Huntington Ingalls Industries, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the first quarter 2023 HII Earnings Conference Call. At this time, all participants are in 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 1 on your telephone keypad. Please be advised that today's conference call is being recorded. If you need further assistance, please press star 1. 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 First Quarter 2023 Earnings Conference Call. Joining me today on the call are Chris Kastner, our President and CEO, and Tom Steele, 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 today's call. First quarter results reflect a good start to the year as we stay on course executing our nearly $50 billion of backlog and growing our mission technologies business in markets that support our customers. And I want to thank our 43,000 employees for continuing to deliver excellent products and services in support of national security. Our priority continues to be a focus on the fundamentals in shipbuilding, driving our shipbuilding schedules and delivering critically needed assets to the fleet. With that, we believe our milestones for 2023 and 2024 remain on track and consistent with our prior expectations. As we discussed last quarter, 2023 milestones include three ship launches and five ship deliveries, and the cadence of these is expected to pick up through the year, specifically in the third and fourth quarters. I will note that we are working closely with the Navy on a change to optimize the CVN-79 schedule, which pulls baseline work from the post-shakedown availability into the construction period in order to provide more capability at ship delivery. Ultimately, this change would allow for a more capable Kennedy to join the Navy's operational fleet, and once this contract change is finalized, we will adjust the crew move aboard and ship delivery dates accordingly. Now let's turn to our results on page three of the presentation. Top line growth was 3.8% from the first quarter of 2022, resulting in record first quarter revenue of $2.7 billion. Diluted earnings per share was $3.23 for the quarter, down from $3.50 in the first quarter of 2022. New contract awards during the quarter were approximately $2.6 billion, which results in backlog of approximately $47 billion at the end of the quarter, of which $26 billion is currently funded. In the first quarter at Ingalls, we were awarded a $1.3 billion detailed design and construction contract for amphibious transport dock LPD-32, continuing the serial production of this critical product line for the U.S. Navy and Marines. At Newport News, we were recently awarded the Columbia Bill 2 advanced procurement contract for $567 million. allowing Newport News to purchase major components and commodity material and to begin advanced construction on the next five submarines in the Columbia class. Finally, at Mission Technologies, we saw strong revenue and margin this quarter, with revenue growing 5.8% over the first quarter of 2022. Notably, this quarter, we were awarded the PRESS program, a base plus six one-year options, $1.3 billion task order, to provide personnel recovery, enterprise services and solutions for the U.S. Africa Command. Shifting to activities in Washington, the President submitted his fiscal year 2024 budget request in March, which is now under consideration by Congress. The proposed budget reflects continued investment in our shipbuilding programs, funding the second Columbia-class submarine, two Virginia-class attack submarines, and two Flight 3 Arleigh Burke-class destroyers. The budget request continues funding Ford-class nuclear aircraft carriers and aircraft carrier refueling and overhaul programs, as well as investment in the submarine industrial base. On the ship maintenance side, the budget request includes $600 million for the engineering overhaul of USS Boise. Funding is included for the final increment of LHA-9, but funding was not included for the LPD program or a third DDG 51 destroyer, although Congress provided advanced procurement for these programs last fiscal year. We will continue to work with Congress and our customers to support their requirements as we move through the budget process. Beyond shipbuilding, the fiscal year 2024 request reflects continued investments in capability enablers such as AI, cyber, and electronic warfare, C5ISR, and autonomous systems, which align well with the advanced technology capabilities of our Mission Technologies Division. Turning to labor, we successfully hired over 1,500 craftsmen and women in the first quarter, which is at 30% of our full year plan of approximately 5,000. This solid pace for hiring reflects continued recovery and stability in rebuilding our labor workforce post-COVID. While hiring is on a positive trajectory, we continue to remain focused on hiring, the training of our workforce, and our workforce development and retention programs. For example, in March, we celebrated the graduation of 200 apprentices from our Newport News Shipbuilding Apprentice School, strengthening our skilled workforce and leadership pipeline. Moving to an update on the health of our supply chain, where we are seeing stabilized lead times, we have not seen a return to pre-COVID levels. It is important We not only manage the risk this creates for our current programs, but also reflect these increased lead times in our future contracting activity. In summary, we've had a solid start to 2023, with record first quarter sales and continued long-term visibility, given our significant backlog as well as future award opportunities based on the strong defense budget. Seeing progress in labor and supply chain lead time stabilization is certainly positive, But we need to continue to manage these risks moving forward. We're maintaining our emphasis on fundamentals, driving productivity to ensure we meet our customer commitments. And now I will turn the call over to Tom for some remarks on our financial results. Tom?

