Business context and reporting period
General Dynamics Corporation’s unaudited Form 10-Q covers the three and six months ended July 5, 2009; comparisons are with the periods ended June 29, 2008. The company operates in Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology, serving defense and business aviation markets.
Financial performance and condition
Unless otherwise stated, amounts are in millions of dollars.
| Metric | Three months | Six months |
|---|---|---|
| Revenue | $8,100, up 10.9% | $16,364, up 14.4% |
| Operating earnings | $945, up 2.6% | $1,850, up 3.8% |
| Operating margin | 11.7%, versus 12.6% | 11.3%, versus 12.5% |
| Net earnings | $618, versus $641 | $1,208, versus $1,213 |
| Diluted EPS | $1.60, versus $1.60 | $3.12, versus $3.01 |
- For the six months, continuing-operations operating cash flow was $763, down from $1,456; free cash flow from operations was $593, versus $1,256. Capital expenditures were $170.
- At July 5, cash and equivalents were $1,614; total debt was $3,915, including $55 current and $3,860 long-term. Management reported net debt of $2.2 billion, compared with $2.3 billion at year-end 2008. The company also held $88 in marketable securities on the balance sheet; management cited $1.7 billion in cash and equivalents and marketable securities for general corporate purposes.
- Current assets were $12,298 and current liabilities were $9,260. Shareholders’ equity was $11,001. The quarterly dividend was $0.38 per share.
- Backlog at quarter-end was $67.6 billion, including $47.7 billion funded; estimated potential contract value was a further $17.7 billion.
Material changes and segment results
- Revenue growth reflected contributions from all groups, led by Combat Systems’ higher military-vehicle activity and acquisition contribution, and Marine Systems’ increased shipyard activity. Jet Aviation, acquired in 2008, contributed to Aerospace revenue growth.
- Aerospace revenue rose 6.5% for the quarter, but operating earnings fell 10.4% and margin declined to 15.2% from 18.1%. Gulfstream faced weaker aircraft demand, fewer deliveries, customer defaults, pricing pressure and reduced service activity; pre-owned aircraft inventory write-downs weighed on first-half results.
- Combat Systems revenue rose 19.4% for the quarter and 19.9% for the half year, while margins declined year over year, partly reflecting less favorable program mix and comparison with unusually strong 2008 margins.
- Marine Systems revenue rose 16.6% for the quarter and operating earnings rose 32.3%; improved shipyard performance lifted quarterly margin to 10.3% from 9.1%.
- Information Systems and Technology revenue rose 3.5% for the quarter and 9.6% for the half year. Operating earnings fell 2.7% in the quarter; a higher mix of lower-margin services reduced margins.
- Company-wide second-quarter operating earnings were described as the highest quarterly amount in company history, although margin was below the prior-year quarter. Margin improved 70 basis points from the first quarter of 2009.
Outlook, risks, and unusual items
- Management forecast 2009 revenue growth of about 22% for Combat Systems, 16% for Marine Systems, and 8% for Information Systems and Technology. Aerospace revenue was expected to decline about 5%, with full-year margins of 13.3%–13.5%. Expected full-year margins were in the mid-12% range for Combat Systems, up 40–50 basis points for Marine Systems versus 2008, and down 30–40 basis points for Information Systems and Technology versus 2008.
- Company guidance included full-year G&A expense at approximately 6% of sales, net interest expense of approximately $150, an effective tax rate of approximately 31.5%, and capital expenditures below 2% of revenue. Management said it expected funds from operations to exceed liquidity needs and considered available cash and borrowing capacity adequate.
- Management cited recessionary conditions and business-aviation weakness, changing defense budgets, government contract termination or restructuring, execution and supplier risks on long-term fixed-price contracts, contract-claim recoveries, and energy and raw-material prices as factors that could cause actual results to differ from expectations. Aerospace revenue and margins were expected to weaken in the second half, particularly in the third quarter, partly due to a planned workforce furlough.
- The company had signed an agreement to acquire Axsys Technologies for $643, subject to regulatory and shareholder approval, with a third-quarter 2009 closing anticipated and cash on hand expected to fund the deal.
- A-12 litigation: On June 2, 2009, an appeals court panel affirmed the government’s default termination of the A-12 contract. General Dynamics intended to seek rehearing and maintained that the termination was unjustified. The filing states a potential company after-tax charge of approximately $790 ($2.04 per share) and after-tax cash cost of approximately $705 if the termination is ultimately sustained. The filing’s stated collective repayment amount and stated company pretax share are internally inconsistent; the exposure should be checked against the full filing.
- Other contingencies included environmental matters, government audits and investigations, letters of credit and guarantees; management did not expect these to have a material aggregate impact. The company reported compliance with material debt covenants and effective disclosure controls.
Important facts for investors to verify
- Reconcile the A-12 litigation exposure figures and monitor the appeal and any rehearing decision.
- Track business-aviation order activity, customer defaults, aircraft deliveries, pre-owned inventory values, and Aerospace’s planned production and furlough effects.
- Assess the sustainability of margin performance and the extent to which revenue growth reflects acquisitions, program mix, or organic activity.
- Monitor operating cash flow and customer advances: first-half operating cash flow was substantially lower year over year, with management citing reduced Aerospace customer deposits.
- Confirm the Axsys acquisition’s completion, funding, and expected financial contribution, and monitor backlog conversion, including unfunded awards and estimated potential contract value.