General Dynamics Corporation — 2014 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended September 28, 2014. Figures are unaudited; dollar amounts are in millions unless noted.
Business context and results
General Dynamics operates in Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology. Its customers include the U.S. government, international governments, and business-aviation customers. Approximately 60% of revenue comes from the U.S. government.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $7,751 | $7,735 | $22,490 | $22,883 |
| Operating earnings | $999 | $961 | $2,822 | $2,765 |
| Operating margin | 12.9% | 12.4% | 12.5% | 12.1% |
| Continuing-operations earnings | $694 | $652 | $1,936 | $1,862 |
| Net earnings | $696 | $651 | $1,832 | $1,862 |
| Diluted EPS | $2.06 | $1.84 | $5.34 | $5.27 |
For the first nine months, operating cash flow was $3,798 and capital spending was $337, yielding company-defined free cash flow of $3,461, versus $1,553, $267, and $1,286, respectively, in 2013. Cash generation included substantial customer deposits tied to a large international Combat Systems contract.
At September 28, cash and equivalents were $5,105, and held-to-maturity securities were $500. Total debt was $3,911, including $501 due within one year; management reported net cash of $1.7 billion after cash, securities, and debt. Current assets were $18,169 and current liabilities $14,670. The company had no commercial paper outstanding and $2 billion of committed credit facilities available; it was in compliance with material debt covenants.
Changes and segment performance
- Q3 revenue was nearly flat, while nine-month revenue declined 1.7%. Management attributed pressure chiefly to lower U.S. Army spending and reduced Information Systems and Technology activity. Aerospace and Marine Systems grew.
- Operating margin improved 50 basis points in Q3 and 40 basis points year to date. Management cited stronger aircraft manufacturing and outfitting performance and cost reductions in Information Systems and Technology; Q3 margin was described as the highest in six years.
- Aerospace: Q3 revenue rose 6.4% and operating earnings 11.4%; nine-month revenue rose 7.1%. Higher large-cabin deliveries and improved manufacturing performance supported results.
- Combat Systems: Q3 revenue increased 6.8%, but nine-month revenue fell 2.9% and operating earnings fell 10.2%. International vehicle work offset declining U.S. military production; new-program mix weighed on margins.
- Marine Systems: nine-month revenue rose 3.7% and earnings were nearly flat. Higher ship construction was partly offset by lower Navy repair and engineering activity; margins eased.
- Information Systems and Technology: nine-month revenue fell 11.7% and earnings fell 4.3%, primarily due to lower mobile communications, IT services, and ISR activity. Cost reductions supported higher margins despite lower revenue.
Year-to-date net earnings declined 1.6% despite higher continuing-operations earnings, largely because the company recorded a $106 after-tax loss to write down its axle business held for sale. The nine-month discontinued-operations result was a $104 loss.
Liquidity, capital allocation, outlook, and risks
- Operating cash flow increased to $3,798 from $1,553; cash used in investing was $826, including a $500 securities purchase. Cash used in financing was $3,194, including $3,117 of share repurchases and $618 of dividends.
- The company repurchased approximately 28.8 million shares during the first nine months and declared dividends of $1.86 per share. The accelerated share repurchase program was scheduled to expire in Q4; final settlement cost remained to be determined.
- Backlog reached a company record of $74.4 billion, up more than 55% from a year earlier. Estimated potential contract value was $26.7 billion, bringing total estimated contract value to $101.1 billion. Combat Systems backlog benefited from a $5.9 billion U.K. SCOUT SV award.
- Management’s 2014 outlook: Aerospace revenue growth of about 8% and margins in the mid-18% range; Combat Systems revenue of about $5.7 billion and margins around 15%; Marine Systems revenue growth of about 7% and margins in the mid-to-high 9% range; Information Systems and Technology revenue of about $9 billion, down 12%, with margins in the mid-8% range. Corporate costs were expected at $70–$75; capital expenditures at about 2% of revenue; net interest expense at about $90; and the effective tax rate at about 30%.
- Management expected the continuing resolution funding defense at prior-year levels through December 11, 2014, not to materially affect Q4 results, citing the relatively consistent FY2015 budget request and backlog. It expected cash flows to moderate from the unusually strong 2014 period.
- Key risks include U.S. and international defense budgets and priorities, government contract termination or restructuring, execution and cost performance on long-term fixed-price contracts, supplier performance, aircraft-market demand, commodity and labor costs, and outcomes of claims or legal proceedings. The filing says pending litigation, environmental matters, government audits, and outstanding contract claims are not expected to have a material effect.
- Other notable items: the company settled a Portugal armored-vehicle contract dispute without material financial impact; it announced a January 2015 consolidation of mobile communications and ISR operations into General Dynamics Mission Systems. The new revenue standard, effective in 2017, may make contract-estimate revisions larger and more variable; its financial effect had not been determined.
Important facts for investors to verify
- Whether the large international Combat Systems order converts into funded backlog and cash collection as expected, and how associated customer deposits and supplier commitments affect future cash flow.
- Whether segment revenue and margin outlooks are achieved, particularly as U.S. defense spending declines and new programs replace mature contracts.
- The final cash or share settlement and cost of the accelerated share repurchase program.
- Progress and sale terms for the axle business, including any further effects on discontinued operations.
- Contract estimate revisions: favorable revisions contributed $13 to Q3 2014 operating earnings and $103 for the first nine months, below the comparable 2013 amounts of $105 and $296.
- The filing reports $165 of outstanding pension-related requests for equitable adjustment with the Department of Defense; recovery remained subject to negotiation.