NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Huntington Ingalls Industries, Inc. ("HII" or the "Company") is one of America’s largest military shipbuilding companies and a provider of professional services to partners in government and industry. HII is organized into
three
reportable segments: Ingalls Shipbuilding ("Ingalls"), Newport News Shipbuilding ("Newport News"), and Technical Solutions. For more than a century, the Company's Ingalls segment in Mississippi and Newport News segment in Virginia have built more ships in more ship classes than any other U.S. naval shipbuilder. The Technical Solutions segment, established in the fourth quarter of 2016, provides a range of services to the governmental, energy, and oil and gas markets.
HII conducts most of its business with the U.S. Government, principally the Department of Defense ("DoD"). As prime contractor, principal subcontractor, team member, or partner, the Company participates in many high-priority U.S. defense technology programs. Through its Ingalls segment, HII is a builder of amphibious assault and expeditionary ships for the U.S. Navy, the sole builder of National Security Cutters for the U.S. Coast Guard, and one of only two companies that builds the Navy's current fleet of
Arleigh Burke
class (DDG 51) destroyers. Through its Newport News segment, HII is the nation's sole designer, builder and refueler of nuclear-powered aircraft carriers, and one of only two companies currently designing and building nuclear-powered submarines for the U.S. Navy. The Technical Solutions segment provides a wide range of professional services, including fleet support, integrated missions solutions, nuclear and environmental, and oil and gas services.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
- The consolidated financial statements of HII and its subsidiaries have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP") and the instructions to Form 10-K promulgated by the Securities and Exchange Commission ("SEC"). All intercompany transactions and balances are eliminated in consolidation. For classification of current assets and liabilities related to its long-term production contracts, the Company uses the duration of these contracts as its operating cycle, which is generally longer than one year.
Accounting Estimates
- The preparation of the Company's consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best available information, and actual results could differ materially from those estimates.
The Bipartisan Budget Act of 2015 established limits on U.S. Government discretionary spending, including defense spending, and provided sequestration relief for 2016 and 2017. Sequestration remains in effect for 2018 through 2021 and could result in significant decreases in DoD spending that could negatively impact the Company's revenues and its estimated recovery of goodwill and other long-lived assets.
Revenue Recognition
- The majority of the Company's business is derived from long-term contracts for the construction of naval vessels, production of goods, and provision of services, primarily to the U.S. Government. In accounting for these contracts, the Company extensively utilizes the cost-to-cost measure of the percentage-of-completion method of accounting, primarily based upon total costs incurred. Under this method, sales, including estimated earned fees or profits, are recorded as costs are incurred, generally based on the percentage that total costs incurred bear to total estimated costs at completion. Certain contracts contain provisions for price redetermination or for cost and/or performance incentives. Such redetermined amounts or incentives are included in sales when the amounts can reasonably be determined and estimated. Amounts representing contract change orders, claims, requests for equitable adjustment, or limitations in funding are included in sales only when they can be reliably estimated and realization is probable. The Company estimates profit as the difference between total estimated revenues and total estimated cost of a contract and recognizes that profit over the life of the contract based on progress toward completion. If the Company estimates a contract will result in a loss, the full amount of the estimated loss is recognized against income in the period in which the loss is identified.
The Company classifies contract revenues as product sales or service revenues depending upon the predominant attributes of the relevant underlying contracts. The Company recognizes changes in estimates of contract sales, costs, and profits using the cumulative catch-up method of accounting. This method recognizes in the current period the cumulative effect of the changes on current and prior periods. Accordingly, the effect of the changes on future periods of contract performance is recognized as if the revised estimate had been the original estimate.
For the
years ended
December 31, 2017
,
2016
, and
2015
, net cumulative catch-up adjustments increased operating income by
$204 million
,
$224 million
, and
$239 million
, respectively, and increased diluted earnings per share by
$2.90
,
$3.08
, and
$3.21
, respectively. Cumulative catch-up adjustments for the
year ended
December 31, 2016
, included favorable adjustments of
$74 million
on a contract at the Ingalls segment
,
which increased diluted earnings per share by
$1.02
. No individual adjustment was material to the Company's consolidated statements of operations and comprehensive income (loss) for the
years ended
December 31, 2017
and
2015
.
For services contracts not associated with the design, development, manufacture, or modification of complex equipment, revenues are recognized upon delivery or as services are rendered once persuasive evidence of an arrangement exists, the price is fixed or determinable, and collectibility is reasonably assured. Costs related to these contracts are expensed as incurred.
Government Grants -
The Company recognizes incentive grants, inclusive of transfers of depreciable assets, from federal, state, and local governments at fair value upon compliance with the conditions of their receipt and reasonable assurance that the grants will be received or the depreciable assets will be transferred. Grants in recognition of specific expenses are recognized in the same period as an offset to those related expenses. Grants related to depreciable assets are recognized over the periods and in the proportions in which depreciation expense on those assets is recognized.
For the
year ended
December 31, 2017
, the Company recognized cash grant benefits of approximately
$21 million
in other long-term liabilities in the consolidated statements of financial position. For the
year ended
December 31, 2016
, the Company recognized grant benefits of approximately
$30 million
in depreciable assets. The Company recognized approximately
$15 million
in other income and gains within the consolidated statements of operations and comprehensive income (loss), and approximately
$15 million
in grant benefits in other long-term liabilities in the consolidated statements of financial position. For the
year ended
December 31, 2015
, the Company recognized no grant benefits.
General and Administrative Expenses
- In accordance with industry practice and regulations that govern the cost accounting requirements for government contracts, most general corporate expenses incurred at both the segment and corporate locations are 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 as an element of cost.
General and administrative expenses also include certain other costs that do not affect segment operating income, primarily consisting of the FAS/CAS Adjustment and the provision for non-current state income taxes. The FAS/CAS Adjustment reflects the difference between pension and postretirement benefits expenses determined in accordance with U.S. Financial Accounting Standards ("FAS") and pension and postretirement benefit expenses allocated to individual contracts in accordance with U.S. Cost Accounting Standards ("CAS"). 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 uncertain tax positions in the relevant period.
Research and Development
- Company-sponsored research and development activities primarily include independent research and development ("IR&D") related to experimentation, design, development, and test activities for government programs. IR&D expenses are included in general and administrative expenses and are generally allocable to government contracts. Company-sponsored IR&D expenses totaled
$17 million
,
$19 million
, and
$19 million
for the
years ended
December 31, 2017
,
2016
, and
2015
, respectively. Expenses for research and development sponsored by the customer are charged directly to the related contracts.
Product Warranty Costs
- The Company provides certain product warranties that require repair or replacement of non-conforming items for a specified period of time often subject to a specified monetary coverage limit. The Company's product warranties are provided under government contracts, the costs of which are immaterial and are included in contract costs for purposes of using the percentage-of-completion method of accounting.
Environmental Costs
- Environmental liabilities are accrued when the Company determines remediation costs are probable and such amounts are reasonably estimable. When only a range of amounts is established and no amount within the range is more probable than another, the minimum amount in the range is recorded. Environmental liabilities are recorded on an undiscounted basis and are not material. Environmental expenditures are expensed or capitalized as appropriate. Capitalized expenditures, if any, relate to long-lived improvements in currently operating facilities. The Company does not record insurance recoveries before collection is probable and, as of
December 31, 2017
and
2016
, did not have any accrued receivables related to insurance reimbursements or recoveries for environmental matters.
Fair Value of Financial Instruments
- The accounting standard for fair value measurements provides a framework for measuring fair value and requires expanded disclosures regarding fair value measurements. Fair value is defined as the price that would be received for an asset or the exit price that would be paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. The accounting standard provides a fair value hierarchy, which requires an entity to maximize the use of observable inputs, where available. The three levels of inputs consist of:
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Level 1:
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Quoted prices in active markets for identical assets and liabilities.
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Level 2:
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Observable inputs, other than Level 1 prices, such as: quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or that the Company corroborates with observable market data for substantially the full term of the related assets or liabilities.
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Level 3:
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Unobservable inputs supported by little or no market activity that are significant to the fair value of the assets and liabilities.
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Except for the Company's long-term debt, the carrying amounts of the Company's financial instruments recorded at historical cost approximate fair value due to the short-term nature of the instruments and low credit risk associated with the respective counterparties.
The Company maintains multiple grantor trusts to fund certain non-qualified pension plans. These trusts were valued at
$94 million
and
$82 million
as of
December 31, 2017
and
2016
, respectively, and are presented within miscellaneous other assets within the consolidated statements of financial position. These trusts consist primarily of available-for-sale investments in marketable securities, which are held at fair value within Level 1 of the fair value hierarchy.
Foreign Currency Translation
- The Company's international subsidiaries that do not have the U.S. dollar as their functional currency translate assets and liabilities at current rates of exchange in effect at the balance sheet date. Revenues and expenses from these international subsidiaries are translated using the monthly average exchange rates in effect for the periods in which the items occur. The cumulative foreign currency translation gains and losses are included as a component of accumulated other comprehensive income (loss) in stockholders’ equity. Gains and losses from foreign currency transactions are included in other income (expense) in the consolidated statements of operations and comprehensive income (loss). Such amounts are not material.
Asset Retirement Obligations
- Environmental remediation and/or asset decommissioning may be required when the Company ceases to utilize certain facilities. The Company records, within other current liabilities or other long-term liabilities as appropriate, all known asset retirement obligations for which the liability's fair value can be reasonably estimated, including certain asbestos removal, asset decommissioning, and lease restoration obligations.
The changes in the asset retirement obligation carrying amounts for the years ended
December 31, 2017
,
2016
, and
2015
, were as follows:
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($ in millions)
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Asset Retirement Obligations
|
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Balance as of December 31, 2014
|
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$
|
22
|
|
|
Liabilities settled
|
|
(4
|
)
|
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Revision of estimate
|
|
(1
|
)
|
|
Accretion expense
|
|
1
|
|
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Balance as of December 31, 2015
|
|
18
|
|
|
Accretion expense
|
|
1
|
|
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Balance as of December 31, 2016
|
|
19
|
|
|
Liabilities settled
|
|
(1
|
)
|
|
Accretion expense
|
|
1
|
|
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Balance as of December 31, 2017
|
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$
|
19
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|
The Company also has known conditional asset retirement obligations related to assets currently in use, including certain asbestos remediation and asset decommissioning activities to be performed in the future, that were not reasonably estimable as of
December 31, 2017
, due to insufficient information about the timing and method of settlement of the obligation. Accordingly, the fair value of these obligations has not been recorded in the consolidated financial statements. A liability for these obligations is recorded in the period in which sufficient information regarding timing and method of settlement becomes available to make a reasonable estimate of the liability's fair value. In addition, there may be conditional environmental asset retirement obligations that the Company has not yet discovered.
Income Taxes
- Income tax expense and other related information are based on the prevailing statutory rates for U.S. federal income taxes and the composite state income tax rate for the Company for each period presented. 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 uncertain tax positions in the relevant period. These amounts are recorded within operating income, while the current period state income tax expense, which is generally considered allowable and allocable, is charged to contract costs and included in cost of sales and service revenues in segment operating income.
Deferred income taxes are recorded when revenues and expenses are recognized in different periods for financial statement purposes and for tax return purposes. Deferred tax asset or liability account balances are calculated at the balance sheet date using current tax laws and rates expected to be in effect when the deferred tax items reverse in future periods. As a result of the reduction in the corporate income tax rate from
35%
to
21%
effective January 1, 2018, under the Tax Cuts and Jobs Act (the "Tax Act"), the Company revalued its net deferred tax assets as of December 31, 2017. This reduced the Company's net deferred tax assets by $56 million, which was recorded as additional income tax expense for the year ended December 31, 2017.
The Company recognizes deferred tax assets to the extent it believes these assets are more likely than not to be realized. In making such a determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. Based on the Company's evaluation of these deferred tax assets, valuation allowances of
$12 million
and
$11 million
were deemed necessary as of
December 31, 2017
and
2016
, respectively.
Uncertain tax positions meeting the more-likely-than-not recognition threshold, based on the merits of the position, are recognized in the financial statements. The Company recognizes the amount of tax benefit that is greater than
50%
likely to be realized upon ultimate settlement with the related tax authority. If a tax position does not meet the minimum statutory threshold to avoid payment of penalties, the Company recognizes an expense for the amount of the penalty in the period the tax position is claimed or expected to be claimed in its tax return. Penalties and accrued interest related to uncertain tax positions are recognized as a component of income tax expense. Changes in accruals associated with uncertain tax positions are recorded in earnings in the period in which they are determined.
Cash and Cash Equivalents
- The carrying amounts of cash and cash equivalents approximate fair value due to the short-term nature of these assets, which have original maturity dates of
90 days
or less.
Concentration Risk
- The Company’s assets that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents. The Company places its cash and cash equivalents with reputable financial institutions and limits the amount of credit exposure with any one of them. The Company regularly evaluates the creditworthiness of these financial institutions and minimizes this credit risk by entering into transactions with high-quality counterparties, limiting the exposure to each counterparty, and monitoring the financial condition of its counterparties.
In connection with its U.S. Government contracts, the Company is required to procure certain raw materials, components, and parts from supply sources approved by the U.S. Government. Only one supplier may exist for certain components and parts required to manufacture the Company's products.
Accounts Receivable
- Accounts receivable include amounts billed and currently due from customers, amounts currently due but unbilled, certain estimated contract change amounts, claims or requests for equitable adjustment in negotiation that are probable of recovery, and amounts retained by the customer pending contract completion.
Inventoried Costs
- Inventoried costs primarily relate to production costs of contracts in process and company owned raw materials, which are stated at the lower of cost or net realizable value, generally using the average cost method. Under the Company's U.S. Government contracts, the customer asserts title to, or a security interest in, inventories related to such contracts as a result of contract advances, performance-based payments, and progress payments. In accordance with industry practice, inventoried costs are classified as a current asset and include amounts related to contracts having production cycles longer than one year. Inventoried costs also include work in process under contracts that recognize revenues using labor dollars as the basis of the percentage-of-completion calculation. These costs represent accumulated contract costs less cost of sales as calculated using the percentage-of-completion method, not in excess of recoverable value.
Advance Payments and Billings in Excess of Revenues -
Payments received in excess of inventoried costs and revenues are recorded as advance payment liabilities.
Property, Plant, and Equipment -
Depreciable properties owned by the Company are recorded at cost and depreciated over the estimated useful lives of individual assets. Major improvements are capitalized while expenditures for maintenance, repairs, and minor improvements are expensed. Costs incurred for computer software developed or obtained for internal use are capitalized and amortized over the expected useful life of the software, not to exceed
nine
years. Leasehold improvements are amortized over the shorter of their useful lives or the term of the lease.
The remaining assets are depreciated using the straight-line method, with the following lives:
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Years
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Land improvements
|
|
2
|
|
-
|
|
40
|
|
Buildings and improvements
|
|
2
|
|
-
|
|
60
|
|
Capitalized software costs
|
|
2
|
|
-
|
|
9
|
|
Machinery and other equipment
|
|
2
|
|
-
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|
45
|
The Company evaluates the recoverability of its property, plant, and equipment when there are changes in economic circumstances or business objectives that indicate the carrying value may not be recoverable. The Company's evaluations include estimated future cash flows, profitability, and other factors affecting fair value. As these assumptions and estimates may change over time, it may or may not be necessary to record impairment charges.
Leases
- The Company uses its incremental borrowing rate in the assessment of lease classification as capital or operating and defines the initial lease term to include renewal options determined to be reasonably assured. The Company conducts operations primarily under operating leases.
Many of the Company's real property lease agreements contain incentives for tenant improvements, rent holidays, or rent escalation clauses. For incentives for tenant improvements, the Company records a deferred rent liability and amortizes the deferred rent over the term of the lease as a reduction to rent expense. For rent holidays and rent escalation clauses during the lease term, the Company records minimum rental expenses on a straight-line basis over the term of the lease. For purposes of recognizing lease incentives, the Company uses the date of initial possession as the commencement date, which is generally the date on which the Company is given the right of access to the space and begins to make improvements in preparation for the intended use.
