Huntington Ingalls Industries, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the fourth quarter 2021 Huntington Ingalls Industries guidance 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 during the call, you may do so by pressing star then one on your telephone keypad. To withdraw your question, please press star then two. Please be advised that today's conference is being recorded. If you need further assistance, please signal the operator by pressing star then zero. I would now like to hand the call over to Christy Thomas, Vice President of Investor Relations. Ms. Thomas, you may begin.

Thanks. Good morning and welcome to the Huntington Ingalls Industries fourth 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 their 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 is posted on our website. We plan to address the posted presentation slides during the call to supplement our comments. Please access our website at HuntingtonEngels.com and click on the Investor Relations link to view the presentation as well as our earnings release. With that, I will turn the call over to our President and CEO, Mike Petters. Mike?

Thanks, Christy. Good morning, everyone, and thanks for joining us on today's call. Before getting into the results for the quarter and the full year, I want to personally thank each of our 44,000 employees for continuing to execute their daily activities with an unwavering commitment to our operational pillars of safety, quality, cost, and schedule. 2021 was a year of solid performance and resiliency during the COVID pandemic. At HII, we are committed to promoting and protecting the health and safety of our employees, their families, and their communities, and continuing to serve our customers in the vital national security interests of our country without disruption as an essential contributor to the nation's critical infrastructure. Most recently faced with uncertainty around the Omicron variant, our employees remain focused on execution while driving continuous improvement, innovation, and creativity. While HII has not become subject to a vaccine mandate through any of our shipbuilding contracts at this time, We continue to be committed to promoting the benefits of a vaccinated workforce. Our technical solutions division does have the vaccine requirement in a number of contracts, and currently we estimate that approximately 81% of our HII full time employees are fully vaccinated. Earlier this morning we released our 2021 results, which we believe reflect consistent shipbuilding program execution with year over year margin expansion. and a transformational year for our technical solutions division. During the year, we captured major contract awards, resulting in maintaining record backlog levels, and we expanded our portfolio by acquiring Alliant in our technical solutions division. With these actions, HII persevered to diligently pursue the business outcomes of driving growth, managing risk, and generating strong returns. Some highlights from the quarter start on slide three of the presentation. Sales of $2.7 billion for the fourth quarter are down 3% from the fourth quarter of 2020, and sales of $9.5 billion for the full year are up 2% from the full year of 2020. Given the numerous challenges in 2021, we were pleased to finish the year with shipbuilding revenues at the low end of our guidance, and we remain confident in the 3% shipbuilding average growth rate over time. We also saw strong growth as anticipated in our technical solutions division. Polluted EPS was $2.99 for the quarter and $13.50 for the full year, down from $6.15 in the fourth quarter of 2020 and $17.14 for the full year in 2020. Full year segment operating income of $683 million is an increase of $128 million or 23% over 2020. These returns, in line with our expectations, are the result of continued performance improvement in shipbuilding margins and strong performance in our technical solutions division. New contract awards during the quarter were approximately $1 billion, resulting in our backlog of approximately $48 billion at the end of the quarter, of which approximately $23 billion is currently funded. Now entering 2022, our shipbuilding program's backlog provides, we believe, unmatched stability and visibility, and we are laser-focused on methodically executing our contracts, while the technical solutions business is positioned to capture growth opportunities. We remain extremely pleased with the technology, capability, talent, and solutions that Alliant has brought to the HII family. Now shifting to activities in Washington for a moment, We are pleased with the passage and enactment of the fiscal year 2022 defense authorization bill and its strong support for shipbuilding. However, more than one quarter into the fiscal year, congressional appropriations have yet to be finalized, and the federal government continues to operate under a continuing resolution through February 18th. It remains uncertain at this point when annual funding measures will be finalized, and we continue to urge Congress to proceed expeditiously. We do remain optimistic that the appropriations process will be completed in the weeks ahead. Now, before I close, let me take a moment to address the recent announcement that, at my recommendation, our Board of Directors elected Chris Kastner to the role of President and CEO effective March 1st. This is consistent with the company's succession plan, and I fully endorse this transition. I truly believe this is a fantastic development for HII. As the Executive Vice Chairman of the Board, I will remain an HII employee through the rest of the year and will be able to support Chris and the Board. As the first CEO of this great company, I can tell you confidently that there is no better choice than Chris to lead HII into this bright new chapter. where I believe we are positioned better than ever before to successfully leverage our substantial backlog to generate strong free cash flow, demonstrate growth in our technical solutions division, and create long-term sustainable value for our shareholders, our customers, and our employees. And now I will turn the call over to Chris for his remarks on the operations.

