General Dynamics Corporation (NYSE:GD) Q4 2023 Earnings Call Transcript

General Dynamics Corporation (NYSE:GD) Q4 2023 Earnings Call Transcript January 24, 2024

General Dynamics Corporation misses on earnings expectations. Reported EPS is $3.64 EPS, expectations were $3.73. 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 Fourth Quarter and Full Year 2023 Earnings Conference Call. All participants will be in listen-only mode. After the speakers’ remarks, there will be a question-and-answer session. [Operator instructions] I’d 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 fourth quarter and full year 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 Phebe Novakovic, our Chairman and Chief Executive Officer and Jason Aiken, Executive Vice President, Technologies and Chief Financial Officer. With the introductions complete, I’ll turn the call over to Phebe.

Phebe Novakovic: Thank you, Nicole. Good morning, everyone and thanks for being with us. Earlier this morning, we reported earnings of $3.64 per diluted share on revenue of $11,668,000,000, operating earnings of $1,288,000,000, and net earnings of $1,000,000,000. Revenue is up $817 million, a strong 7.5% against the fourth quarter last year. Operating earnings are up $61 million, and earnings per share are up $0.06, or 1.7%. The year-ago quarter had $52 million more of other net income, which helps explain the more modest earnings per share growth. In short, the quarter-over-quarter results compare quite favourably, particularly revenue and operating earnings. The sequential results are even better. Here, we beat last quarter’s revenue by $1,097,000, a very strong 10.4%, operating earnings by $231 million, or 21.9%, net earnings by $169 million or 20.2%, and EPS by $0.60, a 19.7% improvement.

As we promised that it would be, the final quarter is our strongest of the year in both revenue and earnings. In fact, revenue, earnings per share, operating earnings, and net earnings improved quarter over the previous quarter throughout the year. It was a nice steady progression of sequential improvement. For the full year, we had revenue of $42.3 billion, up 7.3%, and operating earnings of $4.25 billion, up 0.8%, and earnings per fully diluted share of $12.02, down $0.17, a 1.4% decrease, mostly as a result of below-the-line items like other income, which was higher, and the tax provision, which was lower in 2022. The fourth quarter in the year are $0.04 and $0.09 respectively, below consensus. It is important to note that consensus lowered during the two weeks before this earnings release, as the sell side became aware of Gulfstream’s deliveries from public sources.

This miss was exclusively because the G700 did not certify before year end. As a result, Gulfstream was unable to deliver 15 G700s as we and the sell side had anticipated. I will have more to say about this in my segment remarks. While we miss consensus and our own expectations for reasons beyond our control, it should not distract from an otherwise good quarter and year. Let me ask Jason to provide some detail on our strong cash performance for the quarter and the year, overall order activity, and backlog, and any other items you might like to address.

Jason Aiken: Thank you, Phoebe, and good morning. Order activity and backlog were a strong story for us in 2023. We finished the year with total backlog of $93.6 billion, up $2.5 billion over last year. Total estimated contract value, which includes options and IDIQ contracts, was nearly $132 billion. In terms of orders, the aerospace segment led the way with a 1.2 to 1 book-to-bill ratio in both the fourth quarter and full year, and they ended the year with total backlog of $20.5 billion. The defense segments had a book-to-bill of 0.7 times in the fourth quarter and one-to-one for the full year. Overall, the company had a book-to-bill of 1.1 times for the year, and all four segments were one-to-one or better. Turning to our cash performance, it was another strong quarter with operating cash flow of $1.2 billion, which brings us to $4.7 billion of operating cash flow for the year.

As discussed on previous calls, this level of cash flow was achieved on the strength of Gulfstream orders, additional payments on Combat Systems international programs, and continued strong cash performance in technologies. After capital expenditures, our free cash flow for the year was $3.8 billion, a cash conversion rate of 115%. This was nicely ahead of our anticipated cash flow for the year, notwithstanding the delayed certification and entry into service of the G700. Looking at capital deployment, capital expenditures, as I noted on the last call, were higher in the fourth quarter at $304 million, which brings us to $904 million for the full year. The lion’s share of these investments are of course, in our shipyards to support the Navy’s submarine and shipbuilding plan.

