Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

Our Business

Huntington Ingalls Industries, Inc. ("HII", "we", "us", or "our") is a global, all-domain defense partner, building and delivering the world’s most powerful, survivable naval ships and technologies that safeguard America’s seas, sky, land, space, and cyber. For more than a century, our Ingalls Shipbuilding segment ("Ingalls") in Mississippi and Newport News Shipbuilding segment ("Newport News") in Virginia have built more ships in more ship classes than any other U.S. naval shipbuilder, making us America's largest shipbuilder. Our Mission Technologies segment develops integrated solutions that enable today's connected, all-domain force. Headquartered in Newport News, Virginia, HII employs approximately 44,000 people domestically and internationally.

We conduct most of our business with the U.S. Government, primarily the Department of Defense ("DoD"). As prime contractor, principal subcontractor, team member, or partner, we participate in many high-priority U.S. defense programs. Ingalls includes our non-nuclear ship design, construction, repair, and maintenance businesses. Newport News includes all of our nuclear ship design, construction, overhaul, refueling, and repair and maintenance businesses. Our Mission Technologies segment provides a wide range of services and products, including command, control, computers, communications, cyber, intelligence, surveillance, and reconnaissance ("C5ISR") systems and operations; the application of Artificial Intelligence and machine learning to battlefield decisions; defense and offensive cyberspace strategies and electronic warfare; unmanned autonomous systems; live, virtual, and constructive training solutions; platform modernization; and critical nuclear operations.

The following discussion should be read along with the unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q, as well as our Annual Report on Form 10-K for the year ended December 31, 2022 (our "2022 Annual Report on Form 10-K").

Business Environment

We continue to see uncertainty in the economy, our industry, and our company, with challenges for customers and suppliers, labor shortages, supply chain challenges, and inflation, among other impacts.

U.S. Government Contracts - Congressional consideration of the fiscal year 2024 President’s Budget Request began following its release in March 2023. All four defense oversight committees have acted on their respective bills. The House and Senate have each passed their respective National Defense Authorization bills for fiscal year 2024, both of which support our shipbuilding programs, including the authorization of the additional LPD 33 Flight II amphibious ship. Both bills also authorize funding for two Virginia class (SSN 774) submarines, one Columbia class (SSBN 826) ballistic missile submarine and two Arleigh Burke class (DDG 51) destroyers. Additionally, both bills authorize multiyear procurement authority for the Block VI Virginia class (SSN 774) submarine contract. The Armed Services Committees will now work to adjudicate differences between the House and Senate authorization bills.

Both House and Senate appropriations bills have been passed out of committee, and the House defense appropriations bill has been approved by the full House. The House voted out a defense appropriations measure that broadly supports the President’s budget request, including funding for two Virginia class (SSN 774) submarines, one Columbia class (SSBN 826) ballistic missile submarine and two Arleigh Burke class (DDG 51) destroyers. The Senate Appropriations Committee included $500 million in advance procurement for LPD 33 (unnamed) and advance procurement for a third Arleigh Burke class (DDG 51) destroyer in fiscal year 2025, as well as full funding for two Arleigh Burke class (DDG 51) destroyers, two Virginia class (SSN 774) submarines, and one Columbia class (SSBN 826) submarine in fiscal year 2024.

Appropriations to fund the federal government for fiscal year 2024 have not been enacted. To provide Congress additional time to reach agreements on funding levels for federal agencies, a Continuing Resolution extending funding through November 17, 2023, at fiscal year 2023 levels was enacted on September 30, 2023. We cannot predict the outcome of the fiscal year 2024 budget process or whether additional short-term funding will be required in the event annual appropriations measures are not finalized by the November 17, 2023, the expiration date of the current Continuing Resolution.

Political and Economic Environment - The global geopolitical and economic environment continues to be impacted by uncertainty, heightened geopolitical tensions, and instability. Geopolitical relationships have changed, and are continuing to change, and the U.S. and its allies face a global security environment that includes threats from state and non-state actors, including major global powers, as well as terrorist organizations, emerging nuclear tensions, diverse regional security concerns, and political instability. These global threats persist across all domains, from undersea to space to cyber, and the global market for defense products, services, and solutions is driven by these complex and evolving security challenges. Our current operating environment exists in the broader context of political and socioeconomic priorities and reflects, among other things, the continued impact of and uncertainty surrounding geopolitical tensions, financial market volatility, inflation, and a challenging labor market.

For further information on our business environment, see the discussion under Business Environment under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our 2022 Annual Report on Form 10-K.

Critical Accounting Policies, Estimates, and Judgments

As discussed in our 2022 Annual Report on Form 10-K, we consider our policies relating to the following matters to be critical accounting policies and estimates:

Revenue recognition;
Purchase accounting, goodwill, and intangible assets;
Litigation, commitments, and contingencies;
Retirement related benefit plans; and
Workers' compensation.

As of September 30, 2023, there had been no material changes to the foregoing critical accounting policies, estimates, and judgments since December 31, 2022.

Program Descriptions

For convenience, a brief description of certain programs discussed in this Quarterly Report on Form 10-Q is included in the "Glossary of Programs" in this section.

CONSOLIDATED OPERATING RESULTS

We manage and assess the performance of our business based on our performance on individual contracts and programs using the financial measures referred to below, with consideration given to the Critical Accounting Policies, Estimates, and Judgments referred to in this section. Our portfolio of long-term contracts is largely flexibly-priced. Therefore, sales tend to fluctuate in concert with costs across our large portfolio of active contracts, with operating income being a critical measure of operating performance. Under FAR rules that govern our business with the U.S. Government, most types of costs are allowable, and we do not focus on individual cost groupings, such as cost of sales or general and administrative expenses, as much as we do on total contract costs, which are a key factor in determining contract operating income. As a result, in evaluating our operating performance, we look primarily at changes in sales and service revenues, as well as operating income, including the effects of significant changes in operating income resulting from changes in contract financial estimates and the use of the cumulative catch-up method of accounting in accordance with GAAP. This approach is consistent with the long-term life cycle of our contracts, as management assesses the bidding of each contract by focusing on net sales and operating profit and monitors performance in a similar manner through contract completion. Consequently, our discussion of business segment performance focuses on net sales and operating profit, consistent with our approach for managing our business.

