General Dynamics Corporation (GD) Earnings Call Transcript & Summary

Okay. If everyone's here, take your seat, we're going to move on. We're delighted to have with us our next company is General Dynamics. And delighted to have Chairperson and CEO, Phebe Novakovic. This will be an interview. So there will be forward-looking statements made or remarks made. And so think about Reg FD, you'll be aware of that.

So maybe to start, Phebe, maybe you could kind of recap the key takeaways from 2023. I mean it was a really good year, but things went a little bit differently than you thought when you started.

Well, different in a good way is always beneficial. I think the 2 things that sort of surprised us was the timing and the strength of defense revenue and the lack of G700 certification. That said, we accomplished a lot last year, and particularly in setting us up for additional revenue growth, and in that revenue growth, driving margin improvement. It will bring with it additional earnings, which is always a very strong thing. Operating leverage is critical.

Great. So on the call, you mentioned the temporary disruption from the Hamas attack out on Gulfstream orders in the fourth quarter. But maybe update us more broadly, what does that mean for Israel's ability to develop 280s and given the disruptions of their workforce, and like what does that mean for 280 deliveries potentially for this?

So we fully factored in their projections on 280. They are doing a good job replacing those who were called up to military service with retirees and management. We have factored all of that into our plan. I would say they're doing a bit better on their production and testing plan than we had anticipated, but we like where we are right now with them in terms of how we have derisked that profile.

Got it. So one of the questions we're asking everyone here is supply chain, it's been a big disruption the last couple of years. As you look at it today, is it about the same, getting better? How would you describe it?

Well, let's break it into the 2 groups where supply chain has had the most profound impact. First, in aerospace. Aerospace supply chain is getting better. You saw that in our fourth quarter deliveries. We delivered 39 airplanes in the fourth quarter of last year compared to 24 to 25 in the previous quarters. That was permitted by improvements in the supply chain. That said, there are still elements of the supply chain that are struggling. That manifests itself in, while less, still significant out-of-station work. And the ramp-up this year will begin to tax them, but we think we've given you a very balanced plan, understanding our supply chain very, very well and what the potential impacts could be. On the Marine group side, I think a little context here is important. When -- COVID impacted heavy industry and labor-intensive industries in a profound sort of way and twofold. One was a larger cohort of retirees of experienced labor and workers. And they left at a higher degree and a higher number than we had anticipated and then the very well-known COVID/post-COVID labor disruptions. Both of those things impacted manufacturing businesses across the United States, but particularly those who are labor intensive. That said, our Navy customer has been very, very good at working with us and understanding the supply chain perturbations and some of the challenges, and they've been pushing through long lead material through us in order to stabilize that supply chain. It is getting better, but there's still elements of it that have a long way to go in terms of improving their productivity.

And then the other sort of issue is labor. Maybe speaking to both Gulfstream and to Marine, are -- is the labor market easier today? It's easier to hire folks? And what's your attrition rate look like?

Right. So at Gulfstream, we do not have a labor issue. We have a number of young, highly trained in-place workers who do not have an attrition problem. In the Marine group, our hiring has improved. And one of the things we're very pleased to see is we have a very robust training program and the new shipbuilders who are coming through that training program are coming out at higher productivity levels than we had seen before. They will continue to improve their productivity over time as they come down their learning curves. So for us, in order to offset a lot of the impacts or some of the impacts on -- particularly in the Marine group on the labor market that have had on our supply chain, our job is to increase productivity and velocity, so we can help offset some of those impacts, and we're doing just that. Our -- just to give you an example what -- our throughput on Columbia increased 30% last year. So we're seeing nice velocity. We're seeing nice productivity, but we've got -- there's always more work to do here, always.

Got it. So I think you'd mentioned that demand was strong in the fourth quarter. So what are you seeing here in the first quarter? And I guess you had the Hamas disruption in the fourth quarter. I mean a little hard on the outside to see what that actually meant.

On demand?

Yes.

So as we enter this year, the pipeline remains strong, and we've got nice solid pace of orders. And I would say the United States is particularly strong. This is at Gulfstream.

Okay. And so your guide calls for -- and this sort of confused me, a 39% increase in sales but a 44% lift in deliveries. And presumably, the mix is shifting toward the G700, which is 3x expensive as the G280, which might be a little bit less. So I would have thought you might have more in terms of per unit, the revenues would be stronger. What's happening?

