Huntington Ingalls Industries Inc

NYSE:HII

Earnings Call Analysis

HII Reports Record Q2 Revenue and Raises Guidance

In Q2 2024, HII posted record revenue of $3 billion, a 6.8% increase year-over-year, with diluted EPS rising to $4.38 from $3.27. The Mission Technologies division led growth, with a 19% revenue increase to $765 million. Despite slight shifts in ship delivery schedules, shipbuilding margins improved to 7.4%. New contracts worth $3.1 billion raised the backlog to $48.5 billion. The company raised its Mission Technologies revenue guidance for the year by $50 million, citing robust performance and a promising $83 billion pipeline. Free cash flow for 2024 is projected at $600-$700 million.

Record Revenue and Earnings Growth

HII achieved record revenue and earnings in the second quarter of 2024. The company's total revenue amounted to $3 billion, an increase of 6.8% from the previous year. Diluted earnings per share were $4.38, up from $3.27 in the second quarter of 2023, representing a year-over-year growth of approximately 34% .

Mission Technologies Shines

The Mission Technologies division delivered its seventh consecutive quarter of record revenue, posting sales of $765 million, a 19% increase from the same period last year. This division also has a trailing 12-month book-to-bill ratio of 1.15 and a new business opportunity pipeline exceeding $83 billion, demonstrating its strong market position and growth potential .

Shipbuilding Updates

The shipbuilding division, which includes Ingalls and Newport News, delivered two ships in the quarter—LPD 29 Richard M. McCool, Jr. and SSN 796 New Jersey. Despite some scheduling adjustments, the division remains focused on labor stability and proficiency improvements. Newport News also reported revenues of $1.5 billion, up 1.7% from the previous year, while Ingalls' revenue increased by 7.2% to $712 million. However, Ingalls experienced a decrease in operating income and margin due to lower risk retirement on surface combatants .

Labor and Workforce Developments

HII continues to face challenges with labor and workforce availability but has hired over 3,800 craft personnel year-to-date. The company maintains its goal of hiring approximately 6,000 employees for the full year. Efforts are being made to attract labor by creating new manufacturing footprints in areas like Hampton Roads .

Financial Outlook and Guidance

HII is raising its revenue guidance for the Mission Technologies division by $50 million for the year. The company expects shipbuilding revenue of approximately $2.2 billion and a shipbuilding margin of around 7.8% for the third quarter. HII is also reiterating its free cash flow outlook for 2024 to be in the range of $600 million to $700 million. The company projects free cash flow to be weighted towards the latter part of the year, with strong cash collections expected in the fourth quarter .

Washington and Legislative Support

HII continues to receive bipartisan support for its defense programs, with strong backing from both chambers of Congress for the fiscal year 2025 defense appropriations and authorization bills. This includes additional funding for Virginia-class submarines, Columbia-class submarines, and amphibious ships, enhancing the company's long-term revenue visibility .

Cash Flow and Dividends

The company used $9 million in cash from operations in the quarter and paid dividends of $1.30 per share, totaling $51 million. Additionally, HII repurchased approximately 250,000 shares for about $65 million, underlining its commitment to returning value to shareholders .

Earnings Call Transcript 2024-Q2

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Second Quarter 2024 HII Earnings Conference Call. [Operator Instructions] Please be advised that today's conference 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, executive]

Thank you, operator, and good morning. I'd like to welcome everyone to the HII Second Quarter 2024 Earnings Conference Call. Joining me today on the call are Chris Kastner, our President and CEO; and Tom Stiehle, Executive Vice President and CFO.

As a reminder, statements made today that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results to be materially different from future results expressed or implied by these forward-looking statements. Please see our SEC filings for important factors that could cause our actual results to differ materially from expected results. Also in the 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 our website's Investor Relations page at ir.hii.com.

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

[Christopher Kastner, executive]

Thanks, Christie, and good morning, everyone. The HII team remains focused on executing on our programs and meeting our commitments to our customers. In the second quarter, our shipbuilding division delivered 2 ships, and our Mission Technologies business achieved another quarter of strong performance. The alignment of our products and services to the United States National Security strategy continues to provide strong visibility to our long-term revenue forecast.

