Huntington Ingalls Industries, Inc. (NYSE:HII) Q3 2023 Earnings Call Transcript

Huntington Ingalls Industries, Inc. (NYSE:HII) Q3 2023 Earnings Call Transcript November 2, 2023

Huntington Ingalls Industries, Inc. beats earnings expectations. Reported EPS is $3.7, expectations were $3.39.

Operator: Ladies and gentlemen, thank you for standing by and welcome to the Third Quarter 2023 HII Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference call is being recorded. [Operator Instructions]. I would now like to turn the call over to Christie Thomas, Vice President of Investor Relations. Ms. Thomas, you may begin.

Christie Thomas: Thank you, operator, and good morning. I’d like to welcome everyone to the HII third quarter 2023 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 their remarks today, Chris and Tom will refer to certain non-GAAP measures. For reconciliation of these metrics to the comparable GAAP measures, please see the slides that accompany this webcast, which are available on the Investor Relations website at ir.hii.com. With that, I would like to turn the call over to President and CEO, Chris Kastner. Chris?

Christopher D. Kastner: Thanks, Christie, and good morning, everyone. Today, we released quarterly results that demonstrate continued topline growth across all three of our divisions, steady operational performance and strong free cash flow generation. Our focus on the fundamentals of the business is evidenced through our strong 5.3% year-to-date revenue growth or outstanding 2.4 book-to-bill in the quarter at Mission Technologies and continued shipbuilding milestone achievements. Given our year-to-date results, we are pleased to increase our 2023 revenue and free cash flow guidance, and Tom will provide more information on these increases during his remarks. Our talented workforce remains focused on executing our strategy, supporting our customer’s top national defense priorities by delivering quality platforms, technologies, and solutions, and in parallel, winning new business leading to growth opportunities.

Before I get into the results, I would like to thank our HII employees’ at all three divisions for their dedication, innovation and customer focus. Let’s turn to our results on page three of the presentation. Topline growth increased 7.2% from the third quarter of 2022, resulting in a record third quarter revenue of $2.8 billion. Diluted earnings per share was $3.70 for the quarter, up from $3.44 in the third quarter of 2022. New contract awards during the quarter were $5.4 billion, which resulted in backlog of approximately $49 billion at the end of the quarter, of which $27 billion is currently funded. Shifting to an update on our shipbuilding milestones. In the third quarter at Ingalls, we launched amphibious assault ship LHA 8 Bougainville, and lay the keel for LHA 9 Fallujah.

Also, we successfully completed acceptance trials for NSC 10 Calhoun, and delivered her last month. In addition we successfully launched and christened the Flight III Arleigh Burke-class destroyer, DDG 128 Ted Stevens. Finally, LPD 29 Richard M. McCool Jr. is expected to complete acceptance trials and deliver in the fourth quarter of this year. Ingalls contract awards this quarter included a $155 million contract for the modernization of USS Zumwalt DDG 1000, and the significant award of seven of ten Flight III Arleigh Burke-class destroyer in the FY23 DDG multi-year procurement competition. At Newport News, we continue to make progress on the Virginia-class attack submarines as we laid the keel of Oklahoma, SSN 802, and we reached pressure hull complete on Arkansas SSN 800.

We expect to Float off SSN 798 Massachusetts and deliver SSN 796 New Jersey before the end of the year. We also continue to make progress on nuclear-powered aircraft carrier construction CVN 79 Kennedy is focused on compartment completion and the test program having turned over more than 70% of the ship compartments to the navy and lighting off combat systems for integrated testing. CVN 80 enterprise is progressing well and is approximately 25% complete. The cost for the combined buy of CVN 80 and 81 has benefited from the bundling and early procurement of the majority of the material. So much so, that over 70% of the material for CVN 81 has already been placed on order generating significant savings over the traditional approach to ordering.

However, due to major component delays from the supply chain driven primarily from COVID, and the labor and supply chain effects subsequent to COVID delivery of CVN 80 is forecasted to be approximately 12 months late. To mitigate the delay, HII has worked with the Navy to employ innovative build techniques, which minimize the impact of CVN 81. At Mission Technologies, we saw the third straight quarter of record revenue with sales of $685 million, 15% over the third quarter of 2022. In addition to strong sales growth, Mission Technologies also won several majors strategic competitions in the quarter, and now has posted over $5 billion in potential total contract value bookings year-to-date. These awards resulted in a third quarter backlog book-to-bill of 2.4 and a year-to-date backlog book-to-bill of 1.2. Significant wins in the quarter included the $1.4 billion joint network engineering and emerging operations task order, the $347 million contract for the Navy’s Lionfish SUUV program and $244 million task order to integrate Minotaur software products into maritime platform for the Navy, Marine Corps and Coast Guard.