At 2.1% of sales, full year capital expenditures were a little lower than our original expectation due to timing, so some of that naturally pushes into next year. As a result, we expect CapEx to be between 2% and 2.5% of sales next year and closer to 2% thereafter. We also paid $360 million in dividends in the fourth quarter, bringing the full year to $1.4 billion. There were no shares repurchased in the quarter, so we finished the year with two million shares repurchased for $434 million at $215 per share. With respect to our pension plans, we contributed $106 million in 2023, which included a modest voluntary contribution to one of our commercial plans, and we expect to contribute approximately $75 million in 2024. After all this, we ended the year with a cash balance of $1.9 billion and a net debt position of $7.3 billion, down approximately $1.9 billion, more than 20% from last year.

We have $500 million of debt maturing in 2024. Our net interest expense in the fourth quarter was $78 million, bringing interest expense for the full year to $343 million. That compares to $85 million and $364 million in the respective 2022 periods. We expect interest expense in 2024 to continue to decrease to around $320 million. Turning to income taxes, we had an 18.1% effective tax rate in the fourth quarter, which brings our full year rate to 16.8%, slightly below, but generally in line with our guidance. Looking ahead to 2024, we expect the full year effective tax rate to increase to around 17.5%, reflecting higher taxes on foreign earnings. That concludes this portion of my remarks, and I’ll turn it back over to Phebe for segment comments.

Phebe Novakovic: Thanks, Jason. First, aerospace; the story in aerospace is found in sequential and year-over-year improvement, continuing strong demand for Gulfstream aircraft, the overall strength of Gulfstream service business, and the continuing growth of jet aviation. In the quarter, aerospace had revenue of $2.74 billion and earnings of $449 million. This represents a 12% increase in revenue and a 33% increase in earnings on a quarter-over-quarter basis. The sequential numbers are even stronger, with a 35% increase in revenue coupled with a staggering 68% increase in operating earnings. The important point here is the dramatic increase in the delivery of in-service airplanes in the quarter, 39 versus 27 in the third quarter of 2023.

A strong mix favoring large aircraft, strong pricing in the backlog, better overhead absorption, and improved supply chain response, leading to less out-of-station work, all contributed to a 16.4% margin in the quarter. For the full year, revenue of $8.62 billion is up only $54 million from the prior year, and operating earnings of $1.18 billion, improved by $52 million on a 50-basis point improvement in operating margin. Nevertheless, aerospace revenue and earnings are less than we anticipated for the quarter in the year because, as I mentioned earlier, we did not receive the certification of G700 in the fourth quarter and did not deliver 15 aircraft we had ready to go. That deprived us of slightly over a billion dollars of revenue and close to $250 million in earnings.

These, of course, are orders of magnitude figures. We were also unable during the course of the year to increase production of in-service aircraft as planned because of well-known supply chain issues that began to resolve in the fourth quarter. So, where are we in our journey toward G700 certification? We are almost complete with the final technical inspection authorization. FAA function and reliability flight testing is almost done, and almost all of the paperwork associated with the process has been submitted. In the meantime, we are asking customers to schedule their pre-delivery inspections contemplating delivery this quarter. All that having been said, let me turn to the demand environment. The book-to-bill was 1.2 times in the quarter and 1.2 times for the year.

Backlog increased $395 million sequentially and $938 million for the year. So, aerospace demand remained strong for both aircraft and services at Gulfstream and jet aviation. I should add that strong order intake was interrupted for a two- to three-week period twice during the year, once for a macroeconomic event and the second for a geopolitical event. I refer to the regional bank failures earlier in the year and the conflict initiated by the Hamas attack on Israel and the resultant conflict in Gaza. In each case, order intake resumed after a brief pause. As we go into the New Year, the sales pipeline remained strong and sales activity is at a solid pace. Aerospace backlog is up 72% since the first quarter of 2021 when we first detected a measurable uptake in order activity.

