Huntington Ingalls Industries, Inc. Q3 FY2022 Earnings Call

Ladies and gentlemen, thank you for standing by. And welcome to the Third 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. Please be advised that today's conference call is being recorded. I would now like to hand the call over to Christie Thomas, Vice President of Investor Relations. Mrs. Thomas, you may begin.

Thank you, operator, and good morning, everyone. Welcome to the HII third quarter 2022 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, any forward-looking statements made today that are not historical facts are considered our company's estimates or expectations and are forward-looking statements made pursuant to the safe harbor provisions of Federal Securities Law. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. For additional information regarding factors that could cause actual results to differ materially from expected results, refer to our SEC filings. Also, in their remarks today, Chris and Tom will refer to certain non-GAAP measures. For reconciliations of these metrics to the comparable GAAP measures, please see the slides that accompany this webcast, which are available on the Investor Relations website at ir.hii.com. With that, I would like to turn the call over to our President and CEO, Chris Kastner. Chris?

Thanks, Christie. Good morning, everyone, and thank you for joining us on today's call. I would like to begin today by highlighting the HII teams that work hard day in and day out to support our national defense customers, craftsmen and women constructing and overhauling the most powerful and survivable naval ships ever built, engineers, and technology specialists developing critical capabilities and mission-driven solutions, all aligned with supporting our customers' priorities and pressing national defense needs. Thank you to the entire HII team. Now, let's turn to our results on Page 3 of the presentation. In the third quarter, we had sales of $2.6 billion, which were 12% higher than 2021, and diluted EPS was $3.44 for the quarter, down from $3.65 in 2021. New contract awards during the quarter were approximately $2.1 billion, resulting in a backlog of approximately $46.7 billion at the end of the quarter, of which $23.2 billion is currently funded. We continue to make progress across all of our shipbuilding programs. At Ingalls, we recently completed acceptance trials on DDG 123 Lenah Sutcliffe Higbee. During the third quarter, the keel was authenticated for DDG 129 Jeremiah Denton. In our amphibious ship product lines, fabrication began on LPD 31 Pittsburgh. Last week, we were awarded a $2.4 billion detail design and construction contract for LHA 9. We have commenced work to complete the combat system installation and activation on the Zumwalt-class destroyer, Lyndon B. Johnson, DDG 1002. At Newport News, CVN 79 Kennedy is moving further into the test program and began testing of the electromagnetic launch system. On the other side of the shipyard, the keel was laid in the drydock for CVN 80 Enterprise. The RCOH program continues to make progress with CVN 73 USS George Washington, on track to redeliver next year. We also continue to see progress on the Virginia-class submarine program and expect to deliver SSN 796 New Jersey and SSN 798 Massachusetts next year. In the quarter, we experienced continued challenges from the broader macroeconomic environment, notably a persistent tight labor market with really no material improvement in general economic conditions. Through the third quarter, we have hired over 3,600 craftsmen and women against our full-year plan of approximately 5,000. We continue to utilize the levers of outside leased labor and overtime to offset the short-term deficit of employees. Supply chain challenges continue across our supplier ecosystem, resulting in longer material lead times and inflation pressure. We do have some contractual mitigation for inflation, and we continue to actively manage the supply chain and our production schedules to minimize impacts. To address our shipbuilding labor challenges, we have aggressively enhanced our skilled workforce development pipeline. We've broadened our recruiting efforts to bring in more shipbuilders and are expanding our successful apprenticeship programs, focusing on pre-apprenticeships and outreach to underserved populations and women in the industry. Moving to our Mission Technologies business, our pipeline remains very strong with $4 billion in proposal or evaluation and $17 billion in capture. Our third-quarter book-to-bill was 2.2 and was a healthy 1.1 year-to-date. Integration of operations and business systems following the Alion acquisition is largely complete, and we are already seeing strong synergies such as the recently announced DMATs and awards totaling over $900 million in total contract value. We also received a couple of major contract actions in our Nuclear and Environmental business that were driven by sustained strong performance. At Savannah River, our joint venture received an extension for 4 years, plus an additional option year, and at the Nevada National Security site, our joint venture received a simultaneous early exercise of all 5 of its option years. These are significant wins, and we are very proud to support DOE across the complex. Despite headwinds earlier in the year due to the delayed omnibus spending bill and the ongoing intense competition for talent, we continue to gain momentum and see strong growth potential going forward. This includes both domestic and international markets, where we are expanding our presence in regions consistent with the national security strategy. In summary, I am confident that our presence across all combatant commands, coupled with an increasing demand signal for advanced technology solutions from our DoD customers, positions Mission Technologies well going into FY '23. Shifting to activities in Washington; the federal government began the new fiscal year under a continuing resolution that funds government operations through December. We continue to urge proceedings to be expedited and remain optimistic that the annual defense appropriations and authorization processes will be completed in the months ahead. While final outcomes will depend on eventual respective appropriations and authorization conference committee negotiations, we are pleased to see defense oversight committees providing strong support to shipbuilding. They have included recommendations for new DDG 51 multiyear procurement authority, additional funding for amphibious ships, and requirements for not less than 31 amphibious warfare ships. This strong shipbuilding demand, driven by our national defense requirements, is shown on Slide 5. These critical customer needs span destroyers, amphibious ships, submarines, and aircraft carriers, including new construction, overhaul, maintenance, and modernization, resulting in significant contract award opportunities and driving continued backlog stability. Now, I will turn the call over to Tom for some remarks on our financials. Tom?

