General Dynamics Corporation

Good morning and welcome to the General Dynamics second quarter 2019 earnings conference call. All participants will be in listen-only mode. Should 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, sir.

Thank you, Rocco, and good morning, everyone. Welcome to the General Dynamics second quarter 2019 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.

Thank you, Howard, and good morning, everyone. As you can discern from our press release, we enjoyed a very good second quarter with revenue of $9.56 billion and net earnings of $806 million. We reported EPS at $2.77 per diluted share, $0.15 a share better than the year-ago quarter, and $0.09 per share better than consensus. Compared to the year-ago quarter, revenue was up $369 million or 4%. This is as reported, but organic growth was higher after taking into account the effect of divestitures at GDIT and the acquisition of Hawker Pacific. Remember that divestitures at GDIT provided somewhat more than $250 million per quarter in revenue. Net earnings of $806 million were up $20 million or 2.5% on a modest improvement of operating earnings and a lower effective tax rate, offset in part by higher interest expense. Sequentially, revenue was up $294 million or 3.2% and operating earnings were up $76 million or 7.5% on higher operating margins. With respect to consensus, revenue in the quarter was about $200 million more, and the operating margin rate was 10 basis points higher than forecasted by the South Side. In short, $0.08 of the $0.09 beat was provided by stronger operating earnings. Let me turn very briefly to the first half of 2019 compared to the first half of 2018. Revenue was up 2.1 billion, or 12.5%, against the first half of 2018. driven by strong organic growth plus the acquisition of CSRA at the beginning of the second quarter last year. In other words, CSRA revenue was not reflected in the first quarter's results last year. On the other hand, operating earnings were up only $8 million, burdened by the amortization related to the CSRA acquisition. EPS was six cents better. In short, we had a very good second quarter, good sequential improvement, and a good first half. We are somewhat ahead of both our internal operating plan and external expectations. So let me give you some perspective on the segment reporting for the quarter and for the half. I'll then ask Jason for some comments before I give you some insight into our outlook for the business and each segment for the remainder of the year. First, aerospace. Aerospace had a very good quarter in most important respects. Revenue of $2.14 billion. and operating earnings of 331 million, with 241 million higher and 55 million lower, respectively. Both numbers were consistent with our outlook and the production plan for the year. Operating margin was down 490 basis points, as anticipated. Let me give you a little color here with the quarter-over-quarter comparisons concerning earnings and operating margins. You may recall but the aerospace segment had a banner quarter in the second quarter of last year with 20.4% operating margins against 15.5% this quarter. This delta is driven only in part by mix. No G500s were in the second quarter 2018 results. More importantly, the second quarter of 2018 had an unusually large launch assistance payment from the supplier. The result is higher year-over-year R&D expense. These two items were the significant difference between the quarters. Looking at things sequentially, revenue was down 104 million, but operating earnings were up 3 million on a 90 basis point improvement in operating margins. We enjoyed good order activity in the quarter. The dollar-based book-to-bill was 1 to 1. This brings the book-to-bill to 1.2 to 1 for the first half. The numbers for Gulfstream alone were somewhat higher. We have had very good operating performance for two – order performance for two years now. As you know, the G500 was certified on July 20, 2018, and we have delivered 21 of them to customers and one to ourselves as a demonstrator through the end of the second quarter. The G600 earned both its type and production certification on June 28, 2019. This now paves the way. for G600 pilot training and deliveries commencing in early August. This will help both revenue and earnings in the second half and do much to reduce the operating working capital buildup related to producing the early G600s. Finally, EASA validation for the G500 is planned for Q3 and for the G600 in Q4. Let's now turn to the defense side of the house. Combat systems had a good quarter, as the relevant comparisons clearly indicate. Revenue of $1.66 billion was up $125 million over the second quarter last year, or 8.1%. Similarly, operating earnings of $242 million were up $6 million, or 2.5%, over the second quarter of 2018. I should remind everyone that the second quarter of 2018 represented an 8.5% improvement in revenue, over second quarter of 2017, and a 5% increase in operating earnings. In short, we have experienced strong quarter-over-quarter growth for the last three years. On a sequential basis, the story is similar. Revenue was up 23 million in operating earnings, or up 36 million. For the first half, revenue was up 321 million, or 10.8% against the first half of 2018. However, operating earnings were down $12 million with a one-time settlement of lease litigation in the first quarter, more than accounting for the year-over-year decline. However, as my outlook remarks will indicate, we expect to catch up in the second half. Our U.S.