General Dynamics Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparison period ended April 1, 2018. Amounts are in millions of dollars except per-share data. Unaudited results are not necessarily indicative of full-year performance.
Business context and results
General Dynamics operates five segments: Aerospace, Combat Systems, Information Technology, Mission Systems and Marine Systems. Its businesses include business aviation, defense products and services, IT, and shipbuilding. The U.S. government is its primary customer. Revenue growth included the first full comparative-period contribution from CSRA, acquired in April 2018.
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $9,261 | $7,535 | +22.9% |
| Operating earnings | $1,014 | $1,008 | +0.6% |
| Operating margin | 10.9% | 13.4% | Down 2.5 percentage points |
| Earnings before tax | $915 | $960 | Down $45 |
| Net earnings | $745 | $799 | Down 6.8% |
| Diluted EPS | $2.56 | $2.65 | Down 3.4% |
| Net interest expense | $117 | $27 | Up $90 |
| Effective tax rate | 18.6% | 16.8% | Up 1.8 percentage points |
Revenue increased in every segment, but operating costs grew faster than revenue. Management attributed margin pressure primarily to a less favorable aircraft delivery mix and CSRA-related intangible amortization. Higher interest expense chiefly reflected debt used to finance CSRA; the higher tax rate reflected a smaller benefit from excess tax benefits on equity compensation.
Segment performance
| Segment | Revenue | Operating earnings | Operating margin | Year-over-year context |
|---|---|---|---|---|
| Aerospace | $2,240 (+22.7%) | $328 (down 5.2%) | 14.6% vs. 19.0% | Higher aircraft deliveries, including G500; initial G500 mix weighed on earnings. |
| Combat Systems | $1,636 (+13.6%) | $206 (down 8.0%) | 12.6% vs. 15.6% | More U.S. and international vehicle and munitions work; mix and a former-site lease settlement pressured margin. |
| Information Technology | $2,169 (+90.6%) | $156 (+54.5%) | 7.2% vs. 8.9% | Growth reflected CSRA; acquired-intangible amortization reduced reported margin. Excluding that amortization, margin was 9.5%, up 0.6 points. |
| Mission Systems | $1,158 (+5.5%) | $148 (+1.4%) | 12.8% vs. 13.3% | Higher demand for computing, communications and satellite systems; program mix reduced margin. |
| Marine Systems | $2,058 (+1.2%) | $180 (down 2.2%) | 8.7% vs. 9.0% | Higher Virginia-class submarine construction was partly offset by lower other work; program mix pressured margin. |
Cash flow, balance sheet and capital
- Operating cash flow: Cash used was $795, versus $496 used in Q1 2018. Capital expenditures were $181, versus $104; reported free cash flow from operations, defined as operating cash flow less capital expenditures, was negative $976, versus negative $600.
- Working capital: Cash use reflected increases in unbilled receivables and inventories and lower customer advances and deposits. The company cited payment timing on international armored-vehicle contracts as a key factor.
- Cash and debt: Cash and equivalents were $673 at March 31, down $290 from year-end 2018. Debt principal was $13,646, including $1,865 of commercial paper; net debt was $12.9 billion, versus $11.5 billion at year-end. The company had $5 billion of committed credit facilities and reported covenant compliance.
- Liquidity and current assets: Current assets were $18,867 and current liabilities $15,382. Unbilled receivables rose to $7,367 from $6,576; inventories increased to $6,185 from $5,977, primarily due to G600 production ramp-up.
- Shareholder returns: Dividends paid were $268; the quarterly dividend declared increased to $1.02 per share. The company repurchased 0.5 million shares for $86, with about 7 million shares remaining authorized for repurchase.
Backlog, outlook, risks and unusual items
- Backlog: Total backlog was $69.2 billion, up 2% from $67.9 billion at December 31, 2018. Total potential contract value, including estimated potential contract value, was $103.2 billion. Management expected to recognize about 65% of remaining performance obligations as revenue by year-end 2020, another 25% by year-end 2022, and the remainder thereafter. Potential contract value includes options and other work not yet firm or funded.
- Capital spending: Management expected 2019 capital expenditures to be approximately 3% of revenue, principally supporting shipyard growth. The company anticipated FAA type certification and entry into service for the G600 in 2019.
- International contract collection: A Canadian-government contract involving an international wheeled armored-vehicle customer had a $2.2 billion net unbilled receivable and payment delays. The company said it remained entitled to payment, continued performance, and expected to collect the full outstanding amount.
- Contract estimates: Changes in estimates on long-term contracts increased Q1 2019 operating earnings by $68 and diluted EPS by $0.18, compared with $97 and $0.25 in Q1 2018. No individual contract adjustment was material. Fixed-price work exposes the company to cost and execution risk.
- Litigation contingency: Electric Boat faces a government investigation, related sealed lawsuit and Navy show-cause matter concerning quality oversight of supplier parts. The company could not assess the ultimate outcome or estimate a possible loss; an adverse result could materially affect results, financial condition or cash flows. Other identified legal and environmental matters were not expected by management to be material.
- Accounting change: Adoption of the lease standard on January 1, 2019 added $1.4 billion of operating lease right-of-use assets and liabilities, without a material effect on earnings or cash flow and without restating prior periods.
- Other stated risks: The filing identifies government spending and contract changes, long-term fixed-price execution, supplier performance, aircraft-market demand, claims recovery, acquisitions, legal and regulatory matters, commodity costs and cybersecurity among risks to forward-looking statements. Management reported no material change in risk factors from its 2018 Form 10-K.
Key facts for investors to verify
- Whether margins and earnings recover as new aircraft models mature and CSRA acquisition amortization impacts results.
- Collection timing and recoverability of the $2.2 billion international armored-vehicle contract receivable, and its effect on operating cash flow.
- Progress on backlog conversion, funding of unfunded defense backlog and realization of estimated potential contract value.
- G600 certification and entry-into-service timing, aircraft delivery mix, and the expected 2019 capital-spending level.
- Developments in the Electric Boat quality-related investigation and related proceedings, including any change in the company’s ability to estimate exposure.
- Debt, commercial-paper balances, interest expense and cash generation relative to dividends, repurchases and investment needs.