General Dynamics Corporation — FY2017 Form 10-K
Reporting period: Year ended December 31, 2017; filed February 12, 2018. The filing also reports fourth-quarter supplementary results. Unless stated otherwise, financial amounts are in millions of dollars. 2016 and 2015 figures were restated for adoption of ASC 606.
Business context and performance
General Dynamics is a global aerospace and defense company operating through Aerospace, Combat Systems, Information Systems and Technology, and Marine Systems. The U.S. government accounted for 61% of 2017 revenue, including 50% from the Department of Defense.
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Revenue | $30,973 | $30,561 | +1.3% |
| Operating earnings | $4,177 | $3,734 | +11.9% |
| Operating margin | 13.5% | 12.2% | +1.3 percentage points |
| Earnings from continuing operations | $2,912 | $2,679 | +8.7% |
| Net earnings | $2,912 | $2,572 | +13.2% |
| Diluted EPS, continuing operations | $9.56 | $8.64 | +10.6% |
| Net cash from operating activities | $3,879 | $2,198 | +$1,681 |
| Free cash flow from operations | $3,451 | $1,806 | +$1,645 |
Fourth-quarter revenue was $8,277 versus $7,654 in Q4 2016; operating earnings were $1,034 versus $768; continuing-operations earnings were $636 versus $580; and diluted EPS from continuing operations was $2.10 versus $1.89.
Financial position and business groups
- Liquidity: Cash and equivalents were $2,983 at year-end, up from $2,334. Current assets were $18,328 and current liabilities $13,099 (current ratio approximately 1.40).
- Debt and capital: Total debt was $3,982, versus $3,888; net debt was $999, down from $1,554. Debt-to-equity was 34.8%, compared with 37.7%.
- Backlog: Total backlog rose 1.6% to $63.2 billion, including $52.0 billion funded. Management expects approximately 40% of remaining performance obligations to be recognized as revenue in 2018 and another 40% by 2020.
- Shareholder returns: The company repurchased $1.5 billion of stock and paid $986 million in dividends. Dividends declared were $3.36 per share, up from $3.04.
| Business group | 2017 revenue | 2017 operating earnings | 2017 margin | Revenue change vs. 2016 |
|---|---|---|---|---|
| Aerospace | $8,129 | $1,593 | 19.6% | +4.0% |
| Combat Systems | $5,949 | $937 | 15.8% | +7.6% |
| Information Systems and Technology | $8,891 | $1,011 | 11.4% | -2.8% |
| Marine Systems | $8,004 | $685 | 8.6% | -0.8% |
Material changes and notable items
- Revenue growth came from Aerospace aircraft deliveries and services and higher Combat Systems volume; these gains were partly offset by lower C4ISR revenue, affected by U.S. government funding delays.
- Operating earnings and margins increased in all four groups. Aerospace benefited from favorable production cost performance and aircraft mix; Combat Systems from improved performance; Information Systems and Technology from program performance and contract mix; and Marine Systems from improved performance and the prior-year DDG-51 cost-growth comparison.
- Operating cash flow increased substantially as working-capital pressures from aircraft program inventory and a large international vehicle contract eased, with lower income-tax payments also contributing.
- Tax reform enacted in December 2017 reduced the U.S. federal corporate rate to 21% beginning in 2018, but caused a $119 million unfavorable, noncash charge in 2017 and increased the reported effective tax rate to 28.6%.
- Contract estimate revisions increased 2017 operating earnings by $323 million and diluted EPS by $0.69; comparable impacts were $16 million/$0.03 in 2016 and $271 million/$0.54 in 2015. No single contract adjustment was material, according to the filing.
- ASC 606 was adopted retrospectively. Among other effects, business-jet revenue is now generally recognized at aircraft delivery and acceptance; reported prior-period results were restated.
Outlook, risks and contingencies
- 2018 group outlook: Aerospace revenue growth of 2%–3%, with approximately 18% margin; Combat Systems revenue growth of 3%–4%, with margin in the mid-to-high 15% range; Information Systems and Technology revenue growth of 5%–6%, with margin around 11%; Marine Systems revenue growth of 5%–6%, with margin in the mid-to-high 8% range. Management expected G&A as a percentage of revenue to be generally consistent with 2017, net interest expense of approximately $115 million, an effective tax rate around 19%, and capital expenditures around 2% of revenue. Outlook excludes the CSRA acquisition and related effects.
- At filing, the company was operating under a continuing resolution through March 23, 2018; management did not expect the continuing resolutions to materially affect results, financial condition, or cash flows. Appropriations remained subject to congressional action.
- On February 12, 2018, the company announced an agreement to acquire CSRA for $40.75 per share in cash, valued at $9.6 billion including assumed debt of $2.8 billion. The company expected to fund the deal with cash and new debt and anticipated closing in the first half of 2018, subject to customary conditions.
- Key risks include dependence on U.S. government budgets and appropriations, contract execution and cost-estimate accuracy, fixed-price contract exposure, supplier concentration, foreign-market and export-control risks, business-jet demand, and cybersecurity threats.
- Electric Boat faced a Department of Justice investigation and related lawsuit concerning alleged quality-system failures involving supplier parts, as well as a Navy Show Cause Letter. The company could not estimate the outcome or any reasonably possible loss; an adverse outcome could materially affect results, financial condition, or cash flows. Other disclosed environmental, government-contract, and legal matters were not expected by management to have a material impact.
Important facts for investors to verify
- Track the CSRA transaction’s completion, financing, assumed debt, integration, and actual effects against the filing’s exclusion of acquisition impacts from guidance.
- Monitor defense appropriations, continuing resolutions, and funding conversion for the company’s large funded and unfunded backlog.
- Assess delivery, certification, production transition, and cost performance for the G500/G600 aircraft, as well as Gulfstream demand and margins.
- Follow resolution of the Electric Boat quality-system investigation and related proceedings; the filing provides no clear estimate of potential exposure.
- Evaluate the durability of operating cash flow and the extent to which contract-estimate revisions contributed to reported earnings.
- Compare 2018 results with management’s segment outlook and approximately 19% tax-rate expectation; the 2017 rate includes a one-time tax-reform charge.