Thanks, Chris, and good morning. Today I'll briefly review our first quarter results. For more detail on the segment results, please refer to the earnings release issued this morning and posted to our website. Beginning with our consolidated results on slide five of the presentation, our first quarter revenues of $2.7 billion increased approximately 4% compared to the same period last year and represents a record first quarter result for HII. This increased revenue was attributable to growth at Newport News Shipbuilding and Mission Technologies. Operating income for the quarter of $141 million increased by $3 million or 2% from the first quarter of 2022. An operating margin of 5.3% was essentially flat from the prior year period. The increase in operating income was primarily due to a more favorable operating fast cash adjustment and more favorable non-current state income taxes compared to the prior year period, largely offset by lower segment operating income. Net earnings in the quarter were $129 million compared to $140 million in the first quarter of 2022. Diluted earnings per share in the quarter was $3.23 compared to $3.50 in the first quarter of the previous year. Moving on to slide 6, Ingalls revenues of $577 million in the quarter decreased to $54 million, or 8.6% from the same period last year, driven primarily by lower revenues on the LPD, LHA, and NSC programs, partially offset by higher DDG program revenues. Ingalls operating income of $55 million and operating margin of 9.5% in the quarter declined from last year, primarily due to lower risk retirement on the LPD and LHA programs. It is important to remember that the first quarter of 2022 included a very clean delivery of Fort Lauderdale, LPD 28, which provided significant risk retirement at that time. At Newport News, revenues of $1.5 billion increased by $116 million or 8.3% from the same period last year due to growth in both aircraft carrier and submarine revenues, partially offset by lower support services revenues. Newport News operating income in the first quarter of 2023 was $84 million, an increase of $3 million or 3.7% compared to the first quarter of 2022. Segment operating margin of 5.6% was down slightly from last year, primarily due to unfavorable risk retirement on enterprise CVN 80. Shipbuilding operating margin in the first quarter was 6.7%, slightly below the 7% outlook we previously provided for the quarter. Our outlook for the full year is unchanged. As we have noted previously, our expected milestones for 2023 are concentrated in the second half of the year. which will drive our performance for 2023. At Mission Technologies, revenues of $624 million increased 34 million, or 5.8%, compared to the first quarter of 2022, primarily driven by higher volumes in mission-based solutions, which includes our C5ISR, cyber and electronic warfare, and live virtual and constructive training businesses, as well as growth in fleet sustainment. Mission Technologies operating income of $17 million compares to an operating income of $9 million in the first quarter of last year. Current results include approximately $27 million of amortization of purchased intangibles compared to $30 million in the first quarter of last year. Mission Technologies EBITDA margin in the first quarter was 8% compared to 7.3% for the same period last year. During the first quarter, Mission Technologies did record a provision for a contract loss relating to a manufacturing issue that was not material to our financial results as a whole. Turning to slide 7, cash used by operations was $9 million in the quarter, and net expenditures were $40 million, or 1.5% of revenues, resulting in free cash flow of negative 49. This compares positively to cash used by operations of $83 million. net capital expenditures of $43 million, or 1.7% of revenues, and free cash flow of negative $126 million in the first quarter of 2022. Cash contributions to our pension and other post-retirement benefit plans were $10 million in the quarter. During the first quarter, we paid dividends of $1.24 per share, or $49 million. We also repurchased approximately 39,000 shares during the quarter at an aggregate cost of approximately $9 million. Moving on to slide eight, our free cash flow outlook through 2024 remains unchanged, as do our capital allocation priorities. I'll highlight that we will continue to expect to distribute substantially all free cash flow to shareholders through 2024 after planned debt repayment, which is on track. Turning to slide nine, we are reaffirming our 2023 guidance and providing some color on how we see the second quarter shaping up. Before discussing our second quarter outlook, I want to make clear that we are reaffirming our guidance for the full year with the knowledge that once the PSA modification is completed, the remaining CBN 79 milestones will be updated, including moving the delivery to 2025. We believe we'll be able to reach an agreement that is neutral from a margin and cash perspective to both 2023 and 2024, and our outlook reflects this. Regarding the second quarter, we expect shipbuilding revenue to be largely consistent with first quarter results and shipbuilding operating margin to be approximately 7%. That does imply meaningful improvement in the second half of the year, which is consistent with when we expect our shipbuilding milestones to occur. For mission technologies, we expect second quarter revenue of approximately $600 million and operating margin of 2.5%. We expect the second quarter free cash flow to be approximately negative $150 million. Again, there is no change to our expectations for the year. Our cash generation will fall predominantly in the third and fourth quarters, consistent with both our forecasted milestones and our normal cash cadence over the calendar year. To summarize, the first quarter results were largely in line with the expectations we provided on our fourth quarter call. We are pleased to reaffirm our full-year guidance. and we remain focused on execution and hitting the milestones and commitments that we've laid out. With that, I will turn the call back over to Chris for some final remarks before we take your questions.

Thanks, Tom. Before wrapping up, I would like to point out that we have recently published our 2023 Sustainability Update Report, which among other things, describes the governance and management framework that we have established around sustainability. And finally, I would like to emphasize that we remain focused on successfully executing on our strong backlog and positioning for long-term growth, which will generate value for our employees, customers, and shareholders. Now, I'll 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. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, press star one. As a reminder, if you're using a speakerphone, please remember to pick up your handset before asking your question. We'll pause here briefly as questions are registered. The first question comes from the line of Doug Harned with Bernstein. You may now proceed.

