HUNTINGTON INGALLS INDUSTRIES, INC. 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 Technical Solutions segment provides a range of services to government and commercial customers. Headquartered inNewport News, Virginia , HII employs approximately 42,000 people both domestically and internationally. We conduct most of our business with theU.S. Government , primarily theDoD . 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 Technical Solutions segment provides a wide range of professional services and products, including defense and federal solutions ("DFS"), nuclear and environmental services, and unmanned systems. 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 endedDecember 31, 2020 . 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 20 -------------------------------------------------------------------------------- Table of Contents impacted our operations, and the continuing impacts are uncertain. The most significant elements of uncertainty have been the intensity and duration of the impact on 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 are aggressively managing our response to the uncertainties regarding COVID-19 Events. Our primary focus has been to minimize the risk to our employees by updating leave policies, increasing telecommuting, and making benefits changes to provide employees maximum flexibility. We have also adjusted policies and workspaces to align withCenters for Disease Control and Prevention ("CDC") guidelines and to support social distancing, including increased sanitation efforts, personal protective equipment for employees, and suspension of all non-essential work travel. As a result, we have incurred and expect to continue incurring costs related to COVID-19 Events, including paid leave, quarantining employees, and recurring facility cleaning. Our shipyards and other facilities remained open and productive, but we experienced temporary decreases in workforce attendance, which impacted our operations due to delay and disruption from the lack of availability of critical skills and out-of-sequence work. As ofMarch 31, 2021 , our workforce was operating at normal attendance rates. Under Section 3610 of the CARES Act, contractors may submit claims for employee paid time off caused by restrictions from COVID-19 Events in circumstances where the employee could not work remotely. Such instances may include paid time off for employees to allow for plant decontamination, idle time due to social distancing restrictions, paid time off to take care of dependents impacted by government ordered school or day care closures, and employee quarantines due to travel restrictions or coming into contact, being diagnosed, or taking care of someone diagnosed with COVID-19. We have taken steps to preserve our rights to pursue such claims for HII and our subcontractors, but we have no assurance thatCongress will appropriate sufficient funds to cover the reimbursement of costs contemplated by the CARES Act. While costs related to COVID-19 Events are allowable underU.S. Government contracts, our contract estimates reflect 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. Our reinsurers 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. Although we believe that our position is well-founded, no assurance can be provided regarding the ultimate resolution of this matter. See Note 13: Investigations, Claims, and Litigation. We have also focused on actively supporting our customers, suppliers, and communities. We have been proactive in 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. We are unable to predict how our customers will allocate resources in the future as they react to the evolving demands of the COVID-19 response. We have accelerated payments to small business suppliers in an effort to minimize supply chain disruption. We temporarily halted stock repurchases in Q1 2020, but we resumed share repurchases during the first quarter of 2021. We also deferred certain payroll taxes pursuant to the CARES Act, which increased our cash from operations in 2020, but will reduce cash from operations in 2021 and 2022.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 2021 budget cycle ultimately concluded with the passage and enactment of defense authorization and defense appropriations measures. Both pieces of legislation broadly supported shipbuilding programs, including funding and authority for an additionalVirginia class submarine, the bundled purchase of LHA 9 (unnamed) with LPD 32 (unnamed) and LPD 33 (unnamed), and long-lead material for an additionalArleigh Burke class (DDG 51) destroyer. The final bills also continued support of the dual purchase of Enterprise (CVN 80) andDoris Miller (CVN 81), as well as the Refueling and Complex Overhaul of USS John C. Stennis (CVN 74). 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 21 -------------------------------------------------------------------------------- Table of Contents 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 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 will 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.
Critical Accounting Policies, Estimates, and Judgments
As discussed in our Annual Report on Form 10-K for the year endedDecember 31, 2020 , we consider our policies relating to the following matters to be critical accounting policies: •Revenue recognition;
•Purchase accounting, goodwill, and intangible assets;
•Litigation, commitments, and contingencies;
•Retirement related benefit plans; and
•Workers' compensation.
As of
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. See Note 2: Basis of Presentation. 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, and advertising costs. We monitor our policies and procedures with respect to our contracts on a regular basis to ensure consistent application under similar terms and conditions, as well as compliance with all applicable government regulations. In addition, theDefense Contract Audit Agency routinely audits the costs we incur that are allocated to contracts with theU.S. Government .
