Huntington Ingalls Industries - Q4 2023
February 1, 2024
Transcript
Operator (participant)
Ladies and gentlemen, thank you for standing by, and welcome to the fourth 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. To ask a question during the session, please press star followed by one on your telephone keypad. Please be advised that today's conference is being recorded. If you need further assistance, please press Star zero. I would now like to hand the call over to Christie Thomas, Vice President of Investor Relations. Mrs. Thomas, you may begin.
Christie Thomas (Corporate VP of Investor Relations)
Thank you, operator, and good morning. I'd like to welcome everyone to the HII fourth quarter 2023 earnings conference call. Joining me today on the call are our President and CEO, Chris Kastner, and Executive Vice President and CFO, Tom Stiehle. 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 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?
Chris Kastner (President and CEO)
Thanks, Christie. Good morning, everyone, and thank you for joining us on our fourth quarter 2023 earnings call. 2023 was a strong year for HII. We continued to invest both in our shipyards and in IRAD to both expand capacity and develop new products and solutions for our customers. Our growth rate for the year of more than 7% and our free cash flow generation of almost $700 million demonstrate that we're entering a period of accelerated growth and increased free cash flow generation. In addition to record sales growth, with 2023 revenues of $11.5 billion, fourth quarter revenue was especially strong across all three divisions, with 13% year-over-year growth and a record $3.2 billion of revenue.
In 2023, net earnings were $681 million, 18% higher than the prior year, and strong free cash flow of $692 million was 40% higher than 2022. We also had $12.5 billion of contract awards in 2023, resulting in backlog of $48 billion at year-end. At Ingalls, we delivered DDG-125, Jack H. Lucas, the first Flight III ship at NSC-10 Calhoun. Our DDG-51 team was also awarded the contracts for seven destroyers in the FY 2023 multi-year procurement competition. In our amphibious ship programs, we were awarded a $1.3 billion detailed design and construction contract for LPD-32 and launched LHA-8, Bougainville, the third big-deck amphibious warship in the America class. Ingalls expects to complete sea trials and deliver LPD-29, Richard M. McCool, Jr., in the first half of 2024.
At Newport News, we redelivered CVN-73, USS George Washington after completing her refueling and complex overhaul, and continued to progress on the test program for CVN-79, John F. Kennedy. In the Virginia class program last year, we were awarded the long lead time material for 2 additional Block V boats and the first 2 boats of Block VI. We completed work on SSN-796, New Jersey, and expect to deliver her in the first half of 2024. SSN-798, Massachusetts is nearing float off, which we anticipate in the first quarter of 2024. In addition to the 2024 milestones, we've included our 2025 milestone outlook, which reflects our continued focus on execution. Regarding our workforce, I'm pleased with the positive progress in hiring. We hired over 6,900 craft personnel in 2023 and continued to see progress early this year.
For 2024, we have a hiring target of approximately 6,000 craft personnel. The competition for skilled labor in shipbuilding and the larger manufacturing sector continues to impact our shipyards and our supply base. With our Navy partner, we will continue to invest in our team to improve worker retention and proficiency, both within our shipyard and in the supply chain, to ensure we fulfill our contractual commitments and meet our financial objectives. At Mission Technologies, we delivered another outstanding quarter, performing ahead of plan across all business units, leading to strong revenue growth in 2023. In addition to the record revenue growth, Mission Technologies booked new and recompete contract awards with nearly $6 billion in total contract value. Also, Mission Technologies ended the year with a robust business pipeline of $75 billion, which makes us optimistic about potential growth opportunities in 2024.
Key growth drivers include support for mission readiness in artificial intelligence, cyber and electronic warfare, advanced modeling and simulation, LVC, and C5ISR. Turning to activities in Washington, D.C., for a moment, we are pleased with the passage and enactment of the Defense Authorization Bill for fiscal year 2024. The FY 2024 NDAA strongly supports our shipbuilding programs, including multi-year procurement authority for Virginia-class Block VI submarines and incremental funding authority for LPD-33. The Defense Authorization Act also includes necessary authorities to support the implementation of the AUKUS agreement. Looking ahead, over the next five years, we expect revenue growth of more than 4% and cash generation of $3.6 billion. Our expectations are grounded on the assumption that we must deliver on our commitments to our customers.
Also, while the trajectory may not be linear due to the timing of ship milestones and material timing, we expect that HII will be generating approximately $15 billion annually in revenue by the end of the decade. As always, fundamental to our expectations for the business is executing on our contracts and developing and providing solutions to our all-domain customers. We take this responsibility very seriously and remain focused on executing our program commitments. So with that, I will turn the call over to Tom for some remarks on our financial results and guidance. Tom?
Tom Stiehle (EVP and CFO)
Thanks, Chris, and good morning. Today, I'll review our fourth quarter and full year results and also provide our outlook for 2024. 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 fourth quarter results on slide four, our Q4 revenues of $3.2 billion increased approximately 13% compared to the same period last year. This growth was driven primarily by higher year-over-year revenue at all three segments, leading to record quarterly revenue for HII.
Operating income for the quarter of $312 million increased by $207 million, or 197%, from the fourth quarter of 2022, an operating margin of 9.8% compared to margin of 3.7% in the prior year period, up 609 basis points. The increase in operating margin was primarily due to higher segment operating income. Net earnings in the quarter were $274 million, compared to $123 million in the fourth quarter of last year, up 123%. Diluted earnings per share in the quarter were $6.90, compared to $3.07 in the fourth quarter of the previous year.
Moving to our consolidated results for the full year, revenues were a record $11.5 billion for the year, a significant increase of 7.3% from 2022. The improvement was driven by strong year-over-year growth at all three segments. Operating income for the year was $781 million, and operating margin was 6.8%. This compares to operating income of $565 million and operating margin of 5.3% in 2022. The operating income growth was primarily driven by year-over-year improvement in segment operating income at all three segments.
Net earnings for the year were $681 million, compared to $579 million in 2022, up 17.6%, and diluted earnings per share were $17.07, compared to $14.44 in 2022, up 18.2%. For segment results on slide five, Ingalls revenues of $2.8 billion in 2023 increased $182 million or 7.1% from 2022, driven primarily by higher volumes in surface combatants and amphibious assault ships, partially offset by lower NSC program revenues.
