General Dynamics Corporation — Q3 2019 Form 10-Q
Business context and period. This unaudited filing covers the three and nine months ended September 29, 2019. General Dynamics operates in Aerospace, Combat Systems, Information Technology, Mission Systems and Marine Systems. The U.S. government is its largest customer. Comparisons with 2018 are affected by the April 2018 CSRA acquisition and subsequent portfolio changes.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $9.761B | $9.094B | $28.577B | $25.815B |
| Operating earnings | $1.216B | $1.135B | $3.320B | $3.231B |
| Operating margin | 12.5% | 12.5% | 11.6% | 12.5% |
| Net earnings | $913M | $851M | $2.464B | $2.436B |
| Diluted EPS | $3.14 | $2.85 | $8.47 | $8.12 |
| Operating cash flow | Not separately stated for quarter | Not separately stated for quarter | $587M | $1.081B |
| Free cash flow from operations | Not separately stated for quarter | Not separately stated for quarter | $(19)M | $634M |
Q3 revenue rose 7.3% and operating earnings rose 7.1%; nine-month revenue increased 10.7%, while operating earnings rose 2.8%. Nine-month operating margin fell 90 basis points, reflecting less favorable aircraft delivery and Combat Systems contract mix. Q3 margin held steady as operational improvements and cost controls offset those pressures. Nine-month interest expense rose to $350M from $244M, primarily reflecting CSRA acquisition financing. The effective tax rate was 17.5%, versus 17.1%.
Segment performance
- Aerospace: Q3 revenue grew 22.8% to $2.495B, but margin declined to 15.8% from 18.5%; nine-month revenue rose 19.5%, while operating earnings fell 5.1%. Higher G500 and initial G600 deliveries lifted sales, but new-aircraft mix and a prior-year supplier settlement weighed on earnings.
- Combat Systems: Q3 revenue rose 14.2% and operating earnings 9.5%; nine-month revenue rose 12.0% and earnings 1.6%. Higher U.S. military vehicle and munitions volume was partly offset by unfavorable contract mix and a first-quarter lease-related settlement.
- Information Technology: Q3 revenue declined 10.2% and operating earnings 7.0%; nine-month revenue increased 8.7% and earnings 10.1%. Q3 reflected the sale of a contact-center business and completion of legacy CSRA programs; the nine-month comparison benefited from including CSRA for more of the period.
- Mission Systems: Q3 revenue was down 0.8%, while earnings rose 3.4%; nine-month revenue and earnings increased 5.2% and 3.6%, respectively.
- Marine Systems: Q3 revenue increased 11.6% and earnings 23.7%; nine-month revenue and earnings increased 6.7% and 6.9%, respectively, led by U.S. Navy ship construction.
Financial position and liquidity
- At September 29, 2019, cash was $974M; total debt was $13.650B, including $4.661B current, and net debt was $12.7B. Net debt was $11.5B at year-end 2018.
- Current assets were $20.151B and current liabilities $18.227B. The company reported $5B of committed credit facilities and compliance with debt covenants.
- Nine-month operating cash flow declined to $587M. Free cash flow, defined as operating cash flow less capital expenditures, was negative $19M after $606M of capital spending. Management attributed cash pressure chiefly to working-capital growth, including delayed payments on an international armored-vehicle contract and Aerospace working capital.
- Net unbilled receivables increased to $8.077B from $6.576B. This included $2.6B related to a Canadian-government contract for vehicles being sold to an international customer; General Dynamics reported payment delays but expected collection in full.
- The company paid $858M in dividends and repurchased $184M of shares during the first nine months. It had $2.5B of fixed- and floating-rate notes maturing in May 2020 and planned to repay them using cash and commercial paper.
Outlook, commentary and risks
- Management expected the full-year 2019 effective tax rate to be in the mid-17% range and anticipated minimal Corporate income or expense in Q4. No consolidated revenue or earnings guidance is stated in the filing.
- Management expected G500 and G600 deliveries to continue ramping in Q4. The G600 received FAA type and production certification in June and its first aircraft was delivered in Q3. The G700, announced October 21, 2019, was expected to enter service in 2022, subject to certification.
- Backlog was $67.4B at quarter-end, slightly below $67.7B at June 30; estimated total contract value, including potential opportunities, was $103.0B. The company expected to recognize about 55% of remaining performance obligations as revenue by year-end 2020 and another 30% by year-end 2022. Backlog and potential contract value are not guaranteed revenue or funding.
- A continuing resolution funded U.S. federal agencies at FY2019 levels through November 21, 2019. Management did not expect the CR or subsequent extensions to materially affect results, but noted that new programs generally cannot be funded during a CR.
- A Department of Justice investigation and a qui tam lawsuit concern alleged Electric Boat quality-system failures involving supplier parts. In Q3, DOJ declined to intervene, while noting its investigation continued. The company could not estimate the outcome or potential loss; an adverse result could materially affect results, financial condition or cash flows.
- Other disclosed risks include fixed-price contract cost overruns, supplier and subcontractor performance, government spending and contract changes, aircraft demand, claims recovery, regulatory reviews, litigation and cybersecurity. Management considered other environmental and legal contingencies not material, based on information available.
Important facts for investors to verify
- Whether delayed payments on the international armored-vehicle contract are collected as expected, and how unbilled receivables and operating cash flow develop.
- Whether aircraft delivery mix and G500/G600 production ramp improve Aerospace margins, and whether G700 development and certification remain on schedule.
- Progress on the Electric Boat investigation and lawsuit, including any change in the company’s ability to estimate potential exposure.
- Funding and award timing under the continuing resolution, and the conversion of backlog and estimated potential contract value into funded work and revenue.
- How the company addresses the May 2020 debt maturity and manages leverage while funding capital expenditures, dividends and other shareholder returns.