Key Financial Measures

The following table presents selected financial highlights:


	Three Months Ended September 30									Nine Months Ended September 30
			2023 vs. 2022					2023 vs. 2022
($ in millions)	2023			2022		Dollars		Percent		2023		2022		Dollars		Percent
Sales and service revenues	$	2,816		$	2,626	$	190	7	%	$	8,277	$	7,864	$	413	5	%
Cost of product sales and service revenues	2,400			2,264		136		6	%	7,122		6,763		359		5	%
Income from operating investments, net	9			13		(4)		(31)	%	25		47		(22)		(47)	%

General and administrative expenses	253			244		9		4	%	711		688		23		3	%

Operating income	172			131		41		31	%	469		460		9		2	%
Other income (expense)
Interest expense	(22)			(27)		5		19	%	(70)		(79)		9		11	%
Non-operating retirement benefit	37			71		(34)		(48)	%	111		209		(98)		(47)	%
Other, net	2			(13)		15		115	%	11		(30)		41		137	%
Federal and foreign income taxes	41			24		17		71	%	114		104		10		10	%
Net earnings	$	148		$	138	$	10	7	%	$	407	$	456	$	(49)	(11)	%

Sales and Service Revenues

Period-to-period revenues reflect performance under new and ongoing contracts. Changes in sales and service

revenues are typically expressed in terms of volume. Unless otherwise described, volume generally refers to

increases (or decreases) in reported revenues due to varying production activity levels, delivery rates, or service

levels on individual contracts. Volume changes will typically carry a corresponding income change based on the

profit margin rate for a particular contract.

Sales and service revenues for the three months ended September 30, 2023, increased $190 million, or 7%, compared to the same period in 2022, primarily due to higher volumes at Mission Technologies and Ingalls. Sales and service revenues for the nine months ended September 30, 2023, increased $413 million, or 5%, compared to the same period in 2022, primarily due to higher volumes at Newport News and Mission Technologies.

Cost of Sales and Service Revenues

Cost of sales for both product sales and service revenues consists of materials, labor, and subcontracting costs, as well as an allocation of indirect costs for overhead. We manage the type and amount of costs at the contract level, which is the basis for estimating our total costs at completion of each contract. Unusual fluctuations in operating performance driven by changes in a specific cost element across multiple contracts are described in our analysis.

Refer to "Segment Operating Results" and "Product and Service Revenues and Cost Analysis" in this section for details related to cost of sales for both product sales and service revenues.

Income from Operating Investments, Net

The activities of our operating investments are closely aligned with the operations of the segments holding the investments. We therefore record income related to earnings from equity method investments in our operating income.

Refer to "Segment Operating Results" in this section for details related to income from operating investments.

General and Administrative Expenses

In accordance with industry practice and the regulations that govern the cost accounting requirements for government contracts, most general and administrative expenses are considered allowable and allocable costs on government contracts. These costs are allocated to contracts in progress on a systematic basis, and contract performance factors include this cost component as an element of cost.

General and administrative expenses for the three and nine months ended September 30, 2023, increased $9 million and $23 million, respectively, from the same periods in 2022, primarily due to higher overhead costs and state income taxes.

Operating Income

We consider operating income an important measure for evaluating our operating performance, and, consistent with industry practice, we define operating income as revenues less the related costs of producing the revenues and general and administrative expenses.

We internally manage our operations by reference to "segment operating income," which is defined as operating income before the Operating FAS/CAS Adjustment and non-current state income taxes, neither of which affects contract performance. Segment operating income is not a recognized measure under GAAP. When analyzing our operating performance, investors should use segment operating income in addition to, and not as an alternative for, operating income or any other performance measure presented in accordance with GAAP. It is a measure we use to evaluate our core operating performance. We believe segment operating income reflects an additional way of viewing aspects of our operations that, when viewed with our GAAP results, provides a more complete understanding of factors and trends affecting our business. We believe the measure is used by investors and is a useful indicator to measure our performance. Because not all companies use identical calculations, our presentation of segment operating income may not be comparable to similarly titled measures of other companies. Refer to

"Segment Operating Results" in this section for details related to segment operating income, as well as activity within each segment.

The following table reconciles operating income to segment operating income:


	Three Months Ended September 30									Nine Months Ended September 30
			2023 vs. 2022					2023 vs. 2022
($ in millions)	2023			2022		Dollars		Percent		2023		2022		Dollars		Percent
Operating income	$	172		$	131	$	41	31	%	$	469	$	460	$	9	2	%
Operating FAS/CAS Adjustment	19			36		(17)		(47)	%	55		108		(53)		(49)	%
Non-current state income taxes	(4)			(1)		(3)		(300)	%	(12)		(1)		(11)		(1,100)	%
Segment operating income	$	187		$	166	$	21	13	%	$	512	$	567	$	(55)	(10)	%

Operating income for the three months ended September 30, 2023, increased $41 million compared with the same period in 2022, primarily due to higher segment operating income, favorable changes in the Operating FAS/CAS Adjustment, and non-current state income taxes. Operating income for the nine months ended September 30, 2023, increased $9 million compared with the same period in 2022, primarily due to favorable changes in the Operating FAS/CAS Adjustment and non-current state income taxes, partially offset by lower segment operating income.

FAS/CAS Adjustment and Operating FAS/CAS Adjustment

The FAS/CAS Adjustment reflects the difference between expenses for pension and other postretirement benefits determined in accordance with U.S. GAAP Financial Accounting Standards ("FAS") and the expenses for these items included in segment operating income in accordance with U.S. Government Cost Accounting Standards ("CAS"). The Operating FAS/CAS Adjustment excludes the following components of net periodic benefit costs: interest cost, expected return on plan assets, amortization of prior service cost (credit) and actuarial loss (gain), and settlement and curtailment effects.