Yes, thank you. Good morning. Good morning, Doug. You know, I'm interested when you look at Newport News right now and you appear to be getting some good growth there. Can you give us a sense of the breakdown of where growth is coming from? And I would say across Columbia class, Virginia class, the CVN programs. What really getting at here is as Columbia class starts to ramp, can we expect growth there to move above that kind of 3% to 3.5% trajectory that we've been on?

Well, let me start and then Doug and then Tom can step in here. I continue to think, and I've said previously, that Newport News will provide the majority of the growth in shipbuilding. So is there potential as Columbia comes online and the aircraft carriers become a more significant part of our revenue mix, and then we get Block 5 in full rate and then into Block 6, that growth could be greater than 3%, sure. But on a long-term basis, we think the right way to think about shipbuilding is 3%.

Sure, Doug. And I'll hop behind this, Tom, here. So, yes, we did have – some good growth in Q1. It was up $116 million. It was driven by carrier construction, 80, 79, 81, Columbia class in the VCS program, partially offset by some fleet support that was just slightly underneath. But as Chris says, I think we feel comfortable about that. We have the capacity and the capability to kind of run that. I think long-term, though, it's still kind of governed by labor and the program plans that we have in the yard here. So I think 3% is the right way to take a look at it on a long-term basis.

And then you did the unfavorable, there was an unfavorable adjustment at CVN 80. Can you, that sort of surprised me because I would think of less risk on CVN 80 than there was on 79. Can you talk about where you, you know, what happened there and then also, you know, how Virginia class is still proceeding right now?

Yes, I'll take the CBN 80 first. Just backing up a little bit on color on margin and profitability that we thought we'd be at 7% for the quarter on shipbuilding. We came in at 6, 7, and the majority of just that shortfall there was about the enterprise step back that we took. We find ourselves, as I noted in my remarks up front on CBN 80, that we find ourselves from a time capacity and throughput needing to offload and or outsource unit work and panel work right now. As we're working ourselves through that, it's early in that project as we ramp that up, and we wanted to make sure that we increase the outsourcing risk protection, and we booked that conservatively. There's still many years to go on that chip, and it's just embarking on some additional outsource work on that. I would tell you that since the keel landing last summer, that chip is coming tremendously along. It's in the draw dock right now, throwing a lot of steel at it, The shape of the ship is erecting, and I'm really proud of what the team's doing with that. But again, we just thought it would be prudent to take a balanced approach as we embark on getting some additional workouts hosted.

Yeah, Doug, I'll comment on VCS. Yeah, the VCS program, the program schedules for VCS are pretty stable and have been stable for the last couple quarters. You know, we'll deliver 796 this year. $7.98 will be delivered the year after that, and actually we have a christening with Sheryl Sandberg being the sponsor on Saturday for Massachusetts. So you're all invited. It will be streamed live, and Massachusetts is performing well. And then $800 will deliver the year after that, and then Block 5 will follow. So on Block 5, I do think there's opportunity on Block 5. The team needs to retire risk. in order to achieve that, and we're just not at the phase of the program where you'd be retiring that risk. So I still think there's opportunity in block five. And I apologize for the line cutting out.

No, no problem. Thank you.

Thanks, Doug.

Thank you, Mr. Hearn. The next question comes from the line of Rob Spengar with Mellius Research. You may now proceed.

Hey, good morning. Sticking with Newport News, if resources need to be diverted from Virginia to Columbia to keep that on track and given the priority there, are there any conversations with the customer to mitigate any potential economic losses to you or the industrial base, the submarine industrial base, given that Virginia is fixed cost?

Yeah, so there could potentially be discussions in that regard. I would say from our point of view, our staffing is pretty solid on the Columbia class and the Virginia class right now, so I don't anticipate that. I think you saw that we had a good start to the year from a labor standpoint. Attrition is trending well. Attendance is trending well. A lot of training expenses as well. But we don't anticipate that right now. We're pretty comfortable from a staffing point of view.

Okay. Thank you.

Sure.

Thank you, Mrs. Spangar. The next question comes from the line of Seth Seisman with JP Morgan. You may now proceed.

Thanks very much and good morning. Morning. Morning. Wanted to ask a little bit about the, so I guess we can look on the milestone slide and see that there's a lot of, you know, a lot to come here in 2023 and that that kind of underwrites I guess the margin expansion that you're looking for in the second half. And then I guess, you know, with the margins coming in, I think a little bit lower than people expected in the first half, higher than expected in the second half, and it seems fairly variable based on milestones. And then we look at 2024 and we see that, you know, each one of the yards has fewer milestones in 24 than 23, although we don't know, you know, the value of those milestones could could be different. I guess, you know, how do we think about a margin trajectory given how the first half of this year, the second half of this year is so different? You know, how do we think about where that takes us going into 24? Sure.

