General Dynamics Corporation — Q2 2015 Form 10-Q
Reporting period: Three and six months ended July 5, 2015; comparisons are to the periods ended June 29, 2014. Amounts are in millions of dollars except per-share data and where noted. The statements are unaudited.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $7,882 | $7,474 | $15,666 | $14,739 |
| Operating earnings | $1,081 | $949 | $2,108 | $1,823 |
| Operating margin | 13.7% | 12.7% | 13.5% | 12.4% |
| Earnings from continuing operations | $752 | $646 | $1,468 | $1,242 |
| Diluted continuing-operations EPS | $2.27 | $1.88 | $4.41 | $3.60 |
- Q2 revenue increased 5.5%; operating earnings rose 13.9%. For the six-month period, revenue rose 6.3% and operating earnings rose 15.6%.
- 2014 net earnings included losses from the axle business, sold in January 2015: $105 in Q2 and $106 for the first six months. 2015 had no discontinued-operations earnings or loss; continuing-operations figures offer the clearer comparison.
- Cash from operating activities was $1,348 for the first six months, versus $1,294. Capital expenditures were $190, producing company-defined free cash flow of $1,158, versus $1,132. Operating cash flow equaled 92% of continuing-operations earnings (104% in 2014); free cash flow equaled 79% (91%).
- Cash and equivalents were $4,032 at July 5, down from $4,388 at year-end 2014. Total debt was $3,413, down from $3,911 after repayment of $500 in notes; net cash, as defined by the company, was $619 versus $977.
- Six-month financing cash use was $2,239, including $1,565 of share repurchases and $432 of dividends paid. The company repurchased about 12.1 million shares for $1.7 billion and had 10.3 million shares remaining authorized for repurchase. The $2 billion commercial-paper backup facilities remained available; no commercial paper was outstanding, and the company reported compliance with debt covenants.
Business trends and material comparisons
- Management attributed consolidated growth mainly to additional large-cabin business-aircraft deliveries and higher activity in Marine Systems and Information Systems and Technology. It cited improved performance and cost reduction, particularly in Combat Systems and Information Systems and Technology, for margin expansion.
- Aerospace revenue rose 13.2% in Q2 and 6.0% year to date; operating margin was 19.4% and 19.9%, respectively. Higher large-cabin deliveries contributed. Gulfstream delivered 41 outfitted aircraft in Q2 versus 38 a year earlier.
- Combat Systems Q2 revenue declined 3.9%, while six-month revenue rose 1.8%. Margins improved to 16.1% for Q2 and 15.5% year to date, with lower overhead and stronger performance; 2014 included $29 of restructuring charges in the first half.
- Information Systems and Technology revenue increased 2.4% in Q2 and 3.2% year to date; margins rose to 10.7% and 9.9%. The Q2 operating result included a $23 gain on the sale of a commercial cybersecurity business.
- Marine Systems revenue increased 8.1% in Q2 and 14.3% year to date, while margins eased to 9.3% and 9.5%. Higher shipbuilding and submarine activity was partly offset by work mix and cost growth on the DDG-1000 program.
- Total backlog was $70.0 billion, slightly below $70.5 billion at the prior quarter-end. Estimated potential contract value was $25.6 billion, bringing total estimated contract value to $95.6 billion. Potential value includes unfunded awards, options and other work not yet firm or funded.
Outlook, risks and notable items
- For 2015, management expected Aerospace revenue growth of about 6%, with margins in the mid-18% range; Combat Systems revenue generally consistent with 2014 and margins in the mid-15% range; Information Systems and Technology revenue essentially flat and margins in the mid-9% range; and Marine Systems revenue growth of about 7% with margins in the mid-9% range.
- Management forecast Corporate costs of approximately $45–$50, net interest expense of about $85, a low-29% effective tax rate, and capital expenditures around 2% of revenue for 2015.
- Favorable revisions to contract estimates increased operating earnings by $45 in Q2 and $108 for the first six months ($0.09 and $0.21 per share, respectively). No single contract revision was material. Management cautioned that adoption of the new revenue standard will end its prospective reallocation method; estimate changes may then be larger and more variable from period to period. The company had not selected a transition method or determined the standard’s financial effect.
- Management said deposits received in 2014 for a large international Combat Systems contract would be used for supplier commitments, expected to weigh on operating cash flow in the second half of 2015. It expected liquidity and borrowing capacity to remain sufficient.
- Risks identified include changes in U.S. and international defense spending and priorities, government contract termination or restructuring, execution and supplier risks on long-term fixed-price contracts, recovery of contract claims, business-aircraft demand, input costs, and legal or regulatory proceedings. Management did not expect pending litigation, environmental matters, government audits or claims to have a material financial impact. Certain government contract modifications and claims remain subject to customer resolution.
Important facts for investors to verify
- Whether reported margin improvement and forecast segment margins persist, particularly given the cybersecurity-sale gain and favorable contract-estimate revisions.
- How much of the $95.6 billion estimated contract value converts into firm, funded backlog and revenue; unfunded awards and options are not assured.
- Whether second-half operating cash flow is affected as expected by supplier commitments and lower customer advances, and how cash generation compares with earnings.
- Execution and cost performance on the DDG-1000 and other long-term programs, as well as business-aircraft delivery and demand trends.
- The eventual adoption method and financial effects of the new revenue-recognition standard, and developments in contract claims, government funding and other contingencies.