Huntington Ingalls Industries Inc

NYSE:HII

Earnings Call Transcript 2022-Q2

[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 session. [Operator Instructions] Please be advised that today's conference call is being recorded. [Operator Instructions]

I would now like to hand the call over to Christie Thomas, Vice President of Investor Relations. Mrs. Thomas, you may begin.

[Christie Thomas, Vice President-Investor Relations]

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

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

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

[Chris Kastner, President and Chief Executive Officer]

Thanks Christie. Good morning, everyone. And thank you for joining us on today's call. Before discussing the results, I would like to thank each of our 44,000 employees for the work they do every day as they remain focused on our operational pillars of safety, quality, cost, and schedule and driving the delivery of our customer commitments. Today, we reported another quarter of solid performance across each of our operating segments. These results reflect our continued focus on operational execution.

Starting with our results on Page 3 of the presentation, sales of $2.7 billion for the quarter or 19.3% higher than 2021. And diluted EPS was $4.44 for the quarter, up from $3.20 in 2021. New contract awards during the quarter were approximately $2 billion, which results in backlog of approximately $47 billion at the end of the quarter, of which $24.6 billion 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 procurement contract for LPD 32. Additionally, progress continues on LHA 8 Bougainville and long-lead material procurement continues for LHA 9, with the detailed design and construction contract award expected later this year.

On the DDG program, DDG 121 Frank E. Petersen Jr. sail away this quarter and serial production continues on DDG 123 and subsequent DDGs. On the NSC program we launched and christened NSC 10 Calhoun this quarter. At Newport News, submarine care and carrier construction and maintenance programs continued to progress. On the VCS program as discussed in the first quarter call, SSN 796, New Jersey floated off in April. In addition, SSN 798, Massachusetts achieved pressure hole complete in the quarter and the remaining Block 4 and Block 5 boats continue to make progress.

On CVN 79 Kennedy, we turned over the 1000th compartment to the Navy last month and we will ramp the testing program later this year. CVN 80 Enterprise is beginning to take shape in the drydock and early unit construction has begun on CVN 81 Doris Miller. On the RCOH program CVN 73, USS George Washington continues to make progress on the testing phase and redelivery is now expected in the first quarter of 2023. CVN 74, USS John C. Stennis continues to make progress and pre-advanced planning is underway on CVN 75, USS Harry S. Truman.

Regarding our shipbuilding labor, ensuring our shipyards have the necessary workforce to execute our backlog remains a key risk and focus area. We have hired over 2,000 craftsmen and women through 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.

Even in this current tight labor environment, we have continued to successfully bring shipbuilders on board and utilize our training programs and 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 a long shipbuilding construction schedule into phases, the varying 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 provide feedback on progress and performance. 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, a progress towards delivery of these important assets.

Moving to our mission technologies segment, we successfully demonstrated the prototype platform, the Pharos system, which has capabilities for launching, operating with and retrieving unmanned underwater vehicles from an amphibious ship. 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 Forces Distributed Mission Operations prime contract. This award is a key win in our strategy to expand our live virtual constructive customer base beyond the Navy to the air force and other services.

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 a total ceiling value of over $800 million. And this win is particularly important for further validating our investment thesis, which is bringing together the innovation and technical expertise of legacy alliance 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. However, we continue to have a very large pipeline that creates significant opportunity for bookings and sales growth. In that regard, heading into the third quarter, our mission technologies pipeline stands at $61 billion with $26 billion of qualified pipeline. The DMATS award another expected award will drive up our book-to-bill ratio, which was 0.8 for the second quarter. All-in-all, I'm very pleased with the direction of mission technologies segment. And I'm excited about the growth opportunities in areas that support our customers’ critical needs.

Turning to activities in Washington. The President submitted his fiscal year 2023 budget request in March, which is now under consideration by Congress. As bill progressed through both chambers, we continue to see bipartisan support for our programs reflected into defense appropriations and authorization bills in the House and the Senate. We are very pleased to see the strong support of our ship building programs in the draft Senate appropriations bill released last week. This bill includes an additional Arleigh Burke-class destroyer, $250 million for LPD 33 advanced procurement and $289 million for LHA-10. And continues the serial production of submarines, destroyers and amphibious warships that leverages production lines and supply chains to efficiently produce the ships our nation requires. The two authorization committees have also shown strong support for ship building to include adding LPD 33 advanced procurement funding authority and requiring 31 amphibious warfare ships in the Naval combat force. Both appropriations bills and both authorization bills include language in support of a DDG-51 multi-year procurement contract in FY 2023 and provide additional support and funding for the submarine industrial base.

