Huntington Ingalls Industries, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the second quarter 2021 Huntington & Giles Industries earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question, you may press star then 1 on a touchtone phone. To withdraw your question, please press star then 2. Please be advised that today's conference is being recorded. If you need further assistance, please signal a conference specialist by pressing the star key followed by zero. I would now like to hand the call over to Dwayne Blake, Vice President of Investor Relations. Mr. Blake, you may begin.

Thanks. Good morning and welcome to the Huntington Ingalls Industries Second Quarter 2021 Earnings Conference Call. With us today are Mike Petters, President and Chief Executive Officer, Chris Kastner, Executive Vice President and Chief Operating Officer, and Tom Steele, Executive Vice President and Chief Financial Officer. As a reminder, statements made in today's call that are not historical fact are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Actual results may differ. Please refer to our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results. Also in the remarks today, Mike, Chris, and Tom will refer to certain non-GAAP measures. Reconciliations of these metrics to the comparable GAAP measures are included in the appendix of our earnings presentation that's posted on our website. We plan to address the posted presentation slides during the call to supplement our comments. Please access our website at HuntingtonEngles.com and click on the investor relations link to view the presentation as well as our earnings release. With that, I'll turn the call over to our President and CEO, Mike Petters. Mike?

Thanks, Dwayne. Good morning, everyone, and thanks for joining us on today's call. This morning, we released strong second quarter 2021 financial results driven by another quarter of solid operational performance. So let me share some highlights from the quarter, starting on slide three of the presentation. Sales of $2.2 billion were up from $2.0 billion in the second quarter of 2020. Diluted EPS of $3.20 was up significantly from $1.30 in the second quarter of last year, and pension-adjusted EPS for the quarter was $3.05. New contract awards during the quarter were approximately $1.2 billion... resulting in a backlog of approximately $48 billion, of which approximately $24 billion is funded. And Chris will provide some color on a few of the key awards for the quarter during his remarks. Shifting to activities in Washington, we are pleased that the congressional markup process for fiscal year 2022 has begun in earnest following release of the President's budget request in May. Of note, the budget requests continued recapitalization of the nation's strategic ballistic missile submarine fleet and supported funding for CBN-80 and CBN-81 Ford-class aircraft carriers, two Virginia-class submarines, one DDG-51 Arleigh Burke-class destroyer, and LHA-9. We were also pleased that a second DDG 51 class destroyer was included as the number one priority on the Navy's unfunded requirements list for fiscal year 2022. And we look forward to working closely with the Congress during the FY22 markup process to urge support for the second DDG and other critical priorities, including the efficient production of amphibious warships. In closing, slide four provides some key takeaways from the recently announced agreement to acquire Alliant Science and Technology. The team is preparing for closing of the transaction, and we are very excited about the addition of Alliant to the HII family. Alliant is a perfect complement to our existing capabilities in the technology-driven defense and federal solutions space. The solutions and products they provide are directly in line with the strategic focus that we have articulated for our technical solutions business, and it enhances our technical capabilities and customer access in high-growth national security markets, including C5ISR, military training and simulation, and next-generation technologies and solutions. We firmly believe that Alliant offers significant growth potential and represents an investment in capabilities that support the evolving DoD national security requirements, which, in turn, are expected to generate significant long-term sustainable value for our shareholders, our customers, and our employees. Now I will turn the call over to Chris for some remarks on the operations.