Thanks, Chris, and good morning. Today, I'll briefly review our third-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, our third-quarter revenues of $2.6 billion increased approximately 12% 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 growth at Newport News Shipbuilding. Operating income for the quarter was $131 million, an increase of $13 million or 11% from the third quarter of 2021, and the operating margin of 5% was essentially flat from the prior year period. The increase in operating income was primarily due to more favorable noncurrent state income taxes and an operating fast cash adjustment compared to the prior year period, as well as improved results at Newport News Shipbuilding. Other net expense was $13 million in the quarter, which was primarily driven by losses on equity investments given market volatility in the quarter. Our effective tax rate in the quarter was approximately 14.8% compared to negative 4.3% in the third quarter of last year, which included research and development tax credits for tax years 2016 through 2020. Net earnings in the quarter were $138 million compared to $147 million in the third quarter of 2021. Diluted earnings per share in the quarter were $3.44 compared to $3.65 in the third quarter of the previous year. Moving on to Slide 7, Ingalls revenues of $623 million in the quarter decreased by $5 million or less than 1% from the same period last year, driven primarily by lower revenues on the NSE and LPD programs, partially offset by higher DDG program revenues. Ingalls operating income of $50 million and margin at 8% in the quarter declined from last year, primarily due to lower risk retirement on the DDG program, partially offset by higher LPD risk retirement. At Newport News, revenues of $1.4 billion increased by $91 million or a robust 6.7% from the same period last year due to higher naval nuclear support services, as well as submarine and aircraft carrier revenues compared to the previous year. Newport News operating income of $102 million and margin of 7.1% were up from last year, due to contract incentives on the Columbia-class submarine program, partially offset by lower risk retirement on the VCS program. The Columbia-class contract incentives are related to Newport News support of continued growth in the submarine construction enterprise. At Mission Technologies, revenues of $595 million increased $201 million compared to the third quarter of 2021, primarily driven by the acquisition of Alion in the third quarter of last year. Mission Technologies' operating income of $14 million compared to operating income of $13 million in the third quarter of last year. Current results included approximately $24 million of amortization of Alion-related purchase intangible assets compared to $8 million in the third quarter of last year. Mission Technologies' EBITDA margin in the third quarter was 8.4% and 8.7% year-to-date. Turning to Slide 8, cash used by operations was $19 million in the quarter, and net capital expenditures were $77 million or 2.9% of revenues, resulting in free cash flow of negative $96 million. This compares to cash from operations of $350 million, net capital expenditures of $73 million, or 3.1% of revenues, and free cash flow of $277 million in the third quarter of 2021. While third-quarter free cash flow was below the projection we provided on our last earnings call, this is a function of timing as well as a tax payment of approximately $80 million that we elected to make in the third quarter, given the lower probability of delayed deferral of changes to the R&D tax treatment. In fact, we are increasing our overall free cash flow outlook for fiscal year 2022, which I'll discuss in more detail in a moment. Cash contributions to our pension and other postretirement benefit plans were $11 million in the quarter, of which less than $1 million were discretionary contributions to our qualified pension plan. During the third quarter, we paid dividends of $1.18 per share or $48 million. We also repurchased approximately 66,000 shares during the quarter at an aggregate cost of approximately $14 million. Moving on to Slide 9 and our updated outlook for the 2022 and 2023 pension and postretirement benefits. First, I would like to highlight that our funded status remains strong