General Dynamics Corporation (GD) Earnings Call Transcript & Summary

All right. Good morning, everyone, and welcome back to the Barclays Industrial Select Conference. I'm David Strauss, aerospace and defense analyst. And we're pleased to have Jason Aiken from General Dynamics, the CFO of General Dynamics, here with us today. And I'm going to turn it over to Jason for some forward-looking statements, and then we'll launch into Q&A. Just to remind you on your screen, you should see audience response questions. We appreciate if you could take a couple of minutes to respond to those. And when the conference concludes, we're going to be sharing the results with everyone. So Jason, over to you.

Sure. Thanks, David, and good morning. I appreciate the opportunity to be here today. And as you mentioned, obviously, today, we'll most likely address some forward-looking statements, which, of course, come with some risks and uncertainties. And as always, you can find out more about those in our 10-Q and our 10-K filings. So with that, we're ready to go.

All right. Cool. Got that out of the way. So let's start with the main thing everyone seems to be focused on, which is the potential for a flattening budget environment, even maybe declining. Everyone's talking about how their portfolio stacks up and why they potentially can outgrow whatever happens with the budget. How are you thinking your defense portfolio measures up? So think about the mix between Army, Navy, services and then the international side of things? So thinking about everything just on the defense side, and we'll talk about Gulfstream as we get further into this.

Sure. Look, I think to your point, it's best to talk about our portfolio in this environment. And I think the bottom line is we are in a position where we feel really good about the level of support and the level of funding that we're getting really across the portfolio. If you start on the Marine Systems side, it's pretty clear that submarines are the #1 priority for the Navy, whether that's Columbia you're talking about or the Virginia program. So we feel really good about the support there and the growth prospects that come with those programs. On Marine Systems, I don't think it's limited to submarines. All the other shipbuilding destroyer and other shipbuilding programs are equally supported and funded. So we feel good about that. If you turn to the ground forces side in Combat Systems, I think the key message there that the Army is focusing on is their modernization efforts. And really, if you look at our portfolio and what we're involved in, sort of from one end of the spectrum to the other, I think we're very well supported there, whether you're talking about our existing incumbent platforms and everything we're doing with both the tank and the Stryker to bring in third, fourth and even fifth generation technologies to modernize those platforms today as well as the positioning we sit in, in a number of the Army's new platform development efforts. And I think we're in a very good position there. So really sort of across the spectrum, whether it's what we have in the portfolio today or what the Army is envisioning for the future, I think we sit in a good position. And then when you look at the technology side, I think there's been -- for years, there's been sort of a common theme or thesis that those businesses are sort of short-cycle in nature and tend to be bill payers in times of budget austerity or budget constraint. But the fact is, increasingly, those capabilities are essential and core to our customers' missions. And so we're seeing, if anything, a rising level of priority when it comes to those capabilities. And so look, there's always going to be budget pressures from year to year and cycle to cycle, and nothing is without some level of risk. But I think the way we look at it is the best thing we can do is what we've always focused on, first and foremost and I think what we've always done best, which is have well-performing operations and the resulting programs that we're on. And if you look at our business across the portfolio, almost without exception, all of our programs are, from a schedule, cost, quality, relevance perspective, they're all in very good stead. So look, none of this is without risk, but we feel really good about the positioning we're in as well as our ability to be agile if unexpected things come up.

One area that didn't come up as you walked through that, was space. And a lot of companies are talking about their exposure to space and the high -- the opportunity for growth out of space. What is your -- I think you have some exposures through the -- what used to be the Mission Systems business. What is your exposure to the space side of things?

Sure. Obviously, that's an area where we tend to be a subsystems supplier, and to your point, it's largely in the Mission Systems business. So whether that's satellite payloads, ground stations or other classified type elements of that end of the spectrum, that really is where we sit. Look, we're going to -- we've got long-standing franchises in support of that business. There's exquisite technologies there that we specialize in and can't be easily replicated. And so I think we're in a good position to have some lift with that as that priority continues to be pushed. But we're going to stick to what sort of is in our core in that area. We're not going to chase after something that's sort of unnaturally beyond what we have in the portfolio.