Our contracts typically fall into one of four categories: firm fixed-price, fixed-price incentive, cost-type, and time and materials. See Note 7: Revenue.
•Firm Fixed-Price Contracts - A firm fixed-price contract is a contract in which
the specified scope of work is agreed to for a price that is predetermined by
bid or negotiation and not generally subject to adjustment regardless of costs
incurred by the contractor.
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•Fixed-Price Incentive Contracts - Fixed-price incentive contracts provide for
reimbursement of the contractor's allowable costs, but are subject to a
cost-share limit that affects profitability. Fixed-price incentive contracts
effectively become firm fixed-price contracts once the cost-share limit is
reached.
•Cost-Type Contracts - Cost-type contracts provide for reimbursement of the
contractor's allowable costs plus a fee that represents profit. Cost-type
contracts generally require that the contractor use its reasonable efforts to
accomplish the scope of the work within some specified time and some stated
dollar limitation.
•Time and Materials - Time and materials contracts specify a fixed hourly billing rate for each direct labor hour expended and reimbursement for allowable material costs and expenses.
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.
CONSOLIDATED OPERATING RESULTS
The following table presents selected financial highlights:
Three Months Ended
March 31 2021 over 2020
($ in millions) 2021 2020 Dollars Percent
Sales and service revenues $ 2,278 $ 2,263 $ 15 1 %
Cost of product sales and service revenues 1,936 1,840 96 5 %
Income from operating investments, net 8 6 2 33 %
Other income and gains 3 - 3 - %
General and administrative expenses 206 214 (8) (4) %
Operating income 147 215 (68) (32) %
Other income (expense)
Interest expense (21) (16) (5) (31) %
Non-operating retirement benefit 46 30 16 53 %
Other, net 1 (13) 14 108 %
Federal and foreign income taxes 25 44 (19) (43) %
Net earnings $ 148 $ 172 $ (24) (14) %
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
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the U.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 2021 over 2020
($ in millions) 2021 2020 Dollars Percent
Product sales $ 1,721 $ 1,624 $ 97 6 %
Service revenues 557 639 (82) (13) %
Sales and service revenues $ 2,278 $ 2,263 $ 15 1 %
Product sales for the three months ended March 31, 2021 , increased $97 million ,
or 6%, compared with the same period in 2020. Ingalls product sales increased
$26 million for the three months ended March 31, 2021 , primarily as a result of
higher volumes in surface combatants and amphibious assault ships, partially
offset by lower volume in the Legend class NSC program. Newport News product
sales increased $55 million for the three months ended March 31, 2021 , primarily
as a result of higher volumes in aircraft carriers. Technical Solutions product
sales increased $16 million for the three months ended March 31, 2021 , primarily
as a result of the acquisition of Hydroid in March 2020 and higher volumes in
DFS.
Service revenues for the three months ended March 31, 2021 , decreased $82
million , or 13%, compared with the same period in 2020. Ingalls service revenues
decreased $8 million for the three months ended March 31, 2021 , primarily as a
result of lower volumes in surface combatant and amphibious assault ship
services. Newport News service revenues increased $11 million for the three
months ended March 31, 2021 , primarily as a result of higher volumes in aircraft
carriers. Technical Solutions service revenues decreased $85 million for the
three months ended March 31, 2021 , primarily as a result of the divestitures of
our oil and gas business and San Diego Shipyard , as well as lower volumes in DFS
services.
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Cost of Sales and Service Revenues
Cost of product sales, cost of service revenues, income from operating investments, net, and general and administrative expenses were as follows:
Three Months Ended
March 31 2021 over 2020
($ in millions) 2021 2020
Dollars Percent
Cost of product sales$ 1,454 $ 1,290
$ 164 13 %
% of product sales 84.5 % 79.4 % Cost of service revenues 482 550
(68) (12) %
% of service revenues 86.5 % 86.1 % Income from operating investments, net 8 6 2 33 % Other income and gains 3 - 3 - % General and administrative expenses 206 214 (8) (4) % % of sales and service revenues 9.0 % 9.5 %
Cost of sales and service revenues
4 %
Cost of Product Sales
Cost of product sales for the three months ended March 31, 2021 , increased $164
million , or 13%, compared with the same period in 2020. Ingalls cost of product
sales increased $1 million for the three months ended March 31, 2021 , primarily
as a result of the higher volumes described above, partially offset by risk
retirement on Bougainville (LHA 8). Newport News cost of product sales increased
$64 million for the three months ended March 31, 2021 , primarily as a result of
volume increases described above. Technical Solutions cost of product sales
increased $15 million for the three months ended March 31, 2021 , primarily as a
result of the volume increases described above. Cost of product sales related to
the Operating FAS/CAS Adjustment increased $84 million for the three months
ended March 31, 2021 , as described below.