Ingalls' operating income of $362 million and margin of 13.2% in 2023, both improved from 2022 results, driven primarily by a $70.5 million sale of a court judgment to recover unpaid receivables for the prior repair, refurbishment, and modernization of foreign-built frigates. The higher volumes that I just mentioned and a contract incentive on DDG-129, partially offset by lower risk retirement on LPD-28 and LPD-30 than the prior year. At Newport News, 2023 revenues of $6.1 billion increased by $281 million or 4.8% from 2022, primarily due to higher volumes in aircraft carrier construction and engineering and submarines, and partially offset by lower revenues in the RCOH program and naval nuclear support services.
Newport News' 2023 operating income of $379 million increased $22 million from 2022, and margin of 6.2% was relatively consistent with 2022 performance. The increase was driven by higher volumes, I just discussed, and a revenue adjustment on CVN-73, partially offset by contract incentives on the Columbia-class submarine program in 2022. Shipbuilding margin for 2023 was 8.3%. At Mission Technologies, 2023 revenues of $2.7 billion increased $312 million or 13.1% from 2022, primarily driven by higher volumes in C5ISR and cyber, electronic warfare, and space contracts.
Mission Technologies' 2023 operating income of $101 million, and segment operating margin of 3.7%, both improved to operating income of $63 million and segment operating margin of 2.6% in 2022, driven primarily by a $49.5 million settlement of representations and warranties insurance claim relating to the acquisition of Hydroid and the higher volumes I described, partially offset by a contract loss and lower equity income due to the sale of a joint venture. Mission Technologies' 2023 results included approximately $109 million of amortization of purchased intangible assets, compared to approximately $120 million in 2022. Mission Technologies' EBITDA margin for 2023 was 8.6%.
Turning to cash, 2023 free cash flow was $692 million, handily beating the guidance due to strong year-end collections, as well as benefiting from the sale of the frigate court judgment and settlement of the reps and warranty insurance claims I've highlighted. During the year, the company reduced debt by $480 million, invested $278 million in capital expenditures, paid $200 million in dividends, and used $75 million to repurchase shares, while ending 2023 with $430 million in cash on hand and a liquidity of approximately $1.9 billion. Net capital expenditures finished the year at 2.4% of revenues, just under 2022's value of 2.5%. Cash contributions to our pension and other post-retirement benefit plans totaled $44 million in 2023.
Our pension outlook for 2024 has improved from the update we provided in November, given the better-than-expected returns to assets, partially offset by a decrease in discount rates since that time. Asset returns for 2023 were 12.3%. Pension expectations for 2025 through 2027 have been updated, and similar to the update we provided for 2024 last quarter, the net benefit has increased from our last update, given the more immediate recognition of the positive asset returns experienced in 2023. This is partially offset by the impact of the lower discount rate. We've also provided an initial view of our 2028 expectations. Turning to slide seven of our financial outlook for 2024.
Given backlog, growth performance in 2023, and the strong demand for our products and services, we are now forecasting mid- to long-term HII revenue growth of 4%+. For shipbuilding, mid- to long-term forecast revenue growth has increased from 3% to approximately 4%, although growth in 2024 will be tepid due to the outperformance in 2023. Accordingly, we are forecasting 2024 shipbuilding revenue between $8.8 billion and $9.1 billion. For 2024, we expect shipbuilding operating margin to be between 7.6% and 7.8% as we continue to target incremental margin improvement.
For Mission Technologies, we continue to expect approximately 5% mid- to long-term top-line growth, and again, due to the 2023 outperformance, driven by approximately $80 million of material timing, we expect tempered growth for FY 2024, forecasting revenue $2.7 billion-$2.75 billion. We expect Mission Technologies' operating margins to be 3%-3.5% and EBITDA margins to be 8%-8.5%. In 2024, amortization of purchased intangible assets is expected to total approximately $109 million, of which $99 million is attributable to Mission Technologies. We expect first quarter revenues of approximately $2.2 billion for shipbuilding and $650 million for Mission Technologies, with shipbuilding operating margin near 7% and Mission Technologies' operating margin near 2.5%.
Moving on to capital expenditures. As we've discussed in prior quarters, we continue to see the long-term capital expenditure rate of 1.5%-2% of general sustainment. In the near term, given the significant demand in submarine construction, we are partnering with our Navy customer to invest in expanding our shipbuilding capacity and throughput. The investment is expected to drive CapEx to approximately 5% on average for the next three years, with 2024 targeted to be approximately 5.3% of sales. I will note that the sustainable free cash flow levels we've previously discussed are not expected to be impacted by this due to customer investment, evidenced by the projected free cash flow growth over the next five years I'll provide shortly.
Additionally, on slide seven, we have provided our updated outlook for a number of other discrete items to assist with your modeling. Moving on to slide eight, we have provided an updated view of our free cash flow outlook for 2024, of $600 million-$700 million, ending our prior five-year free cash flow projection period with an estimate of $3 billion, up from our prior estimate of $2.9 billion. I'm also pleased to provide a free cash flow outlook for the next five years or for FY 2024-2028 of approximately $3.6 billion. I would note that these forecasts do not include Section 174 deferral, which, if it occurs, would be a tailwind to approximately $150 million-$200 million in 2024.
On slide nine, we've provided our capital allocation prioritization model, unchanged from previous discussions, but updated for current events. We continue to remain committed to an investment-grade credit rating and have reduced our leverage ratio to under two turns at the end of 2023, a year earlier than planned. In addition, we finished paying off our $650 million term loan in January 2024, which concludes our debt repayment prioritization while securing on investment-grade ratings and credit metrics. In 2024, we expect to return approximately $500 million of free cash flow to shareholders through dividends and share repurchases. Lastly, on this slide, the board has approved a revision to our share repurchase program in both term and amount, resulting in available share repurchase authorization of $1.5 billion through 2028.