Okay. So you mentioned your solid program execution and so during the last -- there's this hyper focus on who among investors it seems to be who's going to grow the fastest. But what we found is during actually the last downturn is that the best-performing stocks, at least, where the companies where we saw the most upside in terms of productivity and margins and what they ultimately did with their cash and how aggressive they were in terms of returning cash. So how do you view -- if you look at your defense portfolio and its entirety, how do you view the opportunity for improved program performance, mix, productivity, the margin side of the equation. And then over on the cash side of things, as you're coming through the end of kind of this deleveraging cycle, how do you feel about the opportunity to maybe outdrive the cash return side of things?

Yes. Look, I think we have long articulated and made clear sort of the internal priorities that we focus on from a value creation standpoint. And that is while revenue growth is always something that we'll go after and seek as appropriate and prudent, our focus has always been on earnings and margin performance. No matter what element of the cycle that we're in. So I think we've proven our ability to behave like a good cyclical and optimize those priorities, no matter what part of the cycle we're in. And I think that's absolutely what you're going to see out of us as we enter into this next cycle. We are absolutely laser-focused on improving our earnings performance year-over-year. And look, while we enter 2021 in a similar position as we exited 2020 in terms of the pandemic and its impacts, we're still going to see some of that lingering effect into 2021, but we do expect to see, as we go into 2022 and beyond, year-over-year improvements in the margin performance across our portfolio as we've demonstrated our ability to perform in the past. So I can frankly say pretty bullishly that we feel good about where we're headed from -- in terms of that bottom line performance. When you turn to the cash side of things, look, I think it's no secret. We've talked quite a bit over the past several years, for those who followed us closely, about the fact that we've been in a fairly significant investment mode, investing across our portfolio for the benefit of our long-term shareholders and that long-term value creation. And so we're now coming to the end of that investment cycle. A lot of those cards have been played, and we're now ready to sort of reap the rewards of those investments, both in terms of the returns that they provide for our shareholders as well as the growing cash flow profile that they afford. And frankly, I think it's reasonable for those patient shareholders who have been with us through that investment period to expect that we can pivot more toward some of the tactical share repurchase that we've done in the past. And so I think that's a reasonable expectation.

So on the cash side of things, this year, it looks like you're going to get back pretty close to 100% conversion. You haven't been there in a couple of years. You've had this drag. You've talked -- you've mentioned there a little bit the investment side, CapEx, but also on the working capital side. Talk about all the individual pieces when it comes to working capital. I mean, we've seen the unbilled receivables around the Middle East program, now that's starting to come down. I think last year, you actually made some really good progress on the inventory side, but you had a pretty big headwind. I think it was from advances at Gulfstream last year. So maybe take those moving pieces and see -- and talk about how those play out in '21 and maybe even beyond that.

Yes. Look, just as a reminder, we ended 2020 in, I think, a really positive position. We -- I think we had 91% of cash conversion versus our original estimate in the 80% to 85% ballpark. So I was, frankly, personally very pleased with the way the business has performed to close out the year. And as you alluded to, a big piece of that was Gulfstream was able to start to turn a little bit on the inventory side. And so that helped from a working capital standpoint. But I think, overall, if I think about how we ended 2020, the working capital situation was, I'll call it a push, maybe a modest headwind, whereas we'd expected it to be a little bit more of a headwind, given COVID and some of the other things we were dealing with. So the outperformance there to what I'll call a push to modest headwind got us up into that 90s range. As I look ahead to 2021, I think we, number one, expect to do a step better on the working capital. To your point, I think we'll start to see a more meaningful unwind of the unbilled receivables in the Combat Systems business this year. And so that will help out. We'll still be at an elevated level of CapEx. I talked, I think, on the earnings call back in January about how we've tried to prudently moderate that while continuing to be supportive of the Navy's programs in the Marine Systems group. But we'll still see a little bit of a headwind from CapEx this year. So hence, being in the 95-ish percent range as opposed to at or above 100%. But it's sort of a mix of the continuing improvement on the OWC, particularly on the unbilled side, offset a little bit with that CapEx. And then I think on the Gulfstream side, with the inventory, you've got the 500 and 600, we're starting -- we expect to start to see that normalize over the next couple of years. But then, of course, with the 700, you'll see a little bit of an uptick there. And then that will normalize in due course. So I think the Gulfstream story is more of a multiyear turn on that inventory, but we do -- we've started to see that heading in the right direction, and we expect to see that continue.

