Lower operating income, pension headwinds, a charge and higher taxes led to a steep drop in earnings as Huntington Ingalls Industries [HII] in the second quarter despite a strong uptick in sales.
Operating income was down at all three of the company’s segments due to lower risk retirements on amphibious landing dock ships, lower performance on the Virginia-class submarine program and a loss on a contract for fleet support services.
The $12 million forward loss was due to work on a fixed-price maintenance availability performed by Technical Solutions segment at its San Diego shipyard on the Navy’s USS Chosin (CG-65) Ticonderoga-class cruiser. The loss was mainly due to unanticipated costs to finish repair work in the super structure and topside of the ship, Mike Petters, HII’s president and CEO, said on the company’s earnings call.
HII also discovered that that the work being done on the ship wasn’t consistent with the remaining scope, necessitating a review by some the company’s “most experience shipbuilders” and “discovered a deficit in the capabilities to manage and execute the work,” leading to the forward loss charge, Petters said.
Petters said that HII has added talent to get the work on the cruiser work done.
Overall, HII is “executing at a very high level but we are fraying on the edges and it’s time now to go and take another turn to clean that up,” Petters said of some recent performance “hiccups.”
Orders in the quarter totaled nearly $900 million, lifting backlog to $39.4 billion, the largest in the company’s history and a block of work that provides the company with visibility to sustain its 3 percent annual growth targets in the coming years, he said.
Performance across HII is what has built the backlog up, Petters said, and now the company has to execute. Petters has directed the company’s leadership to “have a closer look at execution and risk management” as they execute on the backlog.
Net income slid 46 percent to $128 million, $3.07 earnings per share (EPS), from $239 million ($5.40 EPS), missing consensus estimates by 48 cents EPS. Operating margin fell to 8 percent from 12.7 percent a year ago.
The reduced profit on the Virginia-class submarine program was due to a lower booking rate, Chris Kastner, HII’s chief financial officer, said on the call.
Sales in the quarter increased 8 percent to $2.2 billion from $2 billion a year ago, driven by recent acquisitions in the Technical Solutions segment, as well as higher volume for work on aircraft carriers, Naval nuclear support services, support for the oil and gas industry and Energy Department. Organic growth was 5 percent as the acquisitions accounted for $66 million in new revenue.
HII doesn’t provide financial guidance but Kastner said that shipbuilding sales this year will be about 5 percent higher than in 2018 and sales at Technical Solutions between $1.2 billion and $1.3 billion. HII’s two shipbuilding segments had combined sales in 2018 of $7.3 billion and Technical Solutions had $988 million in sales last year.
Free cash flow in 2019 is expected to be just above the $512 million generated in 2018, Kastner said. Free cash in the quarter was a $135 million outflow.
Shipbuilding operating margins so far this year are 7 percent and Petters said the company is on track to reach its target of 9 to 10 percent in 2020.