The components of the Operating FAS/CAS Adjustment were as follows:


	Three Months Ended September 30									Nine Months Ended September 30
			2023 vs. 2022					2023 vs. 2022
($ in millions)	2023			2022		Dollars		Percent		2023		2022		Dollars		Percent
FAS benefit	$	8		$	24	$	(16)	(67)	%	$	23	$	67	$	(44)	(66)	%
CAS cost	10			11		(1)		(9)	%	33		34		(1)		(3)	%
FAS/CAS Adjustment	18			35		(17)		(49)	%	56		101		(45)		(45)	%
Non-operating retirement benefit	(37)			(71)		34		48	%	(111)		(209)		98		47	%
Operating FAS/CAS Adjustment	$	(19)		$	(36)	$	17	47	%	$	(55)	$	(108)	$	53	49	%

The Operating FAS/CAS Adjustment was a net expense of $19 million and $36 million for the three months ended September 30, 2023 and 2022, respectively. The Operating FAS/CAS Adjustment was a net expense of $55 million and $108 million for the nine months ended September 30, 2023 and 2022, respectively. The favorable changes in the Operating FAS/CAS Adjustment of $17 million and $53 million for the three and nine months ended September 30, 2023, respectively, were primarily driven by the more immediate recognition of higher interest rates under FAS.

Non-current State Income Taxes

Non-current state income taxes include deferred state income taxes, which reflect the change in deferred state tax assets and liabilities, and the tax expense or benefit associated with changes in state unrecognized tax benefits in the relevant period. These amounts are recorded within operating income. Current period state income tax expense is charged to contract costs and included in cost of sales and service revenues in segment operating income.

Non-current state income tax benefit was $4 million and $1 million for the three months ended September 30, 2023 and 2022, respectively. Non-current state income tax benefit was $12 million and $1 million for the nine months ended September 30, 2023 and 2022, respectively. The favorable change in non-current state income taxes for each period was driven by a decrease in deferred state income tax expense, primarily attributable to the timing of long-term contract income for tax purposes.

SEGMENT OPERATING RESULTS

Our discussion of business segment performance focuses on sales and service revenues and operating income,

consistent with our approach for managing our business. We are aligned into three reportable segments: Ingalls, Newport News, and Mission Technologies.

The following table presents segment sales and segment operating results:


	Three Months Ended September 30									Nine Months Ended September 30
			2023 vs. 2022					2023 vs. 2022
($ in millions)	2023			2022		Dollars		Percent		2023		2022		Dollars		Percent
Sales and Service Revenues
Ingalls	$	711		$	623	$	88	14	%	$	1,952	$	1,912	$	40	2	%
Newport News	1,453			1,445		8		1	%	4,468		4,268		200		5	%
Mission Technologies	685			595		90		15	%	1,954		1,785		169		9	%
Intersegment eliminations	(33)			(37)		4		11	%	(97)		(101)		4		4	%
Sales and service revenues	$	2,816		$	2,626	$	190	7	%	$	8,277	$	7,864	$	413	5	%
Operating Income
Ingalls	$	73		$	50	$	23	46	%	$	193	$	242	$	(49)	(20)	%
Newport News	90			102		(12)		(12)	%	269		277		(8)		(3)	%
Mission Technologies	24			14		10		71	%	50		48		2		4	%
Segment operating income	187			166		21		13	%	512		567		(55)		(10)	%
Non-segment factors affecting operating income
Operating FAS/CAS Adjustment	(19)			(36)		17		47	%	(55)		(108)		53		49	%
Non-current state income taxes	4			1		3		300	%	12		1		11		1,100	%
Operating income	$	172		$	131	$	41	31	%	$	469	$	460	$	9	2	%

Segment Operating Income

Segment operating income reflects the aggregate performance results of contracts within a segment. Excluded from this measure are certain costs not directly associated with contract performance, such as the Operating FAS/CAS Adjustment and non-current state income taxes. Changes in segment operating income are typically expressed in terms of volume, as discussed above, or performance. Performance refers to changes in contract profit margin rates. These changes typically relate to profit recognition associated with revisions to estimated costs at completion ("EAC") on a contract, which reflect improved or deteriorated operating performance on that contract. Operating income changes are accounted for on a cumulative to date basis at the time an EAC change is recorded. Segment operating income may also be affected by, among other things, contract performance, the effects of workforce stoppages, the effects of natural disasters such as hurricanes, resolution of disputed items with the customer, recovery of insurance proceeds, and other discrete events. At the completion of a long-term contract, any originally estimated costs not incurred or reserves not fully utilized, such as warranty reserves, could also impact contract earnings. Where such items have occurred and the effects are material, a separate description is provided.

Cumulative Catch-up Revenue Adjustments

For the three and nine months ended September 30, 2023 and 2022, favorable and unfavorable cumulative catch-up revenue adjustments were as follows:


	Three Months Ended September 30				Nine Months Ended September 30

($ in millions)	2023		2022		2023		2022
Gross favorable adjustments	$	62	$	84	$	198	$	297
Gross unfavorable adjustments	(41)		(57)		(148)		(157)
Net adjustments	$	21	$	27	$	50	$	140

For the three and nine months ended September 30, 2023 and 2022, net cumulative catch-up revenue adjustments by segment were as follows:


	Three Months Ended September 30				Nine Months Ended September 30

($ in millions)	2023		2022		2023		2022
Ingalls	$	23	$	7	$	54	$	104
Newport News	(6)		13		(15)		22
Mission Technologies	4		7		11		14
Net adjustments	$	21	$	27	$	50	$	140

Ingalls


	Three Months Ended September 30											Nine Months Ended September 30
				2023 vs. 2022						2023 vs. 2022
($ in millions)	2023				2022			Dollars		Percent		2023			2022			Dollars		Percent
Sales and service revenues	$	711			$	623		$	88	14	%	$	1,952		$	1,912		$	40	2	%
Segment operating income	73				50			23		46	%	193			242			(49)		(20)	%
As a percentage of segment sales	10.3		%		8.0		%					9.9		%	12.7		%

Sales and Service Revenues

Ingalls revenues, including intersegment sales, for the three months ended September 30, 2023, increased $88 million, or 14%, from the same period in 2022, primarily driven by higher volumes in amphibious assault ships and surface combatants.

