General Dynamics Corporation (NYSE:GD) Q3 2023 Earnings Call Transcript

General Dynamics Corporation (NYSE:GD) Q3 2023 Earnings Call Transcript October 25, 2023

General Dynamics Corporation beats earnings expectations. Reported EPS is $3.04, expectations were $2.87.

Operator: Ladies and gentlemen, good morning and welcome to the General Dynamics third quarter 2023 earnings conference call. All participants will be in a listen-only mode, and please note that this event is being recorded. After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question during that time, simply press the star key followed by the number one on your telephone keypad. If you would like to withdraw your question, press star, one a second time. Thank you, and I would now like to turn the conference over to Nicole Shelton, Vice President of Investor Relations. Please go ahead.

Nicole Shelton: Thank you Operator, and good morning everyone. Welcome to the General Dynamics third quarter 2023 earnings 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, 10-Q, and 8-K filings. We will also refer to certain non-GAAP financial measures. For additional disclosures about these non-GAAP measures, including reconciliations to comparable GAAP measures, please see the press release and slides that accompany this webcast, which are available on the Investor Relations page of our website, investorrelations.gd.com. On the call today are Jason Aiken, Executive Vice President, Technologies and Chief Financial Officer, and Bill Moss, Vice President and Controller. With the introductions complete, I’ll turn the call over to Jason.

Jason Aiken: Thank you Nicole. Good morning everyone and thanks for being with us. The first thing I’ll note is that our Chairman and CEO, Phebe Novakovic, is under the weather today, so I’ll be conducting today’s call along with Bill. Earlier this morning, we reported earnings of $3.04 per diluted share on revenue of $10.6 billion, operating earnings of $1.06 billion and net income of $836 million. Revenue was up $596 million or 6% against the third quarter last year. Operating earnings were down $41 million or 3.7%. Net earnings were down $66 million and earnings per share were down 6.7%. The quarter-over-quarter results show significant growth in revenue but a 100 basis point contraction in operating margin. On the other hand, sequential results are quite good across the board.

Here, we beat last quarter’s revenue by 4.1%, operating earnings by 9.9%, net earnings by 12.4%, and EPS by 12.6%. From a different perspective, we beat consensus by $0.13 per share on higher revenue and better operating earnings than anticipated. Operating margin is about the same as expected. The beat came almost entirely from operations. On a year-to-date basis, revenue was up 7.2%, operating earnings were down less than 1%, and diluted earnings per share were down 2.6%. We had another very strong quarter from a cash perspective. Net cash flow provided by operating activities was $1.32 billion and free cash flow was $1.1 billion, which is 131% of net earnings. This follows very good cash performance in the first half. Order performance was good in the quarter in all segments and particularly strong at Gulfstream and the marine segment.

You’ll hear more detail on cash and backlog, as well as some of the other financial particulars from Bill in just a minute. In short, we enjoyed a strong quarter, particularly so in light of the supply chain and program mix headwinds that time will cure, so let me move right ahead with some color around the performance of the business segments. First, aerospace. Aerospace had revenue of $2.03 billion and operating earnings of $268 million with a 13.2% operating margin. Revenue was down $315 million from the year-ago quarter, driven by fewer deliveries at Gulfstream due to supply chain constraints. Operating earnings were down $44 million on lower revenue and a 10 basis point contraction in margin. The sequential comparison is much better – revenue was up $79 million or 4%, and operating earnings were up $32 million or 13.6% on 110 basis point improvement in margin.

There were 27 deliveries in the quarter, three more than in the second quarter. To provide some additional color here, Gulfstream has made 72 aircraft deliveries through the end of the quarter. We are on track to deliver between 40 and 45 currently in-service aircraft in the fourth quarter. All-in including G700s, we anticipate in excess of 60 deliveries in the quarter, assuming we’re granted FAA certification before the end of the year. That said, as you can tell, there’s a considerable amount of uncertainty as we get closer to certification. Moving to the demand environment, this was yet another positive quarter reflecting continuing strong demand. Aerospace book-to-bill was 1.4 to 1, and Gulfstream alone had a book-to-bill of 1.5 to 1.

We continue to have vibrant sales activity going into the fourth quarter and expect strong orders. It would, however, be a stretch to get to 1 to 1 in the fourth quarter, given our expectation of over 60 deliveries. A wildcard in the quarter will be the conflict in Israel and its impact on demand, if any. The period of significant increased aircraft demand began in mid-February of 2021, over two and a half years ago. In 2021, Gulfstream’s book-to-bill was 1.7 to 1, in ’22 it was 1.5 to 1, and year-to-date 2023 it’s 1.3 to 1. This includes the first quarter of 2023, when there was a three-week hiatus in orders as a result of the failure of several regional banks. In that quarter, we still managed a 0.9 to 1 book-to-bill. All of this leads quite naturally to an astonishing build of the aerospace backlog.

