Huntington Ingalls Industries, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the fourth quarter 2022 HII 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 during the session, please press star followed by one on your telephone keypad. Please be advised that today's conference is being recorded. If you need further assistance, please press star followed by zero to speak to an operator. I would now like to hand the call over to Christy Thomas, Vice President of Investor Relations. Mrs. Thomas, you may begin.

Thank you, Operator, and good morning, everyone. Welcome to the HII Fourth Quarter 2022 Earnings Conference Call. Joining me today on the call are Chris Kastner, our President and CEO, and Tom Seeley, Executive Vice President and CFO. As a reminder, any forward-looking statements made today that are not historical fact are considered our company's estimates or expectations and are forward-looking statements made pursuant to the safe harbor provisions of federal securities law. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. For additional information regarding factors that could cause actual results to differ materially from expected results, refer to our SEC filings. Also in their remarks today, Chris and Tom will refer to certain non-GAAP measures. For reconciliations of these metrics to the comparable GAAP measures, please see the slides that accompany this webcast, which are available on the Investor Relations website at ir.hii.com. With that, I would like to turn the call over to our President and CEO, Chris Kastner. Chris?

Thanks, Christy. Good morning, everyone, and thank you for joining us on our fourth quarter 2022 earnings call. First, I would like to thank the entire HII team for a solid year and express my gratitude for their outstanding contributions throughout 2022. It was through their dedication and commitment that we were able to deliver results that demonstrated consistent performance in a pretty tough economic environment. Now, let's turn to the highlights for the quarter and the year on page three of the presentation. In 2022, we reported record sales of $10.7 billion, net earnings of $579 million, and free cash flow of $494 million. The demand for our products continues to drive a tremendous backlog of $47 billion, and we grew sales and earnings across all three of our segments in 2022. setting the foundation for continued growth in 2023 and beyond. At Ingalls in the fourth quarter, we delivered DDG-123 Lena Studcliffe-Higbee and completed builder trials on DDG-125 Jack H. Lucas. The first-by-three ship, just one quarter after DDG-123, completed her trials. Our DDG 51 team also started fabrication on DDG 133, Sam Nunn. In our amphibious ship product line, we were awarded a $2.4 billion detailed design and construction contract and started fabrication for LHA 9 Fallujah, the fourth big deck amphibious warship in the American class. Also at Ingalls, in January, we were awarded the Advanced Planning Contract for the modernization period for Zumwalt-class guided missile destroyers. At Newport News in the fourth quarter, we authenticated the keel for SSN 800 Arkansas, honoring the ship's sponsors, the Little Rock Nine. We continue to remain focused on reducing risk and meeting cost and schedule objectives on the Virginia-class boats, As for nuclear aircraft carriers, CBN 79 Kennedy is well into the test program. Distributed systems such as fire mains, potable water, air conditioning, and ventilation are coming to life. The EMALS catapult system, which we began testing in 2022, remains on track and is progressing as planned through her test program. And we expect to enter into the combat systems test program later this quarter. And finally, for the refueling and complex overhaul of CDN 73 USS George Washington, we are 98% complete as we near planned redelivery later this year. At Mission Technologies, we achieved solid revenue growth for 2022 with all of the business groups growing year over year. And we ended the year with a robust potential business pipeline of 66 billion, of which over one third is qualified. Significant wins in 2022 included the Decisive Mission Actions and Technology Services Contract, Mobility Air Force's Distributed Mission Operations Contract, and the REMIS 300 selection as the U.S. Navy's small UUV program of record. From an operational perspective, we have integrated Alliant into our mission technologies and HII team, and with the integration complete, we can turn our full attention towards executing our growth strategies. Moving on to slide four, we are providing the major milestones for 2023 and 2024. I'm proud to say that we met all of the shipbuilding milestones that we highlighted back in the second quarter of last year for 2022, and we are maintaining all of the 2023 milestones. This demonstrates growing confidence in our ship schedules and provides a solid platform to continue to improve our cost performance. Notable anticipated 2023 milestones at Newport News include the planned delivery of SSN 796 New Jersey and planned float-off of SSN 798 Massachusetts, as well as the planned re-delivery of CVN 73 and planned crew move aboard on CVN 79. At Ingalls, DDG 125 Jack H. Lucas, NSC Tim Calhoun, and LPT 29 Richard M. McCool Jr. are all forecast to deliver this year. while LHA 8 Bougainville is expected to launch. In addition to these shipbuilding milestones, Mission Technologies expects to see continued growth resulting from our large opportunity pipeline, including the several award decisions that we expect to be made in the first half of the year. Now, I would like to discuss our operational focus areas. Our top operational priority remains hiring and workforce development. I'm confident in our plans for hiring, and as importantly, our retention and training strategies. These strategies that center around employee skills and leadership development are gaining traction, and we've had a good start to the year. After hiring over 4,900 craft personnel in 2022, we expect a similar hiring rate in 2023, while at the same time improving our productivity, attendance, and overtime together to drive performance. Regarding inflation, we have some insulation to our contracting terms and conditions. However, non-programmatic elements of inflation have impacted us across all of our programs. And finally, the supply chain is stabilizing, and we have worked closely with our customers and suppliers to achieve the best possible schedules. To summarize, and notwithstanding being our most significant risk, as labor and supply chain impacts continue to stabilize and inflation abates, we believe we have the opportunity for improved performance over the next few years. Turning to the budget environment, we're pleased with the passage and enactment of the fiscal year 2023 defense appropriations and defense authorization bills. Both pieces of legislation strongly support shipbuilding, including funding and authority for an additional DDG 51 Flight 3 ship for a total of three DDGs, two Virginia-class attack submarines, the Columbia-class ballistic missile submarine program, Ford-class nuclear aircraft carrier programs, and the refueling and complex overhaul of CBN-74 John C. Stennis. Both appropriations and authorization bills continue funding for LPT-32 and LHA-9 and provide new advanced procurement funding for LPT-33, LHA-10, and a third DDG-51 and FY-24. The Defense Authorization Act also includes language requiring a naval fleet of no less than 31 operational amphibious warships, including a minimum of 10 amphibious assault ships. We continue to see bipartisan congressional support for our programs. We look forward to working with the administration and Congress on the President's fiscal year 2024 budget request. So with that, I will turn the call over to Tom for some remarks on our financial results and guidance. And then I have a few additional comments before we move on to Q&A.

