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HUNTINGTON INGALLS INDUSTRIES, INC. – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
Our Business
Huntington Ingalls Industries, Inc. ("HII", "we", "us", or "our") is America's largest military shipbuilding company and a provider of professional services to partners in government and industry. For more than a century, our Ingalls segment inMississippi andNewport News segment inVirginia have built more ships in more ship classes than any otherU.S. naval shipbuilder. Our Mission Technologies (formerly named Technical Solutions) segment provides a range of services to government and commercial customers. Headquartered inNewport News, Virginia , HII employs approximately 44,000 people domestically and internationally. We conduct most of our business with theU.S. Government , primarily theDepartment of Defense ("DoD"). As prime contractor, principal subcontractor, team member, or partner, we participate in many high-priorityU.S. defense programs. Ingalls includes our non-nuclear ship design, construction, repair, and maintenance businesses.Newport News includes all of our nuclear ship design, construction, overhaul, refueling, and repair and maintenance businesses. Our Mission Technologies segment provides a wide range of services and products, including C5ISR systems and operations; the application of Artificial Intelligence and machine learning to battlefield decisions; defense and offensive cyberspace strategies and electronic warfare; unmanned autonomous systems; live, virtual, and constructive solutions; platform modernization; and critical nuclear operations.
The following discussion should be read along with the unaudited condensed
consolidated financial statements included in this Quarterly Report on Form
10-Q, as well as our Annual Report on Form 10-K for the year ended
2021
Business Environment COVID-19 Pandemic - The COVID-19 global pandemic has had wide-ranging effects on the global health environment and disrupted the global andU.S. economies and financial markets, including impacts to our employees, customers, suppliers, and communities (collectively, "COVID-19 Events"). COVID-19 Events have also impacted our operations, and the extent of future impacts are uncertain. The most significant areas of impact have been the disruption of our employees' ability to work effectively, disruption in our supply chain, disruption of theU.S. Government's and our other customers' abilities to perform their obligations, and impact on pension assets and other investment performance.
We have aggressively managed our response to the uncertainties regarding
COVID-19 Events, and we have incurred costs to respond to COVID-19 Events,
including costs for paid leave, quarantining employees, vaccinations, and
recurring facility cleaning. Our shipyards and other facilities have remained
open and productive,
17 -------------------------------------------------------------------------------- Table of Contents but we continue to experience challenges meeting our hiring requirements, which has impacted our operations due to delay and disruption from a shortage of critical skills and out-of-sequence work. While costs related to COVID-19 Events are allowable underU.S. Government contracts, our contract estimates reflect profit margin impact uncertainty, because such costs may not result in equitable adjustments, particularly on firm fixed-price and fixed-price incentive contracts, or may not be adequately covered by insurance. Reinsurers under our property insurance have failed to acknowledge coverage for various losses related to COVID-19, and we filed a complaint in state court inVermont seeking a judgment declaring that our business interruption and other losses associated with COVID-19 are covered by our property insurance program. We also initiated arbitration proceedings against other reinsurers seeking similar relief. TheVermont court dismissed our complaint in response to a motion of the reinsurers for judgment on the pleadings, and we have appealed the decision. Although we continue to believe that our position is well-founded, no assurance can be provided regarding the ultimate resolution of this matter. See Note 12: Investigations, Claims, and Litigation. We have also focused on actively supporting our customers, suppliers, and communities. We have been proactive engaging with ourU.S. Government customers regarding future contract adjustments. While there has been no change in contract terms or substantial degradation in timely payments from customers, we have experienced delays in decisions on certain contract awards. Our suppliers have experienced reductions in employee attendance and hiring challenges, similar to us, which has affected their performance and delayed material deliveries. We are therefore continuing to monitor material availability and affordability. We are unable to predict how our customers and suppliers will allocate resources in the future as they react to the evolving demands of the COVID-19 response.U.S. Government Contracts - Long-term uncertainty exists with respect to overall levels of defense spending across the future years' defense plan, and it is likely thatU.S. Government discretionary spending levels will continue to be subject to significant pressure. The fiscal year 2022 budget cycle ultimately concluded with the passage of the Consolidated Appropriations Act of 2022, signed into lawMarch 15, 2022 . Final defense appropriations broadly supported shipbuilding programs, including funding for twoArleigh Burke class (DDG 51) destroyers and twoVirginia class attack submarines. Additionally, the appropriations measure provided$250 million for Advance Procurement ("AP") funding for LPD 32 (unnamed), additional AP for a thirdArleigh Burke class (DDG 51) destroyer in fiscal year 2023, funding for theColumbia class ballistic-missile (SSBN 826) submarine program, USS Gerald R.Ford class (CVN 78) nuclear aircraft carrier programs, and the refueling and complex overhaul ("RCOH") of USS John C. Stennis (CVN 74). The President submitted the fiscal year 2023 budget request onMarch 28, 2022 , and it is now under consideration byCongress . The budget request reflects continued investment in shipbuilding, funding two amphibious ships, LPD 32 (unnamed) and LHA 9 (unnamed), twoArleigh Burke class (DDG 51) surface combatants, and two Block V Virginia class submarines equipped with theVirginia Payload Module, and continues funding USS Gerald R.Ford class (CVN 78) nuclear aircraft carrier programs, carrier RCOH programs, and construction ofColumbia class (SSBN 826) submarines. Additionally, the budget request includes investment in the submarine industrial base. Long-term funding for certain programs in which we participate may be reduced, delayed, or canceled. In addition, spending cuts and/or reprioritization of defense investment could adversely affect the viability of our suppliers, subcontractors, and employee base. Our contracts or subcontracts under programs in which we participate may be terminated or adjusted by theU.S. Government or the prime contractor as a result of lack of government funding or reductions or delays in government funding. Significant reductions in the number of ships procured by theU.S. Navy or significant delays in funding our ship programs would have a material effect on our financial position, results of operations, or cash flows. The federal budget environment remains a significant long-term risk. Considerable uncertainty exists regarding how future budget and program decisions will develop and what challenges budget changes will present for the defense industry. We believe continued budget pressures could have serious implications for defense discretionary spending, the defense industrial base, including HII, and the customers, employees, suppliers, subcontractors, investors, and communities that rely on companies in the defense industrial base. Although it is difficult to determine specific impacts, we expect that over the longer term, the budget environment may result in fewer contract awards and lower revenues, profits, and cash flows from ourU.S. Government contracts. It is likely budget and program decisions made in this environment will have long-term impacts on HII and the entire defense industry. 18 -------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies, Estimates, and Judgments As discussed in our Annual Report on Form 10-K for the year endedDecember 31, 2021 , we consider our policies relating to the following matters to be critical accounting policies and estimates:
•Revenue recognition;
•Purchase accounting, goodwill, and intangible assets;
•Litigation, commitments, and contingencies;
•Retirement related benefit plans; and
•Workers' compensation.
