Huntington Ingalls Industries [HII] on Thursday posted a steep drop in second quarter earnings mainly on charges at its shipyards due to efficiency and staffing challenges, at least some of which stem from COVID-19, and the company lowered its top and bottom line guidance for the year.
The company recorded $167 million in charges related to updated cost and schedule assumptions across all programs with the Block IV boat of the Virginia-class submarine program bearing the brunt of the added costs, $111 million.
HII President and CEO Mike Petters didn’t put all the blame for the charges on COVID but said even where the impacts weren’t directly related to the pandemic, it’s hard to separate the indirect effects from the ongoing disruptions created by the novel coronavirus.
For the Block IV submarines, Petters said on HII’s earnings call that the Newport News Shipbuilding operations moved resources elsewhere to meet delivery milestone commitments on near-term programs in line with customer priorities, which “in turn disrupted the cadence of work and significantly impacted our ability to reasonably rely on the assumptions we were using in our risk registers for both the boat learning and cost improvement.”
When things go wrong, Petters said the company first looks inward to say, “Hey, that’s on us. We didn’t manage that right.”
However, the pandemic has created mounting challenges that in some cases are hard to quantify.
“But you don’t have to scratch very far behind those things and either there was a direct impact of COVID or indirect impact of COVID or we just don’t have the degrees of freedom that we need to be able to recover from that inefficiency because of COVID and so the challenge is, we can isolate costs in our business that are 100 percent COVID-related but when you move to the rest of it and say, ‘Hey, we have inefficiencies in a program performance,’ to try to separate out how much of that is, ‘This is because we didn’t have the right person at the right time and this is because we had impact from virus,’ it becomes really hard to separate all of that,” he said.
On average in the second quarter, attendance by hourly production employees averaged 65 percent across HII’s Virginia-based Newport News and Mississippi-based Ingalls Shipbuilding shipyards combined due to COVID-19. By the end of the quarter and through July, that number has settled into around 77 percent currently and is “sustainable and manageable” going forward, Petters said.
HII provided schedule updates for two Virginia-class Block IV boats. Float-off of the SSN-794 Montana has slipped about six months to late 2020 with delivery expected in late 2021. The pressure hull complete for SSN-796 New Jersey has also been delayed about six months until mid 2021, with float-off expected in late 2021 and delivery in late 2022.
Net income in the quarter plunged 59 percent to $53 million, $1.30 earnings per share (EPS), from $128 million ($3.07 EPS) a year ago, well below consensus estimates of $4.30 EPS. The charges were partially offset by favorable pension benefits. Operating margin was 2.8 percent versus 8 percent a year ago.
Sales in the quarter fell 7 percent to $2 billion from $2.2 billion a year ago.
At the operating level, Newport News drove the lower overall earnings decline as the segment swung to a loss on the charges. Sales at the segment were also lower.
Sales at the Ingalls Shipbuilding segment were flat versus a year ago, but profits were also down due to COVID impacts and lower risk retirement on the Coast Guard’s National Security Cutter program.
The company’s Technical Solutions segment also posted flat sales but higher profits because of a loss on a fleet support contract that hurt income a year ago.
For 2020, HII expects shipbuilding sales to be between $7.6 billion and $7.9 billion versus the prior outlook of around $8 billion. For Technical Solutions, sales are expected to range between $1.2 billion and close to $1.3 billion.
The outlook for operating margin at the shipbuilding operations is expected to be between 5.5 and 6.5 percent versus earlier guidance of 9 percent. General Dynamics [GD], HII’s primary competitor for Naval shipbuilding, expects its Marine Systems segment margin to be around 8.8 percent this year. Operating margin at Technical Solutions this year is pegged to be in the range of 5.7 to 6 percent.
Guidance for the year assumes that the government will provide limited relief for costs directly related to the company’s response to COVID-19 such as enhanced cleaning of facilities but not for any delays and disruptions.
HII gave high level guidance for 2021, with shipbuilding sales between $7.8 billion and $8.1 billion and operating margin climbing to between 7 and 8 percent. Sales at Technical Solutions will be around $1 billion and margin between 7 and 9 percent.
Backlog at the end of the second quarter stood at $46.1 billion, down $400 million since the end of 2019, and provides a “stable foundation for the business,” Chris Kastner, HII’s chief financial officer, said on the call.
Asked by a Credit Suisse aerospace and defense analyst if the company’s shipbuilding business can still generate margins between 9 and 10 percent, Petters replied, “Yeah. Why not?” But, he said, “The question is when are you going to get there?” Some of this will be based on how well the company emerges from the pandemic and “accelerate out the other side of it.”