It grew from $11.6 billion at the end of 2020 to $20.1 billion at the end of the third quarter 2023, an increase of over 70% in two and three-quarter years. This all speaks to me of the underlying strength of the market for our products. The G700 flight test and certification program continues to move closer to its ultimate conclusion. We continue to plan for certification in the fourth quarter of this year, largely dependent upon the availability of FAA resources and a credit the FAA may allow for company flying. We currently are spending most of our engineering time on final reports and data submission. Operationally, Gulfstream continues to make good progress under difficult circumstances, but as a result of the supply chain issues that we’ve previously discussed, we plan to deliver 10 to 12 fewer aircraft this year than the 145 we had originally forecast in the beginning of the year.

On the other hand, we continue to expect more service revenue than initially predicted. Next, combat systems. Combat systems had revenue of $2.22 billion, up a stunning 24.4% over the year-ago quarter with growth at each of the business units, but particularly at OTS and European land systems. Earnings were $300 million, which was up 10.7%. Margins at 13.5% represent 170 basis point reduction versus the year-ago quarter, so once again we saw powerful revenue performance coupled with more modest operating margins in large part attributable to mix and new program starts. Some of our revenue increase is a result of facilities contracts to increase our artillery production capacity taken at lower margin. As you’d expect, these contracts will result in additional production at accretive margins over time.

On the subject of munitions, we’re working very closely with our government customer and have accelerated production faster than planned. The large capacity expansion that we’re putting in place today will further increase production. We have a ways to go, but we’re making progress. The increase in combat revenue also came from new international vehicle programs, the ramp-up of the M10 Booker, higher artillery program volume, and higher volume on Piranha and Eagle vehicles in Europe. On a sequential basis, revenue was up $300 million or 15.6%, and earnings were up $49 million or 19.5% on a 50 basis point improvement in margin. Year-to-date, revenue was up $775 million or 15.1% and operating earnings were up $53 million or 7.1% over last year, so the numbers are quite impressive quarter-over-quarter, sequentially and year-to-date.

Combat systems experienced very good order performance. Orders in the quarter resulted in a one-to-one book-to-bill, a very strong performance given the increased revenue and evidencing strong demand for munitions and international combat vehicles. Year-to-date, the book-to-bill is 1.3 to 1, which fully supports the growth outlook. Turning to marine systems, once again our shipbuilding units are demonstrating impressive revenue growth. Marine systems revenue of $3 billion was up $233 million or 8.4% against the year-ago quarter. Columbia-class construction and engineering drove the growth. Operating earnings were $211 million, down $27 million versus the year-ago quarter with 160 basis point decrement in operating margin. The year-ago quarter had a number of favorable EAC adjustments which did not repeat this quarter.

Sequentially, both revenue and operating earnings were down somewhat. Importantly, year-to-date revenue was up $982 million, 12.2%; however, earnings were essentially flat on a 90 basis point contraction in operating margin. The real driver of the margin difficulty has been the late deliveries at Electric Boat from the supply chain, which causes out-of-station work and internal scheduling disruptions. Electric Boat has continued to improve its throughput, but not fast enough to offset the cost of late material. We continue with the help of the Navy to work this issue. At Bath, while we’re seeing signs of improved productivity, it has yet to manifest in the business’ financial performance. All that said, we’re looking for slow but steady incremental margin growth over time.

Importantly, marine systems enjoyed a very good quarter from an orders perspective with a 2.3 to 1 book-to-bill. This is a very large enduring backlog. Lastly, technologies. It was another strong quarter with revenue of $3.3 billion, which is up 8% over the prior year and continues to build on the strong first half of the year. That growth was spread pretty evenly between GDIT and mission systems; in fact, each business grew both year-over-year and sequentially. At GDIT, we’re seeing particular strength in the defense and federal civilian portfolios as our technology accelerator investments and capabilities like zero trust, artificial intelligence, digital engineering and 5G are really resonating with customers and driving increased demand.

At mission systems, the cyber and naval platform markets have been particularly strong. The production and delivery cadence on the hardware side appears to have stabilized, so we expect their results to be somewhat more predictable despite the lingering fragility in the supply chain that will continue to be the new normal. Based on the strength of the first three quarters, the group is on track to achieve our increased sales forecast of $12.7 billion for the year. Operating earnings in the quarter were $315 million, up 10.5%, yielding a margin of 9.5% – that’s up 20 basis points year-over-year and up 70 basis points sequentially, so a very solid performance on strong revenue growth in the quarter. This is a drumbeat we expect to see continue in the fourth quarter.

