General Dynamics Corporation — Q2 2010 Form 10-Q
Reporting period: Three and six months ended July 4, 2010; comparisons are with periods ended July 5, 2009. Dollar amounts are in millions except per-share data.
Business context and results
General Dynamics operates in Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology. Its markets include defense and national security and business aviation; the U.S. military is its largest customer base.
| Metric | Q2 2010 | Q2 2009 | First half 2010 | First half 2009 |
|---|---|---|---|---|
| Revenue | $8,104 | $8,100 | $15,854 | $16,364 |
| Operating earnings | $985 | $945 | $1,903 | $1,850 |
| Operating margin | 12.2% | 11.7% | 12.0% | 11.3% |
| Net earnings | $648 | $618 | $1,245 | $1,208 |
| Diluted EPS | $1.67 | $1.60 | $3.20 | $3.12 |
Cash flow, balance sheet, and capital
- First-half operating cash flow was $687, versus $763 in 2009; capital expenditures were $123, resulting in company-defined free cash flow of $564, versus $593.
- Cash and equivalents were $1,853 at July 4, down from $2,263 at year-end 2009. Cash, equivalents, and marketable securities totaled approximately $2.3 billion.
- Total debt was $3,862, including $703 current; long-term debt was $3,159. No commercial paper was outstanding. Net debt was reported as $1.5 billion at quarter-end, compared with $1.2 billion at year-end 2009.
- Approximately $2 billion of bank credit facilities were undrawn. The company planned to repay $700 of notes maturing in August 2010 with cash on hand and reported compliance with material debt covenants.
- First-half investing cash use was $446, including $237 for three acquisitions; financing cash use was $648, including $511 of share repurchases and $310 of dividends. The quarterly dividend was raised to $0.42 per share.
- Current assets were $13,166 and current liabilities $9,795 at July 4. Customer advances and deposits declined to $3,740 from $4,313 at year-end, contributing to working-capital cash use.
Material changes and segment performance
- Q2 revenue was essentially flat year over year; first-half revenue fell 3.1%, while operating earnings rose 2.9% and operating margin improved 70 basis points. Management attributed the improvement to stronger margins, especially in Aerospace and Combat Systems.
- Aerospace first-half revenue fell 4.5% to $2,740, mainly due to reduced aircraft outfitting, while operating earnings increased to $451. Services activity improved; outfitted Gulfstream deliveries declined.
- Combat Systems first-half revenue declined 14.5% to $4,113, largely reflecting timing and completion of U.S. vehicle programs, including prior MRAP production. Operating earnings fell 2.6% to $564, but margin improved to 13.7%.
- Marine Systems first-half revenue was nearly flat at $3,276 and operating earnings were $328. Navy program activity offset lower commercial ship construction.
- Information Systems and Technology first-half revenue grew 6.3% to $5,725 and operating earnings grew 5.1% to $602, supported by growth across its markets and an acquisition contribution.
Outlook, risks, and contingencies
- Management forecast 2010 revenue growth of low- to mid-single digits for Aerospace, flat to slightly lower revenue for Combat Systems, approximately 5% growth for Marine Systems, and approximately 8%–9% growth for Information Systems and Technology. Expected segment margins were mid-15% for Aerospace, mid-13% for Combat Systems, mid-9% for Marine Systems, and mid-10% for Information Systems and Technology.
- Management expected full-year net interest expense of $155–$160, an effective tax rate of 31.3%–31.5%, corporate operating expense of approximately $90, capital expenditures around 1% of revenue, and free cash flow approaching 100% of earnings from continuing operations. No consolidated revenue or EPS forecast is stated in the supplied filing text.
- Total backlog was $62.5 billion, down 2% from the prior quarter. Estimated potential contract value, which includes certain options and IDIQ work not yet in backlog, was $21.7 billion; it is not equivalent to funded backlog or guaranteed revenue.
- The principal disclosed litigation exposure is the A-12 aircraft termination case. If the government ultimately prevails, General Dynamics estimates its pretax share at approximately $1.4 billion, after-tax charge at $805 ($2.07 per share), and after-tax cash cost at approximately $720. The company disputes the government’s position and believes it has sufficient resources if payment is required.
- Other cited uncertainties include government budget and contract changes, long-term fixed-price contract performance, contract claims and recoveries, business-jet demand, foreign exchange, input costs, and legal or regulatory proceedings. Management said other legal, environmental, and government-contract matters were not expected to have a material financial effect.
- Business-jet order activity slowed in June amid European economic uncertainty. The company also noted currency weakness affecting Combat Systems’ reported results and timing-related reductions in customer advances that it expected to reverse in the second half.
Important facts for investors to verify
- Whether the expected second-half reversal in customer advances and deposits occurs and supports cash flow guidance.
- Execution against segment revenue and margin forecasts, particularly Aerospace delivery and outfitting trends and Marine Systems’ contract-mix shift.
- Conversion of funded backlog and potential contract value into orders, funded work, and revenue; potential contract value depends on future customer actions.
- Repayment of the August 2010 notes and subsequent capital allocation, including the limited remaining share-repurchase authorization.
- Developments in the A-12 litigation and any change in the estimated company exposure.