Cost of product sales as a percentage of product sales increased from 79.4% for
the three months ended March 31, 2020 , to 84.5% for the three months ended March
31, 2021 . The increase was due to unfavorable change in the Operating FAS/CAS
Adjustment and lower risk retirement on the RCOH of USS George Washington (CVN
73), partially offset by higher risk retirement on Bougainville (LHA 8) and
Block IV of the Virginia class (SSN 774) submarine program and year-to-year
variances in contract mix.
Cost of Service Revenues
Cost of service revenues for the three months endedMarch 31, 2021 , decreased$68 million , or 12%, compared with the same period in 2020. Ingalls cost of service revenues decreased$7 million for the three months endedMarch 31, 2021 , primarily as a result of lower volumes described above.Newport News cost of service revenues increased$14 million for the three months endedMarch 31, 2021 , primarily as a result of the volume increases described above. Technical Solutions cost of service revenues decreased$94 million for the three months endedMarch 31, 2021 , primarily as a result of the lower volumes described above and year-to-year variances in contract mix. Cost of service revenues related to the Operating FAS/CAS Adjustment increased$19 million for the three months endedMarch 31, 2021 , as described below. Cost of service revenues as a percentage of service revenues increased from 86.1% for the three months endedMarch 31, 2020 , to 86.5% for the three months endedMarch 31, 2021 , primarily driven by an unfavorable change in the Operating FAS/CAS Adjustment, partially offset by improved performance on DFS services and year-to-year variances in contract mix.
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.
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Income from operating investments, net for the three months ended March 31,
2021 , increased $2 million from the same period in 2020, primarily due to higher
equity income from our nuclear and environmental joint ventures.
Other Income and Gains
For the three months ended
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, 2021 , decreased$8 million from the same period in 2020, primarily driven by favorable changes in current state income tax expense and lower overhead costs.
Operating Income
We consider operating income to be an important measure for evaluating our operating performance, and, consistent with industry practice, we define operating income as revenues less the related cost of producing the revenues and general and administrative expenses.
We internally manage our operations by reference to "segment operating income,"
which is defined as operating income before the Operating FAS/CAS Adjustment and
non-current state income taxes, neither of which affects segment performance.
Segment operating income is not a recognized measure under GAAP. When analyzing
our operating performance, investors should use segment operating income in
addition to, and not as an alternative for, operating income or any other
performance measure presented in accordance with GAAP. It is a measure we use to
evaluate our core operating performance. We believe segment operating income
reflects an additional way of viewing aspects of our operations that, when
viewed with our GAAP results, provides a more complete understanding of factors
and trends affecting our business. We believe the measure is used by investors
and is a useful indicator to measure our performance. Because not all companies
use identical calculations, our presentation of segment operating income may not
be comparable to similarly titled measures of other companies.
The following table reconciles operating income to segment operating income:
Three Months Ended
March 31 2021 over 2020
($ in millions) 2021 2020 Dollars Percent
Operating income $ 147 $ 215 $ (68) (32) %
Operating FAS/CAS Adjustment 40 (63) 103 163 %
Non-current state income taxes 4 4 - - %
Segment operating income $ 191 $ 156 $ 35 22 %
Segment Operating Income
Segment operating income for the three months ended March 31, 2021 , was $191
million , compared with segment operating income of $156 million for the same
period in 2020. The increase was primarily driven by higher risk retirement on
Bougainville (LHA 8) and on Block IV of the Virginia class (SSN 774) submarine
program, improved performance on DFS services and nuclear and environmental
services, partially offset by lower risk retirement on the RCOH of USS George
Washington (CVN 73).
Activity within each segment is discussed in Segment Operating Results below.
