General Dynamics Corporation — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016; quarterly figures below are unaudited. Amounts are in U.S. dollars unless noted.
Business context
General Dynamics is a global aerospace and defense contractor operating through Aerospace, Combat Systems, Information Systems and Technology, and Marine Systems. The U.S. government accounted for 60% of 2016 revenue; the Department of Defense was the largest customer. The company reported 98,800 employees at year-end.
Key financial metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Revenue | $31.353 billion | $31.469 billion | (0.4%) |
| Operating earnings / margin | $4.309 billion / 13.7% | $4.178 billion / 13.3% | +3.1% / +40 bps |
| Continuing-operations earnings | $3.062 billion | $2.965 billion | +3.3% |
| Net earnings | $2.955 billion | $2.965 billion | (0.3%) |
| Diluted EPS, continuing operations / net | $9.87 / $9.52 | $9.08 / $9.08 | Continuing EPS +8.7% |
| Operating cash flow | $2.198 billion | $2.607 billion | (15.7%) |
| Free cash flow from operations* | $1.806 billion | $2.038 billion | (11.4%) |
*Company-defined non-GAAP measure: operating cash flow less capital expenditures.
Year-end cash and equivalents were $2.334 billion, versus $2.785 billion a year earlier. Debt totaled $3.888 billion, up from $3.399 billion; net debt was $1.554 billion versus $614 million. Debt-to-equity increased to 35.4% from 31.7%. The company had $2 billion in committed credit facilities, no commercial paper outstanding, and $900 million of notes due in November 2017. Capital expenditures were $392 million. Dividends declared were $3.04 per share.
Business-group performance
| 2016 | Revenue | Operating earnings | Operating margin |
|---|---|---|---|
| Aerospace | $8.362 billion | $1.718 billion | 20.5% |
| Combat Systems | $5.602 billion | $914 million | 16.3% |
| Information Systems and Technology | $9.187 billion | $992 million | 10.8% |
| Marine Systems | $8.202 billion | $725 million | 8.8% |
Aerospace revenue declined 5.5%, mainly on fewer aircraft deliveries, but margin rose to a record 20.5% on cost savings and stronger services performance. Combat Systems revenue was nearly flat and earnings improved on contract mix and execution. Information Systems and Technology revenue grew 2.5%, with earnings up 9.9%. Marine Systems revenue grew 2.4%, while earnings were slightly lower amid DDG-51 restart cost growth and lower-margin work.
Material changes versus 2015
- Revenue was broadly flat, but operating earnings and margin reached company records, reflecting lower costs and improved performance despite fewer business-jet deliveries.
- Operating cash flow fell by $409 million. Management cited working-capital growth, use of customer deposits received earlier on a large Combat Systems contract, and inventory buildup for the G500/G600 aircraft.
- Total backlog declined to $59.8 billion from $66.1 billion; funded backlog fell to $49.4 billion from $51.8 billion. Marine Systems backlog included $14.1 billion for 15 Virginia-class submarines.
- Share repurchases were $2.0 billion, down from $3.2 billion in 2015; the company repurchased 14.2 million shares and paid $911 million in dividends.
- Net earnings included $107 million of after-tax discontinued-operations losses: a $13 million final axle-business sale adjustment, an $84 million A-12 settlement-related adjustment, and a $10 million environmental matter.
Outlook, accounting changes and risks
- For 2017, management forecast Aerospace revenue growth of about 6% with margin in the low-19% range; Combat Systems revenue growth of 6–7% with margin in the mid-15% range; slightly higher Information Systems and Technology revenue with margin around 11%; and slightly lower Marine Systems revenue with margin in the mid-8% range.
- Management expected 2017 corporate costs of approximately $55 million, net interest expense of approximately $110 million, an effective tax rate near 28%, and capital expenditures of about 2% of revenue. No consolidated revenue or EPS forecast is stated in the filing text.
- The 2017 outlook reflects ASC Topic 606, adopted January 1, 2017. Under the new standard, business-jet revenue generally shifts to final customer acceptance, and long-term contract estimate adjustments use a cumulative catch-up method. Management cautioned that period-to-period earnings adjustments may become larger and more variable. Restated 2016 revenue and operating earnings under the new standard were $30.561 billion and $3.734 billion, respectively; diluted continuing-operations EPS was $8.64.
- A continuing resolution funded U.S. agencies at prior-year levels through April 28, 2017. Management did not anticipate a material 2017 operating impact from the then-current resolution. Nonetheless, 60% U.S. government revenue concentration leaves results exposed to budget changes, funding delays, program reductions, and contract termination rights.
- Electric Boat disclosed a DOJ investigation, a related False Claims Act lawsuit, and a Navy Show Cause Letter concerning supplier quality-system oversight. The company could not assess the outcome or estimate a possible loss; an adverse outcome could materially affect results, financial condition, or cash flows.
- Other material risks discussed include fixed-price contract execution, supplier performance, foreign exchange and international regulatory risks, business-jet demand, cyber threats, and pension assumptions. Management stated that environmental matters and other routine claims were not expected to have a material impact. No goodwill impairment was recorded in 2016.
Most important facts for investors to verify
- Review cash conversion and working-capital movements, especially the rise in contracts in process and the continued use of customer advances.
- Assess backlog quality and funding: total backlog includes unfunded amounts, and future appropriations are not assured.
- Track the Electric Boat investigation and related Navy proceedings; the filing provides no clear estimate of potential exposure.
- Compare 2017 results with guidance on the ASC 606 basis, accounting for aircraft delivery timing and potentially more volatile contract-estimate adjustments.
- Monitor the November 2017 debt maturity, cash deployment, and the effect of ongoing dividends and repurchases on net debt and liquidity.