Huntington Ingalls Industries, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Figures are unaudited and, unless noted, in millions of dollars. HII builds military ships and provides technical services; most business is with the U.S. Government, principally the Department of Defense.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Sales and service revenues | $1,858 | $1,700 | $3,582 | $3,463 |
| Operating income | $237 | $217 | $401 | $415 |
| Net earnings | $147 | $133 | $266 | $269 |
| Diluted EPS | $3.21 | $2.80 | $5.77 | $5.68 |
- Q2 revenue rose 9% and operating income rose 9%; six-month revenue rose 3%, while operating income declined 3% and net earnings declined 1%.
- Operating margin was approximately 12.8% in Q2, versus 12.8% a year earlier; for the first six months it was approximately 11.2%, versus 12.0%.
- Six-month operating cash flow was $284, up from $223. Capital expenditures were $137, yielding free cash flow of $147 versus $138.
- At June 30, cash was $553; long-term debt was $1,281. The $1,250 revolving facility was undrawn apart from $15 of standby letters of credit, leaving $1,235 available. The company reported covenant compliance.
- Current assets were $2,033 and current liabilities $1,247. Total liabilities were $4,540 and equity $1,650.
- HII declared dividends of $0.60 per share in Q2 and $1.20 per share for the first half. It repurchased 1.07 million shares for $210 during the first half.
Material changes and segment results
- Service revenue grew 37% in Q2 and 32% for the first half, largely from Technical Solutions, including the Camber acquisition, as well as fleet-support and oil-and-gas activity. Product sales rose 2% in Q2 but fell 3% for the first half.
- Q2 segment operating income was $98 at Ingalls, $80 at Newport News, and $9 at Technical Solutions. For the first half, segment income was $164 at Ingalls and $152 at Newport News; Technical Solutions recorded a $9 loss.
- Newport News first-half segment income declined $27, primarily from lower risk retirement on Virginia-class submarines and lower volume on the USS Abraham Lincoln overhaul. Technical Solutions’ first-half loss reflected a commercial-contract receivables allowance and the prior-year resolution of contract changes.
- Camber contributed $165 of first-half revenue and $4 of operating income. HII acquired it in December 2016 to expand government technology services.
- Total backlog was approximately $21.1 billion at June 30, including $14.0 billion funded and $7.1 billion unfunded. New awards in the first half were approximately $4 billion; the Bougainville amphibious assault ship award was among the significant awards.
Outlook, commentary, risks and contingencies
- Management said operating cash, current cash and credit facilities should be sufficient to service debt, meet contractual obligations and fund capital expenditures for at least 12 months. For 2017, expected qualified pension contributions were $294, substantially discretionary. Expected capital spending was approximately 2%–2.5% of annual revenue for maintenance and sustainment and 2.5%–3% for discretionary projects.
- Management cited continuing uncertainty about defense budgets and sequestration for 2018–2021. Reduced, delayed or cancelled procurement and funding could adversely affect programs, revenue, profit, cash flow, suppliers and the defense industrial base. The filing does not provide earnings or revenue guidance.
- Contract-estimate revisions added $60 to Q2 operating income and $86 for the first half, increasing diluted EPS by $0.85 and $1.21, respectively. These cumulative catch-up adjustments were primarily favorable, including risk retirement on Tripoli and the Legend-class cutters.
- HII is pursuing recovery of Avondale closure costs after the Navy denied its claim; estimated net restructuring and shutdown costs are $276. Management expects a resolution substantially in line with its recovery expectations, but failure to recover could materially affect results or cash flows. Gulfport closure-cost allocation remains under discussion with the Government.
- A commercial customer bankruptcy led to a receivables allowance; $28 of payments received may be reclaimed if deemed preferential. The company also disclosed a sealed False Claims Act lawsuit concerning allegedly non-conforming supplier parts and a separate Justice Department investigation of previously disclosed employee time-charging/progress-reporting matters. Outcomes and potential losses were not estimable in the filing; government-contract suspension or debarment is identified as a possible consequence.
- Other contingencies include a Venezuela arbitration, asbestos claims, and ongoing government contract matters. Environmental remediation accrual was $1. The filing reported no material change to the risk factors in the 2016 Form 10-K.
- The company planned to adopt the new revenue-recognition standard in Q1 2018 using the modified retrospective method and did not expect a material effect on 2018 revenue or operating income based on its assessment to date.
Important facts for investors to verify
- Whether favorable contract-estimate adjustments and risk retirement persist, and how much reported earnings depend on such revisions.
- Progress and recoverability of Avondale and Gulfport claims, including potential effects on earnings, working capital and cash flow.
- Collection and potential clawback exposure relating to the bankrupt commercial customer, and any further allowance or recovery updates.
- Developments and financial exposure in the False Claims Act case and Justice Department investigation, including any risk to government-contract eligibility.
- Defense budget and ship-program funding developments, and the conversion of the $7.1 billion unfunded backlog into funded orders.
- Cash generation after higher capital spending, planned pension contributions, dividends and share repurchases.