General Dynamics Corporation — Q2 2019 Form 10-Q
Business context and period: Unaudited results for the three and six months ended June 30, 2019, compared with periods ended July 1, 2018. General Dynamics operates in aerospace and four defense segments: Combat Systems, Information Technology, Mission Systems and Marine Systems. The U.S. government is its largest customer.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $9.555 billion | $9.186 billion | $18.816 billion | $16.721 billion |
| Operating earnings | $1.090 billion | $1.088 billion | $2.104 billion | $2.096 billion |
| Operating margin | 11.4% | 11.8% | 11.2% | 12.5% |
| Net earnings | $806 million | $786 million | $1.551 billion | $1.585 billion |
| Diluted EPS | $2.77 | $2.62 | $5.33 | $5.27 |
| Operating cash flow | Not separately provided for Q2 | $(504) million | $291 million | |
| Free cash flow from operations | Not separately provided for Q2 | $(866) million | $12 million |
Six-month revenue rose 12.5%, while operating earnings were nearly flat and operating margin fell 1.3 percentage points. Management attributed margin pressure primarily to a less favorable Gulfstream aircraft delivery mix. Six-month net earnings declined despite higher revenue, partly reflecting increased net interest expense.
At June 30, 2019, cash was $702 million, total debt was $13.935 billion (principal of $14.026 billion), and net debt was $13.2 billion. Current assets were $19.557 billion and current liabilities $18.014 billion. Debt included $2.3 billion of commercial paper; $2.5 billion of notes mature in May 2020. The company had $5 billion in committed credit facilities and reported compliance with debt covenants.
Operating cash flow weakened from the prior-year period, principally due to working-capital growth, including delayed payments on an international armored-vehicle contract and higher aircraft inventory. Capital expenditures were $362 million. Cash dividends paid were $563 million; share repurchases were $184 million.
Material changes and operating trends
- Aerospace: Six-month revenue rose 17.6% to $4.376 billion, but operating earnings fell 10.0% to $659 million and margin declined to 15.1% from 19.7%. Higher G500 deliveries increased revenue, while initial-model delivery mix weighed on profitability. G600 received FAA type and production certification in June; deliveries were expected to begin in Q3.
- Combat Systems: Six-month revenue increased 10.8% to $3.295 billion; operating earnings declined 2.6% to $448 million. U.S. military vehicle and munitions activity grew, partly offset by lower international vehicle volume. Margin also reflected contract mix and an unfavorable lease settlement.
- Information Technology: Six-month revenue rose 20.9% to $4.327 billion and operating earnings increased 20.6% to $310 million, reflecting the CSRA acquisition and program mix. Q2 revenue fell 11.6% year over year as legacy programs ended and a contact-center business had been divested.
- Mission Systems: Six-month revenue increased 8.5% to $2.435 billion and operating earnings rose 3.7% to $310 million; margin declined to 12.7% from 13.3% on program mix.
- Marine Systems: Six-month revenue increased 4.3% to $4.383 billion, while operating earnings were nearly flat at $377 million. Higher U.S. Navy submarine and auxiliary-ship work was partly offset by lower commercial ship construction and mix effects.
Total backlog was $67.7 billion at quarter-end, down from $69.2 billion at March 31, 2019; funded backlog was $54.4 billion. Management expected to recognize about 60% of remaining performance obligations by year-end 2020. The filing reports total estimated contract value, including potential awards and options, of $101.9 billion.
Outlook, risks and unusual items
- 2019 segment outlook: Aerospace revenue of $9.95 billion and operating earnings of $1.525 billion; Combat Systems revenue of about $6.8 billion and operating earnings of about $1.0 billion; Information Technology revenue of about $8.5 billion and margin around 7.4%; Mission Systems revenue of about $5 billion and margin around 13.8%; Marine Systems revenue of about $9 billion and margin around 8.5%. The filing does not provide a consolidated full-year revenue or earnings forecast.
- Management expected 2019 net interest expense of about $460 million, net other income of about $60 million, and an effective tax rate of 18%–18.5%. G&A as a percentage of revenue was expected to be generally consistent with 2018.
- Net unbilled receivables rose to $7.554 billion from $6.576 billion. A Canadian-government contract involving international wheeled armored vehicles accounted for $2.4 billion of net unbilled receivables; the company reported payment delays but said it expected to collect the amount outstanding.
- A pending U.S. government investigation and related litigation concern alleged quality-system failures at Electric Boat. The company could not assess the outcome or estimate a reasonably possible loss; an adverse outcome could materially affect results, financial condition or cash flows. Other disclosed litigation, environmental matters and government-contract matters were not expected by management to have a material impact.
- Key stated risks include government budget and contract changes, performance and cost risks on long-term fixed-price contracts, claims recovery, business-aircraft demand, acquisitions, government audits, and cybersecurity. Contract-estimate adjustments added $139 million to six-month operating earnings ($0.38 diluted EPS), versus $180 million ($0.47) a year earlier.
Important facts for investors to verify
- Progress and collection timing for the $2.4 billion armored-vehicle contract receivable, and the resulting effects on working capital and cash generation.
- Whether Gulfstream delivery mix, G600 production ramp-up and expected Q3 deliveries support the Aerospace outlook and margin recovery.
- Execution of segment forecasts, backlog conversion and the amount of defense backlog dependent on future appropriations, options or expected funding.
- Debt refinancing plans for the $2.5 billion of May 2020 maturities, commercial-paper levels and interest expense.
- Developments in the Electric Boat investigation and litigation, including any eventual estimate of potential exposure.