General Dynamics Corporation — Q2 2013 Form 10-Q
Reporting period: Unaudited results for the three and six months ended June 30, 2013; comparisons are to the corresponding periods ended July 1, 2012. Unless noted, dollar amounts are in millions.
Business context and financial performance
General Dynamics operates in Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology. Its markets include defense and business aviation, with most revenue from U.S. government contracts.
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Revenue | $7,911 | $7,922 | $15,315 | $15,501 |
| Operating earnings | $960 | $970 | $1,807 | $1,830 |
| Operating margin | 12.1% | 12.2% | 11.8% | 11.8% |
| Net earnings | $640 | $634 | $1,211 | $1,198 |
| Diluted EPS | $1.81 | $1.77 | $3.43 | $3.34 |
| Operating cash flow | Not separately stated | Not separately stated | $1,083 | $1,203 |
| Free cash flow from operations* | Not separately stated | Not separately stated | $915 | $1,027 |
*Company-defined measure: operating cash flow less capital expenditures. First-half free cash flow was 76% of net earnings, compared with 86% a year earlier. Management attributed lower cash generation primarily to working-capital timing and higher pension contributions.
Q2 net interest expense was $18; first-half expense was $41 versus $76 a year earlier, reflecting the December 2012 refinancing, which reduced the weighted-average debt rate from 3.9% to 2.2%. First-half effective tax rate was 31.5% in both years.
Financial position and liquidity
- At June 30, 2013, cash and equivalents were $3,757, up from $3,296 at year-end 2012. Debt was $3,908, leaving reported net debt of $151.
- Current assets were $16,538 and current liabilities were $11,841. Customer advances and deposits totaled $6,113.
- No commercial paper was outstanding. The company had $2 billion of committed bank facilities supporting its commercial paper program, plus approximately $285 of facilities for European operations; it reported compliance with material covenants.
- First-half capital expenditures were $168. The company repurchased $485 of shares and paid $198 of dividends in the first half; 7.6 million shares were repurchased at an average $77 per share, with $100 of related cash outflow expected in Q3 due to settlement timing.
Material changes and business-group results
First-half revenue decreased 1.2% and operating earnings decreased 1.3% year over year; operating margin was unchanged. Lower Combat Systems volume, particularly military vehicles, weapons systems, and munitions, was partly offset by increased Gulfstream aircraft deliveries and ship engineering and repair work. Q2 revenue was nearly flat and operating earnings declined 1.0%.
| Business group | Q2 revenue change | Q2 operating earnings | Management outlook for 2013 |
|---|---|---|---|
| Aerospace | +29.0% | $389; 18.9% margin | Revenue growth of about 17%; full-year margin in mid-to-high 16% range |
| Combat Systems | −27.9% | $218; 14.1% margin | Revenue down nearly 15%; margin in mid-14% range |
| Marine Systems | +6.4% | $178; 10.1% margin | Revenue near 2012 levels; margin in mid-to-high 9% range |
| Information Systems and Technology | +0.9% | $198; 7.8% margin | Revenue down approximately 2%; margin approaching 8% |
Backlog at June 30 was $49.4 billion, including $41.1 billion funded and $8.3 billion unfunded, up 2% from the prior quarter. Estimated potential contract value, including certain unfunded IDIQ work and unexercised options, was $27.7 billion. Notable awards included a $2.8 billion Navy contract for four DDG-51 ships, with an option for a fifth.
Outlook, risks, and unusual items
- Management’s defense outlook incorporates its estimates of sequestration impacts and a possible fourth-quarter continuing resolution. The FY 2014 budget request did not include the stated $52 billion in sequestration cuts; the eventual budget and customer actions remained uncertain.
- Company-wide guidance included 2013 G&A expense of approximately 6.5% of revenue, net interest expense of approximately $85, an effective tax rate of approximately 32%, and capital expenditures of approximately 2% of anticipated revenue.
- Favorable contract-estimate revisions increased operating earnings by $83 in Q2 and $191 in the first half of 2013, or $0.15 and $0.35 per diluted share, respectively. No individual contract revision was material.
- The A-12 aircraft termination litigation remains unresolved. The company recorded no accrual, but describes a possible company share of approximately $1.5 billion pretax, or $840 after tax, if adverse legal and recovery outcomes occur. Settlement discussions were ongoing.
- For the Portugal Pandur vehicle program, the company reserved receivables and contract balances and accrued close-out costs totaling $258 in 2012. Approximately $195 of related bank guarantees remained outstanding at June 30 and could be drawn through 2014.
- Other disclosed risks include defense-budget reductions, government contract changes or termination, fixed-price contract cost overruns, supplier performance, aircraft-market demand, and contract claims. Management stated that other litigation and environmental exposures were not expected to be material.
Key facts investors should verify
- Whether sequestration, appropriations, and any continuing resolution affect defense awards, funding, and the stated business-group outlook.
- How much backlog is funded and how much potential contract value converts into funded work and revenue.
- Whether working-capital growth reverses as management expects and whether cash flow recovers from the first-half decline.
- Progress and potential exposure in the A-12 litigation and Portugal arbitration and guarantees.
- Whether contract-estimate revisions, aircraft deliveries, and group margin assumptions support reported earnings and 2013 guidance.