Huntington Ingalls Industries, Inc. — FY2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014; includes unaudited fourth-quarter results. Amounts are in U.S. dollars unless noted.
Business context
HII designs, builds, overhauls and repairs ships, primarily for the U.S. Navy and Coast Guard. Its segments are Ingalls, Newport News and, beginning in 2014, Other, which includes acquired oil-and-gas engineering business UPI. The company is the sole U.S. designer, builder and refueler of nuclear-powered aircraft carriers and one of two builders of nuclear submarines. Approximately 88% of 2014 revenue came from the Navy and 8% from the Coast Guard.
Financial performance and liquidity
| Metric | FY2014 | FY2013 | Change |
|---|---|---|---|
| Sales and service revenue | $6.957 billion | $6.820 billion | +2% |
| Operating income | $655 million | $512 million | +28% |
| Net earnings | $338 million | $261 million | +30% |
| Diluted EPS | $6.86 | $5.18 | +32% |
| Cash from operations | $716 million | $236 million | +$480 million |
| Free cash flow | $551 million | $97 million | +$454 million |
Approximate operating margin rose to 9.4% from 7.5%; net margin rose to 4.9% from 3.8%. Operating cash flow and free cash flow benefited chiefly from lower accounts receivable and lower retiree-benefit funding; free cash flow is a non-GAAP measure and equals operating cash flow less capital expenditures.
Fourth quarter: Revenue was $1.927 billion versus $1.938 billion in Q4 2013. Operating income was $144 million versus $174 million, net earnings were $52 million versus $91 million, and diluted EPS was $1.05 versus $1.82. The quarter included a $47 million goodwill impairment in Other.
At year-end, cash was $990 million, total debt was $1.700 billion and total current assets and liabilities were $2.546 billion and $1.312 billion, respectively. The company reported $619 million of unused revolver capacity, in addition to $31 million of issued but undrawn letters of credit. Debt declined from $1.779 billion; the company issued $600 million of 5.0% notes and used the proceeds to repurchase its 6.875% notes due 2018, recording a $37 million early-extinguishment loss. It was in compliance with debt covenants.
Backlog rose to $21.430 billion from $18.038 billion, with about 28% expected to convert to sales in 2015. Funded backlog was $11.832 billion; unfunded backlog was $9.598 billion.
Material changes versus the prior period
- Ingalls revenue fell 6% to $2.286 billion, while segment operating income rose 39% to $229 million, driven mainly by improvement and risk retirement on LPD-17 and National Security Cutter programs.
- Newport News revenue increased 4% to $4.536 billion and segment operating income rose 3% to $415 million. Higher submarine and energy activity and the SN3 acquisition were partly offset by lower aircraft-carrier and fleet-support revenue.
- UPI and SN3 were acquired during 2014. The new Other segment recorded $137 million of revenue and a $59 million operating loss, including the $47 million goodwill impairment, which management linked primarily to falling oil prices and lower industry valuation multiples.
- HII ceased shipbuilding construction at Avondale in October 2014 and consolidated Ingalls shipbuilding at Pascagoula. It also closed its Gulfport composite facility in August.
- Dividends declared increased to $1.00 per share from $0.50. HII repurchased $138 million of stock and increased its repurchase authorization to $600 million.
Outlook, risks and unusual items
- Outlook: The filing gives no specific 2015 revenue or earnings guidance. Management expected cash, operating cash generation and credit facilities to cover debt service, contractual obligations and capital expenditures for at least 12 months. Maintenance and sustainment capital expenditures, excluding discretionary projects, were expected to be about 2% of annual revenue. Expected 2015 contributions were $99 million to qualified pension plans and approximately $36 million to other postretirement plans.
- Government budgets and customer concentration: Substantially all backlog and most revenue depend on the U.S. Government. Sequestration remained a potential risk for 2016–2021, with possible program delays, reductions or cancellations. The Coast Guard was under a continuing resolution at the filing date.
- Contract performance: Long-term shipbuilding contracts rely on estimates of cost, schedule and completion. Unanticipated cost growth, technical challenges, supplier issues or changes in estimates can reduce margins. FY2014 net cumulative catch-up adjustments increased operating income by $222 million, or diluted EPS by $2.93.
- Avondale and Gulfport: The estimated $284 million of Avondale wind-down and restructuring costs were treated as recoverable, but no agreement with the Navy had been reached on their accounting and pricing treatment. Potential Avondale environmental costs were not estimable. The Navy had taken exception to HII’s treatment of Gulfport closure costs, estimated at approximately $57 million; recovery remained uncertain.
- Contingencies: A False Claims Act complaint related to post-Hurricane Katrina funds seeks at least $835 million plus penalties and fees; damages may be trebled. The DOJ declined to intervene, and HII said it believed it had substantive defenses. A separate inquiry into alleged Ingalls time-charging or progress-reporting issues resulted in remaining Navy and Coast Guard payment withholds; HII estimated potential mischarging at up to $4 million, but regulatory outcomes were uncertain.
- Other risks: The company disclosed asbestos litigation and a Venezuela arbitration in which HII claims $173 million while the Republic counterclaims for $61 million, each plus interest. Pension funding and expense are sensitive to discount rates, asset returns and actuarial assumptions; the qualified plans were 86% funded on a financial-reporting basis versus 93% a year earlier. Government audits, business-system payment withholds, labor availability, cyber threats, environmental obligations and nuclear-operation risks were also identified.
Important facts for investors to verify
- Whether the $284 million Avondale recovery is accepted by the Navy and whether closure, alternative use or environmental obligations change the estimate.
- Progress and potential financial or contracting consequences of the government inquiries, payment withholds and False Claims Act complaint.
- Whether backlog converts to funded awards and revenue as planned, particularly under changing Navy and Coast Guard budgets.
- Whether improved contract margins and cumulative catch-up benefits are sustainable, and how pension assumptions affect reported earnings and contributions.
- Whether lower oil prices affect UPI’s outlook or cause further impairment; the filing reported a $47 million goodwill impairment in 2014.
- Debt maturities, covenant capacity and cash deployment plans, including dividends and share repurchases.