Good morning, and welcome to the General Dynamics’ Second Quarter 2019 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Howard Rubel, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Rocco, and good morning, everyone. Welcome to the General Dynamics second quarter 2019 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 and 10-Q filings. With that, it’s my pleasure to turn the call over to our Chairman and Chief Executive Officer, Phebe Novakovic.

Thank you, Howard, and good morning, everyone. As you can discern from our press release, we enjoyed a very good second quarter with revenue of $9.56 billion and net earnings of $806 million. We reported EPS at $2.77 per diluted share, $0.15 a share better than the year-ago quarter and $0.09 per share better than consensus. Compared to the year ago quarter, revenue was up $369 million or 4%. This is as reported, but organic growth was higher after taking into account the effect of divestitures at GDIT and the acquisition of Hawker Pacific. Remember that divestitures at GDIT provided some of more than $250 million per quarter in revenue. Net earnings of $806 million were up $20 million or 2.5% on a modest improvement of operating earnings and a lower effective tax rate, offset in part by higher interest expense. Sequentially, revenue was up $294 million or 3.2% and operating earnings were up $76 million or 7.5% on higher operating margins. With respect to consensus, revenue in the quarter was about $200 million more and the operating margin rate was 10 basis points higher than forecasted by the sell side. In short, $0.08 of the $0.09 beat was provided by stronger operating earnings. Let me turn very briefly to the first half of 2019 compared to the first half of 2018. Revenue was up $2.1 billion or 12.5% against the first half of 2018 driven by strong organic growth plus the acquisition of CSRA at the beginning of the second quarter last year. In other words, CSRA revenue was not reflected in the first quarter's results last year. On the other hand, operating earnings were up only $8 million, burdened by the amortization related to the CSRA acquisition. EPS was $0.06 better. In short, we had a very good second quarter, good sequential improvement, and a good first half. We are somewhat ahead of both our internal operating plan and external expectations. So, let me give you some perspective on the segment reporting for the quarter and for the half. I'll then ask Jason for some comments before I give you some insight into our outlook for the business and each segment for the remainder of the year.

Thank you, Phebe, and good morning. Our net interest expense in the quarter was $119 million versus $103 million in the second quarter of 2018. That brings the interest expense for the first half of the year to $236 million versus $130 million for the same period last year. The increase in 2019 is due to the debt we issued to finance the acquisition of CSRA. We're also carrying more commercial paper than anticipated due to delayed payments related to one of our large international vehicle programs in Canada. At this point we expect the interest expense for 2019 to be approximately $460 million. Our cash from operations of $291 million in the quarter was also impacted by these payment delays. As we've discussed previously this is a timing item. With respect to the outstanding receivable balance, we were recently told by the customer that we will receive considerable funding next month. We continue to expect to resolve the balance of the arrears by the end of the year. Assuming these outstanding payments come in this year, we still expect full year free cash flow conversion will be well in excess of 100% of net income. On the capital deployment front, capital expenditures were $181 million in the quarter or approximately 2% of revenues. Assuming receipt of the outstanding payments I just noted consistent with the timing I described, we still expect our capital expenditures to reach approximately 3% of revenues for the year, reflecting the investment in our shipyards to support the significant growth that's on the horizon. Our effective tax rate in the quarter was 18%, bringing the rate for the first half to 18.3% consistent with our expectations for the full year. In the quarter, we paid $295 million in dividends and we spent approximately $100 million…

Thanks Jason. So, turning to our outlook for the year. Let me provide our forecasts for the year for each segment compared to what we told you in January and then wrap it into our EPS guidance. For Aerospace, our guidance was to expect revenue of $9.7 billion, up $1.2 billion from 2018; operating earnings around $1.5 billion; and an operating margin around 15.5%. We now expect revenue of $9.95 billion with earnings of $1.525 billion with an operating margin of 15.3%. The increased revenue comes largely from increased preowned sales and modest mix shift. Earnings will be up on improved operating performance, but the margin rate will be diluted by preowned aircraft sales. For Combat Systems, our previous guidance was to expect revenue of $6.5 billion to $6.6 billion, up $260 million to $360 million from 2018 with operating earnings in the range of $965 million to $975 million. We now expect revenue of $6.8 billion and operating earnings of approximately $1 billion. The more revenues drives $25 million to $35 million and more operating earnings. For the Marine Group, we've previously guided to our revenue of $9 billion, margins of around 8.5%, and operating earnings of $770 million. We see no reason to change that guidance, although my bias would be very nominally lower. For Mission Systems, we've previously provided an outlook for this year of $4.8 billion to $4.9 billion with margins in the mid to high 13% range. This implied an operating earnings of around $660 million. We now anticipate revenue of $5 billion, operating earnings around $690 million, with operating margins of around 13.8%. For Information Technology, we guided to revenue of $8.3 billion with an operating margin of 7.5%. We now expect revenue of $8.5 billion and operating earnings of $630 million, with an operating margin of 7.4%, 10 basis points lower. So all of this sums to revenues for General Dynamics of about $39.2 billion and operating earnings of around $4.6 billion. Compared to our initial guidance, we will have both higher revenue and operating earnings. This permits us to increase our EPS outlook from a range of $11.60 to $11.70 to a range of $11.85 to $11.90. As for the quarterly progression, it appears to us that the third quarter will be $0.30 better than the second quarter. Howard, we can now take some questions.