Chris? Thanks, Mike, and good morning, everyone. Let me first congratulate Mike on his transition to Executive Vice Chairman of the Board and thank him on behalf of myself and our 44,000 employees for his extraordinary leadership. I also want to thank the Board of Directors for electing me to succeed Mike as HII's next CEO. Thanks to Mike's vision, HII is positioned well today, and the value creation opportunity in front of us is as strong as ever. I'm honored to lead HII in this next chapter. Now, shifting to our results, I'm very pleased to report another solid operational quarter. Let me share a few highlights. At Ingalls, the Navy continues to fund advanced procurement for amphibious assault ship LHA-9 and LHA-8 Bougainville if achieving cost and schedule performance in line with our expectations. On the DDG program, the team delivered guided missile destroyer DDG-121 Frank E. Peterson, Jr. to the Navy and began fabrication of DDG-131 George M. Neal. This serial production line continues the positive momentum in 2022 with planned delivery of DDG-123 Lena H. Sutcliffe Higbee. On the LPD program, LPD 28 Fort Lauderdale has completed sea trials and is on track for delivery to the Navy in the first quarter of this year. In addition, LPD 29 Richard M. McCool, Jr. was launched in early January. We continue to watch the upcoming budget release for advanced procurement funding for LPD 32 to maintain the benefits of its serial production on LPDs. At Newport News, the Ford-class aircraft carriers are progressing well. CBN 79 Kennedy is approximately 83% complete, and the team is focused on compartment completion and key propulsion plant milestones. Later this year, Kennedy will begin testing of EMALS, the electromagnetic launch system. CBN 80 Enterprise and CBN 81 Doris Miller continue material procurement and early unit construction, and CBN 80 plans to lay keel this year. On the RCOH program, CBN 73 USS George Washington reached 94% complete and is focused on propulsion plant testing and is planned for re-delivery later this year. Regarding CBN 78 USS Gerald R. Ford, the planned incremental availability is on track to complete this year to support the Navy's first deployment of this critical asset. On the VCS program, SSN 794 Montana completed work as planned in Q4 2021 and will complete sea trials and deliver in Q1 2022. SSN 796 New Jersey was christened last year and is expected to achieve its blow-off milestone early this year. While we did not achieve our projected end-of-year milestones, the VCS program continues to improve its progress towards a consistent two-per-year cadence. And finally, on the submarine fleet support program, SSN 725 Helena recently completed sea trials and was re-delivered to the Navy last month. This Los Angeles-class submarine maintenance completion marks the first re-delivery from Newport News of a submarine following a major availability since 2009 and demonstrates the successful reconstitution of our submarine maintenance capability in support of the Navy. At Technical Solutions, the Align integration is progressing on plan, and our organizations are already operating as a consolidated business. Back office systems integration is in full swing and should be largely complete by the end of the year. The bill for 2021 was healthy at 1.1, and the new business qualified pipeline is very robust at over $20 billion, a level strong enough to support our growth expectations for this business. Moreover, the velocity of the pipeline has already increased significantly entering 2022, with nearly $5 billion currently in evaluation or in proposal development. This includes multiple opportunities over $1 billion in total contract value that are expected to award this year. Before I close, I want to provide some remarks regarding our labor and material availability. We continue to keep COVID-19 impacts as watch items and are focused on ensuring our supply chain and labor supply will be able to continue to support our performance. Given the nation's overall labor pressures, we have increased attention with regard to hiring and attrition rates, and we have detailed plans in place to accelerate hiring for 2022. We are leveraging targeted hiring events and actively utilizing our world-class apprentice schools as well as relationships with community colleges and high schools to increase the pace of talent acquisition and development. Now I'll turn the call over to Tom for some remarks on the financials. Tom?