I appreciate the question there. Yeah. So, you know, we did say on Q4 that the milestones were on the back half of the year. We foreshadowed 7% for Q1, and now you can see the outlook for Q2 is going to be that way, too. You do the math against the 7%, 7% to 8%, and the back half of the year is going to be in the upper eights on that, and we feel comfortable with that. You are right that the milestones are on the back half of the year there. I would tell you also that what's in the mix there, there's other things on top of the milestones, although they are the major reason that we have the changes in EACs and affect profitability, there's other areas too in there, whether it's our performance or capital incentives, either on contract or that we anticipate. We either have those factored or they're in potential. There's risks and opportunities, so we can materialize more opportunity than risk that we realize, so that plays out every quarter that we do our AACs. We also do, we have our contracts, especially our COHs that pop in here and both for the condition and the statement of work that could be fluid over the two and a half to three years that those shifts are here. There's change, there's condition, there's cost of contracts. So there's change proposals that are in flux right there. We've talked a little bit about on several calls of unadjudicated change. And what we see here is that the cost is already into the EACs. We conservatively book the recovery on those things. And as that plays out, there's a natural recovery of those true-ups to the contract performance. So there's elements of that that's happening behind the scenes as well as just the milestones. So that gives you some context for 2023. For 2024, there are still more milestones than usual. We have three deliveries and three launches. We're holding everything on the page that we gave you a quarter ago with the caveat on CBN 79. But there will be a natural lift as we work ourselves through. We've talked about in the past Block 4 and Block 5 volumes, so that will assist. closer to the deliveries of the large ships that we have here. And then as we proceed forward, new contracts that will roll in both the performance and inflationary impacts that we've seen. And that will give us new targets. And then lastly, I'd add that, you know, as quarters and years go by here, obviously the inflection point will hit from the production and learning. You know, as we get this workforce up to speed, the more experienced, successive bills on following ships, There's a natural lift in profitability on that front as well.

Great. That's really helpful. And maybe as a follow-up, just a quick confirmation. I want to make sure I understand. The optimization you're talking about on CVN 79, when reaching an agreement there with the Navy and that's finalized, that is a neutral event as far as margin and estimates for the program and cash is concerned for you guys?

I just want to caveat that a little bit. We anticipate it to be neutral. It's a benefit both of us and the customer to have that chip to be more capable, have more functionality in it, and it will be to the latest configuration. And as we work ourselves through the negotiations on that contract, takes on more statement of work, we'll get a schedule, we'll adjust the targets. We'll situate that. Although we won't get the liquidation and the retention release next year, we'll have more statement of work and cost and cash that's running through the books, and we anticipate that that will be margin and cash neutral for the next few years through the delivery of that ship.

Seth, I could also add, I think it's a really smart thing being done by the Navy here relative to integrating the PSA into the base contract because it reduces deployment risk for the ship. So we're participating in that. We'll get it definitized over the summer. We think it's a very positive development.

Great. Thank you very much.

Sure.

Thank you, Mr. Seisman. The next question comes from the line of Miles Walton with Wolf Research. You may now proceed.

Thanks. Good morning. Chris, could you comment on LC29? I think there's both the sea trials and the delivery aspect that you're thinking about for 23. And obviously, you have to have sea trials before you have deliveries. And I'm curious. What's the hold time on the sea trials that you would need to see to actually be able to accomplish the delivery for this year, and how material is that to this back-end loaded margin for the year?

It's definitely in the mix. It's a Q4 trials and delivery. A lot of volume work to go on that ship. They're making really good progress. We let off the engines really last week when we were down there. I'm optimistic that team will start to continue to hit cadence. The LPD program we're very proud of and confident that LPD 29 will get done this year, contingent upon, of course, that labor stays stable and we continue to make progress. But a lot of confidence in that Ingalls team.

Okay. And just one on labor, Chris, you sound – really good on labor. From a hiring perspective, could you comment on attrition as well? And is it showing up in the right disciplines? And, you know, where the where the pinch?

It is. Yeah, it is. So attrition has been positive as well. And it is showing up the right disciplines you always have in shipbuilding moments in time where you you may need welders or or riggers or electricians, you might be out of balance a bit. but that's kind of the art of managing labor and shipbuilding. So it's a positive start to the year. It's taken a lot of effort, a lot of effort, and we need to stay on it. Team's very focused on it, but it is positive thus far.

Great. And sorry, one last one I squeeze in. Tom, you mentioned that Mission Technologies absorbed a customer charge, I think. Can you size that, and is that the same that was disclosed in the queue last quarter, or the K? Yeah.

Yes, I appreciate the question there, Miles. Yeah, it is the same issue that we had last time. You'll note when you get the cue that the disclosure has improved from a top range to now we've taken a charge. And, no, I wouldn't disclose the customer or the charge itself. It's not material to our financials. You won't see it in the cue and correct, all right? So, yeah.

Okay, thank you. Thanks, Miles.

