General Dynamics Corporation (NYSE:GD) Q1 2024 Earnings Call Transcript

General Dynamics Corporation (NYSE:GD) Q1 2024 Earnings Call Transcript April 24, 2024

General Dynamics Corporation misses on earnings expectations. Reported EPS is $2.88 EPS, expectations were $2.95. GD isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. And welcome to the General Dynamics First Quarter 2024 Earnings Conference Call. All participants will be in a listen-only mode and after the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] Please note this event is being recorded 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 first quarter 2024 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 slides that accompany this webcast, which are available on the Investor Relations page of our website, investorrelations.gd.com. On the call today are Phebe Novakovic, our Chairman and Chief Executive Officer; and Kim Kuryea, Chief Financial Officer. I will now turn the call over to Phebe.

Phebe Novakovic: Thank you, Nicole. Good morning, everyone, and thanks for being with us. As you can discern from our press release, we reported earnings of $2.88 per diluted share on revenue of $10.7 billion, operating earnings of $1,036 million and net earnings of $799 million. These results compare quite favorably to the year ago quarter. Revenue is up 8.6% against the first quarter last year. Operating earnings are up 10.4%. Net earnings are up 9.5%. As a result, earnings per diluted share are up $0.24 or 9.1%, more than the year ago quarter. The operating margin for the entire company was 9.7%, a 20-basis-point improvement over the year ago quarter. Overall, these numbers represent a very strong quarter and a good start to 2024.

However, we fell below our own expectations for the quarter and below analyst consensus, which is predicated, at least in part, on our forecast. The rather obvious explanation is that we forecast 15 to 17 G700 deliveries in the quarter, which did not happen. We received FAA Certification for the G700 at the very end of the quarter, too late to make any G700 deliveries. This obviously impacted revenue and earnings in the Aerospace group in the quarter. The good news is that we now have certification, and the delay in deliveries does not change our outlook for the year. Gulfstream still plans to deliver 50 to 52 G700s this year, so our Aerospace forecast for the year remains unchanged. I’ll give you a little more color on this later in my remarks.

And other good news, as you can see, was strong performance across the defense portfolio. In short, we performed very well in the quarter over those things within our control. At this point, let me ask Kim Kuryea, our CFO, to provide details on our order activity, solid backlog and cash activity, before I come back with segment observations.

Kim Kuryea: Thank you, Phebe, and good morning. I’ll start with orders and backlog. We had a solid quarter from an orders perspective, with an overall book-to-bill ratio of 1 to 1 for the company. Order activity was particularly strong in the Combat Systems group, with a book-to-bill of 1.6 to 1, and in the Aerospace and Technology segments, which each had a book-to-bill of 1.2 to 1. We ended the quarter with total backlog of $93.7 billion, up slightly from year-end and up 4% from a year ago. Our total estimated contract value, which includes options and IDIQ contracts, ended the quarter at approximately $134 billion, up 1.5% from year-end. Turning to our cash performance for the quarter, we had an expected slow start to the year, absent the delayed certification and entry into service of the G700 and continued G700 inventory build.

So let’s start with Technologies. We continued to see strong cash performance from that group in the quarter. As anticipated, Combat Systems and Marine Systems both built working capital in the quarter, based on their unique mix of contract timing versus expected payments. Finally, moving to Aerospace, the lack of G700 deliveries drove us to use cash in the quarter. As a result, our free cash flow for the quarter was a negative $437 million. Since all of what I described is timing-related, we still have an expectation for the year of a cash conversion rate around 100%. We expect most of the negative free cash flow to reverse in the second quarter, followed by substantially improving free cash flow in each of the third and fourth quarters.

Now to discuss our capital deployment activities. Capital expenditures were $159 million or 1.5% of sales in the quarter. Similar to last year, you should expect capital expenditures to increase in subsequent quarters throughout the year, as we anticipate spending between 2% and 2.5% of revenue on CapEx this year. Over 50% of that expected spend will be for infrastructure at our three shipyards, as we continue to invest to support the Navy’s submarine and shipbuilding plan. Also in the quarter, we paid $361 million in dividends and repurchased approximately 390,000 shares of stock for $105 million at just under $269 per share. When you add it all up, we ended the quarter with a cash balance of around $1 billion and a net debt position of $8.2 billion.