To start, I'd like to discuss our results. Record second quarter revenue was $3 billion, up 6.8% from a year ago, and diluted earnings per share was $4.38 for the quarter, up from $3.27 in the second quarter of 2023. New contract awards during the quarter were $3.1 billion, which resulted in backlog of $48.5 billion at the end of the quarter, of which $27 billion is currently funded. At Mission Technologies, we had the seventh consecutive quarter of record revenue with sales of $765 million, 19% over the second quarter of 2023. In addition to very strong revenue, Mission Technologies trailing 12-month book-to-bill is 1.15, and its new business opportunity pipeline is over $83 billion. Mission Technologies continues to offer leading-edge technologies aligned with the capabilities our customers need, and this growth in a competitive sector confirms for us that our technology portfolio is ideal for today's market requirements.

In shipbuilding, we remain focused on directing our resources toward meeting our delivery commitments to the Navy. Significant efforts continue in each of our shipyards to create labor stability, improve proficiency and increase capacity, all aimed at meeting our throughput goals. The long-term investments we are making in capital and employee development, coupled with Navy industrial-based investments, will stabilize and improve performance as our portfolio shifts towards new contracts, and our ability to meet scheduled projections and performance goals will support achievement of our financial commitments to our shareholders.

In the second quarter at Ingalls, we delivered LPD 29, Richard M. McCool, Jr. and are looking forward to launching LPD 30 Harrisburg later this year. Other milestones, including the launch of DDG 129, Jeremiah Denton, and the delivery of LHA 8 Bougainville have been adjusted based on workforce availability, the most efficient utilization of shipyard facilities and levels of system completion to support predictable downstream execution of future milestones.

At Newport News, in the second quarter, we delivered SSN 796 New Jersey and continue to make progress toward our remaining milestones that are planned for later this year. During the quarter, SSN 798 construction team experienced a minor disruption to Massachusetts test program due to some equipment replacement identified during testing. The disruption has been resolved, and the team is back into the test program making steady progress. It does, however, shift delivery from late 2024 to early 2025. We are reaffirming our shipbuilding margin outlook for the year. And as we've discussed, we are already in negotiations and expect several significant contract awards by the end of this year, including Block VI Virginia-class submarines, build 2 Columbia-class submarines and additional amphibious ships.

Turning to activities in Washington. We continue to see bipartisan support for our programs reflected in the fiscal year 2025 defense appropriations and authorization bills as they progress through both chambers of Congress. We are pleased that the 2 authorization committees have shown strong support for shipbuilding, including support for additional advanced procurement funding authority for CVN 82, additional funding authority to support Virginia-class construction and a multi-ship procurement of amphibious ships.

The Senate authorizers also included additional funding authority for LPD Flight II and DDG 51 Flight III ships. The House Appropriations bill continues to support our major shipbuilding programs and notably includes investment of $4 billion into the submarine industrial base. We await Senate appropriations positions and the final outcomes will depend on eventual respective conference negotiations by the appropriations and authorization committees.

Now turning to labor. Positive trends continue in talent acquisition as we have hired over 3,800 craft personnel year-to-date, which keeps us on track to achieve our full year plan of approximately 6,000.

In summary, I'm confident that the team's focus on the execution of the fundamentals in our programs positions us positively for the future and look forward to the second half of the year as we meet more milestones and deliver on our commitments to our customers and shareholders.

And now I will turn the call over to Tom for some remarks on our financial results. Tom?

[Thomas Stiehle, executive]

Thanks, Chris, and good morning. Today, I'll 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 approximately $3 billion, increased 6.8% compared to the same period last year and represent a record second quarter result for HII. This increased revenue was attributable to very strong year-over-year revenue growth of nearly 19% at Mission Technologies as well as growth at Ingalls and Newport News shipbuilding.

Operating income for the quarter of $189 million increased by $33 million or 21.2% from the second quarter of 2023. And operating margin of 6.3% compares to operating margin of 5.6% in the same period last year. Net earnings in the quarter were $173 million compared to $130 million in the second quarter of 2023. Diluted earnings per share in the quarter were $4.38 compared to $3.27 in the second quarter of the prior year, representing a year-over-year growth of approximately 34%. Backlog increased slightly to end the quarter at $48.5 billion, up approximately $100 million from Q1's close.

Moving to Slide 7. Ingalls revenues of $712 million in the quarter increased $48 million or 7.2% from the same period last year, driven primarily by higher volumes in amphibious assault ships and surface combatants, partially offset by lower volumes in the National Security Cutter program. Ingalls operating income for the quarter was $56 million and operating margin of 7.9% compared to $65 million and 9.8%, respectively, from the same period last year. The decreases were primarily due to lower risk retirement on surface combatants, partially offset by a delivery contract incentive on LP 29 Richard M. McCool, Jr.

