General Dynamics Corporation — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended October 4, 2015; comparisons are with the periods ended September 28, 2014. Amounts are in U.S. dollars unless noted.
Business context
General Dynamics operates in Aerospace, Combat Systems, Information Systems and Technology, and Marine Systems. Its markets include business aviation, defense systems, IT and shipbuilding; approximately 60% of revenue comes from the U.S. government. The filing is unaudited.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $7.994B | $7.751B | $23.660B | $22.490B |
| Operating earnings | $1.034B | $999M | $3.142B | $2.822B |
| Operating margin | 12.9% | 12.9% | 13.3% | 12.5% |
| Net earnings | $733M | $696M | $2.201B | $1.832B |
| Diluted EPS | $2.28 | $2.06 | $6.68 | $5.34 |
- Nine-month revenue rose 5.2%; operating earnings increased 11.3%, with margin up 80 basis points. Management attributed the margin improvement mainly to better performance and cost reductions in Combat Systems and Information Systems and Technology.
- Third-quarter revenue grew 3.1%, and operating earnings grew 3.5%; operating margin was unchanged. Marine Systems drove much of quarterly revenue growth.
- Nine-month net cash from continuing operating activities was $2.170B, versus $3.798B a year earlier. Free cash flow, defined as operating cash flow less capital expenditures, was $1.810B versus $3.461B. The prior-year period included significant customer deposits on a Middle Eastern Combat Systems contract; those deposits were being used in 2015 for supplier commitments.
- Capital expenditures were $360M for the nine months. Investing activities provided $418M, including $500M from maturing securities and proceeds from asset sales. Financing activities used $3.573B, including $2.729B of share repurchases, $655M of dividends and repayment of $500M of notes.
- Cash and equivalents were $3.372B at October 4, down from $4.388B at year-end 2014. Total debt was $3.413B, versus $3.911B; management reported net debt of $41M, compared with net cash of $977M at year-end. No commercial paper was outstanding. Available committed credit facilities included $2B supporting the commercial-paper program and approximately $120M for European businesses; the company reported compliance with debt covenants.
- The nine-month effective tax rate was 28.6%, compared with 29.8%; management cited higher non-U.S. earnings and favorable contract close-outs.
Business-group results and material changes
- Aerospace: Nine-month revenue increased 4.7% to $6.709B and operating earnings increased 8.1% to $1.296B; margin rose to 19.3%. Gulfstream green deliveries were 110 versus 106, and outfitted deliveries were 116 versus 108. Higher large-cabin deliveries supported results; a supplier settlement helped nine-month earnings, partly offset by higher R&D.
- Combat Systems: Nine-month revenue was essentially flat at $4.116B, while operating earnings rose 9.6% to $648M and margin improved to 15.7%. Management cited improved performance and cost reductions. Third-quarter earnings and margin were lower year over year, partly because the prior-year quarter included a favorable Portuguese government settlement.
- Information Systems and Technology: Nine-month revenue rose 1.7% to $6.804B; operating earnings increased 17.5% to $673M and margin rose to 9.9%. Improved program performance and cost reductions contributed; results included a $23M gain from selling a commercial cybersecurity product business. IT services revenue declined.
- Marine Systems: Nine-month revenue rose 14.4% to $6.031B and operating earnings rose 9.0% to $556M, but margin declined to 9.2%. Higher submarine, repair and Jones Act ship activity drove growth; contract mix, DDG-1000 cost growth and the DDG-51 restart pressured margin.
- Product revenue increased 8.5% year to date, while services revenue declined 0.2%. The axle business sale was completed in January 2015; its 2014 results included a $105M write-down loss in discontinued operations.
- Favorable revisions to contract estimates added $44M ($0.09 per diluted share) to Q3 operating earnings and $152M ($0.30 per diluted share) year to date; no single revision was material.
Outlook, risks and contingencies
- Management expected 2015 Aerospace revenue growth of approximately 4%, with margin around 19%; Combat Systems revenue generally consistent with 2014, with margin in the mid-15% range; Information Systems and Technology revenue essentially flat, with margin in the mid- to high-9% range; and Marine Systems revenue growth of approximately 7%, with margin in the low- to mid-9% range. Corporate costs were expected to be about $45M.
- Management expected full-year net interest expense of approximately $85M, an effective tax rate around 28%, and capital expenditures around 2% of revenue. It stated that current continuing-resolution funding through December 11, 2015, was consistent with expected Q4 revenue and was not expected to materially affect Q4 operating results.
- Backlog was $68.742B at quarter-end, slightly below $70.026B at the prior quarter-end; total estimated contract value, including potential contract value, was $94.290B. Potential value includes unfunded awards and unexercised options and is not assured funding or revenue.
- Principal disclosed risks include changes in U.S. and international defense budgets and priorities, government contract termination or restructuring, cost overruns on long-term fixed-price contracts, supplier performance, recovery of contract claims, business-aircraft demand, commodity costs, and legal or regulatory outcomes. Government audits, litigation, environmental matters, and contract modifications/claims were described as not expected to have a material financial impact based on information available. Letters of credit, guarantees and similar arrangements totaled approximately $1B.
- Adoption of the new revenue-recognition standard was expected to preclude the company’s prospective reallocation method for contract-estimate revisions; management anticipated revisions could consequently be larger and more variable when recognized. The impact and transition method had not yet been determined.
Important facts for investors to verify
- Whether the projected segment growth and margin ranges, tax rate, interest expense and capital spending were achieved for full-year 2015.
- How much of reported earnings growth depended on contract-estimate revisions, the cybersecurity-business gain and the Aerospace supplier settlement.
- Whether operating cash flow improved as the prior-year customer deposits were utilized, and the sustainability of free cash flow after repurchases and dividends.
- Backlog conversion, funding and option exercise—particularly Marine Systems’ large unfunded backlog and the broader gap between backlog and estimated potential contract value.
- Progress and cost performance on fixed-price programs, including DDG-1000 and DDG-51, and exposure to defense-budget decisions and continuing resolutions.
- Debt refinancing or repayment plans for the $500M notes due July 2016, and the effects of continued share repurchases on liquidity and per-share results.