General Dynamics Corporation — Q2 2012 Form 10-Q
Reporting period: Three and six months ended July 1, 2012; comparisons are with periods ended July 3, 2011. Dollar amounts are in millions except per-share data. General Dynamics operates in Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology (IS&T), serving government and business-aviation customers.
Financial results and condition
| Metric | Q2 2012 | Q2 2011 | First half 2012 | First half 2011 |
|---|---|---|---|---|
| Revenue | $7,922 | $7,879 | $15,501 | $15,677 |
| Operating earnings | $970 | $949 | $1,830 | $1,878 |
| Operating margin | 12.2% | 12.0% | 11.8% | 12.0% |
| Net earnings | $634 | $653 | $1,198 | $1,271 |
| Diluted EPS | $1.77 | $1.76 | $3.34 | $3.40 |
| Operating cash flow | — | $1,203 | $1,079 | |
| Free cash flow from operations | — | $1,027 | $927 |
- Q2 revenue increased 0.5% and operating earnings increased 2.2%; first-half revenue declined 1.1% and operating earnings declined 2.6%.
- Cash and equivalents were $2,540 at July 1, 2012, versus $2,649 at year-end 2011. Total debt was $3,933, including $1,028 classified as current; the company reported net debt of approximately $1 billion after cash and marketable securities.
- Current assets were $15,527 and current liabilities $12,179. The company had no commercial paper outstanding and had $2 billion of backup bank facilities. Its next material debt maturity is $1 billion in May 2013.
- First-half capital expenditures were $176; dividends paid were $353 and share repurchases were $592. The company repurchased 9.1 million shares in the half-year and declared a quarterly dividend of $0.51 per share.
Material changes and business-group performance
- Aerospace: First-half revenue rose 17.8% to $3,215 and operating earnings rose 20.3% to $528, primarily on G650 deliveries and improved completions performance. The group delivered 54 green aircraft and 40 outfitted aircraft in the first half.
- Combat Systems: First-half revenue edged down 0.4% to $4,060; operating earnings fell 8.9% to $525. Lower European vehicle and weapons/munitions volume and a $67 prior-period adjustment in the first quarter pressured results.
- Marine Systems: First-half revenue was nearly flat at $3,258, while operating earnings increased 12.2% to $368. Favorable T-AKE program cost performance supported margins; the program is nearing completion.
- IS&T: First-half revenue declined 11.6% to $4,968 and operating earnings declined 22.8% to $444. Tactical communications revenue fell amid delayed customer awards and slower transitions to follow-on work; a shift toward lower-margin IT services also reduced margins.
- Company-wide second-quarter improvement reflected higher Aerospace volume and favorable performance in Combat and Marine Systems. First-half weakness reflected lower IS&T volume and a shift from higher-margin tactical communications products to lower-margin IT services.
- Backlog was $52.4 billion at quarter-end, down from $55.2 billion at the end of Q1. Estimated potential contract value under unfunded IDIQ contracts and unexercised options was an additional $26.2 billion.
Outlook, risks, and contingencies
- Management expected 2012 Aerospace revenue to increase approximately 15%, with margins in the mid-15% range. Combat Systems revenue was expected to approximate $8.5 billion, with margins in the mid-13% range. Marine Systems revenue was expected to decline slightly, with margins in the low-11% range. IS&T revenue was expected to decline approximately 7%, with margins in the low-9% range. Corporate operating costs were expected to be approximately $70.
- Management expected full-year 2012 net interest expense of approximately $155, an effective tax rate of approximately 32%, and capital expenditures of approximately 2% of revenue. These are management estimates, not guarantees.
- Defense-budget uncertainty is a major risk. The filing cites $487 billion of planned defense-spending reductions over a decade and a possible additional $500 billion in sequestration cuts for FY2013–FY2021 if Congress did not meet deficit-reduction requirements. Management could not predict the effects on programs, revenue, margins, cash flow, orders, or backlog.
- The A-12 termination litigation remains unresolved. The government’s claim could require repayment of up to approximately $1.6 billion including interest; General Dynamics estimated its potential share at about $1.5 billion pretax, an approximately $830 after-tax charge and $740 after-tax cash cost. No accrual was recorded; the company believes it has sufficient resources if payment is required.
- Management considered a restructuring of the Portugal Pandur vehicle contract likely but could not predict its timing or financial impact. Approximately $130 was recorded in accounts receivable and contracts in process related to the contract.
- The SEC’s Division of Enforcement requested information about contract-estimate accounting practices; the company is cooperating and cannot predict the outcome. Management reported no material expected aggregate impact from other routine litigation and environmental matters.
- Contract-estimate revisions increased operating earnings by $90 in Q2 and $158 in the first half of 2012; management stated no individual first-half contract revision was material. Changes in estimates and long-term contract performance remain important sources of uncertainty.
Important facts for investors to verify
- Whether defense-budget decisions or sequestration affect program funding, awards, backlog, and the company’s outlook.
- IS&T award timing, tactical communications demand, and whether the lower-margin service mix continues.
- G650 certification, delivery execution, and Aerospace order activity; management expected certification in Q3 2012, subject to the FAA schedule.
- Developments in the A-12 litigation, Portugal contract restructuring, and SEC inquiry into contract estimates.
- The company’s ability to manage the May 2013 debt maturity and sustain cash generation, dividends, and repurchases.