To close on my remarks, the company's mainstay programs are well supported and in demand, and MT's growth success continues to expand and diversify our portfolio. Our future is bright and within our control by executing on our current production contracts and capitalizing on the growth demand for HI products and services. We've exceeded our 2023 financial guidance metrics in terms of revenue, profitability, and free cash flow, while investing in our programs to facilitate growth and throughput. Additionally, we've strengthened our balance sheet, paying down debt and lowering our leverage ratio. Lastly, we fine-tuned the HI investment thesis on the last page of the earnings presentation, focusing on the portfolio strength and visibility, execution, and growth, and free cash flow expansion, driving our current and future capital allocation commitments. With that, I'll turn the call back over to Christie for Q&A.
Christie Thomas (Corporate VP of Investor Relations)
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.
Operator (participant)
Thank you. As a reminder, if anyone would like to ask a question, please press star followed by one on your telephone keypad. If you would like to withdraw your question, please press star followed by two. When preparing to ask your question, please ensure you are unmuted locally. So that's star followed by one to register a question. Our first question today is from Myles Walton from Wolfe Research. Myles, please go ahead. Your line is open.
Myles Walton (Managing Director for Aerospace and Defense)
Great. Thanks. Good morning. Maybe to start with the CapEx change, obviously pretty material, $300 million annualized step-up in run rate. A couple questions on it. One, why isn't it dropping through a higher revenue run rate in the near term, like 2024? And second, why is it only a, you know, couple, three-year investment? What specifically is it going towards? Thanks.
Tom Stiehle (EVP and CFO)
Hey, good morning, Myles. This is Tommy. I appreciate the question. Yeah, so, you know, we mentioned here that, traditionally, we look at the, you know, maintaining the yards to be about 1%-1.5%, with about another 0.5-1.5 of specific projects. As we've talked about in the recent past, you know, we have a lot of activity that's going on in the yards, acquisitions, specifically at Newport News and driving down into the submarine program there. So we're putting more boats on contract in on the VCS and the Columbia program. And, as we're working ourselves through those, those negotiations and schedules, we see it necessitates additional capacity and throughput.
So in conversations with our Navy partner, we've partnered on what that means. There'll be more, a couple more buildings, more capacity in the yard, and it's requiring investments. Just over three years, we have defined projects that we've worked through and we've briefed and we've gotten approved through the board and with the Navy, and the investment there from the Navy will pay for the majority of the, of that. So, as much as it rolls through, that I'm capita, I'm capitalizing the, the projects themselves. I'll get the investments on the contracts to help offset that. So, it's a three-year run. It peaks out the first year at 5.3%.
And as I said, we've kind of given you what the free cash flow projection is from 2024 to 2028 to kind of evidence that, we're still good to our, our thesis of the cash flow inflection to, to $700 million+ as we go forward. There's a shape to it, obviously, of that $3.6 billion I gave you, and, obviously, it grows over time as the revenue and the incremental margin expansion comes online, and then as the CapEx falls off on years four and 5. But, we think it's, it's a good, a good business arrangement. It facilitates the growth that, that we're talking about.
You heard in the comments both from Chris and myself, we're raising shipbuilding from 3%-4%, and this capital investment by both the Navy and us facilitates that growth long term.
Chris Kastner (President and CEO)
Myles, I'd also add that, it obviously won't impact 2024. These projects take a while to get implemented, but it does support the mid to long-term growth.
Myles Walton (Managing Director for Aerospace and Defense)
Okay. Chris, just to follow up on the longer-term projection and the capital allocation prioritization, and you'll probably get on into this at the Investor Day, but the last several years have been, you know, a lot of cash going to pay down debt. It doesn't sound like we need to do that. So are we at a point where we can more commit to a significant majority or not all of the free cash flow to return to shareholders over the time frame looking forward?
Chris Kastner (President and CEO)
Yeah. Yeah, I'll start. So we fundamentally believe the greatest source of value that we can achieve as a corporation is to focus on our operational priorities right now and delivering our ships. So you see that in the capital investments. And then we're fairly clear on our capital allocation priorities relative to investing in our shipyards, being investment grade, progressively improving our dividends, and then providing any remainder back to shareholders. Now, that being said, we're going to have optionality around M&A. We have the responsibility to evaluate M&A projects from time to time. I don't see any significant holes in the portfolio right now, and operationally, I think our greatest focus needs to be on delivering our ships to our customer because they need them.
So while we're not going to commit to providing everything back to shareholders on this call, we need to, we're fortunate we have a strong balance sheet, and we can do everything. So that's how we're thinking about capital allocation moving forward. Yeah, if I could piggyback on top of that, kind of, I think you're looking at it the right way. If you look back on where we've been, right? In 2022, we gave back to the shareholders $249 million in dividends and repos. This year, it's up to $275 million, which is 40% of free cash flow. But we have to keep in mind, for 2023, it was $480 million of debt paydown.
So we actually, between the debt paydown and what we gave back to shareholder, it was better than 100% of the free cash flow of $692 million for 2023. And now for this year, as we're saying, $500 million of dividends and repos. There's still another $229 million. I just paid $145 million in January, and there's $84 million bond payment in May. So $229 million of debt, and that concludes it kind of going forward, plus the $500 million I'm committing to, again, is over 100% of free cash flow going back to the shareholders this year. If you take the midpoint of the guide of $650 million, right? So, it's ramping. We're giving you the commitment through 2024.
We haven't told you a commitment to pass that, but we would envision, as we work off each year and the cash is there, that we'll update you accordingly.
Myles Walton (Managing Director for Aerospace and Defense)
All right, thank you.
Operator (participant)
Thank you. Our next question today is from Gautam Khanna from TD Cowen. Gautam, please go ahead. Your line is open.
Gautam Khanna (Managing Director and Senior Research Analyst for Aerospace & Defense)
Yes. Hey, I joined a little late, so I apologize if you covered this, but could you update us on the timing of when the three milestones that slipped out at Q4 will get caught up? And if there's any downstream impacts from those delays, maybe crowding out labor or anything else. And then if you could just talk about the milestones in 2024, are there any that are kind of late in the year, Q4 weighted, that could pose a similar risk? Thank you.