As of
critical accounting policies, estimates, and judgments since
We have incorporated realized and estimated future effects of COVID-19 Events, based upon current conditions and our judgment of the future impacts of COVID-19 Events, with respect to contract costs and revenue recognition, effective income tax rates, and the fair values of our long-lived assets, financial instruments, intangible assets, and goodwill recorded at our reporting units.
Contracts
We generate most of our revenues from long-termU.S. Government contracts for design, production, and support activities. Government contracts typically include the following cost elements: direct material, labor, and subcontracting costs, and certain indirect costs, including allowable general and administrative expenses. Unless otherwise specified in a contract, costs billed to contracts with theU.S. Government are treated as allowable and allocable costs under the Federal Acquisition Regulation ("FAR") and theU.S. Cost Accounting Standards ("CAS") regulations. Examples of costs incurred by us that are not allowable under the FAR and CAS regulations include certain legal costs, lobbying costs, charitable donations, interest expense, organizational costs, including certain merger and acquisition costs, and advertising costs. Contract Fees - Negotiated contract fee structures include: fixed fee amounts, cost sharing arrangements to reward or penalize contractors for under- or over-cost target performance, respectively, positive award fees, and negative penalty arrangements. Profit margins may vary materially depending on the negotiated contract fee arrangements, percentage-of-completion of the contract, the achievement of performance objectives, and the stage of performance at which the right to receive fees, particularly under incentive and award fee contracts, is finally determined. Award Fees - Certain contracts contain award fees based on performance criteria such as cost, schedule, quality, and technical performance. Award fees are determined and earned based on an evaluation by the customer of our performance against such negotiated criteria. We consider award fees to be variable consideration and generally include these fees in the transaction price using a most likely amount approach. Award fees are limited to the extent of funding allotted by the customer and available for performance and those amounts for which a significant reversal of revenue is not probable.
Program Descriptions
For convenience, a brief description of certain programs discussed in this
Quarterly Report on Form 10-Q is included in the "Glossary of Programs" in this
section.
19 -------------------------------------------------------------------------------- Table of Contents CONSOLIDATED OPERATING RESULTS
The following table presents selected financial highlights:
Three Months Ended
March 31 2022 over 2021
($ in millions) 2022 2021 Dollars Percent
Sales and service revenues $ 2,576 $ 2,278 $ 298 13 %
Cost of product sales and service revenues 2,227 1,936 291 15 %
Income from operating investments, net 7 8 (1) (13) %
Other income and gains (losses), net (1) 3 (4) (133) %
General and administrative expenses 217 206 11 5 %
Operating income 138 147 (9) (6) %
Other income (expense)
Interest expense (26) (21) (5) (24) %
Non-operating retirement benefit 71 46 25 54 %
Other, net (7) 1 (8) (800) %
Federal and foreign income taxes 36 25 11 44 %
Net earnings $ 140 $ 148 $ (8) (5) %
Operating Performance Assessment and Reporting
We manage and assess the performance of our business based on our performance on individual contracts and programs using the financial measures referred to below, with consideration given to the Critical Accounting Policies, Estimates, and Judgments referred to in this section. Our portfolio of long-term contracts is largely flexibly-priced. Therefore, sales tend to fluctuate in concert with costs across our large portfolio of active contracts, with operating income being a critical measure of operating performance. Under FAR rules that govern our business with theU.S. Government , most types of costs are allowable, and we do not focus on individual cost groupings, such as cost of sales or general and administrative expenses, as much as we do on total contract costs, which are a key factor in determining contract operating income. As a result, in evaluating our operating performance, we look primarily at changes in sales and service revenues, as well as operating income, including the effects of significant changes in operating income as a result of changes in contract estimates and the use of the cumulative catch-up method of accounting in accordance with GAAP. This approach is consistent with the long-term life cycle of our contracts, as management assesses the bidding of each contract by focusing on net sales and operating profit and monitors performance in a similar manner through contract completion. Consequently, our discussion of business segment performance focuses on net sales and operating profit, consistent with our approach for managing our business. Cost of sales for both product sales and service revenues consists of materials, labor, and subcontracting costs, as well as an allocation of indirect costs for overhead. We manage the type and amount of costs at the contract level, which is the basis for estimating our total costs at completion of our contracts. Unusual fluctuations in operating performance driven by changes in a specific cost element across multiple contracts are described in our analysis.