At Newport News, revenues of $1.5 billion were up $26 million or 1.7% from the same period last year. Newport News operating income for the quarter was $111 million, and operating margin was 7.2% compared to $95 million and 6.3%, respectively, in the prior year period. The increases were primarily driven by favorable contract adjustments, incentives and volume on the RCOH program, partially offset by lower performance on aircraft carrier construction and the VCS program. Shipbuilding operating margin in the second quarter was 7.4%, up from 6.8% in Q1 of this year. We are pleased to exceed the shipbuilding margin guidance we previously provided for the quarter, and we continue to see significant opportunity in the second half of the year for margin enhancement.

At Mission Technologies revenues of $765 million increased $120 million or 18.6% compared to the second quarter of 2023, primarily due to higher volumes in C5ISR and cyber electronic warfare and space. A portion of Mission Technologies overperformance in the quarter was driven by material and work that may not reoccur on a consistent basis, and we have factored that into our guide going forward. We are obviously very pleased with the growth in the quarter, and we are raising the Mission Technologies revenue guidance range for the year by $50 million.

Mission Technologies operating income for the quarter was $36 million, and operating margin was 4.7%, compared to $9 million and 1.4%, respectively, in the second quarter of last year. The increases were driven primarily by higher volumes I just mentioned as well as stronger performance in fleet sustainment. In addition, in the second quarter of 2023, we recorded a $6 million loss related to the sale of a joint venture interest, which also helps the year-over-year comparison. Second quarter results for Mission Technologies included approximately $25 million of amortization of purchased intangible assets. Mission Technologies EBITDA margin in the second quarter was 8.5% compared to 6.7% in the second quarter of 2023 and 7.7% last quarter.

Turning to Slide 8. Cash used in operations was $9 million in the quarter. Net capital expenditures were $90 million or 3% of revenues. Free cash flow in the quarter was negative $99 million, consistent with the guidance we provided on the first quarter call. Cash contributions to our pension and other postretirement benefit plans were $14 million in the quarter. Also during the quarter, we paid dividends of $1.30 per share or $51 million in aggregate. We also repurchased approximately 250,000 shares during the quarter at a cost of approximately $65 million.

Moving to Slide 9. We have summarized our expectations for the third quarter and the year. For the third quarter, we expect shipbuilding revenue of approximately $2.2 billion and shipbuilding margin of approximately 7.8%, with margin continuing to ramp in the fourth quarter. For Mission Technologies, we expect revenues of approximately $650 million and operating margin of approximately 2.5%. For the year, we are reaffirming our share building revenue and margin expectations and as I previously noted, we are raising Mission Technologies revenue guidance range.

We are also updating our interest expense expectation to $95 million based on the phasing of our latest cash flow forecast. We are reiterating our free cash flow outlook for 2024 of $600 million to $700 million as well as our 5-year free cash flow outlook of $3.6 billion. As we have noted, we expect free cash flow to be weighted towards the latter part of the year, which is not unusual. We currently expect third quarter free cash flow to be near 0, preceding expected strong cash collections in the fourth quarter.

To summarize, we delivered another quarter of strong year-over-year revenue growth and met our shipbuilding expectations, while Mission Technologies portfolio continues to perform very well. Additionally, we are pleased to raise our Mission Technologies revenue guidance and reaffirm our shipbuilding financial outlook for the year.

With that, I'll turn the call back over to Christie to manage Q&A.

[Christie Thomas, executive]

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

[Operator]

[Operator Instructions] The first question is from the line of Myles Walton with Wolfe Research.

[Myles Walton, analyst]

Chris, could we start with labor. It sounds like you continue to have good traction on the hiring front, but it's not clear to me if your net-net increase in your head count to where you want? So maybe just touch on attrition, hiring goals, I guess, are good, but attrition goals for the year at both shipyards and if that's a meaningful driver to some of the milestones slipouts?

[Christopher Kastner, executive]

Yes, sure. Thanks, Myles. Thanks for the question. Yes, we are achieving our hiring goals in both shipyards. So we think we've made significant progress on ensuring that we can get the people to execute the work. Attrition is not materially improving, but we're thinking about it more broadly from a labor standpoint or execution standpoint. Attrition -- excuse me, attendance and over time, both have recovered. We're performing well there. Our outsourcing programs are executing well and the industrial-based funding is being applied where it's necessary to increase the industrial base.

So it's not just labor. We need to execute on our programs, independent of how well attrition is working. We'll continue to work on our attrition issues. We'll work on salary, flexibility, recruiting in the right places. But we're having to go where labor is. We've got some interesting stuff going on in Hampton Roads, where we're actually creating manufacturing footprint in areas we hadn't before to attract labor. So we're thinking about it more holistically now. It's not just simply labor and attrition in order to meet our throughput goals.

