bit and you see we've taken down the 2023 expectation. We had you at $545,000,000 to $595,000,000 or a midpoint of $570,000,000 last time we discussed. And because of the pull ahead That we have here right now, we reset expectations to $400,000,000 to $450,000,000 To your point of working capital, you're right.

Speaker 3

Just a couple of quarters ago, we were at 11.1 Last quarter, we're in the 10% range and we finished 2022 up at 6.1% of working capital. As we have been guiding over the last We saw that the workload and just the cadence of the shifts, we're going to have more deliveries and launches On the back half of the 5 year free cash flow commitment in the front half, and that's exactly what we see here. If you look at the milestone chart, you'll see that we're going from Three deliveries in 2022 to 5 deliveries in 2023. We also have 3 launches in 2023, so that's a pretty big year. And then kind of keep it going forward to the following year on that, we take that perspective up.

Speaker 3

And we have Two deliveries and three launches in 2024. So a lot of activity there, which will continue us alleviating the working capital, getting rid of the retention that we have And helping in the free cash flow lift as we go forward. Also, I would tell you that, as much as we finished up at 6.1% on working capital, It will just grow a little bit. We got a couple of advancements on incentives that we've had. So we'll go from 6.1 to about 6.5 ish working capital in 2023.

Speaker 3

So more deliveries helped, slight rise in working capital in 'twenty three slightly hurts. We've re guided you on CapEx from 2.5 So there's a couple of dollars of headwinds there. So two things against this, but with all those deliveries and launches, we'll see Working capital finished up around $425,000,000 And mind you, 2023 has to repay COVID, which right now is about $125,000,000 The way I look at it and give you confidence on where we're going with that, we have 3 years in the holdout against the 5 year commitment, 757, 449, and 494, That averages out to 567, dollars 567 straight stick math would be about $600,000,000 a year that you need. So we're running behind for the 1st 3 years, But we knew there was a natural ramp with retention with revenue and margin expansion. And also we have a line on board now.

Speaker 3

2022, we have them on board The first year, I was happy with the contribution they made. If you recall, we took the $3,000,000,000 to $3,200,000 with Align. I'm happy with the contribution they made in 2022 And Alain will be on board for 'twenty three, 'twenty four. So as we look going forward, right, even though margins stay flat from 'twenty one to 'twenty two, We're forecasting some margin expansion into 'twenty three. We have the top line growing in shipbuilding right now that we gave you in the guide from 8.4 to 6, and we expect we'll continue incrementally guiding higher revenue margin into 2024.

Speaker 3

And also I'd ask you Take a look at the 3 years that we've had the $757,000,000 $449,000,000 $4.94 free cash flow. That $757,000,000 really had two things that actually helped it. And if you normalize it out, it kind of makes sense of how we're marching to be north of $700,000,000 in free cash flow as we get out to the 24 and on timeframe. The 757 had the FICA relief, which was $130,000,000 and it also had the COVID Repayment benefit for $160,000,000 So $160,000,000 $130,000 $290,000,000 $290,000,000 off the $757,000,000 is about $467,000,000 is really how I look at the 1st of the 3 years, dollars 4.67,000,000 The $449,000,000 for $21,000,000 has the FICA repay in it, so you throw another $5,000,000 in that, that's about $5,000,000 for a normalized 2021. And now for 2022 at $4,94,000 There's $65,000,000 of FICA and that $550,000,000 So I really look at it as we've normalized for what we've seen because of COVID with FICA and repay, It's more like a March of 4.60 ish to 5.10 last year to 5.50, 5.60 this year.

Speaker 3

The guide we give you is $4,000,000 to $4,500,000 for $23,000,000 only because I have the COVID repay. So it's another with $125,000,000 on top of the midpoint. That's a $5.50 a year. And I have the year in front of me to burn down risk and pulling cash. So I'm comfortable with how I'm marching past my average of 567 in the 1st 3 years.

