General Dynamics Corporation

Good morning and welcome to the General Dynamics first quarter 2020 earnings conference call. All participants will be in a 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.

Thank you, Chad, and good morning, everyone. Welcome to the General Dynamics First Quarter 2020 conference call. Any forward-looking statements made today represent our estimates regarding the company's outlook. These estimates are subject to some risks and uncertainty. Additional information regarding these factors is contained in the company's 10-K, 10-Q, and 8-K filings. With that complete, I would like to turn the call over to our Chairman and Chief Executive Officer, Phoebe Novakovic.

Thank you, Howard. Before I address the company's performance in the quarter, let me take a moment to discuss General Dynamics' response to COVID-19 and its impact on us. We have been designated a national critical infrastructure company and as such are required to continue full operations which we have done. I am proud of our patriotic employees who have continued to work hard to fulfill their mission in support of our armed forces as we face this crisis together. Our men and women in uniform continue to serve and we must as well. Ensuring a safe work environment for our workforce has been and remains our top priority. We have 39,000 employees teleworking from home. Unfortunately, our large manufacturing sites cannot do that. At these sites, we follow CDC recommended guidelines and practice social distancing where possible. We have increased shift work and the use of PPE. We are conducting temperature screening where feasible. As additional screening and ultimately testing become available, we will aggressively implement those as well. Our leadership teams have been and will continue to be in the workplace leading our people. This is early in the COVID-19 crisis and its impact on our business. So far, we have experienced some deterioration in efficiency driven by absenteeism at a couple of our facilities. We expect absenteeism to decline as we see the rates of infection slow. We are also incurring rather significant costs to sanitize the work environment in our facilities and to provide additional PPE. We have also seen definite weaknesses in the supply chain, particularly with respect to some of Gulfstream's suppliers. Gulfstream is working closely with its suppliers who have also been hurt by the disruptions of the commercial airplane OEMs. Hopefully we can sort our way through these issues, but some of them are difficult. The Department of Defense is accelerating payment to us to support the defense industrial base. We believe that this will prove to be very helpful. Regarding the company's first quarter performance, as you can discern from our press release, we reported earnings of $2.43 per diluted share on revenue $8.75 billion in operating earnings of $941 million and net income of $706 million. Revenue was down $512 million or 5.5% against the first quarter last year. Operating earnings were down $73 million or 7.2%. And net earnings were down only $39 million or 5.2%. The defense side of the business was up against last year and against the operating plan upon which this forecast was predicated. Not surprisingly, all of the revenue and earnings shortfall occurred in our aerospace group. I will comment on this in more detail shortly. On the defense side of the business, revenue went up modestly against the year-ago quarter and were reasonably consistent with our operating plan. We experienced solid growth at combat systems and marine systems, along with a modest decline in revenue at information technology and mission systems. However, both IT and mission systems had operating earnings consistent with last year on improved operating margins. The operating margin for the entire company was 10.8%, only 10 basis points lower than the year-ago quarter. Before I get into the details at the operating level, particularly at aerospace, I want to give you some revised forecast data anticipating the impact of COVID-19 on our operations for the year. I wanted to spend a moment on the resilience and strength of the company's backlog and its balance sheet. Total backlog of 85.7 billion is down, only 1.2 billion against the end of last quarter. funded backlog at $63.8 billion is up $6.3 billion. The modest reduction in total backlog was largely attributable to the marine segment, working off some of its extremely sizable backlog, which should be further supplemented with a Columbia construction contract later in the year. Importantly, information technology backlog continues to show impressive growth. Aerospace backlog held relatively constant. So all up, the