Thanks, Chris, and good morning. Today I'll briefly review our fourth quarter and full year results and also provide our outlook for 2022. 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 fourth quarter results on slide five of the presentation, our fourth quarter revenues of $2.7 billion decreased approximately 3% compared to the same period last year. This was due to a decline at Newport News and Ingalls Shipbuilding, which was largely driven by a very high level of material volume in the fourth quarter of 2020, partially offset by the growth at Technical Solutions from the acquisition of the line in the third quarter of this year. Operating income for the quarter of $120 million decreased by $185 million from the fourth quarter of 2020, and operating margin of 4.5% decreased 658 basis points. These decreases were largely due to a less favorable operating fast cash adjustment compared to the prior year, as well as lower segment operating income driven by lower risk retirement on the DEG and NSC programs at Ingalls, as well as lower risk retirement on submarine fleet support at Newport News. Moving to our consolidated results for the full year on slide six, revenues were $9.5 billion for the year, an increase of 1.7% from 2020. The increase was primarily driven by the acquisition of the line in the third quarter, as well as growth at Newport News Shipbuilding in the Virginia-class and Columbia-class submarine programs and carrier construction and overhaul. This was partially offset by a decline in revenue at Ingalls due to lower volumes on NFC and amphibious assault ship programs, as well as the divestiture of our oil and gas business and the contribution of the San Diego shipyard to a joint venture early in 2021. On an organic basis, revenue for technical solutions was essentially flat year over year. Operating income for the year was $513 million, and operating margin was 5.4%. This compares to operating income of $799 million and operating margin of 8.5% in 2020. The decreases were due to a less favorable operating fast-cast adjustment compared to 2020, partially offset by strongest segment operating results. Segment operating income for the year was $683 million and segment operating margin was 7.2%. This compares to segment operating income of $555 million and segment operating margin of 5.9% in 2020. Our effective income tax rate was 18.4% for the quarter and 12.5% for the full year. This compares to 17.8% and 14.1% for the fourth quarter and full year 2020, respectively. The decrease in the annual tax rate was primarily due to additional research and development tax credits for tax years 2016 through 2020, recorded in the third quarter of 2021. Net earnings in 2021 were $544 million, compared to $696 million in 2020. Diluted earnings per share in 2021 was $13.50, compared to $17.14 in the prior year. Pension adjusted diluted earnings per share in 2021 were $13.03, an increase of 30% from 2020 results due to stronger segment operating performance. 2021 results included approximately $20 million of pre-tax transaction and financing expenses related to the acquisition of Alliant. additionally 2021 results include amortization of purchased intangible assets totaling approximately 86 million of which approximately 33 million was related to alliance turning to cash flow on slide 7 of the presentation we ended 2021 with a cash balance of 627 million up from 512 million at the end of 2020. cash from operations was 271 million in the fourth quarter and free cash flow was 165 million For the full year, cash from operations was $760 million, and free cash flow was $449 million. Net capital expenditures in 2021 were $311 million, or 3.3% of revenues. Cash contributions to our pension and other post-retirement benefit plans totaled $106 million in 2021. During the fourth quarter, we paid dividends of $1.18 per share, or $48 million, bringing total dividends paid for the year to $186 million. We also repurchased approximately 75,000 shares during the quarter at an aggregate cost of approximately $14 million. In 2021, we repurchased approximately 544,000 shares at an aggregate cost of approximately $101 million. On slide 8, we have provided our updated five-year pension outlook. The notable change from our prior outlook is the increase in the FAST benefit. This was largely driven by asset returns in 2021 of 12.7%, and to a lesser extent, the modest change in the discount rate. Moving on to slide 9, we have provided details on our outlook for 2022. While we continue to expect shipbuilding growth of approximately 3% over time, our 2022 outlook range of $8.2 billion to $8.5 billion acknowledges uncertainties around the current environment. We finished 2021 with shipbuilding operating margins at 7.7%, the high end of our initial guidance range, and at the midpoint of our revised guidance range. This was a marked improvement from the shipbuilding margin of 6.2% in 2020. We expect shipbuilding operating margin to be between 8 and 8.1% for 2022, and we expect 2023 shipbuilding operating margin will continue to improve beyond 2022 results. For technical solutions, we expect revenue of approximately $2.6 billion in 2022, operating margins of approximately 2.5%, and EBITDA margin between 8% and 8.5%. These are all consistent with our guidance and messaging at the time of the Align announcement, and current run rates and 2021 results firmly support our expectations. In 2022, amortization of purchased intangible assets is expected to total approximately $142 million, of which $121 million is attributable to technical solutions. Given the timing of the shipbuilding program milestones and the normal seasonality for technical solutions, we expect the first quarter segment operating results to be the weakest of the year, with shipbuilding operating margin near 7% and technical solutions operating margin near 1%. Additionally, we expect that the first quarter 2022 shipbuilding revenue will be the lightest of the year, given Omicron and the challenging labor market driving to a slow start of the year. Our expectation is for shipbuilding revenue to be approximately $100 million lower than results in the first quarter of 2021, with that equally split between the shipyards. Moving on, we expect 2022 capital expenditures to be between 2.5% and 3% of sales. This guidance does include modest incremental capital expenditures above our prior guidance related to investments in infrastructure and tooling to support the submarine industrial base. We are working with our Navy partner regarding the shared investment and capital incentive structure and believe these critical investments will have minimal impact on our overall free cash flow generation. We expect 2022 free cash flow to be between $300 and $350 million, which includes a number of non-recurring items, First, as we noted on the third quarter call, we now expect the repayment of the advanced progress payments we received in 2020 to occur in 2022, which totals approximately $150 million. Additionally, we have a repayment of approximately $70 million in 2022 due to the 2020 payroll tax holiday. Our 2021 free cash flow results were also about $125 million better than the midpoint of our latest guidance simply due to timing of collections and distributions. The outlook we are providing today is based on the best information we have now and assumes no further degradation in our supply chain. It also assumes that we are able to continue to hire employees at a pace that supports our staffing and that we continue to see limited impacts from inflation given the nature of our contracts and the long-term arrangements that we have in place with our labor unions and suppliers. Additionally, on slide 9, we provided our updated outlook for a number of other discrete items to assist you with your modeling. Regarding our longer-term targets, we remain confident in our pre-cash flow target of $3.2 billion from 2020 through 2024. This outlook does assume the continued expensing of research and development costs for tax purposes. For context, we now believe the impact of 2022 free cash flow would be approximately $100 million if the current R&D amortization treatment remains in place. On slide 10, we have provided a walk-up from our 2022 to 2024 free cash flow outlook. First, 2023 free cash flow is enhanced by the lack of discreet headwinds I just mentioned for 2022. The advance to progress and payroll tax holiday repayments. Secondly, we do expect a working capital tailwind in 2023 that, along with continued top line growth and shipbuilding, is expected to drive approximately $200 million of incremental cash flow. Finally, the growth and margin expansion of technical solutions is expected to contribute meaningful incremental free cash flow in 2023 and beyond. As a reminder, working capital can be quite lumpy as we start the end of 2021, so we have provided ranges to help account for that variability. For 2023, we are expecting free cash flow to be between $750 and $800 million, and between $800 and $9 million for 2024, which is all consistent with the target of $3.2 billion between 2020 and 2024. In closing, given the persistent challenges presented in 2021, we are pleased that we were able to complete the year with the results generally consistent with our guidance, including shipbuilding margin at the high end of our initial range and free cash flow well above our guidance. Notwithstanding the current environment, we remain enthusiastic regarding our long-term outlook as we begin 2022. With nearly $50 billion in backlog and technical solutions business that we believe is poised for very strong growth, we are laser-focused on consistent execution and generating sustainable long-term value. Now I'll turn the call back over to Christy 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 will turn it over to you to manage the Q&A.

