Huntington Ingalls Industries, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; comparisons are with Q1 2011. HII designs, builds, overhauls and repairs ships, primarily for the U.S. Navy and Coast Guard. Its reportable segments are Ingalls and Newport News. The company was spun off from Northrop Grumman on March 31, 2011, so the prior-year period includes pre-spin-off activity and allocations.
Financial results and liquidity
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Sales and service revenues | $1.568 billion | $1.684 billion | Down 7% |
| Operating income | $80 million | $85 million | Down 6% |
| Operating margin | 5.1% | 5.0% | Slightly higher |
| Net earnings | $33 million | $45 million | Down 27% |
| Diluted EPS | $0.67 | $0.92 | Down 27% |
| Operating cash flow | $(329) million | $(364) million | Cash use improved by $35 million |
| Free cash flow | $(356) million | $(427) million | Cash use improved by $71 million |
- Product sales were $1.353 billion versus $1.466 billion; service revenues were $215 million versus $218 million. Cost of product sales and services fell 8% to $1.338 billion, while G&A was nearly unchanged at $150 million.
- Interest expense doubled to $30 million, primarily reflecting debt raised around the spin-off. The effective tax rate was 34.0%, down from 35.7%.
- Segment operating income rose to $101 million from $84 million. Ingalls earned $20 million on $692 million revenue (2.9% margin), versus $17 million on $761 million; Newport News earned $81 million on $895 million (9.1%), versus $67 million on $940 million.
- Cash and cash equivalents were $551 million at March 31, down from $915 million at year-end. Current assets were $2.156 billion and current liabilities $1.252 billion. Total debt was $1.851 billion, including $29 million current; net debt was approximately $1.300 billion. Shareholders’ equity was $918 million.
- The $650 million revolving facility had no borrowings; $137 million of letters of credit were issued, leaving $513 million available. HII reported compliance with debt covenants.
- Operating cash use reflected working-capital outflows, including higher receivables, and $127 million of cash contributions to pension and other benefit plans. Capital expenditures were $27 million. Management expected 2012 qualified pension contributions of approximately $212 million.
Material changes and operating developments
- Revenue declined mainly because of lower activity following deliveries of NSC-3 and LPD-22, as well as lower carrier and submarine activity. Segment operating income nevertheless improved, driven by Virginia-class submarine performance and the absence of certain unfavorable 2011 contract adjustments.
- GAAP operating income was reduced by a $17 million unfavorable FAS/CAS pension adjustment, compared with $4 million unfavorable in Q1 2011, and $4 million of deferred state tax expense versus a $5 million benefit. Management attributed the pension adjustment increase largely to amortization of 2011 actuarial losses.
- Net cumulative catch-up contract estimate adjustments increased operating income by $14 million in Q1 2012, compared with a $4 million reduction in Q1 2011; the 2012 effect increased diluted EPS by $0.18.
- Backlog was approximately $15.5 billion at March 31, down from $16.3 billion at December 31. It included $11.8 billion funded and $3.7 billion unfunded. New awards during the quarter were approximately $0.8 billion.
Outlook, risks and contingencies
- No specific revenue or earnings guidance was provided. Management said cash from operations, together with available credit facilities, should be sufficient to service debt, meet contractual obligations and fund capital expenditures for at least the next 12 months. Approximately 33% of December 2011 backlog was expected to convert to sales during 2012.
- HII expects up to approximately $271 million of Avondale wind-down and facility-shutdown costs. Recovery through government contracts is subject to Navy review and acceptance; the DCAA questioned costs in an earlier proposal, and the company submitted a revised proposal. Failure to recover costs, or higher-than-estimated costs, could materially affect results or cash flows.
- A False Claims Act complaint alleges improper use of Hurricane Katrina-related federal funds and seeks at least $835 million plus penalties and other costs; damages may be trebled. HII says it has substantive defenses and believes the matter will not have a material effect, but cannot predict the outcome.
- Other disclosed matters include ongoing Hurricane Katrina insurance litigation with FM Global, asbestos claims, government investigations and ship-quality issues. HII stated it did not expect the disclosed quality matters or other identified proceedings to have a material effect, while noting outcomes remain uncertain.
- HII’s business is substantially dependent on U.S. Government contracts. The filing identifies risks including government budget and priority changes, contract awards and performance, spin-off-related costs and leverage, Avondale consolidation, and natural disasters. A 1% rise in interest rates was estimated to add about $5 million in annual interest expense on then-outstanding floating-rate debt.
Important facts for investors to verify
- Whether the Navy accepts HII’s revised $271 million Avondale cost-recovery proposal and whether total wind-down costs remain within estimate.
- Progress, potential exposure and any subsequent developments in the $835 million False Claims Act matter and FM Global insurance litigation.
- Conversion of funded and unfunded backlog into revenue, including the impact of U.S. defense budgets and contract timing.
- Cash generation and working-capital trends, pension funding needs, and availability under the revolving credit facility.
- Whether improved segment performance and positive contract estimate adjustments are sustained, given lower revenue and increased pension-related GAAP expense.