and has improved year-to-date. Additionally, I will note that the cash flow impacts related to the pension changes remain muted. For 2023, the FAS benefit has come down considerably from our last update, given the more immediate recognition of the negative asset returns experienced thus far in 2022. While the increase in the discount rate does partially offset the impact of asset returns, the magnitude of the impact related to lower asset returns is clearly more significant. Please remember that 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. Turning to Slide 10, we are narrowing our 2022 Shipbuilding and Mission Technologies revenue guidance to the lower end of our prior guidance ranges, given results through the third quarter and the current operating environment. We are now expecting shipbuilding revenue to be between $8.2 billion and $8.3 billion and expect Mission Technologies revenues to be approximately $2.4 billion. The narrowing of the shipbuilding revenue guidance is a function of the challenging labor environment that we have frequently discussed, as well as our expectations for the timing of materials as we near year-end. The Mission Technologies revenue is a reflection of the slower start of the year as well as the current hiring environment. As Chris noted, our third-quarter book-to-bill ratio exceeded 2.0, a very positive indicator as we move forward, and we remain very enthusiastic about the growth opportunities at Mission Technologies. We are reaffirming our shipbuilding operating margin guidance range of 8% to 8.1%. For Mission Technologies, we are slightly revising our margin guidance to approximately 2.3%, which is largely a function of the lower volume of work in the year. Moving to free cash flow, we are increasing our guidance for 2022. Under the current Section 174 R&D tax law, the midpoint of our prior guidance was $225 million, which has now been raised to approximately $350 million. The most significant driver of that increase is the COVID progress repayment, which we initially expected in 2022, moving to 2023. Given our free cash flow through the third quarter, we are expecting very strong free cash flow generation in the fourth quarter. On Slide 11, we have provided an updated view of our free cash flow expectations. This outlook assumes the current R&D amortization treatment for tax purposes remains in place. Given that adjustment, our 2020 through 2024 free cash flow expectation is now approximately $2.9 billion. As we have noted before, the impact of the R&D treatment is approximately $250 million over the 2022 through 2024 timeframe. We are reaffirming our capital allocation priorities, including our commitment to return substantially all free cash flow after planned debt repayment to shareholders through 2024. This is a significant commitment that should result in increased share repurchases, particularly in 2024 after we have reached a designated debt level. I will also note that we have recently announced and increased our quarterly cash dividend to $1.24, a 5% increase over the prior amount. To summarize, the operating environment remains challenging, and we were not able to overcome the slow start to the services contracting pace, which has resulted in revenue guidance moving to the low end of our prior ranges. We are pleased to reaffirm our shipbuilding margin guidance and increase our free cash flow expectations as we aggressively manage through current business conditions. Regarding fiscal year 2023, we plan to provide detailed guidance on our fourth-quarter call, consistent with our normal guidance. That said, we continue to view a long-term shipbuilding revenue CAGR of 3% as appropriate and we are pleased to reaffirm our long-term free cash flow target through 2024, as I have discussed. We would normally expect incremental shipbuilding operating margin improvement in 2023. However, given the current economic environment, we will need to close out the year to assess risk retirement and operational efficiencies before we can provide more insight. We will finish the year just as we've started, focused on execution, and we'll provide a more comprehensive update on our view for 2023 in February. With that, I'll turn the call back over to Chris for some final remarks before we take your questions.

