Huntington Ingalls Industries Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
August 4, 2022

There are 12 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Second Quarter 2022 HII Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference call is being recorded. I would now like to hand the call over to Christie Thomas, Vice President of Investor Relations. Ms.

Operator

Thomas, you may begin.

Speaker 1

Thank you. Good morning, and welcome To the Huntington Ingalls Industries 2nd quarter 2022 earnings conference call. With us today are Chris Kastner, President and Chief Executive Officer and Tom Seeley, Executive Vice President and Chief Financial Officer. As a reminder, statements made in today's call that are not historical fact are considered forward looking statements and are made pursuant to the Safe Harbor provisions of federal securities law. Actual results may differ.

Speaker 1

Please refer to our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results. Also in their remarks today, Chris and Tom will refer to certain non GAAP measures. Reconciliations of these metrics to the comparable GAAP are included in the appendix of our earnings presentation that is posted on our website. We plan to address the posted presentation slides during the call to supplement our comments. Please access our website athii.com and click on the Investors link to view the presentation as well as our earnings release.

Speaker 1

With that, I will turn the call over to our President and CEO, Chris Kaffner. Chris?

Speaker 2

Thanks, Christy. Good morning, everyone, and thank you for joining us on today's call. Before discussing the results, I would like to Safety, quality, cost and schedule and driving the delivery of our customer commitments. Today, we reported another quarter of solid performance across These results reflect our continued focus on operational execution. Starting with our results on Page 3 of the presentation, sales of $2,700,000,000 for the quarter were 19.3% higher than 2021 And diluted EPS was $4.44 for the quarter, up from $3.20 in 2021.

Speaker 2

New contract awards during the were approximately $2,000,000,000 which results in backlog of approximately $47,000,000,000 at the end of the quarter, Of which $24,600,000,000 is currently funded. At Ingalls this quarter, LPD 29, Richard M. McCool Jr. Was christened And serial production continued on LPD 30 Harrisburg and LPD 31 Pittsburgh. We were also awarded the advanced Additionally, progress continues on LHA 8 Bougainville and long lead material Procurement continues for LHA9 with a detailed design and construction contract award expected later this year.

Speaker 2

On the DDG program, DDG-one hundred and twenty one, Frankie Peterson Jr. Sailed away this quarter and steel production continues On DDG-one hundred and twenty three and subsequent DDGs. On the NSC program, we launched and christened NSC-ten Calhoun this quarter. At Newport News, submarine and carrier construction and maintenance programs continue to progress. On the VCS program, as discussed in the Q1 call, SSN 796 New Jersey floated off in April.

Speaker 2

In addition, SSN 798 Massachusetts achieved pressure hull complete in the quarter And the remaining Block IV and Block V boats continue to make progress. On CVN 79 Kennedy, we turned over the 1,000th compartment to the Navy last month and we will ramp the testing program later this year. CVN-eighty Enterprise is beginning to take shape in the dry dock and early unit construction has begun on CVN-eighty one Doris Miller. On the RCOH program, CVN-seventy three, USS George Washington continues to make progress on the testing phase and redelivery is now expected in the Q1 of 2023. CVN-seventy four USS John C.

Speaker 2

Stennis continues to make progress and pre advanced planning is underway on CVN-seventy five USS Terry S. Truman. Regarding our shipbuilding labor, ensuring our shipyards have a necessary workforce To execute our backlog remains a key risk and focus area. We have hired over 2,000 craftsmen and women To the first half of the year against our full year plan of 5,000. While hiring is behind plan, we are making up this deficit Using outside lease labor and overtime.

Speaker 2

Even in this current tight labor environment, we have continued to successfully bring shipbuilders on board And utilize our training programs in apprentice schools, which has positioned us to execute on our commitments. Now I want to take a moment to discuss the improvements to our execution operating system in the shipyards. Our operating systems utilizes the best practice at each shipyard And allows our leaders and craftsmen across all programs to speak the same language, be predictable and relentlessly focused on execution. For example, the operating system breaks the long shipbuilding construction schedule into phases that vary in duration, but are generally 10 to 12 weeks and allows focus on the commitments and the critical path items to be accomplished in that phase. It also includes a common set of metrics and processes that provides feedback on progress and performance.