So you've talked a lot about the cash conversion at GDIT, what you're now calling technologies, how strong it's been. I think 150% or something along those lines in terms of conversion. Where -- can you just frame in rough terms where the other businesses are converting? You talked about some of the working capital headwinds in Gulfstream and -- but rough range where those businesses are from a conversion standpoint?

Yes. Look, we have a crystal clear expectation with each of these businesses that year in and year out, they should, all other things being equal, be in the 95% to 100% range of conversion. The exception being if you've got a particular working capital issue, which we've, I think, plentifully discussed and people are well aware of in terms of what's happening in a couple of the businesses at this point, or whether there's a particular uptick in CapEx. And each of those things is going to be temporary in nature. But those things notwithstanding, we would expect each of our businesses to be performing in that 95% to 100% free cash flow range. And I think, look over history, these businesses have done that. If you look over any extended 5-, 10-plus-year period and as we look out over the future, we have been and expect to continue to be in that range, notwithstanding some of the dips we've had because of some of those issues in the working capital and the elevated CapEx. I think that there's opportunity as I look ahead. I guess I think of sort of the old adage or the question, why do you rob banks? It's because that's where the money is, right? So you go after where the money is. And in this case, it's the inventory at Gulfstream. And so there's opportunity perhaps there if things get a little better a little quicker. The timing of when we turn that around could help on the cash flow story. But I think 2021 is fairly well baked in terms of production and delivery levels for Gulfstream, and so that's more of an opportunity, I think, in '22, '23 and beyond.

Okay. All right. We'll touch on that a little bit more in a second. I wanted to ask you first what your thoughts are now on the balance sheet and leverage. This -- General Dynamics had -- up until CSRA have been running 0.5 turn, 1 turn levered. You got up to 2 to 2.5x. I think that's come down a little bit slower than you would have expected initially. I think today, you're back down to that 2 range, maybe trend towards kind of 1.5x. But what are your thoughts on leverage? What's the sweet spot? And in light of that, how much room is there actually to buy back stock this year, given you're still sitting around 2x levered?

Yes. So look, we don't overly focus on a single metric like EBITDA turns or anything like that. I think it's more holistic in our -- starting with our approach to focusing on our target mid-A credit rating and the various metrics that are supportive of that. And so when we start with that, that allows us to think about how we make some of these trade-offs. And to your point, we go back -- so prior to the CSRA acquisition, we were essentially 0 net debt, if you will. And when we took on the additional debt associated with that acquisition, we made it clear, hey, this is a temporary elevated state. We have no intention of staying here. We're going to pay this down fairly quickly. But at the same time, we have no intention of going back to where we were before with essentially 0 net debt. That wasn't necessarily an optimized position we were in. And so right now, as we sit here in 2021, I think we're right in the throes of that conversation. We've got about $3 billion of notes coming due this year. And so it's going to be a healthy conversation around those trade-offs to make sure that we maintain the financial flexibility and agility that we prioritize and desire while being able to take advantage of the opportunities as they arise. And so I think you'll -- I won't get up too far ahead of ourselves this year. You'll see how that plays out, but we're in the midst of that conversation. The bottom line is I think we've got some flexibility. As I alluded to before, I think our shareholders should expect us to tactically and opportunistically be in the market.

Okay. So I want to transition to talk a little bit more, ask a couple of questions about each of the businesses. So starting with the Aerospace side. So the 700 was launched 1 year, 1.5 years ago, I think it was or formally launched. We're getting closer to the time frame where we got to start thinking about it and putting it in our models. When we compare and contrast your recent launches, the 650 came into what was a great environment, super strong pricing. And then we have the 500, 600, which started out at what we believe is -- what we believe were much lower margins and have improved from there. I mean, within that framework, how should we think about the 700, the margin profile there as it comes into -- enters into service and starts delivering?