Chris? Thanks, Mike, and good morning, everyone. This was another solid operational quarter, and I'm very pleased with the consistent progress being achieved across our shipbuilding and technical solutions programs. With that, let me share a few key contract awards and programmatic highlights from the business segments for the quarter. At Ingalls, the team received a contract modification from the U.S. Navy for $107 million. to provide additional long lead time material and advanced procurement activities for amphibious assault ship LHA 9, which increases current funding on this ship to approximately $490 million. Regarding the potential bundled acquisition of LHA 9 with LPD 32 and 33, discussions are ongoing with the customer. We believe that a bundled acquisition continues to be the most cost-effective method of procurement of these critically important ships. In addition, Ingalls was awarded a contract with a potential total value of $724 million over seven years for planning yard services in support of a variety of in-service amphibious class shifts, including the LPD-17 San Antonio class and LHA-6 America class. Shifting to program status, LHA-8 Bougainville is making steady progress through the structural erection and initial outfitting phases of construction with cost and schedule performance in line with our expectations. On the DDG program, the team successfully launched the first Flight 3 Arleigh Burke-class guided missile destroyer, DDG-125 Jack H. Lucas, in June, and DDG-121 Frankie Peterson, Jr. is expected to conduct sea trials later this year. On the LPD program, LPD-28 Fort Lauderdale is on track to conduct sea trials during the fourth quarter and LPD 29 Richard M. McCool Jr. continues to achieve production milestones in support of launch early next year. At Newport News, there were no significant contract awards to highlight for the quarter, so I will go right on to program status. CDN 79 Kennedy is approximately 83% complete, and the team remains focused on compartment completion and key propulsion plant milestones. CBN 73 USS George Washington is approximately 90% complete, and the team remains focused on achieving key test program milestones to support re-delivery to the Navy, which is planned for next year. On the VCS program, the team completed shipment of the final module of SSN 797 Iowa during the quarter. In addition, SSN 794 Montana remains on track for delivery to the Navy later this year. and SSN 796 New Jersey remains on track to achieve the float-off milestone as planned in the second half of this year. And finally, on the Submarine Fleet Support Program, SSN 725 Helena is on track for re-delivery to the Navy later this year. At Technical Solutions, contract awards of Remus 300 unmanned underwater vehicles during the quarter to the U.S. Navy and Royal New Zealand Navy affirmed the flexibility and modularity of these units. TS was also recently awarded a $273 million cost plus fixed fee indefinite delivery indefinite quantity contract to support maintenance and planning for the overhaul and repair of equipment and systems associated with the Navy aircraft carriers and West Coast Navy surface ships. In addition, TS was awarded a contract with a one-year base period and four one-year options with a total potential value of $346 million to provide a variety of aircraft and operational support services for U.S. AFRICOM, including planning, management, maintenance, logistics, and airlift airdrop services and emergency medical care. Execution within technical solutions remains consistent with expectations, except for delays and awards in our unmanned business for critical new programs, which we expect to be resolved by the end of the year. As I close, Note that we have included upcoming key program milestones on slide five. There are no changes from what we have previously provided other than designated those milestones that have been completed with the check mark. Now I'll turn the call back over to Tom for some remarks on the financials. Tom?