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FAS/CAS Adjustment and Operating FAS/CAS Adjustment
The FAS/CAS Adjustment reflects the difference between expenses for pension and
other postretirement benefits determined in accordance with GAAP ("FAS") and the
expenses for these items included in segment operating income in accordance with
U.S. Cost Accounting Standards ("CAS"). The Operating FAS/CAS Adjustment
excludes the following components of net periodic benefit costs: interest cost,
expected return on plan assets, amortization of prior service cost (credit) and
actuarial loss (gain), and settlement and curtailment effects.
Effective
The components of the Operating FAS/CAS Adjustment were as follows:
Three Months Ended
March 31 2021 over 2020
($ in millions) 2021 2020 Dollars Percent
FAS expense $ (7) $ (17) $ 10 59 %
CAS cost 13 110 (97) (88) %
FAS/CAS Adjustment 6 93 (87) (94) %
Non-operating retirement benefit (46) (30) (16) (53) %
Operating FAS/CAS Adjustment $ (40) $ 63 $ (103) (163) %
The Operating FAS/CAS Adjustment was a net expense of $40 million and a net
benefit of $63 million for the three months ended March 31, 2021 and 2020,
respectively. The unfavorable change in the Operating FAS/CAS Adjustment from
2020 to 2021 was primarily driven by the more immediate recognition of higher
interest rates under CAS.
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 was
Interest Expense
Interest expense for the three months ended
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, 2021 , the favorable change in the non-operating retirement benefit of$16 million , was primarily driven by higher 2020 returns on plan assets.
Other, Net
Other, net income increased
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Federal and Foreign Income Taxes
Our effective income tax rates on earnings from operations for the three months
ended March 31, 2021 and 2020, were 14.5% and 20.4%, respectively. The lower
effective tax rate for the three months ended March 31, 2021 , was primarily
attributable to the tax loss associated with the sale of our oil and gas
business resulting in a reduction in the effective tax rate of 5.5%.
For the three months ended March 31, 2021 , our effective tax rate differed from
the federal statutory tax rate primarily as a result of the tax loss associated
with the sale of our oil and gas business. For the three months ended March 31,
2020 , our effective tax rate did not differ materially from the federal
statutory corporate income tax rate of 21%. See Note 11: Income Taxes.
SEGMENT OPERATING RESULTS
Basis of Presentation
We are aligned into three reportable segments: Ingalls,
The following table presents segment operating results:
Three Months Ended
March 31 2021 over 2020
($ in millions) 2021 2020 Dollars Percent
Sales and Service Revenues
Ingalls $ 649 $ 629 $ 20 3 %
Newport News 1,407 1,341 66 5 %
Technical Solutions 259 317 (58) (18) %
Intersegment eliminations (37) (24) (13) (54) %
Sales and service revenues $ 2,278 $ 2,263 $ 15 1 %
Operating Income
Ingalls $ 91 $ 68 $ 23 34 %
Newport News 93 95 (2) (2) %
Technical Solutions 7 (7) 14 200 %
Segment operating income 191 156 35 22 %Non-segment factors affecting operating income (loss) Operating FAS/CAS Adjustment
(40) 63 (103) (163) %
Non-current state income taxes (4) (4) - - %
Operating income $ 147 $ 215 $ (68) (32) %
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.
Segment Operating Income (Loss)
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
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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
Three Months Ended
March 31
($ in millions) 2021 2020
Gross favorable adjustments $ 86 $ 61
Gross unfavorable adjustments (36) (29)
Net adjustments $ 50 $ 32
For the three months ended March 31, 2021 , favorable cumulative catch-up
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.
For the three months ended March 31, 2020 , favorable cumulative catch-up
adjustments were related to risk retirement on the Virginia class (SSN 774)
submarine program, the RCOH of USS George Washington (CVN 73), the San Antonio
class (LPD 17) program, and other individually insignificant adjustments. During
the same period, none of the unfavorable cumulative catch-up adjustments were
individually significant.
