Huntington Ingalls Industries, Inc. — FY 2011 Form 10-K
Reporting period: Year ended December 31, 2011; filed March 28, 2012. The company became an independent public company in a March 31, 2011 spin-off from Northrop Grumman. Pre-spin-off financial information was derived from the former parent’s records and may not reflect standalone costs, limiting comparability. HII designs, builds, overhauls and repairs ships, principally for the U.S. Navy and Coast Guard, through its Ingalls and Newport News segments.
Key financial results
| Metric | FY 2011 | FY 2010 |
|---|---|---|
| Revenue | $6.575 billion | $6.723 billion |
| Operating income | $110 million | $248 million |
| Net earnings (loss) | ($94 million) | $135 million |
| Diluted EPS | ($1.93) | $2.77 |
| Cash from operations | $528 million | $359 million |
| Capital expenditures | $197 million | $191 million |
| Free cash flow | $331 million | $168 million |
- Revenue declined 2%. Operating margin was approximately 1.7%, versus 3.7% in 2010; reported net loss included a $290 million non-cash, nondeductible goodwill impairment charge at Ingalls. Excluding that charge, earnings from continuing operations had a 33.8% effective tax rate.
- Cash and cash equivalents were $915 million; current assets were $2.268 billion and current liabilities $1.372 billion. Long-term debt was $1.830 billion, with total debt of $1.859 billion. The $650 million revolving facility was undrawn except for $121 million of letters of credit; $529 million remained available.
- Total assets were $6.001 billion and stockholders’ equity $872 million. The company had $16.3 billion of backlog, down from $17.3 billion; approximately 33% was expected to convert to sales in 2012. New contract awards were approximately $5.6 billion, compared with $3.6 billion in 2010.
Material changes and segment performance
- Ingalls revenue fell 5% to $2.885 billion; segment operating loss widened to $220 million from $61 million, including the $290 million goodwill impairment. Newport News revenue was nearly flat at $3.766 billion; segment operating income decreased to $342 million from $355 million.
- Interest expense rose to $104 million from $40 million, largely reflecting debt issued in connection with the spin-off. HII issued $1.2 billion of senior notes and entered a $1.225 billion credit facility; $554 million was outstanding under its variable-rate term loan at year-end.
- Operating cash flow improved from $359 million to $528 million, while free cash flow increased from $168 million to $331 million. Pension and postretirement funding was $36 million, down from $138 million in 2010.
- Pension plan funded status deteriorated: the reported pension liability increased to $936 million from $381 million, and other postretirement plan liabilities were $581 million. Lower discount rates were a major contributor to increased pension obligations and accumulated benefit-plan losses.
Outlook, risks and unusual items
- Management expected 2012 operating cash generation to be sufficient for debt service, contractual obligations and capital expenditures. It forecast a 2012 FAS/CAS pension adjustment of approximately $77 million and expected pension contributions of about $221 million, plus approximately $33 million for other postretirement plans.
- HII planned to wind down Avondale, Louisiana construction activities in 2013 and consolidate Ingalls construction in Mississippi. Estimated restructuring and asset write-down costs were $271 million. Recovery through government contracts was not agreed with the Navy; the DCAA questioned approximately $25 million of an earlier cost proposal. Environmental costs related to the wind-down were not reasonably estimable.
- Revenue and backlog are highly dependent on U.S. Government appropriations and priorities; approximately 97% of 2011 revenue came from the Navy and 3% from the Coast Guard. The filing highlighted potential defense-budget reductions, including sequestration, and the risk of program delays, reductions or cancellations.
- A False Claims Act complaint concerning alleged misuse of Hurricane Katrina funds sought at least $835 million plus penalties and fees; damages could be trebled. HII said it believed it had substantive defenses and intended to defend the case, but could not predict the outcome. A separate Coast Guard patrol-boat matter involved a $96 million claim against a joint venture; the relator’s claims were dismissed, with appeal proceedings pending.
- Other risks include shipbuilding cost overruns and quality issues, execution of Avondale consolidation, pension funding and assumption sensitivity, dependence on skilled labor and suppliers, government audits and contract termination rights, cyber and nuclear-operation risks, and the company’s debt and restrictive covenants. HII paid no dividends after the spin-off.
- The financial statements received an unqualified independent audit opinion. The auditor did not audit internal control over financial reporting, and management’s ICFR assessment was omitted under the transition rules for newly public companies.
Important facts for investors to verify
- Progress on recovery and timing of the $271 million Avondale wind-down costs, including Navy acceptance and any additional environmental liabilities.
- Resolution, potential financial exposure and any reserve changes for the $835 million Katrina-related False Claims Act complaint and other significant litigation.
- Ingalls contract performance, particularly LPD program costs and quality remediation, and whether segment profitability improves after the impairment charge.
- Cash conversion, backlog funding and conversion, 2012 pension contributions, and compliance with debt covenants as obligations come due.
- Defense budget and shipbuilding-plan developments that could affect HII’s concentrated government customer base.