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.