Thanks, Phebe. As a reminder, we ask participants to ask one question and one follow-up. So, that everyone has a chance to participate. Rocco, could you please remind participants how to enter the queue?

Today’s first question comes from Robert Stallard of Vertical Research. Please go ahead.

Thanks so much. Good morning.

Good morning.

Phebe the Aerospace division, one of your peers noted that their customers took a bit of a strike in May and June with concerns over the economy and tariffs and I was wondering if you saw anything like that at Gulfstream?

No.

That was pretty straightforward.

Look we have continued to have nice order activity. Our pipeline remains robust. As I think I have explained to many of you before, you need to look at the business aviation market, not only by cabin size but really by OEM because our experience in the marketplace is very different from others. So we continue to have good order activity throughout each of the months in the quarter.

That’s great. That’s very helpful. Thank you.

And our next question comes from Ronald Epstein of Bank of America Merrill Lynch. Please go ahead.

Yeah, good morning.

Hi, Ron.

Just to follow on to Rob's question. I mean, can you kind of walk through the demand environment you're seeing across the different products you have at Gulfstream 650, 600, 500, 280?

Sure. So the 650 continues to have very solid demand. I think by the end of this quarter we had 370 in service. It continues to have performance characteristics unmatched by anyone else any other aircraft and it continues to enjoy some very nice solid demand. The 600 has had very good demand. We suspect as we saw that the 500 when we start delivering these airplanes that is the catalyst for incremental demand increases and I have every confidence that that will also increase. 500 continues nicely and the 280 has had good sales but a little bit more episodic that end of the market tends to be that way. But on our big key platforms, airplanes, we’ve continued to have good activity.

And then as a follow-on question, have you seen any blowback in the Chinese market regarding the potential sale of Abrams to Taiwan? Because there were some stuff in the Chinese press about it. I'm not sure if it's just kind of press noise or if there's some reality there?

As far as I know, no tank sales have actually occurred. But let me remind everyone how this works. This is an FMS case or any FMS case. The U.S. Army buys our tanks and sells them to other foreign nations in this case potentially Taiwan. I'd say that that we've had fairly muted demand in that market for a while now, and I suspect that tariffs have had some dampening effect but the pipeline is increasingly active and we've been quite comfortable on where we are.

Great. Thank you very much.

And our next question comes from David Strauss of Barclays. Please go ahead.

Thanks. Good morning.

Hi, David.

Hey. Phebe, so on the G500 it looks like deliveries in the quarter based on the 21 that you said have been delivered so far. It looks like deliveries were pretty light in the quarter on G500. Maybe I expected the margin to be better because of that. Can you just talk about that and if you’re through the first block that's below margin G500 deliveries at this point?

So, we had a bit of catch-up in Q1 right after the -- after the 2018 certification. And frankly this is simply a timing issue and we are continuing to come down our learning curves. Our margin performance is better on each and every airplane that comes down -- and down our line. So, this is simply in the moment a timing issue that we had a bit of a backlog in Q1 and we're through that and we're entering into really steady state.

Okay. And then for my follow-up, on GDIT, it looks like based on your updated guidance, you're still expecting organically ex the divestitures relatively flat in the second half of the year. When do we start to see this strong booking rate that you've highlighted come through in terms of actual organic growth of that business? Thanks.

By 2020, as we said before this is in a transition year for us and a positioning for growth year and all of the indicators of growth are there. So, we are pretty confident that next year is going to realize some of those that increased backlog.

Our next question today comes from Seth Seifman of JPMorgan. Please go ahead.

Hello, thanks very much and good morning.

Morning.

I just want to ask a little bit about the cadence of EPS not that it matters that much, I mean the guidance is out, but just in terms of what you had thought in January has kind of a very heavy fourth quarter and it seems like the EPS that had been in the second half cadence back in January, did some of that show up in the first half?

Somewhat, but our guidance is really -- so you think about it. The real story undergirding the update in the guidance is we've got more revenue with similar margin performance leading to higher earnings. So, when we give you our update mid-year, we guided the result of careful ops reviews and we have very considered guidance that looks at all -- and considers all the risk and opportunities and we tend to narrow our range and have a certain amount of precision, but I'd say the overarching story is more revenue higher earnings.