Thanks, Tom. Before wrapping up, I would like to highlight on Slide 12 that we will release an updated HII's sustainability report in the coming days, which will be available on our website. We are focused on aligning the program with our mission, values, and purpose, and structuring our strategy around securing our business, building our community, and protecting our resources. We have enhancements in process for future sustainability reporting and expect another update to be released in the spring of 2023. Finally, turning to Slide 13, we remain focused on successfully executing on our strong backlog and positioning for long-term growth, which will generate value for our employees, customers, and shareholders. Now, I will turn the call over to Christie for Q&A.

Operator, I will turn it over to you to manage the Q&A.

Your first question comes from the line of Doug Harned with Bernstein.

On Newport News, can you share how progress is going with the Virginia class? I understand there has been less risk retirement this time, but we've discussed the importance of having labor back and trained. What is your current outlook on that?

Yes. Thanks for that, Doug. Definitely some stability in the Virginia class program right now, the Block 14 and 796, which is the upcoming delivery, have some positive developments from a schedule standpoint. They are very stable and looking towards the beginning of next year to get that delivery complete. So I'd say stability in the schedule. Still working hard on the fundamentals of cost and efficiency. But I think we're in a pretty good place from a schedule standpoint there.

In terms of cost and efficiency, do you see a clear path to being satisfied that everything is under control regarding costs? I'm trying to understand what that trajectory looks like for the next few quarters.

Yes. Sure. Fundamentally, when you have stability in your schedules and planning documentation and you know what work is in front of you, you'll have a better chance to achieve efficient performance from a cost standpoint. First things first, let's get the schedule right. We've got the labor. They are fully staffed on Block IV and Block V, and they're making progress on their milestones. Now, it's just about executing the work, progressing to the test program on 796, and advancing on 798. I'm not going to give you a trajectory on margins for the VCS program. The best indicator within the submarine program is ensuring you're making your milestones. If those are stable, you’ll meet your cost objectives. The team is working very hard on the fundamentals of the operating system, and if they get that right, they are going to be successful.

If I can squeeze just one more in here. Related to cost. You mentioned inflation in the last quarter. Historically, I felt your view has been that you can handle inflation. You’ve got enough opportunities in terms of escalators and so forth to deal with that. But when you talk about what may be different this time, because we're seeing in a lot of defense companies now that inflation in the short term is more difficult than we've seen in prior periods.

Yes. As I said previously, we do have some protection. The biggest issue for inflation for us is going to be on new contracts and ensuring that we get the bids right from the supply chain and ensure that the cost and schedule is accurate when we bid those new contracts. That is probably the greatest risk for us. We do have some inflation-related issues within some of our component parts in the supply chain where we didn't have those under contract, but we do have some protections in place, although not fully covered. The real issue for us regarding inflation is getting the bids right on our new contracts, and we are working hard to ensure we do that.

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

Tom, what was the organic growth for Mission Technologies in the third quarter since you have a partial inclusion last year in the third quarter? And then I know Alion has a lot of cost-plus work, but how much might wage inflation have contributed to the top line growth there?

Yes. When I look at that, you are right. We closed August 19 of last year. So the third quarter last year was incomplete. The organic growth for the quarter specifically was about 1.5%. For the year, it could be choppy because of the slow contracting environment, the wins, and the operational side of that. The overall Mission Technologies growth for the year is 4.3%. Alion's growth stood at 8%. Q2, we told you about 6%. Typically, that third quarter or the fourth fiscal quarter is a strong period for both line and legacy MDIS. We anticipated an 8% growth against the Q2 top line, but that didn't materialize. Factors included not sweeping up as much as we thought, having open seats, and just some materials didn’t hit in the quarter. So that's where we stand with growth.