Goodwill and Other Intangible Assets
- The Company performs impairment tests for goodwill as of November 30 of each year and between annual impairment tests if evidence of potential impairment exists, by comparing the carrying value of net assets to the fair value of the reporting unit. If the fair value is determined to be less than the carrying value, the Company records an impairment charge to the reporting unit. Purchased intangible assets are amortized on a straight-line basis or a method based on the pattern of benefits over their estimated useful lives, and the carrying value of these assets is reviewed for impairment when events indicate that a potential impairment may have occurred.
Equity Method Investments
- Investments in which the Company has the ability to exercise significant influence over the investee but does not own a majority interest or otherwise control are accounted for under the equity method of accounting and included in other assets in its consolidated statements of financial position. The Company's equity investments align strategically and are integrated with the Company's operations. Accordingly, the Company's share of the net earnings or losses of the investee is included in operating income (loss). The Company evaluates its equity investments for other than temporary impairment whenever events or changes in business circumstances indicate that the carrying amounts of such investments may not be fully recoverable. If a decline in the value of an equity method investment is determined to be other than temporary, a loss is recorded in earnings in the current period.
Self-Insured Group Medical Insurance
- The Company maintains a self-insured group medical insurance plan. The plan is designed to provide a specified level of coverage for employees and their dependents. Estimated liabilities for incurred but not paid claims utilize actuarial methods based on various assumptions, which include, but are not limited to, HII's historical loss experience and projected loss development factors. These liabilities are recorded in other current liabilities and account for less than
5%
of the total current liabilities balance.
Self-Insured Workers' Compensation Plan
- The operations of the Company are subject to federal and state workers' compensation laws. The Company maintains self-insured workers' compensation plans and participates in federally administered second injury workers' compensation funds. The Company estimates the liability for claims and funding requirements on a discounted basis utilizing actuarial methods based on various assumptions, which include, but are not limited to, the Company's historical loss experience and projected loss development factors as compiled in an annual actuarial study. Self-insurance accruals include amounts related to the liability for reported claims and an estimated accrual for claims incurred but not reported. The Company's workers' compensation liability was discounted at
2.35%
and
2.54%
as of
December 31, 2017
and
2016
, respectively. These discount rates were determined using a risk-free rate based on future payment streams. Workers' compensation benefit obligations on an undiscounted basis were
$925 million
and
$835 million
as of
December 31, 2017
and
2016
, respectively.
Litigation, Commitments, and Contingencies
- Amounts associated with litigation, commitments, and contingencies are recorded as charges to earnings when management, after taking into consideration the facts and circumstances of each matter, including any settlement offers and projected loss or claim development factors, has determined it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated.
Restructuring -
The Company has recorded accruals for restructuring activities in other current liabilities. These accruals include estimates primarily related to facility consolidations and closures, asset retirement obligations, long-lived asset write-downs, employment reductions, and contract termination costs. Actual costs may vary from these estimates. Restructuring related accruals are reviewed and adjusted when circumstances require such a change.
Retirement Related Benefit Costs
- The Company accounts for its retirement related benefit plans on the accrual basis. The measurements of obligations, costs, assets, and liabilities require significant judgment. The costs of benefits provided by defined benefit pension plans are recorded in the period participating employees provide service. The costs of benefits provided by other postretirement benefit plans are recorded in the period participating
employees attain full eligibility. The discount rate assumption is defined under GAAP as the rate at which a plan's obligation could be effectively settled. The discount rate is established for each of the retirement related benefit plans at its respective measurement date.
The expected return on plan assets component of retirement related costs is used to calculate net periodic expense. Unless plan assets and benefit obligations are subject to remeasurement during the year, the expected return on assets is based on the fair value of plan assets at the beginning of the year. The costs of plan amendments that provide benefits already earned by plan participants (prior service costs and credits) are deferred in accumulated other comprehensive income and amortized over the expected future service period of active participants as of the date of amendment. Actuarial gains and losses arising from differences between assumptions and actual experience or changes in assumptions are deferred in accumulated other comprehensive income. This unrecognized amount is amortized to the extent it exceeds
10%
of the greater of the plan's benefit obligation or plan assets. The amortization period for actuarial gains and losses is the estimated remaining service life of the plan participants.
The Company recognizes the funded status of each retirement related benefit plan as an asset or liability in its consolidated statements of financial position. The funded status represents the difference between the plan's benefit obligation and the fair value of the plan's assets. Unrecognized deferred amounts, such as demographic or asset gains or losses and the impacts of plan amendments, are included in accumulated other comprehensive income and amortized as described above.
Stock Compensation
- Stock-based compensation value is determined based on the closing market price of the Company's common stock on grant date, and the expense is recognized over the vesting period. At each reporting date, the number of shares is adjusted to equal the number ultimately expected to vest based on the Company's expectations regarding the relevant performance and service criteria.
Related Party Transactions
- On March 29, 2011, HII entered into a Separation and Distribution Agreement (the "Separation Agreement") with its former parent company, Northrop Grumman Corporation ("Northrop Grumman"), and Northrop Grumman's subsidiaries (Northrop Grumman Shipbuilding, Inc. and Northrop Grumman Systems Corporation), pursuant to which HII was legally and structurally separated from Northrop Grumman. In connection with the spin-off, HII also entered into a Tax Matters Agreement with Northrop Grumman related to taxes prior to the spin-off as described in Note 13: Income Taxes. Under all spin-off related agreements, the Company was due
$8 million
and
$33 million
from Northrop Grumman as of
December 31, 2017
and
2016
, respectively. As of
December 31, 2017
and
2016
, the Company had
$84 million
outstanding under Industrial Revenue Bonds issued by the Mississippi Business Finance Corporation. Prior to the spin-off, repayment of principal and interest was guaranteed by Northrop Grumman Systems Corporation. The guaranty remains in effect, and the Company has agreed to indemnify Northrop Grumman Systems Corporation for any losses related to the guaranty.
3. ACCOUNTING STANDARDS UPDATES
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, “Revenue from Contracts with Customers (Topic 606)”, which will replace existing requirements in U.S. GAAP, including industry-specific requirements, significantly expand the disclosure requirements, and provide companies with a single revenue recognition model for recognizing revenue from contracts with customers. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. In July 2015, the FASB approved the deferral of the new standard's effective date by one year. The new standard is effective for annual reporting periods beginning after December 15, 2017. The FASB permitted companies to adopt the new standard early, but not before the original effective date of annual reporting periods beginning after December 15, 2016.
As part of the Company's corporate governance structure, the Company established an implementation team comprised of key stakeholders across the Company's businesses. The Company developed a plan to identify and implement applicable changes to its business processes, systems, and controls. These changes are necessary to support recognition and disclosure under the new standard. In the first quarter of 2017, the Company reached a point in its assessment to support a transition decision based on information obtained to date. Based on its
evaluation, the Company will adopt the requirements of the new standard in the first quarter of 2018 utilizing the modified retrospective method. As a result, the Company will present the cumulative effect of applying the standard at the date of initial application, January 1, 2018.
The Company has completed its evaluation of the impact of the accounting and disclosure changes on its business processes, controls, and systems and, as a result, has redefined its accounting policies affected by this standard and enhanced internal controls over financial reporting related to the standard. The assessment of the majority of the Company's contracts under the new standard supports the recognition of revenue over time using the cost-to-cost measurement under the percentage of completion method, which is consistent with the Company's current revenue recognition practices. As such, the revenue on the majority of the Company's contracts will continue to be recognized over time considering the continuous transfer of control to the customer. Under U.S. Government contracts, this continuous transfer of control to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay the Company for costs incurred plus a reasonable profit, and take control of any work in process. ASU 2014-09 also requires expanded disclosures regarding the nature, timing, and uncertainty of revenue and customer contract balances, including how and when the Company satisfies its performance obligations and the relationship between revenue recognized and changes in contract balances during a reporting period. The Company has evaluated these disclosure requirements and is incorporating the collection of relevant data into its business processes. The Company does not expect the new standard to have a material effect on its consolidated financial position, results of operations, or cash flows.
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”, which establishes a right-of-use model that requires a lessee to record the right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations and comprehensive income. This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those reporting periods. Early adoption is permitted and should be applied using a modified retrospective approach. The Company is in the process of evaluating the potential impacts of ASU 2016-02 on its consolidated financial statements and disclosures, contracting and accounting processes, internal controls, and information technology systems.
In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”, which eliminates the performance of Step 2 from the goodwill impairment test. In performing its annual or interim impairment testing, an entity will instead compare the fair value of the reporting unit with its carrying amount and recognize any impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss. The Company elected to adopt ASU 2017-04 as of November 30, 2017. The adoption of ASU 2017-04 did not have a material impact on the Company's consolidated financial statements and disclosures, accounting processes, or internal controls.
In March 2017, the FASB issued ASU 2017-07, “Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost”. The update requires employers to present the service cost component of the net periodic benefit cost in the same income statement line item as other employee compensation costs arising from services rendered during the period. The other components of net benefit cost, including interest cost, expected return on plan assets, amortization of prior service cost/credit and actuarial gain/loss, and settlement and curtailment effects, are to be presented outside of any subtotal of operating income. Employers will have to disclose the line(s) used to present the other components of net periodic benefit cost, if the components are not presented separately in the income statement. ASU 2017-07 is effective for fiscal years and interim periods beginning after December 15, 2017, and early adoption is permitted.
The Company expects the adoption of ASU 2017-07 will change the net FAS/CAS pension adjustment within operating income, which will be offset by a corresponding change in Other income (expense), as a result of reclassifying interest cost, expected return on plan assets, amortization of prior service cost/credit and actuarial gain/loss, and settlement and curtailment effects of net periodic benefit expense from operating income to Other income (expense). Additionally, the remaining FAS/CAS Adjustment within operating income will be reclassified from General and administrative expenses to Cost of product sales and service revenues. The Company adopted ASU 2017-07 on January 1, 2018 using the retrospective method and does not expect the impact to 2017 and 2016 operating income to be material when it is recast to reflect the new standard. The Company does not expect ASU 2017-07 to have a material impact on its consolidated statements of financial position, cash flows, accounting processes, or internal controls.
In May 2017, the FASB issued ASU 2017-10, "Service Concession Arrangements (Topic 853): Determining the Customer of the Operation Services", which addresses how an operating entity should determine the customer for operations under a service concession arrangement. The update clarifies that the grantor is the customer of the operation services in all cases for these arrangements. This standard is effective for annual reporting periods beginning after December 15, 2017. The FASB permitted companies to adopt the new standard early, but not before the original effective date of annual reporting periods beginning after December 15, 2016. The Company is currently evaluating the impact of ASU 2017-10 on its consolidated financial statements and disclosures, accounting processes, or internal controls.
Other pronouncements issued but not effective until after December 31, 2017, are not expected to have a material impact on the Company's consolidated financial position, results of operations, or cash flows.
4. AVONDALE
In 2010, plans were announced to consolidate the Company's Ingalls shipbuilding operations by winding down shipbuilding at the Avondale, Louisiana facility in 2013 after completion of LPD-class ships that were under construction at this facility. In October 2014, the Company ceased shipbuilding construction operations at the Avondale facility.
In connection with and as a result of the decision to wind down shipbuilding at the Avondale facility, the Company began incurring and paying related costs, including, but not limited to, severance expense, relocation expense, and asset write-downs related to the Avondale facilities. Pursuant to applicable provisions of the Federal Acquisition Regulation ("FAR") and Cost Accounting Standards for the treatment of restructuring and shutdown related costs, the Company has been amortizing the deferred costs over a five year period since 2014, when the Company ceased shipbuilding construction operations at the Avondale facility.
The Company engaged in communications and negotiations with the U.S. Government beginning in 2010 regarding the amount and recovery of the Company's restructuring and shutdown costs. On November 16, 2017, the U.S. Government and the Company reached a settlement of the Company’s claim for restructuring costs. Under the terms of the settlement,
$251 million
is being treated as allowable costs. Any future gain or loss associated with disposition of the land, facilities, and capital assets located at Avondale was excluded from the settlement and will be recorded by the Company at the time of disposition. The settlement was consistent with management’s cost recovery expectations and did not have a material effect on the Company's consolidated financial position or results of operations. The Company anticipates that a majority of these restructuring and shutdown related costs will be billed to the U.S. Government and collected by the end of 2018.
Effective July 31, 2017, the Company entered into a Purchase and Sale Agreement with a potential buyer of the Avondale facility. After conducting due diligence on the property, the potential buyer has the right to determine whether or not to proceed to closing. As of
December 31, 2017
, the assets related to the Avondale facility were recorded at
$23 million
in land within property, plant, and equipment, net and
$124 million
in contract working capital within inventoried costs, accounts receivable and advance payments and billings in excess of revenues in the consolidated statements of financial position.
5. GULFPORT
In September 2013, the Company announced the closure of its Gulfport Composite Center of Excellence in Gulfport, Mississippi, part of the Ingalls reportable segment, which it completed in August 2014. In connection with this closure, the Company incurred total costs of
$54 million
, consisting of
$52 million
in accelerated depreciation of fixed assets and
$2 million
in personnel, facility shutdown, and other related costs. In March 2015, the Company sold the Gulfport Composite Center of Excellence to the Mississippi State Port Authority for
$32 million
, resulting in a gain on disposition of
$9 million
, recorded as a reduction to contract costs in accordance with the terms of the Company’s contracts with the U.S. Government.
The Company has received communications from the Supervisor of Shipbuilding questioning the Company's treatment and proposed allocation of the Gulfport closure costs. The Company has responded to such communications with the position that its proposed accounting and allocation of the closure costs complies with applicable law, and the Company and the U.S. Government remain in discussions about the proper accounting and allocation of such costs. While the Company anticipates a resolution that is substantially in accordance with
management's cost recovery expectations, any inability to recover such costs substantially in accordance with the Company's cost recovery expectations could result in a material effect on the Company’s consolidated financial position, results of operations, or cash flows.
6. ACQUISITIONS
On December 1, 2016, the Company acquired, for approximately
$369 million
in cash, net of
$27 million
of cash acquired, Camber Holding Corporation ("Camber"), a provider of mission-based and information technology solutions to the U.S. Government. The acquisition was consistent with the Company's strategy to optimize and expand its services portfolio. For the year ended
December 31, 2017
, Camber contributed revenues of
$309 million
and operating income of
$8 million
. In connection with this acquisition, the Company recorded
$261 million
of goodwill, all of which was allocated to its Technical Solutions segment, primarily related to the value of Camber's workforce, and
$76 million
of intangible assets related to existing contract backlog. See Note 11: Goodwill and Other Intangible Assets. For the year ended
December 31, 2017
, the Company recorded a goodwill adjustment of
$17 million
, primarily driven by the finalization of fair value calculations for certain assets and liabilities, as well as the net working capital adjustment. The assets, liabilities, and results of operations of Camber are not material to the Company’s consolidated financial position, results of operations, or cash flows.
On January 30, 2015, the Company acquired, for approximately
$6 million
in cash, the assets of the Engineering Solutions Division ("ESD") of The Columbia Group. ESD, a leading designer and builder of unmanned underwater vehicles for domestic and international customers, is operating as the Undersea Solutions Corporation ("USC"). As the U.S. Navy increases employment of unmanned vehicles in both the surface and undersea domains, this acquisition enhances the Company's ability to compete in these markets. In connection with this acquisition, the Company recorded
$4 million
of goodwill, all of which was allocated to its Newport News segment, primarily attributed to USC's specialized and skilled employees, and
$1 million
of intangible assets, primarily related to technology. See Note 12: Goodwill and Other Intangible Assets. The assets, liabilities, and results of operations of USC are not material to the Company’s consolidated financial position, results of operations, or cash flows.
The Company funded each of these acquisitions using cash on hand. The acquisition costs incurred in connection with these acquisitions were not material. The operating results of these businesses have been included in the Company’s consolidated results as of the respective closing dates of the acquisitions. In allocating the purchase prices of these businesses, the Company considered the estimated fair value of net tangible and intangible assets acquired, with any excess purchase price recorded as goodwill. The total amount of goodwill resulting from these acquisitions expected to be deductible for tax purposes was
$155 million
. These acquisitions are not material either individually or in the aggregate, and pro forma revenues and results of operations have therefore not been provided.