Thanks, Chris, and good morning. Today I'll briefly review our fourth quarter and full year results and also provide an outlook for 2023. For more detail on the segment results, please refer to the earnings release issued this morning and posted to our website. Beginning with our consolidated fourth quarter results on slide five of the presentation, our fourth quarter revenues of $2.8 billion increased approximately 5 percent compared to the same period last year. This growth was driven by higher year-over-year revenue at all three segments, leading to record quarterly revenue for HRI. Operating income for the quarter of $105 million decreased by $15 million, or 12.5 percent, from the fourth quarter of 2021, an operating margin of 3.7 percent compared to a margin of 4.5 percent in the prior year period. The decrease in operating income was primarily due to lower segment operating income. Net earnings in the quarter were $123 million compared to $120 million in the fourth quarter of 2021. Diluted earnings per share in the quarter were $3.07 compared to $2.99 in the fourth quarter of the previous year. Moving to our consolidated results for the full year on slide six, revenues were $10.7 billion for the year, an increase of 12.1% from 2021. The increase was driven by year-over-year growth at all three segments, along with a full year of aligned revenue. Operating income for the year was $565 million, and operating margin was 5.3 percent. This compares to operating income of $513 million and operating margin of 5.4 percent in 2021. The operating income growth was driven by year-over-year improvement at all three segments, as well as the more favorable non-current state income taxes and operating FASCAS adjustment. Net earnings for the year were $579 million compared to $544 million in 2021. And diluted earnings per share were $14.44 compared to $13.50 in the previous year. Moving on to slide seven, Ingalls 2022 revenues of $2.6 billion increased 42 million or 1.7% from 2021. driven primarily by higher revenues in the LHA and DDG programs, partially offset by lower NSC program revenues. Ingalls' 2022 operating income of $292 million and margin of 11.4 percent both improved from $281 million and 11.1 percent last year. These results were driven primarily by favorable changes in contract estimates and price adjustment clauses, as well as higher risk retirement on the LPD program partially offset by lower risk retirement on the DDG program compared to 2021. At Newport News, 2022 revenues of $5.9 billion increased by $189 million, or 3.3% from 2021, primarily due to higher revenues in both aircraft carriers and submarines, partially offset by lower revenues in naval nuclear support services. Increased aircraft carrier revenues were driven by higher volumes on the refueling and complex overhaul of the USS John C. Stennis CVN-74 and the construction of Doris Millis CVN-81 and Enterprise CVN-80, partially offset by lower volumes on the refueling and overhaul of the USS George Washington CVN-73 and USS Gerald R. Ford CVN-78. Submarine revenue growth was due to higher volumes on the Columbia class and Block 5 boats on the Virginia class, partially offset by lower volumes on the Virginia class Block 4 boats. Newport News' 2022 operating income of $357 million and margin of 6.1% were relatively consistent with the performance in 2021 of $352 million and margin of 6.2%. 2022 results included favorable changes in contract estimates from facilities capital and price adjustment clauses, as well as contract incentives on the Columbia-class submarine program, partially offset by lower risk retirement on the VCS program and the refueling overhaul of the USS George Washington CVN-73 compared to 2021. 2022 shipbuilding margin of 7.7% was consistent with the performance of 2021, but below our expectations for year-over-year improvement, as the back half of the year provided limited risk retirement opportunities. Continued labor challenges, including higher attrition rates, the impact of non-programmatic inflation, and supply chain disruption all contributed to slower margin progress. At Mission Technologies, revenues of $2.4 billion increased 911 million or 61.7 percent from 2021, primarily driven by the acquisition of Alliant in the third quarter of 2021. Mission Technologies' operating income of 63 million compares to operating income of 50 million in 2021. Primary drivers of growth are the acquisition of Alliant in 2021, as well as higher equity income from a joint venture, partially offset by higher amortization of purchasing tangible assets in 2022 due to the Alliant acquisition. 2022 results included approximately 96 million of amortization of Alliant-related purchase intangibles compared to approximately 33 million in 2021. I'll also note that the fourth quarter in 2022 results included a non-cash downward valuation adjustment of approximately 10 million or approximately 20 cents per share related to an equity method investment. Mission Technologies EBITDA margin in 2022 was 8.2%, and adjusting out the one-time downward valuation adjustment, EBITDA margin was 8.6%, consistent with 2021 performance. Turning to capital deployment on slide 8, we ended 2022 with a cash balance of $467 million and liquidity of approximately $2 billion. 