General Dynamics Corporation

Good morning and welcome to the General Dynamics third quarter 2019 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. 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 Rubel, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Rocco, and good morning to everyone. Welcome to the General Dynamics Third 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.

Thanks, Howard, and good morning. As you can discern from our press release, we delivered attractive third quarter results with revenue of $9.76 billion. operating earnings of $1.216 billion, and net earnings from continuing operations of $913 million. We reported EPS of $3.14 per diluted share, $0.25 a share better than the year-ago quarter, and $0.37 per share better than the second quarter this year. Compared to the year-ago quarter, revenue was up $667 million, or 7.3%. By the way, We have enjoyed top-line growth every quarter for the past 12 consecutive quarters on a year-over-year basis. Earnings from continuing operations of $913 million were up $49 million, or 5.7%, on a 7.1% improvement in operating earnings, partially offset by a higher effective tax rate and lower pension income. Operating margins returned to the 12.5% level. Sequentially, revenue was up $206 million, or 2.2%, and operating earnings were up $126 million, or 11.6% on higher operating margins. In short, we had significant sequential margin improvements. With respect to consensus, our margin rate was 40 basis points higher than forecasted by the south side. This was offset in part by below-the-line items, leaving our EPS 7 cents better than consensus. The difference was provided by stronger operating earnings. With respect to cash, we had net cash provided by operating activities of $1,091 million and free cash flow of $847 million. As you can see from the charts attached to the press release, we enjoyed a good quarter with a one-to-one book-to-bill. Total backlog of $67.4 billion decreased to $158 million, or about a third of 1%. I'll have more to say about order intake as I discuss the separate operating segments, and Jason will give you some color about cash and backlog in his remarks. Let me turn very briefly to the year-to-date 2019 compared to the first nine months of 2018. Revenue was up. 2.8 billion or 10.7% against the first three quarters of 2018, driven by strong organic growth plus the acquisition of CSRA at the beginning of the second quarter last year. To say it another way for clarity, CSRA's attributed revenue was in every 2018 quarter but the first. Operating earnings were up 89 million or 2.8%. EPS was 31 cents better. In short, we delivered good sequential improvement and a good first nine months. Essentially, we were on track to our internal plan and external expectations. So let me give you some perspective on the segment reporting for the quarter and the year to date. First, aerospace. Aerospace had a very good quarter in most important respects. Revenue of $2.5 billion was 23% higher than the year-ago quarter. Operating earnings of $393 million were $17 million or 4.5% higher on lower margins related to mix as fully expected. Let me give you a little color here with the quarter-over-quarter comparisons concerning earnings and operating margin. You may recall that the aerospace segment had a strong third quarter last year with 18.5% operating margin against 15.8% this quarter. This delta is driven only in part by mix. The third quarter of 2018 contained a positive non-recurring settlement with the supplier. On a sequential basis, the story is even better. Revenue was up $359 million or 16.8% and earnings were up $62 million or 18.7%. on a 30 basis point improvement in operating margin. Excluding pre-owned sales from both periods results in a 70 basis point sequential improvement in aerospace margin. The past quarter saw the first G600 deliveries in the quarter. Over 30% of our large cabin deliveries were comprised of new product, which is notably higher than the second quarter of 2019. So despite the challenges of MIPS, we are making good progress. We are focused on aligning our costs with our operating cadence. The G600 earned both its type and production certification on June 28, 2019. We have commenced deliveries and expect to approach double-digit total this year. This will help both revenue and earnings in the balance of the year and improve working capital turns. EASA validation for this G500 was received on October 11th, and the 600 validation is targeted for December 12th. With respect to orders, we had a booked bill of 0.7 to 1 in the quarter. Activity and interest ranged between very attractive to robust, but the process and time to closure of transactions was slower. We expect, as you would guess, a very strong order activity in the fourth quarter. you are undoubtedly aware of the announcement of the all-new G700. The materials related to this program and its specifications are publicly available. It is an expansion of our product line that brings advances in aviotics and aerodynamics to create an industry leader. The G700 incorporates new engines, new winglets, and brand-new avionics from the G500 and 600 series. The development of this plane is quite mature, and we expect first flight in December. The announcement of the G700 has cleared up some of the mystery and has, in some respects, stimulated G650 discussions. All in all, we are doing quite well at aerospace. Turning to combat systems, we had a good quarter, as the relative comparisons clearly indicate. Revenue of $1.74 billion was up $217 million over the third quarter of last year, or 14.2%. Similarly, operating earnings of $264 million were up $23 million, or 9.5%, over the third quarter of 2018. On a sequential basis, the story is similar. Revenue was up $81 million, or 5%, and operating earnings were up $22 million, a 9.1% increase. Combat systems margins returned to the 15-plus neighborhood. On a year-to-date basis, revenue was up $538 million, or 12% against the same period of 2018. However, operating earnings are only $11 million, or 1.6% higher. NICs and a one-time settlement of lease litigation in the first quarter explain why profits have expanded more slowly than revenue. We expect very good operating leverage in the final period of the year. I think it's worth noting that Combat Systems has enjoyed a year-over-year growth in 11 of the past 12 quarters. Our existing U.S.-based programs continue to perform well, with Abrams volumes up, strong striker business, and nice growth in the ordnance and munitions portfolios. In the aggregate, our U.S. government volume accounted for 57% of revenue year-to-date, compared with 49% in the first three quarters of 2018, underscoring the shift in mix. Army demand to upgrade our platforms in the coming year is manifesting itself in explicit program direction for the tank and striker, which puts us in good stead for continued growth. Furthermore, we recognize the Army set a high bar for the OMSC program, and we are focused on delivering a superior solution to replace the Bradley Fighting Vehicle. 