Well I think a couple of major factors you need to think about at the introduction of any new aircraft model. Number one is the level of, call it, test program start-up burden that has to be amortized over the initial production units. And then second, to your point, is pricing. And I think when you look back at the 650, it definitely came in at very strong margins and improved from there. It was accretive from the get-go. And pricing certainly was a factor there. When you look at the 500 and 600, we talked a good bit over the years about the level of that upfront program burden that was borne with the dual-certification program and the cost that was borne by the early units, particularly the 500. But make no mistake, both of those planes have come nicely down their learning curves and are growing in their margin performance, and we expect that to continue. So they'll continue to be additive to the bottom line. When you look at the 700, I think between a little bit lesser of a program burden and a similar pricing benefit that we talked about in the 650, you should expect the 700 to come into the portfolio, much more similar to the 650, immediately accretive and attractive margins that, again, we expect to then continue to improve from that point on. So I think that will be a good news story for the business. And look, bottom line, I think as we exit 2021, which we expect to be the low point, we expect to see each of these models continue to improve in their overall margin performance and as a result, the business itself to have growing year-over-year margin performance.

I think one of the concerns I hear is the potential for the 700 to cannibalize the 650. Can you talk about what the bookings profile on the 700 has looked like so far? How -- roughly what you've seen in terms of bookings? And what's the background behind those bookings? Are those 650 customers today that are looking to replace the 650? Or is it additive? Is it customer takeaways from your competition? Just some color around what the 700 bookings pipeline, what it's looked like so far?

Bottom line, it's been very strong, robust demand and order interest in the 700. So we've been very pleased with its reception in the market. To your point, the answer, I guess, is perhaps somewhat in the question. You laid it out there. Some of it, you're going to see some 650 owners, particularly on the high net worth in the digital and international side who are interested in moving up into that larger cabin. But there's also market expansion that's leading growth here. And as well as, I think Gulfstream has been demonstrating for several years now, and we expect to continue that they're going to continue to see their market share increase as a result of these new technologies and these new airframes, including the 700 that are being introduced. So I think it's been very encouraging, and the demand is across the board. You mentioned cannibalization. I can't help but sort of pick up on that because I think that's been a concern from some observers around Gulfstream for a number of years since we've been introducing new products. I can recall that there was a lot of chatter that the 650 was going to be the demise of the 550 and cannibalize that market. And sure enough the 550 lasted for a good decade plus beyond the introduction of and the announcement of 650. So I think that was a bit perhaps overstated in terms of concerns. And frankly, the reason for that is, I think, the guys at Gulfstream do a very nice job of stratifying their market, both between mission capability and price point for these various aircraft models. And so you don't necessarily have everybody in the market all seeking to have the largest or longest range airplane that's out there. There's a whole bunch of different mission sets that are suited to different customer interest in different price points. And so I think, frankly, we expect to see that continue with the 700. There's been some chatter, and we get some questions about, will the 700 cannibalize the 650? And you sort of alluded to that perhaps in your question. I think our expectation is that similar to past experience, these planes have been properly differentiated in the market, both in terms of capability and price that we don't expect to see that. And I'll give you some data that I think is interesting that sort of supports that notion. It's not just conjecture. If you look at the 5 quarters since we introduced the 700 and compare that to the 5 quarters prior to the introduction of 700, so sort of 2 windows on either side of that introduction. And you look at order activity for the 650 since the introduction of the 700, order activity during that window, notwithstanding the impact of the pandemic throughout last year, for the 650, is up by about 16% from the 5 quarters preceding the announcement of the 700. So that's about a 2.5-year window of time to give you a pretty good data point in terms of how the market is receiving and responding to having both of these offerings in the market. And so look, we can't predict with precision what the future is going to look like. But I think the data so far support what Phebe has mentioned that the 700 has really provided some clarity to our market offerings and directed the customers who are interested in that type of capability to that all-new platform and the customers who are interested in what the 650 offers to that platform, and both are existing nicely at this point in that market. So we feel really good about where these airplanes are going.

Okay. And last question on the aviation and Gulfstream. So you've talked about the potential for inventory unwind at Gulfstream, working capital tailwind. How does the 700 fit in that? I know you've built the flight test aircraft, but as inventory -- or as production on that ramps up and you build inventory, how does that kind of mesh with the 500, 600 flight test aircraft going away and the inventory down -- for those platforms coming down?