2022 cash from operations was $766 million, and free cash flow was $494 million. Free cash flow generated in the fourth quarter of 2022 was significantly above our prior expectations as we were able to accelerate several large cash collection events. This has a direct impact on our expectations for 2023 free cash flow, which I will discuss in more detail in a moment. I'm pleased to report that the net capital expenditures were $272 million or 2.5% of revenues in 2022, at the very bottom end of the guidance range. Cash contributions to our pension and other post-retirement benefit plans totaled $41 million in 2022. During the fourth quarter, we paid dividends of $1.24 per share, or $50 million, bringing total dividends paid for the year to $192 million. Over the course of 2022, we repurchased approximately 245,000 shares at an aggregate cost of approximately $52 million. Moving on to slide nine and our updated outlook for pension and post-retirement benefits. Our outlook for 2023 has improved modestly from the update we provided in November, given the increase in discount rates since that time. Asset returns for 2022 of negative 16.1% were about as expected compared to our update in the third quarter. Expectations for 2024 through 2026 have been updated, and consistent with the Q3 update, the FAS benefit has come down considerably from our last update given the more immediate recognition of the negative asset returns experienced in 2022. This is partially offset by the impacts of higher discount rates, We also have provided an initial review of our 2027 expectations. Turning to slide 10 and our outlook for 2023, while we continue to expect shipbuilding growth of approximately 3% over time, our 2023 outlook range of $8.4 billion to $8.6 billion acknowledges uncertainties around the current environment, particularly the labor challenges we have discussed. For 2023, we expect shipbuilding operating margin between 7.7 and 8 percent as we continue to target incremental margin improvement, but acknowledge the current challenges have tempered the pace of that progress. For mission technologies, we expect 2023 revenue of approximately 2.5 billion, organic growth of approximately 5 percent year over year. We expect operating margins of between 2.5 and 3 percent, and EBITDA margins of between 8 and 8.5 percent. In 2023, amortization of purchased intangible assets is expected to total approximately $128 million, of which $109 million is attributable to emission technologies. We expect 2023 capital expenditures to be approximately 3 percent of sales. Moving on to expectations for the first quarter of 2023, we expect overall revenue growth for the first quarter to be quite modest, given normal seasonality emission technologies and the strong fourth quarter performance for shipbuilding, which benefited from favorable material timing. Additionally, given the timing of the shipbuilding program milestones and the mentioned mission technology seasonality, we expect first quarter segment operating results to be the weakest of the year, with the shipbuilding operating margin near 7% and mission technologies operating margin near 1%. The outlook we are providing today is based on the best information we currently have and assume no further degradation in our supply chain, that non-programmatic impacts from inflation continue to abate, and most importantly, that we're able to continue to hire and retain employees at a pace that supports our staffing plan. Additionally, on slide 10, we have provided our updated outlook for a number of other discrete items to assist with your modeling. On slide 11, we have provided an updated view on our free cash flow expectations through 2024. Consistent with how we presented this data in the third quarter, this outlook assumes that the current R&D amortization treatment for tax purposes remains in place, and we are reaffirming the $2.9 billion target. If Section 174 is deferred or repealed, all else equal, there would be an opportunity of approximately $215 million in total over the course of 2023 and 2024. As I noted earlier, we significantly outperformed a 2023 free cash flow expectation of approximately 350 million by accelerating collections. This timing difference, along with the delay of the planned COVID-19 repayment now into this year, have impacted 2023 free cash flow expectations. Consistent with our normal seasonality, we expect the first quarter of 2023 free cash flow will be the weakest of the year. And given the portfolio of collections into the fourth quarter of 2022 is likely to be an outflow of 200 to 300 million. Our free cash flow expectation for 2024 remains unchanged as it will not be burdened by COVID-19 repayment. We'll benefit from continued top line growth and margin expansion potential as compared to 2022. Additionally, we expect to see sub-6% working capital levels as a percentage of sales in 2024. We are reaffirming our capital allocation priorities, focused on debt paydown, which is on pace to retire both the $400 million bond this year and the remainder of our line acquisition term loan in 2024, and our commitment to return substantially all free cash flow after planned debt repayment to shareholders through 2024. To close my remarks, it was no doubt a challenging year, but I'm proud of the entire HIA team and the important work we accomplished across the business, from successfully meeting all of our planned shipbuilding milestones to the critical integration work that was completed timely and under budget at Mission Technologies. Across the enterprise, we made meaningful progress in 2022, which resulted in growth across all segments and free cash flow results that were well ahead of our projections. We entered 2023 intent on driving execution, and are well positioned to deliver profitable growth. With that, I will turn the call back over to Chris for some final remarks before we take your questions.