Speaker 2

I expect continued improvement of our operating system to drive our shipbuilding margin expansion opportunities And to take advantage of our significant backlog. The operating system also provides transparency to our customer of progress towards delivery of these important assets. Moving to our Mission Technology segment. We successfully demonstrated the prototype platform, the FARO system, which has capabilities for launching, operating with and retrieving unmanned underwater vehicles from an amphibious This achievement, which leveraged expertise across HII segments, reflects our commitment To delivering advanced technologies and multi domain capability to support our national security customers. We also were awarded the Mobility Air And our live virtual constructive customer base beyond the Navy to the Air Force and other services.

Speaker 2

Turning to slide 5, we have provided a Snapshot of the Mission Technologies pipeline. Among recent contract awards, we were just awarded a task order, Decisive Mission Actions and Technology Services or DMATs to integrate new technology and capabilities and identify and characterize threats in support of the Department of Defense for the purpose of countering and deterring current and emerging global threats. This contract has Total ceiling value of over $800,000,000 and this win is particularly important for further validating our investment thesis, which is bringing together the innovation and technical expertise of legacy Allian with the depth and infrastructure breadth Of HII. This will create opportunity and value for our customers, shareholders and employees more than either company could have achieved on its own. While these strategic synergy wins are very positive, we continue to see contract award delays pressuring timing of current year revenues.

Speaker 2

However, we continue to have a very large pipeline that creates significant opportunity for bookings and sales growth. In that regard, heading into the 3rd quarter, Our Mission Technologies pipeline stands at $61,000,000,000 with $26,000,000,000 of qualified pipeline. The DMAT award and other will drive up our book to bill ratio, which was 0.8 for the 2nd quarter. All in all, I'm very pleased with the direction of And I'm excited about the growth opportunities in areas that support our customers' critical needs. Turning to activities in Washington.

Speaker 2

The President submitted his fiscal year 2023 budget request in March, which is now under consideration by Congress. As bills progress through both chambers, we continue to see bipartisan support for our programs reflected in the defense appropriations and authorization bills We are very pleased to see the strong support of our shipbuilding programs in the draft Senate Appropriations Bill released last week. This bill includes an additional Arleigh Burke class destroyer, dollars 250,000,000 for LPD33 advanced procurement and $289,000,000 for LHA10 and continues the serial production of submarines, destroyers An amphibious warships that leverages production lines and supply chains to efficiently produce the ships our nation requires. The 2 authorization committees have also shown strong support for shipbuilding to include adding LPD33 Advanced Procurement Funding Authority and requiring 31 amphibious warfare ships in the naval combat force. Both appropriation bills and both authorization bills include language in support of a DDG 51 multiyear procurement contract in FY 'twenty three and provide additional support and funding for the submarine industrial base.

Speaker 2

We are pleased with the legislative support And now I will turn the call over to Tom for some remarks on our financial results. Tom?

Speaker 3

Thanks, Chris, and good morning. Today, I will briefly review our Q2 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 6 of the presentation, our 2nd quarter revenues of $2,700,000,000 increased approximately This increased revenue was attributable to the acquisition of Align in the Q3 of 2021 as well as the growth in aircraft carrier revenue in Newport News Shipbuilding. Operating income for the quarter of 191 Increased by $63,000,000 or 49 percent from the Q2 of 2021, and operating margin of 7.2% increased 144 basis points.

Speaker 3

These increases were largely due to a higher segment operating income driven by higher risk retirement and favorable changes in contract estimates In a ship repair and specialty fabrication joint venture. Results were additionally supported by more favorable noncurrent state income taxes and operating fast on investments in marketable securities given negative asset returns in the quarter. Our effective tax rate in the quarter was approximately 19.8% compared to $129,000,000 in the Q2 of 2021. Diluted earnings per share in the quarter was $4.44 compared to 3 point $0.20 in the Q2 of the previous year. Moving on to Slide 7, Ingalls revenues of $658,000,000 in the quarter decreased 12,000,000 1.8% from the same period last year, driven primarily by lower revenues in the DVG program, partially offset by higher amphibious ship revenues.

