General Dynamics Corporation — 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011. The filing also presents unaudited quarterly results, including fourth-quarter 2011. Amounts are in millions of dollars unless stated otherwise.
Business context
General Dynamics is a global aerospace and defense contractor with four groups: Aerospace; Combat Systems; Marine Systems; and Information Systems and Technology. It employed 95,100 people. The U.S. government accounted for 69% of 2011 revenue, including 59% from the Department of Defense.
Financial performance and position
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Revenue | $32,677 | $32,466 | Up 0.6% |
| Operating earnings | $3,826 | $3,945 | Down 3.0% |
| Operating margin | 11.7% | 12.2% | Down 0.5 percentage point |
| Earnings from continuing operations | $2,552 | $2,628 | Down 2.9% |
| Net earnings | $2,526 | $2,624 | Down 3.7% |
| Diluted EPS, continuing operations | $6.94 | $6.82 | Up 1.8% |
| Diluted EPS, net earnings | $6.87 | $6.81 | Up 0.9% |
| Operating cash flow | $3,238 | $2,986 | Up 8.4% |
| Free cash flow from operations | $2,780 | $2,616 | Up 6.3% |
Free cash flow is a company-defined measure: operating cash flow less capital expenditures. The company reported cash conversion of 109% of continuing-operations earnings. The effective tax rate was 31.4%, compared with 30.7% in 2010.
| Business group | 2011 revenue | 2011 operating earnings | 2011 margin |
|---|---|---|---|
| Aerospace | $5,998 | $729 | 12.2% |
| Combat Systems | $8,827 | $1,283 | 14.5% |
| Marine Systems | $6,631 | $691 | 10.4% |
| Information Systems and Technology | $11,221 | $1,200 | 10.7% |
At year-end, cash and equivalents were $2,649; total debt was $3,930; marketable securities were $248; and net debt was approximately $1,033. Debt-to-equity was 29.7%, versus 24.1% in 2010. Shareholders’ equity was $13,232 and total assets were $34,883. The company had no commercial paper outstanding and reported $2 billion of available bank credit facilities. Current liabilities were $11,145 against current assets of $15,368.
Total backlog was $57,410, down from $59,561 in 2010; funded backlog rose to $44,699 from $43,379. The company reported approximately $28 billion of estimated potential contract value outside backlog, primarily related to IDIQ contracts and unexercised options.
Material changes versus 2010
- Revenue increased modestly, but operating earnings and consolidated margin declined. Aerospace revenue grew 13.2%, while its operating earnings fell 15.2% and margin fell from 16.2% to 12.2%.
- Aerospace benefited from initial G650 deliveries and growth in aircraft services, but incurred $111 of intangible-asset impairment and $78 of fourth-quarter contract losses in other-OEM aircraft completions, amid delays and cost growth.
- Information Systems and Technology revenue fell 3.4%, mainly due to delayed tactical communications orders; IT services grew, partly following the Vangent acquisition. Combat Systems revenue was nearly flat, while Marine Systems revenue declined slightly.
- Operating cash flow increased, supported in part by customer deposits due upon provisional G650 certification. Investing cash outflow rose to $1,974, including $1,560 for six acquisitions. The company repurchased 20 million shares for $1,468 and paid $673 in dividends.
- Backlog declined by $2,151 overall. Aerospace and Combat Systems backlog was roughly stable or slightly lower; Marine Systems and Information Systems and Technology backlog also declined, while potential contract value increased.
Outlook, risks, contingencies and unusual items
- Management’s 2012 outlook called for Aerospace revenue growth of about 15% and a margin near 15%, assuming G650 deliveries and improved completions performance. Combat Systems revenue was expected to be about $8.5 billion, with margins in the low-to-mid-14% range. Marine Systems revenue was expected to decrease slightly, with margins in the low-to-mid-10% range. Information Systems and Technology revenue was expected to be roughly flat, with margins in the high-9% range.
- Management cited U.S. defense-budget uncertainty, the Budget Control Act and possible sequestration, continuing-resolution-related delays, and potential shifts in program funding as significant business risks. The U.S. government can terminate contracts, and future funding for multi-year work depends on appropriations.
- The G650 had received provisional FAA type certification; full certification and entry into service were expected in mid-2012. The G280 had provisional Israeli certification, with full FAA certification also expected in mid-2012. These schedules and related deliveries were forward-looking expectations.
- The long-running A-12 contract termination litigation remained unresolved. The company recorded no accrual, but estimated a possible after-tax cash exposure of approximately $735 if the government ultimately prevailed on its recovery theories; it stated that it believed it would prevail.
- The SEC’s Division of Enforcement requested documents and information concerning accounting practices for percentage-of-completion contract estimate revisions. The company said it was cooperating and could not predict the outcome.
- Other notable items included a $38 pretax gain on a business divestiture, $17 of acquisition transaction costs, and $26 of discontinued-operations losses, including environmental-settlement and A-12 legal-cost items. A 2011 acquisition outlay of $1.6 billion and pension contributions of $351 were reported; pension contributions of approximately $500 were expected in 2012.
- The filing identifies risks from contract performance and cost estimates, supplier dependence, international operations, business-jet demand, cybersecurity, acquisitions, and pension assumptions. Management reported effective disclosure controls and internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Progress and financial impact of the SEC inquiry into contract-estimate accounting, and whether any restatement, adjustment, or enforcement action follows.
- Developments in the A-12 litigation and the potential exposure, including the distinction between the estimated pretax liability and after-tax cash cost.
- G650 and G280 certification, delivery schedules, customer deposits, and whether Aerospace can achieve the forecast revenue and margin recovery.
- Execution and remaining losses or charges in the other-OEM completions business after the impairment and fourth-quarter contract losses.
- Effects of defense-budget reductions and award delays on funded backlog, IDIQ task orders, and the conversion of potential contract value into funded work.
- Acquisition integration and returns, pension funding needs, and planned capital deployment, including repurchases, dividends, and capital spending.