book-to-bill was 0.9 to 1, excluding the impact of foreign exchange fluctuations. In this time of crisis and uncertainty, our balance sheet remains strong. Following a number of financing activities undertaken in the quarter, which Jason will walk you through in just a few moments, we increased our financial flexibility and liquidity, reduced our dependence on commercial paper markets, and retained our mid-A credit rating. Both the strength of our balance sheet and our increased liquidity give us confidence in our capital deployment ability, including the payment of an $0.08 per share dividend increase that our board approved this March. This is the 23rd consecutive year that GD has increased its dividend. After all, financial strength is the underpinning of business sustainability. The biggest part of the story in the quarter was Gulfstream's inability to deliver 13 completed aircraft due to COVID-19 travel restrictions. We were able to pull two aircraft scheduled for the second quarter into delivery for delivery in the first quarter to somewhat mitigate the impact. So now we were down 11 scheduled deliveries. These planes are completed, the customers want them, and they will be delivered as soon as travel restrictions are lifted and people feel safe traveling. The inability to make scheduled deliveries at the end of the quarter obviously did not permit us to recognize revenue and earnings on those planes. This is purely a timing issue. In fact, three of the aircraft have delivered this month, three are scheduled to deliver in May, and the others are dependent on travel restrictions imposed by or on foreign countries. We are hopeful for prompt resolution of these issues. With that preface, aerospace had revenue of $1.7 billion and operating earnings of $240 million with a 14.2 operating margin. Jet aviation, for its part, had better revenue and earnings than the year-ago quarter, even though some of its operations experienced considerable difficulty in the last two weeks of the quarter. From an order perspective, the last two or three weeks of a quarter are typically when we see the most order activity. This quarter's activity was progressing quite nicely until mid-March when it largely ceased. However, the aerospace segment did have a book-to-bill of 1.1 to 1, which benefited from reduced deliveries. We continue to see a lot of interest, but transactions are difficult to close in this environment. It is difficult for our people to make in-person sales calls, We can't take customers on demonstration rides, and it's difficult to get folks together to work on contract issues. While demand is very hard to predict at the moment, we believe that we will see accelerated activity once travel restrictions are removed. For the year, we had anticipated delivery of somewhat in excess of 150 aircraft. It now appears that we will be between 125 and 130 deliveries. The reduction in Gulfstream deliveries will be driven primarily by supply chain issues and the shutdown of one of our own facilities. To a lesser degree, our own workforce is less efficient due to absenteeism and our strict compliance with CDC guidelines. In recognition of these impacts, we are reducing production and very carefully managing the cost side of the equation. We believe these actions have bound our risk. Apart from its FBOs and certain of its maintenance facilities, jet aviation is performing well. The FBOs will do much better when reasonable business travel resumes. We do, however, expect impacts here as well. Combat systems had revenue of $1.7 billion, up 4.4% over the year-ago quarter. Sales to the U.S. government were up 12%. Operating earnings at $223 million were up 8.3% on a 50 basis point improvement in margin. This was an impressive performance considering that we have been at a near shutdown in Spain, the headquarters of European land systems and the site of its largest manufacturing assembly facilities. The notable development for this segment in the quarter was the formal signing of the restructured contract on the Canadian International Program, which settled all issues to the satisfaction of the parties. With respect to our standing receivable, you may recall that we received $500 million early in the first quarter, and we received another $500 million this month. This will be very helpful to free cash flow in the second quarter. We will begin a regular cadence of scheduled payments in 2021 consistent with deliveries and making further progress in the scheduled amortization of the arrearage. Combat Systems had nice order activity in the quarter with over $700 million in Stryker and Abrams orders alone in the quarter and over $250 million in orders from customers outside