We are pleased with the legislative support our programs have received thus far and final outcomes will depend on eventual respective conference negotiations between the appropriations and authorization committees. And now I will turn the call over to Tom for some remarks on our financial results. Tom?

[Tom Stiehle]

Thanks, Chris and good morning. Today, I will briefly review our second 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 6 of the presentation, our second quarter revenues of $2.7 billion increased approximately 19% compared to the same period last year. This increased revenue was attributable to the acquisition of Alion in the third quarter of 2021, as well as the growth in aircraft carrier revenue in Newport News Shipbuilding.

Operating income for the quarter of $191 million increased by $63 million or 49% from the second quarter of 2021. And operating margin of 7.2% increased 144 basis points. These increases were largely due to a higher segment operating income driven by higher risk retirement and favorable changes in contract estimates, both at Ingalls and Newport News Shipbuilding. As well as a higher non-recurring equity income at Mission Technologies related to our investment in a ship repair and specialty fabrication joint venture. Results were additionally supported by more favorable non-current state income taxes and operating FAS/CAS adjustment compared to the prior period.

Other net expense was $10 million in the quarter, which was primarily driven by losses 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 19.9% in the second quarter of last year. Net earnings in the quarter were $178 million compared to $129 million in the second quarter of 2021, diluted earnings per share in the quarter was $4.44 compared to $3.20 in the second quarter of the previous year.

Moving onto Slide 7, Ingalls revenues of $658 million in the quarter decreased $12 million or 1.8% from the same period last year, driven primarily by lower revenues on the DDG program, partially offset by high amphibious ship revenues. Ingalls operating income of $106 million 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 $1.4 billion increased by $70 million or 5.1% from the same period last year due to higher aircraft carrier revenues, partially offset by lower naval nuclear support services. Newport News operating income of $94 million 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 million increased $363 million compared to the second quarter of 2021, primarily driven by the acquisition of Alion in the third quarter of last year. Mission Technologies operating income up $25 million compared to operating income of $13 million in the second quarter of last year. Second quarter 2022 results included a non-recurring gain of approximately $15 million related to higher equity income from our ship repair and specialty fabrication joint venture of which we are a minority owner. Additionally results included approximately $24 million of amortization of Alion-related purchase of intangible assets. Mission Technologies, EBITDA margin in the second quarter was a robust 10.7%.

Turning to Slide 8, cash provided by operations was $267 million in the quarter and net capital expenditures were $59 million or 2.2% of revenues, resulting in free cash flow of $208 million. This compares to cash from operations of $96 million, net capital expenditures of $73 million or 3.3% of revenues and free cash flow of $23 million in the second quarter of 2021.

Cash contributions to our pension and other post-retirement benefit plans were $11 million in the quarter of which less than $1 million were discretionary contributions to our qualified pension plans. During the second quarter, we paid dividends of $1.18 per share of $47 million. We also repurchased approximately 80,000 shares during the quarter at an aggregate cost of approximately $17 million.

Turning to Slide 9, we are reaffirming our 2022 ship building 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 $2.4 billion and $2.6 billion. This revision is a function of a slower award in contracting environment than we had initially expected and precipitated by the continuing resolution to start the year. That said we remain very confident and excited by the growth opportunity we see ahead for Mission Technologies.

Regarding our near-term outlook, our second quarter 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 ship building milestones we expect to achieve in 2022 are waited towards the fourth quarter. Given that backdrop, we expect the third quarter ship building revenue to be relatively flat sequentially and ship building 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 third quarter 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 targets, we remain confident in our free cash flow target of $3.2 billion from 2020 through 2024. This outlook does assume the continued expensing of research and development costs for tax purposes. As a reminder, we believe the impact to 2022 free cash flow would be approximately $100 million if the current R&D amortization treatment remains in place.

On Slide 10, we have provided a walk 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 third quarter, given this dynamic and the lack of milestones in the third quarter, we expect free cash flow to be minimal. As a result, we do expect robust free cash flow generation in the fourth 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, our reserve and update to our free cash flow guidance until that is completed and we'll have more details on our third quarter 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 2024. This is a significant commitment, which should result in increased share repurchases, particularly in 2024, after we reached our desired debt level.

To summarize, this was a strong quarter and we are pleased with our progress as we continue to navigate a challenging operating environment. With that, I'll turn the call back to Chris for some final remarks before we take your questions.

