General Dynamics Corporation — Q3 2010 Form 10-Q
Business context and period. The filing covers the three and nine months ended October 3, 2010; comparisons are with the corresponding 2009 periods. General Dynamics operates in Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology, serving defense, government, and business-aviation markets. Dollar amounts below are in millions unless noted.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue | $8,011 | $7,719 | $23,865 | $24,083 |
| Operating earnings | $966 | $874 | $2,869 | $2,724 |
| Operating margin | 12.1% | 11.3% | 12.0% | 11.3% |
| Net earnings | $650 | $572 | $1,895 | $1,780 |
| Diluted EPS | $1.70 | $1.47 | $4.90 | $4.60 |
| Operating cash flow | — | $1,567 | $1,357 |
- Cash generation: Nine-month free cash flow from operations, defined as operating cash flow less capital expenditures, was $1,348 versus $1,106. Capital expenditures were $219 versus $251.
- Liquidity and debt: At October 3, cash and equivalents were $1,843, total debt was $3,204, and net debt was reported at $1.2 billion. No commercial paper was outstanding; approximately $2 billion of bank facilities remained undrawn. Current assets were $13,390 and current liabilities $10,311.
- Capital returns: The company paid $471 in dividends and repurchased $726 of shares in the first nine months. Quarterly dividends declared were $0.42 per share.
- Other balance-sheet items: Total assets were $31,483 and shareholders’ equity $13,582. Contracts in process were $4,986, up from $4,449 at year-end 2009.
Material changes and segment performance
- Q3 revenue rose 3.8%, operating earnings rose 10.5%, and operating margin improved 80 basis points year over year. For the nine months, revenue declined 0.9%, while operating earnings increased 5.3% and margin improved 70 basis points.
- Q3 growth came from Aerospace, Marine Systems, and Information Systems and Technology; Combat Systems revenue fell. For the nine-month period, Combat Systems revenue declined 13.6%, largely reflecting lower U.S. military vehicle activity and program timing, while Information Systems and Technology revenue grew 6.8%.
- Aerospace posted Q3 revenue of $1,291 and operating earnings of $199; the group cited higher aircraft manufacturing and services activity. Combat Systems reported $2,069 revenue and $311 operating earnings; lower revenue was partly offset by productivity and favorable contract mix. Marine Systems reported $1,700 revenue and $169 operating earnings; Navy program growth outweighed lower commercial shipbuilding. Information Systems and Technology reported $2,951 revenue and $306 operating earnings, supported by mission systems and IT services growth.
- Total backlog was $61.8 billion, down about 1% from the prior quarter. Estimated potential contract value, which includes unfunded IDIQ work and unexercised options and is not firm backlog, was $20.8 billion.
Outlook, risks, and unusual items
- Management expected full-year 2010 Aerospace revenue growth in the mid-single digits and margins approaching 16%; Combat Systems revenue of about $9 billion and margins around 14%; Marine Systems revenue growth close to 5% and margins in the high-9% range; and Information Systems and Technology revenue growth of approximately 8% to 8.5% with margins in the mid-10% range.
- Management expected full-year net interest expense of $155–$160, an effective tax rate of approximately 31.2%, capital expenditures of about 1% of revenue, and free cash flow near 100% of continuing-operations earnings. These are forward-looking estimates, not guarantees.
- A-12 litigation: The U.S. Supreme Court agreed to review an issue in the long-running dispute over the Navy’s termination of the A-12 program. The filing describes a potential repayment exposure and says the company believes it has resources to pay if required. The stated exposure figures appear inconsistent: it cites approximately $1.5 billion as the contractors’ combined amount including interest, but then states General Dynamics’ share could be approximately $1.4 billion pretax. Verify the figures against the original filing.
- Other risks include U.S. defense budget and program changes, government contract termination or restructuring, cost overruns on fixed-price work, contract-claim recoveries, business-aircraft demand, input costs, and litigation or regulatory outcomes. The company said environmental, tax, and other legal matters were not expected to have a material adverse effect.
- Three acquisitions were completed for $233 in the first nine months. The company repaid $700 of fixed-rate notes due in August; the next material long-term debt maturity was $750 in July 2011. Management reported compliance with material debt covenants.
Most important facts for investors to verify
- Confirm the A-12 potential liability and the apparent mismatch between the stated combined exposure and the company’s stated share.
- Assess whether the improving operating margins and cash flow are sustainable, particularly amid lower nine-month revenue and working-capital growth.
- Check the quality and funding status of backlog: $61.8 billion is total backlog, while the additional $20.8 billion of estimated potential contract value is not firm backlog.
- Monitor defense-budget decisions, Combat Systems program volumes, and the execution and contract mix of major Navy programs.
- Track business-aviation demand, aircraft orders and deliveries, and management’s segment and cash-flow outlook against actual results.