Huntington Ingalls Industries, Inc. — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. HII builds military ships and provides government and commercial services; most business is with the U.S. Government. Amounts below are in millions except per-share data.
Financial performance
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Sales and service revenues | $2,338 | $2,314 | $6,847 | $6,604 |
| Operating income | $118 | $222 | $393 | $494 |
| Net earnings | $147 | $222 | $424 | $447 |
| Diluted EPS | $3.65 | $5.45 | $10.52 | $10.98 |
| Operating cash flow | — | $489 | $491 | |
| Free cash flow | — | $284 | $288 |
- Q3 revenue rose 1%, but operating income fell 47% and net earnings fell 34%. Nine-month revenue increased 4%, while operating income declined 20% and net earnings declined 5%.
- Reported operating income included an unfavorable Operating FAS/CAS pension accounting adjustment of $41 in Q3 and $118 for nine months, versus benefits of $60 and $186 in the prior-year periods. Segment operating income, which excludes this adjustment and non-current state taxes, was $163 in Q3 versus $162, and $523 for nine months versus $313.
- Q3 cost of product sales was 85.4% of product sales (81.7% in 2020); cost of service revenues was 87.0% of service revenues (79.7%). For nine months, the respective ratios were 84.9% versus 82.9% and 87.2% versus 83.3%.
- Non-operating retirement benefit was $45 in Q3 and $135 for nine months. The Q3 effective tax rate was negative 4.3%, mainly due to research and development credits for prior periods; the nine-month rate was 10.7%.
Cash, debt and liquidity
- Cash was $555 at September 30, 2021, versus $512 at year-end 2020. Current assets were $2,794 and current liabilities $2,444.
- Long-term debt increased to $3,321 from $1,686, primarily to fund the Alion acquisition. Cash flow from operations was $489; capital expenditure additions were $216, partly offset by $11 of grant proceeds, producing reported free cash flow of $284.
- HII reported $1,484 of unused capacity under its $1.5 billion revolving credit facility, with $16 of issued but undrawn letters of credit. The $650 term loan and revolving facility have variable rates; a 1 percentage-point rate increase on the term loan would add about $7 of annual interest expense. HII reported compliance with debt covenants.
- Management expected operating cash, cash on hand and available credit to be sufficient for debt service, retiree benefits, contractual commitments and capital expenditures for at least the next 12 months.
Material changes and business developments
- HII acquired Alion on August 19 for a preliminary purchase price of $1.784 billion, including $148 of acquired cash. Alion contributed $163 of revenue and $4 of operating income through September 30. The purchase accounting remained preliminary; HII recorded $1,080 of goodwill and $710 of acquired intangible assets. Acquisition-related costs were about $16 for the nine-month period.
- Alion financing included $1,000 of senior notes and the $650 term loan. Total assets rose to $10,400 from $8,157, including goodwill of $2,684 versus $1,617.
- Nine-month segment revenue increased 8% at Newport News, was up 1% at Ingalls, and declined 7% at Technical Solutions, which reflected the oil and gas business sale and San Diego Shipyard joint-venture contribution, partly offset by Alion.
- Backlog was $50.1 billion at September 30, up from $46.0 billion at year-end 2020; $23.8 billion was funded and $26.4 billion unfunded. HII expected to recognize approximately 25% of remaining performance obligations through 2022, another 30% through 2024 and the balance thereafter.
Outlook, commentary and risks
- No company-wide revenue or earnings guidance is provided in the supplied filing text. For 2021, HII expected maintenance and sustainment capital expenditures of approximately 1.5% of annual revenue and discretionary capital expenditures of approximately 1.5%–2.5%.
- COVID-19 continued to disrupt attendance, hiring, critical-skilled labor availability and suppliers, contributing to delays and out-of-sequence work. HII warned that the federal contractor vaccine mandate could cause workforce attrition and hinder contract execution. Reimbursement of CARES Act costs was uncertain; the provision expired September 30, 2021, though HII anticipated supplemental reimbursement requests into 2022.
- HII cited uncertainty over FY2022 appropriations and longer-term defense spending, which could delay, reduce or cancel awards. Its highly government-dependent business is exposed to funding, contract-cost estimation and execution risks.
- Net cumulative contract estimate adjustments increased operating income by $21 in Q3 and $106 for nine months, versus $4 and a $75 decrease in 2020. These adjustments increased nine-month 2021 diluted EPS by $2.07; no single 2021 adjustment was individually material.
- Contingencies include an appeal in the COVID-19 insurance coverage case and a dispute with the Navy over workers’ compensation cost billing. HII noted that an unfavorable resolution of the latter could jeopardize recovery of about $120 in unbilled costs. The Hydroid representations-and-warranties insurance claim seeks coverage subject to a $70 limit; outcome is uncertain.
Important facts for investors to verify
- Whether Alion integration, provisional purchase accounting and acquired intangible amortization affect future Technical Solutions profitability as expected.
- Whether contract execution, labor availability, supply-chain conditions and vaccine requirements change costs, schedules or recoverability of COVID-related expenses.
- How much of the $50.1 billion backlog is funded, and whether government appropriations support expected conversion into revenue.
- Whether favorable contract estimate adjustments persist; reported nine-month 2021 earnings included $106 of net favorable cumulative catch-up adjustments.
- Developments in the Navy workers’ compensation billing dispute, insurance proceedings and other litigation or government claims.
- Debt service and interest-rate exposure following the acquisition financing, alongside cash conversion and pension funding needs.