Yes. You've picked up on it. I think just to cut to the chase on this, it's really the reason why the inventory drawdown and the working capital drawdown in Gulfstream will take more of a 2-, 3-year period versus happening over a 12- to 18-month period. We'll see the 500 to 600 turn here over this year in the early part of next. And while the 700 builds up, it's got the 5 test airplanes, but then obviously you got to have the production build there. And then once that gets into full production, we get rid of the test airplanes and so on, then you'll see that tail off. So that's really sort of the sequencing of why we'll see Gulfstream's inventory story play out more over, call it, a 2-, 3-year period versus a shorter 12- to 18-month period.

Okay. Got it. So switching over to marine. So you just saw great growth there in 2020, 9%. You forecasted low single-digit growth in 2021, which -- a tough comp, but I still think a little bit lower than what people were expecting. Yes, can't get anything right, right, after 9% in 2020. But something that's come up with investors is this potential we've seen it on some other large development programs is kind of a -- I want to call it a bathtub, but a flattening in the middle as you transition from development into production on some of these large programs. Are we potentially going to see something -- not see, but is that potentially something you're going to go through on Columbia, where we get a couple of years where it kind of flattens out rather than continue this steep upward trajectory?

I don't think so. I mean, to your point, 2020 turned out even better than we expected. And so to some extent, the '21 suffers by comparison. But let me take a step back and give you a little more data on that as well. If you go back to when this management team took over and you look at the Marine Systems business during that time, that business grew from 2013 to 2020 by an average of about a little over $450 million a year top line. And now we're talking about moving forward by $400 million to $500 million on the top line out into the foreseeable future, out through the next decade. And so I think perhaps when you look at growth rate, you get into a little bit of law of large numbers, right? And so the growth number may suffer a couple of basis points as a result of that. But I don't think there's any slowdown implied or expected in here. I think to your point, Columbia will see in the moment in the '21, '22 time frame, a little bit of that transition from the design and engineering effort to the construction ramp-up, where at '23 and '24, it sort of has just full lift with no impediment. But I think that's pretty consistent with what we've been talking about all along, the '23 is where we'd see the more meaningful net step-up in Columbia. And in the meantime, you've got Block V of Virginia, including the payload module that helps fill in some of that growth. So that $400 million to $500 million a year as we look out into '21, '22 before we get to '23 and beyond.

So just to clarify on that $400 million to $500 million, which Phebe commented on, on the call. I assume -- could we be looking at kind of at the lower end of that or potentially below that over the next -- obviously, this year and maybe '22? And then we accelerate at a higher level in '23, '24 as Columbia really kicks in?

So just to clarify, I don't think we're talking about a net number at the end that the CAGR implies $400 million or $500 million. I think you should see between $400 million and $500 million. Obviously, last year was better than we expected. This year could be better than we expected. 1 year could be worse. But we -- right now, as we look out into that plan horizon, we expect to see $400 million to $500 million per year. So the way I think about this is that has this business growing by roughly $1 billion every other -- every 2 years. And we expect to kind of see that cadence play out over the next several years. So not really an implied flat or lower or dip followed by a hockey stick. It ought to be a pretty reasonable cadence.

Right. And what was the prior comment that I think Phebe has talked about the business doubling, Marine doubling over what period? I mean, obviously, that's within the context of the $400 million to $500 million per year.

Yes. I mean, you got to -- I got to consult with her about that to make sure I know the starting point of that. Because if you go back again to the beginning of this management team's tenure, the business was, I think, about a $6.5 billion business. It's currently a $10 billion business and growing at the cadence I mentioned. So if it keeps going at $1 billion every 2 years for the next -- the rest of this decade, you can kind of do the math and see where the business gets. So depending on your starting and ending point, I don't know if that was from '19 or '20, but it's massive growth between now and the end of the decade.

So we got a couple of minutes left. I want to touch on combat and then we'll go over to technologies. But on combat, you talked about this profile where it's low single-digit growth the next, I guess, 2 years and then accelerating. Can you break that out I guess, near term and beyond domestic versus international, how you frame that? And then if you could also throw into that the dollar has weakened a fair amount. Does that provide any sort of tailwind on the international side to the business?