Ingalls revenues, including intersegment sales, for the nine months ended September 30, 2023, increased $40 million, or 2%, from the same period in 2022, primarily driven by higher volumes in surface combatants and amphibious assault ships, partially offset by lower volumes in the Legend class National Security Cutter (“NSC”) program.

Segment Operating Income

Ingalls segment operating income for the three months ended September 30, 2023, was $73 million, compared to segment operating income of $50 million for the same period in 2022. The increase was primarily driven by higher volumes described above and favorable changes in contract estimates from facilities capital and economic price adjustment clauses.

Ingalls segment operating income for the nine months ended September 30, 2023, was $193 million, compared to segment operating income of $242 million for the same period in 2022. The decrease was primarily driven by lower risk retirement on USS Fort Lauderdale (LPD 28), delivered in 2022, and Harrisburg (LPD 30).

Newport News


	Three Months Ended September 30											Nine Months Ended September 30
				2023 vs. 2022						2023 vs. 2022
($ in millions)	2023				2022			Dollars		Percent		2023			2022			Dollars		Percent
Sales and service revenues	$	1,453			$	1,445		$	8	1	%	$	4,468		$	4,268		$	200	5	%
Segment operating income	90				102			(12)		(12)	%	269			277			(8)		(3)	%
As a percentage of segment sales	6.2		%		7.1		%					6.0		%	6.5		%

Sales and Service Revenues

Newport News revenues, including intersegment sales, for the three months ended September 30, 2023, increased $8 million, or 1%, from the same period in 2022, primarily driven by higher volumes in aircraft carrier construction, partially offset by lower volumes in aircraft carrier refueling and complex overhaul ("RCOH").

Newport News revenues, including intersegment sales, for the nine months ended September 30, 2023, increased $200 million, or 5%, from the same period in 2022, primarily driven by higher volumes in aircraft carrier construction, the Columbia class (SSBN 826) submarine program, and the Virginia class (SSN 774) submarine program, partially offset by lower volumes in aircraft carrier RCOH and naval nuclear support services.

Segment Operating Income

Newport News segment operating income for the three months ended September 30, 2023, was $90 million, compared to segment operating income of $102 million for the same period in 2022. The decrease was primarily due to contract incentives on the Columbia class (SSBN 826) submarine program in 2022, partially offset by improved performance on the Virginia class (SSN 774) submarine program.

Newport News segment operating income for the nine months ended September 30, 2023, was $269 million, compared to segment operating income of $277 million for the same period in 2022. The decrease was primarily due to contract incentives on the Columbia class (SSBN 826) submarine program in 2022, partially offset by higher volumes described above.

Mission Technologies


	Three Months Ended September 30											Nine Months Ended September 30
				2023 vs. 2022						2023 vs. 2022
($ in millions)	2023				2022			Dollars		Percent		2023			2022			Dollars		Percent
Sales and service revenues	$	685			$	595		$	90	15	%	$	1,954		$	1,785		$	169	9	%
Segment operating income	24				14			10		71	%	50			48			2		4	%
As a percentage of segment sales	3.5		%		2.4		%					2.6		%	2.7		%

Sales and Service Revenues

Mission Technologies revenues, including intersegment sales, for the three months ended September 30, 2023, increased $90 million, or 15%, from the same period in 2022, primarily due to higher volumes in mission based solutions.

Mission Technologies revenues, including intersegment sales, for the nine months ended September 30, 2023, increased $169 million, or 9%, from the same period in 2022, primarily due to higher volumes in mission based solutions.

Segment Operating Income

Mission Technologies segment operating income for the three months ended September 30, 2023, was $24 million, compared to segment operating income of $14 million for the same period in 2022. The increase was primarily driven by higher volumes in mission based solutions and improved performance in unmanned systems.

Mission Technologies segment operating income for the nine months ended September 30, 2023, was $50 million, compared to segment operating income of $48 million for the same period in 2022. The increase was primarily driven by higher volumes in mission based solutions, improved performance in unmanned systems, and higher equity income from nuclear and environmental joint ventures, partially offset by lower equity income from our investment in an unconsolidated ship repair and specialty fabrication joint venture, which was sold in June 2023, and lower performance in fleet sustainment.

PRODUCT AND SERVICE REVENUES AND COST ANALYSIS

The following tables present segment sales and service revenues and segment cost of sales and service revenues by both product and service:


	Sales and Service Revenues								Segment Cost of Product Sales and Service Revenues
($ in millions)	Three Months Ended September 30				2023 vs. 2022				Three Months Ended September 30				2023 vs. 2022
Segment Information	2023		2022		Dollars		Percent		2023		2022		Dollars		Percent
Ingalls
Product	$	637	$	577	$	60	10	%	$	514	$	482	$	32	7	%
Service	73		41		32		78	%	62		34		28		82	%
Intersegment	1		5		(4)		(80)	%	1		5		(4)		(80)	%
Total Ingalls	711		623		88		14	%	577		521		56		11	%
Newport News
Product	1,170		1,185		(15)		(1)	%	987		992		(5)		(1)	%
Service	281		259		22		8	%	231		216		15		7	%
Intersegment	2		1		1		100	%	2		1		1		100	%
Total Newport News	1,453		1,445		8		1	%	1,220		1,209		11		1	%
Mission Technologies
Product	28		12		16		133	%	24		12		12		100	%
Service	627		552		75		14	%	563		492		71		14	%
Intersegment	30		31		(1)		(3)	%	30		31		(1)		(3)	%
Total Mission Technologies	685		595		90		15	%	617		535		82		15	%
Segment Totals
Product	$	1,835	$	1,774	$	61	3	%	$	1,525	$	1,486	$	39	3	%
Service	981		852		129		15	%	856		742		114		15	%
Total Segment (1)	$	2,816	$	2,626	$	190	7	%	$	2,381	$	2,228	$	153	7	%

(1) Operating FAS/CAS Adjustment is excluded from segment cost of product sales and service revenues.