Backlog at the end of the quarter was $12.7 billion. Through the first nine months, the group achieved a book-to-bill ratio of 1 to 1, keeping pace with the strong revenue growth across the business. Prospects remain strong with a qualified funnel of over $125 billion in opportunities they’re pursuing across the portfolio. Let me close with a review of the defense units in aggregate. As a whole on a quarter-over-quarter basis, defense had revenue of $8.54 billion, up $911 million or 11.9% over the year-ago quarter. On the same basis, earnings of $826 million were up $32 million or 4%. On a sequential basis, the pattern is similar – revenue was up $340 million or 4.1% and earnings were up $57 million or 7.4%. Year-to-date against the same period last year, revenue of $24.7 billion was up 10.2% and operating earnings were up $60 million or 2.6%.

In short, our defense businesses are experiencing significant growth in revenue and to a lesser degree in earnings; however, we need to continue to work with our supply chain in order to achieve appropriate operating leverage. With that, let me turn it over to Bill.

Bill Moss: Thank you Jason, and good morning. We had another very good quarter from an orders perspective with an overall book-to-bill ratio of 1.4 to 1 for the company. This is particularly impressive with the strong revenue growth in the quarter. Marine systems and aerospace led the way with book-to-bill ratios of 2.3 and 1.4 respectively. For the second quarter in a row, this led to record level backlog of $95.6 billion at the end of the quarter, up 4.6% from last quarter and up 7.6% from a year ago. Our total estimated contract value, which includes options and IDIQ contracts, ended the quarter just shy of $133 billion. Moving to our cash performance, this was another strong story in the quarter with over $1.3 billion of operating cash flow.

This brings us to $3.5 billion of operating cash flow through the first nine months of the year. Including capital expenditures, our free cash flow was $1.1 billion for the quarter and $2.9 billion year-to-date, or 126% of net income through the first nine months. This conversion rate was achieved on the strength of the Gulfstream orders, additional scheduled progress payment on combat systems international programs, and continued strong cash performance in technologies. We are well positioned to achieve our target for the year of a cash conversion rate over 100% of net income. Looking at capital deployment, capital expenditures were $227 million in the quarter, or 2.1% of sales. For the first nine months, we’re at 2% of sales. We’re still targeting to be slightly below 2.5% of sales for the full year, so that implies an uptick in capital investments in the fourth quarter.

We paid $363 million in dividends and repurchased a little over a quarter million shares during the quarter, bringing the total deployed in dividends and share repurchases through the first nine months to $1.5 billion. We also repaid $500 million of debt that matured in August and ended the quarter with a cash balance of over $1.3 billion. That brings us to a net debt position of $7.9 billion, down nearly $1.4 billion from year end. Net interest expense in the quarter was $85 million, bringing interest expense for the first nine months of the year to $265 million, down from $279 million for the same period in 2022. Finally, the tax rate in the quarter was 15.6%, bringing the rate for the first nine months to 16.2%. This is consistent with our guidance last quarter to expect a lower rate in the third quarter and a higher rate in the fourth, so no change to our outlook of 17% for the full year, which again implies a higher tax rate in the discrete fourth quarter.

Now let me turn it back to Jason for some final remarks.

Jason Aiken: Thanks Bill. As far as year-end guidance is concerned, we’re holding at $12.65 for the year. There will be a number of puts and takes from what we published last quarter, but it should all come about the same place. Nicole, that will conclude our remarks, so I’ll turn the call back to you.

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

See also 16 Best Places to Retire in Norway and 20 States That Have The Cheapest Electricity In The US.

Q&A Session

Operator: Yes, thank you. [Operator instructions] We will take our first question from Peter Arment with Baird. Your line is open.

Peter Arment: Yes, thanks. Good morning, Jason and Bill. Jason, it sounds like there’s just obviously a lot of moving parts for Q4 at Gulfstream. Is there a cut-off date, you know, if certification happens in December versus November, about your ability to kind of push out those deliveries, and then any commentary on just–I know you’ve had a long term forecast of 170 deliveries for ’24, whether you still think that holds. Obviously if certification slips, there would be more potentially, but maybe just some commentary there. Thanks.