Sorry, Rob, I don't recall if you just said that, Tom, but I think that we had pro forma growth of 8% year-to-date within Mission Technologies. I feel very positive about the business. We had two real good wins in DMATs and the Air Force training contract, which is very positive. The book-to-bill is positive, so I think that team has a lot of opportunity moving into '23.

Okay. And then just a high-level one, Chris. But on this potential 5-unit block buy for the Columbia class, could you talk about what that might mean for Huntington Ingalls as a cost savings and labor continuity opportunity?

Well, we assume that the Columbia class will be ordered based on the planning documentation we've received from the Navy and Electric Boat, and that has been included in all our capacity planning and future growth expectations. The Navy has been very thoughtful in how they order materials and how they are thinking about bundling procurement to ensure they get the best economics for ordering from the supply chain. It's a smart strategy, and it will definitely be part of our growth in Newport News. The team is working diligently on this.

Is it fair to think that's better visibility than normal, 5 boats?

Absolutely. When you think about defense strategy and the amount of visibility we have right now into what our backlog will be and the demand signal in shipbuilding, we have very good visibility and high confidence that we will be well-positioned over the next 10 to 15 years. The important thing we need to do is focus on execution, make sure we get these bids correct, and then get the ships delivered because the Navy needs them.

I'd comment on the back end of that. We added a new slide to highlight the strong demand for shipbuilding. You can see a backlog chart on Slide 5 here, which shows that backlog at the $46 billion range that has sustained itself through at least 2026. We have excellent visibility from both the shipbuilding plan and then the more immediate FY '23 budget of expectations regarding what we see in the near term. We have tremendous visibility on the awards we expect to come in the next 3 to 5 years.

The next question comes from the line of an unidentified analyst with Credit Suisse.

Tom, can you quantify the benefit of the Columbia class incentives? And just wondering if that's something that could help the business in the coming quarters or maybe that's a one-off?

Yes, sure. You'll see that in the Q later this morning when it comes out. The quantification is $41 million of Columbia incentives. Over the last two or three calls, we've highlighted our close work with our customers regarding the Virginia class and Columbia class, balancing additional boats with the requirements and how that drives capacity and capability needs within Newport News. We see the need for additional capacity at the yard, and we've achieved those incentives in the quarter.

Got it. Chris, it seems the Ukrainians recently employed unmanned surface vessels in combat, which I believe occurred last Saturday. If I remember correctly, you've previously mentioned that there was still work to be done on unmanned surface vessels. Now that we've observed their use in combat, do you think this represents a significant milestone for this category of weapon systems overall? And what implications does that have for Huntington?

Yes, I don't want to comment on the specific mission. But I think getting these assets in the water executing missions for the customer is very important because it will demonstrate how positive and productive these can be as a force multiplier. We think it's a positive development and it will continue to gain momentum, and we really like where we're positioned.

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

Tom, could you just go through the rundown in the quarter?

Sure. We had cumulative adjustments that resulted in $84 million favorable, $57 million unfavorable, a net of $27 million, with about half of that from Newport News and then 25% each for Ingalls.

Great. And then as we think about the opportunity for improved shipbuilding margins next year, I mean, you obviously talked about that there could be leverage on the volume side. But, Chris, from a milestone perspective, how do you see the milestones in '23 relative to '22 giving you an opportunity to enhance margins?

Yes. We'll give you a comprehensive update on the milestones on the next call. But five deliveries in '23 are still on target, and we're pacing towards completing those ships. The balance of milestones is in process and on schedule as we previously indicated. There’s some opportunity, but we will assess the risk and opportunity every quarter. It’s still a tight labor market, and we have had some positive indicators lately, but I don't think two data points will necessarily create a trend. We're going to be measured as we evaluate risks and opportunities and provide a comprehensive update at the end of the year. But the milestones in '23 are holding, and we're comfortable with that. We need to get these assets delivered, and the team is working hard to do that.

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

Yes, I just wanted to pursue. You raised the long-term assets for the pension to 8%. I guess that's maybe just based on how bad it is this year, but could you give some color on it? And then also, how that affects your adjustments for next year?