Chris Kastner (President and CEO)
Sure, sure. Thanks, Gautam. The two VCS milestones, we're essentially complete with both of the operational commitments for those milestones. There were some late-breaking changes on both of those boats that needed to be implemented before we could claim victory and finally achieve them. But, we're essentially complete. The staffing has been significantly reduced on each of the boats, and it's been reallocated to the other boats. And no material financial issue related to those at all. On LPD-29, we ran into an issue going through the test program that we need to stop and do a root cause, corrective action on. We've done that. The ship went to sea this week, performed well, and we think we'll deliver that here, late Q1, early Q2.
Now, from a 2024 milestone impact, we're all aligned within the corporation relative to those milestones. It does put some pressure on the VCS milestones at the end of the year on 798 and 800, but we have detailed plans to achieve those, and we're committed to getting those done.
Gautam Khanna (Managing Director and Senior Research Analyst for Aerospace & Defense)
Thank you. If I could follow up, I just wanted to make sure I understood the accounting on those three that moved out of Q4. Were there positive cum catch-ups related to them in Q4? And if not, do you anticipate that, you know, in Q1 and Q2 as you recover?
Chris Kastner (President and CEO)
No, no, there were no-
Gautam Khanna (Managing Director and Senior Research Analyst for Aerospace & Defense)
It's a-
Chris Kastner (President and CEO)
There were no material financial issues related to those. Obviously, on LPD-29, there was a bit of an opportunity lost there that will recover when it ultimately gets delivered, but it's all included in our guidance.
Gautam Khanna (Managing Director and Senior Research Analyst for Aerospace & Defense)
Gotcha. Thank you so much. Appreciate it.
Chris Kastner (President and CEO)
Sure.
Operator (participant)
Thank you. Our next question is from Seth Seifman, from JP Morgan. Seth, please go ahead. Your line is open.
Seth Seifman (VP for Equity Research Analyst, Aerospace & Defense)
Hey, thanks very much. Good morning.
Chris Kastner (President and CEO)
Good morning.
Seth Seifman (VP for Equity Research Analyst, Aerospace & Defense)
Good morning. I guess, you know, in other of your earnings calls this quarter, you know, we've heard about various supply chain challenges on Virginia. I guess, you know, can you speak to kind of how you feel your estimates are looking on Virginia and the amount of risk in those estimates? And then, you know, to the extent that is there, is there much in there that's contemplated for inflation reimbursement? Because it seems that, you know, contractor expectations for inflation reimbursement have been coming down. You know, has that been the case for HII? Or were they not there in the first place, or is the submarine industrial base different because it's such a priority?
Chris Kastner (President and CEO)
Yeah. So we don't have inflation protection on the VCS program at this time. The supply chain is a challenge across all of our programs, actually. We do have EPA protection for the most part at Ingalls, and we're managing supply chain risk across the portfolio. The Navy is fully aware of this. We're very transparent about it. That's why the SIB funding is so important. That's why getting three-year AP is so important, so we could just eliminate that risk. But we evaluate our EACs every quarter, and if there's risk, we deal with it in that quarter. But it's not going away anytime soon. I think everyone understands that. That's why we have SIB funding being appropriated and authorized.
As soon as we can get that down into the supply chain, the better.
Seth Seifman (VP for Equity Research Analyst, Aerospace & Defense)
Okay. Okay, thanks. And maybe just a quick-
Chris Kastner (President and CEO)
Sure
Seth Seifman (VP for Equity Research Analyst, Aerospace & Defense)
... follow-up on the capital deployment. If I look at the $3.6-
... billion over, over the period. You know, think about the, the dividends and the 2024 debt pay down, that maybe leaves like, you know, $2.25 billion. I know the, the repo authorization, I think the slides say there's about $1.5 billion left. I mean, would, would you think that there's, before, you know, that it's possible to exceed that $1.5 billion, by 2028?
Tom Stiehle (EVP and CFO)
Yes, I would let that be the guiding light. You know, we extended it to term and time, but we can always go back and change that again. So I wouldn't read too much into the math of it, but, you know, as we said, there's 1.5 available, $0.5 billion available right now through 2028, and as we move forward, we'll adjust that accordingly. So that was just more of a housekeeping issue that we cleaned up.
Chris Kastner (President and CEO)
Great. Thank you very much.
Tom Stiehle (EVP and CFO)
Sure.
Operator (participant)
Thank you. Our next question is from Scott Deuschle from Deutsche Bank. Scott, please go ahead. Your line is open.
Scott Deuschle (Director and Equity Research Analyst, Aerospace & Defense)
Hey, good morning.
Tom Stiehle (EVP and CFO)
Hi.
Chris Kastner (President and CEO)
Morning.
Scott Deuschle (Director and Equity Research Analyst, Aerospace & Defense)
Hey, Chris, just to clarify, do the LPD-29 delivery delays have much extra cost associated with them, or is it more just a function of some extra time and a deferral of the AC, rather than a diminishment of the AC opportunity?
Chris Kastner (President and CEO)
Well, I mean, time and shipbuilding is cost, right? So, we probably lost a little opportunity there. It's not material in nature, and we'll do that. We'll take a step up, if appropriate, when we make final delivery. But, it obviously would have been worth more if we did it at the end of the year.
Scott Deuschle (Director and Equity Research Analyst, Aerospace & Defense)
Okay. Got it. And then, Tom-
Tom Stiehle (EVP and CFO)
Sure.
Scott Deuschle (Director and Equity Research Analyst, Aerospace & Defense)
Just from a reporting perspective, why are Venezuela insurance recoveries included in operating earnings rather than below the line? A lot of people are a little confused by the reporting this quarter. Thanks.
Tom Stiehle (EVP and CFO)
Yeah, the way that I think the accounting works on that, down in Ingalls, it's in the operating income and other income because, you know, it's, we've had that contract, we've incurred cost on it, so it's a recovery for costs that we've had booked in the past and we had written off. So it comes back still as an, in, an operating income. It doesn't go into the revenue, so there's not a rev rec to it. But we do, we do account for the margin and income statement, and obviously, we picked up the cash on both of those, on both the frigate and the reps and warranty in Q4.