Sales and Service Revenues
Sales and service revenues were comprised as follows:
Three Months Ended
March 31 2022 over 2021
($ in millions) 2022 2021 Dollars Percent
Product sales $ 1,724 $ 1,721 $ 3 - %
Service revenues 852 557 295 53 %
Sales and service revenues $ 2,576 $ 2,278 $ 298 13 %
Product sales for the three months ended March 31, 2022 , increased $3 million
from the same period in 2021. Ingalls product sales decreased $26 million for
the three months ended March 31, 2022 , primarily as a result of
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lower volumes in surface combatants and amphibious assault ships. Newport News
product sales increased $20 million for the three months ended March 31, 2022 ,
primarily as a result of higher volumes in submarines and aircraft carriers.
Mission Technologies product sales increased $9 million for the three months
ended March 31, 2022 , primarily as a result of higher volumes in unmanned
systems and defense and federal solutions ("DFS").
Service revenues for the three months ended March 31, 2022 , increased $295
million , or 53%, compared with the same period in 2021. Ingalls service revenues
for the three months ended March 31, 2022 , increased $8 million , primarily as a
result of higher volumes in amphibious assault ship services, partially offset
by lower volumes in surface combatant services. Newport News service revenues
decreased $37 million for the three months ended March 31, 2022 , primarily as a
result of lower volumes in aircraft carriers and naval nuclear support services.
Mission Technologies service revenues increased $324 million for the three
months ended March 31, 2022 , primarily as a result of higher volumes in DFS
services, partially offset by the divestiture of our oil and gas business in the
first quarter of 2021 and lower volumes in Fleet Sustainment.
Cost of Sales and Service Revenues
Cost of product sales, cost of service revenues, income from operating
investments, net, and general and administrative expenses were as follows:
Three Months Ended
March 31 2022 over 2021
($ in millions) 2022 2021 Dollars Percent
Cost of product sales $ 1,468 $ 1,454 $ 14 1 %
% of product sales 85.2 % 84.5 %
Cost of service revenues 759 482 277 57 %
% of service revenues 89.1 % 86.5 %
Income from operating investments, net 7 8 (1) (13) %
Other income and gains (losses), net (1) 3 (4) (133) %
General and administrative expenses 217 206 11 5 %
% of sales and service revenues 8.4 % 9.0 %
Cost of sales and service revenues
307 14 % Cost of Product Sales Cost of product sales for the three months endedMarch 31, 2022 , increased$14 million , or 1%, compared with the same period in 2021. Ingalls cost of product sales decreased$10 million for the three months endedMarch 31, 2022 , primarily as a result of volume decreases described above.Newport News cost of product sales increased$20 million for the three months endedMarch 31, 2022 , primarily as a result of volume increases described above. Mission Technologies cost of product sales increased$6 million for the three months endedMarch 31, 2022 , driven by volume increases described above. Cost of product sales related to the Operating FAS/CAS Adjustment decreased$2 million for the three months endedMarch 31, 2022 , as described below. Cost of product sales as a percentage of product sales increased from 84.5% for the three months endedMarch 31, 2021 , to 85.2% for the three months endedMarch 31, 2022 . The increase was primarily due to lower risk retirement on theVirginia class (SSN 774) submarine program and Bougainville (LHA 8), as well as a contract incentive on USS Jack H. Lucas (DDG 125) in the first quarter of 2021, partially offset by higher risk retirement on USS Gerald R.Ford (CVN 78) andFort Lauderdale (LPD 28) following its delivery, as well as a favorable change in the Operating FAS/CAS Adjustment.
Cost of Service Revenues
Cost of service revenues for the three months endedMarch 31, 2022 , increased$277 million , or 57%, compared with the same period in 2021. Ingalls cost of service revenues increased$7 million for the three months endedMarch 31, 2022 , primarily as a result of higher volumes described above.Newport News cost of service revenues decreased$35 million for the three months endedMarch 31, 2022 , primarily as a result of lower volumes described above. Mission Technologies cost of service revenues increased$306 million for the three months endedMarch 31, 2022 , primarily as a result of higher volumes described above. Cost of service revenues related to the Operating FAS/CAS Adjustment decreased$1 million for the three months endedMarch 31, 2022 , as described below. 21
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Cost of service revenues as a percentage of service revenues increased from 86.5% for the three months endedMarch 31, 2021 , to 89.1% for the three months endedMarch 31, 2022 , primarily driven by lower performance in DFS services and higher amortization of purchased intangible assets, partially offset by year-to-year variances in contract mix and a favorable change in the Operating FAS/CAS Adjustment.
Income (Loss) from Operating Investments, Net
The activities of our operating investments are closely aligned with the
operations of the segments holding the investments. We therefore record income
related to earnings from equity method investments in our operating income.
Income from operating investments, net for the three months ended
2022
Other Income and Gains (Losses), Net
Other income and gains (losses), net was a net loss of$1 million and a net gain of$3 million for the three months endedMarch 31, 2022 and 2021, respectively. The unfavorable change of$4 million was primarily due to the gain on sale of our oil and gas business in the first quarter of 2021.
General and Administrative Expenses
In accordance with industry practice and the regulations that govern the cost accounting requirements for government contracts, most general and administrative expenses are considered allowable and allocable costs on government contracts. These costs are allocated to contracts in progress on a systematic basis, and contract performance factors include this cost component as an element of cost. General and administrative expenses for the three months endedMarch 31, 2022 , increased$11 million from the same period in 2021, primarily due to higher overhead costs as a result of the acquisition of Alion in the third quarter of 2021 and current state income tax expense, partially offset by favorable changes in non-current state income taxes.
Operating Income
We consider operating income to be an important measure for evaluating our
operating performance, and, consistent with industry practice, we define
operating income as revenues less the related costs of producing the revenues
and general and administrative expenses.
We internally manage our operations by reference to "segment operating income,"
which is defined as operating income before the Operating FAS/CAS Adjustment and
non-current state income taxes, neither of which affects segment performance.