7. STOCKHOLDERS' EQUITY
Common Stock
- Changes in the Company's number of outstanding shares for the year ended
December 31, 2017
, resulted from shares purchased in the open market under the Company's stock repurchase program and share activity under its stock compensation plans. See Note 19: Stock Compensation Plans.
Treasury Stock
-
In October 2015, the Company's board of directors authorized an increase in the stock repurchase program from
$600 million
to
$1.2 billion
. In November 2017, the Company's board of directors authorized an increase in the Company's stock repurchase program from
$1.2 billion
to
$2.2 billion
and an extension of the term of the program from October 31, 2019, to October 31, 2022.
Repurchases are made from time to time at management's discretion in accordance with applicable federal securities laws. For the year ended
December 31, 2017
, the Company repurchased
1,417,808
shares at an aggregate cost of
$288 million
, of which
$2 million
was not yet settled for cash as of
December 31, 2017
. For the years ended
December 31, 2016
and
2015
, the Company repurchased
1,266,192
and
1,987,550
shares, respectively, at aggregate costs of
$192 million
and
$234 million
, respectively, of which
$2 million
was not yet settled for cash as of December 31, 2015. The cost of purchased shares is recorded as treasury stock in the consolidated statements of financial position.
Dividends
- In November 2017, the Company's board of directors authorized an increase in the Company's quarterly cash dividend from
$0.60
per share to
$0.72
per share. In November 2016, the Company's board of directors authorized an increase in the Company's quarterly cash dividend from
$0.50
per share to
$0.60
per share. In October 2015, the Company's board of directors authorized an increase in the Company's quarterly cash dividend from
$0.40
per share to
$0.50
per share. The Company paid cash dividends totaling
$115 million
(
$2.52
per share),
$98 million
(
$2.10
per share), and
$81 million
(
$1.70
per share) in the years ended
December 31, 2017
,
2016
, and
2015
, respectively.
Accumulated Other Comprehensive Income
- Other comprehensive income (loss) refers to gains and losses recorded as an element of stockholders' equity but excluded from net earnings (loss). The accumulated other comprehensive loss as of
December 31, 2017
and
2016
, was comprised of unamortized benefit plan costs of
$906 million
and
$948 million
, respectively, and other comprehensive income (loss) items of
$6 million
and
$(3) million
, respectively.
The changes in accumulated other comprehensive income (loss) by component for the years ended
December 31, 2017
,
2016
, and
2015
, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
|
Benefit Plans
|
|
Other
|
|
Total
|
|
Balance as of December 31, 2014
|
|
$
|
(864
|
)
|
|
$
|
2
|
|
|
$
|
(862
|
)
|
|
Other comprehensive income (loss) before reclassifications
|
|
(53
|
)
|
|
(5
|
)
|
|
(58
|
)
|
|
Amounts reclassified from accumulated other comprehensive income (loss)
|
|
|
|
|
|
|
|
Amortization of prior service cost (credit)
1
|
|
(1
|
)
|
|
—
|
|
|
(1
|
)
|
|
Amortization of net actuarial loss (gain)
1
|
|
88
|
|
|
—
|
|
|
88
|
|
|
Tax benefit (expense) for items of other comprehensive income
|
|
(13
|
)
|
|
1
|
|
|
(12
|
)
|
|
Net current period other comprehensive income (loss)
|
|
21
|
|
|
(4
|
)
|
|
17
|
|
|
Balance as of December 31, 2015
|
|
(843
|
)
|
|
(2
|
)
|
|
(845
|
)
|
|
Other comprehensive income (loss) before reclassifications
|
|
(249
|
)
|
|
(1
|
)
|
|
(250
|
)
|
|
Amounts reclassified from accumulated other comprehensive income (loss)
|
|
|
|
|
|
|
|
Amortization of prior service cost (credit)
1
|
|
(1
|
)
|
|
—
|
|
|
(1
|
)
|
|
Amortization of net actuarial loss (gain)
1
|
|
78
|
|
|
—
|
|
|
78
|
|
|
Tax benefit (expense) for items of other comprehensive income
|
|
67
|
|
|
—
|
|
|
67
|
|
|
Net current period other comprehensive income (loss)
|
|
(105
|
)
|
|
(1
|
)
|
|
(106
|
)
|
|
Balance as of December 31, 2016
|
|
(948
|
)
|
|
(3
|
)
|
|
(951
|
)
|
|
Other comprehensive income (loss) before reclassifications
|
|
(34
|
)
|
|
14
|
|
|
(20
|
)
|
|
Amounts reclassified from accumulated other comprehensive income (loss)
|
|
|
|
|
|
|
|
Amortization of net actuarial loss (gain)
1
|
|
93
|
|
|
—
|
|
|
93
|
|
|
Tax benefit (expense) for items of other comprehensive income
|
|
(17
|
)
|
|
(5
|
)
|
|
(22
|
)
|
|
Net current period other comprehensive income (loss)
|
|
42
|
|
|
9
|
|
|
51
|
|
|
Balance as of December 31, 2017
|
|
$
|
(906
|
)
|
|
$
|
6
|
|
|
$
|
(900
|
)
|
1
These accumulated comprehensive income (loss) components are included in the computation of net periodic benefit cost. See Note 18: Employee Pension and Other Postretirement Benefits. The tax expense associated with amounts reclassified from accumulated other comprehensive income (loss) for the years ended
December 31, 2017
,
2016
, and
2015
, was
$36 million
,
$27 million
, and
$30 million
, respectively.
8. EARNINGS PER SHARE
Basic and diluted earnings per common share were calculated as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
(in millions, except per share amounts)
|
|
2017
|
|
2016
|
|
2015
|
|
Net earnings (loss)
|
|
$
|
479
|
|
|
$
|
573
|
|
|
$
|
404
|
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding
|
|
45.7
|
|
|
46.8
|
|
|
47.9
|
|
|
Net effect of dilutive stock options and awards
|
|
0.1
|
|
|
0.4
|
|
|
0.4
|
|
|
Dilutive weighted-average common shares outstanding
|
|
45.8
|
|
|
47.2
|
|
|
48.3
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per share - basic
|
|
$
|
10.48
|
|
|
$
|
12.24
|
|
|
$
|
8.43
|
|
|
Earnings (loss) per share - diluted
|
|
$
|
10.46
|
|
|
$
|
12.14
|
|
|
$
|
8.36
|
|
The Company's calculation of diluted earnings per common share includes the dilutive effects of the assumed exercise of stock options and vesting of restricted stock based on the treasury stock method. Under the treasury stock method, the Company has excluded from the diluted share amounts presented above the effects
0.3 million
Restricted Performance Stock Rights ("RPSRs") for the
year ended
December 31, 2017
. The amounts presented above for the
year ended
December 31, 2016
, exclude the impact of
0.1 million
stock options and
0.3 million
RPSRs under the treasury stock method. The amounts presented above for the
year ended
December 31, 2015
, exclude the impact of
0.3 million
stock options and
0.7 million
RPSRs under the treasury stock method.
9. SEGMENT INFORMATION
The Company is organized into
three
reportable segments: Ingalls, Newport News, and Technical Solutions, consistent with how management makes operating decisions and assesses performance. The Technical Solutions segment was established in the fourth quarter of 2016 in conjunction with the Company's acquisition of Camber and realignment of management oversight of operations to enhance strategic and operational alignment among its services businesses. As a result of this realignment, the Company's non-nuclear fleet support and nuclear and environmental services were transferred from its Newport News segment to its Technical Solutions segment. The Company's oil and gas services were transferred from its Other segment to its Technical Solutions segment, and its Other segment was dissolved. The Company has reflected the 2016 segment realignment in prior reporting periods on a retrospective basis. None of these changes impacted the Company's previously reported consolidated financial position, results of operations, or cash flows.
U.S. Government Sales
- Revenues from the U.S. Government include revenues from contracts for which HII is the prime contractor, as well as contracts for which the Company is a subcontractor and the ultimate customer is the U.S. Government. The Company derived over
95%
of its revenues from the U.S. Government for each of the
years ended
December 31, 2017
,
2016
, and
2015
, respectively.
Assets
- Substantially all of the Company's assets are located or maintained in the United States.
Results of Operations by Segment
The following table presents the Company's operating results by segment.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
2015
|
|
Sales and Service Revenues
|
|
|
|
|
|
|
|
Ingalls
|
|
$
|
2,420
|
|
|
$
|
2,389
|
|
|
$
|
2,188
|
|
|
Newport News
|
|
4,164
|
|
|
4,089
|
|
|
4,298
|
|
|
Technical Solutions
|
|
952
|
|
|
691
|
|
|
616
|
|
|
Intersegment eliminations
|
|
(95
|
)
|
|
(101
|
)
|
|
(82
|
)
|
|
Total sales and service revenues
|
|
$
|
7,441
|
|
|
$
|
7,068
|
|
|
$
|
7,020
|
|
|
Operating Income (Loss)
|
|
|
|
|
|
|
|
Ingalls
|
|
$
|
313
|
|
|
$
|
321
|
|
|
$
|
379
|
|
|
Newport News
|
|
354
|
|
|
386
|
|
|
401
|
|
|
Technical Solutions
|
|
21
|
|
|
8
|
|
|
(113
|
)
|
|
Total segment operating income (loss)
|
|
688
|
|
|
715
|
|
|
667
|
|
|
Non-segment factors affecting operating income (loss)
|
|
|
|
|
|
|
|
FAS/CAS Adjustment
|
|
189
|
|
|
145
|
|
|
104
|
|
|
Non-current state income taxes
|
|
(12
|
)
|
|
(2
|
)
|
|
(2
|
)
|
|
Total operating income (loss)
|
|
$
|
865
|
|
|
$
|
858
|
|
|
$
|
769
|
|
Sales transactions between segments are generally recorded at cost.
Goodwill and Intangible Asset Impairment Charges
- The operating loss at the Technical Solutions segment for the year ended
December 31, 2015
, reflects goodwill impairment charges of
$75 million
and intangible asset impairment charges of
$27 million
.
Other Financial Information
The following tables present the Company's assets, capital expenditures, and depreciation and amortization by segment.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
2015
|
|
Assets
|
|
|
|
|
|
|
|
Ingalls
|
|
$
|
1,385
|
|
|
$
|
1,362
|
|
|
1,324
|
|
|
Newport News
|
|
3,350
|
|
|
3,169
|
|
|
3,061
|
|
|
Technical Solutions
|
|
642
|
|
|
692
|
|
|
303
|
|
|
Corporate
|
|
997
|
|
|
1,129
|
|
|
1,336
|
|
|
Total assets
|
|
$
|
6,374
|
|
|
$
|
6,352
|
|
|
$
|
6,024
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
2015
|
|
Capital Expenditures
(1)
|
|
|
|
|
|
|
|
Ingalls
|
|
$
|
131
|
|
|
$
|
97
|
|
|
$
|
53
|
|
|
Newport News
|
|
224
|
|
|
176
|
|
|
130
|
|
|
Technical Solutions
|
|
6
|
|
|
8
|
|
|
5
|
|
|
Corporate
|
|
—
|
|
|
4
|
|
|
—
|
|
|
Total capital expenditures
|
|
$
|
361
|
|
|
$
|
285
|
|
|
$
|
188
|
|
(1)
Net of grant proceeds for capital expenditures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
2015
|
|
Depreciation and Amortization
(1)
|
|
|
|
|
|
|
|
Ingalls
|
|
$
|
73
|
|
|
$
|
68
|
|
|
$
|
65
|
|
|
Newport News
|
|
107
|
|
|
109
|
|
|
102
|
|
|
Technical Solutions
|
|
25
|
|
|
9
|
|
|
13
|
|
|
Total depreciation and amortization
|
|
$
|
205
|
|
|
$
|
186
|
|
|
$
|
180
|
|
(1)
Excluding amortization of debt issuance costs
10. ACCOUNTS RECEIVABLE, NET
Accounts receivable includes unbilled amounts that represent sales for which billings have not been presented to customers at year-end. These amounts are usually billed and collected within one year. Accounts receivable billed but not paid by customers under retainage provisions in long-term contracts were
$64 million
and
$46 million
as of
December 31, 2017
and
2016
, respectively, substantially all of which were under U.S. Government contracts. Accounts receivable at
December 31, 2017
, are expected to be collected in
2018
, except for approximately
$77 million
due in 2019 and
$65 million
due in or after 2020.
Because the Company's accounts receivable are primarily with the U.S. Government or with companies acting as a contractor to the U.S. Government, the Company does not have material exposure to accounts receivable credit risk.
Accounts receivable were comprised of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
Due From U.S. Government
|
|
|
|
|
|
Amounts billed
|
|
$
|
277
|
|
|
$
|
249
|
|
|
Recoverable costs and accrued profit on progress completed - unbilled
|
|
733
|
|
|
830
|
|
|
|
|
1,010
|
|
|
1,079
|
|
|
Due From Other Customers
|
|
|
|
|
|
Amounts billed
|
|
167
|
|
|
69
|
|
|
Recoverable costs and accrued profit on progress completed - unbilled
|
|
26
|
|
|
20
|
|
|
|
|
193
|
|
|
89
|
|
|
Total accounts receivable
|
|
1,203
|
|
|
1,168
|
|
|
Allowances for doubtful accounts
|
|
(15
|
)
|
|
(4
|
)
|
|
Total accounts receivable, net
|
|
$
|
1,188
|
|
|
$
|
1,164
|
|
The Company has limited exposure to credit losses and maintains an allowance for anticipated losses considered necessary under the circumstances based on historical experience with uncollected customer accounts and a review of its currently outstanding accounts receivable. For the three months ended March 31, 2017, the Company
recorded a
$29 million
allowance for doubtful accounts within the Technical Solutions segment related to a commercial customer’s petition for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. For the three months ended June 30, 2017, and September 30, 2017, the Company released
$7 million
and
$13 million
, respectively, of the allowance for doubtful accounts following its receipt of bankruptcy related payments from its commercial customer. Additionally, certain payments totaling
$28 million
received from this customer may be reclaimed by the bankruptcy trustee if any such payments are determined to have been a preferential payment or similar transaction under applicable bankruptcy laws.
11. INVENTORIED COSTS, NET
Inventoried costs were comprised of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
Production costs of contracts in process
|
|
$
|
90
|
|
|
$
|
116
|
|
|
Raw material inventory
|
|
93
|
|
|
94
|
|
|
Total inventoried costs, net
|
|
$
|
183
|
|
|
$
|
210
|
|
12. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
HII performs impairment tests for goodwill as of November 30 of each year and between annual impairment tests if an event occurs or circumstances change that would more likely than not reduce the fair values of the Company's reporting units below their carrying values. Reporting units are aligned with the Company's businesses. The Company’s testing approach utilizes a combination of discounted cash flow analysis and comparative market multiples to determine the fair values of its businesses for comparison to their corresponding book values.
In connection with the Company’s annual goodwill impairment test as of November 30, 2017, management tested goodwill for each of its
four
reporting units. As a result of its annual goodwill impairment test, the Company determined that the estimated fair value of each reporting unit exceeded by more than
10%
its corresponding carrying value as of November 30, 2017.
In connection with the Company’s annual goodwill impairment test as of November 30, 2016, management tested goodwill for each of its
four
reporting units. As a result of its annual goodwill impairment test, the Company determined that the estimated fair value of each reporting unit exceeded by more than
10%
its corresponding carrying value as of November 30, 2016.
In conjunction with the Company's realignment of its operations on December 1, 2016, the Company allocated goodwill among new and realigned reporting units based on the relative fair values of the reporting units being realigned. As a result, during the fourth quarter of 2016, the Company performed a quantitative assessment of goodwill immediately after the realignment for each of the reporting units impacted by the Company's realignment. Based on this quantitative assessment, no impairment charge was necessary as a result of the realignment.