Speaker 3

And then the last piece on how we get that up to how do you get to 780,000,000 is the working capital we see is going to swing about 2 points down. As I mentioned earlier, we finished 6.1% for 'twenty two will be in the mid-six percent for 'twenty three percent and then it's going to swing down to below 5% for 2024 And two points of margin against the top line of $10,800,000,000 is about $200,000,000 So $550,000,000 plus $2,000,000 is $750,000,000 I got you at the midpoint of $780,000,000 because we still have Revenue growth and margin expansion. So I'm quite comfortable with where we are right now. The numbers play out. If you have any questions, you can As we have our calls afterwards, we can break that down for you further.

Speaker 10

Okay. That's a lot of detail. Thank you for that. And Chris, as a follow-up on Mission Technologies, the EBITDA margin there, which I guess is the right way to look at 8%, 8.5%. How do we think about those longer term?

Speaker 10

I mean those are well below kind of what we see out of Typical kind of services companies and you pitched this as not just your typical kind of services business. So how do we think about those EBITDA margin, I guess, the potential there. Thanks.

Speaker 2

Yes. Thanks, David. You have to remember there that the vast majority of that work is cost plus. So that would indicate that you would have a lower EBITDA percentage. I do think there's opportunity for upside As we present more solutions and move into a fixed price sort of arrangement, we're not prepared to say that it's going to get better than that right now, But there is opportunity for improvement and that's something we're evaluating.

Speaker 5

Thank you.

Speaker 3

Thanks.

Operator

Thank you. Our next question comes from Doug Harned from AllianceBernstein. Please go ahead. Your line is now open.

Speaker 11

Great. Thank you. Good morning.

Speaker 2

Good morning. Good morning.

Speaker 11

So I want to go back to Newport News. And you had a 5.1% margin This quarter that follows Q3 that if I take out the Columbia class benefit, that was a 4.1%. And what I want to understand is you've still got certainly the Massachusetts and the New Jersey flowing through there. And so the work that you've done on Block IV, where you've taken charges in the past, I mean, how much of this, What I would call kind of a low margin in Newport News is due to the overhang of those past charges. So then when you get out from under those, should we expect a step up?

Speaker 2

Well, yes, Doug, this is Chris. I'll start and then Tom can jump in there. Yes, there's absolutely an overhang related to Block IV boats that we're dealing with. And so we should expect a margin step up. Now we haven't guided Beyond 'twenty three, and we need to be conservative because we need to make sure the labor shows up and we get them trained up and they go execute.

Speaker 2

But, I think you're right relative to that overhang on Block IV. So we need to get those delivered. And as I said previously, those schedules are Being very consistent right now. Cost performance, we're working on every day.

Speaker 3

If I can hop on the back of that, right. So we talked about Block 4 here and what we took back in Q2 2020, I would tell you the portfolio with Columbia that's coming on board on sale. So that's a new start program that's booking low right now Cross that contract. I have some change, change in unadjudicated change that still has to get proposed and pushed through the system. So that's going to increase.

Speaker 3

We're very conservative on that until those unadjudicated changes are definitized. That's both RC73 and 74 as is in C2, Both cost side contracts. So the portfolio just has a little bit higher level of that as we sit here. And then lastly, I think as we go forward, burn down risk As 79 March to its completion, as Chris said earlier, there's a potential with good performance there for additional upside here. So I think we just find ourselves in a situation where the ships are right now, not too many milestones, a little bit of drag on overhead, down on labor.

Speaker 3

And I think we're booking prudently to conservatively right now as we want to see us pushy ships over the go line. Those deliveries I mentioned is 2 each for 'twenty three and 'twenty four. And I think that will assist in the margin lift as well as Block 4 gets Smaller in the portfolio mix with the potentials of Block V as we move forward here. I think the Columbia program will mature And with 73 out of here at this year, a 74s focus and maturity will assist The portfolio of profitability as well.