Segment operating income is not a recognized measure under GAAP. When analyzing
our operating performance, investors should use segment operating income in
addition to, and not as an alternative for, operating income or any other
performance measure presented in accordance with GAAP. It is a measure we use to
evaluate our core operating performance. We believe segment operating income
reflects an additional way of viewing aspects of our operations that, when
viewed with our GAAP results, provides a more complete understanding of factors
and trends affecting our business. We believe the measure is used by investors
and is a useful indicator to measure our performance. Because not all companies
use identical calculations, our presentation of segment operating income may not
be comparable to similarly titled measures of other companies.
The following table reconciles operating income to segment operating income:
Three Months Ended
March 31 2022 over 2021
($ in millions) 2022 2021 Dollars Percent
Operating income $ 138 $ 147 $ (9) (6) %
Operating FAS/CAS Adjustment 37 40 (3) (8) %
Non-current state income taxes 1 4 (3) (75) %
Segment operating income $ 176 $ 191 $ (15) (8) %
22
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Segment Operating Income
Segment operating income for the three months endedMarch 31, 2022 , was$176 million , compared with segment operating income of$191 million for the same period in 2021. The decrease was primarily due to lower risk retirement on theVirginia class (SSN 774) submarine program and Bougainville (LHA 8), receipt of a contract incentive on USS Jack H. Lucas (DDG 125) in the first quarter of 2021, and higher amortization of purchased intangible assets, partially offset by higher risk retirement onFort Lauderdale (LPD 28) following its delivery and USS Gerald R.Ford (CVN 78), as well as higher performance in DFS services and unmanned systems.
Activity within each segment is discussed in Segment Operating Results below.
FAS/CAS Adjustment and Operating FAS/CAS Adjustment
The FAS/CAS Adjustment reflects the difference between expenses for pension and
other postretirement benefits determined in accordance with GAAP ("FAS") and the
expenses for these items included in segment operating income in accordance with
U.S. Cost Accounting Standards ("CAS"). The Operating FAS/CAS Adjustment
excludes the following components of net periodic benefit costs: interest cost,
expected return on plan assets, amortization of prior service cost (credit) and
actuarial loss (gain), and settlement and curtailment effects.
The components of the Operating FAS/CAS Adjustment were as follows:
Three Months Ended
March 31 2022 over 2021
($ in millions) 2022 2021 Dollars Percent
FAS benefit (expense) $ 24 $ (7) $ 31 443 %
CAS cost 10 13 (3) (23) %
FAS/CAS Adjustment 34 6 28 467 %
Non-operating retirement benefit (71) (46) (25) (54) %
Operating FAS/CAS Adjustment $ (37) $ (40) $ 3 8 %
The Operating FAS/CAS Adjustment was a net expense of $37 million and $40
million for the three months ended March 31, 2022 and 2021, respectively. The
favorable change in the Operating FAS/CAS Adjustment of $3 million was driven by
higher interest rates.
Non-current State Income Taxes
Non-current state income taxes include deferred state income taxes, which reflect the change in deferred state tax assets and liabilities, and the tax expense or benefit associated with changes in state unrecognized tax benefits in the relevant period. These amounts are recorded within operating income. Current period state income tax expense is charged to contract costs and included in cost of sales and service revenues in segment operating income. Non-current state income tax expense for the three months endedMarch 31, 2022 , was$1 million , compared to non-current state income tax expense of$4 million for the same period in 2021. The favorable change in non-current state income taxes was driven by a decrease in deferred state income tax expense, primarily attributable to an increase in expenses that are not currently deductible for income tax purposes. Interest Expense
Interest expense for the three months ended
million
the Term Loan and the issuance of senior notes in
Non-Operating Retirement Benefit
The non-operating retirement benefit includes the following components of net periodic benefit costs: interest cost, expected return on plan assets, amortization of prior service cost (credit) and actuarial loss (gain), and settlement and curtailment effects. For the three months endedMarch 31, 2022 , the favorable change in the non-operating retirement benefit of$25 million was primarily driven by higher 2021 returns on plan assets. 23
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Other, Net
Other, net expense increased
2022
investments in marketable securities.
Federal and Foreign Income Taxes
Our effective income tax rates on earnings from operations for the three months endedMarch 31, 2022 and 2021, were 20.5% and 14.5%, respectively. The higher effective tax rate for the three months endedMarch 31, 2022 , was primarily attributable to a tax loss associated with the sale of the Company's oil and gas business recorded in 2021. For the three months endedMarch 31, 2022 , our effective tax rate did not differ materially from the federal statutory corporate income tax rate of 21%. For the three months endedMarch 31, 2021 , our effective tax rate differed from the federal statutory rate primarily as a result of the loss associated with the sale of our oil and gas business. See Note 11: Income Taxes.
SEGMENT OPERATING RESULTS
Basis of Presentation
We are aligned into three reportable segments: Ingalls,
Mission Technologies.
The following table presents segment operating results:
Three Months Ended
March 31 2022 over 2021
($ in millions) 2022 2021 Dollars Percent
Sales and Service Revenues
Ingalls $ 631 $ 649 $ (18) (3) %
Newport News 1,390 1,407 (17) (1) %
Mission Technologies 590 259 331 128 %
Intersegment eliminations (35) (37) 2 5 %
Sales and service revenues $ 2,576 $ 2,278 $ 298 13 %
Operating Income
Ingalls $ 86 $ 91 $ (5) (5) %
Newport News 81 93 (12) (13) %
Mission Technologies 9 7 2 29 %
Segment operating income 176 191 (15) (8) %
Non-segment factors affecting operating income
Operating FAS/CAS Adjustment (37) (40) 3 8 %
Non-current state income taxes (1) (4) 3 75 %
Operating income $ 138 $ 147 $ (9) (6) %
KEY SEGMENT FINANCIAL MEASURES
Sales and Service Revenues
Period-to-period revenues reflect performance under new and ongoing contracts.