Ingalls
Three Months Ended
March 31 2021 over 2020
($ in millions) 2021 2020 Dollars Percent
Sales and service revenues $ 649 $ 629 $ 20 3 %
Segment operating income 91 68 23 34 %
As a percentage of segment sales 14.0 % 10.8 %
Sales and Service Revenues
Ingalls revenues for the three months ended March 31, 2021 , increased $20
million , or 3%, from the same period in 2020, primarily driven by higher
revenues in surface combatants, partially offset by lower revenues in the Legend
class NSC program. Surface combatant revenues increased due to higher volumes on
George M. Neal (DDG 131), Jeremiah Denton (DDG 129), and Jack H. Lucas (DDG
125), partially offset by lower volumes on USS Fitzgerald (DDG 62) restoration
and modernization following its redelivery and Delbert D. Black (DDG 119)
following its delivery. Revenues on the Legend class NSC program decreased due
to lower volumes on Stone (NSC 9) following its delivery. Amphibious assault
ship revenues were flat as a result of higher volumes on Pittsburgh (LPD 31),
Bougainville (LHA 8), and LHA 9 (unnamed), partially offset by lower volumes on
Richard M. McCool Jr . (LPD 29), Fort Lauderdale (LPD 28), and USS Tripoli (LHA
7).
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Segment Operating Income
Ingalls segment operating income for the three months ended March 31, 2021 , was
$91 million , compared with $68 million for the same period in 2020. The increase
was primarily driven by higher risk retirement on Bougainville (LHA 8).
Newport News
Three Months Ended
March 31 2021 over 2020
($ in millions) 2021 2020 Dollars Percent
Sales and service revenues $ 1,407 $ 1,341 $ 66 5 %
Segment operating income 93 95 (2) (2) %
As a percentage of segment sales 6.6 % 7.1 %
Sales and Service Revenues
Newport News revenues for the three months endedMarch 31, 2021 , increased$66 million , or 5%, from the same period in 2020, primarily driven by higher revenues in aircraft carriers, naval nuclear support services, and submarines. Aircraft carrier revenues increased primarily as a result of higher volumes on Enterprise (CVN 80), the RCOH of USS John C. Stennis (CVN 74), andDoris Miller (CVN 81), partially offset by lower volumes on Kennedy (CVN 79) and the RCOH of USS George Washington (CVN 73). Naval nuclear support services revenues increased primarily as a result of higher volumes in carrier and submarine fleet support services, offset by lower volume in facility maintenance services. Submarine revenues increased primarily as a result of higher volumes on theColumbia class submarine program and theVirginia class (SSN 774) submarine program. The higher volume on theVirginia class (SSN 774) submarine program was due to higher volumes on Block V boats, offset by lower volumes on Block IV boats.
Segment Operating Income
Newport News segment operating income for the three months endedMarch 31, 2021 , was$93 million , compared with segment operating income of$95 million for the same period in 2020. The decrease was primarily due to lower risk retirement on the RCOH of USS George Washington (CVN 73), partially offset by higher risk retirement on Block IV of theVirginia class (SSN 774) submarine program. Technical Solutions Three Months Ended March 31 2021 over 2020 ($ in millions) 2021 2020 Dollars Percent Sales and service revenues$ 259 $ 317 $ (58) (18) % Segment operating income 7 (7) 14 200 % As a percentage of segment sales 2.7 % (2.2) %
Sales and Service Revenues
Technical Solutions revenues for the three months endedMarch 31, 2021 , decreased$58 million , or 18%, from the same period in 2020, primarily due to the divestitures of our oil and gas business andSan Diego Shipyard , as well as lower volumes in DFS services, partially offset by the acquisition of Hydroid inMarch 2020 . 30 -------------------------------------------------------------------------------- Table of Contents Segment Operating Income (Loss) Technical Solutions segment operating income for the three months endedMarch 31, 2021 , was$7 million , compared with a loss of$7 million for the same period in 2020. The increase was primarily driven by improved performance on DFS services and nuclear and environmental services, as well as a gain on the sale of our oil and gas business. BACKLOG Total backlog as ofMarch 31, 2021 , andDecember 31, 2020 , was approximately$48.8 billion and$46.0 billion , respectively. Total backlog includes both funded backlog (firm orders for which funding is contractually obligated by the customer) and unfunded backlog (firm orders for which funding is not currently contractually obligated by the customer). Backlog excludes unexercised contract options and unfunded IDIQ orders. For contracts having no stated contract values, backlog includes only the amounts committed by the customer.