Thank you. At this time, we will begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. And the first question will be from Miles Walton with UBS. Please go ahead.

Hi, good morning. I was wondering if we could focus on cash flow for just a second and beyond 23-24, just the algorithm and the conversion ratios that you think about as being sustainable. Obviously, in 23-24, you're converting well above, I think, what's implied after your just-for-pension, non-cash pension income. You're converting well above 100%. So maybe just... Tell us about what the conversion structure or equation should be after 24.

Sure. Thanks, Myles. I'll take that stop here. Sure. So, you know, as we've been kind of guiding as we get into the out years here, the portfolio is maturing. The shifts are getting deeper into their build cycles. We're getting deeper into progressing, and we're getting more shifts, as we've highlighted in the past, in deliveries in the 22, 23, 24 timeframe from where we've come from. So, We're seeing additional progressing and improvement in working capital in the out years, and then a higher conversion rate as we release retentions and run through the deliveries of our shifts. So I'm with you that there's a couple years that we're playing catch-up, actually. And the bridge I've given here in the PowerPoint page 10 actually kind of shows that. There's some headwinds that we have in working capital exiting 21, going into 22. The working capital actually gets a little bit worse. And on the top end of our range, almost 8% in the high 7s. Then as we get into 23 and out, we actually see that turn back and become favorable for cash, cash contribution as we work off the progress of the ships and we deliver the ships there.

We shouldn't assume any substantive drop-off post-24 from any working capital.

No, I think what we highlighted, you know, long-term, I mean, as we work the ships off, have the collections, and then deliver, you know, the margin of free cash will gravitate to a 1-0. You'll see years where there's some pressure on that as the maturity of the enterprise as a whole is on the front end of the cycle. And then as we kind of move a little bit more on the back end of the cycle, you know, we've accumulated this backlog of $48 million. And now that we're kind of heavy in the ramp up of pushing that work through the snake here, hiring up, and then achieving the progress, you'll see that swing backwards to favorability both in 2023 and in 2024.

Miles, Chris, I think you're getting into a new normal from a free cash flow generation standpoint up at those elevated levels. So it just naturally gets there. Okay.

And congratulations, Chris and Mike. Thank you.

Thanks, Miles.

Thanks, Miles.

And the next question will be from Doug Hard with Bernstein. Please go ahead.

Good morning. Thank you. Good morning, Doug. And first, Mike, I just want to wish you all the best in this transition. It's been great working with you, even from before there was an HII. So it's been a pretty exciting road, I think. Thanks, bud. The question I've got is, you all have talked a lot about a 3% top-line growth rate, which is pretty consistent when we model out where the ship-by-ship things should go. But if I look at the 2022 guidance, there's really negligible growth versus your shipbuilding revenues in 2020. And so is this consistent with your expectations? And can you break it down between Ingalls, Newport News, and also the impact of services.

Sure. I'll take that. I appreciate that. Thanks, Doug. So, yeah, you know, we gave some call on how 2020 finished out against 2019. And when you look at each year, specifically depending on how that material and labor hits at the quarter close of each year, it can sway how the trend line looks. If you think about the shipbuilding we finished off 2019, just under $7.8 billion. We had thought 2020 would be about $8 billion, but we had a strong, strong fourth quarter in 2020. We actually closed out in shipbuilding at $8.25 billion in that. So that was almost a 6% year increase on that. So that material kind of slid in a little bit earlier than we thought it was going to be in 2021 to 2020. So the trend line that we have here is a 7.8, an 8.2. And then last year, although we highlighted 8.3% medium to long term, with the movement just kind of accelerating into the 2020 timeframe that extracted a couple hundred million dollars out of 2021. We did see pressures because of both Delta and Omicron at the end of 2021, which kind of pushed down. We saw, although Newport News was a slight growth up of about $50 million in air sales, Ingalls was up about $150 million under. That was primarily driven either from a planning perspective, that things were accelerated and materialized, and some pressures on the labor, on the back end. It is true that if you look at you know, 2020 and 2021, you're looking at $8,250 and then at $8,191, we actually backed up $50 million in shipbuilding itself for 2021. Now, relative to the range in your question of $8,200 to $8,500, we're seeing right now problems with the virus and Omicron cases. lightning right now. The case rates are going down at a quick pace at the beginning of this year, and if that sustains itself and we have a normal run rate year in the 2020 and then 21, we're both impacted with the virus and case rates. But if we see a normal year right here, we still think that $8.5 billion for shipbuilding, which is a clean over 3.5%, a clean 3% on the actuals would be about... So that's why we've given you a range of 82 to 85. I think 85 is a clean year, and for some reason, runs through the entire year or there's another variant, we could still see another flat year. The pressure would manifest itself on the labor side, right? So we did see some disruption at the end of 2021 and the beginning of 2022. On the labor side, we have hiring plans. We know how to go do that. Our human capital is the most important resource that we have. So we've been successful over the years in being able to establish our labor plans, hire, train, retain, and we just got to put our head down and make it happen this year. I do believe that the pressures that we see, and in my opening notes in Q1, that we see at the beginning of the first quarter. Q1 was going to be a low quarter anyway, and then a little bit light because of the labor, are recoverable this year as long as we don't see continued impact for the remaining part of the year. I would tell you from a growth perspective, if you're concerned about that, you know, if you strike the line, and we always say it's lumpy, whether it's cash or even on the revenue side, so you can't kind of look at it from quarter to quarter, even from one year to another year stuff. But if you look at it from 2017, using that as the base, of shipbuilding at $6.6 billion. The CAGR on that over... four years is 5.5%. If you use 2018 as the base, the CAGR on that is 3.7%. And even using these two years where we had an acceleration in 2020 and then a little flatness in 2021 because of COVID is a 2.4% CAGR. So, I mean, we're being transparent in the notes that although we believe that shipbuilding is still 3%, like I said, over the last four years, it's 5.5%. The last three years, it's 3.7%. Although we believe it's sustainable that we can get 3% long-term, we moderated just