Changes in sales and service revenues are typically expressed in terms of
volume. Unless otherwise described, volume generally refers to increases (or
decreases) in reported revenues due to varying production activity levels,
delivery rates, or service levels on individual contracts. Volume changes will
typically carry a corresponding income change based on the margin rate for a
particular contract.
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Segment Operating Income
Segment operating income reflects the aggregate performance results of contracts
within a segment. Excluded from this measure are certain costs not directly
associated with contract performance, such as the Operating FAS/CAS Adjustment
and non-current state income taxes. Changes in segment operating income are
typically expressed in terms of volume, as discussed above, or performance.
Performance refers to changes in contract margin rates. These changes typically
relate to profit recognition associated with revisions to estimated costs at
completion ("EAC") that reflect improved or deteriorated operating performance
on that contract. Operating income changes are accounted for on a cumulative to
date basis at the time an EAC change is recorded. Segment operating income may
also be affected by, among other things, contract performance, the effects of
workforce stoppages, the effects of natural disasters such as hurricanes,
resolution of disputed items with the customer, recovery of insurance proceeds,
and other discrete events. At the completion of a long-term contract, any
originally estimated costs not incurred or reserves not fully utilized, such as
warranty reserves, could also impact contract earnings. Where such items have
occurred and the effects are material, a separate description is provided.
Cumulative Adjustments
For the three months ended
cumulative catch-up margin adjustments were as follows:
Three Months Ended
March 31
($ in millions) 2022 2021
Gross favorable adjustments $ 107 $ 86
Gross unfavorable adjustments (62) (36)
Net adjustments $ 45 $ 50
For the three months ended March 31, 2022 , favorable cumulative catch-up margin
adjustments were related to risk retirement on Fort Lauderdale (LPD 28)
following its delivery and other individually insignificant adjustments. During
the same period, none of the unfavorable cumulative catch-up margin adjustments
were individually significant.
For the three months ended March 31, 2021 , favorable cumulative catch-up margin
adjustments were related to risk retirement on Bougainville (LHA 8) and Block IV
of the Virginia class (SSN 774) submarine program. During the same period, none
of the unfavorable cumulative catch-up margin adjustments were individually
significant.
Ingalls
Three Months Ended
March 31 2022 over 2021
($ in millions) 2022 2021 Dollars Percent
Sales and service revenues $ 631 $ 649 $ (18) (3) %
Segment operating income 86 91 (5) (5) %
As a percentage of segment sales 13.6 % 14.0 %
Sales and Service Revenues
Ingalls revenues for the three months endedMarch 31, 2022 , decreased$18 million , or 3%, from the same period in 2021, primarily driven by lower revenues in surface combatants, partially offset by higher revenues in amphibious assault ships. Revenues on surface combatants decreased due to lower volumes onJeremiah Denton (DDG 129),George M. Neal (DDG 131), andFrank E. Petersen Jr . (DDG 121), partially offset by higher volumes onSam Nunn (DDG 133). Revenues on amphibious assault ships increased due to higher volumes on LHA 9 (unnamed) and L-Class planning yard services contract, partially offset by lower volumes on Bougainville (LHA 8).
Segment Operating Income
Ingalls segment operating income for the three months endedMarch 31, 2022 , was$86 million , compared with segment operating income of$91 million for the same period in 2021. The decrease was primarily driven by lower 25 -------------------------------------------------------------------------------- Table of Contents risk retirement on Bougainville (LHA 8) and receipt of a contract incentive on USS Jack H. Lucas (DDG 125) in the first quarter of 2021, partially offset by higher risk retirement onFort Lauderdale (LPD 28) following its delivery.Newport News Three Months Ended March 31 2022 over 2021 ($ in millions) 2022 2021 Dollars Percent Sales and service revenues$ 1,390 $ 1,407 $ (17) (1) % Segment operating income 81 93 (12) (13) % As a percentage of segment sales 5.8 % 6.6 %
Sales and Service Revenues
Newport News revenues for the three months endedMarch 31, 2022 , decreased$17 million , or 1%, from the same period in 2021, primarily driven by lower revenues in aircraft carriers and naval nuclear support services, partially offset by higher revenues in submarines. Aircraft carrier revenues decreased primarily as a result of lower volumes on the RCOH of USS George Washington (CVN 73), the construction ofJohn F. Kennedy (CVN 79), and USS Gerald R.Ford (CVN 78), partially offset by higher volumes on the RCOH of USS John C. Stennis (CVN 74). Naval nuclear support services revenues decreased primarily as a result of lower volumes in submarine fleet support services and facility maintenance services, partially offset by higher volumes in carrier fleet support services. Submarine revenues increased due to higher volumes on theColumbia class (SSBN 826) program and Block V boats of theVirginia class (SSN 774) submarine program, partially offset by lower volumes on Block IV boats of theVirginia class (SSN 774) submarine program. Segment Operating IncomeNewport News segment operating income for the three months endedMarch 31, 2022 , was$81 million , compared with segment operating income of$93 million for the same period in 2021. The decrease was primarily due to lower risk retirement on theVirginia class (SSN 774) submarine program, partially offset by higher risk retirement on USS Gerald R.Ford (CVN 78). Mission Technologies Three Months Ended March 31 2022 over 2021 ($ in millions) 2022 2021 Dollars Percent Sales and service revenues$ 590 $ 259 $ 331 128 % Segment operating income 9 7 2 29 % As a percentage of segment sales 1.5 % 2.7 %
Sales and Service Revenues
Mission Technologies revenues for the three months endedMarch 31, 2022 , increased$331 million , or 128%, from the same period in 2021, primarily due to higher volumes in DFS attributable to the acquisition of Alion in the third quarter of 2021, partially offset by the divestiture of our oil and gas business and contribution of ourSan Diego Shipyard to a joint venture in the first quarter of 2021, as well as lower volumes in Fleet Sustainment.