Thanks, Tom. In summary, we delivered consistent results in 2022, and we believe we are well positioned to grow in markets of critical importance to our customers while executing our almost $50 billion of backlog in 2023 and beyond. We will continue to make long-term strategic decisions that benefit our employees, customers, and shareholders, creating long-term value for all of our stakeholders. Now, I will turn the call over to Christy for Q&A.

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

Ladies and gentlemen, if you would like to ask a question, please press star followed by 1 on your telephone keypad now. If you do change your mind, please press star followed by 2. When preparing to ask your question, please ensure your line is unmuted. Our first question today comes from Miles Walton from Wolf Research. Please go ahead, Miles. Your line is now open.

Thanks. Good morning. I was wondering, maybe at a high level, is this still a 9% possibility? Shipbuilding margin business?

Oh, yeah, definitely. I believe that. You know, we've come through some challenging times with COVID, and we've got some shifts that are still working through that. Ingalls is obviously north of that, and Newport News is making great strides. And I think the biggest issue we can work on in Newport News is simply working the operating system, getting the block four boats delivered over the next, next two and three years, and transitioning to Block 5. So, yeah, absolutely, it's a 9% business. I'm not going to give a forecast for when that's going to happen, but I do expect performance to continue to improve from here.

Okay. And then, Chris or Tom, I don't know, in terms of the plug for capital deployment for share repurchase, I guess it's $250 million to $300 million in 2023-2024 is what you plan to do. Do you have any... sites on doing that a little bit earlier, or do you have to wait until 24's big cash flow comes through to have confidence to execute against it?

Yes, Miles, it's Tom here. You know, we haven't given the exact number. Obviously, if you work yourself through the math of where we are, expectations on the revenue, the margin expansion, the free cash flow, bridges that we've given you, and then the capital expense as well as with the working capital, you know, the numbers fall after that way. So as we work ourselves through the year, the cash flow, is generated. We anticipate to continue to buy back shares as we see value in the share price, but we haven't really got into how that is going to be apportioned over 23 and 24. We stand behind our commitment, though, that all excess free cash will be given back to the shareholders after the debt repayment schedule.

And then just one clarification. What is non-programmatic inflation?

Yeah, so I'll give you an example of that, Miles. It's It's related to expenses towards the end of the year that we didn't, that the actuals were higher than what we forecast, stuff like medical benefits, insurance premiums. We just didn't get that right. And we've seen it.

Thank you. So it's overhead type expenses files. Thank you.

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

Hi. Good morning. Good morning, Rob. Good morning, Chris. You talked a lot about the labor constraint, and I wanted to see if you could give us some granularity as to how that number splits between the two shipyards and mission technologies. One thing I've noted is if we look at your job postings, it seems like Newport News has 10X the openings of Ingalls, and does that factor into the margins there?

Not really. Mission Technologies is pretty stable adding throughout the year with really industry standard attrition rates in a very competitive market. We plan to add about 5,000 shipbuilders throughout the year, and there are some positive indications in not only hiring, but also overtime attendance and attrition. So there are some positive indicators. I wouldn't necessarily relate it back to margin. Newport News will hire more this year than Ingalls. We don't break that out separately, but I wouldn't necessarily relate that back to margin, no.

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

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

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

Yeah, sure. You know, interesting enough, there's a lot of initiatives, both at the state and federal level, to help in workforce development. And we're actively communicating with both states that are involved in that and the federal government for infrastructure and workforce development support.

Thanks, Chris.

Thanks, Chris. Sure. Thank you. Our next question comes from Scott Duschel from Credit Suisse. Please go ahead. Your line is now open.

Hey, good morning. Good morning, Scott. Good morning. Tom, did CDN 79 book a net negative EAC in Q4? I'm just trying to interpret what's in the press release on the year-over-year comparison. Thanks.

So we don't provide the actual margin booking rates of step-ups or step-backs on any individual program. I would tell you, to give you some color on that, on the adjustments, there was nothing significant at either yard, up or down, on any individual program. So the answer to your question is no on that. I would tell you that the effect that you're seeing at Newport News there is, although it's net down as far as the adjustments they had, it was really a function of not having the upsides that we would normally see. So, you know, it's kind of range-bound of what we saw on the downside of EC adjustments because of timing on the milestones and just where they saw a little bit of a draw short on labor, a little bit of pressure on overhead costs, overhead absorption was a little bit higher on all the programs there, and CBN 79 was not immune to that effect as well. but it was not significant enough, as you see.

It's not called out in the K. Scott, Scott, I'd also add that CDN 79 had a pretty solid year. They met their compartment commitments for the year. EMALS is essentially built out. It's pretty amazing. I was up there last week, and the equipment is in, and they started that test program. The topside test program has begun. So they've got a bit of momentum. I hate to use a... A football reference, but the big game is this weekend. But 79 is what I call four yards in a cloud of dust, right? Every week they're executing on a lot of volume work. They met their commitments for last year. They've got a lot of work in front of them, but I have high hopes for success on that program.

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

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

Thanks, guys. I appreciate it. Sure.

Thanks, Scott.

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

Hey, good morning, guys. Good morning. Just going back to Kennedy, it's a big contract for you guys. It's a fixed price. And I was just wondering, my recollection was 23-24, you guys are going to have some big risk milestones on that project. It sounds like that's still going to happen. But just the labor situation is kind of, eaten up the upside on that potential risk retirement? Is that the right way to think about it?

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

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

It will definitely give us a lot more confidence moving forward after we get those Block 4 boats delivered and transition into Block 5.

Okay. And Chris, just on that, it's Obviously, labor impacts all your programs, but Block 4 had kind of the unusually aggressive schedule. Is that combination why that's been such kind of a thorn in your side? Is that fair?