[Chris Kastner, President and Chief Executive Officer]

Thanks Tom. In conclusion, I will wrap up on Slide 11 with the key tenants of our investment thesis. First we're focused on execution of our significant backlog, which provides meaningful earnings and cash flow. This coupled with our consistent long-term ship building growth profile and high growth opportunities in Mission Technologies positions us to deliver significant free cash flow and generate value for our employees, customers, and shareholders. Now I'll turn the call over to Christie for Q&A.

[Christie Thomas, Vice President-Investor Relations]

Thanks, Chris. [Operator Instructions] Operator, I will turn it over to you to manage the Q&A.

[Operator]

Thank you. [Operator Instructions] Our first question comes from Robert Springer from Melius Research. Robert, please go ahead.

[Robert Springer, Melius Research]

Good morning.

[Chris Kastner, President and Chief Executive Officer]

Good morning, Rob.

[Robert Springer, Melius Research]

Chris 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 ship building 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?

[Chris Kastner, President and Chief Executive Officer]

Yeah, that's a good question. This is Chris I'll start and then Tom can finish here. That was a bit of an acceleration in that milestone so we got some benefit in Q2, but labor, as I indicated previously is our greatest risk, what we're watching across the portfolio, in ship building, we've hired 2,000 to over to 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. So they started to come back and work overtime, which helps to offset it, but labor remains our large risk. So I'll kick it over to Tom.

[Tom Stiehle]

Sure. 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 121 post-delivery, clean up LPD-28 and LPD-29s, some additional risk retirements. And then on the large deck, we saw like a couple of dollars that popped into Q2 there. I 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 there is the back half of the year to play out as Chris has, we're watching higher 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 in that front.

[Robert Springer, Melius Research]

So just on the back of that, I mean, it sounds like you'd have upside otherwise, but how do we quantify what this leased 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?

[Chris Kastner, President and Chief Executive Officer]

Yeah, that's a great question. Obvious we're fortunate in that we have labor agreements for our own employees, but leased labor can be 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 leased labor overtime in your EACs and that's been reflected in our margin profile. So I think it's a great question. You have to be mindful of that.

[Robert Springer, Melius Research]

Okay. Thanks very much.

[Operator]

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

[Pete Skibiski, Alembic Global]

Hey, good morning guys. Tom, I guess on, on the expectation that share repurchase will ramp in 2024, I think you mentioned we should – when 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?

[Tom Stiehle]

That's correct. You can see we're on a cadence here about $100 million, a quarter for 100 year. We'll continue to go do that in 2022, 2023 we pay down the two-year bond, 2023, the term loan gets paid off in completion in Q3 and you can see that. So we'll follow our capital allocation policy that we have. We'll continue to keep the yard up and running. We don't see any holes in the portfolio from an M&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 desk slug that I've talked about will just kind of transition into repos if we don't have anything better to do with cash.

[Pete Skibiski, Alembic Global]

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

[Chris Kastner, President and Chief Executive Officer]

Yeah. So definitely some positive momentum, we're about halfway through. We like to say that it's a long process, positive momentum on LHA-10, acceleration LPD-33 and some really positive developments by the navy and the Marine Corps on establishing 31 amphibious, which provides some clarity from a planning standpoint. So yeah, positive momentum but we need to get through the process to completion. It solidifies the revenue profile that’s coupled with DDG 51, the 2023 multi-year that we're working on. All of that, all that activity within the 2023 budget really solidifies the Ingalls revenue profile moving forward.

[Pete Skibiski, Alembic Global]

Great, thanks guys.

[Chris Kastner, President and Chief Executive Officer]

Thanks.

[Operator]

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

[Robert Stallard, Vertical Research Partners]

Thanks so much. Good morning/

[Chris Kastner, President and Chief Executive Officer]

Good morning.

[Robert Stallard, Vertical Research Partners]

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

[Chris Kastner, President and Chief Executive Officer]

Yeah. So it's over the last couple years, we do have a newer and greener workforce and we work 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 ship builders are very productive. 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 years.

[Robert Stallard, Vertical Research Partners]

Okay. And then quick follow-up for Tom, I was wondering if you could give us the latest prognosis on the pension, given that all the markets moves we see and also because base rates going higher?

[Tom Stiehle]

Yeah. Sure. So appreciate the question. It is volatile out there, both on the capital front, 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. And 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 provide an update on our Q3 call for 2022 and then the outlook for 2023.