Segment Operating Income
Mission Technologies segment operating income for the three months endedMarch 31, 2022 , was$9 million , compared with segment operating income of$7 million for the same period in 2021. The increase was primarily driven by higher performance in DFS and unmanned systems, partially offset by higher amortization of purchased intangible assets. 26 -------------------------------------------------------------------------------- Table of Contents BACKLOG Total backlog as ofMarch 31, 2022 , andDecember 31, 2021 , was approximately$47.9 billion and$48.5 billion , respectively. Total backlog includes both funded backlog (firm orders for which funding is contractually obligated by the customer) and unfunded backlog (firm orders for which funding is not currently contractually obligated by the customer). Backlog excludes unexercised contract options and unfunded Indefinite Delivery/Indefinite Quantity orders. For contracts having no stated contract values, backlog includes only the amounts committed by the customer.
The following table presents funded and unfunded backlog by segment as of
31, 2022
March 31, 2022 December 31, 2021
Total Total
($ in millions) Funded Unfunded Backlog Funded Unfunded Backlog
Ingalls $ 10,515 $ 815 $ 11,330 $ 10,216 $ 792 $ 11,008
Newport News 12,954 18,859 31,813 11,121 21,198 32,319
Mission Technologies 1,369 3,415 4,784 1,334 3,789 5,123
Total backlog $ 24,838 $ 23,089 $ 47,927 $ 22,671 $ 25,779 $ 48,450
Approximately 19% of the $48.5 billion total backlog as of December 31, 2021 , is
expected to be converted into sales in 2022. U.S. Government orders comprised
substantially all of the backlog as of March 31, 2022 , and December 31, 2021 .
Awards
The value of new contract awards during the three months ended
was approximately
construction of DDG 139 (unnamed).
LIQUIDITY AND CAPITAL RESOURCES
We seek to efficiently convert operating results into cash for deployment in
operating our businesses, implementing our business strategy, and maximizing
stockholder value. We use various financial measures to assist in capital
deployment decision making, including net cash provided by operating activities
and free cash flow. We believe these measures are useful to investors in
assessing our financial performance.
The following table summarizes key components of cash flow provided by operating
activities:
Three Months Ended 2022 over
March 31 2021
($ in millions) 2022 2021 Dollars
Net earnings $ 140 $ 148 $ (8)
Depreciation and amortization 89 67 22
Provision for doubtful accounts (7) - (7)
Stock-based compensation 9 9 -
Deferred income taxes 2 31 (29)
Gain on disposition of business - (3) 3
Loss (gain) on investments in marketable securities 9 (4) 13
Retiree benefit funding in excess of expense (34) (65) 31
Trade working capital increase (291) (140) (151)
Net cash (used in) provided by operating activities $
(83)
We have historically maintained a capital structure comprising a mix of equity
and debt financing. We vary our
leverage both to optimize our equity return and to pursue acquisitions. We
expect to meet our current debt
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obligations as they come due through internally generated funds from current
levels of operations and/or through refinancing in the debt markets prior to the
maturity dates of our debt.
Cash Flows
We discuss below our significant operating, investing, and financing activities
affecting cash flows for the three months ended
classified on our unaudited condensed consolidated statements of cash flows.
Operating Activities
Cash used in operating activities for the three months endedMarch 31, 2022 , was$83 million , compared with$43 million provided by operating activities for the same period in 2021. The unfavorable change in operating cash flow was primarily due to changes in trade working capital and income tax refunds in the first quarter of 2021, partially offset by lower contributions to retiree benefit plans. The change in trade working capital was primarily driven by the timing of receipts of accounts receivable and payments of accounts payable. We expect cash generated from operations in combination with our current cash and cash equivalents, as well as existing credit facilities, to be sufficient to service debt and retiree benefit plans, meet contractual obligations, and finance capital expenditures for at least the 12 months beginningApril 1, 2022 and beyond such 12-month period based on our current business plan.
Investing Activities
Cash used in investing activities for the three months endedMarch 31, 2022 , was$43 million , compared with$46 million used in investing activities for the same period in 2021. The change in investing cash was driven by the disposition of our oil and gas business in the first quarter of 2021 and lower capital expenditures in 2022, partially offset by contribution of ourSan Diego Shipyard to a joint venture in the first quarter of 2021. For 2022, we expect our capital expenditures for maintenance and sustainment to be approximately 1.0% of annual revenues and our discretionary capital expenditures to be approximately 1.5% to 2.0% of annual revenues. Financing Activities Cash used in financing activities for the three months endedMarch 31, 2022 , was$171 million , compared with$102 million used in financing activities for the same period in 2021. The change in financing cash was primarily due to an increase in the repayment of long-term debt of$100 million , an increase of$7 million in employee taxes on certain share-based payment arrangements, and a$1 million increase in cash dividend payments, partially offset by a decrease of$39 million in common stock repurchases.
Free Cash Flow
Free cash flow represents cash provided by (used in) operating activities less
capital expenditures net of related grant proceeds. Free cash flow is not a
measure recognized under GAAP. Free cash flow has limitations as an analytical
tool and should not be considered in isolation from, or as a substitute for, net
earnings as a measure of our performance or net cash provided by operating
activities as a measure of our liquidity. We believe free cash flow is an
important liquidity measure for our investors because it provides them insight
into our current and period-to-period performance and our ability to generate
cash from continuing operations. We also use free cash flow as a key operating
metric in assessing the performance of our business and as a key performance
measure in evaluating management performance and determining incentive
compensation. Free cash flow may not be comparable to similarly titled measures
of other companies.