While the November 30, 2015, annual impairment test did not result in an impairment, considering the limited excess fair value of goodwill over its carrying value in the Oil and Gas reporting unit and the continued decline in oil prices and related industry activity levels, the Company performed an interim assessment of goodwill as of December 31, 2015. The Company’s determination of fair value as of December 31, 2015, considered industry events that occurred in the period since its annual goodwill impairment test, as well as the updated long term outlook for this reporting unit. Those events included continued deterioration in the oil and gas markets, numerous industry-wide project deferrals, and capital spending cuts announced by industry leaders. The analysis concluded the fair value of this reporting unit was less than its carrying value as of December 31, 2015, and the Company recorded a goodwill impairment charge of
$16 million
at the Oil and Gas reporting unit in the Technical Solutions segment in the fourth quarter of 2015.
The Company continuously monitors industry events and changes in circumstances in the industries in which its reporting units conduct business. In consideration of the Oil and Gas reporting unit’s sensitivity to developments within its industry, the continued decline in crude oil prices, significant reductions in its customer capital spending
plans, and project delays, management concluded that an interim goodwill impairment test was necessary to determine whether it was more likely than not that the fair value of its Oil and Gas reporting unit was still higher than its carrying value as of May 31, 2015. As a result of its analysis, the Company recorded a
$59 million
goodwill impairment charge in the Oil and Gas reporting unit at its Technical Solutions segment in the second quarter of 2015.
Accumulated goodwill impairment losses as of each of
December 31, 2017
and
2016
, were
$2,877 million
. The accumulated goodwill impairment losses for Ingalls as of each of
December 31, 2017
, and
2016
, were
$1,568 million
. The accumulated goodwill impairment losses for Newport News as of each of
December 31, 2017
, and
2016
, were
$1,187 million
. The accumulated goodwill impairment losses for the Technical Solutions segment as of each of
December 31, 2017
and
2016
, were
$122 million
.
During the year ended
December 31, 2017
, the Company recorded a goodwill adjustment of
$17 million
in the Technical Solutions segment, primarily driven by the finalization of fair value calculations for certain assets and liabilities, as well as the net working capital adjustment, related to the acquisition of Camber. For the year ended
December 31, 2016
, the Company recorded
$278 million
of goodwill related to its acquisition of Camber.
For the years ended
December 31, 2017
and
2016
, the carrying amounts of goodwill changed as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
|
Ingalls
|
|
Newport News
|
|
Technical Solutions
|
|
Total
|
|
Balance as of December 31, 2015
|
|
$
|
175
|
|
|
$
|
721
|
|
|
$
|
60
|
|
|
$
|
956
|
|
|
Acquisitions
|
|
—
|
|
|
—
|
|
|
278
|
|
|
278
|
|
|
Balance as of December 31, 2016
|
|
175
|
|
|
721
|
|
|
338
|
|
|
1,234
|
|
|
Adjustments
|
|
—
|
|
|
—
|
|
|
(17
|
)
|
|
(17
|
)
|
|
Balance as of December 31, 2017
|
|
$
|
175
|
|
|
$
|
721
|
|
|
$
|
321
|
|
|
$
|
1,217
|
|
Other Intangible Assets
The Company performs tests for impairment of long-lived assets whenever events or circumstances suggest that long-lived assets may be impaired. In December 2015, the Company performed an impairment test on the amortizable intangible assets that arose from the UPI acquisition, which reside in the Company’s Oil and Gas reporting unit within the Technical Solutions segment. The Oil and Gas asset group’s long lived intangible assets consist primarily of customer relationships and, to a lesser degree, trade name and developed technology. The Company performed its impairment test considering the latest market conditions and expectations, as well as lower anticipated revenue and profitability. Based on the nature of UPI's intangible assets, the Company performed the recoverability test at the reporting unit level. In connection with the recoverability test, the Company reevaluated the remaining useful lives of the intangible assets and determined the total undiscounted pretax cash flows generated by the reporting unit over the remaining useful life of the primary asset, customer relationships. The carrying amount of the reporting unit was greater than the total undiscounted pretax cash flows, and, as a result, the intangible assets were written down by
$27 million
, charged against cost of sales and service revenues within income from operations at the Technical Solutions segment, and the new carrying value was adjusted to be amortized using the pattern of benefits method over a weighted-average life of
seven
years.
In connection with the Camber purchase in 2016, the Company recorded
$76 million
of intangible assets pertaining to existing contract backlog and customer relationships, to be amortized using the pattern of benefits method over a weighted-average life of
10 years
. In connection with the USC purchase in 2015, the Company recorded
$1 million
of intangible assets pertaining to technology, to be amortized using the pattern of benefits method over a weighted-average life of
19 years
.
The Company's purchased intangible assets are being amortized on a straight-line basis or a method based on the pattern of benefits over their estimated useful lives. Net intangible assets consist primarily of amounts pertaining to nuclear-powered aircraft carrier and submarine program intangible assets, with an aggregate weighted-average useful life of
40 years
based on the long life cycle of the related programs. Aggregate amortization expense for the
years ended
December 31, 2017
,
2016
, and
2015
, was
$40 million
,
$23 million
, and
$26 million
, respectively.
The Company expects amortization for purchased intangible assets of
$36 million
in 2018,
$32 million
in 2019,
$28 million
in 2020,
$26 million
in 2021, and
$24 million
in 2022.
13. INCOME TAXES
Tax Reform -
The Tax Act, signed into law on December 22, 2017, provides for significant changes to U.S. federal income tax law, including a provision that allows for full expensing of certain qualified property, reduction of the federal corporate income tax rate from
35.0%
to
21.0%
, repeal of the manufacturing deduction, and further limitations on the deductibility of certain executive compensation. The Tax Act contains other provisions that are not expected to materially affect the Company, including requiring a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries that is payable over
eight years
, limitations on the deductibility of interest expense, and the creation of the base erosion anti-abuse tax.
The SEC staff issued Staff Accounting Bulletin ("SAB") 118, which provides guidance on accounting for the tax effects of the Tax Act, including a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under Accounting Standards Codification ("ASC") 740,
Income Taxes.
In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete. Provisional estimates for the income tax effects of the Tax Act can be recorded where a company’s accounting is incomplete but a reasonable estimate can be determined. If a company cannot determine a provisional estimate for the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax law that were in effect immediately before enactment of the Tax Act.
There are no material elements of the Tax Act for which the Company’s accounting is complete. While the Company's accounting for the following elements of the Tax Act is incomplete, the Company was able to make reasonable estimates of certain effects of such elements. Accordingly, the Company recorded provisional adjustments for the following significant items:
Reduction of the U.S. federal corporate income tax rate:
Beginning January 1, 2018, the Company’s income will be taxed at a
21.0%
federal rate, in contrast to the previous rate of
35.0%
. Under ASC 740,
Income Taxes
, deferred tax assets or liabilities must be recalculated as of the enactment date using current tax laws and rates expected to be in effect when the deferred tax items reverse in future periods. Consequently, the Company has recorded provisional decreases in its deferred tax assets and deferred tax liabilities of
$252 million
and
$196 million
, respectively, with a corresponding net adjustment to deferred income tax expense of
$56 million
for the year ended December 31, 2017. While the Company is able to make a reasonable estimate of the impact of the reduction in the U.S. federal rate, it may be affected by other analyses related to the Tax Act, including, but not limited to, accounting method changes for tax purposes that could result in adjustments to federal temporary differences.
Acceleration of Depreciation
: While the Company has not completed its determination of all capital expenditures that qualify for immediate expensing, for the year ended December 31, 2017, the Company recorded a provisional benefit of
$8 million
based on its current intent to fully expense all qualifying expenditures. This resulted in a decrease of approximately
$8 million
to the Company's current income taxes payable and a corresponding decrease in its net deferred tax asset excluding the effect of the reduction in the U.S. federal corporate tax rate.
The Company’s accounting for the following element of the Tax Act is incomplete and the Company is not yet able to make a reasonable estimate of the effect. Accordingly, no provisional adjustment was recorded.
Executive Compensation
: Effective January 1, 2018, the performance-based compensation exception to the
$1 million
deduction limitation of Internal Revenue Code Section 162(m) is repealed and the employees subject to the
$1 million
deduction limitation are revised to include the chief executive officer, the chief financial officer, and the next
three
most highly compensated employees required to be reported in the Company’s proxy statement. The only exception to this rule is for compensation that is paid pursuant to a binding contract in effect on November 2, 2017 that would have otherwise been deductible under prior Section 162(m) rules. Accordingly, any compensation paid in the future pursuant to new compensation arrangements entered into after November 2, 2017, even if performance based, will count toward the
$1 million
annual deduction limit if paid to an executive subject to Section 162(m). The Company has not yet completed an analysis of the binding contract requirement on the Company's various compensation plans to determine the impact of the law change.
The Company's earnings are primarily domestic and its effective tax rate on earnings from operations for the
year ended
December 31, 2017
, was
38.0%
, compared with
26.9%
and
36.1%
for
2016
and
2015
, respectively.
For the
year ended
December 31, 2017
, the Company's effective tax rate differed from the federal statutory rate
primarily as a result of the increase in deferred federal tax expense attributable to the recalculation of the Company's net deferred tax asset to reflect the impact of the federal tax rate decrease included in the Tax Act, partially offset by the income tax benefits resulting from stock award settlement activity and the domestic manufacturing deduction. For the year ended December 31, 2016, the Company’s effective tax rate differed from the federal statutory rate primarily as a result of the adoption of ASU 2016-09, which reduced income tax expense by the income tax benefits resulting from stock award settlement activity, a remeasurement of uncertain tax positions that resulted in a decrease in cumulative unrecognized tax benefits, and the domestic manufacturing deduction. The Company’s effective tax rate for the year ended December 31, 2015, differed from the federal statutory rate primarily as a result of the amount of the goodwill impairment that is not amortizable for tax purposes and other non-deductible expenses, partially offset by the domestic manufacturing deduction.
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 uncertain tax positions 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.
In connection with the spin-off from Northrop Grumman, HII entered into a Tax Matters Agreement with Northrop Grumman, which governs the respective rights, responsibilities, and obligations of Northrop Grumman and the Company with respect to tax liabilities and benefits, tax attributes, tax contests, and other tax sharing regarding U.S. federal, state, local, and foreign income taxes, other taxes, and related tax returns. The Company is severally liable with Northrop Grumman for its income taxes for periods before the spin-off. HII is obligated to indemnify Northrop Grumman for tax adjustments that increase the Company's taxable income for periods before the spin-off and are of a nature that could result in a correlative reduction in HII's taxable income for periods after the spin-off. Northrop Grumman is obligated to indemnify HII for tax adjustments that decrease the Company's taxable income for periods before the spin-off and are of a nature that could result in a correlative increase in HII's taxable income for periods after the spin-off. These payment obligations only apply once the aggregate tax liability related to tax adjustments exceeds
$5 million
. Once the aggregate amount is exceeded, only the amount in excess of
$5 million
is ultimately required to be paid. In 2016 and prior years, HII incurred non-cash federal and state tax adjustments for items governed by the Tax Matters Agreement. The federal tax expense (benefit) adjustment is reported as a component of tax expense, while the state tax expense (benefit) adjustment is treated as an allowable cost in the applicable period under the terms of the Company's existing contracts and is included in general and administrative expenses. In 2016, Northrop Grumman settled with the IRS for the years 2007 through the date of the spin-off, during which HII was part of its consolidated tax returns. Northrop Grumman’s 2007 through 2011 federal tax returns are currently subject to examination due to the filing of refund claims for those years.
Federal and foreign income tax expense for the
years ended
December 31, 2017
,
2016
, and
2015
, consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
2015
|
|
Income Taxes on Operations
|
|
|
|
|
|
|
|
Federal and foreign income taxes currently payable
|
|
$
|
121
|
|
|
$
|
134
|
|
|
$
|
242
|
|
|
Change in deferred federal and foreign income taxes
|
|
172
|
|
|
77
|
|
|
(14
|
)
|
|
Total federal and foreign income taxes
|
|
$
|
293
|
|
|
$
|
211
|
|
|
$
|
228
|
|
Earnings and income tax from foreign operations are not material for all periods presented.
Income tax expense differed from the amount based on the statutory federal income tax rate applied to earnings (loss) before income taxes due to the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
2015
|
|
Income tax expense (benefit) on operations at statutory rate
|
|
$
|
270
|
|
|
$
|
274
|
|
|
$
|
221
|
|
|
Provisional deferred tax asset revaluation - Tax Act
|
|
56
|
|
|
—
|
|
|
—
|
|
|
Goodwill impairment
|
|
—
|
|
|
—
|
|
|
11
|
|
|
Stock compensation - net excess tax benefits
|
|
(25
|
)
|
|
(29
|
)
|
|
—
|
|
|
Manufacturing deduction
|
|
(12
|
)
|
|
(21
|
)
|
|
(10
|
)
|
|
Uncertain tax positions
|
|
—
|
|
|
(15
|
)
|
|
—
|
|
|
Other, Net
|
|
4
|
|
|
2
|
|
|
6
|
|
|
Total federal and foreign income taxes
|
|
$
|
293
|
|
|
$
|
211
|
|
|
$
|
228
|
|
Unrecognized Tax Benefits -
Unrecognized tax benefits represent the gross value of the Company's uncertain tax positions that have not been reflected in the consolidated statements of operations. If the income tax benefits from federal tax positions are ultimately realized, such realization would affect the Company's income tax expense, while the realization of state tax benefits would be recorded in general and administrative expenses.
The changes in unrecognized tax benefits (exclusive of interest and penalties) for the
years ended
December 31, 2017
,
2016
, and
2015
are summarized in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
2015
|
|
Unrecognized tax benefits at beginning of the year
|
|
$
|
2
|
|
|
$
|
27
|
|
|
$
|
19
|
|
|
Additions based on tax positions related to the current year
|
|
—
|
|
|
1
|
|
|
8
|
|
|
Additions based on tax positions of prior years
|
|
—
|
|
|
2
|
|
|
3
|
|
|
Reductions based on tax positions of prior years
|
|
—
|
|
|
(15
|
)
|
|
—
|
|
|
Settlements
|
|
—
|
|
|
(11
|
)
|
|
(1
|
)
|
|
Statute of limitation expirations
|
|
(2
|
)
|
|
(2
|
)
|
|
(2
|
)
|
|
Net change in unrecognized tax benefits
|
|
(2
|
)
|
|
(25
|
)
|
|
8
|
|
|
Unrecognized tax benefits at end of the year
|
|
$
|
—
|
|
|
$
|
2
|
|
|
27
|
|
As of
December 31, 2017
and
2016
, the estimated amounts of the Company's uncertain tax positions, excluding interest and penalties, were liabilities of less than $1 million and
$2 million
, respectively. Assuming sustainment of these positions, as of
December 31, 2017
and
2016
, the reversal of less than
$1 million
and
$2 million
, respectively, of the amounts accrued would favorably affect the Company's effective federal income tax rate in future periods.
In 2016, the Company settled a state uncertain tax position through agreement with the applicable taxing authority. The net impact of the settlement was not material to HII’s consolidated financial position, results of operations, or cash flows.
The Company recognizes interest and penalties related to unrecognized tax benefits as income tax expense. Related to the unrecognized tax benefits noted above, there was a net decrease in income tax expense of
$1 million
in
2017
for interest and penalties, resulting in no material liability for interest and penalties as of
December 31, 2017
. The
2017
changes in interest and penalties related to statute of limitation expirations. In 2016, there was a net decrease in income tax expense of
$2 million
for interest and penalties, resulting in a total liability of
$1 million
for interest and penalties as of December 31, 2016. The
2016
changes in interest and penalties related to reductions in prior year tax positions and settlement with a taxing authority. There were no material changes to accrued interest or penalties during
2015
, and, as of
December 31, 2015
, the Company's liability for interest and penalties was
$3 million
.