I thought 39% was pretty impressive growth.

It is. It is. But on 44% deliveries that have lift...

Either -- look, aerospace is more than just airplane deliveries. We have a large, about $3 billion service business that includes government work that tends to be very lumpy. And that just drives a lot of the revenue that we're looking at this year, but we're quite comfortable with the plan we gave you is quite balanced.

But should we assume that -- I mean so is the service -- so Jet is not going to be -- is going to be down? I'm still confused as to...

Well, look, service varies and Jet service continued strong. Gulfstream service continued strong, particularly with the increase in embedded fleet, but are government orders. And that is both at Gulfstream and a little less at Jet are quite lumpy. And so this year, we see less of that coming through. But managing that 39% increases is challenging. We're quite comfortable that we can do it. We've got all the tools in place to do that, but we've fully factored in all of the elements of these very complex and large businesses in our revenue production. Don't get out ahead of us here.

Okay. Okay. So what are the key margin drivers for Gulfstream this year? I mean where -- is R&D flat? I mean because the revenues are up so much or is R&D to sales down? What about out of sequence work? Is that an issue? G280 disruptions, what are the things that are moving those margins?

So we see margin improvement at Gulfstream, and we'll see, over time, increased margin improvement. This year, it's all about volume, mix, cost efficiency. Recall also that the first 2 lots of 700s carry with them the full cost of the developmental program, those deliver this year. R&D will remain essentially flat. We've got to finish up the 700 certification. We have 2 more airplanes in the certification mix. R&D will come down as a percentage of sales, obviously.

Got it. Okay. And so if we turn to marine, EB's material delay, supplier quality problems, they continuing in the first quarter? Or is it easing up a little bit?

In some places. Some places are getting better and others are continuing to struggle. And as I said earlier, our key challenge then is to increase our profitability and our throughput. That allows maybe to get -- it ships a little bit faster and again, to offset some of these cost impacts of delays in supplier and supplier deliveries. And I would say, too, as we do in Gulfstream, we have a number of flyaway teams that are embedded in with our suppliers, and that helps over time. And the Navy has been an important partner in recognizing these challenges and addressing them quite aggressively. And I think those 2 things, Electric Boats, focus on its supply chain and its own productivity and the Navy's, I think, long lead material and ability to see into the future has really helped. It's a good partnership.

So I think on the third quarter call, Jason noted labor force stability. And one of the things we went last August, we visited Huntington, and they were talking about, gee, the gap between working at Home Depot and working at the shipyard has narrowed. And you guys had some labor contracts. Is your attrition rate improving?

So at Electric Boat and frankly, throughout the Marine group, we have seen increased hiring, increased training and putting new workers and new shipbuilders through that training program has gone very, very well. A lot of the labor shortages that we have seen have largely abated. It's simply getting these new workers in fully trained and then getting them down their learning curves as they enter into the shipyard. But we're pretty encouraged about what we see right now. There's lot less attrition now than there was shortly after COVID. Electric Boat went into COVID in pretty strong condition. And if you enter a crisis with strong operating performance, you tend to weather the crisis better. So we came out of it stronger than most of the supply chain, but we were not without our challenges, and that has showed up in particularly our margins. So you can imagine we're going to be laser focused on margins.

Right. So Marine revenues kind of really overperformed by a big margin last year. How come they were so much above your initial guide? And what's the chance it could happen again?

So Columbia came in faster. There were some additional destroyer work and repair came in at a faster level than we had anticipated, again, reflecting the Navy's needs. They have increased, and I think quite publicly have been open about their need to get these ships turned quickly. So that velocity of contract activity increased and that resulted in increased revenue for us that have -- revenue that was coming, it just came a little bit earlier.

So if we think about margins, you mentioned that's a focus, I mean, everyone is worried about fixed-price development that the Air Force programs have in Northrop, Boeing, name them. But I mean my recollection over time is that shipyards are different because you don't want -- you can't just do a development Columbia. You got to basically have a contract that's a little more forgiving. I mean this might be -- well, Columbia, the first 2 are, I think, cost plus. But as you move into production, it's a fixed-price incentive with a ceiling and with a share pattern. So how should we think about the risk and the margins and the uptrend? It seems like if you perform...