Our net interest expense in the quarter was $82 million, compared with $91 million for the same quarter last year. The reduction in interest expense was attributed to our lower debt balances. Finally, turning to income taxes, we had a 17.5% effective tax rate in the quarter, right in line with our full year guidance, which reflects higher taxes on foreign earnings. Phebe, that concludes my remarks. I’ll turn it back over to you.

Phebe Novakovic: Thanks, Kim. Now let me review the quarter in the context of the business segments and provide detailed color as appropriate, first, Aerospace. Aerospace did very well in the absence of the G700 delivery. It had revenue of $2.1 billion and operating earnings of $255 million with a 12.2% operating margin. Revenue is $192 million more than last year’s first quarter, a 10.1% increase. To give you a little detail here, the increase was driven by an increase in new aircraft deliveries and an increase in services at both Gulfstream and Jet Aviation, partially offset by significantly lower special mission aircraft activity, which is always lumpy. The 24 deliveries in the quarter are fewer than planned, but three more than the year ago quarter.

The mix in the quarter favored large cabin and the 650 in particular, which helped both revenue and earnings. Operating earnings of $255 million are up $26 million over last year’s first quarter, an 11.4% increase. Earnings on both new aircraft and aircraft services enjoyed good increases, offset in part by lower earnings on special mission, higher G&A and net R&D. While Gulfstream will continue to experience part shortages that cause significant out-of-station work, which is inherently less efficient, the supply chain is clearly improving and much more predictable. As is now apparent, we plan to deliver a considerable number of G700s in 2024. The first 20 to be delivered are fully built and deliveries have begun. By the end of this month, the next seven to eight will be ready.

We plan to deliver these 50 to 52 planes over the quarters in relatively even numbers with improving margins quarter-over-quarter as we go along. The first 20, what we call the lot one, carries some cost and retrofit burden that will not affect subsequent aircraft deliveries. So expect margins in the second quarter to be similar to the first quarter with significant improvement in Q3 and Q4. Aerospace had a decent quarter from an orders perspective with a book-to-bill of 1.2 to 1 in dollar terms. Sales activity and customer interest is evident this quarter, but concerns over persistent inflation and monetary policy in the U.S., together with concerns about conflict in the Middle East, has slowed the consummation of transactions to some degree.

It is also worth noting that a significant portion of the demand we see is fleet replenishment for corporations. These multi-aircraft deals usually proceed at a slower pace. The G800 flight test and certification program continues to progress well. The aircraft design, manufacturing and the overall program are very mature. We continue to target certification of G800 for nine months after the G700 certification, although I’m increasingly reluctant to give estimates about these things that are ultimately out of our control. In short, the Aerospace team had a good quarter. G700 FAA certification is in the rearview mirror and we hope EASA certification is hard on its heels and we expect nicely improving margins, particularly in the second half.

Next, Combat Systems. Combat had revenue of $2.1 billion, up almost 20% over the year ago quarter. Earnings of $282 million are up 15.1%. Margins at 13.4% are down 60 basis points over the year ago quarter. It is interesting to observe that this very strong increase in revenue is in comparison to last year’s first quarter, which enjoyed a 5% increase over 2022. We saw increased revenue performance in each of the three businesses. The increase came from higher volume on new international tank programs, higher artillery program volume and higher volume on piranha programs and bridges. We also experienced very strong order performance. Orders in the quarter drove total backlog to $15.6 billion, up $1.5 billion from this time the year ago quarter.

Demand for Combat Systems and products continues to increase, particularly in Europe and in some lines of business in the U.S. Orders for wheeled and tracked combat vehicles are up significantly, reflecting the heightened threat environment. In addition to several new combat vehicle starts, demand for Abrams also continues. We’ve seen tank orders from new users and a number of countries will be introducing Abrams into their combat fleets for the first time. Since Q1 last year, we have received almost $1 billion in orders from both U.S. allies through FMS and the U.S. Army. In the U.S., we are rapidly increasing ammunition production with the opening of our Texas facility, which will increase current 155-millimeter ammo capacity by 83%. As the year goes on, we will continue to work with our Army customer to further increase ammo capacity to meet their requirements.