Speaker 3

Ingalls operating income of $106,000,000 and margin of 16.1% in the quarter were up significantly from last year Due to favorable changes in contract estimates as well as higher risk retirement on the LPD program, partially offset by lower DDG risk retirement. At Newport News, revenues of $1,400,000,000 increased by $70,000,000 or 5.1 percent from the same period last year due to higher aircraft carrier revenues, Newport News operating income of $94,000,000 and margin of 6.6% were up from last year primarily due to favorable changes in contract estimates, partially offset by lower risk retirement on VCS program. At Mission Technologies, revenues of $600,000,000 increased $363,000,000 compared to the Q2 of 2021, primarily driven by the acquisition of Align in the Q3 of last year. Mission Technologies operating income of $25,000,000 compares Operating income of $13,000,000 in the Q2 of last year. 2nd quarter 'twenty two results included a nonrecurring gain of approximately $15,000,000 related to higher equity income from our ship repair and specialty fabrication joint venture, of which we are a minority owner.

Speaker 3

Additionally, results included approximately $24,000,000 of amortization of Alliant related purchased intangible assets. Mission Technologies EBITDA margin in And net capital expenditures were $59,000,000 or 2.2 percent of revenues, resulting in free cash flow of 208,000,000 This compares to cash from operations of $96,000,000 net capital expenditures of $73,000,000 or 3.3 percent of revenues and free cash flow of 23,000,000 the Q2 of 2021. Cash contributions to our pension and other post retirement benefit plans were $11,000,000 in the quarter, Of which less than $1,000,000 were discretionary contributions to our qualified pension plans. During the Q2, we paid dividends of $1.18 per share or 47,000,000 We also repurchased approximately 80,000 shares during the quarter at an aggregate cost of approximately 17,000,000 Turning to Slide 9, we are reaffirming our 2022 shipbuilding sales and margin guidance as well as our Mission Technologies margin guidance And overall free cash flow expectations, while modestly revising our Mission Technologies revenue outlook given a slower start to the year. For Mission Technologies, we are revising our revenue expectation to a range of between $2,400,000,000 of a slower awarding contracting environment than we had initially expected and precipitated by the continuing resolution to start the year.

Speaker 3

That said, we remain very confident in and excited by the growth opportunity we see ahead for Mission Technologies. Regarding our near term outlook, Our Q2 results were positively impacted by higher risk retirement and favorable changes in contract estimates, particularly for LPD 30 As reflected in the Ingalls operating margin, the remaining shipbuilding milestones we expect to achieve in 2022 are weighted towards the Q4. Given that backdrop, we expect the 3rd quarter shipbuilding revenue to be relatively flat sequentially and shipbuilding operating margin to be approximately 7%. Regarding Mission Technologies, we expect results will begin to ramp more meaningfully as the pace of awards increases and expect Q3 sequential sales growth in the 7% to 9% range and operating margin in line with our full year guidance of approximately 2.5%. Regarding our longer term target, we remain confident in our free cash flow target of $3,200,000,000 2020 through 2024.

Speaker 3

This outlook does assume the continued expensing of research and development costs for tax purposes. As a reminder, we believe the impact to 2022 free cash flow would be approximately $100,000,000 if the current R and D amortization treatment remains in place. On Slide 10, we have provided a walk from our 2022 to 2024 free cash flow outlook, which is consistent with the chart we began providing earlier this year. Our strong free cash flow performance in the quarter was partially due to the pull forward from the Q3. Given this dynamic and the lack of milestones in the Q3, We expect free cash flow to be minimal.

Speaker 3

As a result, we do expect robust free cash flow generation in the 4th quarter And do see positive tailwinds on our overall 2022 free cash flow guidance. As we are in the midst of our annual long term plan update, I'll reserve an update to our free cash flow guidance until that is completed, and we'll have more details on our Q3 call. Lastly, we are reaffirming our capital allocation priorities and we are committing today to return substantially all free cash flow after planned debt repayment to shareholders through 20 This is a significant commitment, which should result in increased share repurchases, particularly in 2024 With that, I'll turn the call back to Chris for some final remarks before we take your questions.

