Huntington Ingalls Industries, Inc. — Q1 2018 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2018, compared with the three months ended March 31, 2017. HII builds military ships and provides government, energy, and oil and gas services through Ingalls, Newport News, and Technical Solutions. Most revenue is tied to U.S. Government customers, principally the Department of Defense.
Financial and operating results
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Sales and service revenues | $1.874 billion | $1.724 billion |
| Operating income | $191 million | $168 million |
| Net earnings | $156 million | $119 million |
| Diluted earnings per share | $3.48 | $2.56 |
| Operating cash flow | $120 million | $98 million |
| Free cash flow | $47 million | $40 million |
| Dividends declared per share | $0.72 | $0.60 |
- Revenue increased 9%; product sales rose 5% and service revenue rose 19%. Operating margin was approximately 10.2%, versus 9.7%; net margin was approximately 8.3%, versus 6.9%.
- Segment revenue and operating income: Ingalls $585 million and $64 million; Newport News $1.082 billion and $51 million; Technical Solutions $233 million and $2 million. Intersegment revenue eliminations were $26 million.
- Ingalls revenue grew 6%, while operating income declined 3%. Newport News revenue grew 11%, while operating income declined 29%. Technical Solutions revenue grew 4% and returned to operating profit from a prior-year loss.
- At March 31, cash was $528 million, down from $701 million at year-end 2017. Current assets were $2.210 billion and current liabilities $1.463 billion. Long-term debt was $1.280 billion; cash less long-term debt implies net debt of about $752 million. The $1.25 billion revolver was undrawn except for $15 million of letters of credit; the company reported covenant compliance.
- Quarterly cash use included $75 million of capital expenditures, $166 million of share repurchases, and $32 million of dividends paid. Operating cash flow benefited from working-capital timing; contract balances used $169 million of cash.
Material changes versus the prior comparable period
- Net earnings rose 31%, reflecting higher revenue, a larger operating FAS/CAS benefit, and a favorable $22 million year-over-year swing in non-operating retirement expense. The FAS/CAS benefit included in operating income was $72 million, versus $53 million.
- Revenue growth was led by Newport News, especially aircraft carriers, naval nuclear support services, and submarines. Technical Solutions’ comparison benefited from a $29 million doubtful-account provision recorded in 2017 on a commercial contract.
- Product cost as a share of product revenue improved to 77.6% from 79.0%; service cost as a share of service revenue worsened to 85.7% from 83.3%, partly due to a loss provision on an Ingalls long-term design contract and one-time employee bonuses related to the Tax Act.
- Backlog increased to $22.080 billion from $21.367 billion at December 31, 2017. New contract awards were approximately $2.6 billion, including the LPD 29 design and construction contract. Remaining performance obligations were $22.1 billion; HII expected about 54% to be recognized through 2019 and a further 33% through 2021.
- HII adopted the new revenue standard using the modified retrospective method. Adoption had no significant overall effect; Q1 2018 operating income and net earnings each increased by less than $1 million. Prior-period results were not restated. Adoption of pension presentation guidance also reclassified prior-period presentation.
Outlook, management commentary, risks, and unusual items
- Management stated that cash from operations, cash on hand, and available credit were expected to be sufficient for debt service, contractual obligations, and capital expenditures for at least the next 12 months. For 2018, it expected qualified pension contributions of $508 million, all discretionary; maintenance and sustainment capital expenditure of about 2%–2.5% of annual revenue and discretionary capital expenditure of about 3%–3.5%.
- Net cumulative contract estimate adjustments increased operating income by $28 million and diluted EPS by $0.50 in Q1 2018; no individual adjustment was material. These estimates reflect contract cost, schedule, and recovery judgments and may change.
- The BBA 2018 provided sequestration relief for fiscal 2018 and 2019, but sequestration remained scheduled for 2020 and 2021. Management cited long-term uncertainty over defense budgets, procurement priorities, and program funding as risks to awards, revenue, profit, and cash flow.
- A February 2018 U.S. Government initial determination cited significant deficiencies in Newport News’s material-management business system. HII planned to respond by July; a final finding of unresolved deficiencies could lead to withholding of up to 5% of interim billings on certain contracts, affecting cash receipt timing.
- A sealed False Claims Act matter concerning allegedly non-conforming supplier parts could result in penalties, damages, or suspension/debarment; HII could not estimate a loss range. HII also reported an approximately $151 million arbitration award in its favor against Venezuela and an approximately $22 million counterclaim award; court confirmation or enforcement remained pending.
- HII remained in discussions with the U.S. Government over recovery and allocation of Gulfport closure costs; an adverse resolution could materially affect results or cash flows. The company also reported an initial settlement of its Avondale restructuring-cost claim, with most related costs expected to be billed and collected by year-end 2018.
- The Tax Act’s accounting remained incomplete. The quarter included one-time employee bonuses related to the Tax Act; the effective tax rate was 20.0%, compared with 19.0% a year earlier. HII early adopted a standard and reclassified $202 million of stranded tax effects from accumulated other comprehensive loss to retained earnings; this was an equity reclassification, not a Q1 earnings item.
Important facts for investors to verify
- How much reported earnings growth depends on pension accounting effects and contract estimate adjustments, and whether contract margins remain sustainable.
- Whether Newport News resolves the material-management system findings and whether any payment withholding is imposed.
- The status and potential financial exposure of the False Claims Act matter, Gulfport cost recovery discussions, and Venezuela award enforcement.
- Whether backlog converts to funded orders and revenue on the expected schedule, particularly amid future defense-budget uncertainty.
- HII’s ability to fund the $508 million expected pension contributions while maintaining its capital spending, dividends, and share repurchases.