General Dynamics Corporation — Q3 2013 Form 10-Q
Business context and period. The filing covers the quarter and nine months ended September 29, 2013, compared with the corresponding 2012 periods. General Dynamics operates in Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology, serving defense and business aviation markets. The financial statements are unaudited; amounts below are in millions except per-share data.
Financial results and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $7,796 | $7,934 | $23,111 | $23,435 |
| Operating earnings | $957 | $905 | $2,764 | $2,735 |
| Operating margin | 12.3% | 11.4% | 12.0% | 11.7% |
| Net earnings | $651 | $600 | $1,862 | $1,798 |
| Diluted EPS | $1.84 | $1.70 | $5.27 | $5.04 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $1,550 | $1,907 |
| Free cash flow from operations | Not stated for quarter | Not stated for quarter | $1,279 | $1,621 |
Third-quarter revenue declined 1.7%, while operating earnings rose 5.7%; nine-month revenue fell 1.4% and operating earnings rose 1.1%. Nine-month free cash flow was 69% of net earnings, compared with 90% a year earlier. Capital expenditures were $271 for the nine months.
At September 29, cash and equivalents were $4,065, total debt was $3,936, and reported net cash was $129. Long-term debt on the balance sheet was $3,908; debt levels were broadly unchanged from year-end 2012. Current assets were $17,118 and current liabilities were $12,065. The company had $2 billion of committed credit facilities and approximately $280 of facilities for European operations. It had no commercial paper outstanding at quarter-end, but issued approximately $500 after quarter-end.
Material changes and business-group performance
- Aerospace: Nine-month revenue increased 18.5% to $5,983 and operating earnings increased 35.4% to $1,068, driven principally by higher G650 and G280 deliveries. Outfitted Gulfstream deliveries rose to 103 from 57.
- Combat Systems: Nine-month revenue fell 25.7% to $4,469 and operating earnings fell 17.8% to $657, primarily from reduced U.S. Army spending and lower European vehicle deliveries. Margins improved, aided by performance and restructuring savings.
- Marine Systems: Nine-month revenue rose 3.1% to $5,082, while operating earnings declined 8.5% to $507. Completion of the higher-margin T-AKE program weighed on margins.
- Information Systems and Technology: Nine-month revenue rose 1.8% to $7,577, while operating earnings declined 7.1% to $599. Growth in lower-margin IT services and weak U.K. performance pressured margins; 2013 included $20 of U.K. restructuring charges.
Management attributed the overall margin improvement primarily to better Aerospace and Combat Systems performance. Favorable revisions to contract estimates increased operating earnings by $105 in Q3 and $296 for the nine months in 2013, compared with $45 and $203, respectively, in 2012. No single contract revision was individually material.
Total backlog was $47.9 billion at quarter-end, down from $49.4 billion at the end of Q2; estimated potential contract value was an additional $27.4 billion. The company repurchased 9.2 million shares during the first nine months at an average $78 per share and paid $394 in dividends. The board authorized an additional 10 million-share repurchase on October 2, 2013.
Outlook, risks and contingencies
- 2013 outlook: Aerospace revenue growth of approximately 17% and margins in the low-17% range; Combat Systems revenue down nearly 20% with margins in the mid-14% range; Marine Systems revenue near 2012 levels with margins in the high-9% range; and Information Systems and Technology revenue slightly below 2012 with margins in the high-7% range. Management expected net interest expense of approximately $85, a mid-31% effective tax rate, and corporate operating costs of approximately $90.
- Defense funding and shutdown: The outlook assumed the continuing resolution through January 15, 2014 remained in effect during Q4. Management said it should not materially affect results if executed in line with past practice, but the outlook did not include possible lingering effects of the 16-day government shutdown. Further budget or sequestration actions could affect demand and program timing.
- A-12 litigation: A proposed settlement would provide the Navy $198 in in-kind credit, but depends largely on congressional authorization. No accrual was recorded. If settlement fails and the government prevails, General Dynamics estimated its potential pretax share at approximately $1.5 billion, including interest; estimated after-tax cash cost was approximately $745.
- Portugal vehicle program: The customer drew $75 under bank guarantees after terminating the Pandur contract. Approximately $195 of related guarantees remained outstanding and could be drawn through 2014. The company reserved relevant receivables and contract balances and recorded $258 of estimated close-out costs in 2012; arbitration was ongoing.
- Other disclosed exposures include $1.8 billion of letters of credit, bank guarantees and similar arrangements, government contract claims and audits, and environmental matters. Management did not expect these other matters to have a material aggregate effect. The company was in compliance with material debt covenants.
Key facts for investors to verify
- Whether defense appropriations, continuing resolutions, sequestration, or shutdown-related effects change contract funding, awards, or delivery schedules.
- Whether Aerospace delivery growth and Combat Systems restructuring can sustain margins as defense volumes decline.
- How much reported earnings growth depends on favorable contract estimate revisions, and whether those revisions recur.
- Developments in the A-12 settlement authorization and Portugal arbitration and guarantees, including potential cash exposure.
- Whether operating cash flow and free cash flow recover from the year-over-year decline, considering working-capital movements and pension contributions.