Scott Deuschle (Director and Equity Research Analyst, Aerospace & Defense)
Okay. And then, Tom, last question. Is there any kind of ramp to the, or slope to the free cash flow target, the free—the cumulative target over the next five years, or is it fairly level loaded?
Tom Stiehle (EVP and CFO)
Yes, there are-
Scott Deuschle (Director and Equity Research Analyst, Aerospace & Defense)
2024? Thank you.
Tom Stiehle (EVP and CFO)
No, there is a ramp to it and a shape to it. I knew when we gave that, that people would want to see that because we've been giving you the shape of the current one from 2020 to 2024, but really only the back end of it. You know, when we first announced that, we didn't provide it either. And the only reason why we're not trying to be kind of too nebulous, but, you know, it's 5 years, a lot of moving parts, how it can move around. I can tell you it's not a reach number. We wouldn't put it out there if we don't feel that we can hit it.
But, I'm most comfortable right now. I try and manage by year, and we gave that number to show, you know, with the EBITDA ramp and the revenue that we talked about, 4%+ to HII across the enterprise. We see that Mission Technologies is definitely accretive and pulling cash for us right now. Your modeling should easily be able to get to that number. But, I really want to get through 2024, and then we'll—we can give you a guide on what, you know, like, 2025 kind of looks like and each year thereafter. Okay?
Scott Deuschle (Director and Equity Research Analyst, Aerospace & Defense)
Thank you. Nice results.
Tom Stiehle (EVP and CFO)
Thank you.
Operator (participant)
Thank you. Our next question is from David Strauss from Barclays. David, please go ahead. Your line is open.
David Strauss (Managing Director for Equity Research - Aerospace & Defense)
Great. Thanks. Good morning.
Tom Stiehle (EVP and CFO)
Morning, David.
David Strauss (Managing Director for Equity Research - Aerospace & Defense)
Chris, or Tom, I wanted to ask about the shipbuilding margin target. So I think, you know, you had been targeting 7.7%-8% for 2023, and you talked about 2024 being above that, and then you had milestones slip out that I would assume, you know, with those potential EAC adjustments, that would help. So I guess, what changed in terms of the, you know, the progression on the shipbuilding margin side as it relates to 2024 versus what you talked about or were thinking about before?
Tom Stiehle (EVP and CFO)
Yeah, so we don't want to get ahead of ourselves, right? And we did talk about 77 to 80. There was a couple of milestones that we missed at the end of the year, which caused a little, a little bit of a drag, as you saw how we finished off. Still, shipbuilding healthy with the recovery of the sale of the claim, 8.3% still kind of beat the guidance with the claim. On a recurring run rate, I'm with you that it's a little bit short on that right now, and we'll pick it up kind of going forward, right? So I'm not just going to have a step function up, but we'll pick up where we have on our run rates.
As we finish our milestones and we get credit for that, there'll be some step ups along the way. I think 7.6-7.8 is appropriate. It's, I'm comfortable to conservative on that right now, and, you know, I've guided the last couple of years, and we've missed a couple of tenths right at the end of the quarter, so I don't want us to get ahead of ourselves a little bit. Let's kind of earn each of these quarters. I think 7.6-7.8 is the appropriate way to kind of look at it. If we get the hiring and the retention, and we have clean shifts through the whole year, and we make our milestones, we could be on the upper end of that range, if not higher.
But, I think for now, finishing the year off at, you know, 83 with the claim, the bottom end of the guide right now without the claim, I think that's the right starting point with, you know, a year's worth of shipbuilding to go to 2024.
David Strauss (Managing Director for Equity Research - Aerospace & Defense)
Okay. And then wanted to ask about working capital. You know, I think for the year, at the end of the year, you came in kind of below your target. It looks like you're around 5% of sales. So, how does working capital look going forward? I assume some of the, you know, the CapEx recovery will flow through working capital, at least over the near term. Thanks.
Tom Stiehle (EVP and CFO)
Yeah, sure. Yeah. Yeah, we've had a lot of conversation on that working capital, and I know when we were much higher in that, at 10% and 8% range, there was concern, like, how could we get that down? And we were projecting that that would happen. I'm happy to report that it's kind of landed right where we thought it would be, right? So I think we started the year off in around 6%-6.5%. We finished the year at 5%. The conversations we've had in the recent past, we've talked about it used to be 6%-8% without Mission Technologies. With the additional sales for Mission Technologies, it's more like 4%-6%.
And that I had highlighted that we were coming down, you know, with COVID in the rearview mirror, production programs that we have, maintaining, trying to maintain the schedules with the same type work, we would see a normalization of the working capital, and that's exactly what's played out. We've lost about a point of working capital throughout this year, and I still anticipate kind of going forward, a little bit improvement in that as we go forward. So, four to six is the right way to kind of look at it. We exit 2023 at 5%, and I would expect in 2024 to be on the bo- you know, a little bit lower than that, between 4%-5%.
The capital incentives will help as we get the cash up front, you know, before the cost is completely incurred. I think that's the appropriate way to kind of model it going forward in the 4%-5% range in the next couple of years.
David Strauss (Managing Director for Equity Research - Aerospace & Defense)
Thank you.
Tom Stiehle (EVP and CFO)
Mm-hmm.
Operator (participant)
Thank you. Our next question today is from Pete Skibitski from Alembic Global. Pete, please go ahead. Your line is open.
Pete Skibitski (Director for Aerospace & Defense Equity Research)
Hey, good morning, guys. Nice quarter.
Tom Stiehle (EVP and CFO)
Morning.
Pete Skibitski (Director for Aerospace & Defense Equity Research)
Tom, I think you just helped us out a little bit, but can you quantify, and sorry if I missed it, can you quantify the two one-off gains in the fourth quarter at Ingalls and Mission Technologies?