Speaker 2

Thanks, Tom. In conclusion, I will wrap up on Slide 11 with the key tenets of our investment thesis. 1st, we're focused on execution of our significant backlog, which provides meaningful earnings and cash flow. This, coupled with our consistent long term shipbuilding growth profile and high growth opportunities in Mission Technologies, positions us

Speaker 1

Thanks, Chris. As a reminder to everyone on the call, please limit yourself to one initial 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 and A.

Speaker 3

Thank

Operator

Our first question comes from Robert Springhan from Melius Research. Robert, please go ahead.

Speaker 4

Good morning.

Speaker 2

Good morning, Rob. Chris

Speaker 4

or Tom, because you both talked about it. The strong Ingalls margin sounds like that was LPD 30 primarily, but you didn't change the shipbuilding margin guide. So I assume that was expected From the outset or does this reflect maybe some increased costs from labor and such in the back half of the year?

Speaker 2

Yes. It's a good question. I'll just Chris. I'll start and then Tom can finish here. But that was a bit of an acceleration In that milestone, so we got some benefit in Q2.

Speaker 2

But labor, as I indicated previously, is our greatest risk. What we're watching across the portfolio, in shipbuilding, we've hired 2,000 to a 5,000 Commitment. Now luckily, we have leased labor and we have overtime. And the good news there is people are actually working overtime now. Back in 2021 and after the pandemic started, it was really hard to get people to work overtime.

Speaker 2

So they started to come back and Work overtime, which helps to offset it, but labor remains our largest risk. I'll kick it over to Tom.

Speaker 3

Sure. And just additional Comment on that front is we had a milestone that LPD 30 milestone that we referenced that was planned for Q3 that accelerated to Q2, so that's the timing event. Q2 was a good quarter for Ingalls overall. They had some DDG-one hundred and twenty one post delivery Clean up LP 2829, some additional risk retirements. And then on the launch deck, we saw like a couple of dollars that popped into Q2 there.

Speaker 3

Still think on the back end, the reason why we haven't raised guidance is we don't have as many milestones. We do have DDG 123 in Q4 And it reached the back half of the year to play out. As Chris says, we're watching our labor hire and how that impacts the portfolio here right now. And as the year unfolds and we continue to retire risk, we'll provide additional guidance on that front.

Speaker 5

So just on the back of that,

Speaker 4

I mean, it sounds like you'd have upside otherwise, How do we quantify what this least labor and just labor inflation in general over time you talked about, How does that structurally change the cost of labor in the business if it lingers for a while?

Speaker 2

Yes, that's a great question. We're fortunate in that we have labor agreements for our own employees, but lease labor can be A bit more expensive. Now they don't have the benefits, so you have to trade that off a bit. So what you do is you put estimates for what you think you're going to do in lease labor and overtime In your EACs and that's been reflected in our margin profile. So I think it's a great question.

Speaker 2

You have to be mindful of that.

Speaker 4

Okay. Thanks very much.

Operator

Thank you. Our next question comes from Pete Skibitski from Alembic Global. Pete, please go ahead.

Speaker 6

Hey, good morning, guys.

Speaker 3

Good morning, Pete.

Speaker 6

Tom, I guess on the expectation that share repurchases will ramp in 2024, I think you mentioned, we should while we're trying to figure that out, the level of that, We should assume that you're going to pay off all the debt that's maturing essentially, you're not going to refinance?

Speaker 3

That's correct. As you can see, we're on a cadence here, about $100,000,000 a quarter for $100,000,000 a year. We'll continue to go do that. 'twenty two, 23, we pay down the 2 year bond. 23, the term loan gets paid off in completion in Q3 to Nikita that you can see that.

Speaker 3

So we'll follow our Capital allocation policy that we have will continue to keep the yard up and running. We don't see any holes in the portfolio from an M and A perspective and barring that there's nothing ultra attractive in that timeframe, we'll continue to provide all excess free cash flow back to the shareholders. And basically that debt slug that I've talked about will just kind of transition into repos if we don't have anything better to do with cash. Okay.