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 post it to our website. Beginning with our consolidated results in slide six of the presentation, our second quarter revenues of $2.2 billion increased approximately 10% compared to the same period last year. This was primarily due to the growth at Newport News and Ingalls and was partially offset by decline at Technical Solutions due to the portfolio shaping actions we have taken. Segment operating income for the quarter of 169 million increased 174 million compared to the second quarter of 2020, and segment operating margin of 7.6% compared to a segment operating margin of negative 0.2% of the second quarter of 2020. The prior year results were negatively impacted by the Virginia-class submarine program performance as well as impacts related to COVID-19. Operating income for the quarter of 128 million increased by 71 million from the second quarter of 2020, an operating margin of 5.7% increased 293 basis points. These increases were primarily driven by the segments I just mentioned, partially offset by less favorable operating fast cash adjustment. The tax rate in the quarter was approximately 19.9% compared to 18.5% in the second quarter of 2020. The increase in the tax rate was primarily due to adjustments related to research and development tax credits recorded in the second quarter of 2020. Net earnings in the quarter were $129 million compared to $53 million in the second quarter of 2020. Diluted earnings per share in the quarter were $3.20 compared to $1.30 in the second quarter of 2020. Excluding the impacts of pension, diluted earnings per share in the quarter were $3.05 compared to a loss of $0.49 per share in the second quarter of 2020. Turning to slide 7 of the presentation, cash from operations was $96 million in the quarter and net capital expenditures were $73 million or 3.3% of revenues, resulting in free cash flow of $23 million. This compares to cash from operations of $201 million and $75 million of net capital expenditures or free cash flow of $126 million in the second quarter of 2020. Cash contributions to our pension and other post-retirement benefit plans were $12 million in the quarter, principally related to post-retirement benefits. During the second quarter, we paid dividends of $1.14 per share, or $46 million, and we purchased approximately 95,000 shares at a cost of $20 million. Moving on to slide 8 of the presentation, Ingalls' revenues in the quarter of $670 million increased to $48 million, or 7.7%, from the same period last year, driven primarily by higher revenues on the DDG program and amphibious assault shifts, partially offset by low revenues on the NSC program. Engel's operating income of $80 million and margin of 11.9% in the quarter were up from the second quarter of 2020, driven by the recognition of a capital investment-related incentive for the DDG program that was recognized in DDG 125, as well as higher risk retirement for the LHA 8, LP 28, and LP 29 checks. Turning to slide 9 of the presentation, Newport News revenues of $1.4 billion in the quarter increased $241 million. or 21.5% from the same period last year due to higher revenues in both the submarine and aircraft carrier construction. Newport News operating income of 76 million and margin of 5.6% in the quarter were up year over year primarily due to the impacts related to the Virginia class performance and COVID in the prior year period. Now to technical solutions on slide 10. Technical solutions revenues of $237 million in the quarter decreased 25.9% from the same period last year, mainly due to the divestiture of the oil and gas business and the contribution of the San Diego shipyard to a joint venture in the first quarter of this year, as well as lower volumes in unmanned systems, partially offset by increases in volumes in the defense and federal solutions. Technical Solutions operating income of $13 million in the quarter compares to income of $9 million in the second quarter of 2020. This increase was primarily driven by higher equity income related to our ship repair partnership with Titan, as well as improved performance at Defense and Federal Solutions and Nuclear Environmental Services, partially offset by lower volumes in the unmanned systems. Finally, a perspective on the outlook of the shipbuilding for the remaining part of the year. We continue to see limited opportunities for risk retirements in the third quarter, with the remainder of the milestones weighted towards the end of the year. Given the strong performance in the first half of the year, we now expect that the shipbuilding margin for the full year will be in the 7.5% to 8% range. We continue to expect the Alliant acquisition will close in the coming weeks and that we will incur approximately $25 million of one-time pre-tax transaction and financing-related expenses in 2021. We completed the syndication of the term loan component of the acquisition funding earlier this week and more details of the specifics are available in the 10Q. We will provide a more comprehensive update on our 2021 outlook for technical solutions on our third quarter call following the closing of the acquisition. Now I'll turn the call back over to Dwayne for Q&A.

Thanks, Tom. As a reminder to everyone on the call, please limit yourself to one initial question and one follow-up so we can get as many people through the queue as possible. Operator, I'll turn it over to you to manage the Q&A.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our author. Our first question comes from Doug Harnett with Bernstein. Please go ahead.

Good morning. Thank you. Good morning, Doug. In Q2, you had a big increase in Newport News revenues. When you look at the back half of the year, you've got several pretty important milestones. You've got a lot going on there. Can you give us a sense of what took the revenues up so much in Q2 and how we should expect the workflow to in revenues to kind of play out over these next few quarters?