Tom Stiehle (EVP and CFO)
Yes, at Mission Technologies, it was the warranties and representations for the purchase of Hydroid. That was a settlement we had for $49.5 million. And then, Ingalls, we picked up from a frigate repair effort that we had in the late 1990s and had cost against that, and we've been working to see how we could get a recovery on that. And we did get a judgment, a settlement judgment in 2018, and then we were able to broker and sell that entity for $70.5 million. And you'll see in the 10-K, there's a little bit of a back end on that too. I'll have to see how that plays out, but that's about all I want to say about those two.
It nets about $120 million gross, but obviously, I pay tax on that. So, net tax is the impact to the profitability, and cash was $95 million.
Pete Skibitski (Director for Aerospace & Defense Equity Research)
Yeah, I appreciate it. And then, maybe a more top-level question: What gave you guys the confidence to raise kind of the, the midterm outlook, despite the fact that we don't have a 2024 budget appropriated yet? And then on the 2024 supplemental that's out there, I think there's a lot of shipbuilding industrial-based money in there. Maybe you could talk about that, and is there anything else in the supplemental that could benefit you guys?
Chris Kastner (President and CEO)
Yeah, so, so I'll start with that. The 2024 budget is very positive for us. All our major programs are supported. LPD-33 is supported, which is really important to Ingalls. The submarine industrial base funding in the baseline budget is important. I think that's around $400 million, but the additional $3 billion in the supplemental just furthers effort to improve the supply base. And there's also funds within that to improve the labor force. So getting both of those approved is really important. Now, our confidence relative to the guide is just on the demand for our products. We see the demand for not only the products in shipbuilding, both in Newport News and in Ingalls, but also in Mission Technologies.
When we laid it out and we looked at the investments we're making and the opportunity, it just makes sense. We're in a bit of an inflection point from a sales standpoint, and I actually think there's probably some tailwinds if we can get that submarine industrial base funding approved, executed, and start improving throughput. Tom, you have anything to add?
Tom Stiehle (EVP and CFO)
Sure, yeah. You know, we've talked about the demand for the products and services we have. You know, we go around the horn down there, you know, Ingalls just won 7 destroyers with a pretty good clip on the schedule side of that, with options in the future for that. We see the 30-year shipbuilding plan, the five-year FYDP. We've talked about the 17 boats that are gonna happen. Already 2 long lead for the last 2 in Block V and then VCS Block VI. Those advanced procurements happen. They have to get definitized. We're talking about the Columbia Build 2, the RCOH for 75, and then just the preponderance of work that we have, change work, and then the growth at Mission Technologies. We update our annual plan, you know, every year, obviously.
It's a 10-year look, and when we really kind of look, we say mid to long, that's like 5-7, 5-10 years. I know the Street, that's too far, really, but at least 5 years, we see growth rates at least that, if not higher. Now, things have to break our way with timely awards. We have to get the labor in, and the materials have to hit. But we can just see how the programs are playing out, costs, inflation, orders, backlogs, and things of that nature. And we think it's appropriate to, you know, raise to these levels, and there's still, you know, opportunities above and below this for additional growth.
Pete Skibitski (Director for Aerospace & Defense Equity Research)
Great. Thanks, guys.
Chris Kastner (President and CEO)
Sure.
Operator (participant)
Thank you. Our next question is from Ron Epstein from Bank of America. Ron, please go ahead. Your line is open.
Ron Epstein (Managing Director and Equity Research for Aerospace & Defense)
... Hey, good morning. Yeah, a lot to ask, but maybe just a follow on, on the two questions, one on the supply chain and one on labor. On the labor front, how's retaining labor been? 'Cause, you know, something we've heard across the industry, not specific to you guys, but, you know, generally across the industry, it's been tough to retain labor. That, you know, companies are bringing in, you know, young mechanics or whatever. They stick around for a year or two, and then they take off. I mean, how are you guys faring on that front, and what are you doing to keep them?
Chris Kastner (President and CEO)
Yeah. Hey, Ron, thanks for that question. It's definitely been a challenge over the last couple of years, citing the exact example that you brought up. And the team has a number of initiatives they've implemented over the last year to address the situation, and they center around three fundamental issues, really, which is flexibility for the team that we're hiring in work schedules, potential time off. The craftsperson, man, and woman that we are now hiring is not fully prepared to come right into the workforce and start that kind of daily grind without having some flexibility in their work schedules. So we have a number of pilots that we're working in that regard.
We have some really interesting analytics around targeting geographies that we have better success in hiring and retaining. So we have initiatives there. And then we have very focused incentives on critical skills. An example is machinists, where you have to just pay them more to get them and keep them. So a number of initiatives, we pivot very quickly because we have such good data on what works or what is going to work and what does work, so we can expand upon it.
But, you're hitting on a fundamental issue in the industry right now, in the manufacturing industry as a whole, and, within defense and in shipbuilding, is that the labor issue is, you know, obviously one of our major risk issues and one we're working very hard to resolve. I would also say the Navy understands it, and in the SIB funding, as I previously mentioned, there are workforce development issues as well. Getting people into the apprentice schools because our retention rates in the apprentice schools and established programs are significantly higher because the people that go in there are choosing that as a profession. So it's something we're well, well aware of. Our partners are well aware of it, and the Navy is well aware of it, and we're addressing it.
We've seen some rays of light as we ended the year, but you can't really trust a couple data points, so we're going to keep working on it this year.
Ron Epstein (Managing Director and Equity Research for Aerospace & Defense)
Got it. Got it. And then on the supply chain, with the investment that the Navy is making, where does that have to be made? I mean, where are the weaknesses in the supply chain today as you see it?
Chris Kastner (President and CEO)
Yeah. So they've done a really good job both on the VCS program and on the DDG program. It doesn't get as much press, but on the DDG program as well as identifying single source or sole source vendors in the supply chain that need investment to increase capacity. Because as you know, capacity had dwindled a bit in the previous 10-15 years. So they've done a very good job targeting those suppliers and making investments. And then there's some large critical material where there's single source suppliers that are dealing with the same sort of labor and supply chain issues that we are.
So to identify those and potentially dual source them or qualify an additional source is something that the Navy and we are looking at as well. So it's a very comprehensive review. I think it's managed very well by us and our partners, and I think it's going to get at the issue, but it doesn't turn overnight.