And just related to this on timing, so, you know, you talked about 2021, and one of the things that helped you, that you reported helping you in margins at Newport News was performance on Virginia class. Now, you're going through this Block 4 to Block 5 transition. General Dynamics reported that they were seeing delays in modules and some supply chain issues right now. I mean, when you're looking at 2022, are you seeing any issues there in terms of this overall program and how you do the transition from Block 4 to Block 5?

Yeah, no, Doug, this is Chris. Actually, it's pretty encouraging from a module standpoint in Newport News last year. They met their commitment on modules, so they're getting some stability in the manufacturing organization in Newport News. So it's pretty stable. Missed the milestones at the end of the year related to Montana issues. and New Jersey, but those will happen here momentarily. But they're pressing towards getting back to a two-peer cadence. The team's very focused on it.

Okay. Okay, great. Thank you.

Sure.

And the next question will be from Ron Epstein with Bank of America. Please go ahead.

Yeah, good morning, guys. Good morning, Ron. Thanks for the time. If you could, could you walk through the growth in technical services? Because it looks like if you look at the guide that you guys are implying, it implies organic growth in the core that you took out. Alliant is actually pretty darn good. And it seems like they had organic growth that might have been mid-teens or higher in the business without Alliant. And how do we think about that? And what are the growth drivers for that business as we go into 2022?

Ron, it's Tom here. Consistent with the notes I gave you, actually, if you pull a line at the organic growth, it was flat. We can walk you through that on the side if for some reason you see something that's driving you a different way on that. We did have some pressures on manned, although we feel positive about that business. We've highlighted that we think that's going to, although the budget is small right now, we think that's going to be a high-growth area on the Navy side of the budget, probably fast-growing as any account that they have there. We did see that the appropriations and the awards were delayed, and we've been foreshadowing that that's going to be pushed out to the summer into the fall timeframe of 2022. So that actually stymied the organic side of TSC. From a line perspective, though, and you can work yourself through it on the K, through the performance information that we gave you, they actually had a stellar year last year from a growth perspective. They were up 23% from 2020 to 2021. And consistent with what we've highlighted, you know, 18, 19, 20, they were in the teens from a growth perspective. We've incorporated that into our CSD billion-dollar business. And within the two-sixths, we feel comfortable about the growth rates that we've been highlighting there from 7% to 9% for at least 2024. So also, as I noted in my opening comments, whether it was in Q3 for the first nine weeks or through Q4 and Q3, Q4, the run rates have been consistent. They've been slightly kind of moving up there where we thought they would be to date. And as I've highlighted with actuals at 507, with that run rate itself, it needs about 11% growth to kind of make the $1.6 billion of the $2.6 billion that we're highlighting for the TSD division for 2022. So very comfortable with the line to date, although you're always good at your next bid and win, so they have to go do that. And then from the other side, Andy Green has restructured His business over there, he's got his leaders aligned. He's getting some synergy of combining the leadership and resources with the organic TSD. And we're watching closely how unmanned unfolds to see the growth in that area.

Hey, Ron, from a market standpoint, I mentioned some significant opportunities that we have bid on and will bid on in the first part of the year. I don't want to comment on the specific items because they're competitive, but it's broadly across markets. ISR, advanced training, cyber intel, and then we have unmanned opportunities that were delayed from last year that will come out this year. So it's pretty broad within growth markets that Alliant and the legacy TSD are engaged in.

Got it, got it, got it. And maybe just as a follow-on, Can you speak a little bit to the CapEx investment you're making? Is that prepped for maybe more Virginia class? I mean, how do we think about that?

Yeah, so from the previous quotas, we were kind of highlighting that that was a possibility there. As much as we've seen the CapEx come down from 3.6% in 2020 and last year it finished up at 3.3%, we got into about 2.5%. More recently, because of our taking a look at, we're evaluating both the current submarine requirements as well as future anticipated awards that are coming down, Block 6, Block 5, Block 6, the Columbia-class follow-on. We're in discussions with our Navy customer on these requirements, and there is a need for additional investments for the submarine industry requirements. specifically infrastructure and some tooling. We would partner with the Navy on that investment, and with capital incentives we would be moderately increasing our CapEx to now the forecasted range of 2.5% to 3%, and that would run out over the next several years. Again, we would only go forward with the customer assistance, and to be clear, we'd only move forward if the investment made sense or had an appropriate return against it. This is a minor change that we've incorporated into the business plan, but it is considered in the forecast as a $3.2 billion free cash flow for Generation 2024 that we've confirmed.

Yeah, Ron, it's also consistent with the two per year plus the next phase of the Columbia class. If it were to accelerate to three, then there would be initial investment that would be required.

