Huntington Ingalls Industries, Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Unaudited results; amounts are in millions except per-share data. HII designs, builds, overhauls, and repairs ships, primarily for the U.S. Navy and Coast Guard. Its reportable segments are Ingalls and Newport News.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $1,637 | $1,596 | $4,882 | $4,885 |
| Operating income | $127 | $66 | $338 | $252 |
| Net earnings | $69 | $13 | $170 | $96 |
| Diluted EPS | $1.36 | $0.26 | $3.37 | $1.92 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $(56) | $(41) |
| Free cash flow | Not stated for quarter | Not stated for quarter | $(141) | $(133) |
- Q3 revenue increased 3%; nine-month revenue was essentially unchanged. Product sales declined 2% year to date while service revenue grew 13%.
- Operating margin was approximately 7.8% in Q3 versus 4.1% a year earlier, and 6.9% for the first nine months versus 5.2%. Net margin was approximately 4.2% and 3.5%, respectively.
- At September 30, cash was $895; current assets were $2,531 and current liabilities $1,402. Total debt was $1,808, including $65 current; the company also had $618 of undrawn revolver availability after $32 of letters of credit.
- Capital expenditures were $85 for the first nine months. Cash declined $162 from year-end 2012. HII attributed negative operating cash flow principally to retiree-benefit funding and working-capital timing.
- HII contributed $301 to qualified pension plans during the period and expected no further qualified-plan contributions in 2013. Long-term pension and other postretirement liabilities were $1,082 and $656, respectively.
Material changes and segment results
- Q3 operating income rose $61 year over year; nine-month operating income rose $86. Net earnings rose $56 in Q3 and $74 year to date.
- Ingalls Q3 revenue decreased 5% to $639, while operating income increased to $49 from $1. Nine-month revenue fell 8% to $1,942, while operating income rose to $110 from $59.
- Newport News Q3 revenue increased 8% to $1,018 and operating income increased 6% to $93. Nine-month revenue increased 6% to $2,999 and operating income increased 12% to $288.
- HII reported $19.3 billion of backlog at September 30, up from $15.5 billion at year-end 2012; funded backlog was $12.8 billion and unfunded backlog $6.6 billion. New awards totaled approximately $8.7 billion in the first nine months.
Outlook, risks, contingencies, and unusual items
- Management expected cash from operations, existing cash, and credit facilities to be sufficient for at least the next 12 months, and forecast 2013 capital expenditures of 2%–3% of annual revenue. No earnings or revenue guidance was provided.
- Federal defense sequestration and uncertainty about fiscal 2014 appropriations could affect program funding, revenue, facilities, employees, suppliers, and asset values. HII conducts substantially all of its business with the U.S. Government.
- Hurricane Katrina insurance litigation with FM Global settled in September for a $180 cash payment. The company reported a $46 favorable Q3 operating-income impact from insurance recoveries and customer direction on allocation of recoveries. A separate claim against insurance broker Aon continued. In October, a contracting officer disallowed certain post-Katrina costs and directed allocation of insurance proceeds; HII was evaluating its appeal options.
- Q3 included approximately $17 of operating-income reduction associated with closing the Gulfport facility. HII estimated total closure costs of about $57, mostly non-cash, and planned to complete the closure by May 2014.
- Avondale wind-down costs were estimated at $256, with recovery under government contracts still under discussion. HII said it expected agreement substantially consistent with its recovery expectations, but warned that non-recovery could materially affect results. The company was also pursuing alternative uses for the facility.
- Net cumulative contract estimate adjustments increased operating income by $2 in Q3 and $67 for the first nine months; the nine-month diluted EPS benefit was $0.86. Favorable adjustments included submarine program performance and contract changes; unfavorable items included Gulfport closure, LHA-6 mechanical issues, and LPD-25 damage and delays.
- A False Claims Act complaint seeks at least $835 plus possible penalties, including potential treble damages. HII said it believed the claims lacked merit and intended to defend itself. Separately, a government inquiry into possible employee mischarging led to an initial $24 payment withhold; HII estimated maximum mischarging of about $4, while the Navy cited potential mischarging of $5.3 and planned to reduce its withhold from $18.2 to $13.1. Outcomes remain uncertain.
- On November 6, after quarter-end, HII amended its credit facility with more favorable pricing and greater restricted-payment flexibility; the facility size and amortization schedule were unchanged. The company also increased its stock-repurchase authorization to $300 and extended it through October 2017.
Important facts for investors to verify
- How much of the reported earnings improvement is repeatable, given hurricane recoveries, contract estimate adjustments, and prior-year comparison effects.
- Whether operating cash flow improves after substantial pension contributions and working-capital outflows; reconcile the timing and cash impact of insurance recoveries.
- Funding and conversion risk within backlog, especially the increase in unfunded backlog and uncertainty around defense appropriations.
- Final recoverability of Avondale restructuring costs and the total cost and earnings impact of the Gulfport closure.
- Developments in the government mischarging inquiry, payment withholds, and False Claims Act litigation, including potential penalties or contracting consequences.
- Debt covenant compliance, borrowing costs, and the effect of the amended facility and expanded share-repurchase authorization on liquidity and capital allocation.