Yeah, sure. It's Tom here. Good morning, Doug. I appreciate the question. Yeah. So, you know, although the growth year over year from Q2 was large, you have to recall we took a charge in Q2 last year for the Virginia class program. So that comes both on the margin side and the revenue side. So it has that... 21%, an increase looking larger than it is. I tell you, on the back half of the year, you know, with COVID understood right now, the labor force is stable. The contracts that we have on place right now, the run rate that we see is going to play out pretty consistent to the back half of the year. It's probably a flat to consistent back half of the year, so I wouldn't let it run away from you as you try and see the growth from a year-over-year perspective. I'd stick with the guidance that we gave you. back at the beginning of the year. I still think that we're right on top of that.

Okay. And then you got this $926 million service award at Ingalls. You know, you're in the process of working through the Los Angeles classwork as well in services. Can you give us a sense of how you expect services revenues to flow? You know, I always think of this as something that we kind of know the trajectory for shipbuilding, but services is less certain. So, how do you see that flowing? And do you get a sense from your Navy and budget discussions that, you know, that there's going to be a pretty consistent driver of revenue coming from the services side?

Yeah, so a couple of parts on that answer there. You know, on the Ingalls Award down there, it's a long-term services-type contract. Obviously, as the CLINs and the years get funded and the out years, we'll see that revenue mature down there. You know, the services contract they have there is the oversight and the services aspect for the LPD and LHA programs. So that was anticipated as far as our revenue projections that we had through that. It's not a large portion of the Ingalls portfolio as we see it today. There are potentials going forward, depending on how the landscape plays out, both from a construction and future services and MRO-type work to play out. We'll have to see how that goes forward. From a Newport News perspective, as you mentioned, we took on the L.A. overhaul right now, so those were anticipated in our plans also. That was an overflow right from where the Navy was. I think medium to long term we'd like to see ourselves get into a cadence of getting an overhaul on the sub-side going forward, and as we work with our Navy partner on what that kind of looks like, we'll provide additional guidance on that front.

Okay, thank you.

Our next question comes from Miles Walton with UBS. Please go ahead.

Thanks. Hey, Mike, I think in your remarks you talked about stability or more predictability in the M-TIB purchasing power or purchasing strategy. And I guess you've got to a, quote, unquote, handshake agreement with the Navy. The congressional committees are pushing that to be more formalized into a contract. Can you just give some color, aside from the greater visibility of having the ships under contract, What are the financial implications to Huntington Ingalls? I know there's savings for the customer. I'm just curious from a financial perspective to the company, how would it change if they bought it individually or in that block buy room?

So I'll just kind of talk in general. Anytime you're in a multi-year program, you're able to sequence the schedule of the platforms to conform to the way you've got your capital and your people and your material lined up. You get into, as Tom used the word, cadence matters a lot. In this case, getting the LPDs and the LHA in a cadence that's predictable over the next several years creates a foundation for all the other programs that Ingalls is going to be working or chasing or trying to capture. So it's a foundational piece of predictability from a cost structure, rate structure perspective. And, you know, I guess our view of that is that if you can get that locked in and create that kind of stability, it's worth the savings to our customer. The customer gets a good price for it, but it's also worth that to us from the standpoint of the predictability. So that's kind of the way we think about it. I don't know if Tom, if you want to add any more to that or Chris.

Yeah, so Miles and Chris, it really solidifies the next three to four years at Ingalls moving forward, and maybe even more important than that, it solidifies the supply base that we keep that ship class moving on a normal cadence to support Ingalls' revenue over the next three or five years.

Sure. I'll probably just follow up on the back of that, too, is, you know, these bundles, whether it's a bundle like we're doing here or a multi-event, provide flexibility to our customers and our partners out there. So, whether they decide to take the bundle that's on the table now or buy them kind of separately. The financial impact, so that obviously, as Mike said, there's rates that come into play, the schedule of the ships, how we buy the material in a lot quantity or do we buy them individually. So all that factors into an affordability, profitability piece of the equation there. But, you know, we put that forth to be as flexible to our Navy customer as possible, and we'll see how they move forward, appropriate the funds, and award accordingly. Okay.

