HUNTINGTON INGALLS INDUSTRIES, INC. annual report, FY2012

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Business context and reporting period

Huntington Ingalls Industries, Inc. (HII) designs, builds, repairs, and supports ships, primarily for the U.S. Navy and Coast Guard. This Form 10-K covers the fiscal year ended December 31, 2012; figures are annual unless identified as fourth-quarter results. HII operates through Ingalls (non-nuclear shipbuilding and fleet support) and Newport News (nuclear shipbuilding, refueling, and related work). Approximately 96% of 2012 revenue came from the Navy and 4% from the Coast Guard.

Financial performance and position

  • Revenue: $6.708 billion, up 2% from $6.575 billion in 2011. Product sales rose 1% to $5.755 billion; service revenue rose 6% to $953 million.
  • Profit: Operating income was $358 million versus $100 million in 2011; net earnings were $146 million versus a $100 million loss. Diluted EPS was $2.91 versus a loss of $2.05. Operating margin was approximately 5.3%, compared with 1.5% in 2011; net margin was approximately 2.2%, versus negative 1.5%.
  • Fourth quarter: Revenue was $1.823 billion, operating income $106 million, net earnings $50 million, and diluted EPS $0.98. For Q4 2011, the comparable figures were $1.735 billion, $121 million, $67 million, and $1.35, respectively.
  • Segments: Ingalls revenue declined 2% to $2.840 billion and segment operating income recovered to $97 million from a $220 million loss. Newport News revenue increased 5% to $3.940 billion; segment operating income rose 5% to $360 million.
  • Cash flow: Operating cash flow was $332 million, down from $528 million. Capital expenditures were $162 million; company-defined free cash flow was $170 million versus $331 million. Cash and equivalents at year-end were $1.057 billion, up from $915 million.
  • Debt and liquidity: Total debt was $1.830 billion, down from $1.859 billion; cash exceeded debt by approximately $773 million. The $650 million revolver had $46 million of letters of credit outstanding and $604 million unused. The current ratio was approximately 1.8. HII reported compliance with debt covenants.
  • Other balance-sheet measures: Total assets were $6.392 billion and stockholders’ equity $667 million, compared with $6.069 billion and $859 million, respectively, in 2011. Pension and other postretirement liabilities remained significant.

Material changes versus the prior comparable period

  • HII’s improved annual operating and net results largely reflect the absence of the $290 million goodwill impairment recorded in 2011, improved Ingalls performance, and favorable contract-change resolutions at Newport News. The 2012 results also included higher workers’ compensation expense and a larger FAS/CAS pension-cost adjustment.
  • Revenue increased modestly, with higher aircraft-carrier and service activity at Newport News partly offset by lower Ingalls amphibious-ship revenue. Backlog was approximately $15.5 billion at year-end versus $16.3 billion a year earlier; funded backlog increased to $12.8 billion from $10.8 billion, while unfunded backlog declined.
  • Operating cash flow and free cash flow fell year over year, principally reflecting retirement-benefit funding and working-capital movements. HII made $270 million of pension and other postretirement contributions in 2012, versus $36 million in 2011.
  • The company began paying a quarterly dividend of $0.10 per share and repurchased 31,008 shares for $1 million under its $150 million authorization.
  • HII corrected immaterial errors in prior-year postretirement-plan valuations. Management said the corrections did not affect segment or contract costs; 2012 quarterly statements were not revised.

Outlook, management commentary, risks, contingencies, and unusual items

  • Outlook: Management expected 2013 operating cash generation to be sufficient for debt service, contract obligations, and capital spending. Capital expenditures were expected at 2%–3% of annual revenue; qualified pension contributions were forecast at $270–$330 million, all discretionary. The filing does not provide clear formal revenue or earnings guidance.
  • Defense-budget exposure: Sequestration and other potential defense cuts, the Fiscal 2013 continuing resolution, and delayed or cancelled awards could affect funding, contract timing, and future demand. The Navy postponed the planned start of the CVN-72 refueling overhaul amid funding uncertainty.
  • Avondale consolidation: HII planned to wind down military shipbuilding at Avondale by the end of 2013 and consolidate work in Mississippi. Estimated restructuring and asset write-down costs were $256 million; recovery from the Navy had not been agreed, and DCAA reports said the cost proposal was insufficiently supported for a conclusion. Potential environmental costs were not included and were not estimable.
  • Government investigation: HII disclosed an internal investigation into whether Ingalls employees mischarged time or misstated progress on Navy and Coast Guard contracts. The agencies withheld $24 million in payments pending further information. Potential outcomes include penalties, fines, or suspension/debarment; the company said it could not predict the result.
  • Litigation: A False Claims Act complaint relating to alleged misuse of post-Katrina funds seeks at least $835 million plus other amounts; damages could be trebled. HII disputes the allegations and says the Justice Department declined to intervene. The filing also describes asbestos cases and other proceedings. A separate Coast Guard patrol-boat matter’s relator claims were dismissed and the dismissal affirmed on appeal.
  • Pensions and contract estimates: Lower year-end discount rates contributed to a combined actuarial loss of approximately $699 million and increased reported benefit obligations. The expected pension-asset return assumption was reduced from 8.0% for 2012 expense to 7.5% for 2013. Long-term ship contracts rely on estimates of cost, schedule, and recoveries; changes can cause material cumulative earnings adjustments.
  • Other risks: HII relies heavily on one government customer, faces fixed-price cost-overrun, supplier, workforce, nuclear-operation, environmental, and cyber risks, and carries material debt. The company recorded a $2 million environmental remediation accrual; additional Avondale-related costs were uncertain.

Important facts for investors to verify

  1. Whether the $24 million contract-payment hold is released and what the Ingalls investigation concludes, including any consequences for government contracting eligibility.
  2. Whether the Navy accepts and reimburses Avondale restructuring costs near the $256 million estimate, and whether closure creates additional environmental expense.
  3. How sequestration, continuing-resolution funding, and the delayed CVN-72 overhaul affect contract awards, backlog conversion, and cash receipts.
  4. Whether 2013 pension contributions and working-capital requirements remain consistent with management’s cash-flow expectations.
  5. Developments in the $835 million False Claims Act case and other contingencies, and any resulting change to recorded reserves or exposure.