General Dynamics Corporation — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended October 2, 2011; comparable periods ended October 3, 2010. Amounts are in millions of dollars, except per-share amounts and where noted.
Business context and financial performance
General Dynamics operates in Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology. Its markets include defense and national security and business aviation; most revenue comes from U.S. government contracts.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $7,853 | $8,011 | $23,530 | $23,865 |
| Operating earnings | $998 | $966 | $2,876 | $2,869 |
| Operating margin | 12.7% | 12.1% | 12.2% | 12.0% |
| Continuing-operations earnings | $665 | $649 | $1,949 | $1,899 |
| Net earnings | $652 | $650 | $1,923 | $1,895 |
| Diluted EPS | $1.80 | $1.70 | $5.19 | $4.90 |
Revenue declined 2.0% in the quarter and 1.4% year to date, largely due to lower tactical communications activity and reduced ship-construction volume. Operating earnings rose modestly, lifting margins. Q3 product revenue fell 4.2%, while service revenue grew 2.3%; year-to-date product revenue fell 4.3% and services grew 4.3%. Q3 net earnings included a $13 after-tax loss from discontinued operations.
Cash flow, balance sheet, debt and liquidity
- Operating cash flow for the first nine months was $1,212, down from $1,567. Capital expenditures were $273, producing company-defined free cash flow of $939 versus $1,348 a year earlier. Free cash flow equaled 48% of continuing-operations earnings, compared with 71%.
- Cash and equivalents were $1,540 at October 2, 2011, down from $2,613 at year-end 2010. Net debt, defined by the company as debt less cash and equivalents and marketable securities, was $2.3 billion, up from $378 million.
- Total debt was $4,129, compared with $3,203 at year-end. The company issued $1.5 billion of fixed-rate notes, repaid $750 million of notes at maturity, and had $200 million of commercial paper outstanding. It reported $2 billion of undrawn bank facilities and compliance with material debt covenants.
- Total assets were $33,408 and shareholders’ equity was $13,619. Acquisitions, share repurchases and working-capital growth contributed to cash use; inventories increased by $348 from year-end, mainly as production ramped for Gulfstream G650 deliveries.
Business groups and outlook
- Aerospace: Q3 revenue rose 9.4% to $1,412 and operating margin was 15.4%; nine-month revenue rose 2.7% to $4,141 while margin eased to 15.8%. Management expected full-year 2011 revenue growth of about 13% and margin near 15%. It expected 10–12 initial G650 green-aircraft deliveries in Q4 and FAA provisional type certification in Q4, targeting entry into service in the first half of 2012.
- Combat Systems: Q3 revenue rose 3.4% to $2,140; nine-month revenue rose 0.5% to $6,216. Management expected full-year revenue to approach $9 billion and margin to be about 14%.
- Marine Systems: Q3 revenue fell 4.6% to $1,621, while margin increased to 10.7%; nine-month revenue fell 2.1% to $4,873. Management expected full-year revenue near 2010’s $6.7 billion and margin near 10%.
- Information Systems and Technology: Q3 revenue fell 9.2% to $2,680, but margin improved to 11.6%; nine-month revenue fell 4.3% to $8,300 and operating earnings fell 2.5%. Management expected full-year revenue down 2–3% and margins in the mid-10% range; acquisitions, including Vangent, were expected to offset some organic weakness.
Full-year company guidance included net interest expense of approximately $140, an effective tax rate of approximately 31%, and capital expenditures below 2% of revenue. Management said it expected funds from operations to exceed liquidity needs. Total backlog was $58.5 billion, up 2% from Q2; estimated potential contract value was $27.2 billion, bringing total estimated contract value to $85.8 billion.
Material developments, risks and contingencies
- Four Information Systems and Technology acquisitions were completed for approximately $1.1 billion in cash, including Vangent. Acquisition-related goodwill increased by $840. A Combat Systems business sale generated a $38 pretax gain; acquisition transaction costs included $10, primarily related to Vangent.
- The company repurchased 20 million shares during the first nine months at an average $69 per share and paid $504 in dividends. The quarterly dividend was raised to $0.47 per share. On October 5, after quarter-end, the board authorized repurchases of up to 10 million shares.
- The long-running A-12 contract litigation remains unresolved. The company recorded no accrual, citing its expectation that it would not owe money. If the government ultimately prevails, the company estimated its share at approximately $1.5 billion pretax, an after-tax charge of about $825 and after-tax cash cost of about $735. The filing says the associated potential repayment, including interest, could be substantial.
- The SEC’s Division of Enforcement requested information about accounting practices for revisions to estimates on percentage-of-completion contracts. The company said the request was at an early stage and it was cooperating; the outcome was not predictable.
- Management identified potential impairment exposure in Jet Aviation completions if adverse trends persist: specifically identified intangible assets of $140 and property, plant and equipment of $50. It also noted that future contract backlog must support deferred contract costs for recovery and profitability.
- Other disclosed uncertainties include government budget and award timing, contract performance and cost estimates, aircraft demand, and legal or regulatory proceedings. Management reported no material change in risk factors from its 2010 Form 10-K.
Important facts for investors to verify
- Whether G650 certification, planned Q4 deliveries and the associated customer-deposit cash flows materialized as expected.
- How acquisitions, especially Vangent, contribute to revenue, margins, cash flow and the reported backlog and potential contract value.
- Whether operating cash flow and free cash flow recover as working capital normalizes, and how the company deploys cash for acquisitions, dividends and repurchases.
- Developments in the A-12 litigation and the SEC inquiry into percentage-of-completion estimate revisions.
- Whether Jet Aviation completions performance improves and whether the identified long-lived assets require impairment review or charges.