the U.S. The group had a book-to-bill of 0.9 to 1. As we work through the effects of COVID-19 on the combat businesses, we have more clarity domestically than internationally since each of the countries' response to the crisis is different. As a result, we have, as in the past, we will diligently manage our costs in order to preserve our margin and profitability. Information technology had revenue of almost $2 billion in the quarter and operating earnings of $150 million, an operating margin of 7.5%. Our EBITDA margin was an impressive 13.3%, including state and local taxes, which are a 50 basis point drag on that result. Most of our competitors carry state and local taxes below the line. This is a best-in-segment EBITDA margin and a 90 basis point improvement from the year-ago quarter. The revenue decline in the quarter of about 8% from Q1 2019 is attributable to three factors. A series of program completions in our Intelligence and Homeland Security Division, a decision to exit non-core lines of business in our Federal Civilian Division, and the closure of some customer sites late in the quarter to all but essential personnel. Sequentially, revenue was essentially flat despite a slowdown in contracting actions late in the quarter. As I noted, toward the end of the quarter, some of our customers, including a number of our classified customers, closed their sites to all but essential mission employees. This impacted revenue and will continue to do so until some of the shelter-in-place rules begin to lift. The number of RFPs we have received has increased dramatically in the last four weeks. Since the beginning of March, the government has accelerated 150 RFPs valued at over $4 billion. As I mentioned earlier, IT continues to build backlog with an impressive 1.2 to 1 book to bill in the quarter, despite a slowdown in contract awards due to the virus. The book to bill on a trailing 12-month basis is 1.1 to 1. Their total backlog is $9,500,000,000, and total estimated contract value sits at $28.1 billion. This ultimately positions the business nicely for growth. Mission Systems' revenue of $1.1 billion was down $42 million, but earnings of $148 million held steady against the year-ago quarter on a 50 basis point improvement in operating margins. The modest drop in revenue was driven by a decrease in the sale of various short-cycle products as well as an expected decline in our tactical communications line of business. We saw nice growth in our U.S. Navy surface fleet integration and underwater fire control system programs. We anticipate revenue to pick up as the year progresses, supported by the strong funded backlog and new business pipeline. Turning to marine systems, this is once again a good news story. Revenue of $2.25 billion is up 9.1% against the year-ago quarter. Earnings are up only modestly due to the mixed shift at NASCO and the failure of many employees to report to work at Bath Ironworks, leading to operational inefficiencies. Nevertheless, the performance was good and particularly solid at electric boats. In March, EB successfully completed sea trials for the USS Vermont, the lead ship in Block 4, and delivered the boat to the Navy earlier this month. In addition, work on Block 5 has continued to ramp up and now represents a third of the Virginia program revenue. We have also increased our Vance construction on the First Columbia as we approach the planned construction date in October of this year. So now let me do my best to give you an updated forecast in this uncertain world. Our aerospace forecast at present certainly lacks crystal ball precision, but at the moment we are revising our expectation for aerospace to revenue of about $8.5 billion and operating earnings of about $1.15 billion. To repeat, the reduced 2020 guidance is related to our ability to produce and deliver aircraft given supply chain issues and workforce productivity. While we are largely delivering at a backlog, we are mindful of potential cancellations or default issues as well. With respect to the defense businesses, the impact to date has been minimal, so we are holding our full-year targets for these segments. However, based on our experience over the past several weeks, there is modest pressure on revenue, but at current levels, we have a path to make up that on the earnings side. We will gain more clarity as we progress through the second quarter, and we'll refine our forecast on the defense side of the house at midpoint of the year, consistent with our past practice. So, on a company-wide basis at this point, we see EPS at $11.30 to $11.40 per fully diluted share for the year. I'll now turn the call over to our CFO, Jason Aitken, for further remarks.