	Sales and Service Revenues								Segment Cost of Product Sales and Service Revenues
($ in millions)	Nine Months Ended September 30				2023 vs. 2022				Nine Months Ended September 30				2023 vs. 2022
Segment Information	2023		2022		Dollars		Percent		2023		2022		Dollars		Percent
Ingalls
Product	$	1,775	$	1,766	$	9	1	%	$	1,450	$	1,401	$	49	3	%
Service	171		136		35		26	%	145		118		27		23	%
Intersegment	6		10		(4)		(40)	%	6		10		(4)		(40)	%
Total Ingalls	1,952		1,912		40		2	%	1,601		1,529		72		5	%
Newport News
Product	3,688		3,496		192		5	%	3,135		2,959		176		6	%
Service	777		768		9		1	%	651		643		8		1	%
Intersegment	3		4		(1)		(25)	%	3		4		(1)		(25)	%
Total Newport News	4,468		4,268		200		5	%	3,789		3,606		183		5	%
Mission Technologies
Product	80		65		15		23	%	79		59		20		34	%
Service	1,786		1,633		153		9	%	1,607		1,475		132		9	%
Intersegment	88		87		1		1	%	88		87		1		1	%
Total Mission Technologies	1,954		1,785		169		9	%	1,774		1,621		153		9	%
Segment Totals
Product	$	5,543	$	5,327	$	216	4	%	$	4,664	$	4,419	$	245	6	%
Service	2,734		2,537		197		8	%	2,403		2,236		167		7	%
Total Segment (1)	$	8,277	$	7,864	$	413	5	%	$	7,067	$	6,655	$	412	6	%

(1) Operating FAS/CAS Adjustment is excluded from segment cost of product sales and service revenues.

Product Sales and Segment Cost of Product Sales

Product sales for the three months ended September 30, 2023, increased $61 million, or 3%, from the same period in 2022, primarily as a result of higher volumes at Ingalls in amphibious assault ships and at Newport News in aircraft carrier construction, partially offset by lower volumes at Newport News in aircraft carrier RCOH.

Segment cost of product sales for the three months ended September 30, 2023, increased $39 million, or 3%, compared with the same period in 2022, consistent with higher product sales described above.

Product sales for the nine months ended September 30, 2023, increased $216 million, or 4%, from the same period in 2022, primarily as a result of higher volumes at Newport News in aircraft carrier construction, the Columbia class (SSBN 826) submarine program, and the Virginia class (SSN 774) submarine program, and at Ingalls in amphibious assault ships and surface combatants, partially offset by lower volumes at Newport News in aircraft carrier RCOH, and at Ingalls in the NSC program.

Segment cost of product sales for the nine months ended September 30, 2023, increased $245 million, or 6%, compared with the same period in 2022, consistent with higher product sales described above.

Service Revenues and Segment Cost of Service Revenues

Service revenues for the three months ended September 30, 2023, increased $129 million, or 15%, from the same period in 2022, primarily as a result of higher volumes at Mission Technologies in mission based solutions services, at Ingalls in surface combatant services, and at Newport News in aircraft carrier services.

Segment cost of service revenues for the three months ended September 30, 2023, increased $114 million, or 15%, compared with the same period in 2022, consistent with higher service volumes described above.

Service revenues for the nine months ended September 30, 2023, increased $197 million, or 8%, from the same period in 2022, primarily as a result of higher volumes at Mission Technologies in mission based solutions services,

at Newport News in aircraft carrier services, and at Ingalls in surface combatant services, partially offset by lower volumes at Newport News in naval nuclear support services.

Segment cost of service revenues for the nine months ended September 30, 2023, increased $167 million, or 7%, compared with the same period in 2022, consistent with higher service volumes described above.

OTHER FINANCIAL INFORMATION

Interest Expense

Interest expense for the three months ended September 30, 2023, was $22 million, compared with $27 million for the same period in 2022. Interest expense for the nine months ended September 30, 2023, was $70 million, compared with $79 million for the same period in 2022. The decreases in interest expense of $5 million and $9 million for the three and nine months ended September 30, 2023, respectively, were driven by a decrease in outstanding long-term debt from prior year periods.

Non-Operating Retirement Benefit

The non-operating retirement benefit includes the following components of net periodic benefit costs: interest cost, expected return on plan assets, amortization of prior service cost (credit) and actuarial loss (gain), and settlement and curtailment effects.

For the three months ended September 30, 2023, the non-operating retirement benefit was $37 million, compared with $71 million for the same period in 2022. For the nine months ended September 30, 2023, the non-operating retirement benefit was $111 million, compared with $209 million for the same period in 2022. The unfavorable changes in the non-operating retirement benefit of $34 million and $98 million for the three and nine months ended September 30, 2023, respectively, were primarily driven by lower 2022 returns on plan assets.

Other, Net

Other, net income for the three months ended September 30, 2023, was $2 million, compared with other, net expense of $13 million for the same period in 2022. Other, net income for the nine months ended September 30, 2023, was $11 million, compared with other, net expense of $30 million for the same period in 2022. The increases in other, net of $15 million and $41 million for the three and nine months ended September 30, 2023, respectively, were primarily driven by unrealized net gains in investments.

