Huntington Ingalls Industries, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. The company builds and supports U.S. Navy and Coast Guard vessels and provides government and commercial services. Most business is with the U.S. Government, principally the Department of Defense.
Financial results and liquidity
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Sales and service revenues | $1.724 billion | $1.763 billion |
| Operating income | $164 million | $198 million |
| Net earnings | $119 million | $136 million |
| Diluted earnings per share | $2.56 | $2.87 |
| Operating cash flow | $98 million | $54 million |
| Capital expenditures | $58 million | $37 million |
| Free cash flow | $40 million | $17 million |
Operating margin was approximately 9.5%, versus 11.2% a year earlier; net margin was approximately 6.9%, versus 7.7%. The effective tax rate declined to 19.0% from 23.2%, mainly reflecting tax benefits from stock-award settlements and the domestic manufacturing deduction.
Cash and cash equivalents were $608 million at March 31, down from $720 million at December 31, 2016. Long-term debt was $1.280 billion, with $600 million in principal due in 2021. The $1.25 billion revolving credit facility was undrawn; $25 million of letters of credit were outstanding, leaving $1.225 billion unused. The company reported compliance with debt covenants. Management expected cash, operations and available credit to cover debt service, contractual obligations and capital spending for at least 12 months.
Changes versus prior period
- Revenue fell 2%. Product sales declined 9% to $1.300 billion, while service revenues increased 27% to $424 million, mainly with Camber-related growth in Technical Solutions.
- Operating income declined 17%; segment operating income fell 28% to $120 million. Lower risk retirement on ship programs, a $29 million allowance for a commercial receivable, and prior-year contract-change resolutions weighed on results.
- Ingalls revenue and operating income were $550 million and $66 million, compared with $586 million and $82 million. Newport News reported $971 million and $72 million, versus $993 million and $81 million.
- Technical Solutions revenue rose to $225 million from $208 million, but the segment recorded an $18 million operating loss versus $3 million income. Camber contributed $80 million in revenue and $2 million in operating income.
- Net cumulative contract-estimate adjustments increased operating income by $26 million, compared with $69 million in Q1 2016. Diluted EPS benefit was $0.37 versus $0.95.
- Backlog was approximately $20.0 billion at quarter-end, down from $21.0 billion at year-end; $12.7 billion was funded and $7.2 billion unfunded. New awards were approximately $0.6 billion, with no significant awards.
Outlook, risks and unusual items
- The filing provides no specific revenue or earnings guidance. For 2017, management expected capital expenditures of approximately 2%–2.5% of annual revenue for maintenance and sustainment, plus 2.5%–3% for discretionary projects. Expected qualified pension contributions were $294 million, substantially all discretionary.
- Management cited continuing uncertainty over U.S. defense budgets and sequestration for 2018–2021. Funding cuts, delays or program cancellations could affect awards, revenue, profits, cash flow, suppliers and the defense industrial base.
- A $29 million Technical Solutions allowance followed a commercial customer’s Chapter 11 filing. A further $28 million of payments received from that customer may be reclaimable under bankruptcy law.
- The company is pursuing recovery of Avondale shutdown costs after the contracting officer denied its claim; management expects a resolution substantially consistent with its recovery assumptions, but failure to recover could materially affect results. Government discussions also continue over allocation and recovery of Gulfport closure costs.
- Disclosed legal matters include a sealed False Claims Act case involving allegedly non-conforming supplier parts, a Department of Justice investigation into alleged employee time/progress mischarging, and an arbitration with Venezuela. Outcomes and potential losses for key matters could not be estimated clearly in the filing. The company also described ordinary-course asbestos and other claims.
- Other notable items: the company repurchased $72 million of shares and paid $28 million in dividends during the quarter; the declared dividend was $0.60 per share. The filing noted that future adoption of the revenue standard was planned for Q1 2018 using the modified retrospective method, with no material impact expected on 2018 revenue and operating income based on the assessment to date.
Important facts for investors to verify
- Whether Technical Solutions can restore profitability and resolve the commercial receivable exposure, including possible recovery of the $28 million in payments.
- Progress and outcome of the Avondale cost-recovery appeal, Gulfport cost discussions, and government investigations and litigation.
- Conversion of backlog into funded work and sales, particularly the $7.2 billion unfunded portion, amid U.S. defense-budget uncertainty.
- Contract cost estimates and risk retirement: Q1 earnings included $26 million of favorable net cumulative catch-up adjustments, materially less than the prior-year benefit.
- Cash generation after planned capital spending, share repurchases, dividends and expected $294 million of 2017 pension contributions.