Huntington Ingalls Industries, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Amounts are in millions of dollars except per-share data. HII builds, overhauls, and repairs ships primarily for the U.S. Navy and Coast Guard. Its segments are Ingalls, Newport News, and Other.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $1,745 | $1,719 | $3,315 | $3,313 |
| Operating income | $269 | $181 | $425 | $340 |
| Net earnings | $156 | $100 | $243 | $190 |
| Diluted EPS | $3.20 | $2.04 | $4.99 | $3.84 |
| Operating margin | 15.4% | 10.5% | 12.8% | 10.3% |
- Q2 revenue increased 2%; first-half revenue was essentially unchanged. Product sales fell 3% year to date, while service revenues rose 17%.
- Operating income increased 49% in Q2 and 25% year to date; net earnings rose 56% and 28%, respectively. Results include a $150 million Aon insurance-broker settlement gain, offset by a $14 million credit to the U.S. Government, for a net favorable operating-income impact of $136 million in both periods.
- Q2 segment operating income was $198 at Ingalls, $109 at Newport News, and a $64 loss at Other. Ingalls benefited substantially from the Aon settlement; Other included a $59 goodwill impairment charge. Newport News’ modest improvement reflected submarine performance, partly offset by lower aircraft-carrier performance.
- Net cumulative contract estimate adjustments increased operating income by $71 in Q2 and $126 in the first half. These estimates included favorable risk retirement on submarine and other ship programs, partly offset by weaker performance on CVN-78 Gerald R. Ford.
Cash flow, balance sheet, and capital allocation
- First-half operating cash flow was $163, versus $58 in 2014; free cash flow was $114, versus $7, after $49 of capital expenditures. The improvement was driven in part by the Aon settlement and lower pension contributions, partly offset by working-capital movements.
- Cash was $960 at June 30, down from $990 at year-end. Accounts receivable rose to $1,244 from $1,038, a working-capital item management attributed largely to timing of receipts and payments.
- Total debt was $1,679, including $374 current, compared with $1,700 at year-end. HII reported $620 of available capacity under its prior $650 revolving facility, net of outstanding letters of credit. On July 13, 2015, it repaid the prior facility’s outstanding term loan using cash and entered a new $1.25 billion five-year revolving credit facility.
- HII declared dividends of $0.40 per share in Q2 and $0.80 per share for the first half, double the comparable 2014 amounts. It repurchased 740,225 shares for $93 in the first half.
- Backlog was approximately $24.3 billion at June 30, up from $21.4 billion at year-end, including $13.7 billion funded and $10.6 billion unfunded. New awards totaled approximately $6.1 billion in the first half.
Outlook, risks, and unusual items
- No specific earnings or revenue guidance was provided. Management said cash, expected operating cash generation, and credit facilities should be sufficient for debt service, contractual obligations, and capital expenditures for at least the next 12 months. Maintenance and sustainment capital expenditures were expected to be approximately 2% of annual revenue; management anticipated no further significant qualified pension contributions in 2015.
- Defense and Coast Guard budgets remain a major risk. Management cited uncertainty about sequestration and spending levels from 2016 onward, which could delay, reduce, or cancel programs and affect suppliers, revenue, and asset values.
- HII recorded a $59 goodwill impairment in Other after deterioration in oil-and-gas market conditions, including lower projected prices, customer spending cuts, and project delays.
- Recovery of an estimated $287 in Avondale restructuring and shutdown costs remains under discussion with the Navy. HII is treating the costs as allowable in contract estimates, but stated that inability to recover them could materially affect results. Gulfport closure costs are also under government review; $35 of receivables related to those costs remained at June 30.
- A False Claims Act case alleging at least $835 in damages, plus penalties, was dismissed in June 2015; the relator appealed. Separately, the Department of Justice is investigating HII’s disclosures about possible employee time mischarging on Navy and Coast Guard contracts. The company could not estimate a loss range; possible consequences include penalties, damages, or suspension/debarment. Government payment withholds were reduced, but $8.3 remained withheld, and HII estimated maximum potential mischarging of approximately $4.
- In a separate Venezuela arbitration, HII sought $173 plus interest and expenses, while Venezuela counterclaimed for $61 plus interest; the outcome was uncertain. HII also warned that contract cost estimates and recoveries of disputed costs may differ from actual outcomes.
Most important facts for investors to verify
- How much of the reported earnings and cash-flow improvement reflects the one-time Aon settlement, and how sustainable are underlying segment margins?
- Whether the Navy accepts Avondale restructuring costs and whether Gulfport closure costs are recoverable.
- Developments and potential financial or contracting consequences in the DOJ investigation and False Claims Act appeal.
- Backlog funding, program timing, and the effect of future defense-budget decisions, particularly on major ship programs.
- Execution and profitability on CVN-78, submarine programs, and the oil-and-gas-sensitive Other segment after its goodwill impairment.