The following table summarizes the tax years that are either currently under examination or remain open under the applicable statute of limitations and subject to examination by the major tax jurisdictions in which the Company operates:
|
|
|
|
|
|
|
|
|
|
|
Jurisdiction
|
|
Years
|
|
United States
|
|
2011
|
|
-
|
|
2016
|
|
Connecticut
|
|
2016
|
|
-
|
|
2016
|
|
Mississippi
|
|
2012
|
|
-
|
|
2016
|
|
Virginia
|
|
2012
|
|
-
|
|
2016
|
Although the Company believes it has adequately provided for all uncertain tax positions, amounts asserted by taxing authorities could be greater than the Company's accrued position. Accordingly, additional provisions for federal and state income tax related matters could be recorded in the future as revised estimates are made or the underlying matters are effectively settled or otherwise resolved. Conversely, the Company could settle positions with the tax authorities for amounts lower than have been accrued. The Company believes that it is reasonably possible that during the next 12 months the Company's liability for uncertain tax positions may decrease by less than
$1 million
due to resolution of a federal uncertain tax position.
During 2013 the Company entered into the pre-Compliance Assurance Process with the IRS for years 2011 and 2012. The Company is part of the IRS Compliance Assurance Process program for the 2014 through 2018 tax years. Open tax years related to state jurisdictions remain subject to examination.
Deferred Income Taxes -
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and for income tax purposes. As described above, deferred tax assets and liabilities are calculated as of the balance sheet date using current tax laws and rates expected to be in effect when the deferred tax items reverse in future periods. As a result of the reduction in the corporate income tax rate from
35.0%
to
21.0%
under the Tax Act, the Company revalued its net deferred tax assets as of December 31, 2017. Net deferred tax assets are classified as long-term deferred tax assets in the consolidated statements of financial position.
The tax effects of significant temporary differences and carry-forwards that gave rise to year-end deferred tax balances, as presented in the consolidated statements of financial position, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
Deferred Tax Assets
|
|
|
|
|
|
Retirement benefits
|
|
$
|
263
|
|
|
$
|
568
|
|
|
Workers' compensation
|
|
167
|
|
|
251
|
|
|
Reserves not currently deductible for tax purposes
|
|
44
|
|
|
56
|
|
|
Stock-based compensation
|
|
11
|
|
|
16
|
|
|
Net operating losses and tax credit carry-forwards
|
|
21
|
|
|
22
|
|
|
Other
|
|
—
|
|
|
7
|
|
|
Gross deferred tax assets
|
|
506
|
|
|
920
|
|
|
Less valuation allowance
|
|
12
|
|
|
11
|
|
|
Net deferred tax assets
|
|
494
|
|
|
909
|
|
|
Deferred Tax Liabilities
|
|
|
|
|
|
Depreciation and amortization
|
|
223
|
|
|
320
|
|
|
Contract accounting differences
|
|
51
|
|
|
108
|
|
|
Purchased intangibles
|
|
106
|
|
|
167
|
|
|
Gross deferred tax liabilities
|
|
380
|
|
|
595
|
|
|
Total net deferred tax assets
|
|
$
|
114
|
|
|
$
|
314
|
|
As of
December 31, 2017
, the Company had gross state income tax credit carry-forwards of approximately
$20 million
, which expire from 2018 through 2020. A deferred tax asset of approximately
$16 million
(net of federal benefit) has been established related to these state income tax credit carry-forwards, with a valuation allowance of
$7 million
against such deferred tax asset as of
December 31, 2017
. The Company had a gross state net operating loss carry-forward of
$39 million
, which expires in 2027. A deferred tax asset of approximately
$3 million
(net of federal benefit) has been established for the net operating loss carry-forward, with a full valuation allowance as of December 31, 2017. Other state and foreign net operating loss carry-forwards are separately and cumulatively immaterial to the Company’s deferred tax balances and expire between 2026 and 2036.
14. DEBT
Long-term debt consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
Senior notes due December 15, 2021, 5.000%
|
|
—
|
|
|
600
|
|
|
Senior notes due November 15, 2025, 5.000%
|
|
600
|
|
|
600
|
|
|
Senior notes due December 1, 2027, 3.483%
|
|
600
|
|
|
—
|
|
|
Mississippi economic development revenue bonds due May 1, 2024, 7.81%
|
|
84
|
|
|
84
|
|
|
Gulf opportunity zone industrial development revenue bonds due December 1, 2028, 4.55%
|
|
21
|
|
|
21
|
|
|
Less unamortized debt issuance costs
|
|
(26
|
)
|
|
(27
|
)
|
|
Total long-term debt
|
|
1,279
|
|
|
1,278
|
|
Credit Facility
- In November 2017, the Company terminated its Second Amended and Restated Credit Agreement and entered into a new Credit Agreement (the "Credit Facility") with third-party lenders. The Credit Facility includes a revolving credit facility of
$1,250 million
, which may be drawn upon during a period of
five
years from November 22, 2017. The revolving credit facility includes a letter of credit subfacility of
$500 million
. The revolving credit facility has a variable interest rate on outstanding borrowings based on the London Interbank Offered Rate ("LIBOR") plus a spread based upon the Company's credit rating, which may vary between
1.125%
and
1.500%
. The revolving credit facility also has a commitment fee rate on the unutilized balance based on the Company’s leverage ratio. The commitment fee rate as of
December 31, 2017
was
0.25%
and may vary between
0.20%
and
0.30%
.
The Credit Facility contains customary affirmative and negative covenants, as well as a financial covenant based on a maximum total leverage ratio. Each of the Company's existing and future material wholly owned domestic subsidiaries, except those that are specifically designated as unrestricted subsidiaries, are and will be guarantors under the Credit Facility.
In July 2015, the Company used cash on hand to repay all
amounts outstanding under a prior credit facility, including
$345 million
in principal amount of outstanding term loans.
As of
December 31, 2017
,
$15 million
in letters of credit were issued but undrawn, and the remaining
$1,235 million
of the revolving credit facility was unutilized. The Company had unamortized debt issuance costs associated with its credit facilities of
$11 million
and
$8 million
as of
December 31, 2017
and
2016
, respectively.
Senior Notes
- In December 2017, the Company issued
$600 million
aggregate principal amount of unregistered
3.483%
senior notes with registration rights due December 2027, the net proceeds of which were used to repurchase the Company's
5.000%
senior notes due in 2021 in connection with the 2017 redemption described below. In November 2015, the Company issued
$600 million
aggregate principal amount of unregistered
5.000%
senior notes due November 2025, the net proceeds of which were used to repurchase the Company's
7.125%
senior notes due in 2021 in connection with the 2015 tender offer and redemption described below. Interest on the Company's senior notes is payable semi-annually.
The terms of the
5.000%
and
3.483%
senior notes limit the Company’s ability and the ability of certain of its subsidiaries to create liens, enter into sale and leaseback transactions, sell assets, and effect consolidations or mergers. The Company had unamortized debt issuance costs associated with the senior notes of
$15 million
and
$19 million
as of
December 31, 2017
and
2016
, respectively.
Tender Offers and Redemptions
- During the fourth quarter of 2017, the Company completed a redemption of
$600 million
aggregate principal amount of its
5.000%
senior notes due in 2021.
During the fourth quarter of 2015, the Company completed a tender offer, followed by a redemption of untendered notes, to purchase for cash an aggregate principal amount of
$600 million
of its
7.125%
senior notes due in 2021.
Early Extinguishment of Debt
- Details of the loss on early extinguishment of debt related to the Company's prior credit facility and refinancing of senior notes, which was included in interest expense, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
2015
|
|
Redemption and tender premiums and fees
|
|
$
|
15
|
|
|
$
|
—
|
|
|
$
|
33
|
|
|
Write-off of unamortized debt issuance costs
|
|
7
|
|
|
—
|
|
|
11
|
|
|
Total loss on early extinguishment of debt
|
|
$
|
22
|
|
|
$
|
—
|
|
|
$
|
44
|
|
Mississippi Economic Development Revenue Bonds -
As of each of
December 31, 2017
and
2016
, the Company had
$84 million
outstanding under Industrial Revenue Bonds issued by the Mississippi Business Finance Corporation. These bonds accrue interest at a fixed rate of
7.81%
per annum (payable semi-annually) and mature in 2024. While repayment of principal and interest is guaranteed by Northrop Grumman Systems Corporation, HII has agreed to indemnify Northrop Grumman Systems Corporation for any losses related to the guaranty. In accordance with the terms of the bonds, the proceeds were used to finance the construction, reconstruction, and renovation of the Company's interest in certain ship manufacturing and repair facilities, or portions thereof, located in the state of Mississippi.
Gulf Opportunity Zone Industrial Development Revenue Bonds -
As of each of
December 31, 2017
and
2016
, the Company had
$21 million
outstanding under Gulf Opportunity Zone Industrial Development Revenue Bonds ("GO Zone IRBs") issued by the Mississippi Business Finance Corporation. These bonds accrue interest at a fixed rate of
4.55%
per annum (payable semi-annually) and mature in 2028. In accordance with the terms of the bonds, the proceeds were used to finance the construction, reconstruction, and renovation of the Company's interest in certain ship manufacturing and repair facilities, or portions thereof, located in the state of Mississippi.
The Company's debt arrangements contain customary affirmative and negative covenants, including a maximum leverage ratio. The Company was in compliance with all debt covenants during the year ended
December 31, 2017
.
The estimated fair values of the Company's total long-term debt, including current portions, as of
December 31, 2017
and
December 31, 2016
, were
$1,361 million
and
$1,372 million
, respectively. The fair values of the Company's long-term debt were calculated based on either recent trades of the Company's debt instruments in inactive markets or yields available on debt with substantially similar risks, terms, and maturities, which fall within Level 2 under the fair value hierarchy.
The Company does not have any principal payments due on long-term debt within the next five years.
15. INVESTIGATIONS, CLAIMS, AND LITIGATION
The Company is involved in legal proceedings before various courts and administrative agencies, and is periodically subject to government examinations, inquiries and investigations. Pursuant to FASB Accounting Standards Codification 450
Contingencies,
the Company has accrued for losses associated with investigations, claims, and litigation when, and to the extent that, loss amounts related to the investigations, claims, and litigation are probable and can be reasonably estimated. The actual losses that might be incurred to resolve such investigations, claims, and litigation may be higher or lower than the amounts accrued. For matters where a material loss is probable or reasonably possible and the amount of loss cannot be reasonably estimated, but the Company is able to reasonably estimate a range of possible losses, the Company will disclose such estimated range in these notes. This estimated range is based on information currently available to the Company and involves elements of judgment and significant uncertainties. Any estimated range of possible loss does not represent the Company's maximum possible loss exposure. For matters as to which the Company is not able to reasonably estimate a possible loss or range of loss, the Company will indicate the reasons why it is unable to estimate the possible loss or range of loss. For matters not specifically described in these notes, the Company does not believe, based on
information currently available to it, that it is reasonably possible that the liabilities, if any, arising from such investigations, claims, and litigation will have a material effect on its consolidated financial position, results of operations, or cash flows. The Company has, in certain cases, provided disclosure regarding certain matters for which the Company believes at this time that the likelihood of material loss is remote.
False Claims Act Complaints
- In 2015, the Company received a Civil Investigative Demand from the Department of Justice ("DoJ") relating to an investigation of certain allegedly non-conforming parts the Company purchased from one of its suppliers for use in connection with U.S. Government contracts. The Company has cooperated with the DoJ in connection with its investigation. In 2016, the Company was made aware that it is a defendant in a False Claims Act lawsuit filed under seal in the U.S. District Court for the Middle District of Florida related to the Company’s purchases of the allegedly non-conforming parts from the supplier. Depending upon the outcome of this matter, the Company could be subject to civil penalties, damages, and/or suspension or debarment from future U.S. Government contracts, which could have a material adverse effect on its consolidated financial position, results of operations, or cash flows. The matter remains sealed and given the current posture of the matter, the Company is unable to estimate an amount or range of reasonably possible loss or to express an opinion regarding the ultimate outcome.
U.S. Government Investigations and Claims
- Departments and agencies of the U.S. Government have the authority to investigate various transactions and operations of the Company, and the results of such investigations may lead to administrative, civil or criminal proceedings, the ultimate outcome of which could be fines, penalties, repayments or compensatory, treble, or other damages. U.S. Government regulations provide that certain findings against a contractor may also lead to suspension or debarment from future U.S. Government contracts or the loss of export privileges. Any suspension or debarment would have a material effect on the Company because of its reliance on government contracts.
In January 2013, the Company disclosed to the DoD, including the U.S. Navy, and the U.S. Department of Homeland Security, including the U.S. Coast Guard, pursuant to the FAR, that it had initiated an internal investigation regarding whether certain employees at Ingalls mischarged time or misstated progress on Navy and Coast Guard contracts. The Company conducted an internal investigation, led by external counsel, and took remedial actions, including the termination of employees in instances where the Company believed grounds for termination existed. The Company provided information regarding its investigation to the relevant government agencies, and agreed with the U.S. Navy and U.S. Coast Guard that they would initially withhold
$24 million
in payments on existing contracts pending receipt of additional information from the Company's internal investigation. The U.S. Navy subsequently reduced its portion of the withhold from
$18.2 million
to
$4.7 million
, and the U.S. Coast Guard reduced its withhold from
$5.8 million
to
$3.6 million
. In September 2017, the U.S. Navy and the U.S. Coast Guard paid the Company the respective remaining amounts they were withholding.
In June 2015, the DoJ informed the Company that it was investigating the matters disclosed by the Company to the DoD in January 2013. In August 2017, the Company settled the matters with the DoJ. The settlement did not have a material effect on the Company’s consolidated financial position, results of operations, or cash flows.
Asbestos Related Claims
- HII and its predecessors-in-interest are defendants in a longstanding series of cases that have been and continue to be filed in various jurisdictions around the country, wherein former and current employees and various third parties allege exposure to asbestos containing materials while on or associated with HII premises or while working on vessels constructed or repaired by HII. The cases allege various injuries, including those associated with pleural plaque disease, asbestosis, cancer, mesothelioma, and other alleged asbestos related conditions. In some cases, several of HII's former executive officers are also named as defendants. In some instances, partial or full insurance coverage is available to the Company for its liability and that of its former executive officers. The average cost per case to resolve cases during the years ended December 31,
2017
,
2016
, and
2015
was immaterial individually and in the aggregate. The Company’s estimate of asbestos-related liabilities is subject to uncertainty because liabilities are influenced by numerous variables that are inherently difficult to predict. Key variables include the number and type of new claims, the litigation process from jurisdiction to jurisdiction and from case to case, reforms made by state and federal courts, and the passage of state or federal tort reform legislation. Although the Company believes the ultimate resolution of current cases will not have a material effect on its consolidated financial position, results of operations, or cash flows, it cannot predict what new or revised claims or litigation might be asserted or what information might come to light and can, therefore, give no assurances regarding the ultimate outcome of asbestos related litigation.
Other Litigation
- The Company and its predecessor-in-interest have been in litigation with the Bolivarian Republic of Venezuela (the “Republic”) since 2002 over a contract for the repair, refurbishment, and modernization at Ingalls of
two
foreign-built frigates. The case proceeded towards arbitration, then appeared to settle favorably, but the settlement was overturned in court and the matter returned to litigation. In March 2014, the Company filed an arbitral statement of claim asserting breaches of the contract and
$173 million
in damages plus substantial interest and litigation expenses. In July 2014, the Republic filed in the arbitration a statement of defense denying all the Company’s allegations and a counterclaim alleging late redelivery of the frigates, unfinished work, and breach of warranty and asserting damages of
$61 million
plus interest. An arbitration hearing was held in January 2015, and the Company cannot predict when the arbitration panel will render a decision. No assurances can be provided regarding the ultimate outcome of this matter.
The Company is party to various other claims and legal proceedings that arise in the ordinary course of business. Although the Company believes that the resolution of these other claims and legal proceedings will not have a material effect on its consolidated financial position, results of operations, or cash flows, it cannot predict what new or revised claims or litigation might be asserted or what information might come to light and can, therefore, give no assurances regarding the ultimate outcome of these matters.