Well, remember Block 4 was impacted the most by COVID, right? We had a pretty material impact back in 2020, which really reduced our profit expectations on those boats. So we just need to get through them. We need to get them delivered. The program schedules are pretty stable right now. and a lot of cooperation between Electric World, Newport News, and really Senior Navy to get through those program schedules. So we just need to get through them, and then we'll transition into Block 5.

Chris, if I could hop on that too. Hey, Pete, so on that, you know, to your question of 4 and 5, yeah, you know, Block 4 has been with COVID here 20, 21, 22, so it's long run rate. Those contracts have had the EACs with some additional costs. I think it's twofold. One, getting those Block 4 boats done alleviates the mix in the portfolio at New Putney. So there's a list that you talked about there. But then also it's just those boats give us time to come down the learning curve, the lessons learned, the metrics and the operating system and the personnel that we have on board there. It truly is a production line of all the programs we have. It's the most serial production line. The modules go and then the boats as they're assembled go from unit to unit with the same personnel. getting through four, and then that kind of benefit lifts the block five, which has higher profit potential, and then it will take the preponderance of the portfolio's mix. We crossed over the end of last year, so already now the sales proportion between block four and five is now more in five than four. So there's going to be a natural progression of improvement with learning. four boats being accomplished, and then that learning and higher profit potential on block five is going to be affecting the Newport News portfolio.

Got it. Thanks, guys.

Thanks.

Thank you. Our next question comes from David Strauss from Barclays. Please go ahead, David. Your line is now open.

Thanks. Good morning. Good morning. Tom, similar question that I've asked in the past around working capital. I mean, you obviously had a big improvement in working capital in the fourth quarter. It looks like in your guide for cash, I guess if I back into it, it looks like you're assuming relatively neutral working capital for 24, is that correct? Or sorry, for 23. And then could you help bridge us how you go from $400 million in cash you know, from $400, $450 million in cash to, you know, in 23 to the number you're looking at in 24. I guess maybe a little bit of CapEx help, but what else gets us there?

Sure, yes. I'll break that down. I have several points I want to hit. I'll hit the percentages on working capital last as I walk you through that. So we have updated on slide 11 of the five-point presentation there. You saw we finished at $494, pretty healthy against an expectation of starting the year off at... At 3 to 350, we pulled that down to 2 to 250, kind of mid-year with the re-guide. And then Q3, we told you, 350, we finished with 494. So healthy free cash flow in 22. Obviously, that pulls ahead a little bit. You see we've taken down the 23 expectation. We had you at 545 to 595 or midpoint of 570 last time we discussed. And because of the pull ahead, that we have here right now. We reset expectations to 400 to 450. To your point of working capital, you're right. Just a couple of quarters ago, we were at 11.1%. Last quarter, we were in the 10% range, and we finished 2022 up at 6.1% of working capital. As we have been guiding over the last three or four years, we saw that the workload and just the cadence of the shifts, we're going to have more deliveries and launches on the back half of the five-year free cash flow commitment than the front half, and that's exactly what we see here. If you look at the milestone chart, you'll see that we're going from three deliveries in 2022 to five deliveries in 2023. We also have three launches in 2023, so that's a pretty big year. And then kind of even going forward to the following year on that, we take that perspective up, and we have – two deliveries and three launches in 2024. So a lot of activity there, which will continue us alleviating the working capital, getting rid of the retention that we have, and helping in the free cash flow lift as we go forward. Also, I would tell you that as much as we finished up at 6.1 on working capital, it will just grow a little bit. We got a couple of advancements on incentives that we've had. So we'll go from 6.1 to about 6.5-ish working capital in 2023. So more deliveries helps, slight rise in working capital, and 23 slightly hurts. We've re-guided you on CapEx from two and a half to three, so there's a couple of dollars of headwinds there. So two things against us, but with all those deliveries and launches, we'll see working capital finish up around 425. And mind you, 2023 has to repay COVID, which right now is about $125 million, right? The way I look at it and give you confidence on where we're going with that, we have three years in the hole now against the five years. commitment, 757, 449, and 494. That averages out to 567. Straight stick math would be about $600 million a year that you need. So we're running behind for the first three years, but we knew there was a natural grant with revenue and margin expansion. And also we have a line on board now. 2022, we had them on board for the first year. I was happy with the contribution they made. If you recall, we took the $3 billion into 3.2 with Alliant, and I'm happy with the contribution they made in 2022. And Alliant will be on board for 2023, 2024. So as we look going forward, even though margin space lasts from 2021 to 2022, we're foreshadowing some margin expansion into 2023. We have the top line growing in shipbuilding right now that we gave you in the guide from 8.4 to 8.6, and we expect we'll continue incrementally guiding higher revenue and margin into 2024. And also, I'd ask you to take a look at the three years that we've had, the 757, 449, and 494 free cash flow. That 757 really had two things that actually helped it. And if you normalize it out, it kind of makes sense of how we're marching to be north of 700 in free cash flow as we get out to the 24-hour timeframe. But the 757 had the FICA relief, which was $139. And it also had the COVID repayment. benefit for 160. So 160 and 130 is 290. 290 off the 757 is about 467 is really how I look at the first of the three years. The 449 for 21 has a FICA repay in it. So you throw another 65 in that. That's about 510 for a normalized 2021. And now for 2022 at 494, there's 65 of FICA in that too. That's 550. So I really look at it. We've normalized for what we've seen because like a march of 460-ish to 510 last year to 550, 560 this year. The guide we give you is 4 to 450 for 23 only because I have the COVID repay, so it's another with 125 on top of the midpoint. That's a 550 year, and I have the year in front of me to burn down risk and pull in cash. So I'm comfortable with how I'm marching past my average of 567 the first three years. And then the last piece on how we get that up to, hey, how do you get to 780? about two points down. As I mentioned earlier, we finished 6.1% for 22. We'll be in the mid-sixes for 23. And then it's going to swing down below 5% for 2024. And two points of margin against the top line of $10.8 billion is about $200 million. So $5.50 plus two is $7.50. I got you at a midpoint of $7.80 because we still have revenue growth and margin expansion. So I'm quite comfortable with where we are right now. The numbers play out. If you have any questions, you can As we have our calls afterwards, we can break that down for you further.

