General Dynamics Corporation — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 27, 2020; comparable periods ended September 29, 2019. Amounts are in millions of dollars, except per-share data. The filing is unaudited.
Business context
General Dynamics is an aerospace and defense company with five segments: Aerospace, Combat Systems, Information Technology, Mission Systems and Marine Systems. The U.S. government supplied approximately 70% of revenue. COVID-19 disrupted operations and demand, particularly in business aviation, and affected defense contract execution to a lesser extent.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $9,431 | $9,761 | $27,444 | $28,577 |
| Operating earnings | $1,084 | $1,216 | $2,866 | $3,320 |
| Operating margin | 11.5% | 12.5% | 10.4% | 11.6% |
| Net earnings | $834 | $913 | $2,165 | $2,464 |
| Diluted EPS | $2.90 | $3.14 | $7.52 | $8.47 |
- Cash flow: Nine-month operating cash flow was $1,296 versus $587. Capital expenditures were $622 versus $606; free cash flow from operations, a company-defined non-GAAP measure, was $674 versus negative $19.
- Liquidity and debt: Cash and equivalents were $1,469 at September 27, up from $902 at year-end 2019. Debt carrying value was $13,372, including $3,394 current; management reported net debt of $11.9 billion. The company had no commercial paper outstanding and $5 billion of committed credit facilities.
- Backlog: Total backlog was $81.5 billion, down from $82.7 billion at June 28. Estimated potential contract value was $50.4 billion; total estimated contract value was $131.9 billion. The company expects to recognize approximately 45% of remaining performance obligations as revenue by year-end 2021 and another 30% by year-end 2023.
- Capital returns: Nine-month dividends paid were $925; shares repurchased totaled $501. The quarterly dividend was increased to $1.10 per share.
Material changes versus prior periods
- Q3 revenue declined 3.4% and nine-month revenue declined 4.0%; operating earnings fell 10.9% and 13.7%, respectively. Lower aircraft deliveries and services drove the declines, with lower IT services revenue also weighing on the nine-month comparison.
- Aerospace revenue fell 20.8% in Q3 and 17.9% year to date; segment operating earnings fell 28.0% and 35.2%. Gulfstream deliveries were 32 in Q3 versus 38 a year earlier, and 87 for nine months versus 103.
- Defense-segment revenue collectively increased by approximately $100 for the first nine months, as Marine Systems submarine volume and Combat Systems growth partly offset declines in IT and Mission Systems.
- Nine-month tax provision was lower and the effective tax rate declined to 15.2% from 17.5%, attributed to lower taxes on international income and higher research tax credits.
- Operating cash flow improved substantially year over year, though management said Aerospace working-capital growth and delayed recovery continued to affect cash conversion.
Outlook, risks and unusual items
- Management expected COVID-19 to continue negatively affecting the business, particularly Aerospace, while describing longer-term effects as uncertain. Aircraft production rates were reduced to align output with demand; staffing and other costs were adjusted. Management expected aircraft services activity to improve as air travel resumed, but warned that deliveries and demand could remain pressured.
- The continuing resolution for federal funding ran through December 11, 2020. Management did not expect it, or subsequent extensions, to have a material impact, while noting that delayed appropriations can defer program funding and revenue growth.
- COVID-related effects included customer-site and supplier disruptions, reduced manufacturing man-hours, CARES Act-related cost reimbursement, and an approximately $40 loss in Q2 on a non-U.S. IT contract due to schedule delays. The company noted that some idle-workforce reimbursements carried no fee.
- Contract estimate adjustments increased operating earnings by $84 in Q3 and $169 for nine months, adding $0.23 and $0.46 to diluted EPS, respectively. No adjustment on any one contract was material.
- A DOJ investigation and related qui tam litigation concerning Electric Boat supplier-part quality remain unresolved. The company could not estimate a reasonably possible loss; an adverse outcome could materially affect results, financial condition or cash flows.
- Management reported no impairment trigger for goodwill or long-lived assets at quarter-end, but warned that pandemic-related cost and contract estimates could differ materially from actual outcomes. It cited fixed-price contract performance, government budgets, customer demand, claims, supplier performance and cybersecurity among the risks.
Important facts for investors to verify
- Whether Gulfstream demand, aircraft deliveries and Aerospace margins recover, and how much production-rate reductions persist.
- Whether IT segment activity and profitability continue to improve after Q2 COVID-related disruptions and contract loss.
- Cash conversion and Aerospace working-capital trends, including progress on the large international armored-vehicle contract receivable and scheduled customer payments.
- Backlog funding, conversion timing and exposure to delayed appropriations, particularly the unfunded portion of defense backlog.
- Developments in the Electric Boat investigation and litigation, and any change in the company’s ability to estimate or reserve for potential losses.
- Effects of COVID-19 on contract costs, supply chains, workforce availability, aircraft demand and impairment assumptions.