In summary, aerospace results are in line with our original forecast, excluding the G700 certification delay. We look forward to a significant increase in deliveries in 2024 and improved operating margin, but I’ll say more about this as we get to guidance. We also expect continued growth and margin improvement at Jet Aviation to perform well in the year. Next, combat systems. Revenue in the quarter of $2.36 billion is up 8.5% from the year-ago quarter. Operating earnings of $351 million are up 5.7% on a 40-basis point decrease in operating margin, but still a very good 14.8%. The majority of the growth in the quarter was at ordnance and tactical systems and European land systems. It was largely driven by higher artillery and propellant volume, including programs to expand production volume, higher volume of piranhas, bridges and eagles in Europe, and new international tank programs.

Not surprisingly, the sequential comparisons are even better. Revenue is up $140 million or 6.3% and earnings are up $51 million or 17% on the strength of 130 basis point improvement in margins. From an order perspective, combat had a very good year with a 1.1 times book-to-bill, driven by very strong international demand for the Abrams main battle tank, growing demand on the munitions side of the business, and particular strength in Europe. By the way, combat’s performance for the year significantly outperformed our expectations. 2023 revenue was up 13% against a flat forecast provided earlier in the year. Operating earnings are up $72 million or 6.7%, with operating margin at 13.9% for the year. In short, this group had a wonderful quarter and a year with strong revenue growth, strong margin performance, good order activity, and a strong pipeline of opportunity as we go forward.

Turning to marine, the powerful marine system’s growth story continues. Fourth quarter revenue of $3,408,000,000 is up 14.8% over the year ago quarter. Revenue is also up 13.5% sequentially, and 12.9% for the year. This was driven by Columbia class construction and engineering volume, TAO volume, and service contracts at bat. Operating earnings are down 8.4% over the year ago quarter on a 160 basis point reduction in operating margin attributable to EAC rate decreases at electric boats. These rate decreases similarly impact the sequential and annual comparison with respect to operating earnings. The EAC decreases were primarily driven by two factors, later than promised material to EB [ph], which drove additional out of station work at EB, and quality problems from several vendors.

On the positive side, we are continuing to work with the Navy and the Congress to help further stabilize the supply chain with additional funding for work. We are also working with certain suppliers to set up process improvements where we can. EB also needs to continue to improve its productivity to help offset some of the financial impacts from the supply chain. Marine Systems had a one-time book-to-bill for the year, a good result for a group of shipyards that began the year with a total backlog of nearly $46 billion. Jason will now give you some color on the Technologies group for which he has responsibility, and then I’ll return for our outlook for 2024.

Jason Aiken: The Technologies group had a solid quarter and a very strong year. Revenue in the quarter of $3.2 billion was down 3.1% compared with the prior year, while operating earnings of $305 million were down 10.3% versus the fourth quarter of 2022. For the year, however, the group’s revenue of $12.9 billion was up 3.4%, with both businesses experiencing nice growth. The results exceeded our expectations on strong demand for the group’s products and services. GDIT fared particularly well with increased volume across each of its customer-facing segments; defense, intel, and federal civilian. Operating earnings of $1.2 billion were down by 2% versus the prior year on a 50-basis point contraction in operating margin to 9.3%, and that’s solely a function of the revenue mix as IT services grew faster than the defense electronics portfolio.

Turning back to the quarterly performance, to break it down between the two businesses, GDIT’s revenue was up in all four quarters compared with 2022, and they’ve now grown their top line in each of the past three years. The same is true for mission systems’ quarterly revenue performance, with the exception of the fourth quarter. If you recall, last year’s fourth quarter saw us break through a logjam in the supply chain and deliver an unusually high number of products, lifting both revenue and margins. Barring that anomaly in 2022, the group’s comparisons on a quarterly and full-year basis are quite favorable. With respect to order activity and backlog, the technologies group had a very good year, notwithstanding the continuing trend of customer solicitations pushing to the right and recurring award protests.

The individual businesses and the group as a whole achieved a one-to-one book-to-bill on solid revenue growth. GDIT received awards totalling $13.5 billion, far exceeding their previous annual record set the year before. They’ve got another $15 billion in awards pending adjudication and just shy of $2 billion in awards under protest. Mission systems had a great year as well, with a total value of submitted bids almost triple the level they saw in 2022. Of course, many of the group’s awards come in the form of IDIQ contracts with potential value that doesn’t initially hit the backlog. So much of these positive results will continue to manifest in the reported numbers over time. To that point, we ended the quarter with a total estimated contract value for the group of nearly $41 billion, and the group’s combined qualified pipeline exceeds $130 billion; so all in all, a great year for the technologies group.