Shifting to activities in Washington, the federal government began the new fiscal year under a continuing resolution, which funds government operations through November 17. Well, we applaud the Congress for including an anomaly in the CR that will allow DoD to deviate from typical restrictions and obligate funding to begin construction to begin construction of the second Columbia-class nuclear submarine, we look forward to Congress proceeding as expeditiously as possible on appropriations bills. We also look forward to Congress completing their work on the fiscal year 2024 National Defense Authorization Act with the respected bills of the house and the senate, reflecting strong support for shipbuilding and other national security priorities.

Final outcomes will depend on eventual respective conference negotiations between the appropriations and authorization committees. We are encouraged by the support of our programs thus far in the four committees of jurisdiction during the fiscal year 2024 budget cycle. Now turning to labor, we have hired nearly 5,400 craft personnel year-to-date through the third quarter, which puts us 8% ahead of our full-year plan of approximately 5,000. We have work to do to improve our retention rate and the shipbuilding teams are laser focused on addressing this challenge. Retention and attendance and the acceleration of workforce development will remain consistent focus areas for us going forward. In summary, this was a very strong quarter, demonstrating continued focus and progress on our strategy of executing against our backlog and driving growth in Mission Technologies.

We remain committed to continuing to create value for all of our stakeholders, our employees, customers, shareholders, suppliers, and communities. And now, I will turn the call over to Tom, for some remarks on our financial results. Tom?

Thomas E. Stiehle: Thanks, Chris, and good morning. Today, I’ll briefly review our third quarter results. For more detail on the segment results, please be refer to the earnings release issued this morning and posted to our website. Beginning with our consolidated results on slide six of the presentation, our third quarter revenues of $2.8 billion increased approximately 7.2% compared to the same period last year, and represents a record third quarter result for HII. This increased revenue was largely attributable to growth at Mission Technologies and Ingalls shipbuilding. Operating income for the quarter of a $172 million increased by $41 million or 31% from the third quarter of 2022, and operating margin of 6.1% compares to operating margin of 5% in the same period last year.

The increase in operating income was primarily due to higher segment operating income, a more favorable operating FAS/CAS adjustment and more favorable non-current state income taxes compared to the prior year period. Net earnings in the quarter were a $148 million compared to a $138 million in the third quarter of 2022. Diluted earnings per share in the quarter was $3.70 compared to $3.44 in the third quarter of the previous year. Moving on to slide seven, Ingalls revenues of $711 million in the quarter increased to $88 million or about 14% from the same period last year, driven primarily by higher volumes on amphibious assault ships and surface combatants. Ingalls operating income of $73 million and operating margin of 10.3% in the quarter increased from last year, primarily due to higher volumes I mentioned earlier, and favorable changes in contract estimates compared to the prior year.

At Newport News, revenues of $1.45 billion increased $8 million or 1% from the same period last year. Newport News operating income for Q3 was $90 million, a decrease of $12 million compared to the third quarter of last year. Operating income was lower due to contract incentives earned in the Columbia-class program in the third quarter of 2022, partially offset by improved performance on the Virginia-class submarine program. Shipbuilding operating margin in the third quarter was 7.5%, slightly ahead of the outlook we had provided for the quarter. Our shipbuilding operating margin outlook for the full year remains unchanged. And as we have previously noted, our expected shipbuilding milestones for 2023 are concentrated largely in the fourth quarter.

At Mission Technologies, revenues of $685 million increased $90 million or about 15% compared to the third quarter of 2022, primarily due to higher volumes in mission based solutions, driven by our C5ISR and cyber, electronic warfare, and space programs. Mission Technologies operating income of $24 million compares to operating income $14 million in third quarter of last year. The increase in operating income was driven primarily by the higher volumes I just mentioned, as well as improved performance in unmanned systems. Current results for Mission Technologies included approximately $27 million of amortization of purchased intangible assets. Mission Technologies EBITDA margin in the third quarter was 8.2%. Turning to slide eight, Cash from operations was $335 million in the quarter.

Net capital expenditures were $42 million or 1.5% of revenues. Free cash flow in the quarter was $293 million. This compares to cash used in operations of $19 million. Net capital expenditures of $77 million or 2.9% of revenues and free cash flow of negative $96 million in the third quarter of 2022. Cash contributions to our pension and other postretirement benefit plans were $11 million in the quarter. During the third quarter, we paid dividends of $1.24 per share or $50 million in aggregate. We also repurchased approximately 100,000 shares during the quarter at an aggregate cost of approximately $21 million. Year-to-date through the third quarter, we have repurchased approximately a 176,000 shares as an aggregate cost of approximately $37 million.

Moving on to slide nine, I’d like to provide an update on our pension sensitivities for 2024. Our forecast in early 2023 assumed asset returns of 8% and a discount rate of approximately 5.5%. Through the end of the third quarter, discount rates have increased approximately 60 basis points and our year-to-date asset return is roughly 4.6%. Pension related numbers are subject to year-end performance and measurement criteria. We will provide a multiyear update of pension estimates on our fourth quarter earnings call in February. Also I would like to highlight that our pension funded status remains strong and has improved year-to-date. Additionally, I will note that the cash flow impacts related to pension changes remain minimal. Moving on to slide 10.