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The following table reconciles net cash (used in) provided by operating
activities to free cash flow:
Three Months Ended 2022 over
March 31 2021
($ in millions) 2022 2021 Dollars
Net cash (used in) provided by operating activities $ (83) $ 43 $ (126)
Less capital expenditures:
Capital expenditure additions (43) (60) 17
Grant proceeds for capital expenditures - 1 (1)
Free cash flow $ (126) $ (16) $ (110)
Free cash flow for the three months ended March 31, 2022 , decreased $110 million
from the same period in 2021, primarily due to changes in trade working capital
and income tax refunds in the first quarter of 2021, partially offset by lower
contributions to retiree benefit plans and lower capital expenditures.
Governmental Regulation and Supervision
TheU.S. Government has the ability, pursuant to regulations relating to contractor business systems, to decrease or withhold contract payments if it determines significant deficiencies exist in one or more such systems. As ofMarch 31, 2022 and 2021, the cumulative amounts of payments withheld by theU.S. Government under our contracts subject to these regulations were not material to our liquidity or cash flows.
Off-Balance Sheet Arrangements
In the ordinary course of business, we use letters of credit issued by commercial banks to support certain leases, insurance policies, and contractual performance obligations, as well as surety bonds issued by insurance companies principally to support our self-insured workers' compensation plans. As ofMarch 31, 2022 ,$15 million in letters of credit were issued but undrawn and$276 million of surety bonds were outstanding. As ofMarch 31, 2022 , we had no other significant off-balance sheet arrangements.
ACCOUNTING STANDARDS UPDATES
See Note 3: Accounting Standards Updates in Part I, Item 1 for information
related to accounting standards updates.
FORWARD-LOOKING STATEMENTS AND PROJECTIONS
Statements in this Quarterly Report on Form 10-Q and in our other filings with theSecurities and Exchange Commission ("SEC"), as well as other statements we may make from time to time, other than statements of historical fact, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. You can generally identify forward-looking statements by words such as "may," "will," "should," "expects," "intends," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "continue," and similar words or phrases or the negative of these words or phrases. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by these forward-looking statements. Although we believe the expectations reflected in the forward-looking statements are reasonable when made, we cannot guarantee future results, levels of activity, performance, or achievements. There are a number of important factors that could cause our actual results to differ materially from the results anticipated by our forward-looking statements, which include, but are not limited to: •Changes in government and customer priorities and requirements (including government budgetary constraints, shifts in defense spending, and changes in customer short-range and long-range plans); •Our ability to estimate our future contract costs and perform our contracts effectively; •Changes in procurement processes and government regulations and our ability to comply with such requirements; •Our ability to deliver our products and services at an affordable life cycle cost and compete within our markets; 29 -------------------------------------------------------------------------------- Table of Contents •Natural and environmental disasters and political instability; •Our ability to execute our strategic plan, including with respect to share repurchases, dividends, capital expenditures, and strategic acquisitions; •Adverse economic conditions inthe United States and globally; •Health epidemics, pandemics and similar outbreaks, including the COVID-19 pandemic, and the impacts of vaccination mandates on our workforce; •Our ability to effectively integrate the operations of Alion into our business; •Disruptions impacting global supply, including those attributable to the ongoing COVID-19 pandemic and those resulting from the ongoing conflict betweenRussia andUkraine ; •Changes in key estimates and assumptions regarding our pension and retiree health care costs; •Security threats, including cyber security threats, and related disruptions; and •Other risk factors discussed herein and in our other filings with theSEC . There may be other risks and uncertainties that we are unable to predict at this time or that we currently do not expect to have a material adverse effect on our business, and we undertake no obligation to update or revise any forward-looking statements. You should not place undue reliance on any forward looking statements that we may make. 30
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GLOSSARY OF PROGRAMS Included below are brief descriptions of some of the programs discussed in this Quarterly Report on Form 10-Q. ProgramName Program Description America class (LHA 6) amphibious Design and build large deck amphibious assault ships assault ships that provide forward presence and power projection as an integral part of joint, interagency and multinational maritime expeditionary forces. The America class (LHA 6) ships, together with the Wasp class (LHD 1) ships, are the successors to the decommissionedTarawa class (LHA 1) ships. The America class (LHA 6) ships optimize aviation operations and support capabilities. In
2020, we delivered USS Tripoli
(LHA 7), and we were awarded a long-lead-time material
and construction contract for LHA 9 (unnamed). We are
currently constructing Bougainville (LHA 8).
Arleigh Burke class (DDG 51) Build guided missile destroyers designed for conducting
destroyers anti-air, anti-submarine,
anti-surface, and strike
operations. The
Aegis-equipped
51) destroyers are theU.S. Navy's primary surface combatant, and have been constructed in variants, allowing technological
advances during construction. We
delivered USS Paul Ignatius (DDG 117), USS Delbert D.
Black (DDG 119), and Frank E. Petersen Jr . (DDG121) in
2019, 2020, and 2021,
respectively. We have contracts
to construct the following
destroyers: Lenah H.