Okay. That's a lot of detail. Thank you for that. And, Chris, as a follow-up on mission technologies, you know, the EBITDA margins there, which I guess is the right way to look at it, 18.5%, you know, how do we think about those longer term? I mean, those are well below kind of what we see out of, typical kind of services companies and, you know, you pitch this as not just your typical kind of services business. So how do we think about those EBITDA margin, I guess, the potential there? Thanks.

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

Thank you. Thanks.

Thank you. Our next question comes from Doug Honnard from Alliance Banking. Please go ahead. Your line is now open.

Great. Thank you. Good morning. Good morning. So I want to go back to Newport News. And you had a 5.1% margin this quarter. That follows Q3 that if I take out the Columbia class benefit, that was a 4.1%. And what I want to understand is you've still got certainly the Massachusetts and the New Jersey flowing through there. And so the work that you've done on Block 4, where you've taken charges in the past. I mean, how much of this, what I would call kind of a low margin in Newport News, is due to the overhang of those past charges? So then when you get out from under those, should we expect to step up?

Well, yeah. Doug, this is Chris. I'll start, and then Tom can jump in there. There's absolutely an overhang related to Block 4 boats. that we're dealing with. And so we should expect a margin step up. Now, we haven't guided beyond 23, and we need to be conservative because we need to make sure the labor shows up and we get them trained up and they go execute. But I think you're right relative to that overhang on block four. So we need to get those delivered. And as I said previously, those schedules are being very consistent right now. Cost performance we're working on every day. Sure. Go ahead, Tom.

If I can hop on the back of that, right? So we talked about Block 4 here and what we took back in Q2 of 2020. I would tell you the portfolio with Columbia, that's coming on board on sale. So that's a new start program that's booking low right now across that contract. I have some change, change and unadjudicated change that still has to get, you know, proposed and pushed through the system. So that's going to increase. We're very conservative on that until those unadjudicated changes are definitized. That's both RC73 and 74 is in instance C2, both cost-cut contracts. So the portfolio just has a little bit higher level of that as we sit here. And then lastly, I think as we go forward, burndown risk as 79 marches to its completion. As Chris said earlier, there's a potential with good performance there for additional upside here. So I think we just find ourselves in a situation where the shifts are right now, not too many milestones, a little bit of drag on overheads, down on labor, and I think we're booking prudently to conservatively right now as we want to see us push these ships over the goal line. Those deliveries I mentioned is two each for 23 and 24, and I think that will assist in the margin lift as well as Block 4 gets smaller in the portfolio mix with the potentials of Block 5 as we move forward. I think the club year program will mature, and with 73 out of here this year, a 74's focus and maturity will assist the portfolio profitability as well.

So if I have it right, then block four, the overhang of these past charges is a contributor, but there's still some other, you know, there are a number of other things you just raised. So it's sort of a blend of things that you're working through. I just wondered, you know, General Dynamics, when they did their Q4 calls, highlighted a number of issues somewhat similar related to labor across shipyards. And they did mention Virginia class. Can you talk about how you're working with electric boat sort of together to deal with these problems and if there have been changes over time and how you work together and work through attrition issues, inflation, all these sorts of things?

Thank you for that question, Doug. It's an important one. The Newport News and EB team, they work very closely together in understanding when the work, what work, and how that work gets executed. So there could be movement of work between the yards where it's most efficiently done if there's labor issues. And they're working very closely together. Their objectives are completely aligned to deliver all the block four boats. And I would add also the Navy's engaged as well. From the deck plate to the senior executive force, everybody's all in and all of our objectives are aligned to get those block four boats delivered. I will say that we're fully staffed on block four and Columbia, and we're working very hard on execution there. And not only is EPA and Newport News working between each other, but working to ensure that any sort of outsourcing is effectively managed to ensure that we meet our production schedules.

Okay, very good. Thank you. Sure.

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

Colin, you out there?

Are you on mute, Colin?

Unfortunately, we're not getting any audio from the line, so we'll move on to the next question. And the next question comes from George Shapiro from Shapiro Research. Please go ahead, John, it's now open.

Yes, good morning. I was curious... I was curious that you wound up with 7.7% shipbuilding margins. And, you know, when you did the third quarter call in early November, you were looking for 8 to 8.1. So just wondering, you know, what you missed here in two months, because I thought that shipbuilding would be somewhat predictable sort of business.