Yes, sure, George. I appreciate the question. Yes, we did raise that expectation. When we look at the company as a whole over the past 12 years, we've exceeded the 7.5% target for nine of those years. Obviously, this is a down year for the pension plan given the double-digit negative returns we've experienced. Thus, we believe it's prudent to expect an 8% return in the upcoming year. Relative to the pension, you can observe from our updates that the rate has changed from 3% to 4.90%. We highlighted that returns were around minus 15%. This reflects some headwinds on EPS for next year, but we'll keep you updated and provide a comprehensive projection on our next call.

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

I was going to ask a question about asset returns and thought no one else would bring it up. But if someone did, it would probably be George. I want to ask a broader question, and I hope this isn't too vague. I recently looked at your website, and I noticed an image of a soldier with a gun representing various domains like cyber, land, air, and joint operations. When you think about the long-term direction of the company, Chris, do you have a vision for how you want to position it throughout your time here? Specifically, by 2030, do you have a target for shipbuilding to represent a certain percentage of sales, ideally lower than its current level?

Well, it's going to be a smaller percentage simply because we believe we've made good investments in growth markets. These markets in technology that we’re in — Mission Technologies — relate directly to national priorities like AI, ML, cyber, unmanned, ISR, live virtual constructive training, and advanced synthetic training. Those will naturally grow, so shipbuilding will be less of a percentage of the portfolio. That said, shipbuilding will always be at the heart of this company, and we're focused on it. The Navy is asking for these capabilities. There's no better way to serve your customers than to respond to their calls for increasingly complex missions.

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

I wanted to ask, just to be clear, how does the labor shortfall this year impact the timing of any milestones in the next couple of years? Are all the eight milestones you cited last quarter for '23 still on track? Is there any Q4 weight to those, etc.?

They’re still on track for '23. We assess labor plans and program schedules quarterly. The labor situation we saw this year and what we expect for next year is included in those schedules, and we're comfortable with those milestones.

Okay. What do you anticipate your labor hires to be this year compared to 5,000? Additionally, what will be the annual impact from the difference between 5,000 and whatever the actual number is likely to be?

Well, we're on pace to reach 5,000. I’m still comfortable with that number. We have to see how it goes. There have been some good indicators recently. So we remain confident. As for ‘23, we’ll provide better insights into that in February.

The next question comes from the line of Myles with Wolfe Research.

On the topic of milestones, I was hoping you could touch on the two that were still on the slate for '22, DDG-123, and then another one.

Sure. DDG 123 is on schedule and has had some really good trials. It's on pace to get delivered before the end of the year. The other program has been initiated. I was down in the spaces last month, possibly two months ago. All the equipment is installed, and localized testing has begun, starting that test program. So positive developments there. Yes, both are on schedule.

I understand. I was referring to the announcement which mentioned that there would be few, if any, milestones in the fourth quarter. So, those must be minor milestone releases or reserve releases?

We'll assess them when they're complete, review the entire risk and opportunities, and then deal with the outcomes accordingly.

The next question comes from the line of Tom with Credit Suisse.

Regarding the progress payment rule or Chris, is there any legislative indication that, that rule is going to be reversed at some point? I know it's favorable, but I'm imagining you're flowing it to your suppliers as well. I'm just curious, are you anticipating a rule change? Or are you actually seeing legislative action or policy action that would suggest it's going to change next year?

We think there's interest among lawmakers, but I don't see it as a top priority right now. We'll have to see how it plays out after the elections. Does it get inserted into a bill by year-end or not? As we progress through the year, the benefit for this year won’t materialize until the transition is established. We've highlighted that it’s a $250 million positive impact on free cash flow, so we are eagerly awaiting that. I'm hopeful that it will change, but we’ll just have to monitor how it evolves.

Sorry, Tom, I was referring to the progress payment rule shifts that you thought would be reversed in '22. Now it seems it's going to be reversed in '23. Just the timing of progress statements. Do you see legislative inertia there?

