K. Graney Podcast – Mark Rayha, Finance 101 on Q2 Earnings Report

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Hi everyone; it’s Kevin. Today is Wednesday, August 2. We recently closed the financial books for the second quarter of 2023, and General Dynamics, our CEO Phebe Novakovic, reported our overall financial results to the Street just this past week. Mark Rayha, our VP and Chief Financial Officer, and newly announced Chief of Operations, is with me today, so welcome back Mark and congratulations on the promotion.

Thank you.

It’s well deserved, and I look forward to continuing to work with you in your new role.

In the past Mark and I have done a podcast on Finance 101. This is part of our intentional steps to improve, overall, Electric Boat’s employees’ understanding of what we call financial acumen—how does the business of shipbuilding ultimately make money and continue to grow to provide the Navy with the submarines it needs.

Let’s talk about some of the messages that came out of this most recent earnings report. To start, our revenue volume is ahead of our operating plan, and Phebe commented that our volume growth really is a precursor to margin growth. Let’s talk about what that means from a shipbuilding standpoint.

As you stated in your President’s Intent, and as we’ve maintained as our business focus throughout the year, our drive for volume and velocity has led to growth in revenue during the first half of the year. The growth has come from both EB labor and from increased throughput by our supply chain. As a refresher, the revenue we book is based on the cost; we’re on a percentage-of-completion accounting method, so the cost is the proxy for percent complete, so our revenue is based on the cost we incur building our product.

Although we’re not where we want to be or need to be from a schedule cadence or efficiency standpoint, the increased capacity is essential to our ability to achieve the delivery rates the Navy needs. As we go down that path, and the expanded workforce gains experience, this learning enables efficiency which drives operating leverage and leads to the increased margin as Phebe stated.

I think in shorter terms, the more we get done, the more dilution we see in rates and the better off we are in terms of overall margin.

That’s the rationale behind volume and velocity that we’ve talked about before and as we articulated in my President’s Intent. Volume and velocity really will help us drive improved schedule performance and also our financial outcome. Let’s talk a little bit about how that works.

Submarine construction is extraordinarily labor and capital intense. It takes a lot of skilled laborers and a lot of equipment and machinery to do that work. The level of support labor and fixed equipment and fixture costs are high because of the complexity of our product. To put it in context, it’s roughly one support person supporting each tradesperson that’s doing the work, through Supply Chain, Riggers and all the important elements of the business that support the tradesperson doing the job on the deckplate.

So, the more construction hours we perform and can earn, the lower the fixed support cost per construction hour. That’s all good from the standpoint of our financial results and our efficiencies. We invested in our buildings, equipment and fixtures with the expectation that there would be an equivalent of one Columbia class and two Virginia class delivered per year. Until we reach that rate, the cost per construction hour is going to be higher than it should be. As a result, as that rate continues to be higher than it should be, it negatively impacts the return on investment and, in turn, will limit our ability to continue to invest in the business.

Right, so perform better to realize what we’ve already invested in and getting that return on investment is really what’s that’s all about. Let’s talk a little bit more about that from a capital perspective. We had a pontoon failure earlier this year, and we’ve spent a lot of time thinking about what our posture was with regard to maintenance of our shipbuilding infrastructure. We’re taking some significant turns; I’m proud in the way the team has reacted to that. I think we’re in a much better position today than we were back in February. We need to continue to ensure that we’ve got safe and reliable construction capacity including all of the facilities at Quonset and here in Groton as well. As you noted earlier, submarine construction is pretty capital intensive.

Let’s talk about how we manage the cost of keeping all of our infrastructure in proper working order.

The key is disciplined planning. We’ve all received the response “we can’t afford that right now” when we’ve been asking for either new equipment or for money for a major repair to an existing asset. Planning shipyard infrastructure maintenance is no different than what you’d do at home. We’ll always be under affordability pressure; you can’t fix everything at once. The size of this business and the amount of infrastructure we have to maintain is something that’s extraordinary, as we talked about earlier. The key to leveraging our available funds is by doing the best we can to consistently execute a disciplined plan for the maintenance and then the eventual replacement of the equipment.

The pontoon’s a great example of that—a long-lived asset with a very detailed maintenance plan until we get to the point, which will be coming up soon, that we can fully replace that asset. In a business this large, spreading out the expenditures over time is key to financial management success. We’ll spend hundreds of millions this year on capital equipment, a lot of which is getting spent to increase capacity for one Columbia and two Virginia, but it’s also maintaining the existing infrastructure that we have. No business can afford to fix everything at once. Active participation in the financial budgeting process is essential by everybody. When you’re involved in that planning process, it’s good for everybody if we’re disciplined to that process and provide the best inputs we can at the time. It gets into the rates, which gets into our contracts, and it allows us to create the affordability we need to be able to do this and do a good job maintaining it over time.

That planning piece is critical to us as we go forward; getting that right is the key to being able to do all that affordably. Mark, thanks again, appreciate you taking the time to help us all better understand the financial acumen aspects of the business, how volume and velocity have an impact on our ability to deliver on our mission, now, and really ensure the future continued success of Electric Boat.

Congratulations once again on the COO billet. Really appreciate being able to work with you. Thanks for listening everyone. We’ll talk again soon.

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