General Dynamics Corporation — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended October 2, 2016; comparative periods ended October 4, 2015. Dollars are in millions except per-share amounts. General Dynamics operates in Aerospace, Combat Systems, Information Systems and Technology, and Marine Systems.
Financial performance
- Third quarter: Revenue was $7,731, down 3.3%; operating earnings were $1,069, up 3.4%, and operating margin was 13.8% versus 12.9%. Continuing-operations earnings were $767 and diluted EPS was $2.48, compared with $733 and $2.28. An $84 after-tax discontinued-operations loss reduced net earnings to $683 and diluted EPS to $2.21.
- First nine months: Revenue was $23,120, down 2.3%; operating earnings were $3,192, up 1.6%, and operating margin was 13.8% versus 13.3%. Continuing-operations earnings were $2,255 and diluted EPS was $7.25, compared with $2,201 and $6.68. A $97 discontinued-operations loss brought net earnings to $2,158 and diluted EPS to $6.94.
- Cash generation: Nine-month operating cash flow was $1,372, down from $2,270. Free cash flow, defined by the company as operating cash flow less capital expenditures, was $1,128 versus $1,910. Management attributed weaker cash flow principally to use of customer deposits on a Middle Eastern Combat Systems contract and Aerospace working-capital growth tied to G500/G600 production.
- Liquidity and debt: Cash was $2,303 at October 2, versus $2,785 at year-end 2015. Debt was $3,886, up from $3,399; company-defined net debt was $1.6 billion versus $614. The company had no commercial paper outstanding and reported $2 billion of committed credit facilities. It was in compliance with debt covenants.
- Capital returns: The company repurchased 11.2 million shares for $1.5 billion in the first nine months and paid $678 in dividends. The quarterly dividend was $0.76 per share.
- Backlog: Total backlog was $62.0 billion, down from $63.2 billion at the prior quarter-end; total estimated contract value, including potential work and options, was $87.2 billion.
Material changes and business-group results
- Lower Aerospace aircraft deliveries were the main driver of the quarterly revenue decline. Gulfstream green deliveries fell to 30 from 40 and outfitted deliveries to 27 from 43. Aerospace revenue declined 13.9% in the quarter, while operating margin improved to 21.7% from 18.2%, reflecting cost savings and operating performance.
- Information Systems and Technology revenue increased 5.5% in the quarter, supported by C4ISR work; operating earnings rose 16.9% and margin increased to 10.9% from 9.9%.
- Combat Systems quarterly revenue slipped 1.1%; margin improved to 16.5% from 16.2%. Marine Systems revenue declined 2.1%, and margin fell to 8.1% from 8.7%, principally reflecting cost growth associated with restarting the Navy DDG-51 program.
- Across the first nine months, Aerospace and Combat Systems revenue fell, partly offset by higher Marine Systems shipbuilding and Information Systems and Technology C4ISR revenue. Management cited improved performance and cost reduction in Aerospace, Combat Systems, and Information Systems and Technology as drivers of margin expansion.
Outlook, risks and unusual items
- 2016 outlook: Aerospace revenue of $8.4–$8.5 billion and margin slightly above 20%; Combat Systems revenue expected to increase slightly with margin around 16%; Information Systems and Technology revenue expected slightly above 2015 with margin in the mid-to-high 10% range; Marine Systems revenue expected somewhat higher with margin in the high-8% range. Corporate costs were expected to be approximately $40, net interest expense approximately $95, and the effective tax rate in the high-28% range. Capital expenditures were expected to be about 2% of revenue.
- A continuing resolution funded U.S. defense spending at prior-year levels through December 9, 2016. Management said it supported expected fourth-quarter revenue and was not expected to materially affect 2016 operating results.
- The company recorded an $84 after-tax third-quarter loss related to the cost of the 2013 U.S. Navy A-12 litigation settlement; it also recorded a $13 first-quarter adjustment to the loss on the 2015 sale of its axle business.
- Electric Boat faced a DOJ investigation, a sealed lawsuit, and a Navy Show Cause process concerning oversight of supplier quality systems and allegedly non-conforming parts. The company could not estimate a reasonably possible loss; an adverse outcome could materially affect results, financial condition, or cash flows.
- The company planned to adopt the new revenue standard in Q1 2017 using retrospective transition. It expected more period-to-period variability in contract-estimate adjustments under the cumulative catch-up method, and a change in timing of business-jet revenue recognition; it did not anticipate a material overall impact from other identified contract changes.
- Management identified risks including U.S. defense funding and priorities, fixed-price contract cost and performance, supplier issues, contract claims, business-aircraft demand, commodity and labor costs, and legal or regulatory outcomes.
Important facts for investors to verify
- Whether working-capital pressures and cash conversion improve, particularly customer-advance utilization and Aerospace inventory buildup.
- Whether the stated segment revenue and margin outlooks are achieved, including the DDG-51 cost-growth impact and aircraft delivery mix.
- Developments and potential exposure in the Electric Boat supplier-quality investigation and related proceedings.
- The transition effects of retrospective adoption of the revenue standard, especially contract-estimate volatility and aircraft revenue timing.
- Backlog funding, option exercise, and conversion to revenue; unfunded backlog and estimated potential contract value are not guaranteed funding.