Federal and Foreign Income Taxes

Our effective income tax rates on earnings from operations for the three months ended September 30, 2023 and 2022, were 21.7% and 14.8%, respectively. For the nine months ended September 30, 2023 and 2022, our effective income tax rates on earnings from operations were 21.9% and 18.6%, respectively. The higher effective tax rate for the three months ended September 30, 2023, was primarily attributable to prior period research and development tax credits recorded in 2022. The higher effective tax rate for the nine months ended September 30, 2023, was primarily attributable to prior period research and development tax credits recorded in 2022 and to a tax gain associated with the sale of our interest in an unconsolidated ship repair and specialty fabrication joint venture.

For the three months ended September 30, 2023, our effective income tax rate differed from the federal statutory corporate income tax rate primarily as a result of expenses that are not deductible for income tax purposes. For the nine months ended September 30, 2023, our effective income tax rate differed from the federal statutory corporate income tax rate primarily as a result of tax gain associated with the sale of our interest in an unconsolidated ship repair and specialty fabrication joint venture. For the three and nine months ended September 30, 2022, our effective income tax rate differed from the federal statutory rate primarily as a result of research and development tax credits for prior periods.

BACKLOG

Total backlog as of September 30, 2023, and December 31, 2022, was $49.4 billion and $47.1 billion, respectively. Total backlog includes both funded backlog (firm orders for which funding is contractually obligated by the customer) and unfunded backlog (firm orders for which funding is not currently contractually obligated by the customer).

Backlog excludes unexercised contract options and unfunded Indefinite Delivery/Indefinite Quantity orders. For contracts having no stated contract values, backlog includes only the amounts committed by the customer.

The following table presents funded and unfunded backlog by segment as of September 30, 2023, and December 31, 2022:


	September 30, 2023						December 31, 2022
($ in millions)	Funded		Unfunded		Total Backlog		Funded		Unfunded		Total Backlog
Ingalls	$	13,100	$	2,968	$	16,068	$	9,231	$	3,546	$	12,777
Newport News	11,931		16,012		27,943		11,665		17,742		29,407
Mission Technologies	1,905		3,499		5,404		1,317		3,622		4,939
Total backlog	$	26,936	$	22,479	$	49,415	$	22,213	$	24,910	$	47,123

We expect approximately 20% of the $47.1 billion total backlog as of December 31, 2022, to be converted into sales in 2023. U.S. Government orders comprised substantially all of the backlog as of September 30, 2023, and December 31, 2022.

Contract Awards

The value of new contract awards during the nine months ended September 30, 2023, was $10.6 billion, including a funded award for the construction of two Arleigh Burke class (DDG 51) destroyers, an award for the Joint Network Engineering and Emerging Operations task order, an award modification for the detail design and construction of Philadelphia (LPD 32), an award modification for long-lead-time material and advance construction activities on the Columbia class (SSBN 826) submarine program, an award modification to the construction contract for John F. Kennedy (CVN 79), and an award modification for long-lead-time material for additional Block V boats of the Virginia class (SSN 774) submarine program.

LIQUIDITY AND CAPITAL RESOURCES

We seek to efficiently convert operating results into cash for deployment in operating our businesses, executing our business strategy, and maximizing stockholder value. We use various financial measures to inform our capital deployment strategy, including net cash provided by operating activities and free cash flow. We believe these measures are useful to investors in assessing our financial performance.

The following table summarizes key components of cash flow provided by operating activities:


	Nine Months Ended September 30				2023 vs. 2022

($ in millions)	2023		2022		Dollars
Net earnings	$	407	$	456	$	(49)
Depreciation and amortization	265		269		(4)
Provision for doubtful accounts	—		(7)		7
Stock-based compensation	27		28		(1)

Deferred income taxes	(81)		(14)		(67)



Loss (gain) on investments in marketable securities	(10)		34		(44)

Retiree benefits	(55)		(99)		44

Trade working capital increase	(145)		(502)		357
Net cash provided by operating activities	$	408	$	165	$	243

We have historically maintained a capital structure comprised of a mix of equity and debt financing. We vary our

leverage both to optimize our equity return and to pursue acquisitions. We expect to meet our current debt

obligations as they come due through internally generated funds from current levels of operations and/or through refinancing in the debt markets prior to the maturity dates of our debt.

Cash Flows

We discuss below our significant operating, investing, and financing activities affecting cash flows for the nine months ended September 30, 2023 and 2022, as classified on our unaudited condensed consolidated statements of cash flows.

Operating Activities

Cash provided by operating activities for the nine months ended September 30, 2023, was $408 million, compared with $165 million provided by operating activities for the same period in 2022. The favorable change in operating cash flow was primarily due to a favorable change in trade working capital, partially offset by higher payments for income taxes. The change in trade working capital was primarily driven by the timing of receipts of accounts receivable.

We expect cash generated from operations in combination with our current cash and cash equivalents, as well as existing borrowing facilities, to be sufficient to service debt and retiree benefit plans, meet contractual obligations, and fund capital expenditures for at least the next 12 calendar months beginning October 1, 2023, and beyond such 12-month period based on our current business plans.

Investing Activities

Cash used in investing activities for the nine months ended September 30, 2023, was $111 million, compared with $178 million used in investing activities for the same period in 2022. The change in investing cash was primarily driven by the sale of an unconsolidated ship repair and specialty fabrication joint venture, partially offset by increased investment in one of our unconsolidated nuclear and environmental joint ventures. For 2023, we expect our capital expenditures for maintenance and sustainment to be approximately 1.0% of annual revenues and our discretionary capital expenditures to be approximately 2.0% of annual revenues.

Financing Activities

Cash used in financing activities for the nine months ended September 30, 2023, was $655 million, compared with $497 million used in financing activities for the same period in 2022. The change in cash used in financing activities was primarily due to the repayment of $400 million of senior notes, offset by a $245 million decrease in prepayments of our Term Loan.