Got it, got it, got it. All right, thank you. And, Mike, congratulations, Ron. on the transition. Per Doug's remarks, it's been nice working with you over the years.

Thanks, Ron. I've enjoyed it.

Thank you. And the next question will come from Robert Spingarn with Nellius Research. Please go ahead.

Hi, good morning. Morning. Mike and Chris, congrats. It has been an excellent run working with you, Mike. I wanted to ask Chris if you could talk a little bit about labor, what you expect net headcount to be or growth to be in 22 and the pieces of that. So departures, additions, and how we think about cost within that and how the new collective bargaining agreement might affect things.

Yeah, that's a good question. There's some really positive indicators here. Related to Omicron, we're cautiously optimistic. We only had 20 outs in Newport News or 20 folks that had the virus earlier. earlier this week, and attendance is improving, and that's half the battle. So getting the attendance back to stability, we have a predictable labor force to execute on the program that's really, you know, nirvana for a shipbuilder. So that's half the battle. The other half is we need to hire north of 5,000 people. So I don't want to get into attrition and splitting it by the shipyards. But we're pretty good at building a workforce, our relationships with our apprentice schools, community college, high schools. We think we can meet that commitment. It's going to be a challenge, but we think we can build that workforce in order to achieve our sales guidance.

Okay. And then just a quick one for Tom, if you could run through the details on the EACs and the quarter.

Sure. So for Q4, we saw a net $10 million favorability, 45 favorable and 35 unfavorable. And the net there of the 10 was basically attributable to a split between England and TSD. Okay.

Thank you. And the next question will come from Mike McGarry with Wolf Research. Please go ahead.

Hey, good morning. Thank you, guys. And Mike and Chris, congratulations to both of you. Chris, following on Doug's question, can you add a little bit more color around the transition between Virginia Class Block 4 and Block 5? As you close out the year, risk items you're keeping an eye on that happen in Block 4, what you're sort of expecting for Block 5, and whether it could be upside there?

Yeah, so remember we did take a charge on Block 4, so there could potentially be some upside in Block 5. The team is very focused on early module fabrication. We met our commitments this year in that regard. And the best thing about kind of the rhythm we're getting there on the VCS program is you're training a team. Right, and you're training a team to deliver one and float off one every year. That team is going to roll right on to Block 5. So if we can get predictable performance, that's really the place you want to be in shipbuilding in serial production. So we just need to keep the positive momentum going.

Got it. And then related follow-up, how does the mix between Block 4 and Block 5 trend over the next three, four years, three years probably?

We don't have that specific information for you. We don't really provide guidance at that level, but the deliveries on Block 4 happen one a year for the next three years after we get through Montana, and then we'll transition. So it'll slowly evolve into more Block 5 revenue.

Got it. Thank you. Sure.

The next question will come from Seth Seifman with J.P. Morgan. Please go ahead.

Hey, thanks very much and good morning and congratulations to Mike and Chris. Just wanted to start off asking a little bit about the cash flow bridge and just kind of understanding the piece that's in 23, I think, the $200 million of shipbuilding growth and working capital. Just when we think about shipbuilding growth and we think about, you know, 3% top line with a shipbuilding margin type drop through after tax, you know, that would imply that the, you know, the vast, vast majority of that $200 million is working capital. So, you know, I just want to confirm that that's kind of the right way to think about it. And then when we think about what drives the growth from 23 to 24, is it a similar dynamic where there's that level of, you know, underlying EBITDA growth from the shipyards on that kind of 3% and then anything else is kind of working capital as you go to 24?

Oh, yeah, thanks. I appreciate the question. It's Tom here. So, yeah, from the working capital perspective, you are right. You know, the bar there shows $200 million, so there is a lift there both in the volume and then the expected returns from the 7.7 Roth that we gave you for shipbuilding to now the range that we have here. So you can do the quick math of that. It's about a quarter of that, a fifth of that. The rest is in working capital, which is the preponderance of it. And there is a piece, even though the CapEx is not at the 2.5, but at 2.5 to 3% on the low end of the range, there is a little bit of a push there. We did put it on the chart kind of going forward. The capex could be $10 to $20 million on a run rate cheaper going forward on that. The working capital itself, the way I kind of look at that, as I mentioned, is we see a drag from the working capital leaving 21, going into 22 by about $100 million additional working capital. And then that reverses itself to over $300 million. I mean, it's both the bar there as well as what's kind of sitting in the advanced progress and the FICA repayments. That's interesting. give back there too. And that comes about through both the contract working capital that we have as well as the trade working capital. So you can work yourself through that. It does improve, as I say, significantly from 22 to 23, and we find ourselves going from the top end of the range in 22 of the 6% to 8% to actually with cap incentives actually kind of gets us even below the bottom end of that 6% range in 23 with a slight improvement going forward in 24. Okay.

Okay, thanks. And then just wanted to follow up quickly on the hiring. The 5,000 people, how does that compare to other years recently in terms of, you know, I guess that's the number of gross ads? Because just looking at it as a percentage of the shipbuilding workforce, it seems like it's, you know, it's pretty high. It's probably about 14% of the shipbuilding workforce.

Yeah, Seth, we're pretty good at hiring people. We hired that almost that much last year. We'll actually hire north of that this year. So, yeah, we're pretty good at this. My boss considers it a core competency, and so do I. Great.

Okay. Thanks very much, guys.