Turning to Marine Systems, once again, our shipbuilding units are demonstrating impressive revenue growth. Let me repeat the recent history that I gave you last year at this time with respect to growth in this decade. The first quarter of 2020 was up 9.1% against Q1 of 2019, Q1 2021 was up 10.6% over Q1 2020, Q1 2022 was up 6.8% over Q1 2021 and Q1 2023 was up 12.9% over Q1 2022. Finally, this quarter at $3.3 billion is up 11.3% over Q1 2023. This is an impressive growth ramp by any standard. However, growth ramps of this character bring with them supply chain and operation issues that are challenging. This particular quarter’s growth was almost exclusively Columbia-class construction. Operating earnings are $232 million in the quarter, up 10% from the year ago quarter.

Operating margin is basically the same as last year’s quarter. We anticipate that this will improve as we progress through the year. As we have talked about on previous calls, the story at the Marine Group is efficiently managing the growth propelled by the U.S. Navy’s need for ships, particularly submarines. As a labor-intensive heavy manufacturing industry, the shipbuilding industrial base was hit hard by the demographic impacts of COVID. This, coupled with a number of sole-source suppliers of highly complex components, has made it difficult for the industrial base to keep pace with increasing demand. The significant financial investments we have made in our shipyards over the last 12 years, particularly at Electric Boat, has mitigated the impact on us, but we are still hit by schedule and quality problems in the supply chain.

Our job is to minimize the efficiency and schedule impacts of late material by increasing our throughput and we are doing that each and every quarter. In Q1 alone, our productivity increased 11%, but there is more to do. Finally, the Navy’s investment in the supply chain has helped and will continue to help as we move forward. For Technologies, we’re off to a solid start. Revenue in the quarter of $3.2 billion is down less than 1% from the prior year, but up 2% over the fourth quarter of last year and modestly ahead of our expectations for the start of the year. Operating earnings of $295 million are consistent with last year, yielding a margin of 9.2%. As we have previously discussed, margins will continue to be driven by the mix of IT service activity and hardware volume.

The group received $4 billion in orders during the quarter for a book-to-bill ratio of 1.2 to 1. Both businesses experienced strong order activity, in GDIT’s case the highest book-to-bill since mid-2019. This led to a total backlog of $13.5 billion, an increase of over 5% from a year ago and total estimated contract value of $42.7 billion. The story in Technologies is one of steady growth, particularly at GDIT and increasingly at mission systems as they transition from legacy programs to new programs and faster growth lines of business. Both businesses have robust pipelines driven by their respective investments in different technologies. The group’s continual focus on margin performance will result in sequential margin expansion throughout the year as they continue to build their backlog and growth.

As you know, we never update guidance at this time of year. Apart from what I have already said about Aerospace, I will stick to that custom. We do, however, confirm the guidance we gave you at the end of last quarter and will update it at midpoint of the year as we typically do. This concludes my remarks with respect to what was, in many respects, a rewarding quarter. Let me now turn the call back to Nicole to take your questions.

Nicole Shelton: Thank you, Phebe. 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 10 Fastest Growing Cities in Kentucky and 12 Most Shorted Stocks in 2024.

Q&A Session

Operator: And thank you. [Operator Instructions] And your first question comes from Scott Deuschle with Deutsche Bank. Your line is open.

Scott Deuschle: Hey. Good morning.

Phebe Novakovic: Good morning.

Scott Deuschle: Kim, can you clarify the G700 delivery expectation for the second quarter? Is it the 20 that are ready to go plus the seven to eight that will be ready at the end of this month?

Phebe Novakovic: So, let me kind of tackle that. I alluded to it in my opening statement. But we are — we have 50 to 52 airplanes that are going to deliver in about equal amounts of the 700 in the second through the fourth quarters. So think about it that way. So I think that will help you.

Scott Deuschle: Okay. Thank you. And then, Phebe, I was hoping you could spend a moment maybe talking about the growth that Combat Systems is currently seeing in Europe, and perhaps, how you expect that to trend over the coming quarters? Thank you.

Phebe Novakovic: So the growth in Europe is clearly driven by the threat environment. We’ve seen increases in orders for combat wheeled and tracked vehicles and significant bridge orders. We’re also seeing increased orders coming out of various countries in Europe for Abrams through the FMS process. So we see that demand signal continuing until the threat environment, frankly, improves.

Operator: And we will take our next question from Seth Seifman with JPMorgan. Your line is open.