H. Lucas (DDG 125),Ted Stevens (DDG 128),Jeremiah Denton (DDG 129),George M. Neal (DDG 131),Sam Nunn (DDG 133),Thad Cochran (DDG 135),John F. Lehman (DDG 137), and DDG 139 (unnamed). Carrier RCOH Perform refueling and complex overhaul ("RCOH") of nuclear-powered aircraft
carriers, which is required at
the mid-point of their
50-year life cycle. USS George
Washington (CVN 73) arrived atNewport News for the start of its RCOH inAugust 2017 , and USS John C. Stennis (CVN 74) arrived atNewport News for the start of its RCOH inMay 2021 .
class submarine as a
replacement for the current aging
Ohio class nuclear ballistic missile submarines, which were first introduced into service in 1981. TheOhio class SSBN includes 14 nuclear ballistic missile submarines and four nuclear cruise missile submarines. TheColumbia class program plan of record is to construct 12 new ballistic missile submarines. TheU.S. Navy has initiated the design process for the new class of submarines, and, in early 2017, theDoD signed the acquisition decision
memorandum approving the
class program's Milestone B, which formally authorizes
the program's entry into the engineering and
manufacturing development phase. We perform design work
as a subcontractor to Electric Boat, and we have
entered into a teaming
agreement with Electric Boat to
build modules for the entire
submarine program that
leverages our
(SSN 774) experience. We have
been awarded contracts
from Electric Boat for
integrated product and process
development, providing
long-lead-time material and
advance construction, and
construction of the first two
boats of theColumbia class (SSBN 826) program. Construction of the firstColumbia class (SSBN 826) submarine began in 2020. Defense and federal solutions ("DFS") Develops integrated solutions that enable today's connected, all-domain force. Capabilities include: C5ISR systems and operations; the application of artificial intelligence
("AI") and machine learning to
battlefield decisions; defensive and offensive
cyberspace strategies and electronic warfare ("EW");
and live, virtual, and
constructive ("LVC") solutions.
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Fleet sustainment Maintains and modernizes a significant majority of the
U.S. Navy fleet, from small watercraft to submarines,
combatants, and aircraft carriers, our systems and
maintenance experts help
the
of readiness. Ensures
effective system operation and
sustainment by actively
supporting design and
decision-making processes
through studies, analyses, and
reviews of program
documents, and provides a wide range
of logistics products.
USS Gerald R. Ford class (CVN 78) Design and construction for the Ford class program,
aircraft carriers which is the aircraft
carrier replacement program for
the decommissioned
Enterprise (CVN 65) and Nimitz class
(CVN 68) aircraft carriers. USS Gerald R.Ford (CVN 78), the first ship of theFord class, was delivered to theU.S. Navy in the second
quarter of 2017. In
we were awarded a contract for the detail design and
construction of John F. Kennedy (CVN 79), following
several years of
engineering, advance construction, and
purchase of long-lead-time
components and material. In
addition, we have received
awards for detail design and
construction of Enterprise (CVN 80) andDoris Miller (CVN 81). This category also includes the class' non-recurring engineering. The class is expected to bring improved warfighting
capability, quality of life
improvements for sailors,
and reduced life cycle costs.
Legend class National Security Cutter Design and build theU.S. Coast Guard's National Security Cutters ("NSCs"), the largest and most technically advanced class of cutter in theU.S. Coast Guard . The NSC is equipped to carry out maritime homeland security, maritime safety, protection of natural resources, maritime mobility, and national defense missions. The plan is for a total of 11 ships, of which the first nine ships have been delivered.Calhoun (NSC 10) and
Friedman (NSC 11) are currently
under construction.
Naval nuclear support services Provide services to and in
support of the
ranging from services
supporting the
submarine fleets to
maintenance services at
training facilities. Naval
nuclear support services
include design,
construction, maintenance, and disposal
activities for in-serviceU.S. Navy nuclear ships worldwide through mobile and in-house capabilities. Services include
maintenance services on nuclear reactor
prototypes.
Nuclear and environmental services Supports the national
security mission of the Department
of Energy ("DoE") through
the management and operation
of its sites, as well as
the safe cleanup of legacy
waste across the country.
We meet our clients' toughest
nuclear and environmental
challenges and are positioned
to serve the growing
commercial nuclear power plant
decommissioning market. We participate in several joint
ventures, including Newport News Nuclear BWXT Los
Alamos, LLC (" N3B"),
Mission Support and Test Services,
LLC ("MSTS"), and Savannah River Nuclear Solutions, LLC
("SRNS"), and we are an integrated subcontractor to
Triad National Security.
N3B was awarded the Los Alamos
Legacy Cleanup Contract at theDoE/National Nuclear Security Administration's Los Alamos National Laboratory. MSTS was awarded a contract for site management and operations at the Nevada National Security Site. SRNS provides site management and operations at the DoE's
Savannah River Site near
South Carolina . Triad provides site management and operations at theDoE's Los Alamos National Laboratory . 32
-------------------------------------------------------------------------------- Table of ContentsSan Antonio class (LPD 17) amphibious Design and build amphibious transport dock ships, which transport dock ships are warships that embark, transport, and land elements of a landing force for a variety of expeditionary warfare missions, and also serve as the secondary aviation platform for
Amphibious Readiness Groups. The
San Antonio class (LPD 17) is the newest addition to theU.S. Navy's 21st century amphibious assault force, and these ships are a key element of theU.S. Navy's seabase transformation. In 2022, we deliveredFort Lauderdale (LPD 28). We are currently constructingRichard M. McCool Jr . (LPD
29) and
In 2020, we were awarded a contract to construct
Pittsburgh (LPD 31).
Unmanned systems Creates advanced unmanned maritime solutions for
defense, marine research,
and commercial applications.
Serving customers in more
than 30 countries, unmanned
systems provides design, autonomy, manufacturing,
testing, operations, and sustainment of unmanned
systems, including unmanned underwater vehicles and
unmanned surface vessels.
Virginia class (SSN 774) fast attack Construct attack submarines as the principal
submarines subcontractor to Electric
Boat. The
774) is a post-Cold War
design tailored to excel in a
wide range of warfighting missions, including
anti-submarine and surface ship warfare; special
operation forces; strike;
intelligence, surveillance,
and reconnaissance; carrier and expeditionary strike
group support; and mine warfare.
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