Huntington Ingalls Industries, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods. Amounts are in millions except per-share data. HII builds naval ships and provides services, principally to the U.S. Government, through Ingalls, Newport News, and Technical Solutions.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Sales and service revenues | $1,863 | $1,683 | $5,445 | $5,146 |
| Operating income | $237 | $175 | $638 | $590 |
| Net earnings | $149 | $107 | $415 | $376 |
| Diluted EPS | $3.27 | $2.27 | $9.04 | $7.93 |
| Operating cash flow | Not presented by quarter | Not presented by quarter | $380 | $477 |
| Capital expenditures | Not presented by quarter | Not presented by quarter | $228 | $145 |
| Free cash flow | Not presented by quarter | Not presented by quarter | $152 | $332 |
- Revenue increased 11% in Q3 and 6% year to date; service revenue rose 33% and 32%, respectively. Product sales rose 5% in Q3 but declined 1% year to date.
- Operating income increased 35% in Q3 and 8% year to date; net earnings increased 39% and 10%. Cost of product sales was 79.4% of product revenue in Q3 (79.8% prior year) and 80.2% year to date (78.7%). Cost of service revenue was 83.3% in Q3 and 84.1% year to date, down from 86.5% in both prior-year periods.
- Net cumulative contract-estimate adjustments added $56 million to operating income in Q3 and $142 million year to date, versus $24 million and $167 million in 2016. These estimates materially influence reported results.
- By segment, Q3 revenue and operating income were: Ingalls $593 million and $74 million; Newport News $1,053 million and $96 million; Technical Solutions $241 million and $22 million. Technical Solutions revenue growth chiefly reflects the Camber acquisition.
Cash, debt, and liquidity
- Cash and equivalents were $499 million at September 30, down from $720 million at December 31, 2016. Long-term debt was $1,282 million, compared with $1,278 million; the filing reports $600 million of principal due in 2021.
- Nine-month operating cash flow fell $97 million to $380 million. HII attributed the decline principally to increased retiree-benefit funding and working-capital changes. Capital spending rose $83 million, and free cash flow decreased $180 million to $152 million.
- HII made $294 million of discretionary qualified-pension contributions in the first nine months and anticipated no further significant qualified-plan contributions in 2017. It said cash, operating cash generation, and credit facilities should be sufficient for at least the next 12 months.
- The $1.25 billion revolving facility was undrawn, except for $15 million of issued, undrawn letters of credit; $1.235 billion remained available. HII reported compliance with debt covenants.
- Dividends declared were $0.60 per share in Q3 and $1.80 year to date, compared with $0.50 and $1.50 in 2016. Year-to-date share repurchases were $247 million.
Material changes, outlook, and risks
- Backlog was approximately $22.6 billion at September 30, up from $20.7 billion at December 31, 2016; $14.5 billion was funded. New awards during the first nine months were approximately $7 billion.
- Management forecast 2017 maintenance and sustainment capital expenditures of 2%–2.5% of annual revenue and discretionary capital expenditures of 2.5%–3%. It gave no specific earnings or revenue guidance in the provided filing text.
- Management cited uncertainty over U.S. defense budgets and sequestration for 2018–2021. At filing, the government was operating under a continuing resolution through December 8, 2017. Funding reductions, delays, or cancellations could affect programs, revenue, profit, and cash flow.
- HII recognized a roughly $76 million increase in pension liability and pretax accumulated other comprehensive loss following a pension-plan amendment tied to a labor agreement. Pension plan liabilities on the balance sheet declined to $926 million from $1,116 million at year-end, while nine-month pension contributions increased substantially.
- Avondale restructuring-cost recovery remains disputed: the contracting officer denied HII’s claim, and HII is pursuing appeals. Management expects recovery substantially in line with its expectations, but says a materially lower recovery could affect financial results. A potential buyer also had a right to decide whether to close on the facility.
- Other contingencies include a sealed False Claims Act case concerning allegedly non-conforming supplier parts, for which HII could not estimate a loss; a Venezuela arbitration involving HII’s $173 million claim and a $61 million counterclaim; and a possible clawback of $28 million in payments from a bankrupt commercial customer. HII settled a separate DoJ investigation in August 2017 without material financial effect, and the Navy and Coast Guard released remaining payment withholds in September.
- HII increased its share-repurchase authorization to $2.2 billion and extended the program through October 31, 2022, on November 7, 2017, after quarter-end.
Most important facts for investors to verify
- Whether contract-estimate gains and favorable risk retirements are repeatable, and how they affect segment profitability and future margins.
- Progress and funding status for major shipbuilding programs, including the growth and funding composition of backlog.
- Resolution and recoverability of Avondale costs, and developments in the False Claims Act, Venezuela arbitration, and commercial-customer bankruptcy matters.
- Cash generation after elevated pension contributions and capital spending, together with the company’s repurchase and dividend pace.
- Defense-budget developments and their potential impact on U.S. Government contracts, suppliers, and program schedules.