Business context and reporting period
General Dynamics Corporation filed this Form 10-K for the fiscal year ended December 31, 2014. It operates through four groups: Aerospace, Combat Systems, Information Systems and Technology, and Marine Systems. Its offerings span Gulfstream business aircraft and services, combat vehicles and munitions, information and communications systems, and military and commercial shipbuilding. The filing also provides unaudited fourth-quarter results.
About 58% of 2014 revenue came from the U.S. government, including the Department of Defense; the balance came from U.S. and non-U.S. commercial and defense customers.
Financial and operating highlights
| Metric | 2014 | 2013 |
|---|---|---|
| Revenue | $30.852 billion | $30.930 billion |
| Operating earnings / margin | $3.889 billion / 12.6% | $3.689 billion / 11.9% |
| Continuing-operations earnings | $2.673 billion | $2.486 billion |
| Net earnings | $2.533 billion | $2.357 billion |
| Diluted EPS, continuing operations / net | $7.83 / $7.42 | $7.03 / $6.67 |
| Operating cash flow / free cash flow | $3.728 billion / $3.207 billion | $3.111 billion / $2.675 billion |
| Cash and equivalents / total debt | $4.388 billion / $3.911 billion | $5.301 billion / $3.909 billion |
| Net cash (cash plus securities less debt) | $0.977 billion | $1.392 billion |
| Total backlog | $72.410 billion | $45.885 billion |
Capital spending was $521 million. The company repurchased 29 million shares for approximately $3.4 billion and paid $822 million in dividends; declared dividends were $2.48 per share. The debt-to-equity ratio was 33.1%, compared with 27.0% in 2013. Cash flow benefited from significant customer deposits tied to a large Combat Systems contract; management expects cash flow to moderate as those deposits fund supplier commitments.
Fourth quarter 2014: Revenue was $8.362 billion, operating earnings $1.067 billion, continuing-operations earnings $737 million, and net earnings $701 million. Diluted EPS was $2.19 from continuing operations and $2.09 net. The quarter included a $36 million after-tax discontinued-operations loss, primarily a final adjustment related to the axle-business sale.
Business-group results
| Group | 2014 revenue | 2014 operating earnings | Change versus 2013 |
|---|---|---|---|
| Aerospace | $8.649 billion | $1.611 billion | Revenue +6.5%; margin 18.6%, up from 17.4% |
| Combat Systems | $5.732 billion | $862 million | Revenue −1.7%; margin 15.0%, down from 15.6% |
| Information Systems and Technology | $9.159 billion | $785 million | Revenue −10.8%; margin 8.6%, up from 7.7% |
| Marine Systems | $7.312 billion | $703 million | Revenue +8.9%; margin 9.6%, down from 9.9% |
Material changes versus the prior period
- Revenue was essentially flat, but operating earnings increased 5.4% and operating margin expanded 70 basis points, reflecting improved Aerospace production performance and Information Systems and Technology cost reductions.
- Aerospace benefited from higher large-cabin aircraft deliveries: 144 green and 150 outfitted aircraft, versus 139 and 144, respectively, in 2013.
- Combat Systems revenue remained pressured by lower U.S. Army spending, partly offset by the start of work on major international vehicle awards. New-program start-up and contract mix reduced the group’s margin.
- Information Systems and Technology revenue declined primarily because of lower U.S. Army mobile-communications work and lower volume in several services programs; cost reductions improved its margin.
- Marine Systems revenue rose on Virginia-class submarine and commercial Jones Act ship construction, while its margin eased as new programs ramped up and mature work declined.
- Total backlog rose nearly 60%, principally from major Combat Systems and Marine Systems awards. Funded backlog was $52.929 billion; unfunded backlog was $19.481 billion.
Outlook, commentary, risks and unusual items
Management’s 2015 outlook calls for Aerospace revenue growth of about 8%, with margins around 18%; Combat Systems revenue and margins broadly consistent with 2014; Information Systems and Technology revenue down about 5.5%, with margins slightly above 9%; and Marine Systems revenue up 2% to 2.5%, with margins in the mid-9% range. Expected corporate costs are $65 million to $70 million. Management expects 2015 net interest expense of $82 million, an effective tax rate of about 30.5%, and capital expenditures of approximately 2% of revenue.
Key risks include reliance on U.S. government budgets and appropriations, delays or termination of government contracts, contract-cost estimation and fixed-price execution risk, supplier and subcontractor performance, international budget, currency and regulatory exposure, business-jet demand, cybersecurity threats, and the ability to develop products and retain skilled employees. The company reported no material off-balance-sheet arrangements other than operating leases. It said pending litigation, environmental matters, government audits and contract claims were not expected to have a material financial impact based on information then available.
Unusual items include the $146 million after-tax loss recognized in 2014 on the planned sale of the Combat Systems axle business, completed in January 2015. The 2013 discontinued-operations loss included a $129 million after-tax charge from settlement of the terminated A-12 contract litigation. The sharp 2013-versus-2012 earnings comparison also reflects a $1.994 billion goodwill impairment in Information Systems and Technology in 2012, as well as other 2012 charges. The 2014 pension discount-rate and mortality assumption changes increased pension benefit obligations by $566 million and other post-retirement obligations by $28 million; the pension funded deficit was $4.152 billion at year-end.
Management noted that the 2017 revenue-recognition standard will replace its prospective method for recognizing revisions to estimated contract profit with a cumulative catch-up approach, potentially increasing period-to-period earnings variability. The company had not yet determined the adoption impact or selected a transition method.
Important facts for investors to verify
- Whether the large international Combat Systems awards convert into funded work and deliver the anticipated revenue, margins and cash flows; unfunded backlog is not guaranteed funding.
- Whether operating cash flow remains strong after the exceptional customer deposits that supported 2014 cash generation are spent.
- Whether 2015 segment guidance is achieved, particularly given expected Information Systems and Technology revenue contraction and Aerospace product-development spending.
- How pension assumptions, asset returns and the substantial retirement-benefit deficit affect future funding needs and reported equity.
- The final financial and operating effects of the axle-business disposal and the transition to the new revenue-recognition standard.
- Exposure to U.S. defense-budget changes, foreign-exchange movements and cyber or contract-execution events; the filing reports $9.1 billion of foreign-currency forward-contract notional at year-end.