[Robert Stallard, Vertical Research Partners]

Okay. That's great. Thank you.

[Operator]

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

[Seth Seifman, JPMorgan]

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

[Tom Stiehle]

Sure. Great, Seth. Yeah it's net of $68 million, it was 106 favorable, 38 unfavorable and on the net for $68 million, it was split between Ingalls, Newport News and Mission Technologies a ratio of 80:15:5, so 68 net 80:15:5.

[Seth Seifman, JPMorgan]

Cool, very good and just as a quick follow-up appreciate the some of the pace of contracting activity in Mission Technologies and we've seen it in other companies in 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 the – not only did the guidance come down a little bit for the year, but the quarter itself fell a little bit short and so how you – what gives you confidence in sort of the remainder of the year there?

[Chris Kastner, President and Chief Executive Officer]

Yeah, 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 was a lot of opportunity in this space. It has started slow for the beginning of the year, but the wind of DMATS which will help backlog and then book-to-bill in Q3 and the win of the LVC contract with the air force, which really transition to legacy established program from the Navy established that over that end of the air force, which will allow us to sell to other services as well.

It is a really good indicator that things are hopefully starting to break loose and really validates our strategy for the Alion acquisition. So we are seeing some things break loose. 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.

[Tom Stiehle]

Yeah, sure. So just from a baseline perspective on this question, it was $590 million in the first quarter we had gotten about 5% on $620 million, we did stop in light here at $600 million, so we finished the year off just at under $1.2 million with a run rate at like $23.80 million[ph] against initial guidance of $2.6 billion, so that's background. Going forward we do think that we'll see for Q3 a run rate here of what we said the growth would be, which would be 7% to 9%. I don't know if you noticed enough, but in the PowerPoint briefing up front, we added Mission Technology slide and how we look at that business.

Alion has a legacy process there, very robust on their pipeline and how they handle their work. Exploratory, $61 billion down to $27 billion on the Exploratory side, 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 have been a little bit slower than we thought.

We have seen some awards that popped on here in the end of Q2 timeframe. 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 there. 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.

But we still have the $2.4 billion to $2.6 billion. We haven't let go of the top end, depending on a couple of awards, which the awards will really affect next year sales and this, and filling the seats that are unoccupied. We believe that we're still in the range there between $2.4 billion and $2.6 billion.

[Seth Seifman, JPMorgan]

Great. Thanks for the detailed responses. Thank you.

[Operator]

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

[Gautam Khanna, Cowen]

Hey, good morning guys.

[Chris Kastner, President and Chief Executive Officer]

Good morning Gautam.

[Gautam Khanna, Cowen]

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 EAC in this quarter. Just where are we on the program relative to your expectations? And if you could just maybe give us some color on what your accrual rate might be so that we should either be…

[Chris Kastner, President and Chief Executive Officer]

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

[Gautam Khanna, Cowen]

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

[Chris Kastner, President and Chief Executive Officer]

Okay, great. Yes, so the VCS program, I would characterize that as stable from a scheduling standpoint and over the last few quarters, pretty stable from a EAC standpoint actually. There's always minor adjustments from quarter-to-quarter but I think some of the data you may be referencing is a bit dated as you know, we do quarterly EACs. 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 dedicated to getting it right. They're making progress. There's some potential momentum within Block 4 which we ought to translate into Block 5. I think there's some upside in Block 5.

So I think the team is very focused. I think they're working the operating system very well. We need to get back to two per year. 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.

[Tom Stiehle]

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 cadences launch and sell off a ship a year. There was already a list and a risk and a hiring ramp right there, obviously in 2020 after two quarters of that, it kind of midyear we saw with COVID impacting us.

And then obviously, that continued without a prime into 2021. So there's been pressure on the program from what was the baseline of already being able to do two plus one between those two programs, hiring ramp with more junior people on board. And then that line that we've talked about in the 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.

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 order was possible and how we could recover or we'll finish off the back end of Block 4 as that translates into Block 5. So I think as Chris says, we're relying on operating system, we're trying to stay to our manning 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. 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, a run-out, reevaluating our booking rates, the changes on that large. So you don't see them on the downside there, but we do have incremental changes from quarter-to-quarter here. So possible with where we're booking these ships right now.

[Gautam Khanna, Cowen]

Thank you very much, guys.

[Operator]

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

[George Shapiro, Shapiro Research]

Yes. Good morning,

[Chris Kastner, President and Chief Executive Officer]

Good morning.

