Huntington Ingalls Industries, Inc. — Q1 2016 Form 10-Q
Business context and reporting period. Unaudited results cover the three months ended March 31, 2016, compared with the three months ended March 31, 2015. HII designs, builds, overhauls, and repairs ships, primarily for the U.S. Navy and Coast Guard. Its reportable segments are Ingalls, Newport News, and Other.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Sales and service revenues | $1.763 billion | $1.570 billion | +12% |
| Operating income | $198 million | $156 million | +27% |
| Net earnings | $136 million | $87 million | +56% |
| Diluted EPS | $2.87 | $1.79 | +$1.08 |
| Operating cash flow | $54 million | $10 million | +$44 million |
| Free cash flow | $17 million | $(10) million | +$27 million |
Operating margin was approximately 11.2%, versus 9.9%; net margin was approximately 7.7%, versus 5.5%. HII reported $793 million of cash at March 31, down from $894 million at December 31, 2015. Current assets were $2.203 billion and current liabilities $1.155 billion. Long-term debt was $1.275 billion. Its $1.25 billion revolving facility was undrawn, except for $25 million in issued but undrawn letters of credit; HII reported compliance with debt covenants.
Cash from operations exceeded capital expenditures of $37 million. Financing used $118 million, including $24 million in dividends and $44 million in cash share repurchases. The company declared a $0.50-per-share dividend, up from $0.40 in Q1 2015.
Changes versus the prior comparable period
- Revenue growth reflected higher volumes in Ingalls Surface Combatants and Amphibious Assault Ships, and in Newport News Energy and Submarines. Other-segment revenue fell 40%, mainly due to lower oil and gas services volumes.
- Ingalls segment operating income rose to $82 million from $45 million, primarily due to risk retirement on LPD-26 and LPD-27. Newport News segment operating income declined to $89 million from $93 million, reflecting lower risk retirement in Virginia-class submarines and lower carrier program volumes.
- Net favorable cumulative contract estimate adjustments increased operating income by $69 million, compared with $55 million in Q1 2015. The 2016 adjustments added $0.95 to diluted EPS; a $22 million favorable Ingalls contract adjustment added $0.30 per diluted share. No single adjustment was material to the statements.
- The effective tax rate declined to 23.2% from 34.6%, primarily because early adoption of stock-compensation accounting guidance recognized $18 million of tax benefits from stock award settlements in income tax benefit.
- Operating cash flow improved, but remained affected by working-capital timing and retiree-benefit funding. Discretionary qualified pension contributions were $53 million, versus $2 million a year earlier.
Outlook, commentary, risks, and unusual items
- Management said cash from operations, cash on hand, and available credit were expected to be sufficient to service debt, meet contractual obligations, and fund capital expenditures for at least the next 12 months. For 2016, it expected qualified pension contributions of $167 million, all discretionary. Planned capital spending was approximately 2%–2.5% of annual revenue for maintenance and sustainment and 1.5%–2% for discretionary investment.
- Backlog was approximately $21.3 billion at March 31, 2016, down from $22.1 billion at year-end; $13.5 billion was funded and $7.8 billion unfunded. New awards were approximately $1.0 billion in Q1. Nearly all backlog was from the U.S. Government.
- The 2015 Bipartisan Budget Act provided sequestration relief for 2016 and 2017, but sequestration remained a risk for 2018–2021. Management cautioned that future defense budget or program reductions could delay, reduce, or cancel work and adversely affect revenue, profit, cash flow, suppliers, and subcontractors.
- HII continued to recognize Avondale restructuring costs as allowable contract costs. It had incurred $282 million through March 31, 2016, against an estimated total proposal of $287 million. The government’s contracting officer could reject aspects of the cost allocation; failure to recover costs broadly as expected could materially affect results or cash flows.
- Government investigations and litigation include a Department of Justice investigation of previously disclosed employee time-charging and progress-reporting matters, with $8.3 million in Navy and Coast Guard payments still withheld at the stated provisional amounts. HII estimated potential mischarging at approximately $4 million but could not predict the investigation’s outcome. A separate sealed False Claims Act case involving allegedly non-conforming supplier parts had no estimable loss range. The filing also describes a False Claims Act appeal related to post-Katrina funds; an appellate court affirmed dismissal as to one relator in March 2016, but HII gave no assurance about the ultimate outcome of the broader matter.
- Other contingencies include Avondale and Gulfport cost-recovery disputes and Venezuela arbitration, where HII claimed $173 million and the Republic counterclaimed $61 million, plus interest. Environmental remediation accruals were $1 million. HII reported no material changes to the risk factors in its 2015 Form 10-K.
Important facts for investors to verify
- How much of Q1 earnings growth and diluted EPS reflected cumulative contract estimate adjustments and the one-time tax benefit from stock-award settlements.
- Whether the $282 million of Avondale costs and Gulfport closure costs are ultimately recovered, and the potential financial exposure if government positions differ from management’s expectations.
- Developments and possible payment, penalty, or contract-eligibility effects from the DoJ investigations and the sealed supplier-parts lawsuit.
- Backlog conversion, funding status, and exposure to future U.S. defense budget decisions, especially for unfunded orders.
- Cash generation after planned pension contributions, capital spending, dividends, and share repurchases.