Thank you, Mr. Walton. The next question comes from the line of David Strauss with Barclays. You may now proceed.

Thanks. Good morning. Good morning, David. Good morning, David. Chris, you mentioned in your prepare remarks that there was no amphib funding in fiscal 24. If you could just kind of update us on the status there? I mean, we seem like there are always these ongoing reviews, and then Congress adds money back, just kind of where things stand there.

Yeah, 24 is pretty positive from a budgetary standpoint for us. The one issue, as you mentioned, is LPD 33. We'll work with the customer and the Congress to ensure that they understand the importance of that ship to Ingalls, and we'll just follow it through the process. Got high confidence based on the law of 31 ANFIDs that we have a chance to get that back in the budget, but we'll just have to follow it through the process.

Okay. And Block 4 versus Block 5, can you give us an idea of how much of Virginia class revenue at this point is Block 4 versus Block 5 and how that transitions over the next year in terms of You know, I mean, Tom, your point is some potential margin left as we progress there, some sort of baseline where we are today and what that looks like.

Yeah, so as we crossed over at the end of last year, Block 5 actually has more revenue than Block 4 in it, although you find the programs where one's better than 80% accomplished with 794 delivered, 796 to go, 798 floating off, and then the successive years of the sell-off to 798, 800. So Block 4 is... significantly more complete with costs in the books here. Block five is still less than 30% complete right now. So there's a mix there. I have more volume on five, and I still have a large amount of that program in front of me. As we talked about, I think keeping the pedal to the metal on the labor, training that workforce, getting serial production cadence happening, which we see that with the operating system that they incorporated down there. I think all that's going to add to a real potential of additional profitability in Block 504. You don't see it yet, obviously, because it's early in the program. So it's good that we're getting the sales volume from the VCS program, a lot of interest in that. And we'll just keep working to get the production efficiency going on the VCS program.

Thanks very much. Thanks, David.

Thank you. Thank you, Mr. Stroud. The next question comes from the line of Gautam Khanna with Cowan. You may now proceed.

Gautam, you out there? We may have lost Gautam. Operator, do you still hear us?

Yes, I still hear you. I don't have Gautam.

Okay. Maybe he'll come back in. If you could maybe just go to Pete.

Absolutely. The next question comes from the line of Pete Skibiski with Alibic Global. You may now proceed.

Hey, good morning, guys. Hey, Chris, I think a lot of us were targeting the return of shipbuilding margins to that 9% range by 2025 or so. Is that going to be still reasonable, that target, after the Kennedy contract changes? and where you see labor going right now, or is that a stretch at this point? What are you thinking there?

Yeah, I don't want to give commentary on 25 margins at this point. We're comfortable with our guidance for this year. I'm comfortable that the way we have the ships delivering and the stability of the milestones that we look for improvement next year. The teams are working on the fundamentals today. every day within both shipbuilding organizations coming through COVID and the labor challenges. But there are still significant labor challenges we're working through. So I don't want to predict when we'll recover to 9%. I still believe it is a 9% plus business. We just need to continue to focus on the fundamentals and execute.

And if I could comment on that too, Chris. Pete, we're obviously not happy with where we are right now. We're driving hard. We're being realistic with it. The strategy that we have that we've shared with the street and shareholders is we anticipate and expect expansion of margin. We'll continue to fight through that, and we do that every day and every week here. We get realistic with the ranges that we give that are definitely attainable. We have strategies and plans, and the profiles and the forecasts show that we can meet our forecast that we tell the street. So we'll just keep you updated like we have every quarter. But, you know, the trajectory needs to go up, and we're working really hard every day to make that happen.

Okay, appreciate it. And last one for me. Guys, I remember a while back one of the next big contractual things you were looking to accomplish was getting the fifth Ford class carrier under contract. And I think you wanted to do that in the midterm, nothing near term. But is that now in the budget? And there was talk maybe even doing, you know, another – two-carrier bundle, are those things still in play in terms of where the budget should go?

Well, it is. It is in the budget, and we do still think and we know that buying them together absolutely saves the Navy money, and it's the right way to buy it. That hasn't shown up in the budget as of yet, but we believe that that is the right way to acquire aircraft carriers. So positive, it's in the budget, and then we'll continue to work with the Navy on potentially working on a two-ship buy, but that hasn't manifested as of yet.

I'd comment on that, too, on the strategy front there. We're looking, and we think it makes financial and program sense to buy two carries at a time with three years of AP on four-year centers, right? And that's what we're focused on. from a timeframe, we would be looking for a construction turn on in 2028 and then optimistically AP in 2025, if not 2026. But that's the playbook we used last time. It's buying power for our customer. It's efficiency for the yard here. We get to buy two sets of only materials and get the buying efficiency from that. So that's what we're working closely with our customer on. Great. Thanks, guys. Thanks, Pete.

Thank you, Mr. Skibiski. The next question comes from the line of George Shapiro with Shapiro Research. You may now proceed.