Speaker 6

So if I

Speaker 11

have it right, then Block 4, the overhang of these Past charges is a contributor, but there's still some other there are a number of other things you just raised. So it's sort of a blend of things that you're working through. I just wondered, General Dynamics, when they did their Q4 call, highlighted a number of issues that is somewhat similar that related to labor across Shipyards and they did mention Virginia class. Can you talk about how you're working with Electric Boat Sort of together to deal with these problems and if there have been changes over time and how you work together and Work through attrition issues, inflation, all these sorts of things.

Speaker 2

Thank you for that question, Doug. It's an important one. The Newport News and EB team, They work very closely together in understanding when the work, what work And how that work gets executed. So, there could be movement of work between the yards where it's most efficiently done, if there's labor issues. And they're working very closely together.

Speaker 2

Their objectives are completely aligned to deliver all the Block IV boats. And I would add also the Navy is engaged as well. It's all the way from the deck plate to the senior executive force. Everybody is all in and all of our objectives are aligned to get those Block IV both delivered. I will say that we're fully staffed on Block IV and Columbia, And we're working very hard on execution there.

Speaker 2

And not only is EPO and Newport News working between each other, but Working to ensure that any sort of outsourcing is effectively managed to ensure that we get that we meet our production schedules.

Speaker 3

Okay, very good. Thank you. Sure.

Operator

Thank you. Our next question comes from Gautam Khanna from Cowen. Please go ahead. Your line is now open.

Speaker 2

Are you on mute, Connor?

Operator

Unfortunately, we're not getting Any audio from the lines, we'll move on to the next question. Our next question comes from George Shapiro from Shapiro Research. Please go ahead. Your line is now open.

Speaker 12

Yes. Good morning.

Speaker 3

Good morning, Josh.

Speaker 12

I was curious that you wound up with 7.7% shipbuilding Margins and when you did the Q3 call in early November, you were looking for 8% to 8.1%. So just wondering What you missed here in 2 months because I thought that shipbuilding would be somewhat predictable sort of business.

Speaker 3

Yes, it was just a drag that we talked about at the end of the year. We had a strong first half of the year. We were over 9% and we got it 7% for the back half of the year. And even Q3 was in that lane. And we thought that the remaining 13 weeks of the year, we had that.

Speaker 3

But, the shortfall in labor that we saw, a Couple of the overhead of the non programmatic issues drove hit both yards actually on the cost that we talk about on medical. And just that shortfall as we go through and take a look at EEC performance and then the cost and how overheads flow through there. There's a little bit of a drag on where we thought we'd land. So if you call out on the call, I was focused on saying I want to see how The year plays out. We did stay on the guide at 881, and we thought we could get that home.

Speaker 3

But as the EACs kind of Rolled up, there was just a little bit of a draw. I would say both to this question, George, and the previous one, from a new produce perspective, 6.2% last year, 6.1% this year, About the same type of performance overall, if you think about it, another year with some drag upfront With the effects of COVID and supply chain, inflation, big year on inflation and then the hiring demands that we had here. So I'm quite comfortable and proud as far as what the Newport News team accomplished there. But to your point, we thought we'd get that home and Q4 came in a little flattish on Newport News than we expected.

Speaker 12

And Tom, did you give the EACs for the quarter for

Speaker 3

Not yet, but I can't handle it. No, I didn't. Yes, I referenced them just that we didn't have tremendous downside. We just didn't have upside at Newport News. But from a for the quarter perspective, what we saw was The gross favorables were $29,000,000 The gross unfavorables were $56,000,000 That was a net of $27,000,000 And effectively about 100% of that was At Newport News, basically, neutral angles, emission technologies.

Speaker 3

So it was quiet at the other two divisions, and Newport News saw a net Down of that unfavorable for the corporation of 27,000,000.

Speaker 12

Okay. Thanks very much.