Thank you, Phoebe, and good morning. The first thing I'd like to note is a key accomplishment on the financing front in the quarter. In anticipation of the pending maturity of $2.5 billion of notes in May of this year, and given the extreme volatility we've seen in the market since the outbreak of the pandemic, we issued $4 billion of fixed rate notes in late March at very attractive rates. While this financing was part of our planning pre-COVID-19, the additional liquidity enhances our financial flexibility during the pandemic. particularly in light of the fact that our free cash flow is weighted toward the second half of the year. To that point, our free cash flow in the quarter was negative $851 million. The cash performance in the quarter was impacted by the COVID-19 outbreak, most notably at Gulfstream, due to delayed customer payments associated with the net 11 airplanes we weren't able to deliver. As Phoebe noted, customer orders were also postponed in the last two weeks of the quarter. On the defense side, we've seen accelerated payments coming from some of our customers starting in the month of April in the form of increased progress payment rates and other contract mechanisms. But we've passed those monies on to our suppliers to help sustain our supply base. In fact, as of last week, we had received approximately $65 million in accelerated payments from our customers and advanced almost $300 million to our suppliers on an accelerated basis. After all this, we ended the first quarter with a cash balance of $5.3 billion and a net debt position of $12.7 billion, down slightly from this time last year. Our net interest expense in the quarter was $107 million, down from $117 million in the first quarter of 2019, on a lower average outstanding commercial paper balance. But for the year, we're revising our interest forecast up to approximately $490 million to reflect the additional borrowings I discussed earlier. Q2 will be the peak interest expense for the year. As Phoebe noted, we have ample liquidity, including $5 billion in lines of credit, which we renewed during the first quarter. And we expect the outstanding debt balance to come down over the next couple of quarters as we repay the $2.5 billion maturing in May, as well as our commercial paper balance. On the capital deployment front, capital expenditures of $185 million in the quarter were consistent with a year ago. We expect CapEx for the year to be down somewhat from our original forecast as we manage that spend in light of the circumstances, but still in the range of 2.5% of sales on a reduced sales number. In the quarter, we paid $295 million in dividends and spent $500 million on the repurchase of 3.4 million of our shares. This covers the dilution from stock option exercises that we were unable to address last year due to cash constraints, plus the anticipated dilution for the current year. For the year, we now expect free cash flow to be in the range of 80% to 85% of net income versus the 85% to 90% we previously forecasted, reflecting the reductions in Gulfstream aircraft production and delivery rates partially offset by the reduced capital expenditures, cost savings across the company, and somewhat lower cash taxes. Speaking of taxes, our effective tax rate was 16.7% for the quarter, benefiting from several factors, including lower international taxes and increased research and development tax credits. For the year, we're lowering our anticipated tax rate from 17.5% to 17%. As Phoebe mentioned in her remarks, we finished the quarter with total backlog of $85.7 billion. That's up 24% over this time last year, and total potential contract value, including options and IDIQ contracts, was 124 billion, up 20% over the year-ago quarter. And just one last thought for you as you consider the quarterly progression throughout the year. Obviously, there's more uncertainty than we would normally have at this point in the year, But as you might expect, we anticipate the second quarter being the low point in EPS, in the range of 25 to 30 cents below the first quarter, with a steady ramp in the second half to achieve the updated targets that Phoebe discussed. Howard, that concludes my remarks. I'll turn it back over to you for the Q&A.

