GENERAL DYNAMICS CORP annual report, FY2018

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General Dynamics Corporation — FY2018 Form 10-K

Reporting period: Fiscal year ended December 31, 2018. This is an annual filing; selected fourth-quarter results are also noted below. General Dynamics operates in business aviation, combat systems, IT, mission systems, and marine systems. The April 3, 2018 acquisition of CSRA expanded its IT business and reorganized its former information segment into Information Technology and Mission Systems.

Financial performance and liquidity

  • Revenue: $36.193 billion, up 16.9% from $30.973 billion in 2017. Management attributed most of the increase to CSRA; excluding CSRA, revenue grew 5%, with growth in all segments.
  • Operating results: Operating earnings were $4.457 billion, up 5.2%; operating margin declined to 12.3% from 13.7%. Continuing-operations earnings were $3.358 billion, compared with $2.912 billion. Diluted continuing-operations EPS rose 17.4% to $11.22; net earnings were $3.345 billion.
  • Fourth quarter: Revenue was $10.378 billion, operating earnings $1.226 billion, continuing-operations earnings $909 million, and diluted net EPS $3.07. The comparable 2017 fourth-quarter figures were $8.277 billion, $1.060 billion, $636 million, and $2.10, respectively.
  • Cash flow: Operating cash flow was $3.148 billion, down from $3.876 billion. Capital expenditures were $690 million, leaving management-defined free cash flow of $2.458 billion, versus $3.448 billion in 2017. Cash generation reflected working-capital growth and a $255 million discretionary pension contribution.
  • Balance sheet and liquidity: Cash and equivalents were $963 million; short- and long-term debt totaled $12.417 billion, versus $3.982 billion a year earlier. Debt-to-equity increased to 105.8% from 34.8%. Current assets were $18.189 billion and current liabilities $14.739 billion. The company reported $5 billion in committed credit facilities and $850 million of commercial paper outstanding.
  • Shareholder returns: Repurchased 10.1 million shares for $1.8 billion and paid $1.075 billion in dividends. Declared dividends were $3.72 per share, up from $3.36.
  • Backlog: Total backlog reached $67.871 billion, up 7.4%; funded backlog was $55.826 billion. Estimated total contract value, including potential contract value, was $103.4 billion.

Segments and changes versus 2017

  • Aerospace: Revenue rose 4.0% to $8.455 billion, while operating earnings declined 5.5% to $1.490 billion and margin fell to 17.6% from 19.4%. Gulfstream delivered 121 aircraft; G500 received FAA certification and its first customer delivery occurred in Q3.
  • Combat Systems: Revenue increased 4.9% to $6.241 billion and operating earnings rose 2.7% to $962 million; margin eased to 15.4%. Growth included Abrams, international vehicle production, and weapons and munitions.
  • Information Technology: Revenue rose 87.5% to $8.269 billion, principally due to CSRA. Operating earnings increased to $608 million, but margin declined to 7.4% from 8.5%, reflecting acquired intangible-asset amortization. Excluding that amortization, management reported a 9.6% margin.
  • Mission Systems: Revenue grew 5.5% to $4.726 billion and operating earnings increased 3.3% to $659 million; margin was 13.9%, down from 14.2%.
  • Marine Systems: Revenue increased 6.2% to $8.502 billion and operating earnings rose 11.1% to $761 million; margin improved to 9.0% from 8.6%, with solid performance across shipyards.

Outlook, commentary, and risks

  • 2019 segment outlook: Aerospace revenue around $9.7 billion and margin about 15.5%; Combat Systems revenue $6.5–$6.6 billion and operating earnings $965–$975 million; Information Technology revenue around $8.3 billion and margin about 7.5%; Mission Systems revenue $4.8–$4.9 billion and margin in the mid-to-high 13% range; Marine Systems revenue around $9 billion and margin about 8.5%.
  • Management expected 2019 net interest expense of approximately $430 million and an effective tax rate of 18–18.5%. It expected capital expenditures of approximately 3% of revenue and corporate operating costs of about $20 million.
  • CSRA financing and acquisition accounting were significant: the company paid $9.749 billion for CSRA, issued $7.5 billion of fixed- and floating-rate notes, and recorded $2.1 billion of acquired intangible assets. Approximately $75 million of one-time acquisition-related costs were recognized. The purchase-price allocation remained preliminary through the second quarter of 2019.
  • The Information Technology reporting unit’s estimated fair value exceeded carrying value by only slightly more than 5%; management identified CSRA synergies, U.S. government funding, and interest rates as important assumptions affecting impairment risk.
  • A $1.9 billion net unbilled receivable on an international wheeled armored vehicle contract was subject to payment delays. Management expected full collection, but timing and collection remain important to monitor.
  • Electric Boat faced a U.S. government investigation and related litigation concerning alleged quality-system failures involving supplier parts. The company could not estimate the outcome or potential loss; an adverse outcome could materially affect results, financial condition, and cash flows.
  • Other risks include U.S. defense-budget and appropriations uncertainty, potential program delays or termination, fixed-price contract execution and supplier risks, business-jet demand and delivery mix, foreign-market and currency exposure, cybersecurity, and regulatory requirements. A partial federal shutdown in late 2018/early 2019 had no material reported impact at filing, but prolonged disruption could increase risk.
  • The company reported no material off-balance-sheet arrangements other than operating leases. It expected to recognize $1.2–$1.6 billion of operating lease liabilities upon adopting the new lease standard in 2019, with no material expected effect on earnings or cash flows.

Important facts for investors to verify

  • Whether CSRA integration produces expected benefits, and whether the Information Technology segment sustains its outlook and avoids goodwill impairment.
  • Progress in reducing debt and interest expense after the acquisition, alongside continued dividends, repurchases, and capital investment.
  • Collection timing for the $1.9 billion international contract receivable and the resulting working-capital and cash-flow effects.
  • Developments in the Electric Boat investigation and litigation, including any disclosed estimate of potential exposure.
  • G500/G600 delivery mix, certification and production progress, and the associated Aerospace margin transition.
  • Backlog conversion, funding of unfunded awards and options, and the company’s ability to meet 2019 segment guidance.