General Dynamics Corporation — Q1 2013 Form 10-Q
Business context and period: The filing covers the three months ended March 31, 2013, compared with the three months ended April 1, 2012. General Dynamics operates in Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology, serving defense, government, business aviation, and commercial customers. Dollar amounts below are in millions except per-share data.
Financial results and position
| Metric | Q1 2013 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $7,404 | $7,579 | Down 2.3% |
| Operating earnings | $847 | $860 | Down 1.5% |
| Operating margin | 11.4% | 11.3% | Up 0.1 percentage point |
| Net earnings | $571 | $564 | Up 1.2% |
| Diluted EPS | $1.62 | $1.57 | Up 3.2% |
| Operating cash flow | $504 | $414 | Up $90 |
| Free cash flow from operations | $429 | $324 | Up $105 |
Product revenue fell 5.5% to $4,459, while services revenue rose 2.9% to $2,945. Net interest expense declined to $23 from $39, following the December 2012 refinancing, which reduced the weighted-average interest rate on debt from 3.9% to 2.2%. The effective tax rate was 30.7%, versus 31.3%.
At March 31, cash and equivalents were $3,745, long-term debt was $3,909, and company-defined net debt was $165. Cash increased $449 during the quarter. Current assets were $16,350 and current liabilities $11,769. The company had no commercial paper outstanding and maintained $2 billion of bank credit facilities; it reported compliance with material debt covenants. Total assets were $34,609 and shareholders’ equity was $11,582.
Operating cash flow was 88% of net earnings; free cash flow was 75% of net earnings. The company attributed working-capital movements largely to timing of contract payments and expected much of the change to reverse by year-end. Capital expenditures were $75. The filing reports no dividends paid in the quarter because the first-quarter 2013 dividend had been paid in December 2012; the board declared a quarterly dividend of $0.56 per share.
Material changes and business-group performance
- Aerospace: Revenue rose 9.6% to $1,778 and operating earnings increased 14.4% to $310; margin improved to 17.4% from 16.7%. Higher G650 outfitted and G280 green aircraft deliveries contributed.
- Combat Systems: Revenue declined 18.7% to $1,553, mainly from lower domestic Stryker, Abrams, and MRAP activity and lower weapons-system sales. Earnings rose to $215 from $203 and margin increased to 13.8%; the prior-year quarter included a $67 negative out-of-period adjustment.
- Marine Systems: Revenue increased 1.3% to $1,626, but earnings fell 14.1% to $159 and margin declined to 9.8%. The T-AKE program’s completion reduced ship-construction activity; submarine overhaul and repair work partly offset the decline.
- Information Systems and Technology: Revenue was nearly flat at $2,447, while earnings fell 15.1% to $185 and margin declined to 7.6%, reflecting growth in lower-margin IT services.
Total backlog declined to $48.5 billion from $51.3 billion at year-end 2012; estimated potential contract value declined to $25.2 billion from $26.9 billion. The company cited lower volume in military vehicles and certain weapons and ship programs as key drivers of the consolidated revenue decline.
Outlook, commentary, and risks
- Management expected 2013 Aerospace revenue to increase approximately 16% from 2012, with margins in the mid-15% range; Combat Systems revenue to decline 8%, with margins in the mid-to-high-13% range; Marine Systems revenue to remain near 2012 levels, with margins in the mid-to-high-9% range; and Information Systems and Technology revenue to decline approximately 5%, with margins in the low-8% range.
- Management forecast 2013 G&A expense of approximately 6.5% of revenue, net interest expense of approximately $90, an effective tax rate of approximately 32%, and capital expenditures of approximately 2% of anticipated revenue.
- Defense spending uncertainty remained material. The federal sequester took effect March 1, 2013; the FY 2013 defense budget was passed in late March but did not include the sequester’s required cuts. Management said award timing remained affected and that its outlook reflected its current understanding of implementation.
- The long-running A-12 contract termination litigation remained unresolved. No accrual was recorded. If the government prevailed on its claims, General Dynamics estimated its pretax share at approximately $1.5 billion and after-tax cash cost at approximately $740; management believed the company had resources to meet such an obligation if required.
- For the Portugal Pandur vehicle program, the customer had drawn $75 under bank guarantees; approximately $195 of guarantees remained outstanding and could be drawn through 2014. The company had reserved related receivables and contract-in-process balances and accrued estimated close-out costs totaling $258 in 2012. Management also expected $15 of additional European Land Systems severance costs in Q2 2013.
- Contract-estimate revisions increased operating earnings by $108, or $0.20 per diluted share, in Q1 2013, compared with $68, or $0.13 per share, in the prior-year quarter. No individual Q1 2013 revision was material.
- Other identified risks include U.S. and international defense-budget changes, contract performance and cost estimates, claims and contract modifications, business-jet demand, input costs, and legal or regulatory proceedings. Management said other pending legal and environmental matters were not expected to have a material aggregate impact.
Most important facts for investors to verify
- Whether sequester implementation and defense-award timing affect the stated segment outlook and the declining defense backlog.
- Aircraft delivery pace, order trends, and whether Aerospace can achieve its forecast revenue growth and margin range.
- Progress and potential exposure in the A-12 litigation and Portugal arbitration, including the remaining guarantees.
- Whether working-capital movements reverse as expected and support cash conversion and free cash flow.
- The extent to which quarterly earnings benefited from favorable contract-estimate revisions and whether those benefits persist.