Thanks, Jason. As a reminder, we ask participants to ask one question and one follow-up so that everyone has a chance to participate. Chad, could you please remind participants how to enter the queue?

Thank you. To enter the queue and ask a question, you may press star then one in the telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we'll pause momentarily to assemble our roster. And our first question will come from Seth. Seifman with JP Morgan. Please go ahead. Mr. Seifman, your line has been opened. Perhaps your line is muted on your end. Sir, we are still unable to hear you.

Sorry, I think I was muted. Apologies. Hi, Seth. Hi, good morning. Sorry, I was muted. Okay. So I realize this is probably very difficult given where we are and the unprecedented nature of the situation. I think the deliveries you talked about at Gulfstream this year coming out of backlog I think was probably fairly consistent with maybe where people thought or maybe even a bit better. As we look out beyond this year and we think about what what might happen to the backlog as we move through the year and as you deliver out of backlog. Is there any way to kind of, I don't know if there's any way to bound that or maybe any way to talk about some of the distinct aspects of this pressure that Coldstream is seeing now versus periods of pressure in the past?

So let me address that in two parts. Reduction in production this year was driven most exclusively by perturbations in the supply chain. Some of our suppliers entered this crisis somewhat impaired, both from exposure to the commercial aviation market and some financial difficulties. The crisis exacerbated that And even before this all hit, they were having some difficulty keeping up with our original production rate. So we took down production, which we believe helps de-risk the current environment and, frankly, de-risks some of 21 if, in fact, we see weakening demand. But look, with respect to this year's production, you can only go as fast as your weakest link. in your chain. So that's part one. Part two, which you're really, I think, teasing at a bit, is how you see demand in this environment. And as I think we alluded to, we fully expect business aviation to recover in due course. The question is specific timing, but this will again be a robust market for us, and we'll lead it with a strong portfolio of new products. You know, if you think about it, one of the outcomes that could occur as a result of this particular crisis is that business can ill afford to rely on those commercial airline providers who are either financially weak or unpredictable. So the fundamental case for business aviation remains the same, if not somewhat strengthened by this crisis. And frankly, I think there's a case to be made that much will inert a business aviation as a result of this particular crisis. But there's an important reality, I think, for all of us to comprehend to understand this market. And that is in all markets, up or down, we have the distinct advantage in product, service, and cost. that leaves the competition to compete only on price and availability.

Great. Thank you very much.

The next question will come from Robert Stallard with Vertical Research. Please go ahead.

Thanks so much. Good morning. Morning. Phoebe, I was wondering if you could comment on what you might have seen in the shorter cycle business jet aftermarket and the FBOs this quarter and perhaps in April as well. and whether this could be a lead indicator of where the demand environment is going.

So I think this is a particularly unusual environment in that it was worldwide and affected all human beings, not just particular sectors. So hence the imposition of travel restrictions both in the United States and elsewhere. That really drove flying hours. So we saw a considerable decrease in the number of flying hours that we believe will resume when some of the travel restrictions begin to ease and people feel a little bit safer in traveling. I will tell you the loading at most of our service centers remains solid. We've implemented some rolling furloughs at a couple of our smaller sites, but scheduled inspections and planned maintenance continue at a good pace, but some of the discretionary work, think refurbs or avionics upgrades, have fallen back a bit. But again, once we resume normal or begin to approach normal flying cadence, then we anticipate that some of this will likewise resolve.

Okay, thank you.

And the next question will come from George Shapiro with Shapiro Research.

Yes, good morning. Hi, George. One for Jason and then one for you, Phoebe. The one for Jason, and maybe you mentioned it, but if you did, I missed it. If you can reconcile, you know, you have in the back your gross orders, and then if you just look at backlog, I guess that's a net number. Is the roughly $300 million difference primarily cancellations, which you gave a list in the back there, or what is it? And then for you, Phoebe, in terms of the expectation for deliveries for the year, I assume the second quarter is going to be a lot weaker than the rest of the year. And also, what's the status of the ESA certification for the 600? Thanks.

Okay. Well, we had four defaults in the quarter. A chunk of those were not for 2020 airplanes. Those are customers we'll expect to see back. With respect to the second quarter, I think deliveries will be stronger. But as you can imagine, with the reduction in production, we are taking costs out of our business. And we'll have some charges around those, particularly in any of the RIF charges in the moment. And so that could, that depresses second quarter a bit. But deliveries could be, we expect them to be higher once and depending on how fast and at what sequence and in what areas these travel restrictions lift. You know, it's very hard, you know, if you think about it, it is we need those travel restrictions to kind of abate because people typically come to pick up their airplanes in Savannah or we fly them elsewhere to effectuate the transfer, and that's extremely difficult in this kind of constrained environment. But as we see some of the rolling reopenings, both in the United States and outside the United States, we expect some of those deliveries to resolve nicely.

Okay. Thank you.

And the next question is from David Strauss with Barclays. Please go ahead.

Thanks. Good morning. Just, Phoebe, one to ask on the implied Gulf Stream decremental margins. I think you took down revenue by about $1.5 billion and your EBIT expectation by about $400 million, applying somewhere mid to high 20 decremental margins. How much of this is driven by just... you know, reduced productivity because of production issues, you know, work-related issues and supplier issues and all that. Just the decremental margins are a bit higher than I thought we would see.