Yes, I wanted to ask, General Dynamics on their call commented that they were having supply chain issues in Virginia. I think it was more Block 5 than 4, and they took a charge for that. And I guess you're not experiencing that? There's different suppliers, or if you could just explain maybe.

Yeah, well, I can't comment on GD's phone call. That would not be appropriate. I'm comfortable with where we are in the VCS program this quarter, both Block 4 and Block 5. As I said, we're progressing down the delivery path on our Block 4 boats, and then we need to transition to the Block 5. But it would just be inappropriate for me to comment on GD's call, but we're comfortable with where we're at.

So you're not seeing supply chain issues, is that it?

Well, I think we're seeing supply chain issues across the board, really. It is definitely stabilized from a lead time standpoint, but it's stabilized at a higher level than pre-COVID, and we need to make sure we take that into consideration, not only on our current EACs, but on our future bids. So, yeah, there are supply chain issues, but they've stabilized a bit over the last couple quarters from a lead time standpoint.

Right, and I'd add the cost and projected future costs have been incorporated into our EACs. We've updated the milestone schedules here, George. You've seen that we have walked those over the last couple years when COVID started, and there has been some charges at Newport News that you know about. So as Chris said, I'll reiterate that every 13 weeks we take a look at the actuals to date, the ETC expected, the forecast, the material indices, how costs are going to come in, And we are comfortable with how we're booked, both in the milestone chart that we give you from a scheduling perspective and then obviously what's put into the financial reports from an EAC perspective.

Okay. And then, Tom, the net EACs can you give for the quarter and the break between the sectors?

Yes, sir. So the gross favorable was 64 up. The gross unfavorable was 55 down. The net favorable obviously was $9 million after that is. And that's made up of actually, you know, you'll see now in the queue, there's a revised disclosure that has that information. Ingalls is 14 up of the nine. MT is four up of that nine. It's 18 up. And then the Newport News is cumulatively down $9 million. And really, that $9 million is the preponderance of, you know, a 7% shipbuilding versus 6-7. And we had that discussion early on the outsourcing on CBN 80.

Okay. And then one last one, if I can get in here. Can you... Mention what drives the more negative free cash flow in the second quarter, and then what drives the almost doubling of your free cash flow in 24 after three years of relatively similar numbers?

Yeah, so for the free cash flow here, there's a rhythm and a cycle that we have. We usually cash users at the beginning of the year. We saw that in Q1. We had guided a minus 200 to 300. We actually came in at minus 49. So we just had some better timing and collections in Q1. That's just probably pull ahead from Q1 to Q2. We're guiding a minus 150 for Q2 now. To combine the two, Q1 actual and the Q2 forecast, we're still right on plan and where we thought we would be. And I think when I look with a street perspective, if we add up both the Q1 and Q2 expectation, We're slightly ahead of that, which is good. For the free cash flow kind of going forward here, you know, you can look at it like one of two ways. We've talked about the top line revenue expansion. We haven't had a question on it here, but you heard in the remarks, you know, almost 4%, 3.8% growth. Emissions Technologies grew 5.8% this quarter. And Q1, year over year, it grew 3.5% from last quarter. And like Q4, every one of Andy Green and Emissions Technologies businesses unit expanded their top lines. That's a good sign right there. I really like what we're seeing. But I think that's false as well. We had talked about long-term shipbuilding growth at three, and it was 3.1% this quarter. We talked about long-term growth in emissions technology at five, and it was 5.8%. The weighted mix should be 3.5%, but as we said, we came in at 3.8% this quarter. So the case is there, and the numbers are playing out. From an emissions technologies perspective, I would just leave you with You know, they're coming up on year two now this August. You know, the restructures behind them, the leadership's chosen, the business units are understanding. They've integrated operations, systems, processes, and I really think the team now has full-time focus and support on their objective of go win a lot of work and execute their contracts. So I feel really good about that top-line growth. Margin expansion, I know we've talked about it. There's an expectation that 8% to 10% that Mission Technologies would move that up. We had guided that, and that thesis is still in place to get from the low 8% to the higher end of the range of 8% to 10%. And we saw the EBITDA margins in pretty good shape. 8.2 last year, when we normalized out the booking for a joint venture sale that we have there, it was 8.6. And this quarter, it's 8%. It's early in the year. So I think both the expansion of the top line and the bottom line is real, and it's in front of us. Managing our CapEx, we've got it to 3% here. So we've come off our highs of almost 5% and upper 4s over the last four or five years. And that adds to the bottom line. We get through the adjustments for COVID, both the FICA and the COVID payments back. I think there's a natural lift there that you'll see. Macro perspective, you can just take a look that from a shipyard perspective, we were generating in the 475 to 550 just between the two yards. And then when you throw another 2.5 billion business with mission technology that's growing annually, 8% to 9% EBITDA to take the midpoint at 9%, the math easily generates through taxes. in the vicinity of about $200 million for mission technology. So five and two is 700. So I'm comfortable that we'll get there. We've talked about the step up from 23 to 24 specifically will happen as we get into the cadence of production across both yards. And what we'll find is that working capital will come down a little bit. That will be the initial lift to get 23 up to 24. But then with the growth and the expansion of margin, we see us being 700 million plus, 700 to 700 plus, going forward in the out years.