Okay, great. And just in Combat, in terms of if there were kind of specific platforms that drove the increase in the guide and, kind of, was there a meaningful amount of FX that you had to offset on the P&L just to be able to raise the guide by that $30 million?

Not on the P&L with respect to FX. This is simply continuing to come down our learning curves on the domestic programs that we now have and are increasing and then it's the velocity of the domestic program vehicles as we increase our manufacturing capacity. So that's really the undergirding. It's all a story about domestic right now in the U.S. Army.

Thank you very much.

And our next question today comes from Noah Poponak of Goldman Sachs. Please go ahead.

Hey, good morning, everyone.

Hi, Noah.

Jason on the free cash flow, I was wondering if it's maybe kind of worthwhile to bridge from this year to next year just on the bigger pieces just because I think I heard you say the Canadian labs payments coming in the back half of this year take you to 100% free cash to net income conversion this year, so it would imply still below 100% conversion without those payments assuming -- I know CapEx is still albeit, I'm assuming there's other working capital happen. So can we kind of -- can you help us bridge 2019 to 2020? Or is it actually just as simple as it starts clipping 100% conversion pretty clean beyond this year?

Yeah, I think if you isolate to catching up on the arrears on the international program this year, we had previously indicated and still are of the position that this year and frankly the years looking forward are in the 95 -- 90%, 95%, 100% conversion range on a pretty steady basis, fluctuating in that range based on CapEx investments and things like that. So really this one timing item and the resolution of that item is what causes the anomaly, it caused the anomaly last year. And I think to put a little bit more precision on the outlook for this year is if we get fully caught up this year, we would expect to be nicely in excess of 100%. So I think that may be reconciles a little bit of the math you were thinking about. But to your point beyond this year we're really -- we expect to be consistently in the range of 90% to 100% conversion year-on-year subject to some fluctuations with CapEx and other investments like that.

Got it. And then Phebe just going back to Gulfstream, can you speak to what pricing has been like in your recent order activity, better, worse or the same and what that means for margin improvement in the business going forward?

Well, as you can imagine, we're very sensitive about discussing pricing, but you can well imagine that we continue to enjoy the pricing that we've seen recently in our business and on each of our platforms.

And our next question today comes from Peter Arment of Baird. Please go ahead.

Yeah thanks. Good morning, Phebe and Jason.

Hi.

Good morning.

Phebe on GDIT, it sounds – it’s great, it sounds like the integration is tracking ahead of your planning and given that we're seeing the 1.2 book-to-bill you saw this quarter, do you characterize this as kind of -- you're picking up share gains? Or is it just the environment with all the spending? Just maybe some color on what you're seeing there? Thanks.

So for those of you who have known us for a while, we never track share. That can be a fool’s errand. You can have an awful lot of share and go broke. So what we're really looking for is how we have built our pipeline; our win rates, which since the acquisition have been about 75 -- 74% to 75% on recompetes about 90% very strong at least 1:1 book-to-bill since the acquisition and we've been building -- we've been building that backlog with programs that we think we can execute quite effectively and quite efficiently. Let's talk a little bit about what GDIT is. You know, this is a people business and the way you attract people is by establishing a superior culture with very clear career development opportunities and some very interesting work. We have done quite well on that side in my mind and that I think undergirds this really quite impressive performance that this management team has exhibited since the acquisition. And again, just to give you a size and scope and complexity of this business, you know, on the first half we submitted almost $24 billion in proposals and that was more than the entire submittals in 2018. And for the remainder of the year and the second half we're looking at about $27 billion proposals. We submitted about 350 proposals just in terms of numerically in the second quarter and then -- and about 560 -- or 650 in the first half. So that tells you that what you need to undergird that kind of execution in proposals and velocity in submittals. And the win -- and the resultant win rate you need a very, very strong management team undergirded by the culture and the people that I've just talked about. And I'm very pleased with where we are right now. We are doing very well with GDIT.

Appreciate all the color. Thanks, Phebe.

And our next question comes from Cai von Rumohr of Cowen and Company. Please go ahead.

Yes. Thank you very much. So Phebe, could you give us some color in terms of the lead times at Gulfstream particularly for the G650 and 280?

So as we've been transitioning to new aircraft we're no longer following individual plane lead times. But let me tell you all of our wait times are comfortably within the range of 1 year to 18 months and that's across our portfolio. So I'm good with that. I think that's the way you think about it and we have continued to perform quite nicely and hit our -- hit comfortable lead times in each of our legacy airplanes as well as our new ones. So we're really just managing to the orders and the demand. And we did well I think.

