General Dynamics Corporation — Q1 2015 Form 10-Q
Reporting period: Three months ended April 5, 2015; unaudited. Comparisons are with the three months ended March 30, 2014, except balance-sheet comparisons, which are with December 31, 2014. Amounts are in millions unless otherwise noted.
Business context and results
General Dynamics operates in Aerospace, Combat Systems, Information Systems and Technology, and Marine Systems. Its customers include the U.S. government, other governments, and business-aircraft buyers. The company reported that revenues increased in all three defense groups for the first time in more than four years.
| Metric | Q1 2015 | Prior period | Change |
|---|---|---|---|
| Revenue | $7,784 | $7,265 | +7.1% |
| Operating earnings | $1,027 | $874 | +17.5% |
| Operating margin | 13.2% | 12.0% | +1.2 percentage points |
| Earnings from continuing operations | $716 | $596 | — |
| Net earnings | $716 | $595 | — |
| Diluted EPS | $2.14 | $1.71 | — |
Product revenue rose 11.1% to $4,932; service revenue increased 0.9% to $2,852. Operating earnings grew faster than revenue, with management attributing the margin improvement primarily to better performance in Combat Systems and Information Systems and Technology. Favorable contract estimate revisions contributed $63 to operating earnings ($0.12 per share), versus $38 ($0.07 per share) a year earlier; no individual revision was material.
Cash flow, balance sheet and capital
- Operating cash flow was $745, compared with $422; capital expenditures were $98, producing company-defined free cash flow of $647, versus $335.
- Cash and equivalents were $4,412, up from $4,388. Debt totaled $3,411, down from $3,911 after repayment at maturity of $500 in notes. Management reported a $1 billion net cash position and no commercial paper outstanding.
- Current assets were $16,352 and current liabilities were $13,112. Customer advances and deposits totaled $6,487, down from $7,335 at year-end.
- Available liquidity included $2 billion in committed credit facilities, plus approximately $115 in committed facilities for European businesses. The company said it was in compliance with debt covenants.
- The company repurchased approximately 4.7 million shares for $634 and paid $206 in dividends. The quarterly dividend was raised to $0.69 per share; 7.7 million shares remained authorized for repurchase at quarter-end.
- Comprehensive income was $432, compared with $577, reflecting a $284 after-tax other comprehensive loss, primarily related to cash-flow hedges and foreign-currency translation.
Business-group performance and outlook
| Group | Revenue | Operating earnings | Management’s 2015 outlook |
|---|---|---|---|
| Aerospace | $2,108 (−0.8%) | $431 (+6.7%); margin 20.4% | Revenue expected to rise about 8%; margin around 18%, pressured by R&D, aircraft mix and pre-owned sales. |
| Combat Systems | $1,363 (+8.3%) | $204 (+46.8%); margin 15.0% | Revenue and margin expected to be consistent with 2014. |
| Information Systems and Technology | $2,370 (+3.9%) | $217 (+18.6%); margin 9.2% | Revenue expected to decline about 5.5%; margin expected to improve to slightly above 9%. |
| Marine Systems | $1,943 (+21.4%) | $188 (+13.3%); margin 9.7% | Revenue expected to grow about 2%–2.5%; margin expected in the mid-9% range. |
Other 2015 expectations included capital expenditures of about 2% of revenue, G&A expense of about 6.5% of revenue, net interest expense of $82, an effective tax rate of about 29.5%, and corporate costs of $65–$70.
Backlog, changes and notable items
- Total backlog, including funded and unfunded work, was $70.5 billion, down 3% from $72.4 billion at year-end. Estimated total contract value, including potential contract value, was $96.1 billion. Defense backlog was $57.4 billion.
- Marine Systems’ revenue growth was driven by ship construction and engineering activity; Combat Systems benefited from international vehicle programs. Aerospace revenue was nearly flat, with fewer outfitted Gulfstream deliveries.
- The Combat Systems axle business was sold in January 2015, and its results are presented as discontinued operations.
- Q1 operating cash flow benefited from earnings and working-capital movements. Management cautioned that supplier commitments for a large non-U.S. Combat Systems contract were expected to weigh on operating cash flow during 2015.
- ASU 2014-09 was not yet adopted. The company had not determined its financial-statement impact or selected a transition method; adoption was expected to make contract-estimate revisions potentially larger and more variable by requiring recognition when identified.
Risks, contingencies and management commentary
Management stated that pending litigation, environmental matters, government audits and investigations, and outstanding contract modifications or claims were not expected to have a material effect, based on information then available. The company had approximately $972 in letters of credit, guarantees, surety bonds and similar arrangements. Backlog and potential contract value depend on customer funding, appropriations, exercised options and contract performance, and are not assured revenue.
Forward-looking risks identified include changes in U.S. and international conditions and defense budgets, government contract termination or restructuring, fixed-price contract and supplier performance, recovery of claims, business-aircraft demand, input costs, and legal or regulatory outcomes. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the reported operating improvement and favorable contract-estimate revisions persist, and how much future results depend on contract mix and performance.
- Whether backlog converts to funded work and revenue, particularly given the decline in total backlog and the dependence on customer appropriations and options.
- The timing and cash-flow effects of supplier commitments on the large non-U.S. Combat Systems contract, including the use of customer advances.
- Progress against segment outlooks, especially Aerospace’s margin expectations and the projected revenue decline in Information Systems and Technology.
- The eventual adoption requirements and financial impact of ASU 2014-09, along with any material developments in claims, environmental matters or government proceedings.