Okay, thanks, Tom. That's a good, complete answer.

Thanks, George.

Thank you, Mr. Chipperoo. The next question comes from the line of Gautam Khanna with Cowan. You may now proceed.

Hey, can you hear me, guys?

We can. Thanks, Gautam.

Terrific. Thank you. Hey, I wanted to ask what your best guess as to why in the fit-up, a number of the delivery dates on Ingalls ships had moved to the right, and just relative to the last time they published those delivery dates, and they gave reasons for it, but do you broadly agree with those revised delivery dates expressed in the fit-up?

Yeah, I think what you're seeing there, Gautam, is kind of two different processes with potentially different risk And obviously, we look at our delivery dates and our – so they don't specifically align, right? We can project better deliveries based on what we're seeing in the quarter or the year or some of the indicators that could impact delivery. So I just think there are different processes with different objectives. So you're going to have differences from time to time, but we're comfortable with where we're at.

Yeah, and I'll come behind that, too. You know, that comes out every year, and we take a look at it, and we microanalyze it. And I will tell you that at times you'll see ships and boats move, and other times they don't move, and sometimes they stick on a contract date for years, and then they move aggressively. I can tell you from our perspective, you know, we're aligned programmatically and with our customers on the status of the programs. We're aligned from both the milestones and schedules that we run our yards to, our master construction schedules that go into the milestones that we feed to the street, and then from an EAC perspective to make sure we have the duration of the programs understood and priced in EACs. So I would not be overly concerned. At times it's just risks and opportunities. When's the ship available? When's the crew available? When is the test sequencing to get the ships and boats out of here? So a lot goes into that. I would dismiss them. They're important. But our information is updated and evaluated every 13 weeks here. And I can tell you that the schedules and ESCs are aligned to the current performance of both yards.

Thank you. That's a great answer. And just to follow up on an earlier question about the differences on the Virginia class at GD relative to HII, and I know you're not going to opine on GD, but I was just curious if you could talk about since Q2 of 2020, when you guys announced the large charge related to COVID and the schedule impacts on Virginia class, have you had much in the way of negative cum catch-ups on that program or was that kind of a big, the big reset, if you will, on the program accounting? I'm just curious. It doesn't seem to be called out quarter after quarter.

So thank you. So obviously that was a significant adjustment we made with block four, but we from time to time have adjustments and we've had adjustments on the block for a program between then and now. They just haven't been material enough to mention. As you know, we have a disciplined process around REACs, and if we have to make adjustments, we do. So you kind of got it right on there. We had a significant adjustment. We've made smaller, less material adjustments between now and then, and we're very comfortable with where we are right now.

Thanks, guys.

Yeah.

Thank you, Mr. Karnak. The next question comes from the line of Noah Poppenock with Goldman Sachs. You may now proceed.

Hey, good morning, everyone. Morning. I guess at this point, should we expect the shipbuilding margin to be up or down in 2024?

Well, I absolutely think not getting guidance for 24 yet, but I expect it to improve. I expect both shipyards to execute, barring any unforeseen labor issues or supply chain issues or macroeconomic issues, all things being equal, I expect it to be up. But we're not giving formal guidance on 2024 yet. Okay.

I'll reiterate that. I'll reiterate that, too. We've told you where we want to take it to. We haven't told you when because of the environment that we operate under. Three variants of the COVID virus, inflation, unforeseen inflation from a couple years ago, and then the tightness of the labor market going back two years, and as we work ourselves through the back end of that right now, you know, it just creates headwinds into the market. We try to be as transparent with you as possible. We set our objectives and share our forecasts, and we have plans behind us to kind of make them, and then we've got to fight through new risks We've got to find other opportunities, but clearly we anticipate to incrementally expand our margin performance going forward.

Appreciate that. Thanks, Noah. Is it possible to give more specifics on maintaining margin and cash flow on CBN 79 while moving the schedule? Just if you can give us more detail on how that happens. And is that true year by year in the remainder or just in the full aggregate of the remainder?

Yeah, so as Tom mentioned in his remarks, we need to keep that financially neutral. And so as we come through that Class 1 change, that's the objective. So the team's working on ensuring that on an annual basis or annualized basis, we keep cash and margin kind of in a neutral place and risk in a neutral place from where we were today.

Okay. And Tom, you walked through the good quarter at MT, but in your QQ guide, you've got it back to flat year-over-year and the margin a little lower sequentially. Just what's behind that? And then I guess maybe just what's your latest thinking on the longer-term margin potential of the segment?

