Huntington Ingalls Industries, Inc. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing also reports unaudited fourth-quarter results. HII designs, builds, overhauls, and supports military ships, and provides government, energy, and oil-and-gas services through Ingalls, Newport News, and Technical Solutions. More than 95% of 2019 revenue came from the U.S. Government; approximately 87% came from the Navy.
Financial performance
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Sales and service revenues | $8.899 billion | $8.176 billion | +9% |
| Operating income | $736 million | $951 million | -23% |
| Net earnings | $549 million | $836 million | -34% |
| Diluted EPS | $13.26 | $19.09 | Down $5.83 |
| Operating cash flow | $896 million | $914 million | -2% |
| Free cash flow (non-GAAP) | $460 million | $512 million | -10% |
Operating margin was approximately 8.3%, down from 11.6%. Revenue growth reflected higher aircraft-carrier and submarine activity at Newport News and acquisitions and increased service activity at Technical Solutions. Profitability was pressured by a less favorable pension accounting adjustment, reduced risk retirement on certain Ingalls programs, a fleet-support contract loss, and a $29 million goodwill impairment. Net income also reflected a higher effective tax rate: 19.6% versus 13.9% in 2018.
Fourth quarter: Revenue was $2.412 billion, operating income $186 million, net earnings $149 million, and diluted EPS $3.61. In Q4 2018, these were $2.199 billion, $213 million, $212 million, and $4.94, respectively. Q4 2019 included the $29 million goodwill impairment.
Segment results: Ingalls revenue was $2.555 billion and segment operating income $235 million, versus $2.607 billion and $313 million. Newport News revenue rose 10% to $5.186 billion and operating income increased to $390 million from $318 million. Technical Solutions revenue rose 32% to $1.309 billion, while operating income fell to $6 million from $32 million, mainly due to the impairment and a fleet-support contract loss.
Cash, debt, and liquidity
- Cash and cash equivalents were $75 million at year-end, down from $240 million. Operating cash flow was nearly flat year over year; working-capital timing and lower pension funding affected the comparison.
- Capital expenditure additions were $530 million, partly offset by $94 million of grant proceeds. HII defines free cash flow as operating cash flow less capital expenditures net of grant proceeds.
- Long-term debt was $1.286 billion. The $1.25 billion revolving credit facility was undrawn at year-end, with $1.234 billion available after letters of credit. HII also established a commercial-paper program of up to $1 billion and reported compliance with debt covenants.
- Current assets were $1.785 billion and current liabilities $1.890 billion. Management said cash from operations, cash on hand, and credit facilities should be sufficient for debt service, retiree benefits, contractual obligations, and capital expenditures for at least 12 months.
- Total contractual obligations were $7.176 billion, including $4.263 billion of purchase obligations. HII paid $149 million in dividends and repurchased $214 million of shares in 2019; the board raised the quarterly dividend to $1.03 per share and expanded the repurchase authorization to $3.2 billion.
Material changes, outlook, and risks
- Backlog increased to approximately $46.5 billion from $23.0 billion, reflecting $32.3 billion of 2019 awards, including Ford-class carriers and Virginia-class Block V submarines. Approximately 17% of year-end backlog was expected to convert to sales in 2020. Backlog includes $28.6 billion unfunded, principally at Newport News, and remains dependent on future government funding.
- Management expected 2020 maintenance and sustainment capital expenditures of approximately 1.0% of annual revenue and discretionary capital expenditures of 3.0%–4.0%. It expected $205 million of qualified pension contributions and about $33 million of other postretirement contributions. The filing does not provide a clear consolidated revenue or earnings forecast.
- HII expects its 2020 FAS/CAS pension adjustment to be a net benefit of approximately $367 million, including an operating adjustment of approximately $247 million; these estimates are subject to change.
- Key risks include dependence on government appropriations and changing defense priorities; cost overruns, schedule delays, and contract-estimate revisions; workforce and supplier constraints; extensive government regulation and audit exposure; cyber and nuclear-operational risks; and pension assumptions and funding needs.
- A False Claims Act lawsuit concerning allegedly non-conforming supplier parts was unsealed after the Department of Justice declined to intervene; HII could not estimate a reasonably possible loss. A separate submarine-material lawsuit was voluntarily dismissed. HII is also pursuing enforcement of a $151 million arbitration award against Venezuela, subject to uncertainty.
- In February 2020, HII agreed to acquire Hydroid for approximately $350 million, subject to closing conditions, and agreed to contribute its San Diego shipyard to Titan for a minority interest. These were subsequent events, not 2019 operating results.
Most important facts for investors to verify
- Whether the large backlog, particularly its unfunded portion, receives appropriations on schedule and converts into revenue as expected.
- Whether shipbuilding cost estimates, delivery schedules, and contract margins improve or deteriorate, especially on programs cited for delays or losses.
- Whether Technical Solutions recovers profitability after the oil-and-gas goodwill impairment and fleet-support contract loss.
- How pension discount rates, asset returns, contributions, and the expected FAS/CAS adjustment affect earnings and cash flow.
- Developments in the supplier-parts lawsuit, recovery of costs relating to the DDG 119 damage incident, and collection of the Venezuela arbitration award.
- Execution, financing, and expected returns from the Hydroid acquisition and San Diego shipyard transaction.
The independent auditor issued an unqualified opinion on the financial statements and an unqualified opinion on internal control over financial reporting. Revenue estimation for long-term contracts was identified as a critical audit matter.