Yeah, it was just the drag that we talked about at the end of the year. We had a strong first half of the year, over 9%, and we got it to 7% for the back half of the year. And even Q3 was in that lane. And we thought the remaining 13 weeks of the year, we had that. But the shortfall in labor that we saw, a couple of the overhead or the non-programmatic issues hit both yards, actually, on the cost that we talked about on medical. And just that shortfall as we go through and take a look at EDC, performance, and then the cost and how overheads flow through there. there's a little bit of a drag on where we thought we'd land. So if you called on the call, I was focused on saying I want to see how the year plays out. We did stay on the guide, 8-8-1, and we thought we could get that home. But as the EACs kind of rolled up, there was just a little bit of a draw. I would say both to this question, George, and the previous one, from a Newport News perspective, 6-2 last year, 6-1 this year, about the same type of performance overall. If you think about it, another year, with some drag up front with the effects of COVID and supply chain, inflation, big year on inflation, and then the hiring demands that we had here. So I'm quite comfortable and proud as far as what the Newport News team accomplished there. But to your point, we thought we'd get that home, and Q4 came in a little flattish on Newport News than we expected.

And, Tom, did you give the – EACs for the quarter for... Not yet, but I can hand you... No, I didn't yet.

I referenced them just that we didn't have tremendous downside. We just didn't have upsides at Newport News. But from the quarter perspective, what we saw was the gross favorables were $29 million. The gross unfavorables were $56 million. That was a net of $27 million. And effectively, about 100% of that was at Newport News. Basically... So it was quiet at the other two divisions, and Newport News saw a net down of that unfavorable for the corporation of 27L.

Okay, thanks very much.

Thank you. Our next question comes from Seth Seisman from J.P. Morgan. Please go ahead, Seth. Your line is now open.

Thanks very much, and good morning. Maybe to follow up on that question, Tommy, you talked about Newport News being in the low sixes for 22 and 21. I know you guys don't typically guide segment margins, but if we're just to think kind of maybe qualitatively, overall shipbuilding margins should be up 10 to 20 basis points at the midpoint of the guidance. Does that mean you know, there's a little bit of improvement in each yard? Or given the way that some of the one-timers or some of the potential upside associated with the milestones that you're expecting at the shipyards, is there opportunity for, you know, more expansion in Newport News and maybe some headwinds at Ingalls? You know, how do we think about that for this year?

Well, I'll start and then Tom can get into details. And thank you for saying we don't guide by shipyards. We don't do that. But I firmly expect Newport News will be better this year. I think they're executing their operating system very well. I think labor is more stable. I think the supply chain is more stable. I think the team has some momentum, and I think Newport News is going to do better this year. So with that, Thomas, you want to add anything about Ingalls? I think they're pretty stable as well.

So I'm with you that we don't guide by division, but from a historical perspective, you know, getting this 10-5, 11-1, 11-4 the last three years, they have the same portfolio. basically down there fighting labor and overhead pressures that we talked about, but very strong operating team, a leadership. They know what they're building. Those ships are in serial production, so I would think historically they're going to continue to perform well down there. And I think from a Newport News perspective, as they just fight their way through here, new technology started with Ford and now Columbia. We had that booking we talked about back in 2020, a little bit of COVID pressure, inflation, supply chain, and hiring, but, you know, stabilization, both in the performance over the last two years. We see stabilization and some stability in hiring and the schedules here. And, you know, expectation is that you are going to perform better. So I would expect that to increase as we go forward in the years here, too.

Okay. Great, great. And then maybe to follow up real quick on a similar type of question on mission technology, I think you said that EBITDA margin there X the valuation allowance was – like 8.6 in 22, and so what's driving it down in 23?

We're probably just being conservative on the guys. So we had a 6.6 quarter. With the impairment out of it, it was 8.3. We've had quarters at Mission Technology anywhere from the low 8s to the low 9s. Last year was 8.6, and as I say, unadjusted was 8.2, 8.6 right now. So I think it's just a function of that sales base. You know, we have fixed and semi-variable costs there. It's a good size operation. We think we have the right people on board. We have the right strategy. The pipeline's grown from year over year. The pipeline is more mature. And I think with the mission technology integration into the HI family with that behind us, as I mentioned in my notes, it was done under budget and it's on time. that the team can completely focus on that pipeline, bids, execution, and performance. So I think the 8 to 8.5 is just being conservative. Obviously, we wanted a couple more dollars out of that division last year. We're guiding growth year over year right now. We did see mission technologies grow 4% from 21 to 22, and each of the business units had growth in them. So those were all positive signs. I think the 8 to 8.5 is just awaiting and seeing the awards happen. When the sales hit, I would expect we're going to be on the up end of that range. It's not over yet.

Great. Thank you very much. Thanks, Seth.

Thank you. The next question is from Gelson Connor from Cohen. Please go ahead. Your line is now open.

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

Oh, yeah, thanks. Now we had you, Gelson.

Great, great. Hey, thanks. I was curious if you could just give us some color on the timing of the milestones through the year, if you can tell us, like, if there's anything that's in the month of December or, you know, that has the potential to move out, things we should be watching in terms of Q4 waiting.

Sure, sure, Gautam. When you look at the 23 milestones, I think Tom already mentioned that Q1 was pretty light They're pretty evenly distributed across Q2 and Q3, but then CD79, excuse me, LPD29 is in Q4. So that's at the end of the year. So that's the one we'll have to watch. We've got a lot of confidence in the team down in Mississippi, but that's the one towards the end of the year.