[Tom Stiehle]

Good morning.

[George Shapiro, Shapiro Research]

My question is if you take your EACs, it would imply the underlying margin that 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?

[Chris Kastner, President and Chief Executive Officer]

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

So you may just be a little high there, but generally speaking, we've talked about the maturity, the portfolio data at Ingalls, 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'd leave you with that, George.

[George Shapiro, Shapiro Research]

Yes, no, that's really the question. If I did the numbers this quarter, it looks like it would come out to seven, nine. And like you suggest it's normally like closer to seven. So I'm just wondering if there's something unique that made this quarter out of line or is it at new run rate?

[Chris Kastner, President and Chief Executive Officer]

It's not a new run rate. It's just how the match plays out to the quarter.

[George Shapiro, Shapiro Research]

Okay. Thanks very much.

[Chris Kastner, President and Chief Executive Officer]

Thanks, George.

[Operator]

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

[David Strauss, Barclays]

Thanks. Good morning.

[Chris Kastner, President and Chief Executive Officer]

Good morning.

[David Strauss, Barclays]

Tom, wanted to ask about the free cash flow of cadence. I know you mentioned Q3 close to, I guess zero break-even 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 to 350, assuming R&D, it doesn't happen?

[Tom Stiehle]

Yes. So astute question and you're putting pieces together out there, as we highlighted in the opening comments, we did say 300 to 350, we're holding that, 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 five months of the year to play out. But right now, we do see although Q3 will be light just the way that year is playing out, Q2 and Q4 are going to be the cash flow quarters.

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 in 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&D amortization. You reference we'll see how that plays, but that could be the $100 million that we talk about as a down take this year could go away.

And if the law changes, this seems like there's some traction and momentum to get attached to a bill at the back half of the year. That changes over. We could see the 100 million go away as we force out on a downside, and then it would validate the 3.2 billion over the five years. Cash from operations was very strong in Q2. We saw some nice pickups as far as older contracts, some service contracts 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 of the year, 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 contract that I have on there for cash. And then CVN 81 is going to be able to have progress payment billings as they work through kind of getting into Q4. We have some incentives on BCF and then Laurie 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.

[David Strauss, Barclays]

Okay. Thanks. And I mean, is any of this borrowing from kind of the upside, you've talked about for 2023 going up to 750 to 800, or you think maybe there's a little bit upside, but the plans full unpack to get to those kind of numbers in 2023?

[Chris Kastner, President and Chief Executive Officer]

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 million, $50 million, $75 million 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 2023 to now. But I believe by the time we have our Q3 call in November, I have complete clarity into that and I give you more visibility to that.

[David Strauss, Barclays]

Okay. Thanks very much.

[Operator]

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

[Ron Epstein, Bank of America]

Hey, good morning guys. Maybe why don’t you just walk through a couple different programs and how things are going? In the unmanned underwater vehicle business, I mean, how's Excel UUV coming for you guys with Boeing?

[Chris Kastner, President and Chief Executive Officer]

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

[Ron Epstein, Bank of America]

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 DDG(X)?

[Chris Kastner, President and Chief Executive Officer]

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's 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, getting the design correct on the next-generation destroyer.

And I think that's a smart move. 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.

[Ron Epstein, Bank of America]

Okay. Okay. Okay. And then I might have missed this, but maybe not. Where did we stand on the Coast Guard offshore patrol cutter? Was that formally awarded yet or where did we stay on that program?

[Chris Kastner, President and Chief Executive Officer]

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 that.

[Ron Epstein, Bank of America]

Is there another opportunity for that poll in another competition?

[Chris Kastner, President and Chief Executive Officer]

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

[Ron Epstein, Bank of America]

Got it. Got it. And maybe just one last one, what – when we look down the road at maybe in future things you potentially could be bidding for, what can we be looking out for?

[Chris Kastner, President and Chief Executive Officer]

Yes. So interesting. Newport News is full, right. They've got a lot of the 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 LHAs and LPDs, they're going to be in a very good place, but they have other opportunities. They have a DDG 1000 is down there now, and they're doing some combat system upgrades for that.

And there's potential other DDG 1000 work that might be available. And then other 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.

[Ron Epstein, Bank of America]

Okay, great. Thank you.

[Chris Kastner, President and Chief Executive Officer]

Sure.

[Operator]

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

[Chris Kastner, President and Chief Executive Officer]

Okay. Thank you for your interest in HII. 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.