General Dynamics Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended April 1, 2018; comparable period ended April 2, 2017. Unaudited results. Dollar amounts are in millions except per-share data.
Business context and results
General Dynamics operates in Aerospace, Combat Systems, Information Systems and Technology, and Marine Systems. Its business spans business aviation, defense vehicles and weapons, IT and C4ISR, and shipbuilding and repair. The U.S. government is its primary customer. Most defense-contract revenue is recognized over time; aircraft manufacturing revenue is generally recognized at delivery.
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $7,535 | $7,441 |
| Operating earnings | $1,008 | $1,046 |
| Operating margin | 13.4% | 14.1% |
| Earnings before tax | $960 | $1,010 |
| Net earnings | $799 | $763 |
| Diluted EPS | $2.65 | $2.48 |
| Operating cash flow | $(496) | $533 |
| Free cash flow from operations | $(600) | $471 |
Revenue grew 1.3%, while operating earnings fell 3.6% and operating margin declined 0.7 percentage points. Net earnings increased 4.7% and diluted EPS increased 6.9%. The effective tax rate fell to 16.8% from 24.5%, primarily reflecting the U.S. corporate tax-rate reduction to 21%, along with excess tax benefits from equity compensation.
Segments and material changes
- Aerospace: Revenue fell 12.0% to $1,825 and operating earnings fell 21.2% to $346; margin declined to 19.0% from 21.2%. Gulfstream deliveries fell to 26 from 30, mainly due to fewer G650 deliveries. Management said new G500 deliveries were expected later in 2018; lower delivery volume and mix reduced earnings.
- Combat Systems: Revenue rose 11.9% to $1,440 and operating earnings rose 9.3% to $224. International military-vehicle production drove growth; margin eased to 15.6% from 15.9%.
- Information Systems and Technology: Revenue rose 4.2% to $2,236 and operating earnings rose 4.7% to $247; margin was 11.0% in both periods. Higher IT-services activity and a prior acquisition contributed.
- Marine Systems: Revenue rose 5.2% to $2,034 and operating earnings rose 14.3% to $184; margin improved to 9.0% from 8.3%, reflecting better shipyard performance.
Management attributed consolidated revenue growth to the three defense groups, which more than offset lower Aerospace revenue. G&A increased to $537 from $472, or 7.1% of revenue versus 6.3%. Contract-estimate adjustments added $97 to operating earnings and $0.25 to diluted EPS, compared with $50 and $0.11 a year earlier; no single adjustment was material.
Cash, debt, liquidity and capital allocation
Cash and equivalents were $4,332 at quarter-end, up from $2,983 at December 31, 2017. Debt was $6,479, including $2,500 of commercial paper; net debt was approximately $2.1 billion versus $999 at year-end. The company reported compliance with debt covenants and said it had adequate funds and borrowing capacity.
Operating cash use was driven chiefly by working-capital growth, including the timing of billings and collections on large international vehicle contracts, as well as aircraft-program inventory and customer-deposit timing. Capital expenditures were $104 versus $62. The company repurchased $257 of shares and paid $250 in dividends; the quarterly dividend was raised to $0.93 per share.
Backlog was $62.1 billion, down from $63.2 billion at year-end; total estimated contract value, including potential awards and options, was $87.6 billion. Management expected to recognize approximately 60% of remaining performance obligations as revenue by 2019, a further 25% by 2021, and the balance thereafter.
Acquisitions, outlook and risks
On April 3, 2018, after quarter-end, General Dynamics completed its $9.7 billion CSRA acquisition, funded partly with cash, commercial paper and a $7.5 billion borrowing under a 364-day credit facility. CSRA was expected to add approximately $3.6 billion of 2018 Information Systems and Technology revenue. After an approximately $80 one-time Q2 charge for acquisition-completion costs, management expected the acquisition to be break-even to slightly accretive to diluted EPS in the second half of 2018. The initial purchase accounting was incomplete. The company also agreed on April 11 to acquire Hawker Pacific for $250, subject to customary closing conditions.
Management planned approximately $550 of 2018 pension contributions, including required contributions of about $315. Key risks include U.S. and international defense budgets and priorities, performance and cost overruns on long-term fixed-price contracts, supplier performance, business-jet demand, contract claims and legal proceedings. In particular, Electric Boat faces a government investigation and related litigation concerning supplier-part quality systems; the company could not assess the outcome or estimate a possible loss, and an adverse outcome could materially affect results, financial condition or cash flows. Other disclosed litigation and environmental matters were not expected to have a material effect.
Most important facts for investors to verify
- Whether cash conversion and working capital improve, especially billings and collections on international vehicle contracts.
- Whether Aerospace delivery timing and mix, including G500 certification and deliveries, track management’s expectations.
- CSRA integration, the expected $3.6 billion revenue contribution, acquisition-related costs, and post-acquisition debt refinancing.
- Backlog conversion, funding of unfunded defense work, and execution of major vehicle and shipbuilding programs.
- Potential developments in the Electric Boat investigation and related litigation, for which the filing provides no clear loss estimate.