General Dynamics Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 30, 2014; comparative period ended March 31, 2013. Unaudited consolidated results. General Dynamics operates in Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology, serving primarily U.S. government customers alongside international governments and business-aviation customers.
Financial results and liquidity
Dollars in millions, except per-share amounts and percentages.
| Metric | Q1 2013 | Q1 2014 |
|---|---|---|
| Revenue | $7,404 | $7,324 |
| Operating earnings | $847 | $871 |
| Operating margin | 11.4% | 11.9% |
| Net earnings | $571 | $595 |
| Diluted EPS | $1.62 | $1.71 |
| Operating cash flow | $504 | $428 |
| Capital expenditures | $75 | $87 |
| Free cash flow from operations | $429 | $341 |
Revenue declined 1.1%, while operating earnings rose 2.8%. Lower U.S. Army-related activity reduced revenue in Combat Systems and Information Systems and Technology; higher Gulfstream aircraft deliveries partly offset the declines. Improved consolidated margin reflected a stronger contribution from higher-margin Aerospace work and slightly higher Marine Systems earnings. Favorable contract-estimate revisions contributed $38 million ($0.07 per share) to Q1 2014 operating earnings, versus $108 million ($0.20 per share) in Q1 2013.
Cash and equivalents were $4.296 billion at quarter-end, down from $5.301 billion at year-end 2013. Total debt was $3.911 billion, including $502 million current debt; the company reported a net cash position of $385 million. Current assets were $16.964 billion and current liabilities $12.623 billion. There was no commercial paper outstanding. Available backup facilities included $2 billion in committed credit facilities and approximately $280 million for European businesses; the company reported compliance with material financing covenants. The $500 million notes due January 2015 were under consideration for repayment with cash or refinancing.
Operating cash flow fell to $428 million from $504 million, and free cash flow (company-defined as operating cash flow less capital expenditures) fell to $341 million from $429 million. Financing used $1.347 billion, primarily reflecting $1.430 billion of common-stock repurchases; cash dividends paid were $198 million. The quarterly dividend declared was $0.62 per share.
Business-group performance and material changes
| Group | Revenue, Q1 2014 | Operating earnings, Q1 2014 | Year-over-year highlights |
|---|---|---|---|
| Aerospace | $2,125 million | $404 million | Revenue +19.5%; margin 19.0%, up from 17.4%. Gulfstream green deliveries rose to 35 from 30; outfitted deliveries to 39 from 29. |
| Combat Systems | $1,317 million | $136 million | Revenue −15.2%; margin 10.3%, down from 13.8%. Lower U.S. Army spending and $29 million of Austrian restructuring charges weighed on results. |
| Marine Systems | $1,601 million | $166 million | Revenue −1.5%; margin 10.4%, up from 9.8%. Construction growth was offset by lower Navy engineering, repair, and service activity. |
| Information Systems and Technology | $2,281 million | $183 million | Revenue −6.8%; margin 8.0%, up from 7.6%. Lower mobile communications activity was partly offset by growth in IT services and cost reductions. |
Backlog increased to $56.0 billion from $46.0 billion at year-end 2013, and estimated potential contract value was $28.7 billion, bringing total estimated contract value to $84.7 billion. Defense-group backlog rose 34%, with each defense group reporting a book-to-bill ratio above one. The reported increase included a $10 billion international vehicle contract; the company noted approximately $3 billion of additional potential value associated with it. Estimated potential contract value transferred between Combat Systems and Information Systems and Technology due to the U.K. Specialist Vehicle program responsibility change.
Outlook, risks, and unusual items
- 2014 outlook: Aerospace revenue expected to rise approximately 11%, with operating margin around 17%. Combat Systems revenue expected to decline 4%–4.5%, with margin around 14%. Marine Systems revenue expected to rise about 2.5%, with margin around 9.5%. Information Systems and Technology revenue expected to decline nearly 20%, with margin in the low-8% range.
- Management expected G&A expenses of approximately 6.5% of revenue, net interest expense of approximately $90 million, an effective tax rate of 30.5%–31%, and capital expenditures around 2% of anticipated revenue for 2014. Corporate operating costs were expected to be approximately $85 million.
- Management cited U.S. defense spending and budget priorities, government contract termination or restructuring, long-term fixed-price contract execution and supplier performance, recovery of claims, business-jet demand, energy and raw-material prices, and legal or regulatory proceedings as risks to forward-looking results. The filing cautions that quarterly results are not necessarily indicative of full-year results.
- In Portugal, the company was in arbitration over termination of a Pandur vehicle contract; the customer had drawn $75 million under bank guarantees, and approximately $145 million remained outstanding under an offset-requirements guarantee that could be drawn through 2014. Other disclosed matters included routine litigation, environmental remediation, government contract disputes and claims, and approximately $1.1 billion of letters of credit, bank guarantees, and similar arrangements. Management did not expect these matters to have a material aggregate financial impact.
- Warranty liabilities increased to $375 million from $356 million at year-end. The company also had approximately $165 million of pension-related requests for equitable adjustment outstanding with the Department of Defense. Management said resolution of open tax matters was not expected to have a material impact.
- Share repurchases totaled approximately 14 million shares during the quarter, including 11.4 million shares under an accelerated share repurchase arrangement. The final cost of that program remained dependent on its weighted-average market-price formula and settlement later in 2014. The company reported that $48 million of repurchase cash outflow would be recorded in Q2 for shares that had not settled by quarter-end.
Important facts for investors to verify
- Whether expected Aerospace growth and defense-group revenue and margin forecasts remain achievable, particularly given U.S. defense spending trends and the timing of new international work.
- Backlog quality and funding: distinguish funded backlog from unfunded backlog and estimated potential contract value, which is not equivalent to firm funded orders.
- Cash generation and capital returns: monitor operating cash flow, working-capital movements, share-repurchase settlement and remaining authorization, and dividend payments.
- Debt and liquidity: track the January 2015 note maturity, refinancing or repayment plans, and continued access to credit facilities.
- Developments in the Portugal arbitration and guarantee exposure, pension-related claims, and other government-contract or legal contingencies.
- Changes in contract estimates and the contribution of favorable revisions to earnings; Q1 2014 included a smaller benefit than the prior-year quarter.