General Dynamics Corporation — Q1 2011 Form 10-Q
Reporting period: Three months ended April 3, 2011; comparative quarter ended April 4, 2010. Dollar amounts are in millions except per-share data. The company operates Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology businesses, serving defense, government, and business-aviation markets.
Financial results and liquidity
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Revenue | $7,798 | $7,750 | Up 0.6% |
| Operating earnings | $929 | $918 | Up 1.2% |
| Operating margin | 11.9% | 11.8% | Up 0.1 percentage point |
| Earnings from continuing operations | $618 | $599 | Up 3.2% |
| Net earnings | $618 | $597 | Up 3.5% |
| Diluted EPS | $1.64 | $1.53 | Up $0.11 |
| Operating cash flow | $327 | $210 | Up $117 |
| Free cash flow from operations* | $266 | $150 | Up $116 |
- Product revenue declined to $5,061 from $5,162, while services revenue grew to $2,737 from $2,588. Net interest expense fell to $34 from $44, primarily reflecting repayment of $700 of notes in 2010. The effective tax rate was 31%, versus 31.5%.
- Operating cash flow was 53% of continuing-operations earnings, compared with 35% in the prior-year quarter. Management attributed working-capital growth mainly to timing of contract payments and expected it to reverse over the remainder of 2011.
- At April 3, cash and equivalents were $2,484; current assets were $14,795 and current liabilities $11,252. Total debt was $3,203, comprising $792 current and $2,411 long-term. Management reported net debt of $432, calculated after cash and marketable securities.
- Cash declined $129 during the quarter. Investing used $138, including $61 of capital expenditures; financing used $318, including $314 of share repurchases and $157 of dividends.
*Company-defined non-GAAP measure: operating cash flow less capital expenditures.
Business groups and material changes
- Aerospace: Revenue was $1,353, essentially flat, while operating earnings rose 5.5% to $230 and margin increased to 17.0% from 16.1%. Fewer green Gulfstream deliveries were offset by a more favorable aircraft mix, more outfitted deliveries, and stronger services. A single fleet-customer liquidated-damages transaction supported quarterly margins.
- Combat Systems: Revenue declined 2.3% to $1,955, mainly from lower U.S. military-vehicle activity. Earnings increased 3.0% to $277 and margin rose to 14.2%, reflecting productivity and contract mix.
- Marine Systems: Revenue grew 2.3% to $1,676 and earnings rose 3.7% to $167. Higher Navy program and engineering/repair work more than offset lower commercial shipbuilding revenue.
- Information Systems and Technology: Revenue increased 2.3% to $2,814, led by IT services. Earnings declined 4.8% to $276 and margin fell to 9.8% from 10.5%, due to contract mix and price competition in IT services.
- Total backlog was $57.6 billion, down 3% from year-end 2010; estimated potential contract value was $20.6 billion, versus $21.8 billion. The filing cites delayed orders under the federal continuing resolution as one factor in defense backlog changes.
Outlook, risks, and unusual items
- Management forecast full-year 2011 net interest expense of about $130 and an effective tax rate of about 31%. Expected capital expenditures were less than 2% of revenue.
- Segment outlook: Aerospace revenue growth of approximately 15–16% and margin of 15.5–16%; Combat Systems revenue of about $9 billion and margin of about 14%; Marine Systems revenue near $6.7 billion and margin in the low-9% range; Information Systems and Technology revenue growth of 3–5% and margin above 10%. Corporate operating expense was expected to be about $90.
- The April 2 crash of a G650 flight-test aircraft led to a temporary suspension of flight activity for the other four test aircraft. The effect on certification and initial delivery timing was unknown; other certification and production work continued. Aerospace’s outlook assumed initial G650 deliveries later in 2011.
- A-12 litigation: The company and Boeing face a long-running dispute over the Navy’s 1991 termination of the A-12 contract. No accrual was recorded. In an adverse outcome, the company estimated its pretax share at approximately $1.4 billion, with an after-tax charge of about $820 ($2.18 per share) and after-tax cash cost of about $730. The Supreme Court was considering a state-secrets issue; the company stated it believed significant legal obstacles remained to government recovery.
- $750 of fixed-rate notes was scheduled to mature in July 2011; management had not decided whether to repay or refinance. The company had no commercial paper outstanding, approximately $2 billion in backup bank facilities, and was in compliance with material debt covenants.
- Other disclosed risks include U.S. defense budget and contract changes, execution and cost risk on long-term fixed-price programs, business-jet demand, and legal or regulatory outcomes. Management said other litigation, environmental matters, and government disputes were not expected to have a material effect.
Most important facts for investors to verify
- Progress and schedule impact of the G650 investigation, certification, and planned initial deliveries.
- Developments in the A-12 Supreme Court litigation and potential exposure if the company’s position is not upheld.
- Refinancing or cash repayment of the $750 million July 2011 debt maturity and the company’s capital-return plans.
- Whether operating working capital reverses as management expected and whether cash generation sustains share repurchases and dividends.
- Defense budget actions, funded contract awards, and backlog conversion, particularly in Marine Systems and U.S. vehicle programs.