Operator

Thank you. Our next question comes from Seth Seifman from JPMorgan. Please go ahead, sir. Your line is now open.

Speaker 6

Hey, thanks very much and good morning.

Speaker 12

Good morning, Seth. Maybe to

Speaker 7

follow-up on that question. Tommy, you talked about Newport News being in the low 6s for 2022 and 2021. I know you guys don't typically guide segment margins, but if we're just to think Kind of maybe qualitatively, overall, shipbuilding margins should be up 10 to 20 basis points At the midpoint of the guidance, does that mean there's a little bit of improvement in each yard? Or given the way that some of the one timers or some of the Potential upside associated with the milestones that you're expecting at the shipyard. Is there opportunity for more expansion in Newport News and maybe some Headwinds in Ingalls, how do we think about that for this year?

Speaker 2

Well, I'll start and then Tom can get into details. And thank you for saying we don't guide By shipyards, we don't do that. But I firmly expect Newport News will be better this year. I think They're executing their operating system very well. I think labor is more stable.

Speaker 2

I think the supply chain is more stable. I I think the team has some momentum and I think Newport News is going to do better this year. So with that, Thomas, you want to add anything about Ingalls? I think they're pretty stable as well. So I'll

Speaker 3

wait for you that we By division, but from a historical perspective, things 10.5, 11.1, 11.4 the last 3 years, they have the same portfolio basically down there. Fighting labor and overhead, the pressures that we talked about, but very strong operating team, a leadership. They know what they're building, those ships in serial Production, so I would think historically, they're going to continue to perform well then. And I think from a Newport News perspective, as they just fight their way through here, New technology started with Ford and now Columbia. We had that booking we talked about back in 2020.

Speaker 3

A little bit of COVID pressure inflation supply chain and hiring. But you can see some stabilization both in the performance over the last few years. We see stabilization and some stability in hiring and the schedules here. And your expectation is that you are going to perform better. So I would expect that to increase as we go forward in the year, Q2.

Speaker 6

Okay. Great. Great. And then maybe to follow-up

Speaker 3

real quick on similar type of

Speaker 7

question on Mission Technology. I think you said that EBITDA margin there ex the valuation allowance was like 8.6% in 2022. And so what's driving it down in 2023?

Speaker 3

We're probably just being Conservative on the guys. So we had a 6.6 quarter with the impairment out of it. It was 8.3%. We've had quarters at Mission Technology anywhere from the low 8s It's below 9s. Last year, it was 8.6%.

Speaker 3

And as I say, adjusted, it was unadjusted, it was 8.2%, 8.6% right now. So I think it's just a function of that sales base. We have fixed and semi variable costs there. It's a good sized operation. We think we have the right people on board.

Speaker 3

We have the right strategy. The pipeline has grown from year over year. The Pipeline is more mature. And I think with the Mission Technologies integration into the HII family with that behind us, as I mentioned in my notes, it's done under budget and it's on time, That the team can completely focus on that pipeline, bids, execution and performance. So I think the 8% to 85% is just being conservative.

Speaker 3

Obviously, we wanted to see a couple more dollars out of that division. Last year, we're guiding growth year over year right now. We did see Mission Technologies grow 4% from 'twenty one to 'twenty two, and each of the business units had growth in them. So those were all positive signs. I think the 8 to 85 is just awaiting and seeing the awards happen.

Speaker 3

When the sales hit, I would expect

Operator

Thank you. The next question is from Galsam Khanna from Cowen. Please go ahead. Your line is now open.

Speaker 6

Hey, sorry about that. I hope you can hear me.

Speaker 2

Yes, thanks. Now we had you got them.

Speaker 6

Great, great. Hey, thanks. I was curious if you could just give us some color on the timing of the milestones through the year. If you can tell us like if there's anything that's in the month of December or that has the potential to move out, things we should be watching

Speaker 2

Sure, Gautam. When you look at the 23 milestones, I think Tom already mentioned that Q1 was pretty light, pretty evenly distributed across Q2 and Q3, But then, CVN, excuse me, LPD 29 is in Q4. So that's at the end of the year. So that's the one We'll have to watch. Got a lot of confidence in the team down in Mississippi, but that's the one towards the end of the year.