Phebe Novakovic: Good morning, Seth.

Seth Seifman: Good morning. Thanks very much. Looking to Marine, when we think about the expectation for the profit margin for the year and kind of where we started, are there kind of visible milestones that you see through the remainder of the year that bring that number higher or kind of is it a change in mix or kind of what drives the underlying margin improvement through the year?

Phebe Novakovic: So two things. One is the increase in productivity at each of the shipyards and we see that and we’ve been seeing that for the last few quarters, and it’s also fewer disruptions from the supply chain. So those are the two primary factors.

Seth Seifman: All right. Okay. Okay. Great. And then just when we think about it, I think, you mentioned some of the headwinds to demand at Gulfstream from here in terms of monetary policy, geopolitical issues. Just to kind of affirm, the expectation for 160 deliveries this year and the way that the backlog will trend through the year, the expectation is that that’s a very sustainable number with potential for that to grow in the years beyond?

Phebe Novakovic: So let me clarify a bit. There are — I don’t see concerns about inflation or monetary policy impacting demand. It really is just impacting the time from the initiation of a potential interest to the closure of an order, which is also impacted somewhat by large fleet — airplane fleet orders from corporate customers. So, think about it that way, more of a timing issue with the completion of the deals and not ness — and not a headwind to overall demand. So I think that’s an important nuance and we’re still sticking to our delivery guidance for the year. And I think, on a going forward basis, we — as we’ve intimated before, we see that those deliveries increasing over time.

Operator: And we will take our next question from Robert Stallard with Vertical Research. Your line is open.

Robert Stallard: Thanks so much. Good morning.

Phebe Novakovic: Good morning.

Robert Stallard: Phebe, I was wondering if you could comment on the recently passed or soon to be signed supplemental and what implications that could have for the Combat business, but also on the submarine side, what sort of additional funding could come from the U.S. Navy? Thank you.

Phebe Novakovic: So let me take them in the inverse order. On the submarine side, the preponderance of the funding in the supplemental is to help stabilize the industrial base, ensuring that we continue to drive order activity on a consistent and repeatable basis. So that is really on the submarine side. In Combat, I think, you can see there’s a fair amount of ammo funding and we had fully anticipated that.

Robert Stallard: Okay. And then just secondly, I was wondering if you could give us an update on the AJAX program in the U.K.?

Phebe Novakovic: So it is proceeding extremely well through test and continue to work with that customer, but they’re very pleased with the performance of the vehicle.

Robert Stallard: Okay. That’s great. Thank you very much.

Operator: And we will take our next question from Sheila Kahyaoglu with Jefferies. Your line is open.

Sheila Kahyaoglu: Good morning, Phebe. Thanks for the…

Phebe Novakovic: Hi, Sheila.

Sheila Kahyaoglu: Thank you for the time. I wanted to ask one about Aerospace, and I’m sorry for putting you on the spot with the mental math, but last year or last quarter, you talked about the G700 profit contribution being around 25%. So when we think about the Q1 performance, it was actually really good relative to our number of 12.1% margins. It would imply you see a deceleration in the underlying business for Aerospace, just given G700 comes in at 50 units. So I guess how do we think about the mixed movement throughout the year for Aerospace?

Phebe Novakovic: Well, let’s talk about the first predicate in that question. I don’t believe we’ve ever disclosed any margin on a particular airplane and we haven’t there. I think we can’t take and discern revenue and earnings in any given quarter as attributable to one airplane. So I think you need to think about it holistically. But we see the — we don’t see any real changes in the mix throughout the year and we’ll do a detailed bottom-up review in Q2. But for right now, we’re sticking with both our mix, our earnings, our margin and revenue expectations. So we’re off to a pretty good start, I’d say, and we’re very encouraged at how the outlook looks for the rest of the year.

Sheila Kahyaoglu: Can we assume that G700 is accretive to the 15% full year guidance?

Phebe Novakovic: So think about it this way. This is ultimately going to be a very profitable program. But as I explained in my remarks, the first lot, 20 or so, carries with it additional costs. We’ll see those largely in Q2. So think about Q2 as an increase in revenue of about $1 billion to $1.1 billion and in earnings of about $100 million to $110 million, and then progress nicely thereafter. And again, that’s all impacted by the multiplicity of factors in our Aerospace business that drive margins.