Speaker 6

Okay. Thank you for that. And then last one for me. Chris, are we how are you feeling in terms of extending the amphib Kind of life cycle at Ingalls. I know there were some concerns there on the LPD line, on the LHA line, and it seems like you're making some progress.

Speaker 6

Do you feel like you're kind of out of the woods there as long as the kind of momentum you're seeing in Congress continues?

Speaker 2

Yes. So definitely some positive momentum. We're about halfway through, right? We like to say that it's a long process. Positive momentum on LHA10 acceleration, LPD 33, And some really positive developments by the Navy and the Marine Corps on establishing 31 amphibs, which provides some clarity from a planning standpoint.

Speaker 2

So Yes, positive momentum, but we need to get through the process to completion. It solidifies the revenue profile That coupled with DDG 51, the 2023 multiyear that we're working on, all of that, All that activity within the 2023 budget really solidifies the Ingalls revenue profile moving forward.

Speaker 6

Great. Thanks guys.

Speaker 2

Thanks.

Operator

Thank you. Our next question comes from Robert Stallard from Vertical Research Partners. Robert, please go ahead.

Speaker 7

Thanks so much. Good morning.

Speaker 2

Good morning.

Speaker 7

Chris, I'll start with you, following up on the labor issues. I wonder if you could also comment not just on the numbers, For the experience and skill set of the folks you've been able to get through the door, how that compares to your target?

Speaker 2

Yes. So it's over the last couple of years, we do have a newer and greener workforce And we worked very hard to train and get that workforce ready to be productive. So it's not New or unexpected for us. We've done it before, but it definitely is a greener workforce. That's why I mentioned the operating system In my script, it's very important that you kind of get into the fundamentals and make sure that all our shipbuilders are very productive.

Speaker 2

So, But you are correct. We do have a greener workforce today, but it's not unexpected. We've seen that for the last couple of

Speaker 7

Okay. And then quick follow-up for Tom. I was wondering if you could give us the latest prognosis on the pension given all the markets moves we've seen and also

Speaker 3

Yes, sure. So, appreciate the question. It is volatile out there, both on the capital front and interest rates On the market front, right now there's a favorability for the higher discount rates, which is partially offset by the unfavorable returns on the assets. It's hard to predict right now how that play out by year end, but we do the re measurement at the end of the year. But consistent with the prior years, we still will

Speaker 8

Thank

Operator

you. Our next question comes from Seth Seifman from JPMorgan. Seth, please go ahead.

Speaker 9

Hey, thanks very much. Good morning. Just real quick, I apologize if I missed it, but if you could Quantify the EACs and roughly how they were allocated between the arts?

Speaker 3

Sure. Great, Seth. Yes, it's net it was $68,000,000 net, it was $106,000,000 favorable, dollars 38,000 unfavorable. And on the net for $68,000,000 it was But between Ingalls Newport News and Mission Technologies are a ratio of 80, 15.5. So it's 68 net, 80, 15.5.

Speaker 9

Cool. Very good. And just as a quick follow-up, appreciate some of the Case of contracting activity in Mission Technologies and we've seen it in other companies in the IT Services space. But I guess if you could speak to the level of quarterly visibility that you have in that business, just given That's a not only did the guidance come down a little bit for the year, but the quarter itself fell a little bit short. And How you what gives you confidence in sort of the remainder of the year there?

Speaker 2

Yes. So I'll start and I'll let Tom. In the pipeline within our presentation because we wanted to make sure everybody understood that there's a lot of It has started slow for the beginning of the year, but the win of DMATs, which will help backlog And book to bill in Q3 and the win of the LVC contract with the Air Force, which really transitions a legacy, established Program from the Navy established over that end of the Air Force, which will allow us to sell to other services as well. It's a really good indicator that Thanks for hopefully starting to break loose and really validates our strategy for the Alliant acquisition. So We are seeing some things break loose.

Speaker 2

We're going to have to see how that translates into revenue. But I'll let Tom talk about how it's distributed by quarter.