16. COMMITMENTS AND CONTINGENCIES
Contract Performance Contingencies
- Contract profit margins may include estimates of revenues for matters on which the customer and the Company have not reached agreement, such as settlements in the process of negotiation, contract changes, claims, and requests for equitable adjustment for previously unanticipated contract costs. These estimates are based upon management's best assessment of the underlying causal events and circumstances, and are included in determining contract profit margins to the extent of expected recovery based on contractual entitlements and the probability of successful negotiation with the customer. As of
December 31, 2017
, recognized amounts related to claims and requests for equitable adjustment were not material individually or in aggregate.
Guarantees of Performance Obligations -
From time to time in the ordinary course of business, HII may enter into joint ventures, teaming, and other business arrangements to support the Company's products and services. The Company generally strives to limit its exposure under these arrangements to its investment or the extent of obligations under the applicable contract. In some cases, however, HII may be required to guarantee performance of the arrangement's obligations and, in such cases, generally obtains cross-indemnification from the other members of the arrangement.
In the ordinary course of business, the Company may guarantee obligations of its subsidiaries under certain contracts. Generally, the Company is liable under such an arrangement only if its subsidiary is unable to perform its obligations. Historically, the Company has not incurred any substantial liabilities resulting from these guarantees. As of
December 31, 2017
, the Company was not aware of any existing event of default that would require it to satisfy any of these guarantees.
Environmental Matters
- The estimated cost to complete environmental remediation has been accrued where it is probable that the Company will incur such costs in the future to address environmental conditions at currently or formerly owned or leased operating facilities, or at sites where it has been named a Potentially Responsible Party ("PRP") by the Environmental Protection Agency or similarly designated by another environmental agency, and the related costs can be estimated by management. These accruals do not include any litigation costs related to environmental matters, nor do they include amounts recorded as asset retirement obligations. To assess the potential impact on the Company's consolidated financial statements, management estimates the range of reasonably possible remediation costs that could be incurred by the Company, taking into account currently available facts on each site, as well as the current state of technology and prior experience in remediating contaminated sites. These estimates are reviewed periodically and adjusted to reflect changes in facts and technical and legal circumstances. Management estimates that as of
December 31, 2017
, the probable future cost for environmental remediation was
$1 million
, which is accrued in other current liabilities. Factors that could result in changes to the Company's estimates include: modification of planned remedial actions, increases or decreases in the estimated time required to remediate, changes to the determination of legally responsible parties, discovery of more extensive contamination than anticipated, changes in laws and regulations affecting remediation requirements, and improvements in remediation technology. Should other PRPs not pay their allocable shares of remediation costs, the Company may incur costs exceeding those already estimated and accrued. Although management cannot predict whether new information gained as projects progress will materially affect the
estimated liability accrued, management does not believe that future remediation expenditures will have a material effect on the Company's consolidated financial position, results of operations, or cash flows. In addition, there are certain potential remediation sites where the costs of remediation cannot be reasonably estimated.
Financial Arrangements
- In the ordinary course of business, HII uses standby letters of credit issued by commercial banks and surety bonds issued by insurance companies primarily to support the Company's self-insured workers' compensation plans. As of
December 31, 2017
, the Company had
$15 million
in standby letters of credit issued but undrawn, as indicated in Note 14: Debt, and
$258 million
of surety bonds outstanding.
U.S. Government Claims
- From time to time, the U.S. Government communicates to the Company potential claims, disallowed costs, and penalties concerning prior costs incurred by the Company with which the U.S. Government disagrees. When such preliminary findings are presented, the Company and U.S. Government representatives engage in discussions, from which HII evaluates the merits of the claims and assesses the amounts being questioned. Although the Company believes that the resolution of any of these matters will not have a material effect on its consolidated financial position, results of operations, or cash flows, it cannot predict the ultimate outcome of these matters.
Collective Bargaining Agreements
- Of the Company's approximately
38,000
employees, approximately
50%
are covered by a total of
nine
collective bargaining agreements and two site stabilization agreements. Newport News has
four
collective bargaining agreements covering represented employees, one of which covers approximately
50%
of Newport News employees and was renewed July 2017. The remaining collective bargaining agreements at Newport News expire August 2018, December 2018, and November 2020. Newport News craft workers employed at the Kesselring Site near Saratoga Springs, New York are represented under an indefinite Department of Energy ("DoE") site agreement. Ingalls has
five
collective bargaining agreements covering represented employees, all of which expire in March 2022. Approximately
35
Technical Solutions craft employees at the Hanford Site near Richland, Washington are represented under an indefinite DoE site stabilization agreement. The Company believes its relationship with its employees is satisfactory.
Collective bargaining agreements generally expire after
three
to
five
years and are subject to renegotiation at that time. The Company does not expect the results of these negotiations, either individually or in the aggregate, to have a material effect on the Company's consolidated results of operations.
Purchase Obligations -
Periodically the Company enters into agreements to purchase goods or services that are enforceable and legally binding on the Company and specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum, or variable price provisions; and the approximate timing of the transaction. These obligations are primarily comprised of open purchase order commitments to vendors and subcontractors pertaining to funded contracts.
Operating Leases
- Rental expense for operating leases for the
years ended
December 31, 2017
,
2016
, and
2015
, was
$63 million
,
$69 million
, and
$62 million
, respectively. These amounts are net of immaterial amounts of sublease rental income. The amounts of minimum rental commitments under long-term non-cancellable operating leases for each of the years
2018
through
2022
and thereafter are:
|
|
|
|
|
|
|
|
|
($ in millions)
|
|
|
|
2018
|
|
$
|
39
|
|
|
2019
|
|
35
|
|
|
2020
|
|
28
|
|
|
2021
|
|
24
|
|
|
2022
|
|
17
|
|
|
Thereafter
|
|
51
|
|
|
Total
|
|
$
|
194
|
|
17. IMPACTS FROM HURRICANES
In August 2005, the Company's Ingalls operations were significantly impacted by Hurricane Katrina, and the Company's shipyards in Louisiana and Mississippi sustained significant windstorm damage from the hurricane. As a result of the storm, the Company incurred costs to replace or repair destroyed or damaged assets, suffered losses
under its contracts, and incurred substantial costs to clean up and recover its operations. At the time of the storm, the Company had an insurance program that provided coverage for, among other things, property damage, business interruption impact on net profitability, and costs associated with clean-up and recovery. The Company recovered
$677.5 million
of its Hurricane Katrina claim from participating program insurers, which included
$180 million
from Factory Mutual Insurance Company (“FM Global”) in settlement of litigation arising from a disagreement concerning the coverage of certain losses related to Hurricane Katrina.
In January 2011, the Company, through a predecessor-in-interest, filed suit in Superior Court in California against Aon Risk Insurance Services West, Inc. ("Aon"), which acted as broker to the predecessor-in-interest in connection with the policy with FM Global, seeking damages for breach of contract, professional negligence and negligent misrepresentation, as well as declaratory relief. Those included damages unrecovered from FM Global plus costs, legal fees, and expenses incurred in the lawsuit against FM Global, as well as interest. In January 2014, the Company amended its complaint to allege fraud and seek punitive damages.
In May 2015, the Company and Aon entered into a settlement agreement, pursuant to which Aon made a cash payment of
$150 million
to the Company and the Company released its claims against Aon. In the second quarter of 2015, the
$150 million
settlement was recorded as a gain in operating income and the Company recorded a credit to the U.S. Government, which resulted in a reduction in operating income of
$14 million
. Should the U.S. Government disagree with the Company’s allocation of proceeds, the Company may be required to allocate additional amounts to the U.S. Government. The
$150 million
gain and allowable cost credit resulted in a net favorable impact to operating income for the year ended December 31, 2015, of
$136 million
.
18. EMPLOYEE PENSION AND OTHER POSTRETIREMENT BENEFITS
The Company provides defined benefit pension plans and postretirement benefit plans to eligible employees. Non-collectively bargained defined benefit pension benefits accruing under the traditional years of service and compensation formula were amended in 2009 to freeze future service accruals and have been replaced with a cash balance benefit for all current non-collectively bargained employees. Except for the major collectively bargained plan at Ingalls, the Company's qualified defined benefit pension plans are frozen to new entrants. The Company's policy is to fund its qualified defined benefit pension plans at least to the minimum amounts required under U.S. Government regulations.
Plan obligations are measured based on the present value of projected future benefit payments to participants for services rendered to date. The measurement of projected future benefits is dependent on the terms of each individual plan, demographics, and valuation assumptions. No assumption is made regarding any potential changes to the benefit provisions beyond those to which the Company is currently committed, for example under existing collective bargaining agreements.
The Company also sponsors 401(k) defined contribution pension plans in which most employees, including certain hourly employees, are eligible to participate. Company contributions for most defined contribution pension plans are based on the matching of employee contributions up to
4%
of eligible compensation. Certain hourly employees are covered under a target benefit plan. In addition to the 401(k) defined contribution pension benefit formula, non-collectively bargained employees hired after June 30, 2008, are eligible to participate in a defined contribution benefit program in lieu of a defined benefit pension plan. The Company's contributions to the qualified defined contribution pension plans for the
years ended
December 31, 2017
,
2016
, and
2015
, were
$78 million
,
$71 million
, and
$73 million
, respectively.
The Company also sponsors defined benefit and defined contribution pension plans to provide benefits in excess of the qualified limits. The liabilities related to these plans as of
December 31, 2017
, were
$182 million
and
$32 million
, respectively, and as of
December 31, 2016
, were
$154 million
and
$29 million
, respectively. Assets, primarily in the form of Level 1 marketable securities held in grantor trusts, are intended to fund certain of these obligations. The trusts’ fair values supporting these liabilities as of
December 31, 2017
and
2016
, were
$94 million
and
$82 million
, respectively, of which
$61 million
and
$51 million
, respectively, were related to the non-qualified defined benefit pension plans.
The Company provides contributory postretirement health care and life insurance benefits to a dominantly closed group of eligible employees, retirees, and their qualifying dependents. Covered employees achieve eligibility to participate in these contributory plans upon retirement from active service if they meet specified age, years of service, and grandfathered requirements. Benefits are not guaranteed, and the Company reserves the right to
amend or terminate coverage at any time. The Company's contributions for retiree health care benefits are subject to caps, which limit Company contributions when spending thresholds are reached.
The measurement date for all of the Company's retirement related plans is December 31. The costs of the Company's defined benefit pension plans and other postretirement benefit plans for the
years ended
December 31, 2017
,
2016
, and
2015
, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
Other Benefits
|
|
|
|
Year Ended December 31
|
|
Year Ended December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
2015
|
|
2017
|
|
2016
|
|
2015
|
|
Components of Net Periodic Benefit Cost
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service cost
|
|
$
|
146
|
|
|
$
|
133
|
|
|
$
|
150
|
|
|
$
|
10
|
|
|
$
|
10
|
|
|
$
|
13
|
|
|
Interest cost
|
|
266
|
|
|
262
|
|
|
242
|
|
|
24
|
|
|
25
|
|
|
27
|
|
|
Expected return on plan assets
|
|
(367
|
)
|
|
(346
|
)
|
|
(351
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Amortization of prior service cost (credit)
|
|
20
|
|
|
18
|
|
|
19
|
|
|
(20
|
)
|
|
(19
|
)
|
|
(20
|
)
|
|
Amortization of net actuarial loss (gain)
|
|
97
|
|
|
84
|
|
|
86
|
|
|
(4
|
)
|
|
(6
|
)
|
|
2
|
|
|
Net periodic benefit cost
|
|
$
|
162
|
|
|
$
|
151
|
|
|
$
|
146
|
|
|
$
|
10
|
|
|
$
|
10
|
|
|
$
|
22
|
|
The funded status of the Company's pension and other postretirement plans as of
December 31, 2017
and
2016
, was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
Other Benefits
|
|
|
|
December 31
|
|
December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
Change in Benefit Obligation
|
|
|
|
|
|
|
|
|
|
Benefit obligation at beginning of year
|
|
$
|
6,050
|
|
|
$
|
5,635
|
|
|
$
|
578
|
|
|
$
|
566
|
|
|
Service cost
|
|
146
|
|
|
133
|
|
|
10
|
|
|
10
|
|
|
Interest cost
|
|
266
|
|
|
262
|
|
|
24
|
|
|
25
|
|
|
Plan participants' contributions
|
|
4
|
|
|
8
|
|
|
8
|
|
|
8
|
|
|
Plan amendments
|
|
74
|
|
|
—
|
|
|
(10
|
)
|
|
—
|
|
|
Actuarial loss (gain)
|
|
457
|
|
|
216
|
|
|
(15
|
)
|
|
9
|
|
|
Benefits paid
|
|
(219
|
)
|
|
(204
|
)
|
|
(42
|
)
|
|
(40
|
)
|
|
Benefit obligation at end of year
|
|
6,778
|
|
|
6,050
|
|
|
553
|
|
|
578
|
|
|
Change in Plan Assets
|
|
|
|
|
|
|
|
|
|
Fair value of plan assets at beginning of year
|
|
4,911
|
|
|
4,613
|
|
|
—
|
|
|
—
|
|
|
Actual return on plan assets
|
|
840
|
|
|
321
|
|
|
—
|
|
|
—
|
|
|
Employer contributions
|
|
301
|
|
|
173
|
|
|
34
|
|
|
32
|
|
|
Plan participants' contributions
|
|
4
|
|
|
8
|
|
|
8
|
|
|
8
|
|
|
Benefits paid
|
|
(219
|
)
|
|
(204
|
)
|
|
(42
|
)
|
|
(40
|
)
|
|
Fair value of plan assets at end of year
|
|
5,837
|
|
|
4,911
|
|
|
—
|
|
|
—
|
|
|
Funded status
|
|
$
|
(941
|
)
|
|
$
|
(1,139
|
)
|
|
$
|
(553
|
)
|
|
$
|
(578
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Amounts Recognized in the Consolidated Statements of Financial Position:
|
|
|
|
|
|
|
|
|
|
Pension plan assets
(1)
|
|
$
|
6
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Current liability
(2)
|
|
(25
|
)
|
|
(23
|
)
|
|
(139
|
)
|
|
(147
|
)
|
|
Non-current liability
(3)
|
|
(922
|
)
|
|
(1,116
|
)
|
|
(414
|
)
|
|
(431
|
)
|
|
Accumulated other comprehensive loss (income) (pre-tax) related to:
|
|
|
|
|
|
|
|
|
|
Prior service costs (credits)
|
|
122
|
|
|
68
|
|
|
(75
|
)
|
|
(86
|
)
|
|
Net actuarial loss (gain)
|
|
1,477
|
|
|
1,589
|
|
|
(18
|
)
|
|
(6
|
)
|
|
|
|
|
(1)
|
Included in miscellaneous other assets.
|
|
|
|
|
(2)
|
Included in other current liabilities and current portion of postretirement plan liabilities, respectively.
|
|
|
|
|
(3)
|
Included in pension plan liabilities and other postretirement plan liabilities, respectively.
|
The Projected Benefit Obligation ("PBO"), Accumulated Benefit Obligation ("ABO"), and asset values for the Company's qualified pension plans were
$6,596 million
,
$6,202 million
, and
$5,837 million
, respectively, as of
December 31, 2017
, and
$5,896 million
,
$5,530 million
, and
$4,911 million
, respectively, as of
December 31, 2016
. The PBO represents the present value of pension benefits earned through the end of the year, with allowance for future salary increases. The ABO is similar to the PBO, but does not provide for future salary increases.
The PBO and fair value of plan assets for all qualified and non-qualified pension plans with PBOs in excess of plan assets were
$5,386 million
and
$4,440 million
, respectively, as of
December 31, 2017
, and
$6,050 million
and
$4,911 million
, respectively, as of
December 31, 2016
.
The ABO and fair value of plan assets for all qualified and non-qualified pension plans with ABOs in excess of plan assets were
$5,001 million
and
$4,440 million
, respectively, as of
December 31, 2017
, and
$5,672 million
and
$4,911 million
, respectively, as of
December 31, 2016
. The ABO for all pension plans was
$6,367 million
and
$5,672 million
as of
December 31, 2017
and
2016
, respectively.