So within our planned horizon, it's all about increasing our throughput and our velocity, increasing our shipbuilder productivity and managing costs. And as I said, we're laser-focused on managing costs. So during our plan horizon, we're quite comfortable that we can drive margin improvement, assuming there is no additional deterioration in the supply chain. But as I've said earlier, we've put together a plan that we see as very balanced, including in the Marine group. When you get into the future to bid a fixed price on particularly submarines, where these are large, long-term contracts. You've got to truly understand your cost environment. The Navy understands that thoroughly, and we will negotiate with them appropriately as we always do. They understand our challenges. We understand their needs. That [ intimacy ] is important. So I think discipline on all parties is critical.

Is there a reason...

And by the way, we are the company that suffered. If you go back 25, 20 -- maybe even closer to 30 years, remember A-12, for those of you who have been around for a while, fixed-price development contract and almost took out the old GD and McDonnell Douglas, spent 20 years in the U.S. court system, including, I think, 2, if not 3x to the Supreme Court. So for many, many years, fixed-price development contracts were taboo because it can -- they can damage the industrial base badly. And the customer ends up not getting a product. A-12 was never delivered. This is an ancient history, but my experience in life is the fundamentals don't really change. You make money the old-fashioned way, contracting and programming for -- the realities of contracting and programming for large defense programs doesn't change. So remembering what the basics are on the fundamentals of really driving the industrial base...

But A-12 was a plane. I mean, basically, with ships, there is a more forgiving -- it's a fixed price but fixed price with...

Well, forgiving isn't the right word because that would suggest the Navy is forgiving and the Navy is pretty tough. I think there has been an understanding of the economic realities by the Navy of what it's faced -- what the shipyards face and frankly, much of their industrial base faces. And I think that kind of realism is important.

Right. Right. So Combat, my favorite, up 13% last year, you thought it was going to be flat. So what's -- given likely it continue, doesn't sound like OTS is going to slow down or European Land Systems' looking pretty good. You only have a 3% increase this year?

Once again, 3% on 13%, I think, is pretty impressive.

It is. It is.

So this year is a lot about absorbing the growth that we experienced last year. And as we have -- as we continue to increase the production and throughput on munitions, that will continue to build over time. We've got that fully factored into our plan. And there remains strong demand across Europe and in the United States. So it's just really a question of timing. In a high-growth environment, oftentimes, but particularly a growth environment that we're seeing in Land Systems, you tend to have lumpy orders, contracts just execute at different timing levels.

Right, right. I think what the -- didn't the Army just say they want to double 155 out by October? So I mean...

So we have fully factored in all those plans into our plan. Think about 155 production in this way. Along with our Army customer and partner, we have more than tripled the 155 production in 2-plus years. So that tells you what industry aligned with the customer can do when you are fully focused on doing the right thing and it's important to replace our stockpiles.

So that's an issue. One of the issues is like sort of how far into the future, but it certainly looks like munitions replenishment is going to take a while. European vehicle demand looks like it's quite durable. You made the point, it takes a while until folks come around to order. The orders are lumpy. What's the potential for combat that sort of the uptrend continues through '26?

So as we see mid- to upper single-digit growth throughout our plan period, and that's driven by munitions, both increased in our portfolio and in our activity as well as just increased in the actual production of the shells. Bridges are -- the demand for bridges is increasing. There are a lot of rivers in Europe. And I would also say in -- we're seeing some in Asia. Wheeled and tracked vehicle demand is increasing and demand in the United States at Land Systems for both tracked and wheeled vehicles, it's also increasing both domestic and foreign. So we see the threat environment is unfortunately, as you all know, an ugly -- we're in an ugly period right now, and that is driving the need for our allies and the United States to arm in the face of threat.

Right. We haven't talked for a while about the Saudi lab or the -- or AJAX. Are they doing okay? Are they -- they sunset...

So the -- as you know, we talk about one of these programs as the large international order through Canada. That has gone extremely well. As for those of you who may remember, we had a lot of cash tied up on the balance sheet for a while. That has completely been liquidated. And the vehicle is a superb vehicle, and we're coming down toward the end of that program. AJAX has stabilized. It's in test and is performing very well in test. The British soldier likes it. And we'll continue to work that program. But the risk from -- on a cash perspective has been taken off that program as well.