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 entered into reliability testing in the third quarter of this year. We expect to enter steady-state production this year and continue through 2024. Combat systems enhanced their backlog this quarter with a book-to-bill of 1.3 to 1. The Government of Canada ordered 360 armored combat support vehicles for $1.3 billion. Work has begun on the program, and we expect to begin deliveries in Q1 of 2021. ELS is negotiating a contract with the Spanish Government to deliver the first tranche of 348 Piranha 5 vehicles. As a consequence, we have a very good line of sight for production planning and for driving continuous improvement in all businesses in this segment. We are turning in the right direction at Combat Systems. Every one of our businesses in this segment is on the move. With respect to the Marine Group, revenue of $2.24 billion was $232 million, or 11.6% higher than at Q3 a year ago. Operating earnings were up 40 million or 23.7% against the year-ago quarter, due in part to the progress toward closing out Virginia Class Block 3 and better year-over-year earnings at NASCO. On a sequential basis, revenue was down 90 million due to timing. Operating earnings were up 12 million. For the first three quarters of the year, revenue of $6.6 billion was up $413 million, or 6.7%, against the same three quarters of 2018. Operating earnings were $38 million better on a 10-voice basis point improvement in margin rates. Similar to combat systems, the Marine Group has enjoyed year-over-year growth in nine of the past ten quarters. Work on our submarine programs, the Virginia-class construction and engineering on Columbia ballistic missile submarine continues to make good progress. We have completed the design of Columbia and are 54% complete on the production drawings, which reflects good progress. Virginia-class Block 4 work remains steady. Volume at EB has been driven by early work on Virginia Block 5 in Columbia. We expect the plot contract to be awarded this year, resulting 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 the 1001 and 2 and the follow-on DDG-51 ships. We have 11 DDG-51 ships in backlog. with a very good opportunity to improve performance steadily across this large backlog. Finally, revenue at NASCO for the quarter was up due to higher repair volumes. Similarly, year-to-date volumes were up due to higher repair and work on the TAO class oiler program. We also expect the first two Madsen ships and the ESB-5 to deliver in the fourth quarter. In all, Marine Systems has been a compelling growth story for us and will continue to be so for a long time to come. Our focus going forward is operating efficiency and margin improvement over this very large backlog. For Mission Systems, Mission Systems had revenue of $1.2 billion in the quarter, flat with the year-ago results. Earnings of $187 million were up $6 million against the third quarter last year. Margins were an impressive 60 basis points higher. Sequentially, margins of 15.2% were up on the even more impressive 250 basis points. On a year-to-date basis, mission systems revenue was up $180 million, or 5.2%. Earnings for the nine months were up $17 million versus the first nine months of 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, 2017, and 2018 and stands above one-to-one at the three-quarter mark in 2019. Its wins have been broad-based, reflect its capabilities in space, communication, and sophisticated command and control solutions. Information technology reported revenue of $2.1 billion in the third quarter, down $236 million against the year-ago quarter. This is largely a result of the divestitures made in the segment. Operating earnings were up $146 million, down $11 million, despite a modest improvement in margin rates. The results were somewhat lower than expected as the company entered into a termination settlement related to its exit of a non-core line of business. Absent that charge, earnings and margin would have more appropriately reflected the progress we have made in combining CSRA with GDIT. Our integration of CSRA into GDIT has gone very well and is ahead of our internal schedule. Our management team pulled from both businesses this job very nicely. We are meeting cost synergies and are working to exceed this year's goals. To that end, we have continued to generate good bookings. In the quarter, we generated $2.38 billion for a book-to-bill of 1.2 to 1. For the nine months, our book-to-bill was 1.2 to 1. Our nine-month booking for 2019 are nearly 8% higher than those captured during the first three quarters of 2018. Our total backlog of $9.16 billion is up 15% from the start of the year. The strong order activity comes in the face of a protracted procurement cycle. GDIT has close to a billion dollars in awarded contracts that have been delayed by protests. and over half of the $65 billion in outstanding awards that the customer had expected have slipped to the right. The underlying metrics of this business remain solid. Cash flow continues to be strong. GDIT generated robust free cash flow to imputed net income of over 190% this quarter, despite controlled investments in customer infrastructure and restructuring expenses. So to offer a summary on the performance of all of the defense businesses, operating earnings have grown over 8% in the quarter on a nearly 3% advance in revenue. Excluding the divestiture of the call center's business, the organic growth rate for revenue and operating profit are about 1 to 2 points higher. Booked a bill for the defense operations was 1.1 to 1 in the quarter. Orders are just shy of $8 billion. on a revenue of $7.27 billion for the quarter. For the nine months, defense bookings have essentially kept pace with approximately 8% in revenue growth. So I don't think I have any changes to make with respect to our prior guidance. We seem to be right on track with the comprehensive outlook I gave you last quarter. And finally, in closing, As tempting as it may be at this time of year for you to ask about next year, let me just remind you that we have our planning process later this fall when the businesses get better insight into the upcoming year. The guidance that we give you in January, as of last January, is grounded in that process and, as a result, will be full and thorough. So I don't want to prematurely piecemeal next year at this juncture. You'll hear from me in detail in January. It's been our custom for many, many years. So let me turn over the call to our CFO, Jason Aiken.