Speaker 3

Yes, sure. So just from a baseline perspective on this question, it was 5.90 in the Q1. We had guided about 5% on 6.20. We did top in light here at 600. So we finished the year up just under 1.2 with a run rate at like 23.80 against initial guidance of 2.6.

Speaker 3

So that's background. Going forward, we do think that we'll see for Q3 a run rate what we said the growth would be, which would be a 7% to 9%. I don't know if you noticed it up, but in the PowerPoint briefing upfront, we added emission technology slide and how we look at that Yes. Lyon has a legacy process there, very robust on their pipeline and how they handle their work. Exploratory, dollars 61,000,000,000 down to $27,000,000 on the exploratory side.

Speaker 3

They break that down to which opportunities that they can qualify And capture and then that goes into the evaluations it did. So we see that pipeline actually growing from the time that we picked them up last year. So that's a positive sign right now. As Chris said, we were impacted at the beginning of the year with the CRA. And then just the general outflow of contracting and acquisitions A little bit slower than we thought.

Speaker 3

We have seen some awards that popped on here in the end of Q2 time frame and there's still Additional opportunity that will happen on the back half of the year. So I'm still optimistic on the awards front. The other piece that holds us up there is We do have more seats than we have heads right now. So like the shipyard, there's a hiring crunch, the job market is tight, finding people with That type of background and tickets. So there's seats there we have unfilled and that brings in some variability on the sales outcome of the year.

Speaker 3

But We still have the 2.4 to 2.6. We haven't let go of the top end depending on a couple of awards, which the awards will really affect next year sales in this and filling this To see fit on occupied, we believe that we're still in the range there between $2,400,000,000 $2,600,000 All right?

Speaker 9

Great. Thanks for the detailed responses. Thank you.

Speaker 8

Sure.

Operator

Thank you. Our next question comes from Gautam Khanna from Cowen. Gautam, please go ahead.

Speaker 8

Hey, good morning guys.

Speaker 2

Good morning, guys.

Speaker 8

I was wondering if you could talk a little bit about the VCS program. There's been a lot of press and GAO and industry scuttle about the program being well behind Schedule and obviously you guys took a big charge in Q2 of 2020. It looks like there was another negative EBITDA

Speaker 2

in this quarter.

Speaker 8

Just where are we on the program relative to your expectations? And if you could maybe give us some color on what your accrual rate might be so that We should either be Yes.

Speaker 2

So thanks, Vikram. It's Yes. I'm sorry. I'll let you finish. Did you have anything else?

Speaker 8

No, please. No, that's great. Thank you.

Speaker 2

Okay. Okay, great. Yes, so the VCS program, and I would characterize that That's stable from a scheduling standpoint. And over the last few quarters, pretty stable from an EAC standpoint actually. There's always minor adjustments from quarter to quarter, but I think some of the data you may be referencing It's a bit dated.

Speaker 2

As you know, we do quarterly ACs. We incorporate the risk in all of the ships And boats on a quarterly basis. So I'm pretty comfortable with where we are From an EAC standpoint on the VCS, I don't think anything is any of us are comfortable relative to the How we performed historically on the program, we need to improve, right? I think the Newport News team is very motivated And I'm dedicated to getting it right. They're making progress.

Speaker 2

There's some potential Momentum within Block IV, which will have to translate into Block V. I think there's some upside in Block V. So I think the team is very focused. I think they're working the operating system very well. We need to get back to 2 per year.

Speaker 2

We need to get these assets back to our customer because they need them. So I would consider it stable from a schedule standpoint And we need to continue to improve from a cost standpoint. And any details, I'll send over to Tom here.

Speaker 3

Sure. Yes. I think when we took that charge back in Q2 of 2020, the preface of that was we had a list already with Columbia coming online. We saw that Ramping up and then getting to full two cadence of launch and sell off the ship a year, there was already a lift and a risk And a hiring ramp right there. Obviously, in 2020, after 2 quarters of that, it kind of mid year we saw with COVID impacting us.