Free Cash Flow

Free cash flow represents cash provided by (used in) operating activities less capital expenditures net of related grant proceeds. Free cash flow is not a measure recognized under GAAP. Free cash flow has limitations as an analytical tool and should not be considered in isolation from, or as a substitute for, net earnings as a measure of our performance or net cash provided by operating activities as a measure of our liquidity. We believe free cash flow is an important liquidity measure for our investors because it provides them insight into our current and period-to-period performance and our ability to generate cash from continuing operations. We also use free cash flow as a key operating metric in assessing the performance of our business and as a key performance measure in evaluating management performance and determining incentive compensation. Free cash flow may not be comparable to similarly titled measures of other companies.

The following table reconciles net cash provided by operating activities to free cash flow:


	Nine Months Ended September 30				2023 vs. 2022

($ in millions)	2023		2022		Dollars
Net cash provided by operating activities	$	408	$	165	$	243
Less capital expenditures:
Capital expenditure additions	(164)		(179)		15
Grant proceeds for capital expenditures	14		—		14
Free cash flow	$	258	$	(14)	$	272

Free cash flow for the nine months ended September 30, 2023, increased $272 million from the same period in 2022, primarily due to a favorable change in trade working capital and lower capital expenditures, partially offset by higher payments for income taxes.

Governmental Regulation and Supervision

The U.S. Government has the ability, pursuant to regulations relating to contractor business systems, to decrease or withhold contract payments if it determines significant deficiencies exist in one or more such systems. As of September 30, 2023 and 2022, the cumulative amounts of payments withheld by the U.S. Government under our contracts subject to these regulations were not material to our liquidity or cash flows.

Off-Balance Sheet Arrangements

In the ordinary course of business, we use letters of credit issued by commercial banks to support certain leases, insurance policies, and contractual performance obligations, as well as surety bonds issued by insurance companies principally to support our self-insured workers' compensation plans. As of September 30, 2023, $12 million in letters of credit were issued but undrawn and $360 million of surety bonds were outstanding. As of September 30, 2023, we had no other significant off-balance sheet arrangements.

ACCOUNTING STANDARDS UPDATES

See Note 3: Accounting Standards Updates in Part I, Item 1 for information related to accounting standards updates.

FORWARD-LOOKING STATEMENTS AND PROJECTIONS

Statements in this Quarterly Report on Form 10-Q and in our other filings with the Securities and Exchange Commission ("SEC"), as well as other statements we may make from time to time, other than statements of historical fact, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. You can generally identify forward-looking statements by words such as "may," "will," "should," "expects," "intends," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "continue," and similar words or phrases or the negative of these words or phrases. 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, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by these forward-looking statements. Although we believe the expectations reflected in the forward-looking statements are reasonable when made, we cannot guarantee future results, levels of activity, performance, or achievements. There are a number of important factors that could cause our actual results to differ materially from the results anticipated by our forward-looking statements, which include, but are not limited to:

Changes in government and customer priorities and requirements (including government budgetary constraints, shifts in defense spending, and changes in customer short-range and long-range plans);
Our ability to estimate our future contract costs, including cost increases due to inflation, and perform our contracts effectively;
Changes in procurement processes and government regulations and our ability to comply with such requirements;
Our ability to deliver our products and services at an affordable life cycle cost and compete within our markets;
Natural and environmental disasters and political instability;
Our ability to execute our strategic plan, including with respect to share repurchases, dividends, capital expenditures, and strategic acquisitions;
Adverse economic conditions in the United States and globally;
Health epidemics, pandemics, and similar outbreaks;
Our ability to attract, train, and retain a qualified workforce;
Disruptions impacting global supply, including those resulting from the ongoing conflict between Russia and Ukraine;
Changes in key estimates and assumptions regarding our pension and retiree health care costs;
Security threats, including cyber security threats, and related disruptions; and
Other risk factors discussed herein and in our other filings with the SEC.

Additional factors include those described in our 2022 Annual Report on Form 10-K, including under the captions “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Business,” in our subsequent quarterly reports on Form 10-Q, including under the captions “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in our subsequent filings with the Securities and Exchange Commission.

There may be other risks and uncertainties that we are unable to predict at this time or that we currently do not expect to have a material adverse effect on our business, and we undertake no obligation to update or revise any forward-looking statements. You should not place undue reliance on any forward looking statements that we may make.

GLOSSARY OF PROGRAMS

Included below are brief descriptions of some of the programs discussed in this Quarterly Report on Form 10-Q.


Program Name						Program Description

Aircraft carrier RCOH						Perform refueling and complex overhaul ("RCOH") of nuclear-powered aircraft carriers, which is required at the mid-point of their 50-year life cycle. USS John C. Stennis (CVN 74) arrived at Newport News for the start of its RCOH in May 2021, and USS George Washington (CVN 73) was redelivered to the U.S. Navy in May 2023.

America class (LHA 6) amphibious assault ships						Design and build large deck amphibious assault ships that provide forward presence and power projection as an integral part of joint, interagency and multinational maritime expeditionary forces. The America class (LHA 6) ships, together with the Wasp class (LHD 1) ships, are the successors to the decommissioned Tarawa class (LHA 1) ships. The America class (LHA 6) ships optimize aviation operations and support capabilities. We are currently constructing Bougainville (LHA 8) and Fallujah (LHA 9).

Arleigh Burke class (DDG 51) destroyers						Build guided missile destroyers designed for conducting anti-air, anti-submarine, anti-surface, and strike operations. The Aegis-equipped Arleigh Burke class (DDG 51) destroyers are the U.S. Navy's primary surface combatant, and have been constructed in variants, allowing technological advances during construction. We delivered USS Frank E. Petersen Jr. (DDG 121), USS Lenah H. Sutcliffe Higbee (DDG 123), and Jack H. Lucas (DDG 125) in 2021, 2022, and 2023, respectively. We have contracts to construct the following Arleigh Burke class (DDG 51) destroyers: Ted Stevens (DDG 128), Jeremiah Denton (DDG 129), George M. Neal (DDG 131), Sam Nunn (DDG 133), Thad Cochran (DDG 135), John F. Lehman (DDG 137), Telesforo Trinidad (DDG 139), DDG 141 (unnamed), and DDG 142 (unnamed).

