General Dynamics Corporation

Good morning and welcome to the General Dynamics fourth quarter and full year 2018 earnings conference call. All participants will be in listen only mode. Did you need assistance? Please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Howard Rubell, Vice President of Investor Relations. Please go ahead.

Thank you, Nicole, and good morning to everyone. Welcome to the General Dynamics fourth quarter and full year 2018 conference call. Any forward-looking statements made today represent our estimates regarding the company's outlook. These estimates are subject to some risks and uncertainties. Additional information regarding these factors is contained in the company's 10-K and 10-Q filings. With that, it's my pleasure to turn the call over to our Chairman and Chief Executive Officer, Phoebe Novakovic.

Good morning, and thank you, Howard. We enjoyed a solid fourth quarter. The results and comparisons with prior periods are straightforward for the most part. As a result, I will go through them briefly to leave more time for my thoughts on the business segments, our outlook for 2019, and your questions. I also think you will find the press release and the additional presentation on our website fulsome and helpful. So earlier today, we reported fourth quarter revenue of $10.38 billion. earnings from continuing operations of $909 million and earnings of $3.07 per fully diluted share. This is a significant improvement against the fourth quarter of 2017, which was adversely impacted by a discrete $119 million increase in the tax provision as a result of the 2017 Tax Cuts and Jobs Act. Even after adjusting for the adverse impact in Q4 2017, EPS was up $0.07, and earnings from continuing operations were up $154 million. Earnings per share at 307 also beat consensus by $0.09. Revenue and operating earnings were largely consistent with consensus. Most of the difference comes from a lower tax provision and a somewhat lower share count. So all in all, a solid quarter with good performance, particularly compared to the year-ago quarter, as well as the third quarter of 2018. For the year, we had fully diluted earnings per share from continuing operations of 1122. This was also 9 cents above consensus. Revenue of $36.2 billion was up over 2017 by $5.2 billion. On an organic basis, excluding CSRA, Revenue was up $1.5 billion. Revenue was up across each of our reporting segments. Operating earnings of $4.5 billion were up $221 million or 5.2% over 2017. Earnings from continuing operations were up $446 million or 15.3% over 2017. Importantly, earnings per share from continuing operations were 166 above 2017. All in all, 2018 was a very good year, a year of growth, and a year of important order intake that left the company well positioned for 2019. I will review the full year and the quarters on a year-over-year basis for the groups without reference to sequential comparisons. On a sequential basis, suffice it to say that we had more revenue, higher operating earnings, higher earnings from continuing operations, and higher earnings per share than in the third quarter of 2018. So let me discuss each group and provide some color where appropriate. First, aerospace. Aerospace revenue of $2.7 billion was up against the year-ago quarter by an impressive $722 million. That is 36.4%. This was attributable in large part to the delivery of nine G500s in the quarter and also a strong fourth quarter in the service centers. For the full year, revenue of $8.46 billion was up $326 million or 4%. Operating earnings of $1.49 billion were down $87 million on lower operating margins. The lower operating earnings were attributable to poor performance in the completions business at Jet Aviation, the mixed shift at Gulfstream, and costs attendant to the introduction of the G500. This time last year, we told you to expect revenue between $8.35 to $8.4 billion, with a margin rate of 18%, leading to forecasted earnings of $1.5 billion. We finished the year with more than forecasted revenue at 17.6% margin and $1.49 billion of operating earnings. All in all, very close to the forecast we gave you this time last year. On the order front, activity in the quarter was good, and the pipeline activity remains robust. The book to bill at aerospace in the fourth quarter was $0.8 to $1 denominated. You can see more information on deliveries and orders in the Exhibit J to the press release. We expect the G600 to be certified this year, although the exact timing is hard to predict given the impact of the government shutdown on the FAA. But we fully expect certification of the 600 this half. The pacing item for deliveries of the G500 and 600 will be our ability to deliver nacelles. We have that line in good order. Costs are increasingly under control and we are producing very good quality. But we had to restart the supply chain that had gone dormant with the filing of the Nordham bankruptcy proceedings. That has impacted rate and our ability to keep schedule. We expect all schedule issues to be behind us by mid-year. As a result, you will see accelerating G500 deliveries as the year progresses and and our ability to provide missiles to support GE 600 deliveries in the second half as well. Next, combat systems. At combat, revenue of $1.74 billion was almost the same as the year-ago quarter. The same holds true for operating earnings of $261 million and an operating margin of 15%. For the full year, revenue of $6.24 billion was up $292 million, just short of 5%. Operating earnings of $962 million were up $25 million on a 40 basis point contraction in margin, largely related to mixed shift. By the way, this performance is reasonably consistent with the forecast we provided at this time last year. We enjoyed somewhat better revenue than our initial forecast, which was an increase of $200 to $250 million over 2017. We actually grew revenue $292 million. We forecast operating earnings of 970 and came in at 962, an $8 million shortfall largely attributable to the diplomatic issues that slowed production of the vehicle program in Canada in the fourth quarter. We continue to see nice order activity in this group, with fourth quarter orders of $2.19 billion, a book-to-bill of 1.3 to 1 in the quarter, and 1 to 1 for the year. Tank orders alone are in excess of a billion. We also continue to have significant international opportunities, particularly in Europe. We've been negotiating with Spain with respect to a program valued at $2 billion for Piranha vehicles. And of note, we acquired FWW, a qualified maintenance and service provider to the German Army and other international customers to enhance our position in a key market. FWW will become part of European land systems. In our U.S. market, our Army customer is modernizing and providing a growing demand across our combat vehicles and munitions business. In short, this group had quite positive revenue growth, continued its history of strong margin performance, and had very good order activity. Next, marine systems. This is a really good news story across the board. Marine revenue of $2.3 billion was up $237 million, a stunning 11.5% over the year-ago quarter. Operating earnings of $213 million were up $46 million against the year-ago quarter, a 27.5% increase on a 120 basis point improvement in operating margin. This is very strong operating leverage in a growth environment. By the way, the sequential comparison is equally impressive. For the full year, revenue of $8.5 billion was up $498 million in excess of 6%. Operating earnings for the year of $761 million were up $76 million, over 11% on a 40 basis point improvement in operating margin. At this time last year, we told you to expect revenue of $8.4 to $8.5 billion in operating earnings of $735 to $745 billion. We came in at the higher end of the revenue range. Operating earnings of 761 outperformed our forecast by 16 to 26 million. In response to the significant increased demand from our Navy customer across all three of our shipyards, we continue to invest in each of our yards with particular emphasis at electric boats to prepare for increased production associated with the Block 5 of the Virginia Submarine Program and the new Columbia Ballistic Missile Submarine. As you may recall, Block 5 is a significant upgrade in size and performance, requiring additional manufacturing capacity. As you know, we have also increased our internal training programs, as well as our public-private partnerships with Connecticut and Rhode Island to meet our need for skilled trades. At $243 million, CapEx in 2018 from Marine was more than double its depreciation for the year. For 2019, we again expect the marine segment to command the larger share of our capital budget as we work towards satisfying the nation's need for its critical naval systems. So suffice it to say, we are poised to support our Navy customers as they increase the size of the fleet. As you are aware, the Information and Systems Technology Group has been realigned and reshaped into two separate segments. Mission Systems, a large C4ISR business, and GDIT, a leading provider of information solutions to the federal government and its agencies. That was supplemented in the second quarter of 2018 by the acquisition of CSRA. I'm going to ask Jason to interject some comparison data here that you might find relevant and helpful.