So I think to your point, it's a good balanced portfolio right now. And we've seen that over the past several years that in contrast with where we were so heavily Army, U.S. domestic dependent, that we've got a nice balance. I think right now, we're just below 60-40 perhaps, U.S. versus international, and it's kind of ebbed and flowed between 40-60, 60-40 over the past several years. But right now, for the next year or 2, I think it is low single-digit growth. And it's a -- I'll call it a mixed bag. It's not any one big driver one way or the other. I think we've got some nice, modest lift in some domestic programs like Stryker and some of the munitions portfolio as well as some areas of the international portfolio that have got some modest growth, whether that's Canada or some areas of Europe. And then we've got some others that are just notching down slightly. So I think it's -- there's no 1 or 2 things I could point to. It's sort of a, like I said, a mixed bag over the next couple of years. Really, when you get out to '23 and beyond, we hope to see -- or I shouldn't say hope, we expect to see that uptick really as a number of things happen. We've got, as we talked about or I alluded to earlier, a number of the Army modernization programs that we're participating in as well as the ongoing efforts we've got with our existing platforms. Again, I spoke to this a little bit earlier. But that Stryker vehicle has proven to be perhaps the most versatile thing in the Army's force capability. It seems we haven't found anything yet that it can't do. So we do expect to see some lift from that. And frankly, then, and I'll end here before droning on for too long. But internationally, Europe, we've won a great deal of work, and we've got a good CAGR outlook on that European business, including the Spanish VCR program award last year as well as a number of others. So all of that will start to manifest itself in another year or 2 out.

And does currency help you at all in this?

Sorry. Yes. I mean, if it stays where it is today, I mean, yes. Certainly, it'll -- we've had a headwind from that for a couple of years. We've talked about the impact that's had on the backlog and the revenue. But if you can help me predict if that's going to stay that way, you and I will make a lot of money.

All right. So last question, I don't want to leave technologies out here. But I guess I was a little bit -- if we parsed down and look at GDIT specifically. I was a little bit surprised that maybe there was a little bit more. I mean, we've all focused on the top line. But I was a little bit surprised there wasn't more in the way of EBIT growth out of that business. You get the -- you've got a pretty easy comp. Q2 was hit hard by COVID and some -- I think you took a charge on a couple of programs. And then you have lower intangible amortization, I think, that's flowing through the business. So I know you guys are talking about from an EBITDA basis. But just from an EBIT basis, I was a little bit surprised that there wasn't more than $50 million of EBIT growth out of the combination at this point.

Look, I guess I'll put it this way. As we sit here in early 2021, we're entering this year very much the way we exited last year. So the impact of this pandemic is far from gone. And so we've got opportunity. And we do, to that point, believe that the growth and the trajectory coming out of this year is a positive trend that we expect to continue into 2022 and beyond. But we've got a long way to go before we get the customer fully back at work on a full-time basis, get our guys back on a full-time basis, get that workforce fully and productively employed and earning fee versus sitting idly. So those things just are going to continue to persist. And I can't predict with precision when we're going to sort of see the clouds part and have that sunshine come in and the lift comes, but we do expect it to come. It's just I don't want to get too far out ahead of ourselves with that expectation. We'll see it when we see it, but we're confident that the trajectory is there. And it's supported by the underpinnings of the growth we talked about. At the top line, maybe we said 4.5% for the overall segment, but 7% growth from GDIT specifically. And so as you'd expect, a lot of that's coming from new program wins. They've had some good experience in terms of awards and book-to-bill. And so some of that, you'll start to see that lift from new programs, which, as we've talked about, naturally carry early program margins, which are going to be a little more conservative, and then we'll have the opportunity to outperform that over the long run. But in the meantime, some of that new work and the growth that comes from it will bring modestly dilutive margin that will then pick up over time as we perform on those programs.

All right. Well, unfortunately, we're out of time. I still got a whole bunch to ask, but I'll let you run to your meeting and -- but thanks, Jason, for joining us again this year. And I hope you'll come back next year, and we're both in Miami. But thanks again, and enjoy the rest of your day.

Absolutely. Always a pleasure. Thanks, Dave.

Thanks, Jason.

See you.