General Dynamics Corporation — Q2 2011 Form 10-Q
Reporting period: Three and six months ended July 3, 2011; comparisons are with periods ended July 4, 2010. Dollar amounts are in millions unless stated otherwise. General Dynamics operates in Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology, serving defense, government, and business-aviation markets.
Financial performance
- Second quarter: Revenue was $7,879, down 2.8%; operating earnings were $949, down 3.7%, and operating margin was 12.0% versus 12.2%. Continuing-operations earnings were $666; net earnings were $653 versus $648. Diluted EPS was $1.76 versus $1.67.
- First half: Revenue was $15,677, down 1.1%; operating earnings were $1,878, down 1.3%, with a 12.0% operating margin, unchanged. Continuing-operations earnings were $1,284 versus $1,250; net earnings were $1,271 versus $1,245. Diluted EPS was $3.40 versus $3.20.
- Second-quarter revenue declines were concentrated in Information Systems and Technology, particularly tactical communications, and Marine Systems. Services revenue increased while product revenue declined. First-half operating earnings by group were Aerospace $439, Combat Systems $576, Marine Systems $328, and Information Systems and Technology $575.
- Cash flow: First-half operating cash flow was $1,076 versus $687; capital expenditures were $152, yielding company-defined free cash flow of $924 versus $564. Operating cash flow represented 84% of continuing-operations earnings, compared with 55%.
- Liquidity and debt: Cash and equivalents were $2,157 at July 3, versus $2,613 at year-end 2010. Total debt was $3,181 ($772 current and $2,409 long-term); reported net debt, after cash and marketable securities, was $630. No commercial paper was outstanding, and $2 billion of bank facilities were undrawn. Current assets were $14,673 and current liabilities $11,493.
- Capital returns: First-half share repurchases were $1,121 and dividends paid were $333. The quarterly dividend was raised to $0.47 per share. The company repurchased 14.2 million shares during the half at an average $73 per share.
- Backlog: Total backlog was $57.1 billion, down 1% from the prior quarter; funded backlog was $44.3 billion, up 1%. Estimated potential contract value was $21.2 billion.
Changes, outlook, and management commentary
- Management attributed consolidated revenue pressure mainly to the timing of tactical-communications work and lower activity on certain Navy programs. Defense margins improved slightly overall, while Aerospace margins fell because of R&D supplier-payment timing and weaker Jet Aviation completions results.
- Aerospace revenue was essentially flat for the half. Management expected full-year 2011 revenue growth of approximately 14%–15% and margins near 15%, assuming FAA certification and initial G650 deliveries later in the year, as well as continued services growth. G650 flight testing resumed after a temporary suspension following an accident involving a test aircraft.
- Combat Systems expected 2011 revenue of approximately $9 billion and margins near 14%. International vehicle growth was expected to offset lower U.S. vehicle-program volume.
- Marine Systems expected revenue near 2010’s $6.7 billion and margins in the high-9% range. Higher Virginia-class submarine production and engineering work were expected to offset lower DDG-51, T-AKE, and commercial shipbuilding activity.
- Information Systems and Technology expected revenue near 2010 levels and margins in the mid-10% range. IT-services growth was expected to offset weaker tactical-communications revenue associated with procurement delays. Corporate expense guidance was approximately $85–$90 for 2011.
- Management expected full-year net interest expense of approximately $140 and an effective tax rate of approximately 31%. Full-year capital expenditures were expected to be less than 2% of revenue. The filing reports that, after quarter-end, the company issued $1.5 billion of fixed-rate notes and used part of the proceeds to repay $750 million of notes at maturity.
- A second-quarter sale of the detection-systems portion of the Combat Systems weapons business generated a $38 pretax gain, included in other income, or $0.07 per diluted share. A-12 litigation-related legal costs were recorded in discontinued operations; discontinued operations reduced second-quarter and first-half earnings by $13.
Risks and contingencies
- A-12 litigation: The Supreme Court vacated the prior appellate judgment and remanded the case; further proceedings remained pending. General Dynamics believes the contractors will prevail and recorded no accrual for potential repayment. If the government ultimately prevails, the filing estimates a company pretax exposure of approximately $1.5 billion, an after-tax charge of approximately $825 ($2.22 per share), and an after-tax cash cost of approximately $730. The company says it has resources to meet the obligation if required.
- Other disclosed risk factors include U.S. and international political and economic conditions, changes in U.S. defense priorities and appropriations, government contract termination or restructuring, fixed-price contract execution and supplier performance, recovery of contract claims, business-aircraft demand, commodity costs, and legal or regulatory outcomes.
- The company disclosed environmental matters, government-contract audits and investigations, letters of credit totaling approximately $1.6 billion, and aircraft trade-in and warranty obligations; it stated that these matters were not expected to have a material aggregate financial impact based on information then available.
- Management said working-capital growth in the first half was primarily due to contract-payment timing and expected it to reverse over the rest of 2011. Interim results were cautioned not to necessarily indicate full-year results.
Important facts for investors to verify
- Whether G650 certification and initial deliveries occurred as assumed in Aerospace guidance, and whether the program’s accident-related testing or schedule created further effects.
- Progress and eventual outcome of the A-12 case, including the potential liability and the assumptions behind the company’s exposure estimate.
- Whether the expected reversal of working-capital growth supported full-year cash conversion and free cash flow.
- Defense budget and procurement timing, particularly its effect on tactical communications and major Navy programs, and whether backlog converted into funded orders and revenue.
- Performance against segment revenue and margin outlooks, including Aerospace completions, Marine Systems program mix, and competitive pressure in IT services.
- Debt and liquidity after the post-quarter note issuance and repayment, and the continued scale of share repurchases and dividends.