Huntington Ingalls Industries, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. HII became an independent public company following its March 31, 2011 spin-off from Northrop Grumman. Comparisons with 2010 may not reflect stand-alone costs or operations; pre-spin-off costs include allocations from the former parent.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Sales and service revenues | $1.593 billion | $1.665 billion | $4.840 billion | $4.987 billion |
| Operating income (loss) | ($190 million) | $77 million | ($14 million) | $144 million |
| Net earnings (loss) | ($248 million) | $42 million | ($163 million) | $72 million |
| Diluted EPS | ($5.07) | $0.86 | ($3.34) | $1.48 |
- Revenue declined 4% in Q3 and 3% for the nine-month period. Lower ship-program volumes were partly offset by activity on newer ship construction and planning work.
- Results included a preliminary, non-cash $300 million goodwill impairment at Ingalls, with no tax benefit. Excluding this charge, reported results would have been materially stronger; the impairment analysis was not yet complete.
- Q3 cost of product sales was 84.2% of product sales, versus 88.1% a year earlier; service costs rose to 78.5% of service revenue from 71.4%. Management cited lower product volume and fewer unfavorable contract adjustments as factors in lower product costs.
- Ingalls recorded operating losses of $281 million for Q3 and $245 million for nine months, including the impairment. Newport News generated operating income of $94 million and $240 million, respectively.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $54 million, down from $151 million. Capital expenditures were $119 million, producing negative free cash flow of $65 million, compared with positive $55 million in 2010. Management attributed the operating cash-flow decline principally to a $169 million year-over-year increase in trade working capital, largely due to customer collection timing.
- Cash and cash equivalents were $536 million at September 30, 2011. Total debt was $1.866 billion, including $1.2 billion of senior notes and a $561 million term loan; the current portion was $29 million. Interest expense rose to $75 million for nine months from $30 million.
- The $650 million revolver had no borrowings; $121 million of letters of credit were issued but undrawn and $529 million remained unused. HII reported compliance with debt covenants and said cash from operations and available credit should cover debt service, contractual obligations and capital expenditures for the next 12 months.
- Assets totaled $5.715 billion, liabilities $4.560 billion and shareholders’ equity $1.155 billion at quarter-end.
Changes, outlook and material matters
- The spin-off financing funded a $1.429 billion payment to Northrop Grumman. HII issued $1.2 billion of notes and entered into a $575 million term loan and $650 million revolving facility. Interest-rate sensitivity disclosure estimates that a 1 percentage-point rate increase would add about $6 million in annual interest expense on debt outstanding at quarter-end.
- Total backlog was approximately $17.3 billion, broadly level with $17.3 billion at year-end 2010; funded backlog increased to $11.8 billion from $9.6 billion. New awards in the first nine months were approximately $4.8 billion. About 31% of year-end 2010 backlog was expected to convert to 2011 sales.
- Management expects Avondale shipbuilding operations to wind down and close in 2013. Estimated future restructuring and shutdown costs are approximately $271 million; recovery under government contracts remains subject to Navy review. The DCAA had questioned about $25 million of an earlier, larger proposal. The company had recorded $56 million of related liabilities at September 30, primarily for severance and relocation, capitalized in inventory and expected to be expensed beginning in 2013.
- A False Claims Act complaint alleges improper use of Hurricane Katrina-related funds and seeks at least $835 million plus penalties and other costs; damages may be trebled. The Department of Justice had not decided whether to intervene. HII said it believes it has substantive defenses but cannot predict the outcome.
- Other disclosed uncertainties include continuing Katrina insurance litigation, including claims involving FM Global and Munich Re; shipbuilding quality matters; and government contract audits and investigations. Management did not expect the disclosed matters to have a material adverse effect, but outcomes are uncertain.
- No specific earnings or revenue guidance was provided. Key risks cited include government budget and priority changes, contract awards and execution, spin-off-related costs and debt, Avondale consolidation, and further goodwill impairment. The company expected to complete the goodwill review in Q4 2011 and warned the $300 million estimate could change.
Investor verification priorities
- Check the final goodwill impairment assessment and any subsequent adjustment to the preliminary $300 million charge.
- Track cash conversion, customer collections, working capital and capital spending after the negative nine-month free cash flow.
- Verify progress on the $271 million Avondale cost-recovery submission, Navy/DCAA review and expected timing of related expenses.
- Monitor backlog funding and conversion, new awards, and segment contract performance—particularly Ingalls.
- Follow the False Claims Act matter and Katrina insurance disputes, including potential financial exposure and developments in government proceedings.