Sure.

The next question will come from David Strauss with Barclays. Please go ahead.

Great, thanks. And let me echo my congratulations to you both as well. Just wanted to ask you about the shipbuilding margin profile. So you're calling for a couple, I guess, 40-50 bps of improvement. Can you talk or give some color how that might break out amongst the shipyards? I mean, we've been on a trend here where Newport News has been coming up, Ingalls has been trending down. So how does that look, I guess, in 2022? And then for the additional progress you're expecting beyond 2022?

Yeah. So, uh, you know, to date we give, uh, our outlook, uh, against the enterprises. So we don't kind of break that up between both angles or Newport news. Um, as I kind of mentioned earlier, a little bit, it is the shifts that we have in the contract working them through, through the EAC processes, the risk registers, burning down risk. As we get deeper into, um, the build cycle, the additional progress payment clause allows us to have more collections. And with the burn down of risk, we'll have high booking rates as we get into more deliveries in the out years. So, I mean, that's the essence of it.

Yeah, I will say, David, I agree with Tom, but it's really the maturity of the shifts that Newport News are going to drive a lot of that earnings growth.

Okay. Got it. And, Chris, maybe if you could touch on the unmanned portfolio. I think you highlighted it as a bit of a risk item last quarter, and I guess you also highlighted in the release today that it dragged on. TS margin, just an update on what you're seeing there. Thanks.

Yeah, some progress there. Small and medium, we think. We'll both be awarded late Q1, early Q2, really after the budget is agreed upon. So we'll know a lot more after small and medium size are awarded. We're making good progress on XL. We shipped our first modules to Boeing, so it's critically important we get that ship or that boat or Boeing gets that boat in the water to start demonstrating its capability. So reasonable progress and unmanned will know a lot more this year. All right. Thanks very much. Sure.

And the next question is from Pete Skibitsky with Alembic Global. Please go ahead.

Yeah, good morning, guys. And I'll reiterate, Mike, best of luck. And Chris, congrats. I want to talk about aircraft carriers. It looks like work on the Ford elevators is finally finished up and the ship's getting closer to deployment. And I saw on your slides that the statement of work, I think, on the Kennedy is now done. Can you talk about maybe what you've learned about the technical risk on the Ford class and how that's going to apply to the Kennedy? And do you have that contract mod yet on the Kennedy? That's it. Thanks.

Yeah, we do have them all on the Kennedy. I've got an old aircraft carrier program manager here that hasn't answered a question, so I'm curious if he wants to jump in here on the aircraft carriers, then I'll jump in after. Thanks, Chris.

I think the first part of your question is what do we learn from Ford that's going to go through the rest of the class? And I think, you know, over time we've talked about, you know, we've pointed out that the first ship in our production run is also a prototype where we have to test out the manning plans, the design, the supply chains, the construction plans, all those things get tested. We then came off of that, just to kind of set you on how we did this, we came off of that with a plan to invest capital. We invested about $250 million in capital, and we reduced the price of the Kennedy by about $1 billion based on that. And that was really driven by learning curves. We went to the government and said, okay, we have now figured out how to efficiently build this ship, understanding the supply chains and understanding the manning and the technology and all that sort of stuff and the learning curves. The next thing we need to do is we need to buy these things smarter. And so the government worked with us, and we came up with a two-ship buy for 80 and 81. I think that where we are right now is weapons elevators on Florida behind us. The ship is accelerating towards delivery from its last availability with us post-shock trials, and it's accelerating towards its first deployment. I think you're going to see this ship out there carrying the flag and doing great things. In the meantime, we've got the modification for Kennedy to go forward. We've taken all of the lessons that we've learned from Ford. We've invested against those lessons to drive success on Kennedy. And as I think Chris pointed out, the fabrication and work that we're already doing on Enterprise after that and then Dory Miller after that, I mean, you're talking about a four-shift program here that's going to be very mature and hot and running really well. And I think it's going to put our customer in a place where they can think seriously about how do we extend this program and move forward. And, you know, my focus would be at this point is how do we take all of this in a package and start talking about 82%. I think that's where we need to be going with the program. I think it's positioned very well to do that. We're through the growing pains now, and we're ready to accelerate into efficient production. I'm excited about the future of the program, and it is a tremendous ship.

That's great. Thanks very much.

The next question will be from Gautam Khanna with Cowan. Please go ahead.

Hey, good morning, guys, and congratulations, Mike and Chris.

Thanks, Adam.

By the way, it's sad. Now we have Dwayne leaving, and, you know, now you, Mike. But anyway, I just wanted to... You'll be okay, I'm sure. I won't leave. No, we will. No, no insult meant there. I just, you know, it's been a long time. You know, I was going to ask... about the guidance on shipbuilding margin, first of all. I mean, it seems extraordinarily precise, 8% to 8.1%. It's a tighter range than you've given in the past. And I was curious, you know, what informs that conviction around, you know, a 10 basis point swing? And given the soft Q1 start, I mean, is there any weighting you could tell us, like Q4 has got a ton of Q and catch-ups or risk retirement opportunities or what have you? Like, just if you could kind of Give us a sense for why the precision and, you know, when do we get those lumpy cube catch-up opportunities later in the year?