-based programs continue to perform well, with Abrams volumes up and nice growth in the ordnance and munitions portfolios. In the aggregate, our U.S. government volume accounted for 57% of revenue in the first half as compared with 48% in the first half of 2018. Army demand to upgrade our platforms in the upcoming years is manifesting itself in explicit program direction for the tank and striker, which puts us in good stead for continued growth. Our international programs continue to progress nicely. work on the UK AJAX program is transitioning from engineering to test and then to full production. Live fire testing has been successful and we expect to enter reliability testing in Q3 of this year. Backlog in this segment is lumpy and the second quarter is no exception. Major orders for the fiscal year were captured in the fourth quarter of 18. As a consequence, we have a very good line of sight for production planning and for driving continuous improvement. We are trending in the right direction at combat. It is a very nice growth story. With respect to the Marine Group, revenue of $2.33 billion was $157 million or 7.2% higher than Q2 a year ago. Operating earnings were up only $2 million against the year-ago quarter on a 50 basis point contraction in margin. On a sequential basis, revenue was up $267 million and operating earnings were up $17 million, 13% and 9.4% respectively. For the first half, revenue of $4.38 billion was up $181 million or 4.3% against the first half of 2018. Operating earnings were down $2 million on a 40 basis point contraction in margin rates. Work on our submarine programs, the Virginia-class construction and engineering on the Columbia ballistic missile submarine continues to make good progress. We are building Virginia-class Block 4 boats and have begun to purchase long-lead material for Block 5. We expect the 10-boat Block 5 contract to be awarded later this year. It will result in a considerable addition to backlog. With respect to BAS, the challenges on the first DDG-1000 ship and the DDG-51 restart ships are behind us, with nice performance on DDG-1001 and 1002 and the follow-on DDG-51 ships. We have 11 DDG-51s in backlog, was a very good opportunity to improve performance steadily across this large backlog. Finally, revenue at NASCO for the quarter and year-to-date was up due to higher volumes related to the TAO Lewis-class oil program. In all, marine systems has been a compelling growth story for us and will continue to be so for a long time to come. Mission Systems. Mission Systems had revenue of $1.28 billion in the quarter, an increase of $130 million or 11.3% over the year-ago quarter. Earnings of $162 million were up $9 million against the second quarter last year. On a sequential basis, revenue was up $119 million and earnings were up $14 million. On a year-to-date basis, Mission Systems revenue was up $190 million or 8.5%. First half earnings were up $11 million against the first half last year. Mission Systems has been a high-performance business for us and will continue to be so. It has enjoyed a book-to-bill of at least one-to-one in 2016, 17, and 18. While the first half of 2019, the book-to-bill is slightly below one time, so we expect that to remedy in the second half. Information technology reported revenue of $2.16 billion in the second quarter, down $284 million against the year-ago quarter. This is largely the result of the divestitures made in this segment through the course of last year, as I mentioned earlier in my remarks. However, operating earnings were only $2 million down as a result of improved margin rates. On a sequential basis, the results were also quite solid. Revenue was essentially stable at $2.2 billion for each quarter. Operating profits were also quite similar, with 2Q at $154 million versus $156 million in Q1. We are experiencing good program mix and synergies. Our industry leading EBITDA was 12.4% in the quarter, matching Q1's results. Our integration of CSRA into GDIT has gone very well and is ahead of our internal schedule. Our management team pulled from both businesses gelled very nicely. We are meeting cost energy targets and are working to exceed this year's goals. To that end, we have continued to generate good bookings. In the quarter, we had orders of $2.67 billion for a book-to-bill of 1.2 to 1. For the first half, our book-to-bill is also 1.2 to 1. On a trailing 12-month basis, book-to-bill also tops one time. Our total backlog of $8.85 billion is up 5% after excluding the backlog related to divested businesses. So in summary, we've delivered solid operating results across the business. The comparisons quarter over quarter, sequentially, and year-to-date are all wholesome. I'm now going to turn the call over to Jason and then come back to you with our outlook for the rest of the year.