[Myles Walton, analyst]

And in terms of its effect on the milestones? I understand the Massachusetts sounds more like a technical discovery. Are the Ingalls milestone slippages more workforce limitations driven?

[Christopher Kastner, executive]

Well, it's both actually. It's -- on LHA 8, it's just a significant amount of volume and labor and application of the labor to achieve those milestones. So we move that. DDG-129 is a little different. There's sequencing involved in getting to that launch, but also some impact related to labor. Now all of that is included in our financials and in our guidance, and we're comfortable with where we are.

[Operator]

The next question is from the line of Robert Spingarn with Melius Research.

[Scott Mikus, analyst]

This Scott Mikus, on for Rob Spingarn. Tom or Chris, I wanted to ask, based on the guidance, you need to generate about $1 billion of free cash flow in the fourth quarter. So I'm just wondering if you could talk about your level of visibility into that cash generation? And then if possible, can you quantify how much of the fourth quarter free cash is tied to working capital that could move into early '25?

[Christopher Kastner, executive]

Yes. Thanks for the question. I'll start, and then Tom can finish it off with some details here, but I hate to give the answer of timing because it's just not specific enough for you all. But there is a lot of timing in the back half of the year for margin and cash. In order to achieve that progress over the back half of the year, we need to make our milestones on our ships. So we need to achieve contract incentives, and it's not just one. It's -- we risk adjust all of our programs over the back half of the year to ensure that we can make guidance, and we have a line of sight to it. So yes, it is over the back half of the year. There is some timing. There's some unwind in working capital, but we do have line of sight to it.

Tom?

[Thomas Stiehle, executive]

Yes, I'll provide some more color on that, too. Scott, I appreciate the question. It's not uncommon from where we are right now. I mean we usually use cash at the beginning of the year. We have guided both minus 200 and minus 100 for Q1 and Q2, respectively. We find ourselves right now through the quarter -- through the first half of the year at minus $274 million. And this is broken, there was about $100 million that moved from Q1 to Q2 in a payment, and then we closed Q2 kind of missing a $75 million of payment. So I mean, from performance and where we thought we'd be, we're kind of right where we guided.

From a perspective, the year had to shape to it. It was back end and loaded anyway. It was more back-end loaded in '24 than it was in 2023. When you get the Q and you can take a look at, there is comparison in there from '23 over to '24, and we're down operationally in cash, about $284 million, and then we have another $54 million of CapEx that we're spending in '24 over '23. So that constitutes about $330 million down in '24 over '23. But again, in line with where we thought we'd be in the plan, the portfolio.

I would tell you a couple of the milestones that you had at the end of '23 that dragged into '24, although it's only a couple of ships, LPD 29, the SSN 796 and then the launch of 798, all just brought that work into 2024 and created just a little bit of a draw on making kind of cost and progress and headway on the existing portfolio we have here. But the guides that have we provided, 0 on free cash flow for Q3, which has some variability to it. There's a lot of activity that milestones that you have on major milestones, smaller milestones underneath. Capital incentives, the capital is a little bit slower than we guided. We guided 5.3% for the year. It was 2.6% in Q1 and 3% for Q2. But as that comes online in the back half of the year, the progress that we want to make to close out the work packages that are in play right now will allow us to fully build all the costs that you see on the balance sheet. You can see the contract liabilities and the [ AP and AR ] in there. So there's some net working capital that's going to burn itself down.

We finished last year at 5% of working capital at the end of 2023. We sit just under 9% right now. And I kind of foreshadow at the beginning of the year that we were going to have this shape and by the end of the year because the capital incentives we've had, we'd actually have a little bit of an advancement, we'll work ourselves down to the 2% to 3% range in working capital. And that's aligned with our plan. It's aligned not only with the free cash flow perspective we gave you to $600 million to $700 million this year. But in the 5-year goal, I told you that had some shape into it, too. And net working capital level exiting 2024 into 2025 is planned in the guidance that I gave you for $3.6 billion kind of going forward.

So I think we have -- we understand where we are. We aligned with the plan that we had this year. The increases on the back half of the year between the progressing, milestones, incentives, capital incentives. And then we have some new contract awards that introduced some alignment with the business environments that we have here that, that itself, it was just at the beginning of those contracts, we anticipate them to be awarded if not at the end of Q3 and Q4, a little variability of the effect is that going to be like show up in Q3 or Q4. But it will -- by the end of the year, we'll have new awards that will assist both in margin and cash as well.