Speaker 3

And then, obviously, that continued with Omicron into 2021. So, there's been pressure on the program From what was the baseline of already being able to do 2 plus ones between those two programs, hiring ramp with more junior people on board. And then that line that we've talked about in past calls is very serial in nature more than any of our other lines. Each boat goes Exactly through crew to crew. So if one boat in front of us gets impacted, it affects the line behind it, both the crews being able to cycle and then The schedule aspect of each boat.

Speaker 3

So, I think when we took that look see where we were in Q2 of 2020, we had A perspective of what was in the art of possible and how we could recover or finish off the back end of Block 4 as that It translates into Block 5. So I think as Chris said, we're relying on operating system. We're trying to stay to arm any plan that we have. We're doing lessons learned from boat to boat. We are seeing incremental improvement from operational where we were a quarter ago to now.

Speaker 3

So that's a positive sign right now. And as Chris says, we run a very rigorous EAC process and we look at our Labor and material and overhead, run as reevaluating our booking rates, The changes on that are large, so you don't see them on the downside there. But we do have incremental changes from quarter to quarter here. So I'm comfortable with where we're booking these ships right now.

Speaker 8

Thank you very much guys.

Speaker 10

Thanks, Gavin.

Operator

Thank you. Our next question comes from George Shapiro from Shapiro Research. George, please go ahead.

Speaker 5

My question is, if you take your EACs, it would imply the underlying margin at Ingalls is like 7.9%, which is generally higher than what you've seen in the past around 7 So I was just wondering, is that just unique to this quarter or is this more of an ongoing underlying margin rate?

Speaker 3

Yes, it is a little bit of a unique for this quarter. That's a high number. The run rate Ingalls is usually a lower than upper 6s and low 7s. I think just how all the math kind of played out with the performance lift. We talked about the economic adjustments that were allowed because of the clauses that we have in the contract.

Speaker 3

So, your math may just be a little high there. But generally Speaking, we've talked about the maturity of the portfolio data angles, more our serial production and follow on ships down there. So their run rate is out in front of Newport News and we generally say it's between 6% and 7%. So I leave you with that George.

Speaker 5

Yes. No, that's really the question. If I did the numbers this quarter, it looks like it would come out to 7.9%. And Like you suggest, it's normally like closer to 7. So I was just wondering if there's something unique that made this quarter Out of line or is it a new run rate?

Speaker 3

It's not a new Our run rate is just how the math plays out for the quarter.

Speaker 5

Okay. Thanks very much.

Speaker 2

Thanks, George.

Operator

Thank you. Our next question comes from David Strauss from Barclays. David, please go ahead.

Speaker 11

Thanks. Good morning.

Speaker 2

Good morning. Good morning.

Speaker 11

Tom, wanted to ask about the free cash flow cadence. I know you mentioned Q3 closed to, I guess, 0 breakeven. But I think you're still calling for a pretty meaningful working capital tailwind in the second Half of the year, it looks like CapEx might be trending towards the lower end of your range. What keeps you from coming in A decent amount above kind of the $300,000,000 to $350,000,000 assuming R and D doesn't happen.

Speaker 3

Yes. So, a few questions and you're putting pieces together out there. As we highlighted in the opening comments, we did say $3,000,000 to $3,000,000 We're holding that Right now, I do feel comfortable that with the risk we've seen behind us and in front of us, we still have like 5 months of the year to play out. But right now, we do see Although Q3 will be light, it's just the way that year is playing out. Q2 and Q4 are going to be the cash flow quarters.

Speaker 3

But I do see we've been the COVID repay is pushed to the back half of the year. And as I come through our planning process and I have the complete Visibility on how the year is going to play out. Is the COVID repay either happening this year or next year? That's more of a timing play. The R and D Amortization you referenced, we'll see how that plays, but that could be the $100,000,000 that we talked about as a downtick this year could go away.

Speaker 3

It's a lot of changes there. It seems like there's some traction and momentum to get attached to bill at the back half of the year. If that changes over, we could see the $100,000,000 go away As we foreshadow on a downside and then it would validate the $3,200,000,000 over the 5 years. Cash from operations was very strong in Q2. We saw some nice pickups as far as older contracts, some service contracts.