The changes in amounts recorded in accumulated other comprehensive income (loss) were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
Other Benefits
|
|
|
|
Year Ended December 31
|
|
Year Ended December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
2015
|
|
2017
|
|
2016
|
|
2015
|
|
Prior service cost (credit)
|
|
$
|
(74
|
)
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
10
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Amortization of prior service cost (credit)
|
|
20
|
|
|
18
|
|
|
19
|
|
|
(20
|
)
|
|
(19
|
)
|
|
(20
|
)
|
|
Net actuarial loss (gain)
|
|
16
|
|
|
(241
|
)
|
|
(144
|
)
|
|
15
|
|
|
(9
|
)
|
|
91
|
|
|
Amortization of net actuarial loss (gain)
|
|
97
|
|
|
84
|
|
|
86
|
|
|
(4
|
)
|
|
(6
|
)
|
|
2
|
|
|
Other
|
|
(1
|
)
|
|
1
|
|
|
(1
|
)
|
|
—
|
|
|
—
|
|
|
1
|
|
|
Total changes in accumulated other comprehensive income (loss)
|
|
$
|
58
|
|
|
$
|
(138
|
)
|
|
$
|
(40
|
)
|
|
$
|
1
|
|
|
$
|
(34
|
)
|
|
$
|
74
|
|
The amounts included in accumulated other comprehensive income (loss) as of
December 31, 2017
, expected to be recognized as components of net periodic expense in
2018
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in millions)
|
|
Pension Benefits
|
|
Other
Benefits
|
|
Prior service cost (credit)
|
|
$
|
23
|
|
|
$
|
(22
|
)
|
|
Net loss
|
|
82
|
|
|
(3
|
)
|
|
Total
|
|
$
|
105
|
|
|
$
|
(25
|
)
|
The weighted average assumptions used to determine the net periodic benefit costs for each year ended December 31 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
|
|
2017
|
|
2016
|
|
2015
|
|
Discount rate
|
|
4.47
|
%
|
|
4.73
|
%
|
|
4.34
|
%
|
|
Expected long-term rate on plan assets
|
|
7.25
|
%
|
|
7.50
|
%
|
|
7.50
|
%
|
|
Rate of compensation increase
|
|
3.68
|
%
|
|
3.66
|
%
|
|
3.64
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Benefits
|
|
|
|
2017
|
|
2016
|
|
2015
|
|
Discount rate
|
|
4.38
|
%
|
|
4.58
|
%
|
|
4.22
|
%
|
|
Initial health care cost trend rate assumed for next year
|
|
6.50
|
%
|
|
7.00
|
%
|
|
7.00
|
%
|
|
Gradually declining to a rate of
|
|
5.00
|
%
|
|
5.00
|
%
|
|
5.00
|
%
|
|
Year in which the rate reaches the ultimate rate
|
|
2025
|
|
|
2024
|
|
|
2023
|
|
The weighted average assumptions used to determine the benefit obligations as of December 31 of each year were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
Other Benefits
|
|
|
|
December 31
|
|
December 31
|
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
Discount rate
|
|
3.82
|
%
|
|
4.47
|
%
|
|
3.85
|
%
|
|
4.38
|
%
|
|
Rate of compensation increase
|
|
3.71
|
%
|
|
3.68
|
%
|
|
|
|
|
|
Initial health care cost trend rate assumed for next year
|
|
|
|
|
|
6.00
|
%
|
|
6.50
|
%
|
|
Gradually declining to a rate of
|
|
|
|
|
|
4.50
|
%
|
|
5.00
|
%
|
|
Year in which the rate reaches the ultimate rate
|
|
|
|
|
|
2025
|
|
|
2025
|
|
Health Care Cost Trend Rate -
The health care cost trend rate represents the annual rates of change in the cost of health care benefits based on estimates of health care inflation, changes in health care utilization or delivery patterns, technological advances, government mandated benefits, and other considerations. Using a combination of market expectations and economic projections on
December 31, 2017
, the Company selected an expected initial health care cost trend rate of
6.00%
and an ultimate health care cost trend rate of
4.50%
to be reached in
2025
. On
December 31, 2016
, the Company assumed an expected initial health care cost trend rate of
6.50%
and an ultimate health care cost trend rate of
5.00%
to be reached in
2025
.
A one percent change in the assumed health care cost trend rates would have the following effects on
2017
results:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 Percentage Point
|
|
($ in millions)
|
|
Increase
|
|
Decrease
|
|
Effect on postretirement benefit expense
|
|
$
|
2
|
|
|
$
|
(2
|
)
|
|
Effect on postretirement benefit obligations
|
|
26
|
|
|
(25
|
)
|
The Employee Retirement Income Security Act of 1974 ("ERISA"), including amendments under pension relief, defines the minimum amount that must be contributed to the Company's qualified defined benefit pension plans. In determining whether to make discretionary contributions to these plans above the minimum required amounts, the Company considers various factors, including attainment of the funded percentage needed to avoid benefit restrictions and other adverse consequences, minimum CAS funding requirements, and the current and anticipated future funding levels of each plan. The Company's contributions to its qualified defined benefit pension plans are affected by a number of factors, including published IRS interest rates, the actual return on plan assets, actuarial assumptions, and demographic experience. These factors and the Company's resulting contributions also impact the funded status of each plan. The Company made the following contributions to its pension and other postretirement plans for the years ended
December 31, 2017
,
2016
, and
2015
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31
|
|
($ in millions)
|
|
2017
|
|
2016
|
|
2015
|
|
Pension plans
|
|
|
|
|
|
|
|
Discretionary
|
|
|
|
|
|
|
|
Qualified
|
|
$
|
294
|
|
|
$
|
167
|
|
|
$
|
99
|
|
|
Non-qualified
|
|
7
|
|
|
6
|
|
|
4
|
|
|
Other benefit plans
|
|
34
|
|
|
32
|
|
|
33
|
|
|
Total contributions
|
|
$
|
335
|
|
|
$
|
205
|
|
|
$
|
136
|
|
In the third quarter of 2017, the Company concluded negotiations on one of its collective bargaining agreements, which required an amendment to one of its pension plans. As a result of the amendment, the remeasurement of the plan increased the pension liability and pre-tax accumulated other comprehensive loss by approximately
$76 million
.
For the year ending
December 31, 2018
, the Company expects its cash contributions to its qualified defined benefit pension plans to be
$508 million
, all of which will be discretionary. For the year ending
December 31, 2018
, the Company expects its cash contributions to its postretirement benefit plans to be approximately
$35 million
.
The following table presents estimated future benefit payments, using the same assumptions used in determining the Company's benefit obligations as of
December 31, 2017
. Benefit payments depend on future employment and compensation levels, years of service, and mortality. Changes in any of these factors could significantly affect these estimated amounts.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Benefits
|
|
($ in millions)
|
|
Pension Benefits
|
|
Benefit Payments
|
|
Subsidy Receipts
|
|
2018
|
|
$
|
233
|
|
|
$
|
35
|
|
|
$
|
—
|
|
|
2019
|
|
249
|
|
|
36
|
|
|
—
|
|
|
2020
|
|
266
|
|
|
38
|
|
|
—
|
|
|
2021
|
|
285
|
|
|
40
|
|
|
—
|
|
|
2022
|
|
306
|
|
|
41
|
|
|
—
|
|
|
Years 2023 to 2027
|
|
$
|
1,830
|
|
|
$
|
201
|
|
|
$
|
2
|
|
Pension Plan Assets
Pension assets include public equities, government and corporate bonds, cash and cash equivalents, private real estate funds, private partnerships, hedge funds, and other assets. Plan assets are held in a master trust and overseen by the Company's Investment Committee. All assets are externally managed through a combination of active and passive strategies. Managers may only invest in the asset classes for which they have been appointed.
The Investment Committee is responsible for setting the policy that provides the framework for management of the plan assets. The Investment Committee has set the minimum and maximum permitted values for each asset class in the Company's pension plan master trust for the year ended
December 31, 2017
, as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Range
|
|
U.S. equities
|
|
15
|
|
-
|
|
37%
|
|
International equities
|
|
10
|
|
-
|
|
28%
|
|
Fixed income securities
|
|
25
|
|
-
|
|
50%
|
|
Alternative investments
|
|
10
|
|
-
|
|
25%
|
The general objectives of the Company's pension asset strategy are to earn a rate of return over time to satisfy the benefit obligations of the plans, meet minimum ERISA funding requirements, and maintain sufficient liquidity to pay benefits and address other cash requirements within the master trust. Specific investment objectives include reducing the volatility of pension assets relative to benefit obligations, achieving a competitive, total investment return, achieving diversification between and within asset classes, and managing other risks. Investment objectives for each asset class are determined based on specific risks and investment opportunities identified. Decisions regarding investment policies and asset allocation are made with the understanding of the historical and prospective return and risk characteristics of various asset classes, the effect of asset allocations on funded status, future Company contributions, and projected expenditures, including benefits. The Company updates its asset allocations periodically. The Company uses various analytics to determine the optimal asset mix and considers plan obligation characteristics, duration, liquidity characteristics, funding requirements, expected rates of return, regular rebalancing, and the distribution of returns. Actual allocations to each asset class could vary from target allocations due to periodic investment strategy changes, short-term market value fluctuations, the length of time it takes to fully implement investment allocation positions, such as real estate and other alternative investments, and the timing of benefit payments and Company contributions.
Taking into account the asset allocation ranges, the Company determines the specific allocation of the master trust's investments within various asset classes. The master trust utilizes select investment strategies, which are executed through separate account or fund structures with external investment managers who demonstrate experience and expertise in the appropriate asset classes and styles. The selection of investment managers is
done with careful evaluation of all aspects of performance and risk, demonstrated fiduciary responsibility, investment management experience, and a review of the investment managers' policies and processes. Investment performance is monitored frequently against appropriate benchmarks and tracked to compliance guidelines with the assistance of third party consultants and performance evaluation tools and metrics.
Plan assets are stated at fair value. The Company employs a variety of pricing sources to estimate the fair value of its pension plan assets, including independent pricing vendors, dealer or counterparty-supplied valuations, third-party appraisals, and appraisals prepared by the Company's investment managers or other experts.
Investments in equity securities, common and preferred, are valued at the last reported sales price when an active market exists. Securities for which official or last trade pricing on an active exchange is available are classified as Level 1. If closing prices are not available, securities are valued at the last trade price, if deemed reasonable, or a broker's quote in a non-active market, and are typically categorized as Level 2.
Investments in fixed-income securities are generally valued by independent pricing services or dealers who make markets in such securities. Pricing methods are based upon market transactions for comparable securities and various relationships between securities that are generally recognized by institutional traders, and fixed-income securities typically are categorized as Level 2.
Investments in collective trust funds and commingled funds based on the use of Net Asset Values (“NAV”) are valued based on the redemption price of units owned by the master trust, which is based on the current fair values of the funds’ underlying assets, as reported by the investment manager.
Investments in hedge funds generally do not have readily available market quotations and are estimated at fair value, which primarily utilizes NAV or the equivalent, as a practical expedient, as reported by the investment manager. Hedge funds usually have restrictions on redemptions that might affect the ability to sell the investment at NAV in the short term.
Real estate funds are typically valued through updated independent third-party appraisals, which are adjusted for changes in cash flows, market conditions, property performance, and leasing status. Since real estate funds do not have readily available market quotations, they are generally valued at NAV or its equivalent, as a practical expedient, as reported by the asset manager. Redemptions from real estate funds are also subject to various restrictions.
Private partnership interests include debt and equity investments. These investments are valued based on NAVs or their equivalents, adjusted for capital calls and distributions, from the respective general partners. The terms of the partnerships range from seven to ten or more years, and investors do not have the option to redeem their interests in these partnerships. As of December 31, 2017, unfunded commitments to private partnerships were
$112 million
.
Management reviews independently appraised values, audited financial statements, and additional pricing information to evaluate the net asset values. For the very limited group of investments for which market quotations are not readily available or for which the above valuation procedures are deemed not to reflect fair value, additional information is obtained from the investment manager and evaluated internally to determine whether any adjustments are required to reflect fair value.
The Company might be unable to quickly liquidate some assets at amounts close or equal to fair value in order to meet the plans' liquidity requirements or respond to specific events, such as the creditworthiness of any particular issuer or counterparty. Illiquid assets are generally long-term investments that complement the long-term nature of the Company's pension obligations and are generally not used to fund benefit payments in the short term. Management monitors liquidity risk on an ongoing basis and has procedures designed to maintain adequate liquidity for plan requirements.
The master trust has considerable investments in fixed income securities for which changes in the relevant interest rate of a particular instrument might result in the inability to secure similar returns upon the maturity or sale. Changes in prevailing interest rates might result in an increase or decrease in fair value of the instrument. Investment managers are permitted to use interest rate swaps and other financial derivatives to manage interest rate and credit risks.
Counterparty risk is the risk that a counterparty to a financial instrument held by the master trust will default on its commitment. Counterparty risk is generally related to over-the-counter derivative instruments used to manage risk exposure to interest rates on long-term debt securities. Certain agreements with counterparties employ set-off agreements, collateral support arrangements, and other risk mitigation practices designed to reduce the net credit risk exposure in the event of a counterparty default. Credit policies and processes are in place to manage concentrations of risk by seeking to undertake transactions with large well-capitalized counterparties and by monitoring the creditworthiness of these counterparties.
Certain investments that are measured at fair value using NAV per share (or its equivalent) as a practical expedient are not required to be categorized in the fair value hierarchy table. The total fair value of these investments is included in the table below to permit reconciliation of the fair value hierarchy to amounts presented in the funded status table above.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
($ in millions)
|
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Plan assets subject to leveling
|
|
|
|
|
|
|
|
|
|
U.S. and international equities
|
|
$
|
1,270
|
|
|
$
|
1,270
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Government and agency debt securities
|
|
409
|
|
|
—
|
|
|
409
|
|
|
—
|
|
|
Corporate and other debt securities
|
|
1,287
|
|
|
—
|
|
|
1,287
|
|
|
—
|
|
|
Group annuity contract
|
|
3
|
|
|
—
|
|
|
3
|
|
|
—
|
|
|
Cash and cash equivalents
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
Net plan assets subject to leveling
|
|
$
|
2,969
|
|
|
$
|
1,270
|
|
|
$
|
1,699
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
Plan assets not subject to leveling
|
|
|
|
|
|
|
|
|
|
U.S. and international equities (a)
|
|
2,012
|
|
|
|
|
|
|
|
|
Corporate and other debt securities
|
|
165
|
|
|
|
|
|
|
|
|
Real estate investments
|
|
279
|
|
|
|
|
|
|
|
|
Private partnerships
|
|
16
|
|
|
|
|
|
|
|
|
Hedge funds
|
|
281
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, net (b)
|
|
115
|
|
|
|
|
|
|
|
|
Total plan assets not subject to leveling
|
|
2,868
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net plan assets
|
|
$
|
5,837
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
U.S. and international equity securities include investments in small, medium, and large capitalization stocks of public companies held in commingled trust funds.
|
|
|
|
|
(b)
|
Cash and cash equivalents are liquid short-term investment funds and include net receivables and payables of the trust. These funds are available for immediate use to fund daily operations, execute investment policies, and serve as a temporary investment vehicle.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
($ in millions)
|
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Plan assets subject to leveling
|
|
|
|
|
|
|
|
|
|
U.S. and international equities
|
|
$
|
988
|
|
|
$
|
988
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Government and agency debt securities
|
|
391
|
|
|
—
|
|
|
391
|
|
|
—
|
|
|
Corporate and other debt securities
|
|
1,126
|
|
|
—
|
|
|
1,126
|
|
|
—
|
|
|
Group annuity contract
|
|
3
|
|
|
—
|
|
|
3
|
|
|
—
|
|
|
Cash and cash equivalents
|
|
16
|
|
|
16
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
Net plan assets subject to leveling
|
|
$
|
2,524
|
|
|
$
|
1,004
|
|
|
$
|
1,520
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
Plan assets not subject to leveling
|
|
|
|
|
|
|
|
|
|
U.S. and international equities (a)
|
|
1,653
|
|
|
|
|
|
|
|
|
Corporate and other debt securities
|
|
119
|
|
|
|
|
|
|
|
|
Real estate investments
|
|
309
|
|
|
|
|
|
|
|
|
Hedge funds
|
|
262
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, net (b)
|
|
44
|
|
|
|
|
|
|
|
|
Total plan assets not subject to leveling
|
|
2,387
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net plan assets
|
|
$
|
4,911
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
U.S. and international equity securities include investments in small, medium, and large capitalization stocks of public companies held in commingled trust funds.
|
|
|
|
|
(b)
|
Cash and cash equivalents are liquid short-term investment funds and include net receivables and payables of the trust. These funds are available for immediate use to fund daily operations, execute investment policies, and serve as a temporary investment vehicle.
|
The master trust limits the use of derivatives through direct or separate account investments, such that the derivatives used are liquid and able to be readily valued in the market. Derivative usage in separate account structures is primarily for gaining market exposure in an unlevered manner or hedging investment risks. The fair market value of the pension master trust's derivatives through direct or separate account investments resulted in a net liability of approximately
$1 million
and
$2 million
as of
December 31, 2017
and
2016
, respectively.