And I think you increased the five-year cash flow to $3.2 billion after a lie on acquisition from 2020 to 2024. As we look to 2022 to 2024, I guess it implies $740 million or so. Is that – remind us, is that a linear profile? Is it a big – step up with significantly higher back-ends? Can you just give any colors to that as you see it today?

Yes. So if they come online, as you know, we'll close on the deal in August. In Q3, you'll get a look-see of the financials with the line rolled in there. We'll give you a little bit more colors on the Q3 call for the specifics of how we see 2021 falling out. And then I'd give additional color. I'd hold until Q4, the February timeframe of next year, when we give that guidance going forward. I mean, there's only so many ways you can spread the $200 million. But I just hold the thought there until we come through the integration and we finish out this year.

Okay. All right. Thank you.

Our next question comes from Robert Pingarn with Credit Suisse. Please go ahead.

Hey, good morning. Tom, the margins at Newport News were a bit below where we were thinking and also below the underlying margins we've seen over the past couple of quarters. So I wanted to just ask what's going on there, you know, driving the fluctuations in the underlying margins, ex-EACs, or was this, you know, net negative EACs at work? And while we're at it, maybe you can just give us the EAC splits between the segments. Thank you.

Great. I appreciate the question. Sure. So now from an input news perspective, we kind of guided in Q1 that there was not going to be many opportunities for risk decline into milestones, Q2, Q3. That was exasperated at Newport News. I tell you, although 5-6 sounds a bit low when you combine it with the first quarter, it's 6-1 for the first half of the year. So it's right at the run rate of 6-7, even if it's on the low side. It was not impacted significantly. Any major setbacks, the favorable EAC increases were $62 million. The unfavorable were $27 down for a net of $35. The upside is a little bit slated towards Ingalls. And then on the unfavorable, it was just slightly slopped from $50.50. towards Newport News, but there wasn't anything specific to call out there. On the favorable side, you will find in the queue there was a, and in my comments up front, that the DBG 125 took an incentive for the CapEx, and there was some solid performance and risk reduction at LHA 8, LPD 28, and LPD 29. But on the downside, there's nothing notable to kind of highlight here. Okay?

Can you quantify the benefit of the capital investment incentive recognized on Jack Lucas? Yes.

Yeah, it's for $14 million. And you'll find that in the queue. It's up front.

All right. Thank you very much.

Our next question comes from George Shapiro with Shapiro Research. Please go ahead.

Yes. Good morning. It seems like where you raise the shipbuilding margin for the year that this capital investment benefit was something that you weren't anticipating? Or is it raised because you're expecting higher EACs in the second half of the year, or it's just continued performance versus the first half?

Good morning, George. It's Tom here. I'll tell you that with half year in the books, we kind of have a line of sight of how the year is going to play out. So factoring in actuals of two quarters and what we see here, we're still foreshadowing that Q3 is going to be light in terms of milestones and risk retirement. And the back end of the year affords additional opportunities, another six months of run rate to burn down risk. So I think we just felt comfortable, and we wanted to help the street understand where we think we're going to land by the time the year is out.

Okay. But specifically, was that capital investment benefit not an expected thing for the year?

It's a one-time event, and it was expected, but it doesn't play out in the run rate for the range that we're giving you at 7.5% to 8%.

Okay. And then the free cash flow is pretty weak in the First half, and it looks like working capital is up north of $200 million. The guide of $150 to $250 for the year still holds, and what would it cause the second quarter to be as weak as it was? Thanks.

Sure. So I'll tell you, traditionally we use cash up front, so we punched out, you know, minus $16 in the first quarter, $23 up here for a net of plus $7 through the first half of the year, not unexpected. And then Q2 was the working capital was 7.9%. So again, in the range of 68, what we expect. The back half of the year usually does see some favorability to the working capital, and that will come. A little bit that we have to keep our eye on is we have to pay back the COVID progress payments at the end of 2021. That negates some of the positiveness that you see in the working capital, traditionally in the back half of HII. So, you know, from where we stand here, to get to the 150, 250, it's just an old operational run of the revenues and the payments flowing through the book.