[Scott Mikus, analyst]

Okay. That gets into my next question. So I wanted to ask, just high level, a big part of the margin story, at least for shipbuilding, is putting new ships and boats on contract that have better pricing compared to some of your older contracts. So can you give us an update on how many ships and boats you put on contract so far this year? And how many you expect to put on contract in the next 12 to 18 months?

[Christopher Kastner, executive]

Yes. So we expect to put under contract over the next 6 to 12 months and probably before the year expires actually another 21 boats with pricing that reflects the current macroeconomic environment. So it's a significant amount of work that we intend to put under contract over the back half of the year.

[Operator]

The next question is from the line of Pete Skibitski with Alembic Global.

[Peter Skibitski, analyst]

Nice quarter. I did have a question on Ingalls margin. I know you've touched on it a little bit just because it's dipped here for the first time in almost a couple of years. The release talked about lower risk retirement on service combatants. And I wasn't sure if that's kind of -- you've got some early DDG 51s in the yard and you're booking conservatively, or I wasn't sure if that was if the DG 129 push out next year impacted this quarter. Could you maybe talk through that a little bit with us a little more deeply...

[Christopher Kastner, executive]

Yes, sure, I'll. Sure. Sure. I can start. I think you probably have a little bit of a compare issue from last year in that language. But obviously, you moved to 2 milestones, cost goes with schedule, so that impacted the quarter. And then 129 had a bit -- or excuse me, LPD 29 at delivery had a little bit less risk retirement than we usually have. So Ingalls is going to continue to execute. This is just a bit of a quiet quarter for them, and I expect them to recover very quickly here.

[Peter Skibitski, analyst]

Okay. I appreciate it. And just one follow-up. I know some of the -- there's been some supply chain issues on the Virginia, I think -- and the carriers, but I think one of the issues has been development of the new electric generators. Do you guys have a time line of when that new system is expected to arrive in the yard?

[Christopher Kastner, executive]

Yes. So I'm probably not the right person to talk about that depending on what program you're referencing. We have -- our estimates have not changed for 80, if that's what you're referencing. And our schedules have not changed materially either. They're making good progress on 80. They're doing some very interesting things relative to ensuring that we hold on to the schedule for 81 and how we're going to build those. But I'm not really comfortable because there's been no material change between Q1 and Q2 relative to those delivery requirements or expectations.

[Operator]

The next question is from the line of David Strauss with Barclays.

[David Strauss, analyst]

Chris, can you talk about where you are in terms of Block IV, Block V work and then negotiating Block VI on VCS?

[Christopher Kastner, executive]

Sure. Sure. Block IV, we're marching towards delivery on 798. We did have that minor move on the milestone, but they're making progress on the test program now. And it's a good team on. It's a good crew. It's a good leadership. So I fully expect 798 will resolve at the beginning of next year. 800 is making progress. That milestone is holding to float off the back half of this year, and then we have one more module that we have to deliver to General Dynamics. And then we're making progress on Block V and then they'll start to fill in behind Block 4, in those getting into the integrated delivery and test of the Block V Virginia-class boats.

Block VI, we're in discussions with the government relative to negotiation of that block. I expect that to resolve this year. Working closely, I think it will be a fair deal, dealing with this macroeconomic environment we talk about with inflation and supply chain insurance. We have all that risk protected. The good news is, we're making investments, the Navy is making investments in the industrial base in order to get at this throughput issue. And we fully expected and when we do Block VI, all of that will be wrapped into that deal, and it will be a fair deal. So that's where we stand on Virginia class.

[David Strauss, analyst]

What is your revenue mix right now between Block IV and Block V?

[Christopher Kastner, executive]

Yes. The vast majority of -- Tom has the details, but the vast majority of it is headed in the Block V now.

[Thomas Stiehle, executive]

Yes. So we're at 95% complete on Block IV. And then Block V -- I know it's not the exact answer to your question, but we're at 95-plus percent of the contract completed on Block IV and Block V in the mid-20% range. And we're spending -- we crossed over about 6 quarters ago, that Block V has higher revenue than Block IV.

[David Strauss, analyst]

Okay. And then a follow-up on working capital. Did I hear correctly, now it's going to drop to -- you're saying 2% by the end of this year? Where does that go in 2025?

[Thomas Stiehle, executive]

So a couple of things here. We got -- I think the last couple of calls, we've been talking about that, right? And the -- for the 600 to 700 guys, and where the working capital is right now, the capital incentives pop in here. We will burn down the 9% that we see through Q2 to that level going forward, right, lower than what we traditionally guided to between 4% and 5% because of what's going on, on the capital front. We haven't guided both for free cash flow specifically for 2025.