Okay, thank you. Just curious, on VCS, anything incremental from last quarter on schedule with respect to – Not really.

Pretty stable. Pretty stable from a schedule standpoint on the VCS program. We have movement here and there, but it's pretty stable. I've got to hand it to that team, the program team and the construction team. They're getting after it, and they're learning every day. So it's been pretty stable. We just need to stay on it.

Chris has talked about that rhythm of the program, you know, launch one and sell one off, and we saw that in 22, and in the milestones, you'll see that in 23 and 24, so we're working it.

Okay, and just on that last point, anything with respect to negative team catch-ups that you can talk about for 22 on VCS and aggregate anything? You can never call it out as material, but can we assume that they were kind of consistent negative marks on the program, or anything you can tell us about that?

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

Okay, thank you, guys.

All right, go ahead.

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

Hi. Good morning, everyone. Hi, Noah. Thanks for joining.

For sure. Tom, so just back to the cash flow breakdown and appreciate all the detail you gave there and appreciate that there are a lot of moving pieces. But if I just kind of zoom out on the cash flow statement and look at a long history of It sort of ranged $400 million to $600 million for a while, and the business is pretty stable, top line and margin. I recognize you have some opportunity to grow the business and expand margins going forward. I think the pension looks pretty net neutral. The CapEx looks pretty stable. It sounded like you said earlier that you expect in that 24 – uh you know 780 midpoint about 200 million of working capital and i guess you know should i think of working change in working capital as not a sustainable recurring part of the free cash flow and therefore that kind of 580 600 as sort of the you know predictable sustainable engine of the cash flow statement going forward Or is there some other reason to think of the base business as eventually making up that $200 million?

Yes, that's a great question, and we study that all the time. And it's the former with the caveat, right? So we are hitting the point right now. We've been impacted. If you look at the cash flow statement, we were in the $400 million to $600 million. I tell you, from 2020, 2021, and 2022, those COVID – cycle repays and the COVID payments have tripped up, uh, and you have to normalize it after that. A couple of things are happening. Obviously prior to this window, they, um, the margin has dropped in shipbuilding as we've kind of run through COVID. So we're fighting and working ourselves back with incremental improvement, the revenue growth with the backlog that we've shown you there. And we expect to at least have, you know, 3% here kind of going forward when we get through this labor crunch, that's in place. I think you can model that at, um, the, um, As we go forward, the working capital, I believe, will be in that 5% to 6% range. And both yards are in a good rhythm right now. The DDG program annually, what we're doing with launch and sell off a boat on VCS. The rhythm of Block 5 is behind that. The two carry by following 79. The Columbia bill 1, bill 2. So I think we're settling down on the mix of the... the portfolios in each yard, and the timing on when they're going to pop out. We have told you in the past, traditionally, a shipbuilding is like 6% to 8% of what we would expect. That gets watered down a little bit because now with mission technology and Alliant, with more sales in the base, the numbers kind of pop down. If you normalize them just to the traditional shipbuilding, what we've talked about, we were at 12% in Q1 of 22%. Q3 of 23, we're at 14%. We finished the year off at 7.8% just for shipbuilding. And now as we go from 7.8% to 8.3% for shipbuilding sales, we'll see ourselves go down to 6% in 2024. That's in the range that we were highlighting, say, for the first 10 years of the corporation of 6% to 8% in working capital. We were at that range in 2018. We were in the 6%. So I think that's sustainable as long as we're in a normal rhythm of adding work, which we have to backlog. We're performing to schedule, so we're selling ships off timely. And although being either at 6% on shipbuilding sales or is a sub-five, including all my sales with mission technologies, is on the low end of the range, I think what offsets that is the revenue and incremental revenue and margin that we think we're going to have in the coming years. So I'm still bullish on the north of 700 is going to be a run rate in a couple years from now. And I think 2024 is that inflection point to kind of start that run.

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

Yeah, no, we're not going to forecast 25 free cash right now, but I think your logic is okay. The business is going to grow, and if we stay down with those working capital numbers, you're not going to get a benefit from it. You're going to have to get it from growth. and margin improvement. So I think your logic is sound, but we do definitely believe that free cash is going to get north of 700 in 2024 and then continue to grow from there.

I tell you, stick with the law of the numbers, right? I walked through how I normalized out the 2021 and 22 because of COVID, but you can see we're incrementally going from that 460-ish to 510 to 550 with a guy to 425 this year. COVID adjusted us another 550. And then I'm telling you the working capital is going to get it there in 2024. So then it's just, hey, what's the run rate? I think you're looking at it the right way on how you model it. And we'll provide, you know, guidance for 25 a year from now.

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

Yeah, well, it's absolutely more stable now than it was a year ago. Okay, and that's a testament to the hard work the shipyards have put in. to really kind of pivot who they were hiring, increase the training, increase the leadership training. So it's absolutely better. I don't know if you're ever done, right? It was a pretty generational change in our workforce where we lost a large swath of people through COVID. So we are retraining a workforce and retraining foremen and general foremen and construction superintendents and And that's happening, and the best thing we can do and the greatest learning potential is delivering ships. We're going to deliver five this year. Once you've been through that, you've learned a lot, and they're going to continue to learn a lot. So I think it's only improvement from here. I don't think you're ever done, but I think we've made great, great progress.

Okay. Thanks for the time.

Yeah. Thanks, Nod. Thank you.

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

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

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