Okay, thanks.

Our next question comes from Seth Safeman with J.B. Morgan. Please go ahead.

Hey, thanks very much, and good morning. Question, I guess, about profitability and whether, I guess, you know, you look at the margin slide and you talk about the opportunities for risk retirement later in the year and sort of the, you know, the correlation between those two things. I guess the new margin guide implies a down margin in the second half versus the first half, but you look at all the opportunities to check off at Newport News. And even at Ingalls where margins have been very strong, still, you know, more risk retirements ahead than have been checked off. So I guess the first part is kind of, you know, given this list for the second half, why wouldn't we expect a stronger uh shipbuilding margin than we saw in in first half you know and then um you know second i guess when we look at 2022 and we see sort of you know fewer milestones for for newport news um how do we think about uh you know what that means for profitability there and then you know ingalls kind of coming off a high base but obviously it looks like there's a lot to do there um so i guess you know looking at the correlation between these upcoming milestones and and the shipbuilding markets.

Sure, yes. I can give you some color on both of those questions. So, you know, when you look at Q1, Q2, there's quite a few one-time events that are in there. The incentives we're talking about here on DDG 125 and Q2. Q1, there was a couple of incentives in there, too, that we highlighted. I've been asked, can Ingalls keep this up at 14% and now 11.9%, and I keep providing the guidance down that the That's not a run rate that's sustainable. I think between the one-time events and the incentives that we talked about, we'll see that come down. So I wouldn't really read that because we're giving you the 7.5 to 8 that somehow the margins are dropping off from a performance or operational standpoint in angles. It's just that we won't see those one-time events in Q3 and Q4. From the question on the Newport News perspective, right now, if you look at it, they have a lot of new ships in their portfolio, right? So 80, 81 is coming online. There's CBN 74 that just popped in here. And CBN 73 is nearing the end from a revenue perspective, and they have less weight on the portfolio there. So it's the mix of the ships that are in at Newport News. So when you talk about 2022 timeframe, those shifts as they run through, you know, another three, four, five quarters, they'll be burning down risk and there'll be a potential to increase booking rates.

Okay, great. I'll take the one this morning. Thanks very much.

The next question comes from Ron of Stein with Bank of America. Please go ahead.

Good morning, guys. Just quickly, could you give us an update on how things are proceeding with the Virginia class? Because I know that's a program that you ran into some challenges in the last 18 months. How is it tracking now?

Yeah, Ron, this is Chris. I'll start if Mike wants to add on here. We'll do that, but Really, the team performing well and the partnership performing well. Montana is proceeding to delivery this year. New Jersey is proceeding to launch and then delivery next year. And then the shops are executing on the modules to support assembly for the subsequent boats. So confident and comfortable with how the Block 4 and Block 5 programs are executing right now. Mike, do you want to?

Yeah, I would just say that You know, just moving to two per year in block four and then adding in the Virginia payload modules in block five, success is going to depend on rhythm. And what we have established here, Chris's team and Jennifer at the shipyard are establishing right now is they're establishing a rhythm and a program that's going to make that successful. You know, we were working that when COVID hit us last year, and so we kind of had to step back a little bit and reset. But we're pretty excited right now about what's happening today, but also the rhythm that we're setting up for the rest of this program and the rest of the next program. So I'm pretty excited about that.