The following table presents funded and unfunded backlog by segment as of
March 31, 2021
Total Total
($ in millions) Funded Unfunded Backlog Funded Unfunded Backlog
Ingalls $ 10,516 $ 1,687 $ 12,203 $ 10,443 $ 1,758 $ 12,201
Newport News 13,321 22,247 35,568 9,536 23,132 32,668
Technical Solutions 754 304 1,058 502 646 1,148
Total backlog $ 24,591 $ 24,238 $ 48,829 $ 20,481 $ 25,536 $ 46,017
Approximately 16% of the $46.0 billion total backlog as of December 31, 2020 , is
expected to be converted into sales in 2021. U.S. Government orders comprised
substantially all of the backlog as of March 31, 2021 , and December 31, 2020 .
Awards
The value of new contract awards during the three months endedMarch 31, 2021 , was approximately$5.3 billion , comprised primarily of awards for the RCOH of the USS John C. Stennis (CVN 74), construction of a 10th boat of theVirginia class (SSN 774) submarine program, and construction ofJohn F. Lehman (DDG 137).
LIQUIDITY AND CAPITAL RESOURCES
We seek to efficiently convert operating results into cash for deployment in
operating our businesses, implementing our business strategy, and maximizing
stockholder value. We use various financial measures to assist in capital
deployment decision making, including net cash provided by operating activities
and free cash flow. We believe these measures are useful to investors in
assessing our financial performance.
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The following table summarizes key components of cash flow provided by operating
activities:
Three Months Ended 2021 over
March 31 2020
($ in millions) 2021 2020 Dollars
Net earnings $ 148 $ 172 $ (24)
Depreciation and amortization 67 59 8
Stock-based compensation 9 7 2
Deferred income taxes 31 18 13
Gain on disposition of business (3) - (3)
Loss (gain) on investments in marketable securities (4) 16 (20)
Retiree benefit funding less than (in excess of) expense (65) (13) (52)
Trade working capital decrease (increase) (140) (191) 51
Net cash provided by operating activities $ 43 $ 68 $ (25)
Cash Flows
We discuss below our major operating, investing, and financing activities for
the three months ended March 31, 2021 and 2020, as classified on our unaudited
condensed consolidated statements of cash flows.
Operating Activities
Cash provided by operating activities for the three months endedMarch 31, 2021 , was$43 million , compared with$68 million provided by operating activities for the same period in 2020. The unfavorable change in operating cash flow was primarily due to higher contributions to retiree benefit plans, partially offset by a federal income tax refund and changes in trade working capital. The change in trade working capital was primarily driven by the timing of receipts of accounts receivable and payments of accounts payable. For the three months endedMarch 31, 2021 , we made discretionary contributions to our qualified defined benefit pension plans totaling$60 million , compared with$20 million of discretionary contributions for the same period in 2020. As ofMarch 31, 2021 , we anticipate no further significant cash contributions to our qualified defined benefit pension plans in 2021. 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 next 12 months.
Investing Activities
Cash used in investing activities for the three months endedMarch 31, 2021 , was$46 million , compared with$444 million used in investing activities for the same period in 2020. The change in investing cash was driven by the acquisition of Hydroid in 2020, disposition of our oil and gas business in 2021, and lower capital expenditures in 2021, partially offset by the acquisition of a non-controlling interest in Titan in 2021. For 2021, 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 2.0 % to 3.0% of annual revenues. Financing Activities Cash used in financing activities for the three months endedMarch 31, 2021 , was$102 million , compared with$329 million provided by financing activities for the same period in 2020. The change in financing cash was primarily due to a decrease in net proceeds from revolving credit facility borrowings of$380 million , a decrease of net proceeds from issuances of commercial paper of$88 million , and a$4 million increase in cash dividend payments, partially offset by a decrease of$35 million from common stock repurchases and a decrease of$6 million in employee taxes on certain share-based payment arrangements. 32
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Free Cash Flow
Free cash flow represents cash provided by (used in) operating activities less
capital expenditures net of related grant proceeds. Free cash flow is not a
measure recognized under GAAP. Free cash flow has limitations as an analytical
tool and should not be considered in isolation from, or as a substitute for,
analysis of our results as reported under GAAP. We believe free cash flow is an
important liquidity measure for our investors because it provides them insight
into our current and period-to-period performance and our ability to generate
cash from continuing operations. We also use free cash flow as a key operating
metric in assessing the performance of our business and as a key performance
measure in evaluating management performance and determining incentive
compensation. Free cash flow may not be comparable to similarly titled measures
of other companies.