Some of that is based on efficiency, particularly as we learned to optimize operating in a CDC-driven environment. But some of it is also mixed.

Okay. And then a follow-up on capital deployment. Obviously, you have the debt pay down here in May. You've got to deal with commercial paper. But how are you thinking about share repurchase in the current environment, given maybe political headwinds to doing that versus where your stock price currently sits? Thanks.

I think you're quite right to point out – The political concerns are concerns within the policy arena about stock buybacks. But from my perspective, in periods of great uncertainty and volatility, maintaining your liquidity and the strength of your balance sheet is key. So we're going to stand pat on stock repurchases at the moment.

Our next question comes from Carter Copeland with Melliot's Research. Please go ahead.

Good morning, Phoebe, Jason, Howard. Hi, Carter. Phoebe, I know each one of these downturns or demand shifts in aerospace has its own sort of unique fingerprint. And I wondered if you might just kind of help give us some color on, you know, what this one is like in terms of your customer conversations. I mean, I would imagine that, you know, the big majority of your customers, the Fortune 500 companies out there are, you know, going through some sort of exercise on the, you know, the timing of expenditures on aircraft when they're, you know, tapping revolvers and whatnot. I just – how does that discussion – how is that going, and then how does that evolve in terms of, you know, the timing of those – what I would assume are continued purchases in the future? Thanks. So –

One of the elements that is distinctly different from the last time that we experienced in the 2008 timeframe, the Great Recession, was that interest remains very active. Whereas in the recession, it simply stopped because of the impact on multiple key sectors. Here, it's really been more about simply timing. How soon does the economy reopen? How soon can we get travel restrictions back? So the conversations are continuing. That hasn't stopped. But in terms of translating that activity into order, some of that is going to take some time as we see how all of the reduction in travel restrictions as well as the stabilization in the economy occur, but we see this more as a question of timing in this environment as of the moment. You know, the backlog is holding up very nicely, which is also distinctly different from the last time. But we're always mindful that if you have serious worldwide economic crises of the large economies that become really dire, Backlog is an issue that we're going to have to follow very carefully, and we're being very mindful. This is a company that has been to this kind of environment before, albeit for very different reasons, and manifesting itself in different ways.

And is it fair to characterize the decisions you'll make from a production standpoint to get to the lower deliveries as temporary in nature, whether that's, you know, furloughs or timing related? I guess what I'm getting at is are you protecting upside in, you know, your production capacity for when things return to normal? Is that the right way to think about what you're doing?

I think the right way to think about it is that, you know, when you have changes in your environment, you have to react fairly quickly, right? postulating as best as you can what various outcomes are like. And what we have done is, in the moment, sized our production so that our supply chain can keep up with it, but also recognizing that it prepares us if, in fact, demand does increasingly weaken in next year to manage that risk as well. So I think we have bound our risk as well as we possibly can in the moment, understanding what we see.

The next question comes from Kai Von Rumer with Cowan. Please go ahead.

Yes, thank you very much. So a number of dealers we've talked to kind of as you indicate, that demand should pick up later in the year as kind of COVID impact updates. But one of the concerns they have is that basically there's been a weakening in terms of the pre-owned market, that the pricing there is starting to erode and may go down. And in particular, with the G650, where you have a large installed base, that pre-owned G650s would compete with your production. Are you seeing or to what extent are you concerned about potential pricing pressures from the pre-owned market? Thanks.

We have yet to see any. We don't see any significant buildup of like new pre-owned Gulfstream. And we see no impact on price. You know, the pre-owned inventory for each of our large cabins, including the 650, is well below the market standard threshold. So at the moment, we either have a lot of pre-owned inventory in our house, nor do we see that it has impacted our current demand nor our current pricing. So this, again, is very different than what we saw in the 2008-2009 timeframe. Pre-owned is simply not an issue in the moment.

