Why did reported earnings jump so much in 1993 if the core business was shrinking?

Net earnings of $885 million included a $645 million after-tax gain from selling the Tactical Military Aircraft business to Lockheed. Earnings from continuing operations were $270 million, lower than the $305 million reported in 1992, which had a $95 million tax credit. Investors should focus on continuing operations for run-rate earnings.

How sustainable is the company's revenue after the divestitures?

Management acknowledges limits. Submarine backlog is thin, with two SSN 688s and four Tridents remaining. Without a third Seawolf contract or other government work, the company says it cannot sustain current construction revenue until the NSSN program begins, which is not expected until the end of the decade. Armored Vehicle revenue depends on M1A2 orders from Saudi Arabia and Kuwait and on a SINCGARS competitive decision expected in the first half of 1994.

What is the biggest legal or contingent risk?

The A-12 aircraft contract, terminated for default by the Navy in 1991. The Navy has demanded about $1.4 billion in unliquidated progress payments, though collection is deferred. The company and McDonnell Douglas dispute the default and seek recovery. If found in default, an additional pre-tax loss of about $650 million could be recognized. The Court of Federal Claims will not decide before July 21, 1994. Environmental exposure is also notable, including Superfund sites and the California Casmalia and Chatham sites.

Is the dividend and capital return policy sustainable?

The board raised the quarterly dividend to $.35 per share (split-adjusted) on March 4, 1994, citing confidence in the cash flows of continuing operations. Dividends paid in 1993 were only $56 million, while special distributions were $1,531 million, which came from business sale proceeds and are not expected to recur. Management expects pre-tax operating cash flow to approximate operating earnings in 1994, and it has authority to repurchase up to 3 million shares.

What did the company look like at the start of 1994, and what happens next?

After the 1993 divestitures, the company was a smaller defense company with about 30,500 employees (about 23,100 excluding discontinued operations) and sales of about $3.2 billion. Pending items include the Space Launch Systems sale to Martin Marietta (about $209 million cash, expected by April 1994), the $850 million credit line renewal (expiring May 1994), the SINCGARS competition, and possible new submarine and tank orders.

GD 10-K FY1993 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 29, 1994. Cited figures are marked; the original filing is the authoritative source.

General Dynamics' 1993 10-K shows a company in the middle of a deliberate contraction.

Following the end of the Cold War and sharp defense budget cuts, management sold or agreed to sell most of its businesses, including Tactical Military Aircraft (to Lockheed, March 1993, $1,525^a cash), Cessna, Missile Systems, Electronics and the pending Space Launch Systems sale to Martin Marietta (about $209 cash, expected to close by April 1994). Continuing operations are now concentrated in Nuclear Submarines (Electric Boat) and Armored Vehicles (Land Systems, M1 Abrams tanks), plus a small 'Other' segment of coal mining, ship management and ship financing. Continuing net sales were $3,187 million in 1993, roughly flat with 1992, and operating earnings rose 21% to $309 million.

Headcount fell from about 80,600 at the end of 1991 to about 30,500 at the end of 1993. Reported net earnings were $885 million^b, or $13.99 per share, but this figure is inflated by the $645 million gain on the Tactical Military Aircraft sale. Continuing operations earned $270 million, or $4.27 per share, down from $305 million in 1992, which included a $95 million tax credit.

Discontinued operations lost $30 million^c. Capital returned to shareholders was large: $1,531 million in special distributions (a tax-advantaged plan of contraction), $960 million from the 1992 Dutch Auction tender offer, and a two-for-one stock split declared March 4, 1994. Quarterly dividends were raised to $.35 per share (split-adjusted).

Total assets fell to $2,635 million^d from $3,530 million, and shareholders' equity fell to $1,177 million from $1,874 million. The key risks are concentration and backlog. Total backlog was $7,015 million, but only $4,401 million is expected to be filled in 1994.