Gotcha, gotcha. And maybe just another written summary and question. Do you guys, does the industrial base have enough manpower labor right now to do the virginia and the columbia at the projected rates where in a given year if there's two virginias delivered in a columbia so you get three subs is there is there enough capacity in terms of a qualified amount of pipe fitters to do that well ron i i guess uh

If you decided that everything was static and that you had to do all of that with the people that you have in the plant today, the answer is no, we don't have enough people in the plant today to do that. The fact is that since COVID began last March, we've hired 6,000 people and trained them. And I will be forever remembered for saying that we can build capacity in the industry faster than the government can appropriate funding for it. So if the government wants to move ahead with a higher rate of submarine production in a sustained way, not just doing it once in a while, but in some sort of sustained way, they want to go to three submarines a year or three Virginia class a year or two Virginia class and a Columbia a year, and they're going to sustain that for a period of time, we can absolutely have the workforce and the physical plant and the supply chain set up to go execute that. If you said that it's a light switch and starting, you know, in the FY22 budget, we're going to expand the buy from two to four, well, we probably have some startup things there. But we don't believe that's the way that's going to go. We believe that this is going to be done in concert with the history of it. And so I think... I guess my own experience is that when you hear budget people talking about lack of capacity, what they really mean is that they don't have funding. And that's kind of the way the industry looks at it. So I think we can expand capacity if that's the plan, if it's a sustained demand.

Got it. Thank you.

The next question comes from Gautam Khanna with Colin. Please go ahead.

Hey, guys, I was wondering if you could talk a little bit about integration planning and sort of what the early milestones we should be thinking about on the Allion deal to make sure that it's tracking the plan. So could you outline what you're doing, what you're planning in terms of integration, sort of what you hope to have accomplished by the end of the year with that deal? Sure.

Yeah, you've got to be careful here because this, Chris, we're not close yet, obviously, so you don't want to get ahead of that. I will say there was a very detailed integration plan in place and been working very well with Alliant in putting that plan in place. And I'd also like to say that the Alliant leadership team is going to play a very prominent role in the leadership team of the combined company when we do get closed. And we'll be able to report that status of the integration on the Q3 call. But I don't want to get in front of closing on that. And, Mike, I don't know if you want to add anything.

I mean, I think we – all I would say is that we integrated Hydroid last year. We have a blueprint for how to go do that in an effective and efficient way. Obviously, this is a bigger one than Hot Toys was, but the muscles are the same. And I'm pretty excited about the opportunity to go do this. That'll be a lot of hard work by a lot of folks, but it'll be the right kind of stuff to do. And we're certainly going to keep your posts on how it's going.

Okay, and just as a follow-up, you talked about the $14 million benefit from the capital incentive this quarter if i recall last quarter you guys talked about q2 and q3 having fewer ship building milestones and i know this has been asked on the call but um just trying to get a sense for should we have thought about the potential for kim catch-ups you know maybe last quarter as 35 million minus the 14 like when we say not a lot of kim catch-up opportunities is Is $20 million sort of the not a lot opportunity, or should we think of it as like zero? There isn't a lot of, you know, risk retirement opportunities. Because I guess, you know, that was sort of the upside that certainly relative to my expectations walking in today was that there was an opportunity for a lot of favorable net adjustments.

Yeah, I'll hop in there. But, you know, we give that guidance. We talk about, hey, milestones, you know, hard milestones. So either milestones that if we hit the milestone, we take a step up, you know, as we check the EACs, we sell the chip off, you know, really define milestones that will bring in additional margins. I mean, that's true when we guided it in Q1, and it's true right now when I look at, you know, if you punch through here in Q2 and into Q3. As I mentioned, you know, there was 62 up, 27 down, and then a 35. And the 62 is 14 of it, right? So as you do the math of that, I guess we're asking, hey, zero or 20 or $40 million is a lot of cash. As I mentioned to you, 60-40 Ingalls versus a Newport News there. But, hey, just steady performance down at Ingalls, you know, LHA, LPD programs. And it wasn't a specific hard milestone, but as we come through our quarterly EAC processes, we check the burn rates and the risk registers and where we stand. The programs are running smoothly right now. So I don't think out of ordinary performance there, and I think our guidance still holds true about Q3 is going to be light on milestones and there's opportunities over the next six months to retire additional risks.

Thanks a lot.

The next question is from Noah Poppenack with Goldmine Sachs. Please go ahead.