There was no activity attributable to Level 3 retirement plan assets during the years ended December 31,
2017
and
2016
.
19. STOCK COMPENSATION PLANS
As of
December 31, 2017
, HII had stock-based compensation awards outstanding under the following plans: the Huntington Ingalls Industries, Inc. 2011 Long-Term Incentive Stock Plan (the "2011 Plan") and the Huntington Ingalls Industries, Inc. 2012 Long-Term Incentive Stock Plan (the "2012 Plan").
Stock Compensation Plans
On March 23, 2012, the Company's board of directors adopted the 2012 Plan, subject to stockholder approval, and the Company's stockholders approved the 2012 Plan on May 2, 2012. Award grants made on or after May 2, 2012, were made under the 2012 Plan. Award grants made prior to May 2, 2012, were made under the 2011 Plan. No future grants will be made under the 2011 Plan.
The 2012 Plan permits awards of stock options, stock appreciation rights, and other stock awards. Each stock option grant is made with an exercise price of not less than 100% of the closing price of HII's common stock on the date of grant. Stock awards, in the form of RPSRs, restricted stock rights ("RSRs"), and stock rights, are granted to key employees and members of the board of directors without payment to the Company. The 2012 Plan authorized (i)
3.4 million
new shares; plus (ii) any shares subject to outstanding awards under the 2011 Plan that were subsequently forfeited to the Company; plus (iii) any shares subject to outstanding awards under the 2011 Plan that were subsequently exchanged by the participant as full or partial payment to the Company in connection with any such award or exchanged by a participant or withheld by the Company to satisfy the tax withholding obligations related to any such award. As of
December 31, 2017
, the remaining aggregate number of shares of the Company's common stock authorized for issuance under the 2012 Plan was
4.1 million
.
The 2011 Plan permitted the awards of stock options and other stock awards. Each stock option grant was made with an exercise price of not less than 100% of the closing price of HII's common stock on the date of grant, with the exception of stock options issued at the time of the spin-off in exchange for Northrop Grumman stock options. Stock awards, in the form of stock rights, were granted to members of the board of directors without payment to the Company.
Stock Awards
Stock awards include RPSRs, RSRs, and stock rights. The fair value of stock awards is determined based on the closing market price of the Company's common stock on the grant date. Compensation expense for stock awards is measured based on the grant date fair value and recognized over the vesting period, generally
three years
.
For purposes of measuring compensation expense, the amount of shares ultimately expected to vest is estimated at each reporting date based on management's expectations regarding the relevant service or performance criteria.
The Company issued the following stock awards in the years ended
December 31, 2017
,
2016
, and
2015
:
Restricted Performance Stock Rights
- For the year ended
December 31, 2017
, the Company granted approximately
0.1 million
RPSRs at a weighted average share price of
$218.54
. These rights are subject to cliff vesting on December 31, 2019. For the year ended
December 31, 2016
, the Company granted approximately
0.2 million
RPSRs at a weighted average share price of
$134.53
. These rights are subject to cliff vesting on December 31, 2018. For the year ended
December 31, 2015
, the Company granted approximately
0.2 million
RPSRs at a weighted average share price of
$142.02
. These rights were fully vested as of December 31, 2017. All of the RPSRs are subject to the achievement of performance-based targets at the end of the respective vesting periods and will ultimately vest between
0%
and
200%
of grant date value.
Restricted Stock Rights
- Retention stock awards are granted to key employees primarily to ensure business continuity. In
2017
the Company granted approximately
3,100
RSRs at a weighted average share price of
$188.13
, with cliff vesting
two years
from the grant date. In
2015
, the Company granted approximately
3,000
RSRs at a weighted average share price of
$115.50
, with cliff vesting
one year
from the grant date. As of
December 31, 2017
, approximately
3,100
of these RSRs were outstanding.
For the year ended
December 31, 2017
,
0.4 million
stock awards vested, of which approximately
0.2 million
were transferred to the Company from employees in satisfaction of minimum tax withholding obligations. For the year ended
December 31, 2016
,
0.8 million
stock awards vested, of which approximately
0.3 million
were transferred to the Company from employees in satisfaction of minimum tax withholding obligations. For the year ended
December 31, 2015
,
0.9 million
stock awards vested, of which approximately
0.4 million
were transferred to the Company from employees in satisfaction of minimum tax withholding obligations.
Stock Rights and Stock Issuances
- The Company granted stock rights to its non-employee directors on a quarterly basis in
2017
, with each grant less than
10,000
shares. All stock rights granted to non-employee directors are fully vested on the grant date. If a non-employee director has met certain ownership guidelines, the non-employee director may elect under the terms of the Directors’ Compensation Policy and Board Deferred Compensation Policy to receive their annual equity award for the following calendar year in the form of either shares of the Company’s common stock or stock units that are payable in the fifth calendar year after the year in which the annual equity award is earned, or, if earlier, upon termination of the director’s board service.
The stock award activity for the
years ended
December 31, 2017
,
2016
, and
2015
, was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Awards
(in thousands)
|
|
Weighted-Average
Grant Date Fair
Value
|
|
Weighted
Average
Remaining
Contractual Term
|
|
Outstanding as of December 31, 2014
|
|
1,311
|
|
|
$
|
51.23
|
|
|
0.7 years
|
|
Granted
|
|
163
|
|
|
140.48
|
|
|
|
|
Adjustment due to performance
|
|
315
|
|
|
36.36
|
|
|
|
|
Vested
|
|
(865
|
)
|
|
36.36
|
|
|
|
|
Forfeited
|
|
(33
|
)
|
|
83.44
|
|
|
|
|
Outstanding as of December 31, 2015
|
|
891
|
|
|
75.73
|
|
|
0.6 years
|
|
Granted
|
|
169
|
|
|
134.78
|
|
|
|
|
Adjustment due to performance
|
|
326
|
|
|
46.75
|
|
|
|
|
Vested
|
|
(783
|
)
|
|
46.75
|
|
|
|
|
Forfeited
|
|
(25
|
)
|
|
127.45
|
|
|
|
|
Outstanding as of December 31, 2016
|
|
578
|
|
|
113.95
|
|
|
0.8 years
|
|
Granted
|
|
109
|
|
|
217.02
|
|
|
|
|
Adjustment due to performance
|
|
163
|
|
|
97.00
|
|
|
|
|
Vested
|
|
(387
|
)
|
|
97.00
|
|
|
|
|
Forfeited
|
|
(14
|
)
|
|
154.75
|
|
|
|
|
Outstanding as of December 31, 2017
|
|
449
|
|
|
$
|
147.13
|
|
|
0.8 years
|
Vested awards include stock awards that fully vested during the year based on the level of achievement of the relevant performance goals. The performance goals for outstanding RPSRs granted in
2017
,
2016
, and
2015
are based on two metrics as defined in the grant agreements: earnings before interest, taxes, depreciation, amortization, and pension, weighted at
50%
, and pension-adjusted return on invested capital, weighted at
50%
.
Stock Options
Effect of the Spin-Off -
Prior to the spin-off, HII's current and former employees received stock options under Northrop Grumman's stock-based award plans (the "Northrop Grumman Plan"). As of the date of the spin-off, the stock options under the Northrop Grumman Plan were converted to stock options under the 2011 Plan. The conversion was effected so that the outstanding stock options held by the Company's current and former employees on the distribution date were adjusted to reflect the value of the distribution, such that the intrinsic value of the stock options was not diluted at the time of, and due to, the separation. This was achieved using the conversion rate included in the spin-off agreement. Unless otherwise stated, share amounts and share prices detailed below were retroactively adjusted to reflect the impact of the conversion. The Company measured the fair value of the stock options immediately before and after the conversion, and there was no incremental compensation expense associated with the conversion.
The following is a description of the Northrop Grumman Plan stock options, which were converted into stock options under the 2011 Plan.
Converted Stock Options
- As of the date of the spin-off, outstanding stock options held by HII's current and former employees under the Northrop Grumman Plan were converted to stock options of HII under the 2011 Plan. Based on the conversion factor of
1.65
, included in the spin-off agreement, approximately
1.0 million
stock options under the Northrop Grumman Plan were converted into approximately
1.6 million
stock options under the 2011 Plan, approximately
1.4 million
of which were fully vested at the time of conversion. Outstanding stock options granted prior to 2008 generally vested in
25%
increments over
four years
from the grant date and expire
ten years
after the grant date. Stock options granted in 2008 and later vested in
33%
increments over
three years
from the grant date and expire
seven years
after the grant date. The cumulative intrinsic value of the stock options at conversion was maintained in the conversion, and totaled
$15 million
at March 31, 2011.
Compensation expense for the outstanding converted stock options was determined at the time of grant by Northrop Grumman. No stock options were granted during the
years ended
December 31, 2017
,
2016
, and
2015
. The fair value of the stock options was expensed on a straight-line basis over the vesting period of the options. The fair value of each of the stock options was estimated on the date of grant using a Black-Scholes option pricing model.
The stock option activity for the
years ended
December 31, 2017
,
2016
, and
2015
, was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares Under
Option
(in thousands)
|
|
Weighted-
Average
Exercise Price
|
|
Weighted- Average
Remaining
Contractual Term
(in years)
|
|
Aggregate
Intrinsic
Value
($ in millions)
|
|
Outstanding as of December 31, 2014
|
|
644
|
|
|
$
|
36.06
|
|
|
1.4 years
|
|
$
|
49
|
|
|
Exercised
|
|
(111
|
)
|
|
46.46
|
|
|
|
|
|
|
Outstanding as of December 31, 2015
|
|
533
|
|
|
33.90
|
|
|
0.6 years
|
|
50
|
|
|
Exercised
|
|
(271
|
)
|
|
30.20
|
|
|
|
|
|
|
Outstanding as of December 31, 2016
|
|
262
|
|
|
37.73
|
|
|
0.1 years
|
|
38
|
|
|
Exercised
|
|
(262
|
)
|
|
37.73
|
|
|
|
|
|
|
Outstanding as of December 31, 2017
|
|
—
|
|
|
$
|
—
|
|
|
|
|
$
|
—
|
|
|
Vested as of December 31, 2017
|
|
—
|
|
|
$
|
—
|
|
|
|
|
$
|
—
|
|
Intrinsic value is measured using the fair market value at the date of exercise for stock options exercised or at period end for outstanding stock options, in each case less the applicable exercise price. The intrinsic value of stock options exercised during the
years ended
December 31, 2017, 2016, and
2015
, was
$43 million
,
$26 million
, and
$11 million
, respectively. The Company issued new shares to satisfy exercised stock options.
Compensation Expense
The Company recorded
$34 million
,
$36 million
, and
$43 million
of expense related to stock awards for the
years ended
December 31, 2017
,
2016
, and
2015
, respectively. The Company recorded
$9 million
(net of impact of reduction in statutory federal corporate income tax rate),
$14 million
, and
$17 million
as tax benefits related to stock awards and stock options for the
years ended
December 31, 2017
,
2016
, and
2015
, respectively.
The Company recognized tax benefits for the
years ended
December 31, 2017
,
2016
, and
2015
, of
$28 million
,
$39 million
, and
$41 million
, respectively, from the issuance of stock in settlement of stock awards, and
$17 million
,
$10 million
, and
$4 million
for the
years ended
December 31, 2017
,
2016
, and
2015
, respectively, from the exercise of stock options.
Unrecognized Compensation Expense
As of
December 31, 2017
, the Company had less than
$1 million
of unrecognized compensation expense associated with RSRs granted in 2017, which will be recognized over a weighted average period of
1.4 years
, and
$25 million
of unrecognized expense associated with RPSRs granted in
2017
and
2016
, which will be recognized over a weighted average period of
0.9 years
. As of
December 31, 2017
, the Company had no unrecognized compensation expense related to stock options. Compensation expense for stock options was fully recognized as of December 31, 2013.
20. UNAUDITED SELECTED QUARTERLY DATA
Unaudited quarterly financial results for the
years ended
December 31, 2017
and
2016
, are set forth in the following tables:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2017
|
|
($ in millions, except per share amounts)
|
|
1st Qtr
|
|
2nd Qtr
(1)
|
|
3rd Qtr
|
|
4th Qtr
(2)
|
|
Sales and service revenues
|
|
$
|
1,724
|
|
|
$
|
1,858
|
|
|
$
|
1,863
|
|
|
$
|
1,996
|
|
|
Operating income (loss)
|
|
164
|
|
|
237
|
|
|
237
|
|
|
227
|
|
|
Earnings (loss) before income taxes
|
|
147
|
|
|
218
|
|
|
220
|
|
|
187
|
|
|
Net earnings (loss)
|
|
119
|
|
|
147
|
|
|
149
|
|
|
64
|
|
|
Dividends declared per share
|
|
$
|
0.60
|
|
|
$
|
0.60
|
|
|
$
|
0.60
|
|
|
$
|
0.72
|
|
|
Basic earnings (loss) per share
|
|
$
|
2.57
|
|
|
$
|
3.22
|
|
|
$
|
3.28
|
|
|
$
|
1.41
|
|
|
Diluted earnings (loss) per share
|
|
$
|
2.56
|
|
|
$
|
3.21
|
|
|
$
|
3.27
|
|
|
$
|
1.41
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2016
|
|
($ in millions, except per share amounts)
|
|
1st Qtr
(3)
|
|
2nd Qtr
(4)
|
|
3rd Qtr
|
|
4th Qtr
|
|
Sales and service revenues
|
|
$
|
1,763
|
|
|
$
|
1,700
|
|
|
$
|
1,683
|
|
|
$
|
1,922
|
|
|
Operating income (loss)
|
|
198
|
|
|
217
|
|
|
175
|
|
|
268
|
|
|
Earnings (loss) before income taxes
|
|
177
|
|
|
199
|
|
|
157
|
|
|
251
|
|
|
Net earnings (loss)
|
|
136
|
|
|
133
|
|
|
107
|
|
|
197
|
|
|
Dividends declared per share
|
|
$
|
0.50
|
|
|
$
|
0.50
|
|
|
$
|
0.50
|
|
|
$
|
0.60
|
|
|
Basic earnings (loss) per share
|
|
$
|
2.89
|
|
|
$
|
2.83
|
|
|
$
|
2.28
|
|
|
$
|
4.26
|
|
|
Diluted earnings (loss) per share
|
|
$
|
2.87
|
|
|
$
|
2.80
|
|
|
$
|
2.27
|
|
|
$
|
4.20
|
|
(1)
In the second quarter of 2017, the Company recorded a
$30 million
favorable cumulative adjustment on a contract at the Ingalls segment.
(2)
In the fourth quarter of 2017, the Tax Act resulted in an increase of
$56 million
to the Company's income tax expense.
(3)
In the first quarter of 2016, the Company recorded a
$22 million
favorable cumulative adjustment on a contract at the Ingalls segment.
(4)
In the second quarter of 2016, the Company recorded a
$38 million
favorable cumulative adjustment on a contract at the Ingalls segment and a
$23 million
favorable cumulative adjustment on a contract at the Newport News segment.