Phebe Novakovic: So let me provide our operating forecast for 2024 with some color around our outlook for each business group and then the company-wide roll-up. In 2024, we expect aerospace revenue of about $12 billion, up around 40% over 2023. Operating margin is expected to be up 130 basis points to 15%. Gulfstream deliveries will be around 160, materially over the 111 delivered in 2023. This is about 10 fewer deliveries than we anticipated in the multiyear forecast we gave you in January of ’22. The mix will include about 50 G700 deliveries and fewer G280s as a result of the Gaza conflict’s impact on our Israel-based supplier. As I just noted, we anticipate a 15% operating margin for the year, weaker in the first half, particularly in the second quarter, and then well over 15% in the third and fourth quarters.

While the ramp-up is slightly less than previously anticipated, it is not without supply chain challenges. In combat systems at this time last year, we had anticipated revenue to be flat in ’23. With a changed threat environment, we had a 13% increase in revenue. For ’24, we expect revenue to be up about 3% to $8.5 billion, coupled with a 50 basis point improvement in operating margin to 14.4%. The outlook is the result of the strong order activity we saw in ’23 and the demand signals we see in Europe. To the extent that these demand signals start to convert into order activity, we could see some opportunity for additional revenue later in the year, particularly in our armaments and munitions business. As I noted earlier, the Marine group has been on a remarkable growth journey.

In 2023, revenue came in much stronger than expected, almost $1.6 billion against a flattish forecast. Our outlook for this year anticipates revenue of about $12.8 billion, with operating margin improvement to 7.6%, which should result in a meaningful improvement in earnings in 2024. In technologies, 2023 revenue was stronger than anticipated in both businesses. 2024 revenue is expected to be up about 1% to $13 billion. Within the group, GDIT will be up low single digits, emissions systems will be down slightly due to a transition from legacy systems and a slow ramp up on new programs. Operating margins are expected to improve 20 basis points to about 9.5%. We see long term low single digit growth for the group and continued industry leading margins.

So for 2024 company wide, we expect to see revenue of approximately $46.3 billion to $46.4 billion, an increase of around 9.5%. We anticipate operating margin of 11% up 100 basis points from 2023. All this rolls up to an EPS forecast of around $14.40. A reasonable range would be $14.35 billion to $14.45 billion. On a quarterly basis, the first two quarters look a lot alike with very strong third and fourth quarters. In summary, as we go into this year, we feel very good about the demand environment across all of our businesses. It has been some time since I have seen stronger demand signals and better promise of organic growth. We also have some very good opportunities across the business to improve operating margins. All we must do is execute.

It almost goes without saying that we will be laser focused on operations. Nicole, back to you.

Nicole Shelton: Thanks, 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?

Operator: [Operator instructions] We will take our first question from Myles Walton at Wolfe Research.

Myles Walton: Thanks. Good morning. Phebe, I was hoping you could touch on the 700, not a surprise. How many do you have ready for pre-delivery inspection from your customers and also, relative to confidence of when the deliveries could take place, I mean, this is pretty much out of your control. The FAA has published a few rules last week that are pending and have to go through their process. I’m just curious, your confidence level for first quarter delivery versus, say, where you were in the fourth quarter expecting deliveries by year end? Thanks.

See also Dividend Challengers List Ranked By Yield: Top 30 and 15 Best Places in Washington State for a Couple To Live on Only Social Security.

Q&A Session

Phebe Novakovic: So we have 15 airplanes ready to go and the hope is that we deliver them this quarter. The notifications that Gulfstream made earlier, I guess, this week, are in the regular order and really have no material impact on the certification process. I tried to give you as much clarity as I could around the certification and where we are.

Myles Walton: Is there an 800 delivery assumed in the guidance for ’24?