Columbia class (SSBN 826) submarines						Design and construct modules for Columbia class (SSBN 826) nuclear ballistic missile submarines ("SSBNs") as a subcontractor to Electric Boat. SSBNs are the most secure and survivable of our nation’s nuclear deterrent triad. Columbia class SSBNs will carry approximately 70 percent of the nation’s nuclear arsenal. The Columbia class (SSBN 826) program plan of record is to construct 12 new SSBNs to replace the current aging Ohio class. We have a teaming agreement with Electric Boat to build modules for the entire Columbia class (SSBN 826) submarine program that leverages our Virginia class (SSN 774) experience. We have been awarded contracts from Electric Boat for integrated product and process development, providing long–lead–time material and advance construction, and construction of the first two boats of the Columbia class (SSBN 826) submarine program. Construction of the first Columbia class (SSBN 826) submarine began in 2020. In 2023, we received an award modification for long-lead-time material and advance construction for the next five boats.

Fleet sustainment						Maintains and modernizes a significant majority of the U.S. Navy fleet, from small watercraft to submarines, combatants, and aircraft carriers, our systems and maintenance experts help the Navy maintain a high state of readiness. Ensures effective system operation and sustainment by actively supporting design and decision–making processes through studies, analyses, and reviews of program documents, and provides a wide range of logistics products.


USS Gerald R. Ford class (CVN 78) aircraft carriers						Design and construction for the Ford class program, which is the aircraft carrier replacement program for the decommissioned Enterprise (CVN 65) and Nimitz class (CVN 68) aircraft carriers. USS Gerald R. Ford (CVN 78), the first ship of the Ford class, was delivered to the U.S. Navy in the second quarter of 2017. In June 2015, we were awarded a contract for the detail design and construction of John F. Kennedy (CVN 79), following several years of engineering, advance construction, and purchase of long-lead-time components and material. In addition, we have received awards for detail design and construction of Enterprise (CVN 80) and Doris Miller (CVN 81). This category also includes the class' non-recurring engineering. The class is expected to bring improved warfighting capability, quality of life improvements for sailors, and reduced life cycle costs.

Legend class National Security Cutter						Design and build the U.S. Coast Guard's National Security Cutters ("NSCs"), the largest and most technically advanced class of cutter in the U.S. Coast Guard. The NSC is equipped to carry out maritime homeland security, maritime safety, protection of natural resources, maritime mobility, and national defense missions. The plan is for a total of 11 ships, of which the first ten ships have been delivered. Friedman (NSC 11) is currently under construction.

Mission based solutions						Develops integrated solutions that enable today's connected, all– domain force. Capabilities include: command, control, computers, communications, cyber, intelligence, surveillance, and reconnaissance ("C5ISR") systems and operations; the application of artificial intelligence and machine learning to battlefield decisions; defensive and offensive cyberspace strategies and electronic warfare ("CEWS"); and live, virtual, and constructive ("LVC") solutions.

Naval nuclear support services						Provide services to and in support of the U.S. Navy, ranging from services supporting the Navy's carrier and submarine fleets to maintenance services at U.S. Navy training facilities. Naval nuclear support services include design, construction, maintenance, and disposal activities for in-service U.S. Navy nuclear ships worldwide through mobile and in-house capabilities. Services include maintenance services on nuclear reactor prototypes.

Nuclear and environmental services						Supports the national security mission of the Department of Energy ("DoE") through the management and operation of DOE sites, as well as the safe cleanup of legacy waste across the country. We meet our clients' toughest nuclear and environmental challenges and are positioned to serve the growing commercial nuclear power plant decommissioning market. We participate in several joint ventures, including Newport News Nuclear BWXT Los Alamos, LLC (" N3B"), Mission Support and Test Services, LLC ("MSTS"), and Savannah River Nuclear Solutions, LLC ("SRNS"), and we are an integrated subcontractor to Triad National Security. N3B was awarded the Los Alamos Legacy Cleanup Contract at the DoE/National Nuclear Security Administration’s Los Alamos National Laboratory. MSTS was awarded a contract for site management and operations at the Nevada National Security Site. SRNS provides site management and operations at the DoE’s Savannah River Site near Aiken, South Carolina. Triad provides site management and operations at the DoE’s Los Alamos National Laboratory.


San Antonio class (LPD 17) amphibious transport dock ships						Design and build amphibious transport dock ships, which are warships that embark, transport, and land elements of a landing force for a variety of expeditionary warfare missions, and also serve as the secondary aviation platform for Amphibious Readiness Groups. The San Antonio class (LPD 17) is the newest addition to the U.S. Navy's 21st century amphibious assault force, and these ships are a key element of the U.S. Navy's seabase transformation. In 2022, we delivered USS Fort Lauderdale (LPD 28), and we were awarded a long-lead-time material contract for Philadelphia (LPD 32). In 2023, we received an award modification for the detail design and construction of Philadelphia (LPD 32). We are currently constructing Richard M. McCool Jr. (LPD 29), Harrisburg (LPD 30), and Pittsburgh (LPD 31).

Unmanned systems						Creates advanced unmanned maritime solutions for defense, marine research, and commercial applications. Serving customers in more than 30 countries, unmanned systems provides design, autonomy, manufacturing, testing, operations, and sustainment of unmanned systems, including unmanned underwater vehicles and unmanned surface vessels.

Virginia class (SSN 774) fast attack submarines						Construct attack submarines as the principal subcontractor to Electric Boat. The Virginia class (SSN 774) is a post-Cold War design tailored to excel in a wide range of warfighting missions, including anti-submarine and surface ship warfare; special operation forces; strike; intelligence, surveillance, and reconnaissance; carrier and expeditionary strike group support; and mine warfare.

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