Huntington Ingalls Industries, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Financial amounts are in millions of dollars, except per-share data. HII is a U.S. military shipbuilder and government-services provider, with Ingalls, Newport News and Technical Solutions segments; most business is with the U.S. Government, primarily the Department of Defense.
Financial results
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $2,027 | $2,188 | $4,290 | $4,268 |
| Operating income | $57 | $175 | $272 | $336 |
| Net earnings | $53 | $128 | $225 | $246 |
| Diluted EPS | $1.30 | $3.07 | $5.54 | $5.91 |
| Operating cash flow | Not provided quarterly | Not provided quarterly | $269 | $(33) |
| Free cash flow | Not provided quarterly | Not provided quarterly | $128 | $(198) |
- Q2 revenue fell 7% year over year; first-half revenue increased 1%. Q2 operating margin was about 2.8%, versus 8.0% a year earlier; first-half margin was about 6.3%, versus 7.9%.
- Q2 product sales declined 7% and service revenues declined 9%. Newport News revenue was down 12% in Q2 and 4% for the first half; Technical Solutions first-half revenue increased 14%, reflecting acquisitions and higher service volumes.
- First-half operating cash flow improved by $302 million year over year, mainly from working-capital timing and lower income-tax payments, partly offset by higher retiree-benefit contributions. Free cash flow improved by $326 million. Capital expenditures, net of grant proceeds, were $141 million.
Balance sheet, debt and liquidity
- At June 30, cash and equivalents were $631 million, up from $75 million at year-end 2019. Total debt was $2.276 billion, up from $1.286 billion; cash less debt was approximately negative $1.645 billion.
- HII issued $1 billion of senior notes: $500 million due 2025 at 3.844% and $500 million due 2030 at 4.200%. It also established a $500 million 364-day revolving facility. Its existing $1.25 billion revolving facility and the new facility were undrawn at quarter-end; $1.234 billion remained available under the existing facility.
- Management said cash, operating cash generation and available facilities should be sufficient to service debt, meet obligations and fund capital expenditures for at least 12 months. The company was in compliance with debt covenants.
- Six-month dividends paid were $84 million; shares repurchased cost $84 million. Management said repurchases were temporarily halted amid COVID-19 uncertainty.
Material changes and unusual items
- Q2 included $111 million of unfavorable cumulative contract estimate adjustments, reducing diluted EPS by $2.15. The main item was a $111 million charge on Block IV Virginia-class submarines, including $95 million tied to cost, schedule and expected future efficiencies and $16 million of COVID-19 disruption. The $111 million program charge is included within the broader $167 million of unfavorable Q2 segment adjustments.
- Across programs, HII recognized $61 million of unfavorable COVID-19 delay and disruption impacts in the quarter and first half. These impacts included lower employee attendance, limited critical skills and out-of-sequence work. Recovery under government relief or contract adjustments is uncertain.
- Newport News reported a Q2 segment operating loss of $69 million, compared with $71 million of income in Q2 2019, primarily due to the Virginia-class submarine estimate revision. Ingalls earned $55 million, down from $69 million; Technical Solutions earned $9 million, versus a $2 million loss.
- Hydroid was acquired in March for approximately $378 million cash, net of acquired cash, adding maritime robotics capabilities to Technical Solutions. Its purchase-price allocation remained preliminary.
- Non-operating retirement benefit income was $30 million in Q2, versus $2 million a year earlier; first-half amounts were $60 million and $5 million, respectively. This benefit partly cushioned lower operating income.
Outlook, risks and contingencies
- Backlog was approximately $46.1 billion at June 30, 2020, compared with $46.5 billion at year-end. HII expected to recognize about 30% of remaining performance obligations as revenue through 2021 and a further 25% through 2023. First-half new awards were approximately $3.8 billion.
- No full-year earnings or revenue guidance is stated in the provided filing text. HII estimated 2020 maintenance and sustainment capital expenditures at about 1.5% of annual revenue and discretionary capital expenditures at 3.0%–4.0%. It expected $205 million of 2020 qualified pension contributions, all discretionary.
- COVID-19 effects on staffing, productivity, suppliers, customer decisions, investment performance and cost recovery remain uncertain. Management warned continued disruption could affect milestones and future results. Payroll-tax deferrals increase 2020 operating cash but reduce cash flow in 2021 and 2022.
- Long-term defense-budget pressure could reduce or delay awards and funding. HII also disclosed a False Claims Act lawsuit concerning allegedly non-conforming supplier parts; it could not estimate a loss range or predict the outcome. The company is pursuing enforcement of an arbitration award of approximately $151 million against Venezuela, with no assurance of collection.
- Management found no goodwill impairment at June 30, but identified the Government Services reporting unit as potentially at risk: estimated fair value exceeded carrying value by less than 10% under interim sensitivity analyses.
Important facts for investors to verify
- Whether Virginia-class Block IV cost and schedule performance stabilizes, and whether further contract estimate adjustments are required.
- How much COVID-19-related cost is ultimately recovered through contract changes, CARES Act relief or other government action.
- Cash conversion and working-capital trends, including the timing of receivables and payables, pension contributions and deferred payroll taxes.
- Backlog funding, program awards and execution—especially the distinction between $21.35 billion funded and $24.72 billion unfunded backlog.
- Hydroid integration and final purchase accounting, plus progress on held-for-sale asset disposals.
- Developments in the False Claims Act case, Venezuela award collection and other government investigations or litigation.