Huntington Ingalls Industries, Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. Unaudited results. HII designs, builds, overhauls and repairs ships, primarily for the U.S. Navy and Coast Guard, through its Ingalls and Newport News segments. Substantially all business is with the U.S. Government.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $1.683bn | $1.721bn | $3.245bn | $3.289bn |
| Operating income | $116m | $106m | $211m | $186m |
| Operating margin | 6.9% | 6.2% | 6.5% | 5.7% |
| Net earnings | $57m | $50m | $101m | $83m |
| Diluted EPS | $1.12 | $1.00 | $2.00 | $1.67 |
- Revenue declined 2% in Q2 and 1% for the first half. Product sales fell, partly offset by higher service revenue.
- Operating income rose 9% in Q2 and 13% for the first half; net earnings rose 14% and 22%, respectively. Lower product costs and stronger contract performance supported results.
- Ingalls revenue fell 11% in Q2 and 10% year to date, mainly on lower amphibious-ship activity. Newport News revenue rose 5% and 6%, with operating income up 13% and 15%.
- Net cumulative contract estimate adjustments added $35m to operating income in Q2 and $65m in the first half, versus $34m and $48m in 2012. These adjustments increased diluted EPS by $0.44 in Q2 and $0.84 year to date in 2013.
Cash flow, debt and liquidity
- First-half operating cash flow was negative $337m, versus negative $178m in 2012; capital expenditures were $55m and free cash flow was negative $392m, compared with negative $235m.
- The cash outflow reflected higher pension contributions and working-capital use, including receivables and inventory timing. HII made $301m of discretionary qualified-pension contributions in the first half and anticipated no further qualified-plan contributions in 2013.
- Cash was $623m at June 30, down from $1.057bn at year-end 2012. Total debt was $1.817bn, including $52m current; net debt was approximately $1.194bn. The $650m revolving facility was undrawn except for $46m of letters of credit, leaving $604m available.
- HII reported compliance with debt covenants and said operating cash generation plus existing credit facilities should cover debt service, obligations and capital expenditures for at least 12 months. 2013 capital expenditures were expected to be 2%–3% of annual revenue.
- Current assets were $2.269bn and current liabilities $1.220bn. The company’s long-duration contract operating cycle affects working-capital classifications.
Outlook, developments and risks
- Backlog rose to approximately $20.7bn from $15.5bn at year-end, including $13.7bn funded and $7.0bn unfunded. First-half contract awards were approximately $8.5bn, including five DDG-51 destroyers and major carrier and cutter work.
- Management highlighted uncertainty from the Budget Control Act and sequestration, which could reduce defense and Coast Guard funding and affect revenue, facilities, employees, suppliers, goodwill and long-lived assets. HII gave no formal earnings guidance in the provided filing text.
- The Avondale facility wind-down estimate was $256m; recovery under government contracts remained under discussion. DCAA audits questioned approximately $25m of costs in earlier submissions, and failure to recover costs could materially affect results or cash flows.
- HII disclosed an internal investigation into possible employee mischarging or progress misstatements on Ingalls contracts. Government customers initially withheld $24m; HII estimated maximum mischarging at approximately $4m and was seeking release of a substantial portion. Potential penalties or contracting consequences remained uncertain.
- A False Claims Act complaint seeks at least $835m plus penalties and potentially treble damages. The DOJ declined to intervene; HII said it believes the claims lack merit, but the outcome is uncertain. Asbestos and other legal matters also remain.
- After quarter-end, damage to LPD-25 Somerset delayed sea trials and delivery; HII estimated a $2m–$15m contract-profit reduction. The Navy’s decision to use a steel rather than composite deckhouse on DDG-1002 prompted HII to evaluate future use of its Gulfport facility.
- Pension and postretirement plan changes contributed to a $130m first-half increase in other comprehensive income. The post-65 retiree plan amendment reduced the postretirement liability by approximately $177m; a collective bargaining-related pension amendment increased pension liability by approximately $30m.
- HII paid $0.10 per share quarterly dividends and repurchased $26.5m of stock since the buyback program began. The $150m authorization had $123.5m remaining at June 30.
Important facts for investors to verify
- Whether defense appropriations and sequestration affect funded backlog, award timing and contract volumes.
- Conversion of the substantial unfunded backlog to funded orders, and the sustainability of contract-estimate gains—especially the $65m first-half catch-up benefit.
- Recovery of Avondale restructuring costs and resolution of the government investigation, payment withholding and False Claims Act case.
- Cash conversion and working-capital trends after the first-half $337m operating cash outflow, alongside pension funding and capital-spending requirements.
- Final cost and schedule effects of the Somerset damage and consequences of the DDG-1002 deckhouse decision.