Submarine backlog is thin: two SSN 688s and four Tridents remain, and management states it cannot sustain current construction revenue without a third Seawolf or other government work. The U.S. Government accounted for 94% of sales. The largest contingent liability is the A-12 aircraft default termination, in which the Navy demands about $1.4 billion in unliquidated progress payments and the company estimates up to about $650 million of additional pre-tax loss if it loses.

A decision from the Court of Federal Claims is not expected before July 21, 1994. Environmental and Superfund exposure is also significant, including the Casmalia and Chatham sites.

02—Key points

Key Highlights

Net earnings of $885 million ($13.99/share) were driven by a $645 million one-time gain on the sale of Tactical Military Aircraft; continuing operations earned $270 million ($4.27/share), down from $305 million in 1992.
Operating earnings from continuing operations rose 21% to $309 million on sales of $3,187 million, with Armored Vehicles operating earnings up to $174 million and Nuclear Submarines up to $124 million.
Shareholder returns were large: $1,531 million in special distributions in 1993, $960 million in 1992 tender offer buybacks, and a 2-for-1 stock split with a dividend increase to $.35 per quarter (split-adjusted).
Total backlog fell to $7,015 million from $8,488 million, and only $4,401 million is expected to be filled in 1994. Management says the submarine backlog cannot sustain current construction levels without a third Seawolf or other government work.
The U.S. Government accounted for 94% of 1993 net sales, and some contracts can be terminated for convenience or default, so concentration risk is high.
The A-12 termination dispute carries a potential additional pre-tax loss of about $650 million if the company is found in default, against about $1.4 billion in unliquidated progress payments the Navy has demanded; no decision is expected before July 21, 1994.
Balance sheet shrank sharply, with total assets of $2,635 million (from $3,530 million), shareholders' equity of $1,177 million (from $1,874 million), and cash plus marketable securities of $585 million.

03—Questions

Frequently Asked Questions

Why did reported earnings jump so much in 1993 if the core business was shrinking?
Net earnings of $885 million included a $645 million after-tax gain from selling the Tactical Military Aircraft business to Lockheed. Earnings from continuing operations were $270 million, lower than the $305 million reported in 1992, which had a $95 million tax credit. Investors should focus on continuing operations for run-rate earnings.
How sustainable is the company's revenue after the divestitures?
Management acknowledges limits. Submarine backlog is thin, with two SSN 688s and four Tridents remaining. Without a third Seawolf contract or other government work, the company says it cannot sustain current construction revenue until the NSSN program begins, which is not expected until the end of the decade. Armored Vehicle revenue depends on M1A2 orders from Saudi Arabia and Kuwait and on a SINCGARS competitive decision expected in the first half of 1994.
What is the biggest legal or contingent risk?
The A-12 aircraft contract, terminated for default by the Navy in 1991. The Navy has demanded about $1.4 billion in unliquidated progress payments, though collection is deferred. The company and McDonnell Douglas dispute the default and seek recovery. If found in default, an additional pre-tax loss of about $650 million could be recognized. The Court of Federal Claims will not decide before July 21, 1994. Environmental exposure is also notable, including Superfund sites and the California Casmalia and Chatham sites.
Is the dividend and capital return policy sustainable?
The board raised the quarterly dividend to $.35 per share (split-adjusted) on March 4, 1994, citing confidence in the cash flows of continuing operations. Dividends paid in 1993 were only $56 million, while special distributions were $1,531 million, which came from business sale proceeds and are not expected to recur. Management expects pre-tax operating cash flow to approximate operating earnings in 1994, and it has authority to repurchase up to 3 million shares.
What did the company look like at the start of 1994, and what happens next?
After the 1993 divestitures, the company was a smaller defense company with about 30,500 employees (about 23,100 excluding discontinued operations) and sales of about $3.2 billion. Pending items include the Space Launch Systems sale to Martin Marietta (about $209 million cash, expected by April 1994), the $850 million credit line renewal (expiring May 1994), the SINCGARS competition, and possible new submarine and tank orders.

04—Continue

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