Given the strong third quarter free cash flow, we are increasing our 2023 free cash flow guidance to approximately $500 million, an increase of $75 million from the prior midpoint guidance. This increase is primarily driven by the conclusion of the negotiations regarding the payment of COVID advances as well as positive cash flow contributions for Mission Technologies. We continue to expect approximately $1.2 billion of free cash flow over the two-year period of 2023 and 2024. I’ll highlight that we continue to expect to distribute substantially all free cash flow shareholders through 2024 after planned debt repayment, which is currently on track. Turning to slide 11, in addition to increasing our fiscal year ’23 free cash flow guidance we’re increasing our revenue guidance of both shipbuilding and Mission Technologies.

Given the strong third quarter revenues across all three divisions, we are increasing the midpoint of shipbuilding revenue guidance by revising a range from $8.4 billion to $8.6 billion to a range of $8.5 billion to $8.6 billion, and increasing our Mission Technologies revenue guidance from approximately $2.5 billion to approximately $2.55 billion. This is an increase to the midpoint of shipbuilding revenue guidance of $50 million an increased to Mission Technologies revenue guidance of $50 million. Additionally, we are reaffirming our shipbuilding Mission Technologies margin guidance. To summarize, we delivered strong revenue growth in the third quarter and finished slightly ahead of our margin expectations for the quarter. We also delivered strong free cash flow.

Mission Technologies had an impressive third quarter backlog book-to-bill of 2.4, and year-to-date has the potential total contract value awards of over $5 billion, in addition to a robust opportunity pipeline of $70 billion. Looking to the end of the year, we are pleased to raise 2023 revenue and free cash flow guidance and reaffirm margin guidance as we continue to execute the milestones and commitments that we’ve laid out. With that, I’ll turn the call back over to Christie to manage Q&A.

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

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Q&A Session

Operator: Thank you, Christie. [Operator Instructions]. Our first question today comes from Scott Deuschle from Deutsche Bank. Scott, your line is now open. Please go ahead.

Scott Deuschle: Hey, good morning.

Christopher D. Kastner: Good morning, Scott.

Scott Deuschle: Chris, what’s the financial impacts from the delay on CVN 80? I think you said it was 12 months. And then was that delay known when you closed the books and accrued the EACs for the quarter?

Christopher D. Kastner: Yes, approximately 12 months. And we’ve been holding that risk for a while on our financials. So there’s no financial impact related to it. That impact is driven by some issues in the supply chain and some major equipment in the bottom of the ship, but no financial impact related to it. And the team’s doing their best to mitigate the impact. The good news on that is we do have some EPA protection, which mitigates it a bit. But the team’s focused on it and they’re going to do their best to mitigate the impact going forward.

Scott Deuschle: Okay. That’s great. And then I think one thing that’s been maybe a bit confusing to investors is trying to understand the impacts to Huntington or the read through when your partner books negative EACs on Block V Virginia-class boats due to supplier costs. Can you just maybe, like, level set us on how we should interpret that? And I realize your booking rates are probably lower in there. So it doesn’t necessarily mean you book, need to book negative EACs, but does it have any impact to your longer term margin trajectory on Block V? Thanks.

Christopher D. Kastner: Yes. So, we evaluate our EACs on all our programs on a quarterly basis and take appropriate adjustments up or down as we see fit. I continue to believe that there’s opportunity in Block V. As we transition out of the Block IV boats and get into Block V, we should have some upside. But I wouldn’t comment on our partner’s accounting, but I’m very comfortable with where we’re at.

Scott Deuschle: Okay. Great. Thank you so much.

Christopher D. Kastner: Sure.

Operator: Thank you. Scott. Our next question today comes from David Strauss from Barclays. David, your line is open. Please proceed with your question.

Josh Corn: Hi. Good morning. This is actually Josh Corn, on for David.

Christopher D. Kastner: Hi.

Josh Corn: I wanted to ask about the outlook for shipbuilding margins in 2024 if you see any improvement and what some of the drivers might be. Thanks.

Christopher D. Kastner: Yes. So I fully expect incremental improvement in shipbuilding margins as we move forward. It’s all about transitioning out of the Block IV boats in Newport News and the Block V and continuing to improve in Newport News. So the story hasn’t really changed quarter-to-quarter. Newport News continues to stabilize. Labor is good. Hiring is good. We still need to work on retention. But I’m comfortable with where we’re at.

Josh Corn: Okay. Thank you.

Christopher D. Kastner: Sure.

Operator: Thanks very much. Our next question comes from Doug Harned from Bernstein. Doug, your line is now open. Please go ahead.

Doug Harned: Good morning. Thank you.

Christopher D. Kastner: Good morning, Doug.

Doug Harned: On your margins, at Newport News, you talked about you met your goal of 7.4% for the quarter. But when you look at the margin improvement you’re going to have to have in Q4, can you walk through what has to happen there because there you’re going to have to get a lot of upside in margins in Q4 to meet your guidance, it looks like.