Got it. So if we turn to Technology, I think Jason mentioned $13.5 billion in awards last year versus $8 billion in revenues, $15 billion of pending awards, $2 billion under protest. How come only low single-digit growth?

So a lot of these orders come in the form of IDIQs that enter revenue over time. So our backlog will support the revenue growth going forward and additional -- in addition to new orders that will manifest. We project low single-digit growth for this business, but given the size of this business, and additional order activity and margin improvement, we see some really nice potential for solid earnings growth.

Got it. So you mentioned margin potential. But basically, unlike others, you don't show us adjusted EBITDA, you just show us the EBIT after the amortization. If we look at it on an EBITDA basis, are the margins also going up? Or is this just that you're winding off the amortization.

I'm like -- I think this -- but remember, Mission Systems is in the middle of that and has a little amortization. So as they have come for them, it's coming off of their legacy programs, which has impacted their revenue, and then -- and earnings and margin, obviously, and then coming back up slower to ramp new programs. But both of those businesses have been investing in [ vast currents ]. Take Mission Systems, for example, high-end crypto space, undersea guided munitions. All of those are areas where they are targeting their R&D investments. And a number of those are beginning to pay off just as a kind of an indicator of how they're doing. We expect a 25% increase in their space order activity this year. So these investments have been well placed.

So I was going to get to that. So I think, what, they tripled the bid submit in 2023, but you've got revenues down slightly. But what should we look for, for -- at Mission Systems? What should we look for, for the bookings? I mean is the book-to-bill going to be...

I think they'll have a very solid book-to-bill. I would say, in the 1:1, maybe a little higher, but I like their positioning. They are a heavy merchant supplier to a lot of the primes, and that's a good place to be, particularly as you see growth in platform businesses. They will grow along with those platform businesses. So they're in a good position. And again, throughout our business, you'll hear me say this again and again and again, it's execution, execution, focus on your margins. In a growth environment, and this should be obvious, but I will just reiterate it anyway. In a growth environment, cost is often difficult to control, overhead in particular. So that is why we are laser-focused on our cost and our margin improvement. That's actually how we can drive value for our customers, for our people, for our shareholders is increase those earnings that go -- to naturally increase over the period as our revenue grows. All about operating performance.

So you mentioned space orders up 25%. What are the key -- any particular -- is that, I assume, a big portion of Mission Systems?

It's some. It's not their biggest. They're very active in undersea and that, as everyone knows, is growing.

But -- so the revenues are down a little bit this year. But should we think that as we move toward '25, '26, we're talking mid-single digit, maybe a little...

We're looking to low to, on occasion, mid-single digit growth. Again, this is a very large portfolio. And the key will be, this is a broken record here, but I think it's important you understand the key is just driving operating performance, get those margins up. That's controlling your cost in this growth environment.

Right, right. And so what about the margins at Technology? I mean those emission systems has been below -- you've been kind of below where you once were. When do you see...

Their natural margins are higher and they will work toward that. You may recall, they got hit pretty hard by supply chain shortages, particularly in chips, but not exclusively in chips. They will -- that is behind us now. And as they ramp up on these newer programs, you start off with lower margins, but they'll continue to do better and better. This is a high operating leveraged company.

Got it. So we've talked about, I guess, all of the areas. But I guess we haven't talked about the G700, that sort of is still waiting for certification. I think you have 15 or that you had 15 that were ready to go should -- I mean what can you tell us about the certification?

Well, we're largely done. And we're simply waiting for the FAA to conclude its deliberations. So we're on track. It's just -- that is as we've been quite open, not a process that we control, but we're on a good track here.

Okay. Okay. And so I guess on the fourth quarter call, you were talking about Gulfstream certainly being better '25, '26. Marine, $600 million to $1 billion starting in '25 for a couple of years. Technology is now sounding like it's going to do some pretty good things. Combat looks like it's well positioned through '26. I mean, on paper, it looks like all the major operations are kind of -- have an upward bias through '26. So any major headwinds that we should think about that could disrupt that kind of a run?

