General Dynamics Corporation — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 28, 2020; unaudited. General Dynamics operates in Aerospace, Combat Systems, Information Technology, Mission Systems and Marine Systems. COVID-19 affected both commercial aerospace demand and execution across defense programs.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $9.264B | $9.555B | $18.013B | $18.816B |
| Operating earnings | $841M | $1.090B | $1.782B | $2.104B |
| Operating margin | 9.1% | 11.4% | 9.9% | 11.2% |
| Net earnings | $625M | $806M | $1.331B | $1.551B |
| Diluted EPS | $2.18 | $2.77 | $4.61 | $5.33 |
Q2 revenue fell 3.0% year over year and operating earnings declined 22.8%; first-half revenue fell 4.3% and operating earnings fell 15.3%. Lower Aerospace deliveries and services and lower IT services volume were key revenue pressures. Aerospace and IT also weighed on operating profit; lower aircraft margins reflected production changes, delivery mix, pre-owned aircraft losses and restructuring. Marine Systems and Combat Systems revenue grew, partly offsetting declines elsewhere.
For the six months, operating cash flow was $177M, versus cash used of $504M a year earlier. Capital expenditures were $406M, producing negative free cash flow from operations of $229M, compared with negative $866M in 2019. Cash and equivalents rose to $2.3B from $902M at year-end 2019. Debt principal was $14.724B ($14.591B carrying value); net debt was $12.3B. The company reported $5B of committed credit facilities and compliance with debt covenants.
Liquidity, capital allocation and backlog
- Operating cash flow remained modest despite the year-over-year improvement; management attributed pressure partly to Aerospace working-capital needs and COVID-related delays in aircraft production and deliveries.
- In March, the company issued $4B of fixed-rate notes, repaid $2.5B of notes maturing in May, and used proceeds for general corporate purposes. It also had $1.2B of commercial paper outstanding at quarter-end.
- First-half dividends paid were $610M; the quarterly dividend was increased to $1.10 per share. The company repurchased 3.4M shares for $501M in the first half, but none in Q2.
- Backlog was $82.7B at quarter-end, down from $85.7B at March 29. Total estimated contract value, including potential contract value, was $132.2B. Management expects to recognize about 50% of remaining performance obligations by year-end 2021 and another 30% by year-end 2023.
Outlook, risks and unusual items
- Management expected COVID-19 to continue negatively affecting operations during the remainder of 2020. Impacts included restricted customer-site access, travel limits, supplier slowdowns and reduced manufacturing hours. The company reduced aircraft production rates to 125–130 for 2020 from approximately 150 and adjusted staffing and costs.
- Segment 2020 outlook: Aerospace revenue around $8.4B and operating margin about 13.5%; Combat Systems about $7.3B and 14.3%; Information Technology about $8.1B and 6.3%; Mission Systems about $4.9B and 14.5%; Marine Systems about $9.6B and 8.8%. Management forecast full-year net interest expense of about $480M and an effective tax rate in the mid-15% range. No consolidated revenue or earnings guidance is stated in the filing.
- The quarter included an approximately $40M loss in IT on a non-U.S. customer contract due to COVID-related travel delays. Aggregate contract-estimate adjustments reduced Q2 operating earnings by $5M, but increased first-half operating earnings by $85M.
- Aircraft delivery delays contributed to inventories rising to $6.666B from $6.306B at year-end. A large international armored-vehicle contract had $2.3B of net unbilled receivables; revised payment terms included $500M progress payments in each of the first two quarters, with further annual payments expected.
- The company said pandemic duration and effects on contract costs, supply chains and demand remain uncertain; estimated reimbursements under the CARES Act depend on customer agreement and available government funding. It had not identified a COVID-related impairment trigger at quarter-end.
- Electric Boat faces a False Claims Act-related investigation and qui tam litigation concerning supplier-part quality-system allegations. The company could not estimate a reasonably possible loss; an adverse outcome could materially affect results, financial condition or cash flows. Management considered other disclosed legal and environmental matters not expected to have a material impact.
Key facts for investors to verify
- Whether aircraft demand, delivery timing, production rates and services activity recover as assumed in Aerospace guidance.
- Whether pandemic disruption, fixed-price contract execution and the approximately $40M IT contract loss lead to further cost or margin pressure.
- Conversion of the $82.7B backlog into funded work, revenue and cash, and timing of collections on the international armored-vehicle contract.
- Cash generation, working-capital needs, commercial-paper use and debt refinancing as obligations mature.
- Developments in the Electric Boat legal matter and any change in the company’s assessment of potential exposure.