Jason Aiken: Yes, thanks Peter. As it relates to certification, I think what we’ve said for some time now is that if we can achieve certification in the, call it early to mid December time frame, then we’ve got a good shot at getting the planned deliveries of G700s out the door this year. Obviously if that pushes further to the right, that puts that a little bit at risk. To your point about 2024, it’s probably not appropriate to get into specifics about next year until we go through our plan period, which we’ll engage in coming up here in the next month or two, but I think the way to think about this is a lot of what we’ve been talking about this year between the supply chain challenges, as well as the G700 cert timing, is really timing issues, and to your point, to the extent some of the deliveries that we anticipated this year don’t happen, that really just pushes into next year, so that naturally is an adder to the outlook for 2024.

But what we can’t do yet is declare victory on the supply chain issues and say that by early next year, they’re going to be completely solved, so a lot remains to be seen as to the timing of how that ultimately works itself out. I think it’s that that will determine the net impact to 2024, so I think a little bit more time is going to be needed to see between what pushes out of 2023 into 2024 and the timing of the supply chain fix, what the net impact is to that ’24 outlook. I think we’ll have a better sense of that when we come back to you with guidance in January.

Peter Arment: Appreciate the color, thanks Jason.

Operator: We will take our next question from David Strauss with Barclays. Your line is open.

David Strauss: Thanks, good morning.

Jason Aiken: Good morning David.

David Strauss: Hey. Jason, at the beginning of the year, you guys had forecasted marine and combat to be relatively flat. At this point, we’re looking at probably double-digit growth for both of those businesses this year. Does any of that–as we start thinking about how those businesses could look next year, does any of this represent any sort of pull-forward that would potentially moderate the growth that we could see out of those two businesses next year?

Jason Aiken: Yes, so I think as it relates to marine systems, David, nothing has really fundamentally changed from the narrative that we’ve talked about for some time, which is to expect roughly $400 million to $500 million on average per year, year-over-year growth in that business. Obviously this year has turned out to be quite a bit different than we originally anticipated, and that’s largely attributable to the increased throughput that we’ve seen at Electric Boat in particular as the hiring and retention dynamics have really improved faster than we thought, so that’s really driven a lot of the revenue acceleration into this year. That backlog is so large and so long term, I don’t really see that having a direct effect on next year or any given year, but obviously again we’ll have to go through the specific planning period that we’re about to engage in before we get too specific about next year, so we’ll be back with more on that, but not a direct correlation in my mind from that marine systems increase in throughput.

On combat systems, to your point, we had been expecting sort of flat to down-ish revenue before the threat environment really took a turn in the opposite direction, and as you’ve seen through the first part of the year, up 15% so far year-to-date, almost 25% in the quarter – that certainly was well beyond what our original expectations were, and frankly we don’t see that demand signal slowing down. When you think about the munitions side of the business as well as the international demand we’re seeing, along with the new program starts in the U.S., I don’t necessarily see that as being a pull forward or something that creates a headwind into 2024. Again, not being specific about that outlook because we’ll get into the planning period and get back to you in January.

David Strauss: As a follow-up, the IRS came out with updated guidance on Section 174 R&D. What impact does that have on your cash flow outlook?

Jason Aiken: Really, nothing other than what we’ve told you before. We’ve actually been pretty consistent on this throughout the drama on this issue over the years. We didn’t originally anticipate the law to be changed, so our guidance was predicated on the law as it is. It turned out not to be changed, and our expectation of what that would mean for us, ultimately you can call it lucky or good, we expected the net impact from a cash perspective to be right on course with what we’re seeing right now.

Operator: We will take our next question from Ken Herbert with RBC Capital Markets. Your line is open.

Ken Herbert: Yes, hi. Good morning, Jason and Bill. Maybe just to start, Jason, again on Gulfstream. Last quarter, you called out sort of 19 as the expected 700 delivery number, depending upon cert timing this year. Is that still a number we should expect into the fourth quarter, assuming you get certification in time, and can you just comment on any potential risk around 280 production levels, considering some of the uncertainty in the Middle East?

Jason Aiken: Yes, so far as the G700 is concerned, 19 is the number that we have targeted and are still striving to get to. Again, as you note, that is predicated on timing of cert. What I can tell you in terms of a little bit of color behind that is we’ve got 15 of those 19 that are ready to go and are in good shape, and we’re working toward the others, so again predicated on when the cert comes, we should be in good shape to be somewhere in that range for deliveries this year. As it relates to the 280s, what I would tell you is the modest down-tick that we–that I talked about earlier this morning in terms of our overall 2024–excuse me, 2023 deliveries, that five or six aircraft reduction from our previous guidance in July, that is largely related to G280s.

I would tell you that what we planned to deliver this year, we now have in hand at our Dallas facility for completion, so there’s really not any incremental risk to 2023. We will have to see, obviously, how the events in Israel play out and what impact that may have in 2024, but a little premature to get into that at this point.