Sure. Yeah, it is a more precise range than we gave last year. Last year we started out at 7.8, and we narrowed that from 2.3 to 7.5 to 8, and it came in at 7.7. And although that range was probably a safe and conservative range, we wound up on the top end of that range. We did foresee that that could happen, but we wanted to see the year play out with COVID, so that was why we did that. I think going into 2022, we did want to give a really wide range. We thought we'd be a little bit more transparent where we think the year is going to land. We feel comfortable that from where we exited at 7.7% for shipbuilding. We know the work we're doing, the backlog that's coming on board, which isn't really going to influence 2022 that much, but the work we're doing the serial production, the lessons learned that Mike and Chris have talked about. We feel strong about that kind of going forward. COVID could have an impact on the revenue, but the cost efficiency and how we're operating right now we feel good about, and we think this is going to be a lift. We've been guiding that we're going to march our way back up, and we think that's still in play here right now. The portfolio mix, as we've said, what we've taken behind us on VCS is in the mix, so that's going to slow the march back, but it's still a march back up from where we thought we'd be. So we feel good about it right now. As we get into the year and work down the risk, we'll see that we'll realize that, right? Now, specifically, what we see happening here is with more deliveries in 22, 23, and 24 than where we came from in 18, 19, 20, with the shifts as we're building them with the lessons learned in serial production. And there are a couple of shifts in the next year or so, uniquely contracted, higher incentives. I think of, like, DDG 125, for example, that was a modified Flight 2 that we incorporated in ECP, uniquely how we contracted that with incentives on the schedule side of it. There's a couple of nuances in the shifts that we believe are going to provide additional margin, say, than a normal shift. But we have line of sight of that right now, and we feel comfortable on that outlook of 8 to 8.1.

And your point is it sequentially builds through the year? So Q4 is greater than Q3, greater than Q2, et cetera, in terms of margin?

We didn't provide that guidance. I would tell you it's pretty flat. I mean, I think obviously a Q1 is going to be light. And then from there, we'll see how it plays out. But after we get out of Q1, it's not a significant driver from quarter to quarter there.

Okay. And just to follow up on that.

It's not a quarter to quarter game, right?

Got it. Okay. Now that's helpful. And then with Allianz, I'm just curious. We've seen a lot of the government services contractors, you know, not have great results of late for whatever reason, whether it be COVID, whether it be, you know, bookings are soft. because the government's not getting stuff awarded on time due to COVID or continuing revolution and the like. I'm just curious, what can you say about sort of the Allianz book to bill in Q4? And you mentioned there were some contracts you're bidding on in the first half. What do you expect for book to bill in Allianz in 2022?

Thank you. We think of this, Chris, I think the book to bill will be north of one based on the significant opportunities we have there. If the CR extends too far into the year, there could be some pressure on the top line. But we're pretty comfortable with our pipeline and the significant opportunities we're bidding on and the markets that we're in. We're pretty comfortable with the line and technical solutions.

And Q4, what's the bill?

Yeah, I was south of that. I don't have that specific information in front of me. Excuse me, Tom, if you have it, go ahead.

No, I know it was 1-1. 1-1, right.

Thank you, guys.

The next question will be from George Shapiro with Shapiro Research. Please go ahead.

Yes. Could you comment on where the learning curve has been on the Kennedy? You're 89% done. I remember in the beginning there was this big issue that you were going to have twice the learning curve that the Navy was suggesting.

Yeah, so we don't have a specific learning curve on Kennedy at this point. We just extended the schedule for the single-phase delivery. They're heavily into the volume work on the ship. They're miles ahead in some systems and making really good progress. So I'm comfortable with where they're at financially, but I don't have a specific learning curve for you right now, George.

Okay, and then maybe one quick one for Tom. Given that New Jersey and Montana didn't meet the milestones in Q4, are they expected to meet them in Q1? And if so, why wouldn't the margin be a little better than the 7%?

So they were planned to happen last year. I will tell you, though, that just as we go over the goal line, some of the milestones don't specifically bring margin immediately. Depending on where they finish in the quarter, there's an EAC and hot wash that we do, and it could be both a subsequent quarter. Even though they will bring a couple of dollars, it goes into the mix against the portfolio. So when you really add up all the math, you're not going to see a big driver in one specific quarter like that. But it is a slight list. and that probably adds more credit to the 7-7 last year without them coming into this year, you know, bolsters our outlook and our perspective on why 8-8 all looks good.

Remember, George, those are block four boats, and we did take a charge on those, so the opportunity for risk retirement is reduced.

Okay, thanks, and congratulations, Chris, and lots of luck to you, Mike. Thanks, George. Thanks, George.

Thank you. I'm not showing any further questions at this time. I would like to hand the conference back over to Mr. Petters for any closing remarks.

My last earning calls, I just want to take the opportunity to say thank you again to all of the folks that I've had the opportunity to work alongside with the last 35 years. It's been a privilege for me to serve as CEO of this company for so many years, and I frankly have enjoyed working with each and every one of you. in the financial community, in the business, in our customer set. And I do appreciate your research and thoughtful questions, even if I didn't say so at the time. I've learned a lot. I would hope that maybe you've learned a little along the way. But as we look forward, and as you can tell by today's call, our company is in very good hands with Chris and the senior leadership team, and I am confident that HII has a very bright, bright future. Thanks for joining us on today's call. I hope that you and your families continue to stay safe and healthy. We appreciate your time and your continuing interest in our company. Thank you very much.

Thank you, sir. The conference has now concluded. Thank you for attending today's presentation.