Huntington Ingalls Industries, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited. HII builds military ships through Ingalls and Newport News and provides government, energy, and other services through Technical Solutions. Most revenue is from U.S. Government customers, primarily the Department of Defense.
Financial results
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Sales and service revenues | $2.263 billion | $2.080 billion |
| Operating income | $215 million | $161 million |
| Net earnings | $172 million | $118 million |
| Diluted EPS | $4.23 | $2.85 |
| Cash from operations | $68 million | $11 million |
| Free cash flow | $2 million | $(63) million |
- Revenue rose 9%; operating income rose 34% and net earnings rose 46%. Approximate operating margin increased to 9.5% from 7.7%; approximate net margin increased to 7.6% from 5.7%.
- Segment revenue and operating income: Ingalls $629 million and $68 million; Newport News $1.341 billion and $95 million; Technical Solutions $317 million and a $7 million operating loss. Technical Solutions revenue rose 32%, but the segment moved from $2 million operating income to a loss.
- Cash and cash equivalents were $28 million at March 31, down from $75 million at year-end 2019. Total debt was approximately $1.755 billion, including $88 million of commercial paper; long-term debt was $1.667 billion. The existing $1.25 billion revolving facility had $380 million drawn, $16 million of letters of credit issued, and $854 million unused.
- Total assets were $7.615 billion and stockholders’ equity was $1.643 billion. Contract assets were $1.211 billion; contract liabilities were $387 million.
- Declared dividends were $1.03 per share versus $0.86. HII repurchased 390,904 shares for $84 million during the quarter.
Material changes and drivers
- Revenue growth reflected higher shipbuilding volumes, especially submarines, amphibious assault ships, and surface combatants, and higher Technical Solutions activity. Technical Solutions revenue also benefited from the 2019 Fulcrum acquisition.
- Segment operating income increased 21% to $156 million. Ingalls and Newport News improved, partly due to higher risk retirement on certain programs; Technical Solutions performance weakened.
- Q1 results included $32 million of favorable net cumulative catch-up adjustments, compared with $6 million of unfavorable adjustments in Q1 2019. Management said these adjustments increased 2020 operating income by $32 million and diluted EPS by $0.62.
- Operating income also included a $63 million favorable Operating FAS/CAS adjustment, versus $34 million a year earlier. Net earnings benefited from a $30 million non-operating retirement benefit, versus $3 million, primarily reflecting higher 2019 plan-asset returns.
- Hydroid was acquired in March for approximately $378 million cash, net of acquired cash. Preliminary goodwill and intangible assets totaled $310 million, allocated to Technical Solutions; purchase accounting remained incomplete.
- Backlog was approximately $45.2 billion at quarter-end, down from $46.5 billion at December 31, 2019. Remaining performance obligations were also reported as $45.2 billion; HII expected to recognize about 30% as revenue through 2021 and another 25% through 2023.
Liquidity, outlook, risks, and contingencies
- Management said operating cash, current cash, and available credit were expected to be sufficient for debt service, contractual obligations, and capital expenditures for at least the next 12 months.
- In Q2 2020, after quarter-end, HII issued $1 billion of senior notes ($500 million due 2025 and $500 million due 2030) and entered a $500 million 364-day revolving facility to strengthen liquidity. Proceeds were intended for general corporate purposes, potentially including debt repayment and working capital.
- Management expected 2020 qualified pension contributions of $205 million, all discretionary. Expected maintenance and sustainment capital expenditures were approximately 1% of annual revenue, with discretionary capital expenditures of approximately 3%–4% of annual revenue.
- COVID-19 had no material impact on Q1 reported results, but the effect on 2020 and later periods was uncertain. HII reported lower workforce attendance and anticipated response costs; reduced staffing, lower productivity, supply-chain disruption, customer constraints, and weaker investment performance could affect results. Recovery of COVID-related costs under government contracts was uncertain and might be incomplete.
- HII temporarily halted stock repurchases in response to the pandemic, after the quarter’s repurchases had occurred. The filing did not provide a quantified full-year earnings or revenue forecast.
- Other risks include future U.S. defense budget reductions or delays, contract cost-estimate changes, and government investigations. A False Claims Act lawsuit involving allegedly non-conforming supplier parts remained at an early stage; HII could not estimate a loss range or predict the outcome. Asbestos-related claims and other litigation were also disclosed. HII reported no material environmental remediation accrual.
Most important facts for investors to verify
- Whether COVID-19 absenteeism, productivity losses, supplier disruption, and related costs affected subsequent-quarter performance, and how much cost recovery customers allowed.
- How repeatable Q1 earnings growth is, given the favorable catch-up adjustments, FAS/CAS benefit, and non-operating retirement benefit.
- Hydroid’s finalized purchase-price allocation, integration performance, and contribution to Technical Solutions.
- Debt, cash, and liquidity after the Q2 note issuance and new revolving facility, including the intended use of proceeds and future borrowing costs.
- Backlog conversion, government funding and program decisions, and Technical Solutions’ return to profitability.
- Developments in the False Claims Act matter and other legal contingencies for which the company could not estimate potential losses.