Thanks so much. My one follow-up would be, can you give us an update on how you're doing on G500-600 production and the expectation for certification of the G700 in late 2021? So...

Let's go in inverse order. The G700 continues to perform its test patterns. We have about 100 flying hours under our belt, and the airplane is performing extremely well. The 500 and 600, of course, are going to be some of the change in the production that we have. set for the year, some of that mix issue, but the demand for both of those programs has been wholesome and is increasing. You know, I think George asked a question that I failed to answer on EASA, and you tease at that as well indirectly. EASA had been slowed by the impact of the MACs, and while I can't speak to their directly in terms of their timing, this has no doubt impacted them as well. But we will get through that. And these airplanes, the more that they're in the market, the more people see, you know, exactly what these airplanes can do for them, and they're pretty impressed.

The next question comes from Noah Popanak with Goldman Sachs. Please go ahead.

Hi, good morning, everyone.

Hi, Noah.

Phoebe, is 100% of the Gulfstream delivery and revenue outlook reduction that you've made here today, is 100% of that from supply chain disruption and inability to fly to deliver airplane disruption and none of it from demand impact?

It really isn't demand-driven. I think I noted two factors a couple times. Let me just, you know, help reiterate, as I think I've discussed in some fulsome detail, the supply chain. But we also have some efficiency issues within these plants, within our assembly manufacturing plants, as we learn to optimize production under the social distancing rules, additional PPE cleaning. shift work as we've increased the number of shifts. So as we begin to optimize that over time in a production environment, that will also allow us to mitigate any impacts from some of the inherent inefficiencies there. But that was also an issue, but overwhelmingly the predominant issue here was was the supply chain. And frankly, as I said, if you think about it in terms of should we see significantly weakening demand, we have done a nice job to de-risk some of 21. And I think that's where you could potentially see demand. And one of the salutary benefits of the actions that we're taking today do provide some risk mitigation for 21. So that's why I've said a couple times, We believe that we've bounded our risks in all respects at the moment.

Have you seen any, not just through Q1, but year to date, have you seen any cancellations or deferrals in the existing backlog?

Yeah, I mentioned earlier we had four, and all of whom we have, well, three of whom we expect to come back, and... But that is all that we've seen to date. And that backlog is continuing to hold up very nicely. But we recognize that we'll deal with any additional impacts to the backlog. But so far, we're not hearing noises coming out of the customer base in the backlog of any note at the moment.

Our next question is from Ron Epstein with Bank of America. Please go ahead.

Yeah, good morning. Maybe changing gears a little bit to your Navy business, the Navy has accelerated its procurement of systems. I mean, if you talk to the procurement leadership in the Navy, they'll tell you how they're very proud of the amount of work they've put under contract in a short period of time. How are you seeing that in your Naval business, and how do you expect that to flow through the rest of the year?

So our Navy procurement people have been really leaders and beacons of stability and foresight during this entire crisis. They have increased the velocity at which we've gotten contract awards. We particularly see that on the repair side. Our new ship construction, These are large, big contracts. I wouldn't expect to see any additional particular increase in velocity on those, but we have on the shorter cycle businesses, and they have been very, very supportive in understanding the need to undergird the defense industrial supply chain.

And then as one follow-on, you mentioned a couple times in your prepared remarks and even in some of the questions, that you've got some concerns over the supply chain. How do you see that playing out, particularly if you've got a smaller, let's just call it a mom-and-pop supplier who is largely commercial aerospace, they don't do much defense work, and they're supplying into Gulfstream? I mean, how are you trying to mitigate that risk?

Sure. As you can imagine, these are all sunset negotiations. We're working closely with all. We know who all of our challenge suppliers are at the moment, working closely with them to provide on-site mitigation and support where we can. And ultimately, if we have to bring it in-house, we will. But we have managed through this and will continue to do so. But there is risk here. It's not without the risk for reasons that I think you all can understand as well as we can.

Thank you. The next question comes from John with Citigroup. Please go ahead.