Speaker 3

We're able to get COVID Costs that we had on our books included in our billing rates, so that was a pickup. And that's how Q2 kind of played out. When you think about Q4 on the back half I have 123 delivery on the DDG side. I have a couple of supply Capital incentives that play out, LHA 8 billings, LHA 9 with the construction award helped clean up the long lead contracts that I have on there for cash. And then Cvent 80 1 is going to be able to have progress payment billings as they work through kind of getting into Q4.

Speaker 3

We have some incentives on VCS and then a line of Knowles kind of kick in that I'll use at the end of the year too. So A good upside potential there, but I'm not ready to call that ball until I can get through our planning process.

Speaker 10

Okay.

Speaker 11

Thanks. And I mean is any of this borrowing from kind of the upside you've talked about For 'twenty three going up to $750,000,000 to $800,000,000 or you think maybe there's a little bit of upside, but The plan is full on path to get to those kind of numbers in 2023.

Speaker 3

So just to be clear, the majority of what I talked about is in the plan and the forecast right now. Those things could kick out $25,000,000 $50,000,000 $75,000,000 upside. The tiny aspect would be the COVID Repay. So if I do not have to pay it at the end of this year, that would be a pull forward from 'twenty three to now. But, I believe by the time we have our In November, I'll have complete clarity into that and I'll give you more visibility.

Speaker 11

Okay. Thanks very much.

Operator

Thank you. Our next question comes from Ron Epstein from Bank of America. Ron, please go ahead.

Speaker 10

Hey, good morning guys. Maybe I can just walk through a couple of different programs and how things are going. In the unmanned underwater vehicle business, I mean, how's XL UPE coming for you guys?

Speaker 2

Yes. So, XL is progressing, right? We've delivered our first unit to Boeing, really Kind of a test unit. We're progressing through the other units. So it's going okay.

Speaker 2

I think normal first of question issues that you have On a new program, on a development sort of program. So it's going okay.

Speaker 10

Okay, great. And then maybe just Another program, if we can. On the next generation destroyer, where does that stand? And when do you think there'd be Competition for that and what's going on there, if you could give us an update on the DDGX?

Speaker 2

Yes. So I think you may have seen in the press, we got the next Contract for development there, kind of concept development working. I think the Navy has done some really smart things in this regard and with Bath And Ingalls working on the development of that program. I think the important thing on the DDG programs is to Ensure we don't stop building DDG-51s prior to transitioning and getting the design correct on the next generation destroyer. And I think that's a smart move.

Speaker 2

I think they're continuing with the design effort in both shipyards and we're continuing to build DDG 51. So I think it makes great sense right now.

Speaker 10

Okay. Okay. Okay. And then I might have missed this, but I just maybe not. Where did we stand on the Coast Guard Offshore Was that formally awarded yet or what it was down on that program?

Speaker 2

Yes, it was awarded. It was not awarded to us. It was disappointing. We know how to build those ships. Coast Guard is a great customer, but we were not awarded

Speaker 10

Is there another opportunity for that hole in another competition?

Speaker 2

Not sure. I mean, they're just coming through this competition for the next block of those boats. So not sure at this point.

Speaker 10

Got it. Got it. And maybe just one last one. When we look down the road at maybe some future things you potentially could be bidding for, What can we be looking out for?

Speaker 2

Yes. So interesting, Newport News is full, right? They've got a lot of work to do. They're executing on it, and their legacy programs will continue over the medium to long term actually. Ingalls is, Based on the pace of LHS and LPDs, they're going to be in a very good place, but they have other opportunities.

Speaker 2

DDG 1000 is down there now, And they're doing some combat system upgrades for that and there's potential, other DDG-one thousand work that might be available. And another repair sort of activity, but Ingalls is a pretty scrappy group. I wouldn't count them out. And with the pace of LHAs And LPDs, we've got a lot of time to figure that out.

Speaker 10

Okay, great. Thank you.

Operator

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

Speaker 2

Okay. Thank you for your interest in HAI. We welcome your continued engagement and feedback. Please have a safe and great rest of summer. Thank you.

Operator

This concludes today's call. Thank you for joining. You may now disconnect your lines.

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Earnings Conference Call
Huntington Ingalls Industries Q2 2022
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