Yes, I think that's just being conservative on where we are in timing. We'll see how that plays out. You know, the quick turn quarters, especially in that business where the contract duration is shorter, a potential for re-competes and wins and when programs pop online and things of that nature. So I think it's just us being more conservative. You know, at our position for Q1, you know, the run rate at that is 2496. We got a 2.5 for the year. Feeling good about that. It's the largest quarter by far that MT has had with a line on it. And the 5.8% growth is fantastic. And then each of the business units growing is a great sign, too. And that's two quarters in a row of that happening. So I think there's some really good positive signs there. We don't want to overcommit. And that business is highly competitive. There's a lot of proposal work in there, plus $60 billion of proposals. Half of that's qualified. a lot of moving pieces on when things either get awarded or delayed or extended or option year exercise. So we're just being conservative on how that plays out. I do think as we, as I mentioned about restructure in the review mirror and the team even more focused and experienced working together over there, the additions of the chief technology officer that we have here, Eric Tuning, as being from executive BS&D, all those will help us mature that portfolio over there. So I do anticipate that although the portfolio has a lot of cost type contracts in it, I think we'll see as we move forward a push for more products and services, more technology than just the service side, and that will have a natural lift too in the profitability in there. So the guide we gave you was 8% to 10% EBITDA when we purchased the line, and that construct still holds here. and expectation that we'll grow that up over the next couple of years.

No, I would mention between Q1 and Q2, there are some contracts within mission technologies that are relatively lumpy in nature when you book the margin. So that's why the lower guide in Q2 from a margin standpoint.

Okay. Okay. Thanks very much.

Thanks, Noah.

Thank you, Mr. Papanak. The next question comes from the line of Scott Deschelle with Credit Suisse. You may now proceed.

Hey, good morning. Tom, does the back half margin guide accommodate for the risk of additional negative EACs like we saw this quarter on CBN 80?

So that's a very specific question. I would tell you that each quarter, you know, once we come through our DSE analysis, we evaluate performance, existing costs, we update our projections going forward, we evaluate material, labor costs, schedule, and overhead. All that goes into the construct of coming up with the booking rate. And then from there, we update our sets of opportunities and risks against that forecast. And from there, we'll make a determination of what the forecast is for ourselves and out to the street here. So I would tell you that There's always the potential to either exceed the forecast or underrun it. Specifically, we think we've booked the risk on the CB&AD outsourcing project accordingly, so I would not anticipate that to continue to bleed. If anything, I'd like to see us do better than what we have in the plan right now from a risk mitigation standpoint. But I think the guidance still holds that I gave you. Between 7.7% and 8%, the back half will be better, and we'll just watch that play out.

Okay. And then, Chris, can you help reconcile the improved hiring and attrition trends you've noted with the increased outsourcing on CV and AD that drove the negative EAC? I'm just trying to understand why you needed to do the unplanned outsourcing if hiring and attrition did track better.

Yeah, that's a really good question. And so when you're putting in your plans, you're projecting what your workload is going to be and what your labor is going to be. And it just made good sense to, you know, over the last year or so, put together outsourcing plans. And the risk showed up when we finally rationalized and realized the cost estimate for that outsourcing, we needed to incorporate it into our EACs. So it's all in the mix together, and it's all related. Still positive on a labor front, but we still needed to do that outsourcing on 80. Okay.

And then last question, a kind of bigger picture, but if you priced your fixed price contracts assuming wage inflation would be at a low single-digit rate and it's a mid to high single-digit rate instead, I'm just trying to understand mechanically how this can still be a 9% margin of business until you burn through a lot of the $47 billion backlog, which I assume would take another four to five years. I'm just trying to understand the mechanics of how that works. Yeah, sure. Sure.

Sure, I can start and then potentially Tom. But remember, we do have EPA protection at Ingalls and some EPA protection at Newport News, and we do have long-term labor agreements in place both at Newport News and Ingalls. So that mitigates it to some extent.

I'd comment on that front, too. We do have the $47 million backlog. Only 55% of it's funded. That's one. There's other areas there, whether they're going to get finalized, negotiated, or exercised. Two is, as Chris said, about 45% of our workforce, we do have union agreements, so I know what I'm paying on that front. Much of the work we do, we've talked in the past about long-lead contracts, advanced procurement contracts. We really make sure we get current bids that we can both use in the proposal, get the advanced procurement turned on, and then immediately exercise those bids and get the contractors locked into fixed price on the large material components. Most of Engel's contracts have EPA provisions, which is 90-10 fixed price, and then the Newport News where it's more 50-50 cost type. The cost will be recognized against those cost type contracts. A lot of things are in play. I'm with you that there was an expectation on inflation, and for any long, long-term contract that was put on before, without EPA, the material could have some exposure. These are the headwinds that we talk about that we try and fight through, but then there's other avenues and ways to get contract adjustments, incentives, work through, work around, or realize more opportunity than risks to still maintain and improve our profitability.

All right, appreciate the detail. Thanks, guys.

Thanks, Scott.

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

All right, thank you for your interest in HI today. We look forward to continuing to engage with all of you. Thank you.

That does conclude today's conference call. You may now disconnect your lines.