Phebe Novakovic: So we’re not going to go into what we’ve assumed for any given airplane in our guidance. So let me give you guys some perspective about this. For the last about eight years, we’ve tried to give you some clarity about a process over which we have no control and it’s kind of like sticking your fingers in a light socket to predict a process that we just don’t control. So I think we’re going to be silent as we go forward about any specificity around certification timing because then we hear words like slip and miss and these planes are going to get certified, but get certified on the FAA schedule.

Myles Walton: All right. Thank you.

Operator: We’ll move next to Ron Epstein at Bank of America.

Ron Epstein: Hey, good morning, Phebe and Jason. Maybe just circling back on your remarks, Phebe, around EB, but maybe more broadly, just kind of the ship industrial base, the DOD has been making some big investments. Now, where do you see Virginia-class build rates ultimately getting, Columbia, too, because it just seems like the supply chain and maybe just also from just a capacity perspective, we’re just under-capacitized. So, any thoughts on that?

Phebe Novakovic: So let’s step back a minute and talk a little bit about the shipbuilding industrial base in general and the submarine industrial base in particular. These are very heavily manpower-driven businesses and industry and an entire supply chain and manpower availability was impacted significantly as a result of COVID in two respects. First, we had a really stunning increase in the timing and the number of retirements of seasoned workers throughout the industrial base. That, coupled with the post-COVID labor shortages, caused considerable perturbation in the supply chain. Those will begin to remedy. We’ve already seen some stabilization in the labor market. Those won’t remedy, but there’s clearly learning that has to happen throughout the supply chain.

I’d say with respect to capacity, at Electric Boat, we are nicely sufficient capacity at the moment to deal with the demand that we have — we see at the moment, but should that demand signal increase in the near term, we’ll work closely with our Navy customer. I think key to the stabilization of the supply chain is improved delivery and improved quality and that happens as new workers come down their learning curves. We’ve benefited from Electric Boat because they have a very robust training system in which our new workers come out at a higher level of proficiency, but still they need to come down their learning curves and they’re doing so nicely. I think to add a little bit of perspective to that, Electric Boat, we increased our velocity and throughput on Virginia by about 10% this year in ‘24% and about 30% on Columbia.

So Electric Boat is continuing to do well. They just need to continue to improve their productivity, so we can continue to offset some of these financial impacts that we’re seeing from the supply chain. But I would finally mention the Navy has been a very good partner in recognizing these challenges and working hard to get orders and certainty of demand into the supply chain and that helps the entire supply chain plan.

Ron Epstein: Got it. And maybe just one quick follow-on. Are we capacitized enough to meet the demand that AUKUS would require, having an extra Virginia class every three years?

Phebe Novakovic: So I think we’re going to look at all of that with the Navy, but let me tell you, the best thing we can do for AUKUS in the moment is get back to two-a-year production. That’s one step at a time.

Operator: We’ll take our next question from Jason Gursky at Citigroup.

Jason Gursky: I was wondering if you could talk a little bit about the G400 and how that plane seems to be performing from a market acceptance perspective and kind of the pipeline that you’re seeing for that aircraft. I’m just kind of curious how that segment of your market is shaping up there as we come into the New Year.

Phebe Novakovic: So the plane is performing very nicely in excess of the design parameters. We see considerable interest in that end of the market and so we are quite positive about that airplane when it enters into service.

Jason Gursky: Okay, great. And then your comments on combat and the potential for some orders converting into revenue coming out of Europe in the second half of the year, that doesn’t sound like it’s implied in your guidance, but I’m just kind of curious that how far into the year can we go to get those orders and actually convert them into revenue?

Phebe Novakovic: Well, it depends on what the orders are for. On faster transaction material like service and munitions, they can move a little more quickly. Longer lead orders on combat vehicles take a little bit longer. So we factored to the best of our ability the known demand signals and the velocity of contracting into our plan. So the extent that there is upside, it’ll be I think largely on the armament munition programs that execute at a faster rate and to the extent that we can speed up even further the installation of additional jigs and fixtures for productivity as well as our increased scope on delivery of munitions, that should help as well. But we think we had — look in all cases, we give you a very balanced I’d say, 50-50 plan with opportunities and risks and we’re quite comfortable with the estimates that we’ve given you at the time.