And I would be -- I don't want to get into specific targets going forward. But I will tell you that we're kind of on plan on that front relative to its implications to the 5-year free cash flow guidance. And as we close out the year for Q3, Q4, a lot of activity has to happen and how that's going to fall with everything [indiscernible] on how we're going to make the $600 million to $700 million. I'd prefer to hang on to the exact working capital guidance at the back half of the year as we set the trajectory and the targets for next year on the February's call.

[Operator]

The next question is from the line of Gautam Khanna with TD Cowen.

[Gautam Khanna, analyst]

I have 2 questions. First, just on the Q4 cash flow. Was there -- are there any major like lumpy events that you could -- that might actually move that number materially if they were to slip out? And relatedly, do the delivery milestone slips have any impact on that whatsoever? And then I have a follow-up.

[Thomas Stiehle, executive]

Yes. So I would tell you the ramp that we're going to see here between Q3, Q4, again, we conservatively guided to 0 for Q3, but that could be 100 to 200 higher. It could be 50 to 100 less there, just depending on how everything that I said earlier kind of falls out. But the ramp from now where we are to Q3 and Q4, it's a composite there of improved trade working capital between AP and AR, but progressing and closing a build. You can see I have cost in the balance sheet. So it's just getting the right progressing as we make headway on schedule to be able to build all the costs.

The major milestones add into that. We talked a bit about that. We have a slide on the PowerPoint briefing that you can see the ones that we have to hit there on the deliveries. And then we kind of work ourselves through both incentives -- program contract incentives and then capital incentives. And then the new awards kind of contribute that rise and lift on the back half of the year, too. So it's all of it. I don't think missing 1 milestone here or there is not going to drive the preponderance of the lift that we see kind of going forward. But we'll keep you informed, and we'll give you an update on the November call.

And the part 2 of your question?

[Gautam Khanna, analyst]

Great. And Chris, I was just wondering what's your appetite for acquisitions at this point? If you could just talk about that.

[Christopher Kastner, executive]

Yes. So capital allocation has been fairly consistent here for the last year after we started to pay down the debt. We like to be investment grade. We think that's where we need to be and where we want to be. We're going to continue to invest in our shipyards. We're going to pay a dividend. And then with excess cash, we're going to provide it back to shareholders, but we'll continue to evaluate M&A opportunities as they present themselves. And if it makes strategic and financial sense, we'll evaluate it and entertain it. So there's not really a change in our capital allocation philosophy.

[Operator]

The next question is from the line of Jason Gursky with Citi.

[Jason Gursky, analyst]

Chris, just a quick question first on Mission Technologies. You mentioned the trailing 12 book-to-bill of 1.15 and the quantum of the pipeline that you have there in that business. I'm wondering if you can step back for a minute and just talk a little bit about the 1.15 and when you can execute on that backlog and the pipeline that you have available to you? And what that means for growth rates beyond 2024? We are obviously off to a really solid start here in the first half of this year. I'm just kind of curious how this growth rate settles out over the next couple of years.

[Christopher Kastner, executive]

Yes. So thanks, Jason. We're still comfortable with our 5% growth rate in Mission Technologies. It was a bit of a conservative guide. We've increased it for the year. And beyond that, if we can execute on the $83 billion pipeline and the book-to-bill continues to be very good. It could be north of that. And it's really broad-based across the business that each one of those business areas is executing very well.

I would like to point out that there's a lot of interesting things going on in Mission Technologies. This is the first time that the Navy is going to deploy Virginia-class submarine with launch and recovery all autonomously of REMUS vehicle. And it's not just an exercise that's full deployment, it's the [indiscernible]. It's a great -- it's a great product, and it demonstrates the kind of the man and -- autonomous and man teaming that we really think about provides a lot of value for our customer.

So if they continue to execute like this, they continue to execute on that backlog and they take advantage of that pipeline, it could be north of that. But we don't want to get too far over our skis. We're going to be relatively conservative as you would expect for us to be, but I'm very encouraged by how Mission Technologies is developing.

[Jason Gursky, analyst]

Okay. Great. That's helpful. Appreciate that. And then secondarily, just on labor productivity in the shipyards. I know you talked a little bit earlier during the Q&A session about attrition rates and hiring and all that kind of stuff is a good step, which is great. But I think probably just as important maybe to those numbers is kind of the learning curve of the employees. And I'm wondering if you have the ability maybe just from a big picture perspective to talk about labor productivity, where you are today relative to maybe where you were pre-pandemic? Just wondering if we're still down relative to pre-pandemic levels from a labor productivity perspective? And kind of what you would back over the next couple of years and maybe when we can return back to kind of pre-pandemic productivity?