Ron Epstein (Managing Director and Equity Research for Aerospace & Defense)
Got it. Got it. Thank you very much.
Chris Kastner (President and CEO)
Thanks, Ron.
Operator (participant)
Thank you. Our next question is from Noah Poponak, from Goldman Sachs. Noah, please go ahead. Your line is open.
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
Hey, good morning, everyone.
Chris Kastner (President and CEO)
Morning, Noah.
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
Tom, can you give us the pieces that bridge your actual full year 2023 free cash versus what you had last guided it to?
Tom Stiehle (EVP and CFO)
So we started the year at $400 million-$450 million. We got it up to $500 million. You can, you know, at $692 million at completion, if you take out the two claims, you know, net tax, obviously, that's $95 million comes off the $692 million, gets you to $597 million. And then the difference between, you know, the increased guide in Q3 of $500 million-$597 million, with some strong, strong collections in Q4. The team really stayed on it. We made sure that, we got our, our bills in on time, and we, we had a clean, a clean Q4, receivable.
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
Okay.
Tom Stiehle (EVP and CFO)
So it was just across the enterprise. There wasn't anything of significance to really note in that.
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
Okay. So if I take that final and take out the claims, I'll, I guess, call that closer to $600. Can you bridge me-
Tom Stiehle (EVP and CFO)
Yep
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
... from that to staying there in 2024 while CapEx is going up as much as it is? If, if you're, you know-
Tom Stiehle (EVP and CFO)
Yeah
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
... because you got revenue guidance, that's up, you know, kind of 2%-3% in a flat segment operating margin.
Tom Stiehle (EVP and CFO)
Yeah. So I had mentioned in my comments up front that there's, you know, active and significant Navy participation in that. So I don't want to get too much into the details, but we're both contributing to it. But that's helping offset that increase there.... So, you know, the guide of $600-$700, we took that down a little bit from where I left you last quarter. As we exceeded this year, but a little bit timing, too, was in there on the collections.
A little overachievement in 2023, a little back off from where I left you last time at $700 million, now it's $600 million-$700 million, but I would not be alarmed because of the higher CapEx in 2024, 2025, or 2026, that it's gonna be a major draw on the free cash flow from the discussions we've had in the past. That's been a little bit of guiding light. We definitely wanna support our customer, perform existing contracts. Much of the work we're talking about for the new CapEx is on the new requirements that are coming, and as we broker that relationship and how we make that happen, we're gonna ensure that we kinda keep everything in lockstep.
We gotta get these ships out here cleaner and sooner, high-quality value, and on our side, we still have to be able to, you know, kind of run the business here and have good working capital. So all that's in the mix, and, I would not be concerned on the 5.3% against the cash flow projection that we've given you. Again, that's why we gave you, you know-
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
Okay
Tom Stiehle (EVP and CFO)
... you probably won't see that too often, a five-year projection going forward. But we wanted to settle everyone out there that all that's been factored in as we run the business and we manage our cash.
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
How will we actually-
Tom Stiehle (EVP and CFO)
I would te-
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
physically-
Tom Stiehle (EVP and CFO)
I would tell you, if I could-
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
see that-
Tom Stiehle (EVP and CFO)
I think I have one more-
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
Yeah.
Tom Stiehle (EVP and CFO)
I'm sorry, go ahead. Go ahead.
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
Well, I'm just wondering, like, if there's a Navy participation, it... Will not all of that actually be recorded in CapEx, or will it flow to your CapEx and come back in your rates, in your operating margin, or how will we actually see that in your financials?
Tom Stiehle (EVP and CFO)
So, you know, when we do our CapEx, obviously, it's our cost. We get incentivized to go do that, so it comes on the contract in the form of capital incentives, additional margin, and cash that flows through there. That helps offset my additional cost of that.
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
Okay.
Tom Stiehle (EVP and CFO)
I would comment just earlier to your question, as you tried to kind of normalize the $692 out to, like, $597, as I said, when you pull out the two claims, you know, it's the ramp that we've been talking about. If you go back to 2021, it's 499, and 2022 at 494, and now even without the claims, now it's ramped to $597, and now we're at $600-$700. We've talked about a $700 number in 2024. Just a little bit, but it's range-bound now because we exceeded in 2023. Now the $3.6 billion, you know, the average of that is $720. That's got a shape to it, obviously. It's gonna be smaller upfront.
As the revenue incremental margin grows in the out years, it's gonna be larger in the back. I think that's appropriate right now. It's not a stretched number. It's reasonable. It's conservative to reasonable number. We have risks to kind of go work off, and I think that has, you know, both risks and opportunities associated with it. So I'd leave you with that.
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
So the piece that goes through CapEx that's supported by the Navy, that will, we'll just see that in future margins as it flows through your rates? Is that right?
Tom Stiehle (EVP and CFO)
Yes. Margins and cash, yes.
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
Okay, and then I guess I just... So for 2024, with the margin guidance flattish year-over-year, I still struggle to see where that $300 million is coming from.
Tom Stiehle (EVP and CFO)
So on the margin side first, there's a timing of it when that happens, right? So you get that on contract, and you gotta go do the work, and there's a percentage of completion you take. So there's a lag on the margin side. But on the cash side, we try and make sure that we stay neutral so that we're not impacted as we're incurring cost, that high of 5.3% of CapEx that gets offset on the inside, on the payment schedule of the CapEx, right? So the margin's not running exactly with the cash. But on our side, we're trying to keep it neutral, so it's not gonna impact our projections that we've given.
Chris Kastner (President and CEO)
Yeah, it's part of the total ship P&L, Noah.
Noah Poponak (Managing Director and Senior Equity Research Analyst - Industrials)
Okay. Okay. All right, I appreciate that. Thanks so much.
Chris Kastner (President and CEO)
Sure. Sure, Noah.
Tom Stiehle (EVP and CFO)
Thanks for the question.
Operator (participant)
Thank you. Our next question is from George Shapiro from Shapiro Research. George, please go ahead. Your line's open.