I indicated previously that I believed it would be pushed to the end of the year, and that's reflected in our free cash flow guidance. We had projected a midpoint of $2.25 billion and now expect to pay those payments back in 2023. It’s an adjustment in the free cash flow bridge, and we anticipate covering those in the first quarter of '23.

The next question comes from the line of Ron Epstein with Bank of America.

Yes, looking at Mission Tech, do you still feel confident in that 6% to 8% margin target by '24?

Yes, we're on target. When we review EBITDA, you'll notice we adjusted the EBITDA target down from 8.5% to 8.3% due to volume pressures, but we feel comfortable with that. We have a robust pipeline and many opportunities in the portfolio. Thus, we are still aiming for that margin.

Remember, a lot of that work is cost-plus. We expect stability in the margin rate moving forward, so we remain confident.

Got it. And then, if you look at Newport News and back out the Columbia, the $41 million, that suggests the balance of the business was at maybe a 4% margin in the quarter. Can you kind of walk through what was going on there?

We had minor adjustments within the quarter on a few programs at Newport News, not material enough to mention, and this was offset by the Columbia class incentives. Performance incentives are a normal way to incentivize success. We continuously assess our EACs every quarter and make adjustments where we deem necessary for risks and opportunities. There were just some minor adjustments in those programs.

The next question comes from the line of Noah Poponak with Goldman Sachs.

Why did you choose to exclude the milestone slide from the deck this quarter?

We only do that twice a year as part of our convention. We have done that in the past. I can comment on any of the milestones you’d like. I want to assure you that the last two for this year are on schedule, and the deliveries for next year are also on track. It's just been our custom to exclude it now.

I wasn't sure if it was, hey, something's happening with the milestones or nothing's changed, so it doesn’t need to be there. I just had forgotten that it was a choice here.

If there were issues, I would tell you, but they're on schedule. Thanks for your understanding.

With your discussion of inflation, do you expect inflation to actually negatively impact margins in any noticeable way in the medium term? Or do you believe you have the contracting conventions to offset it?

Yes, it could. I'll start, and then Tom can chime in. We do have some protections from an inflation standpoint. We were fortunate that our labor union relationships allowed us to get long-term arrangements, which helps mitigate costs to some extent. Having suppliers under contract before we entered this situation has also helped. However, there are still impacts from salary increases for new hires and inventory costs that we couldn’t put under contract. Thus, it modestly impacts us. We believe we have managed it within our EAC process, but we will need to be mindful of inflation moving forward.

Okay. Your commentary about next year's shipbuilding margin, do we need to consider the potential that it could be down year-over-year? Or are you stating that the plan is for some expansion that’s still possible, but flattish is also possible?

It's more of the latter. Obviously, we want to achieve our targets. We're monitoring the risks carefully. We're maintaining our schedule, and there's ongoing hiring and material progress. We aim for a reduction in the volume constraints and have excellent exposure on contracts, including escalation provisions and elements that will help counter inflation. We haven’t changed our shipbuilding operating margin guidance, and we still feel comfortable with 8% to 8.1%. In fact, we forecast strong performance in the back half. You can do the math based on our earlier comments. We're hoping to hold at around 7% for the latter half of the year.

We now have a follow-up question from the line of David Strauss with Barclays.

Tom, can you go over the expectations for net working capital? I believe you mentioned we're currently at about 11%. Is your target around 8% at the end of this year, and will it remain relatively flat as a percentage of sales from there, while decreasing in absolute terms? Please provide an update.

Yes, that's exactly right. We're at about 11.1% for Q3. I anticipated that. We’ll reduce that as we exit the year while we work through trades, payments, and progress, so that will come down. I expect '23 to revert back to a traditional 6% to 8% range. That’s the plan, and we're on that trajectory.

That concludes the question-and-answer session. I will now pass the line back to the management team, Chris Kastner, for final remarks.

Thanks a lot. I appreciate your interest in HII. We welcome your continued engagement and feedback. Thank you.

That concludes the conference call. Thank you for your participation. You may now disconnect your lines.