Huntington Ingalls Industries, Inc. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; unaudited. HII became an independent public company in the March 31, 2011 spin-off from Northrop Grumman. The filing cautions that pre-spin-off results include allocated parent-company costs and may not represent results as a standalone company.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Sales and service revenue | $1.563 billion | $1.610 billion | $3.247 billion | $3.322 billion |
| Operating income (loss) | $91 million | $(20) million | $176 million | $67 million |
| Net earnings (loss) | $40 million | $(11) million | $85 million | $30 million |
| Diluted EPS | $0.80 | $(0.23) | $1.72 | $0.61 |
| Operating margin | 5.8% | (1.2%) | 5.4% | 2.0% |
- Q2 revenue declined about 3%; first-half revenue declined about 2%. Lower DDG-51 deliveries and completed carrier maintenance work were among the factors, partly offset by activity on LHA, National Security Cutter, and carrier overhaul programs.
- Q2 operating results improved substantially from 2010, primarily because the prior-year period included a $113 million Avondale-related charge. Ingalls reported $19 million of Q2 segment operating income versus a $94 million loss a year earlier; Newport News reported $79 million versus $84 million.
- H1 cash used in operations was $178 million, versus $22 million used in 2010; capital expenditures were $83 million, making free cash flow negative $261 million versus negative $82 million. Management attributed the cash-flow deterioration principally to higher trade working capital, including timing of customer collections.
- At June 30, cash was $381 million; current assets were $1.994 billion and current liabilities $1.184 billion. Total debt was $1.873 billion, including $29 million current, and shareholders’ equity was $1.411 billion. Cash less total debt was approximately $1.492 billion of net debt.
- Backlog was $16.828 billion, including $11.869 billion funded and $4.959 billion unfunded, compared with $17.337 billion at year-end 2010. H1 new awards were approximately $2.7 billion.
Capital structure, liquidity, and outlook
- Spin-off financing included $1.2 billion of senior notes ($600 million due 2018 at 6.875% and $600 million due 2021 at 7.125%) and a $575 million floating-rate term loan due 2016. A $650 million revolving facility was undrawn, apart from $121 million of letters of credit; $529 million remained available.
- HII transferred $1.429 billion to Northrop Grumman in connection with the spin-off. The filing reports no remaining borrowing or lending relationship with the former parent as of June 30.
- Management expected operating cash and existing credit facilities to be sufficient for the next 12 months to service debt, meet contractual obligations, and fund capital expenditures. The filing provides no quantified earnings or revenue guidance.
- Management expected about 31% of year-end 2010 backlog to convert to 2011 sales. A 1 percentage-point rise in interest rates was estimated to increase annual interest expense by approximately $6 million on the term loan balance then outstanding.
Key changes, risks, and unusual items
- The company plans to wind down and close its Avondale, Louisiana shipbuilding facility in 2013. It estimated future restructuring and shutdown costs could approximate $271 million and treated them as allowable contract costs, but recovery remains subject to Navy review. The DCAA had not accepted an earlier $310 million cost proposal and questioned approximately $25 million of that submission. Failure to recover costs, or higher costs, could materially affect results and cash flow.
- Ingalls recorded $19 million of negative cumulative margin corrections on LPD-22 through LPD-25 in Q2 2011. The company also discussed ongoing ship-quality matters, including LPD-17-class pipe weld and propulsion-system issues, while stating it did not expect a material adverse effect.
- A False Claims Act complaint concerning alleged use of Hurricane Katrina-related funds seeks at least $835 million plus penalties and other costs; statutory damages may be trebled. HII said it believes the claims lack merit and intends to defend the matter, but cannot predict the outcome.
- Other contingencies include asbestos-related claims, a Coast Guard patrol-boat case on appeal, and unresolved Hurricane Katrina insurance disputes. HII reported that it had not recognized an FM Global insurance recovery receivable because of uncertainty.
- Environmental remediation accruals were $3 million, but potential future costs are uncertain. The filing warns that new boiler-emissions requirements could require significant upgrades or replacement costs; Avondale-related environmental costs could not yet be estimated.
- HII remained exposed to federal budget and customer-priority changes, contract performance and cost-estimate risk, spin-off transition costs, pension funding and cost-recovery timing, and facility-consolidation execution. The filing noted a proposed CAS pension rule was expected in 2011, with likely application to contracts in 2012.
Important facts for investors to verify
- Whether HII collects customer receivables and reverses the working-capital-driven operating cash outflow.
- Progress and final Navy/DCAA acceptance of the revised Avondale cost-recovery submission, including whether the estimated $271 million is recoverable.
- Further LPD contract margin adjustments and costs or schedule effects from Ingalls and Newport News quality matters.
- Developments, potential exposure, and any financial provision relating to the $835 million False Claims Act demand and other litigation or insurance disputes.
- Funded versus unfunded backlog conversion, new contract awards, and the effect of federal defense budgets on demand.
- Standalone costs after the transition-services period, debt covenant headroom, and sensitivity to floating interest rates.