[Christopher Kastner, executive]

Great. So it's a great question, Jason. So productivity is not as it was before the pandemic. There's no getting around that. And it's related to the experience level of the team. Now do I expect it -- do I expect it to improve? Absolutely. And both teams in Ingalls and Newport News are making investments to ensure it does. And the SIB investments that you see coming out of the Navy are focused on that as well, it's not just infrastructure. It's targeted at the proficiency of the workforce as well. So I do expect it to improve. We're investing against it. We've done it before, we've seen it before, and I expect it to continue to improve as we stabilize moving forward.

[Operator]

The next question is from the line of Seth Seifman with JPMorgan.

[Seth Seifman, analyst]

In the slides, I think you talked about a reduction year-on-year in Virginia sub profitability. Should we attribute that to what's happening on Massachusetts? Or was there a reduction in expected profitability on Block V?

[Christopher Kastner, executive]

Yes. So I think that's probably a compare issue related to last year. There's no material issue that we can note related to that. It's kind of broadly across the blocks. We assess our [ ACs ] every quarter. We have to make an adjustment, we do that, plus or minus. So this is not anything individually material there.

[Seth Seifman, analyst]

Okay. So -- and I think you mentioned earlier about the carrier. So with both the carrier and Virginia Block V, there weren't meaningful changes to the estimated profitability?

[Christopher Kastner, executive]

No, not material enough to note. No. But we -- as I said, we assess our [ ACs ] every quarter when we make those adjustments dictated by our evaluation in that quarter.

[Seth Seifman, analyst]

Okay. Okay. Great. And then just for Ingalls, I guess, should we expect profitability there, too? we've seen typically kind of solidly double-digit margin for Ingalls. Is that something kind of going forward that Ingalls can still be kind of at the high end of kind of good shipyard margins?

[Christopher Kastner, executive]

Yes. So we don't guide by shipyard, but I fully expect Ingalls to continue to execute on their programs very well. But yes, we don't provide guidance by our shipyards.

[Operator]

The next question is from the line of George Shapiro with Shapiro Research.

[George Shapiro, analyst]

Tom, I wanted to pursue a little bit the free cash flow needs for the fourth quarter. I mean, obviously, we can all do the arithmetic $973 million to $1.73 billion. Now if I look back, that's nearly twice what you've ever done before, the last highest year in the last 5 was $539 million in the fourth quarter of '18. In addition, you've never had 3 quarters in a row where no quarter generated positive cash flow. So my question is what has changed in the last 5 years in terms of contracts that you have or what to suggest such a dramatic swing this year from what we've seen before.

[Thomas Stiehle, executive]

Yes. So I think we have had a couple of quarters that were negative. So we can catch up offline on that, George. But this isn't an odd year. I would tell you it's backloaded, one. Two, I would tell you that pre-COVID we're executing these contracts right now, we have seen a draw in the schedules over the last 3 or 4 years. And that just changes the construct of as we get progress and collect costs and what we're allowed to bill and creates a little bit of a draw on that. We still manage it annually. And as you know, we've been pretty good at providing a 5-year target back in '19, providing the guidance annually for each of the years, and we've met or exceeded that.

So I mean we're in the lane right now. We've actually increased that $2.9 billion to $3 billion. So we put another $100 million at it. We've given the next 5 years a 20% more. So we have pretty good visibility into the portfolio. It's a relatively -- I'm sorry? Yes. There was some feedback here. It's a relatively mature portfolio that's going on that we have here. So we have line of sight as far as what we have to build, program plans, the expected costs. And then all that rolls in once we come through our quarterly ACs into the guidance of free cash flow going forward here.

It is backloaded. And as I commented earlier, I did a comparison, you could take peak of the Q there on what's driving that? A little bit more CapEx that we've seen. Last 2 years have been 2.6% and 2.4% of sales, respectively, and already, we saw the 3% quarter of last year, and that's going to ramp in the back half of the year. Last year's capital incentives that come along with that. As we continue to make progress, the cost that you can see that's on the books and the balance sheet there, we plan to liquidate that and really drive that working capital, that's going to be the catalyst the working capital coming down, milestones and deliveries and additional awards as well as on contract performance and capital incentives are going to drive the back half of the year.