Speaker 6

Okay. Thank you. And then just curious on VCS, anything incremental from last quarter on schedule With respect to

Speaker 2

Not really. Pretty stable from a schedule standpoint on the BCS program. We have movement here and there, but it's pretty stable. I got to hand it to that team, the program team and the construction team. They're getting after it and they're learning every day.

Speaker 2

So it's been pretty stable. We just need to stay on it.

Speaker 3

Chris has talked about that rhythm of the program, Launch 1 and sell 1 off and we saw that in 'twenty two and in the milestones you'll see that in 'twenty three and 'twenty four. So we're working it.

Speaker 6

Okay. And just on that last point, anything with respect to negative teen catch ups that you can talk about 4.22.1 BCS in aggregate anything. You can never call it out as material, but Can we assume that there were kind of consistent negative marks on the program or anything you can tell us about that?

Speaker 3

Nothing really significant to highlight here. I mean, I mentioned in Q the QNET was at Newport News on that, which was down and it was just kind of Sprinkled over the programs, but there was nothing really to highlight here.

Speaker 6

Okay. Thank you, guys.

Speaker 3

All right, go on.

Operator

Thank you. Our final question today comes from Noah Poponak from Goldman Sachs. Please go ahead, Noah. Your line is now open.

Speaker 8

Hi, good morning, everyone.

Speaker 2

Hi, Nilesh, but thanks for joining.

Speaker 8

For sure. Tom, so just back to the cash flow breakdown And appreciate all the detail you gave there and appreciate that there are a lot of moving pieces. But if I just kind of zoom out on the cash Slow statement and look at a long history, it's sort of ranged $400,000,000 to $600,000,000 for a while And the business is pretty stable top line and margin. I recognize you have some opportunity to grow the business and expand margins going forward. I think the pension looks pretty net neutral.

Speaker 8

The CapEx looks pretty stable. It sounded like you said earlier that you In that 24,000,000,000, 780,000,000 midpoint about $200,000,000 of working capital. And I guess, should I think of working change in working capital as not a sustainable recurring part of the free cash And therefore that kind of $580,000,000 $600,000,000 as sort of a predictable, sustainable Engine of the cash flow statement going forward? Or is there some other reason to think of the base business as eventually making up that $200,000,000

Speaker 2

Yes.

Speaker 3

That's a great question. And we study that all the time. And it's the Formal with the caveat, right? So we are hitting the point right now. We've been impacted.

Speaker 3

If you look at the cash flow statement, we were in the $400,000,000 to $600,000,000 I tell you from 20 2020, 2021 and 2022, those COVID, FICA repays and the COVID payments have tripped up and you have to normalize it after that. Couple of things are happening. Obviously, prior to this window, the margin has dropped in shipbuilding as we've kind of run So we're fighting and working ourselves back with incremental improvement. The revenue growth with the backlog that we've shown you there and we expect to at least Have the 3% here kind of going forward when we get through this labor crunch, that's in place. I think you can model that out.

Speaker 3

The As we go forward, the working capital, I believe, will be in that 5% To 6% range. And both yards are in a good rhythm right now. The DDG program annually, what we're doing with launch and sell off A boat on VCS, the rhythm of Block 5 is behind that. The 2 carry by following 79, The Columbia Bill 1, Bill 2. So I think we're settling down on the mix of the portfolios in each year and the timing on when they're going to pop out.

Speaker 3

So We have told you in the past, traditionally, a shipbuilding is like 6% to 8% of what we would expect. That gets watered down a little bit Now with Mission Technology and Alliant with more sales in the base, the numbers kind of pop down. If you normalize them just to the traditional shipbuilding what we've talked about, right, We were at 12% in Q1 of 2022. Q3 of 2023, we're at 14%. We finished the year up at 7.8% just for shipbuilding.