George Shapiro (Managing Partner and Aerospace & Defense Analyst)
Yes, I wanted to ask, your actual ship revenues were, like, almost $300 million higher than what you, the high end of the guide that you provided on the November call. So just wondering why, given that, to me, this is a fairly predictable business. And I have a different question, too. Thanks.
Tom Stiehle (EVP and CFO)
Yeah, sure. Sure. So from the MT side, we saw a nice rush at the end of the year of some receivables. I mentioned in my notes, it's about $80 million, so that was a big pickup. On the shipbuilding side, just the timing of material on how that flowed in. The majority of the overage and where we thought we would land was on the material side. We have some outsourcing going on as well, so those costs flow through, you know, opportunistic that they landed in 2023 here. But we guided $86 million-$88 million. We came about $100 million over that, and, you know, you kind of normalize that. It was good growth there.
You saw it in shipbuilding, better than 5%, 5.5% in shipbuilding. You know, Ingalls up in the 7s and Newport News at 4.8%. But it was a sharing between all three divisions that just exceeded. It was a nice run at the end of the year there on the revenue side.
Chris Kastner (President and CEO)
But George, you're familiar with material timing. You know, you can miss by a month to two months from time to time. It just came in at the end of the year. Now, unfortunately, it impacts the guide for the next year, right? So you had to, we had to include that, but it was just timing.
George Shapiro (Managing Partner and Aerospace & Defense Analyst)
Okay. And then the other one, probably for Tom: If you had a $49 million benefit in mission systems from Hydroid, I mean, it implies the rest of the business made $2 million. Now, you alluded to some charges at some of the other businesses there, but if you could just provide some more information on that.
Tom Stiehle (EVP and CFO)
Yeah, that's right. A piece of that's timing on how the programs just play out in the, in the mix, in execution on that. We did have one job over there that we just took a, you know, a slight step back. It wasn't material. You won't find it in the K there, 'cause it's not at the threshold. There's $2 million on that, but, you know, not a lot of dollars when you break down that kind of business to begin with. And then when you, you take a small charge, and then, then the timing of performance on, on how we book things, it came out to be a light quarter there. But, you know, overall, overall, with the claim 8.6% EBITDA, the ROS at 3.7% you can normalize that out.
It'd be a little bit on the bottom end of the guide that we gave you, you know, 8% -8.5% at the beginning of the year for EBITDA. But as we had mentioned throughout the year, there was the joint venture that we sold off. We picked up cash, but we lost some equity. And we've been kind of mentioning about a charge on a manufacturing effort that we have over there. So I think that's behind us right now, kind of going forward, and I'm still very satisfied with the numbers that MT kind of put up across the board for revenue, margin, and cash.
George Shapiro (Managing Partner and Aerospace & Defense Analyst)
Tom, if you could just provide the EACs for each of the sectors in the quarter?
Tom Stiehle (EVP and CFO)
Sure. So for the quarter, it was $111 million of favorability, $43 million of unfavorability, a net of $68 million. It was made up of about 50%... That net was 50% in Ingalls, about 35% in Newport News, about 15% in MT. Just for everyone on the call, you'll see it in the K, which does the whole year, it was $309 million gross favorability for the whole year, $191 million gross unfavorable, with a net of $118 million. And that breaks out to be about 75% Ingalls and 15% MT and 10% Newport News. Appreciate the question.
George Shapiro (Managing Partner and Aerospace & Defense Analyst)
Okay, thanks very much.
Tom Stiehle (EVP and CFO)
Yes, sir.
Chris Kastner (President and CEO)
Thanks, George.
Operator (participant)
Thank you. We will now be taking our last question from Scott Mikus, from Melius Research. Scott, please go ahead. Your line is open.
Scott Mikus (Director for Aerospace, Defense & Space Equity Research)
Good morning.
Chris Kastner (President and CEO)
Good morning, Scott.
Scott Mikus (Director for Aerospace, Defense & Space Equity Research)
Chris, I wanted to ask, is any of the customer-funded investments over the next three years, is any of that contingent on the supplemental package making its way through Congress?
Chris Kastner (President and CEO)
That's a good question. I don't have that in front of me. That's a really good question. I don't have that in front of me. I know a part of it. I think a part of it is, but I couldn't quantify it for you. So we'll get that information for you, Scott.
Scott Mikus (Director for Aerospace, Defense & Space Equity Research)
Okay, got it. And then thinking about the shipbuilding revenue growth rate, you've for a long time talked about labor being the governor on output there. So how much can these investments improve throughput in the shipyards if retention rates don't improve materially?
Chris Kastner (President and CEO)
Well, it has to be both, right? And when we do our projections, we risk adjust them. It's not assuming that everything works out perfectly. So it has to be both. We have to improve our retention rates, we have to improve the supply chain, and we have to improve capacity. And if we do that, then throughput will significantly increase. But you're absolutely correct. We have to, we have to be successful in both.
Tom Stiehle (EVP and CFO)
To kind of supplement that, too, you know, that as we're building that out on, you know, how we hire, how we train, how we retain. We're not standing flat-footed, but I know that the yards themselves have active plans on either outsourcing or contract labor, using additional overtime with the crew that we do have, working the three full shifts where there's a critical path. But there's dials that we have to try and offset that in the near term. You can't run that, you know, five or 10 years. If you see the... we see the demand, we're building out, you know, organically, that we'll be able to do things in the yards.
But right now, there are dials and opportunity sets for additional labor outside the yard that we're employing right now.
Scott Mikus (Director for Aerospace, Defense & Space Equity Research)
Okay, got it. Thank you.
Chris Kastner (President and CEO)
Mm-hmm. Thanks.
Operator (participant)
Thank you. This is all the time we have for the Q&A session today, so I would now like to hand back over to Mr. Chris Kastner for any closing remarks.
Chris Kastner (President and CEO)
Yeah, thank you, and thank you for joining the call today. I'm very proud of our team's strong performance last year, and I'm confident that we will continue to create value for our shareholders this year. I would also like to remind you that we are hosting an investor day on March 20, and look forward to seeing many of you then. Have a good afternoon.
Operator (participant)
Thank you, everyone, for joining today's call. You may now disconnect your lines and have a lovely day.
