Huntington Ingalls Industries, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing is an annual report; it also provides unaudited fourth-quarter results. Unless otherwise stated, amounts are in U.S. dollars.
Business context
HII is a major U.S. military shipbuilder and government-services provider, operating through Ingalls, Newport News, and Technical Solutions. Its shipbuilding businesses build, maintain, overhaul, and refuel naval vessels; Technical Solutions provides government, nuclear and environmental, fleet-support, and oil-and-gas services. Revenue is highly concentrated in government work: the U.S. Navy generated about 88% of 2018 revenue and the Coast Guard about 5%; more than 95% came from the U.S. Government overall.
Financial results and liquidity
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Sales and service revenues | $8.176 billion | $7.441 billion | +10% |
| Operating income | $951 million | $881 million | +8% |
| Net earnings | $836 million | $479 million | +75% |
| Diluted EPS | $19.09 | $10.46 | +83% |
| Operating cash flow | $914 million | $814 million | +$100 million |
| Free cash flow | $512 million | $453 million | +$59 million |
Operating margin was approximately 11.6% in 2018 versus 11.8% in 2017; net margin was approximately 10.2% versus 6.4%. Segment operating income fell 4% to $663 million, despite revenue growth: Ingalls was flat at $313 million, Newport News declined 10% to $318 million, and Technical Solutions rose to $32 million from $21 million.
Fourth-quarter 2018 revenue was $2.199 billion, operating income $213 million, net earnings $212 million, and diluted EPS $4.94. In fourth-quarter 2017, these were $1.996 billion, $231 million, $64 million, and $1.41, respectively; the 2017 quarter included a $56 million tax expense related to tax reform.
Cash and equivalents were $240 million at year-end, down from $701 million. Long-term debt was $1.283 billion. The $1.25 billion revolving facility was undrawn, with $1.234 billion available after outstanding letters of credit; HII reported covenant compliance. Current assets were $1.745 billion and current liabilities $1.829 billion. The company repurchased $788 million of shares and paid $132 million in dividends during 2018.
Material changes and notable items
- Revenue increased in both principal shipbuilding segments, especially Newport News, where higher aircraft-carrier and nuclear-support activity contributed to growth. Lower Virginia-class submarine performance and reduced contract risk retirement weighed on segment earnings.
- Net earnings benefited from a 13.9% effective tax rate, compared with 38.0% in 2017, reflecting the lower federal corporate tax rate and research-and-development credits. The 2017 comparison was also affected by deferred-tax revaluation under the Tax Cuts and Jobs Act.
- Operating cash flow improved with working-capital timing and lower tax payments, partly offset by increased retiree-plan funding. HII contributed $546 million to pension and other postretirement plans, including $508 million in discretionary qualified-pension contributions.
- Total backlog rose to approximately $23.0 billion from $21.4 billion. About 30% of year-end backlog is expected to convert to revenue in 2019. New 2018 awards were approximately $9.8 billion; the filing also reports $15.2 billion of carrier-program awards in 2019.
- HII adopted ASC 606 in 2018 using the modified retrospective method. It reported no significant overall impact; 2018 earnings and diluted EPS were increased by less than $1 million and $0.01, respectively. Prior-period results were not restated.
Outlook, risks, and contingencies
- Management expected 2019 operating cash generation, cash on hand, and credit facilities to cover debt service, retiree benefits, contractual commitments, and capital spending for at least 12 months. It projected 2019 maintenance and sustainment capital expenditures of 1.5%–2.0% of revenue and discretionary capital expenditures of 3.5%–4.0%.
- HII expects approximately $21 million of 2019 qualified-pension contributions and about $33 million for other postretirement benefits. It projected a 2019 net FAS/CAS adjustment benefit of approximately $159 million, subject to actuarial updates.
- Management cited continuing uncertainty over federal budgets and sequestration for fiscal years 2020–2021. Program funding changes, delays, or cancellations could affect revenue, profits, and cash flow; the business is particularly exposed to U.S. Navy priorities and funding.
- A DCAA audit identified potentially significant deficiencies in Newport News’s material-management business system. If the government makes a final adverse determination and corrective actions are inadequate, it may withhold up to 5% of applicable interim billings, potentially affecting cash-receipt timing.
- A False Claims Act case concerning allegedly non-conforming supplier parts remains under seal; HII said it could not estimate a possible loss range. In a separate Venezuela dispute, an arbitral tribunal awarded HII approximately $151 million and the Republic approximately $22 million; court confirmation or enforcement remained pending.
- Other risks include contract cost and schedule overruns, supplier concentration, skilled-labor availability, government audits and termination rights, cyber and nuclear-operation risks, pension assumptions and asset returns, and natural disasters. The 2018 actual pension asset return was approximately negative 6.4%, below the 7.25% expected-return assumption.
Most important facts for investors to verify
- Whether shipbuilding contract estimates, especially Virginia-class submarine performance, improve or deteriorate; cumulative catch-up adjustments increased 2018 operating income by $110 million.
- Progress and any cash-flow effects from the Newport News material-management audit and potential billing withholdings.
- Backlog funding, conversion timing, and delivery schedules, including how much of the $23 billion backlog is funded versus unfunded.
- Cash deployment, including share repurchases, dividends, capital expenditures, and pension contributions, alongside the decline in year-end cash.
- Developments in the sealed False Claims Act matter and enforcement of the Venezuela arbitration award.
- Federal defense appropriations and the effect of budget decisions on HII’s concentrated government customer base.