Huntington Ingalls Industries [HII] on Thursday reported a steep drop in net income in the fourth quarter largely due to expenses related to a new tax law and the early retirement of debt, although adjusting for these items the results beat consensus estimates.

While the new tax reform package hit the company’s earnings in the fourth quarter, as it has other defense manufacturers, HII said the lower federal tax rate that went into effect on Jan. 1 will ultimately generate more cash for investing in the business.

Mike Petters, HII’s president and CEO, on an earnings call outlined three buckets where the company will be making additional investments due to tax reform. The first, and largest, is a $300 million increase in an ongoing shipbuilding facilities modernization effort that will bring HII’s planned investments in this area to $1.8 billion between 2015 and 2020.

Huntington Ingalls President and CEO Mike Petters. Photo: HII
Huntington Ingalls President and CEO Mike Petters. Photo: HII

The company said that $200 million of the additional investments will be for improving capacity at the Ingalls Shipbuilding division and $100 million will be for digital tools to boost operational efficiencies at the Newport News Shipbuilding division.

The capital investments are to “improve affordability, efficiency and competitiveness and to preserve and protect future U.S. Navy programs,” Petters said.

HII will also pay a one-time $500 bonus to its hourly and salaried employees, which equates to about $18.6 million for the company’s roughly 37,200 employees. Petters also said HII will increase its charitable contributions in the communities it operates. HII doesn’t disclose the value of its charitable contributions, a company spokeswoman told Defense Daily.

Net income in the quarter was $64 million, $1.41 earnings per share (EPS), down 68 percent from $197 million ($4.20 EPS) a year ago, with tax expenses lopping $63 million from the bottom line and interest expense related to the early debt repayment another $14 million. Operating margin was down 250 basis points to 11.4 percent.

Adjusting for the various expenses, HII’s net earnings in the quarter were $141 million ($3.11 EPS), which beat analysts’ per share expectations by 17 cents.

At the operating level, segment income was down overall, mainly due to challenging comparisons at Newport News versus a year ago when the division benefited from improved overhead costs and a local incentive grant. Income was down at Ingalls on lower risk retirement related to the Coast Guard’s National Security Cutter and the Navy’s DDG destroyers.

Sales were up 4 percent to $2 billion from $1.9 billion a year ago, driven by the acquisition of Camber Corp. in December 2016, and nuclear support services and aircraft carrier work for the Navy.

Overall, in 2017, sales increased 5 percent to $7.4 billion from $7.1 billion, and net income fell 16 percent to $479 million ($10.46 EPS) from $573 million ($12.14 EPS). Operating margin was 11.6 percent. Adjusting for the one-time tax and interest expenses, earnings were down slightly to $556 million ($12.14 EPS).

HII doesn’t provide financial guidance but Petters said that congressional support for a larger naval fleet, combined with the new National Defense and Security Strategies, and plans for a 355-ship Navy, point to about 3 percent annual growth over the next five years, a prediction he’s “cautiously optimistic” about.

The outlook for total operating margin is still in the 9 to 10 percent range, but there will be near-term pressure here as the company continues to transition existing programs at Newport News and adds new ones at Ingalls, he said. New programs typically carry lower margins but profits usually improve as programs mature.

The effective tax rate this year is expected to be around 21 percent versus 38 percent in 2017.

Free cash flow in 2017 was $453 million and is expected to be down about $100 million this year due to higher planned capital expenditures and pension plan contributions.  Orders for the year were $8.1 billion and total backlog at the end of 2017 stood at 21.4 billion, $13 billion of it funded. Backlog at the end of 2016 stood at $21 billion.