Hi. Good morning, everyone. Good morning. Tom, did you say you also had capital investment-related incentive in the first quarter?

I may have said that, but now that you bring it up again, we had an ECP that we closed out, and I mistakenly said capital incentive. So we had an ECP on the DDT program that cleaned up for us.

Okay. Yeah, I was going to say I was looking for that, and I couldn't find it. Okay. Is that something that, you know, has the potential to occur often and, you know, it's usually small enough to not call out, or is that pretty unusual?

We do have ACPs that close out from time to time. They're not big adjustments. That happened to be a rather larger adjustment than we had, and so that kind of weighed into the Q1 timeframe.

And same question on capital incentives?

It's fairly unusual to have a capital incentive that large. Okay. So we work ourselves through as we come through on these ECPs that we provide for proposals. We go to the table and negotiate. You know, there's a balance of affordability and equity on these deals. And as we work ourselves through, sometimes they take time. And then as we settle the deal, you know, whether it's additional margin or capital incentive, we'll let the street know when we close out and we'll take the booking.

Got it. Is there any other change to the previously provided 2021 guidance items outside of what you've mentioned on the shipbuilding margin?

No. We're going to give additional guidance on setting Q3 as we close out.

So that not being in the release or the deck is mainly just a reiteration as opposed to something else?

That's correct.

Okay. Thanks very much.

The next question comes from David Charles with Barclays. Please go ahead.

Thanks. Thanks for taking the question. Good morning. So In terms of performance year to date, does it change anything about how you're thinking about the shipability margin progression beyond 2021? I think you talked about low 8% in 22 and then going up from there. So anything about the performance year to date gives you more confidence? Maybe that could be a little bit better than that?

No, I would say where we got it and where we expect it to be. And our outlook right now on next year is still home.

Okay. And, Tom, what has to happen from a working capital perspective over the next couple of years to be able to hit this $3 billion or $3.2, I guess, with Allianz included in it, that free cash flow target? What's that in bed for working capital? And where specifically could the working capital upside come from?

Well, I think what we've always talked about is the working capital will be between 6% and 8%, so I think we'll continue to run our operations accordingly. The LAI portfolio, 85% is cost-to-contract, so we don't see that as a drain from a working capital perspective, and that gets integrated into the HI portfolio. But the big drivers that we kind of had highlighted, how that $3 billion and now $3.2 come about, were more from a function of the 3% CAGR from the revenue, the margin rates popping up from shipbuilding, the capital getting back to 2.5%, and then when you run through the math of that, the pension we've kind of cleaned up with safe harbor, so there's not going to be fluctuations on that front. I think on a couple of calls we've worked that through for you, how $700 million on a run rate was attainable prior to a Lion purchase.

Okay. And thinking on pension, it's still kind of a net neutral CAS versus your contribution? Yeah. All right. Thank you very much.

As a reminder, if you have a question, please press star, then 1. Our next question comes from with Morningstar. Please go ahead.

Hey, thank you so much for taking the question. So I was taking a look at the awards of $1.2 billion, and if you take out the uh shipbuilding the um i'm sorry the servicing contract and i think another 100 million dollar contract you get to about um 360 million and um you know six unmanned awards and i'm wondering is that a good way to think about the pricing point for um you know uub's or am i not thinking about that right

Yeah, so there's a number of awards across the corporation in that value for awards. We don't give specific values for the prize points of all our UUVs. So, yeah, I wouldn't necessarily think about it that way.

Okay, thanks.

Thank you. I'm not showing any further questions at this time. I would now like to hand the call back over to Mr. Peders for enclosing remarks.

Well, I just want to thank everybody for joining us this morning. We had a good, strong quarter. I'm pleased with where the leadership team is and where we're going. I hope that you and your families are able to stay safe and that you're able to encourage everyone out there to go get your shots. That's what we need right now. They're ready to get shots. Thank you all very much. We look forward to seeing you.