General Dynamics Corporation — Q1 2010 Form 10-Q
Reporting period: Three months ended April 4, 2010; comparative quarter ended April 5, 2009. Unaudited results. The company operates in Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology, serving defense, government, and business-aviation markets. Most revenue comes from U.S. military contracts.
Financial performance and position
Dollars in millions, except per-share amounts.
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Revenue | $7,750 | $8,264 | Down 6.2% |
| Operating earnings | $918 | $905 | Up 1.4% |
| Operating margin | 11.8% | 11.0% | Up 0.8 percentage points |
| Earnings from continuing operations | $599 | $593 | Up 1.0% |
| Net earnings | $597 | $590 | Up 1.2% |
| Diluted EPS | $1.53 | $1.53 | Unchanged |
| Operating cash flow | $210 | $154 | Up $56 |
| Free cash flow from operations | $150 | $73 | Up $77 |
- Cash and equivalents were $2.025 billion at April 4, down from $2.263 billion at year-end 2009. Total debt was $3.863 billion; management reported net debt of $1.3 billion, essentially unchanged from year-end.
- No commercial paper was outstanding. The company had approximately $1.8 billion in backup bank facilities and $1.3 billion in local international credit facilities. A $700 million note matures in Q3 2010; financing covenants were met.
- Current assets were $13.353 billion and current liabilities $9.937 billion. Funded backlog was $47.4 billion, total backlog $63.9 billion, and estimated potential contract value $17.0 billion.
- The effective tax rate was 31.5%. Dividends declared were $0.42 per share, versus $0.38 a year earlier. The company repurchased 2.9 million shares for $200 million.
Material changes and business-group results
- Revenue declined mainly because of lower Combat Systems volume, including the wind-down of MRAP production and cancellation of the manned ground vehicle portion of Future Combat Systems, and fewer aircraft deliveries in Aerospace. Higher operating earnings and margin reflected improved Aerospace and Combat Systems performance despite lower sales.
- Aerospace: Revenue $1.357 billion, down 6.7%; operating earnings $218 million, up 9.0%; margin 16.1% versus 13.7%. Gulfstream green-aircraft deliveries fell to 28 from 31; outfitted deliveries fell to 17 from 34.
- Combat Systems: Revenue $2.002 billion, down 16.8%; earnings $269 million, down 3.6%; margin 13.4% versus 11.6%. Improved Stryker and Abrams performance and favorable munitions mix supported margins.
- Marine Systems: Revenue $1.639 billion, down 1.8%; earnings $161 million, down 1.2%; margin steady at 9.8%. Results reflected the timing and mix of shipbuilding programs.
- Information Systems and Technology: Revenue $2.752 billion, up 0.7%; earnings $290 million, up 0.3%; margin 10.5% versus 10.6%. The group recorded its highest quarterly revenue to date.
Outlook, commentary, and risks
- Management forecast 2010 revenue growth of low-to-mid single digits for Aerospace, 4–5% for Combat Systems, 7–8% for Marine Systems, and 8–9% for Information Systems and Technology. Expected segment margins: Aerospace around 14% with some upside; Combat Systems in the high-12% range; Marine Systems in the mid-9% range; and Information Systems and Technology in the mid-10% range.
- Management expected full-year G&A at about 6% of revenue, net interest expense of $150–$160 million, and an effective tax rate of 31.5–31.7%. Capital expenditures were expected to be below 2% of revenue; free cash flow was expected to approach 100% of continuing-operations earnings.
- Total backlog fell 3% from year-end, while funded backlog rose 3%. Management cited strong defense order activity, particularly in Information Systems and Technology. Aerospace orders improved, but customer defaults continued; the outlook assumes economic recovery and lower defaults.
- Operating cash flow included working-capital growth from contract-payment timing, which management expected to reverse over the remainder of 2010. The quarter included a $48 million acquisition of a military mission-planning software provider and $247 million of held-to-maturity securities purchases.
- Major contingency: The long-running A-12 termination litigation remained pending before the U.S. Supreme Court. If the government ultimately prevails, the company estimated its pretax share at approximately $1.4 billion, an after-tax charge of about $800 million ($2.06 per share) and after-tax cash cost of about $715 million. Management disputed the government’s position and said it had sufficient resources if payment were required.
- Other risks include changes to defense budgets or contract priorities, performance and cost overruns on long-term fixed-price contracts, supplier issues, recovery of contract claims, business-aircraft demand, input prices, and legal or regulatory outcomes. Management considered other litigation, environmental matters, and government disputes not material based on information available. It reported effective disclosure controls and no material change in internal control during the quarter.
Important facts for investors to verify
- Whether full-year segment growth and margin expectations remain achievable, particularly the anticipated second-half revenue ramp in Combat Systems and Marine Systems.
- Whether Gulfstream demand and customer-default trends continue to improve, and how delivery mix affects Aerospace revenue and margins.
- Whether working-capital cash use reverses as management expected and whether full-year free cash flow approaches its stated target.
- Funding, timing, and execution of major defense awards underpinning backlog; distinguish funded backlog from unfunded backlog and estimated potential contract value.
- Developments in the A-12 litigation, including the potential exposure and cash consequences if the outcome is adverse.
- The $700 million Q3 2010 debt maturity and continued availability of commercial-paper backup facilities.