Huntington Ingalls Industries, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; unaudited. HII designs, builds, overhauls, and repairs ships, primarily for the U.S. Navy and Coast Guard. Its segments are Ingalls, Newport News, and Other.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $1.683B | $1.800B | $5.146B | $5.115B |
| Operating income | $175M | $200M | $590M | $625M |
| Operating margin | 10.4% | 11.1% | 11.5% | 12.2% |
| Net earnings | $107M | $111M | $376M | $354M |
| Diluted EPS | $2.27 | $2.29 | $7.93 | $7.28 |
- Q3 revenue fell 7%, mainly from lower product sales; nine-month revenue rose 1%. Service revenue increased 5% in both periods.
- Q3 operating income fell 13%; nine-month operating income fell 6%. Segment operating income declined 19% for Q3 and 10% year to date. Lower risk retirement on selected ship programs and weaker performance on certain carrier and submarine work weighed on results.
- Nine-month net earnings rose 6%, despite lower operating income, helped by lower interest expense and lower taxes. The 2015 comparison included a $59M goodwill impairment; 2015 also included a favorable $136M net operating-income effect from the Aon insurance settlement.
- Nine-month operating cash flow was $477M, versus $428M; capital expenditures were $145M versus $86M. Free cash flow was $332M versus $342M.
- Cash was $957M at September 30, 2016, versus $894M at year-end 2015. Long-term debt was $1.277B. The $1.25B revolving facility was undrawn except for $25M of letters of credit; $1.225B remained available. HII reported covenant compliance.
- Total assets were $6.008B; current assets were $2.344B and current liabilities $1.228B. Pension plan liabilities were $866M, down from $1.001B at year-end 2015.
Material changes and operating context
- Ingalls nine-month revenue increased 9% to $1.748B, but segment operating income declined 26% to $236M. Newport News revenue decreased 3% to $3.315B and operating income declined 11% to $270M. Other segment revenue fell 20% to $84M; its operating loss narrowed to $16M, partly because 2015 included the goodwill impairment.
- Net cumulative contract estimate adjustments increased operating income by $24M in Q3 and $167M for nine months, compared with $62M and $188M, respectively, in 2015. The company recognized a favorable $67M nine-month adjustment on an Ingalls contract. These estimates affect reported contract profit.
- Backlog was approximately $20.0B at September 30, down from $22.1B at year-end 2015. It included $12.0B funded and $8.0B unfunded. New awards totaled approximately $3.1B for the nine months.
- Declared dividends were $0.50 per share for Q3 and $1.50 per share for nine months, up from $0.40 and $1.20 in the comparable 2015 periods. The company repurchased 1.01M shares for $152M during the first nine months.
Outlook, risks, and unusual items
- Management said cash, operating cash generation, and available credit were expected to be sufficient for debt service, contractual obligations, and capital expenditures for at least the next 12 months. For 2016, it expected maintenance and sustainment capital spending of 2%–2.5% of annual revenue and discretionary capital spending of 1.5%–2%. No earnings or revenue guidance is provided in the filing.
- Management anticipated no further significant qualified pension contributions in 2016 after $167M of discretionary contributions during the first nine months.
- Federal fiscal-year 2017 funding remained under a short-term continuing resolution. Sequestration was scheduled to resume for fiscal years 2018–2021; budget reductions, delays, or cancellations could affect awards, revenue, profit, cash flow, suppliers, and programs.
- HII estimated net Avondale restructuring and shutdown costs of $276M and had incurred $285M by September 30. Recovery is subject to a U.S. Navy contracting-officer decision; HII said an adverse recovery outcome could materially affect results or cash flows. A separate Gulfport closure-cost recovery issue remained unresolved.
- Government investigations include alleged employee time-charging or progress-reporting issues and allegedly non-conforming supplier parts. HII could not estimate the outcomes or possible losses of key matters; penalties, damages, or suspension/debarment from government contracting could be material. A False Claims Act case related to Hurricane Katrina funding was dismissed and the Supreme Court denied review in October 2016.
- Other disclosed matters include asbestos litigation and a Venezuela contract arbitration; the company gave no assurance as to their ultimate outcomes. Environmental remediation costs accrued were $1M.
- After quarter-end, on November 1, 2016, HII agreed to acquire Camber Holding Corporation for $380M, subject to closing.
Most important facts for investors to verify
- Whether contract cost estimates and cumulative catch-up adjustments remain achievable, especially the favorable Ingalls adjustment and risk retirement assumptions.
- Progress and resolution of Avondale and Gulfport cost recovery, and the potential financial exposure from government investigations and litigation.
- Backlog conversion, funding status of the $8.0B unfunded backlog, and the effects of federal budget decisions on shipbuilding programs.
- Cash generation after elevated capital expenditures and pension contributions, alongside planned dividends, repurchases, and the proposed $380M Camber acquisition.
- How much of nine-month earnings improvement reflects recurring operations versus tax benefits, prior-year impairment, and other period-specific effects.