Huntington Ingalls Industries, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Amounts are in millions of dollars, except per-share data. HII builds military ships and provides government, energy, and other services through Ingalls, Newport News, and Technical Solutions. Most business is with the U.S. Government, primarily the Department of Defense.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $2,314 | $2,219 | $6,604 | $6,487 |
| Operating income | $222 | $214 | $494 | $550 |
| Net earnings | $222 | $154 | $447 | $400 |
| Diluted EPS | $5.45 | $3.74 | $10.98 | $9.66 |
| Operating margin | 9.6% | 9.6% | 7.5% | 8.5% |
- Q3 revenue rose 4%, led by product sales, up 10%; service revenue fell 9%. Nine-month revenue increased 2%.
- Nine-month segment operating income fell 32% to $313 million. Newport News income declined to $105 million from $273 million; Ingalls rose to $185 million from $176 million, and Technical Solutions rose to $23 million from $9 million.
- Q3 net earnings benefited from a 1.8% effective tax rate, primarily due to prior-period R&D tax credits, and a $29 million non-operating retirement benefit. These items helped lift earnings despite higher interest expense.
- Cash from operations was $491 million for nine months, versus $330 million. Free cash flow, as defined by the company, was $288 million versus $52 million, reflecting working-capital timing, lower capital spending and lower income-tax payments, partly offset by higher retiree benefit contributions.
Financial position and capital allocation
- At September 30, cash was $744 million, versus $75 million at December 31, 2019. Current assets were $2,881 million and current liabilities $2,233 million.
- Long-term debt was $2,278 million, up from $1,286 million at year-end, following issuance of $1 billion of senior notes in 2020. The company reported $1,234 million of unused capacity under its $1.25 billion revolving facility and $500 million under a separate 364-day facility; both were undrawn at quarter-end. HII was in compliance with debt covenants.
- HII paid $126 million in dividends and repurchased $84 million of stock during the first nine months. Repurchases were halted temporarily amid COVID-19 uncertainty. The quarterly dividend declared was $1.03 per share, compared with $0.86.
- In October, HII announced redemption of its outstanding $600 million, 5.000% senior notes due 2025, scheduled for November 2020.
Material changes and operating developments
- Nine-month unfavorable cumulative contract estimate adjustments totaled $75 million, versus $57 million of favorable adjustments in 2019. The 2020 total included $134 million of unfavorable adjustments on Block IV Virginia-class submarines, partly offset by favorable adjustments elsewhere.
- HII attributed the submarine cost and schedule revisions to performance trends and reduced expected learning-curve improvements. COVID-19-related delay and disruption reduced operating margin by $61 million across programs during the first nine months.
- HII acquired Hydroid, a marine robotics provider, for approximately $377 million in March. The acquisition added $310 million of preliminary goodwill, subsequently adjusted as purchase accounting was refined.
- Total backlog was approximately $45.3 billion at September 30, down from $46.5 billion at year-end; funded backlog increased to $21.9 billion from $17.9 billion. Remaining performance obligations were $45.3 billion; HII expected to recognize about 20% as revenue through 2021 and a further 25% through 2023.
Outlook, risks and contingencies
- The filing provides no specific revenue or earnings guidance. Management expected operating cash, cash on hand, and credit facilities to be sufficient for debt service, contractual obligations, and capital expenditures for at least 12 months.
- For 2020, HII expected maintenance and sustainment capital expenditures of about 1.5% of annual revenue and discretionary capital expenditures of about 2.5% to 3.5% of annual revenue.
- COVID-19 risks include absenteeism, lower productivity, supply-chain disruption, delayed customer decisions and uncertainty over recovery of related costs under government contracts or insurance. HII was pursuing CARES Act-related recovery and had sued reinsurers over coverage; outcomes and the full extent of losses were uncertain.
- Defense funding remained uncertain: fiscal 2021 appropriations were unresolved and the government was operating under a continuing resolution through December 11, 2020. Reduced or delayed ship-program funding could materially affect HII.
- HII reported no goodwill impairment at September 30, but said Government Services goodwill was at risk: estimated fair value exceeded carrying value by less than 10%. The next annual impairment test was scheduled for November 30, 2020.
- Other matters include asbestos claims and ongoing litigation and government investigations. HII said it did not expect most disclosed matters to materially affect results, but noted uncertainty around recovery of costs from the 2019 dry-dock incident and enforcement of a roughly $151 million arbitration award against Venezuela.
Important facts for investors to verify
- Whether submarine program cost and schedule performance improves, and whether further contract estimate adjustments arise.
- Whether COVID-19 disruption costs can be recovered through contract adjustments, CARES Act provisions, or insurance, and the effect of continued workforce and supply constraints.
- Whether defense appropriations and ship procurement support backlog conversion and planned production.
- Whether cash generation and liquidity remain adequate after debt redemption, pension funding, dividends, and planned capital expenditures.
- Whether Government Services goodwill remains recoverable and whether the insurance, litigation, and government-claims matters develop materially.