The guide at 3% was probably on the conservative side. We didn't want to say -- it could be $100 million to $200 million higher or $50 million to $100 million less, and we didn't want to provide a number that we leaned into for Q3. The events and criteria and milestones that we see have to happen are right in that end of September, October and November time frame. So we guided conservatively, which does make the Q4 look like it's a larger lift than it may be as it plays out.

[George Shapiro, analyst]

Okay. Just one comment. What I said -- what I meant to say, if I didn't say it properly on the cash flow was, there hasn't been -- if you look at quarter-by-quarter, there's been no time in the last 5 years where 1 quarter hasn't had at least positive cash flow of the 3. There's been several quarters where 2 have been negative, but not 0 in the third. A follow-up I had was in Mission Technologies, the guide for the second quarter was like $650 million, you did $750, which is -- $765 million, which was similar to the first quarter. And you had mentioned the material and that may drop down in the third quarter. Can you just be a little clear as kind of what actually drove in the materials comment that you made?

[Thomas Stiehle, executive]

Yes. So on the material comment that I said in my opening statements, that was more applicable to Q1. So there was some sales that we had, which are not in -- we don't envision to be on a recurring basis were not included in the Q2 or the guide kind of going forward. The Q2 revenue that we had at Mission Technologies was driven by strong performance in C5ISR and CEWS. And we believe that will continue going forward. We have normalized that for the book of business on contract right now. So we know what contracts we have and we're executing and we see the -- how we load that out, and we have a clear sight on expectations of the revenues for the last 2 quarters as well as there is some -- there's still awards happen every month. And there's -- even though we're in the back half of the year, there's several tens of millions of dollars of potential sales that happen on awards.

So we have to execute our plan that we have in existing contracts. Those awards have to play out. And we've got it rightfully probably on the conservative side of where we stand. The run rate at Mission technologies between the first 2 quarters at [ $750 million and $765 is $1,515 million ] on an annual basis, over $3 billion. We've conservatively taken the beginning of the year guide from [ 2 7 to 2 750 up to 2 750 to 2 80 ]. So let's see how it plays out.

We don't want to get ahead of ourselves. Chris made a comment earlier about the growth. We saw some good growth in '21 to '22 at 4% from '22 to '23 at 12.7% and now both Q1 and Q2, respectively, has seen 20% and 18% growth. But we don't want to overly guide here. Obviously, we've got to get the people in, win those contracts and continue some good performance. But I'm feeling really strong about the Alion acquisition, the business proposition that we set that MT would be a $200 million cash generated, which it is. And I feel really good about the portfolio of contracts we have and that pipeline growing.

[George Shapiro, analyst]

So just one last one. So why guide to only [ $650 million ] in the third quarter?

[Thomas Stiehle, executive]

Well, I'd rather say we have a lot of work to do going forward here. We don't want to over guide and miss, and it's still a function of a couple of awards that will have a minor impact on the revenue for the rest of the year here.

[Operator]

The next question is from the line of Jordan Lyonnais with Bank of America.

[Jordan Lyonnais, analyst]

On CapEx, the sequential uptick that you guys had, is there a percentage or a portion of that, that you could give color on that you'd expect to get back from the Navy CapEx incentives?

[Thomas Stiehle, executive]

Yes, we always invest with our partner with the Navy on this and depending on what the CapEx is and the timing and value equation, what it adds and the design of getting in the yard, whether it's for operational here or Navy sales and things like that nature. There's a mix there of investment. We don't get into that. I mean, that's just part of the business case. And I will tell you that any capital projects that we do add value, we get a return on that capital, and it goes into the business construct and how we choose which projects we bid, we approve and we execute here. I leave it at that. It was 2.6% in Q1, 3% in Q2. The guide is still 5.3% for this year with a 5% CapEx over the next 3 years.

[Jordan Lyonnais, analyst]

Got it. Okay. And then also to -- on the contract that Deloitte won that's for Navy shipbuilding, do you have any sense of the scope for it or why like Mission Tech wasn't picked or you guys in general?

[Christopher Kastner, executive]

I can't necessarily hear the question. There's some feedback. Can you repeat that?

[Jordan Lyonnais, analyst]

Yes. So Deloitte, they won, it was a $2.4 billion Navy contract for -- it seems like an HR contract on the Navy shipbuilding base.

[Christopher Kastner, executive]

Yes. I think they're supporting their identification allocation of investments to support where they should make investments. So yes, we were -- we were not involved in that contracting process.

[Operator]

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.

[Christopher Kastner, executive]

Thanks, everybody, for joining today. Before we go, I'd like to extend my thanks to the entire HII team for their continued focus, and we look forward to speaking with you on our next earnings call. Thank you.

[Operator]

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