Nothing other than the ordinary unexpected geopolitical events and macroeconomic stress. Those are always the 2 factors that impact us. But if you think about it, and for those of you who followed us for many years, we have been investing over the last 5- or 6-year period. Those investments were prudent. They were -- they anticipated the growth that we now see. And capitalizing on those investments is exactly what we're all about right now. It's manifesting itself in the revenue increase, earnings increase, and that's why I am and our leadership team is so focused on margin improvement.

Got it. So I think you had a good cash flow year last year. You're talking about 100% conversion this year and then '25. What are the key drivers there?

So we have good cash flow conversion across almost all of our businesses. The large -- the [ major ] in our current plan, foreseeable investments at the Marine group are largely behind us. There might -- there are likely to be some more given the increase in submarine demand. But we'll work over time with our Navy customer. We fully factored all of that into our 100% conversion. We'll be a very strong converter of cash for the foreseeable future.

Got it. And then, I mean, I've followed you long enough where -- I mean when Nick was there, I was like 100% is like most of the time because you have businesses with high returns on sales, so well managed. So I mean...

It's all about cash. End of the day, it's all about cash, right? Because who here is going to disagree about that, right? They get it better.

So you've got -- finally, you've got the cash, you've got the balance sheet where it's looking pretty good. What do you use it for? I mean, obviously, internal investment as required. But I mean thinking about repurchase, M&A, special dividend, what -- how do you think about how you would deploy it?

So I think our deployment plans are largely unchanged with a bias towards share repurchases given the investments that we've made internally to our business. I don't see the facts and circumstances that would suggest a special dividend. Our Board has always been very engaged in our dividend policy. I have no doubt that they will continue to be, and we just never discuss M&A.

And what about M&A? I mean, you basically ran the M&A shop when Nick was there so...

Well, I shut it -- for those of you who followed us for a while, you know that one of the first things we did when this leadership team took over, was shut down our M&A because a company that had been built on M&A had lost its discipline. We quickly regained that, but have been very prudent. The fundamentals of making money on acquisitions again do not change. There can sometimes be an impetus internal to the business for overpaying for a strategic investment. You hear strategic investment, you ought to run for the doors because all that means is that you're going to overpay. So we've been pretty disciplined about M&A and will remain so.

What about niche fillers? Any sort of areas where you could use your capabilities?

I think we're always looking for small bolt-ons that can be accretive and that can add to our portfolio. But I think you could gather by now, both inference and directly, that we're pretty conservative when it comes to that. Cash is precious and how you deploy that cash is critical.

So I think your fourth quarter was the first time I've heard you mention the word stock repurchase. And I think you've said in the past that you're disinclined to doing an ASR. How should we think about -- when you talk about stock repurchase, you've been opportunistic. How should we think about is this $1 billion? I mean how do we -- how should we think about how big or how important this might be?

I think our position on stock repurchase will be as it always has been. We are very tactical about it, and we repurchased our stock at appropriate intervals. And I think in this environment, that's probably the best we should say. I'm not a big believer in announcing our priority stock repurchases so everybody else can bet against you. I don't get that. So we'll be what we always are is prudent. And I think that, that's a healthy way to be.

Terrific. So I guess to conclude, so when you look at the outlook, it looks pretty good. What do you worry about in terms of -- you mentioned kind of generating the cash and operating, but are there any particular things that you kind of are on your watch list or for you to watch this to sort of make the numbers?

Well, clearly, the supply chain has to continue to stabilize. But some broken record up here, but it's really about our ability to control the costs. And that is what we are as a leadership team going to be focused on. And I think that's how you're going to drive real value creation and enduring value creation, not a particular pop and then how you wisely invest your capital again to drive enduring value. So I think that's our very straightforward, back to basics fundamentals of providing for your customer your on-time deliveries and rewarding your shareholders. So this -- as I step back and look, this is about the best organic growth we have seen in this company probably since the Reagan build up. And this leadership team's focus on its operating performance, I think, ensures -- and disciplined capital deployment ensures that we'll see a nice growth pattern ahead of us and we're pretty excited about it. Not without its challenges, but we are -- we like where we are right now. We like what we see, and it's just about delivering on our promises.

Terrific sounds good to me. Thank you so much. That was great.

Thank you for bringing us.