Speaker 3

And now, as we go from 7.8% to 8.3% for shipbuilding sales, we'll see ourselves go down to 6% in 2024. That's in the range that we were Highlighting, say, for the 1st 10 years of the corporation of 6% to 8% in working capital, we were at that range in 2018. We were In the 6% or so. I think that's sustainable as long as we're in a normal rhythm of adding work, which we have to backlog. We're performing to schedule, so we're selling shifts off timely.

Speaker 3

And although being either at 6% on shipbuilding sales or is a sub size including all my sales with Mission Technologies is on the low end of the range. I think what offsets that is the revenue and incremental revenue and margin that we think we're going to have in the coming years. So I'm still bullish on the Novus 700 is going to be a run rate in a couple of years from now. And I think 2024 is that inflection point To kind of start that run.

Speaker 8

Okay. The north of 700 in a few years, I guess, if 2024 is 780,000,000 midpoint, both 200,000,000 of working capital, once you get to the working capital goal, You then cease to have positive change in working capital flow to the cash flow. So 25, I mean, who knows exactly what it's going to be, but sort of directionally would not have that. So is there a step down from 24 And then as the business grows, you over time get back to that $700,000,000

Speaker 2

Yes. No, we're not going to this is Chris. We're not I forecast $25,000,000 free cash right now, but I think your logic is okay, the business is going to grow. And If we state out those working capital numbers, you're not going to get a benefit from it. You're going to have to get it from growth and margin improvement.

Speaker 2

So I think your logic is sound, But we do definitely believe that free cash is going to get north of $700,000,000 in 2024 and then continue to grow from there.

Speaker 3

Yes. I'll tell you, stick with the law of the numbers, right? So I walked through how I normalized out the 2020 1 2022 because of COVID. As you can see, we're incrementally going from that 460 ish to 510 to 550 with a guide of 425 this year. COVID adjusted, it's another 550.

Speaker 3

And then I'm telling you the working capital is going to get us there in 2024. So that is just pay what's the run rate. I think you're looking at it the right way on how you model it. And we'll provide guidance for 25 a year from now.

Speaker 8

Great. And then Chris, just on labor, You spent some time on it, but and it's unpredictable, but I guess maybe just When do you think you could get to something close to normal on your labor churn and Development of the people you're hiring in, I guess with the amount of time you spend on it, the amount of time you've been in the business, obviously, it's an unprecedented situation, but How much more time do you need to get to something that's pretty stable?

Speaker 2

Yes. Well, it's absolutely more stable now than it was a year ago, Okay. And that's a testament to the hard work that the shipyards have put in to really kind of pivot who they were hiring, Increase the training, increase the leadership training. So it's absolutely better. I don't know if you're ever done, right?

Speaker 2

It was a pretty generational Change in our workforce where we lost a large swath of people through COVID. So We are retraining workforce and retraining foremen and general foremen and construction superintendents And that's happening. And the best thing we can do and the greatest learning potential is delivering ships. We're going to deliver 5 this year. Once you've been through that, you've learned a lot and they're going to continue to learn a lot.

Speaker 2

So I think it's only improvement from here. I don't think you're ever done, But I think we've made great progress.

Speaker 8

Okay. Thanks for the time.

Speaker 2

Yes. Thanks, Nao. Thank you.

Operator

Thank you. This concludes our Q and A session for today. I would now like to hand the call back over to to Casner for any closing remarks.

Speaker 2

Thank you for joining today. I'm proud of all the hard work put in by the team And I'm confident the hard work we're doing will pay off in value creation for all our stakeholders moving forward. Thanks again for joining the call.

Operator

Thank you. That does conclude today's conference call. You may now disconnect.

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Earnings Conference Call
Huntington Ingalls Industries Q4 2022
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