Huntington Ingalls Industries, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. Unaudited results; dollar amounts are in millions unless stated otherwise.
Business context
HII designs, builds, overhauls, and repairs ships, primarily for the U.S. Navy and Coast Guard. Its reportable segments are Ingalls, Newport News, and Other. The business depends heavily on U.S. Government contracts, many of which are long-term and flexibly priced.
Financial performance and liquidity
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Sales and service revenues | $1,570 | $1,594 |
| Operating income | $156 | $159 |
| Net earnings | $87 | $90 |
| Diluted earnings per share | $1.79 | $1.81 |
| Operating cash flow | $(3) | $(214) |
| Free cash flow | $(23) | $(238) |
- Revenue declined 2%. Product sales fell 6% to $1,250; service revenues rose 22% to $320.
- Cost of product sales was 78.8% of product sales, compared with 79.6% a year earlier. Cost of service revenues increased to 87.5% of service revenues from 86.6%.
- Segment operating income was $128, down 7%. Ingalls earned $45 (up 5%), Newport News earned $93 (down 1%), and Other reported a $10 operating loss.
- Cash and equivalents were $904 at March 31, versus $990 at year-end 2014. Total debt was $1,700, including $108 current; the $650 revolving facility was undrawn, with $30 of letters of credit issued. HII reported compliance with debt covenants.
- Total assets were $6,319 and stockholders’ equity was $1,380. Pension plan liabilities were $949 and other postretirement liabilities were $509.
Changes versus the prior comparable period
- Ingalls revenue declined $78, mainly from lower amphibious assault ship and National Security Cutter volumes. Newport News revenue increased $14, helped by submarine and fleet-support work.
- Service revenue growth included $40 from the Other segment, primarily following the 2014 UPI acquisition. UPI also contributed to Other’s $10 operating loss.
- Operating cash flow improved by $211, mainly due to working-capital movements and lower pension contributions. Accounts receivable increased $189 during the quarter; management cited payment timing as a factor in working-capital changes.
- Interest expense declined to $23 from $27, primarily after refinancing higher-coupon notes. The effective tax rate rose to 34.6% from 31.8%; the earlier period benefited from a non-recurring tax benefit.
Outlook, commentary, and risks
- Management expected cash from operations, existing cash, and credit facilities to be sufficient for debt service, contractual obligations, and capital expenditures for at least the next 12 months. It expected 2015 qualified pension contributions of $99, all discretionary, and maintenance and sustainment capital expenditures of approximately 2% of annual revenue.
- Backlog was approximately $21.5 billion at March 31, including $14.1 billion funded and $7.4 billion unfunded. New awards were approximately $1.6 billion for the quarter. Backlog is predominantly U.S. Government work and is not equivalent to guaranteed future revenue.
- Net cumulative contract estimate adjustments increased operating income by $55 and diluted EPS by $0.73, versus $44 and $0.58 a year earlier. Favorable adjustments primarily reflected risk retirement on submarine, cutter, and amphibious-ship programs.
- HII recorded a $9 gain from the March sale of its Gulfport facility for $32, reducing contract costs. Recovery of Gulfport closure costs remains disputed; related receivables were $35 at quarter-end.
- Avondale shutdown and restructuring costs were estimated at $287. HII expected recovery under government-contract rules and included the costs in contract performance estimates, but recovery remained under discussion with the Navy. At quarter-end, $203 was capitalized in inventoried costs and $52 of receivables related to these costs. Failure to recover amounts, or costs exceeding estimates, could be material.
- Risks include potential defense and Coast Guard budget reductions or delays, which could affect programs, suppliers, revenue, and asset values. Sequestration relief covered 2014 and 2015; effects beyond that period remained uncertain.
- Legal and government matters include a False Claims Act complaint seeking at least $835 plus penalties, which HII disputes; a separate internal investigation concerning possible employee mischarging, with customer payment withholds still under discussion; and an arbitration involving Venezuela, where HII claimed $173 and the Republic counterclaimed $61, plus interest. Outcomes are uncertain.
- HII reported effective disclosure controls and no material change in internal controls. It reported no material changes to the risk factors in its 2014 Form 10-K.
Important facts for investors to verify
- Whether contract estimate adjustments and segment margins remain sustainable, particularly as program volumes and contract risks change.
- Conversion and funding of the $21.5 billion backlog, especially the unfunded portion and exposure to federal budget decisions.
- Cash conversion, receivables, and working-capital movements, given negative operating cash flow in the quarter.
- Resolution and recoverability of Avondale and Gulfport costs, and developments in the disclosed legal and government matters.
- Debt maturities and refinancing plans, pension funding needs, and the capacity to support dividends and share repurchases.