The following table reconciles net cash provided by operating activities to free
cash flow:
Three Months Ended 2021 over
March 31 2020
($ in millions) 2021 2020 Dollars
Net cash provided by operating activities $ 43 $ 68 $ (25)
Less capital expenditures:
Capital expenditure additions (60) (71) 11
Grant proceeds for capital expenditures 1 5 (4)
Free cash flow $ (16) $ 2 $ (18)
Free cash flow for the three months ended March 31, 2021 , decreased $18 million
from the same period in 2020, primarily due to higher contributions to retiree
benefit plans, partially offset by a federal income tax refund, changes in trade
working capital, 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, 2021 and 2020, 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, 2021 ,$15 million in letters of credit were issued but undrawn and$272 million of surety bonds were outstanding. As ofMarch 31, 2021 , 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. Forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those expressed in these statements. Factors that may cause such differences include: •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); 33 -------------------------------------------------------------------------------- Table of Contents •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; •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; •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. 34
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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. We delivered USS Tripoli (LHA 7) inFebruary 2020 , and 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 the U.S. Navy's primary surface
combatant, and have been constructed in variants,
allowing technologicaladvances during construction. In
2019 we delivered USS Paul Ignatius (DDG 117), and in
2020 we delivered USS Delbert
have contracts to construct
the following
class (DDG 51) destroyers:
121), Lenah H. Sutcliffe Higbee (DDG 123), Jack H.
Lucas (DDG 125), Ted Stevens (DDG 128),
(DDG 129), George M. Neal (DDG 131), Sam Nunn (DDG
133), Thad Cochran (DDG 135), and John F. Lehman (DDG
137).
Carrier RCOH Perform refueling and complex overhaul ("RCOH") of
nuclear-powered aircraftcarriers, which is required at
the mid-point of their 50-year life cycle. USS Abraham
Lincoln (CVN 72) was
redelivered to the
the second quarter of 2017 and USS George Washington
(CVN 73) arrived at Newport News for the start of its
RCOH in August 2017 .
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 teamingagreement with Electric Boat to
build modules for the entire Columbia class (SSBN 826)
submarine program that leverages our Virginia class
(SSN 774) experience. We have been awarded contracts
from Electric Boat to begin integrated product and
process development andprovide long-lead-time material
and advance construction for the Columbia class (SSBN
826) program. Construction of the first Columbia class
(SSBN 826) submarine began in 2020.
Defense and federal solutions DFS is focused on solving tough national security
challenges for the DoD , the intelligence community, and
federal civilian agencies around the globe. The group's
expertise includes maritime fleet sustainment;
intelligence, surveillance, and reconnaissance; cyber
operations; secure enterprise information technology
engineering and operations; advanced modeling,
simulation, and training; and logistics management.
35-------------------------------------------------------------------------------- Table of Contents USS Gerald R.Ford class (CVN 78) Design and construction for theFord 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 the Ford class, was delivered to the
U.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 ofengineering, 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) and Doris Miller
(CVN 81). This category also includes the class'
non-recurring engineering. The class is expected to
bring improved warfightingcapability, 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 service U.S. Navy nuclear ships
worldwide through mobile and in-house capabilities.
Services include maintenance services on nuclear reactor
prototypes.
Nuclear and environmental services Provide services in nuclear management and operations,
including site management, nuclear and industrial
facilities operations and maintenance, decontamination
and decommissioning,radiological and hazardous waste
management services, and technical engineering services.
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
are an integrated subcontractor to Triad National
Security. N3B was awarded the Los Alamos Legacy Cleanup
Contract at the DoE/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 Aiken, South Carolina . Triad
provides site management and operations at the DoE's Los
Alamos National Laboratory .
San 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 forAmphibious 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 the
transformation. We are currently constructing Fort
Lauderdale (LPD 28), Richard M. McCool Jr . (LPD 29), and
Harrisburg (LPD 30). In 2020 we were awarded a contract
to construct Pittsburgh (LPD 31).
Unmanned systems Our unmanned systems products and services create
advanced unmanned maritime solutions for defense, marine
research, and commercialapplications. 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.
36-------------------------------------------------------------------------------- Table of ContentsVirginia 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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