General Dynamics Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended July 1, 2018; unaudited. Comparative periods ended July 2, 2017. Amounts are in millions except per-share data. General Dynamics operates in aerospace and defense; it acquired CSRA on April 3, 2018, and reorganized its reporting segments into Aerospace, Combat Systems, Information Technology, Mission Systems and Marine Systems.
Financial performance and liquidity
| Metric | Three months | Six months |
|---|---|---|
| Revenue | $9,186, up 19.7% | $16,721, up 10.6% |
| Operating earnings / margin | $1,088 / 11.8%, versus $1,067 / 13.9% | $2,096 / 12.5%, versus $2,113 / 14.0% |
| Net earnings | $786, versus $749 | $1,585, versus $1,512 |
| Diluted EPS | $2.62, versus $2.45 | $5.27, versus $4.94 |
| Operating cash flow | $291, versus $1,010 in the first half of 2017 | |
| Free cash flow from operations | $12, versus $857 in the first half of 2017 |
Revenue growth reflected CSRA and higher defense-segment activity, partly offset by fewer business-jet deliveries. Reported operating margins declined as acquisition-related intangible amortization and transaction costs increased expenses. The effective tax rate for the first half was 17.9%, versus 26% in 2017, primarily reflecting the lower U.S. statutory rate and equity-compensation tax benefits.
At July 1, cash and equivalents were $1,862, down from $2,983 at year-end 2017. Debt was $14,278 carrying value ($14,400 principal), compared with $3,982 carrying value at year-end; net debt was $12.4 billion, versus $999 million. The increase primarily reflects CSRA acquisition financing. Current assets were $19,827 and current liabilities $16,573. Unbilled receivables rose to $7,125 from $5,240, driven in part by billing timing on large international vehicle contracts. The company reported $2.8 billion of commercial paper outstanding, $5 billion of committed credit facilities, and compliance with debt covenants.
Material changes and business drivers
- CSRA was acquired for a total purchase price of $9.749 billion, including repayment of CSRA debt. It contributed $1.3 billion of revenue and $134 million of operating earnings in the reported periods. The preliminary allocation included $7.807 billion of goodwill and $2.069 billion of intangible assets; valuation remained ongoing.
- Information Technology revenue increased substantially with CSRA, while its margin was reduced by acquired-intangible amortization. Excluding that amortization, management said segment margins improved.
- Aerospace revenue and earnings fell 8.8% and 8.3%, respectively, in Q2, with Gulfstream deliveries down to 26 from 30. Management attributed the decline to the planned transition to G500 and G600 production. Combat Systems, Mission Systems and Marine Systems reported revenue growth; Marine Systems also improved margins.
- First-half operating cash flow and free cash flow fell sharply, primarily due to working-capital growth and timing of billings and collections, alongside investment in the new aircraft programs.
- Backlog was $66.3 billion at quarter-end, up from $62.1 billion on April 1, primarily due to CSRA. Total estimated potential contract value was $99.0 billion. Management expects about 60% of remaining performance obligations to be recognized as revenue by year-end 2019.
Outlook, risks and unusual items
- Management’s 2018 segment outlook: Aerospace revenue around $8.6 billion and operating earnings about $1.5 billion; Combat Systems revenue $6.3–$6.35 billion and margin in the mid-15% range; Information Technology revenue $8.3–$8.4 billion and margin around 7%; Mission Systems revenue $4.8–$4.9 billion and margin around 14%; Marine Systems revenue slightly above $8.5 billion and margin in the mid- to high-8% range.
- Other 2018 expectations: net interest expense about $355 million, net other expense about $25 million, effective tax rate about 19%, Corporate operating costs about $25 million, and capital expenditures around 2% of revenue. The filing provides segment outlook but no single consolidated revenue or earnings forecast.
- Management reported FAA type certification for the G500 on July 20, 2018, after quarter-end, and expected initial deliveries later in 2018. G600 certification was anticipated later in 2018, with entry into service in 2019.
- Approximately $75 million of CSRA-related one-time costs were recognized. The purchase-price allocation was preliminary and subject to revision through 2018. The acquisition also increased interest expense and amortization.
- A U.S. Department of Justice investigation and related proceedings concern alleged Electric Boat quality-system failures involving supplier parts. The company could not estimate a possible loss; an adverse outcome could materially affect results, financial condition or cash flows. Other identified risks include government spending and contract changes, fixed-price contract performance, claims recoveries, aircraft demand, input costs and legal or regulatory outcomes.
Key facts for investors to verify
- Progress on CSRA integration, final purchase accounting, goodwill and acquired-intangible amortization, and realization of expected synergies.
- Whether working-capital use and low first-half free cash flow reverse, particularly the timing of billings and collections on international vehicle contracts.
- Debt repayment and refinancing needs, including near-term maturities, commercial-paper funding and the effect of acquisition financing on interest expense.
- Execution and profitability of long-term contracts, including contract-estimate adjustments, fixed-price work and the Electric Boat investigation.
- G500 and G600 certification, production ramp and delivery timing, and achievement of the segment outlook and backlog conversion expectations.