Thanks, and good morning. Turning to IT for a moment, you know, any visibility or perspective on when we might see some of those nice backlog trends translate into growth, you know, when some of those items that you flagged might dissipate? And then also, can you talk about how IT is supporting the customer in the current environment and how it can be oriented to support new priorities coming out of the coronavirus crisis?

So one of the elements of GDIT is an enormous agility coupled with their customer intimacy. So as our customers adjust both on the defense intel and federal civilian environments. We'll work very closely with them on new opportunities. I think one of the challenges is that our customer needs to get back up and in a regular cadence and regular order, and that will then drive our ability to attend these sites. You know, while many of our people can work from home, a lot of them have to be on site with the customer. And so once the customer gets up and full bore operations, that will... That will drive, then, additional revenue on our part. But look, GDIT has been very successful in winning additional business. That ultimately begins to translate into revenue and profitable revenue at that. I think we need to particularly on IT get everybody back and working and then have a sense if we have any timing issues from some incremental backed up impact from the revenue side, from just this a bit of a hiatus that some of our customers have taken. But they are positioned for good growth with their backlog. They've had superb win and capture rates. So they sit very nicely and comfortably right now in their market space.

And this is a follow-up. Can you talk about how customer conversations in that business might be developing in the current environment where there might be more focus on disaggregated workforces, further acceleration to the cloud, further IT modernization, larger implementation of CDC, NIH-type work packages, and these are sort of thinking about how the national priorities might shift or accelerate coming out of this?

I don't know that we have seen anything that one could realistically discern a trend from. I think it's too early. As far as the distributed workforce, I think that's way too early. I think we have to look at the efficiency metrics on how that actually plays out. As I say, a lot of our people need to be on customer sites. But we haven't seen a wholesale strategic or structural shift in the way that our customer is thinking about either the cloud or its mission in a post-COVID environment. I suspect naturally there will be some. Again, as we think about how long do we keep social distancing? How long do we keep integrated shifts and rolling shifts? So I think some of that will play out, but so far I haven't seen a material or structural change in how our customer is thinking about their mission.

And then we have one final question, operator.

Sure. And that question will come from Sheila Keoglu with Jefferies. Please go ahead.

Hi. Good morning, Phoebe, Jason, and Howard, and thank you for the time. Good morning. Jason, maybe this one's for you, given it's free cash flow. Can you revisit some of the dynamics of the 85% to 90% conversion in 2020? It seems the Canada payments are on track, so that's still about $1 billion. And what are other changes to working capital, perhaps with either progress payments or inventories? Is it fair to assume that Gulfstream was maybe $500 million or so of inventories in Q1, given you couldn't deliver 11 aircraft?

Sure. I think you've picked up instinctively on a number of the drivers here. The two $500 million payments on the Canadian program were inherent in our forecast, so those coming in is certainly welcome news to solidify that element of the outlook. When you think about the defense side of the business and some of the accelerated contract payments, progress payment rates have moved from 80% to 90%. and some other advanced mechanisms we're seeing. As I mentioned, most, if not all, of that is essentially flowing through to the supply chain, so that's really sort of a net pass when it comes to the outlook. So bottom line, really, when you think about the overall impact, it really is at Gulfstream, and it's that push of the production out, or I should say the production rate down, When you think about it, we were expecting to start this year with sort of the inflection point on working through some of the inventory working capital at Gulfstream between the test airplane deliveries and getting 500 and 600 up to a more steady state production level. With these production shifts, that sort of pushes that out, call it six to 12 months. And so the inflection point on that working capital drawdown at Gulfstream will just push out somewhat. So that's really the driver here. and the difference on the free cash flow conversion.

Great. Thank you very much.

Thank you. And, Chad, thank you and everyone else for being on this call today. As a reminder, please refer to the General Dynamics website for the first quarter earnings release and the highlights presentation, which contains our summary outlook. If you have any additional questions, I can be reached at 703- 876-3117. Thank you.

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