Okay. Terrific. Great. Thank you. And then at GDIT you've given us the bid submits. Can you tell us at mid-year how much of -- what's the number for bids awaiting decision over the remainder of the year? And maybe give us some color some of the potential pursuits like GSMO and next gen?

So I don't actually know the timing and award decisions, given all the input that is really idiosyncratic to the individual customer, but I think one of the reasons I wanted to share with you the velocity of contracts and the enormity of the velocity of proposals and the enormity of the proposals, to give you a sense that we do not track and I don't think about this business in terms of any particular pursuits. And many of the pursuits you happen to mention are in our competitive space, so we’re certainly not going to talk about that. But I think that both the size and velocity of the submissions give you a real sense of this is a big business with a lot of moving parts. And frankly I don't worry about any one particular program.

Terrific. Thank you very much.

And our next question comes from Myles Walton of UBS. Please go ahead.

Myles?

Hello, Myles, your line is open.

Sorry about that. Good morning. Jason I was wondering if you could first maybe clarify on the payment you expected next month or just give a rough size of the burden at hand you have there. Would you get to full conversion for the year if that one came through?

Well, I think -- listen these are very -- I think we said all we're going to say about where we are right now on that program. As you can well imagine these are sensitive tripartite conversations and we've told you where, we're making nice progress and let's just leave it at that.

Okay. Maybe a follow-up then.

Yes, go ahead.

The Marine Group, Phebe, you mentioned on the Marine Group that you weren’t changing the guidance that your bias was nominally lower, I just wanted to clarify was that lower on the margin or on the topline?

I think I said very -- nominally lower. So, listen I am in a big business that has a number of moving parts. I'm very sensitive particularly when we have new starts and we have a number of new starts, primarily at our West Coast shipyard and that plus we may see depending on the Navy needs, we may see additional material come in this year and that tends to carry a lower margin. So, I'm just at the absolute -- let's say very nominally I want -- condition that there's two things that we don't have as much clarity about as we typically do in any given quarter and so that's why I gave you that -- ever so-mild caveat.

Yes, I know. I was just clarifying because it looked like revenue was running ahead, so that makes sense on the margin. Thanks Phebe.

And our next question today comes from Pete Skibitski of Alembic Global. Please go ahead.

Hey, good morning guys. Phebe what's your view as you look at this two-year budget deal that's kind of shaped up this week for 2021. How do you think about the Navy’s ability to afford the Columbia class or for the potential for that program to crowd out other ship priorities or other programs for – if we are going to go into a flattening, kind of, environment?

Well, it’s certainly very good news that it looks like we've got some clarity in our political landscape at the moment. Listen, let's talk about Columbia for a moment. Columbia is a national priority and I have no doubt that as a national priority funding will be made available for it. There are a lot of different ways to do that from a budget perspective and I think that the U.S. Congress and our customer is talking about various avenues of ways to ensure healthy budgeting. I'll tell you back when we did the Ohio in the 80s a separate account was set up. That's a potential option. So I don't worry too much about Columbia crowding other programs out. There is an imperative for the Navy to recapitalize its ships and build more ships. There is a consensus in Washington across political spectrum, at least political parties -- leadership in the major political parties that understand that we need ships and we need to replace the under seed light of the deterrent. And So I'm comfortable that the Department of Defense working with the Congress will find appropriate funding mechanisms to address what you have raised.

Got it. Just as a follow-up what's the reason behind the -- at a higher pre-owned volumes this year at Gulfstream? Is that --- just a really active market? Or maybe this year is just an anomaly in terms of initial 600 customers or something like that?

There is nothing in particular. On occasion we'll have a bit more pre-owned but it signifies nothing.

Okay. Thanks, guys.

Our next question comes from Carter Copeland of Melius Research. Please go ahead.

Hey. Good morning, guys.

Hi, Carter.

Good morning.

Just a quick clarification and question. I had in my notes that Maximus was like a $900 million impact on the organic calculation, but I think you said 250 plus. Phebe, I just wondered if you would clarify that for us. And then just wondering now that you've gotten certification at Aerospace on the two new airplanes if you expect -- R&D to be a little bit more stable I know you had a comparison in the quarter that caused a little bit year-over-year variability, but should we expect that to be a little bit more steady in the future than we've seen in the last several quarters?

So me -- let's answer that in inverse order. As we move the test airplanes from the test program in the customer set you'll see some reduction in R&D. And then as you all know we keep a nice level loaded amount of R&D in our business. We think that that's appropriate and so I think we'll see some decline. But we continue to have an active R&D -- series of active R&D activities in that -- in Gulfstream.

And then Carter on the first half of your question, I think, your inference was correct on the scale of the business that we divested to Maximus. There were however in the last 12 months or so a couple of other smaller divestitures we did in the IT portfolio. We had a small commercial health care divestiture. We had a next-generation 911 supportive business. When you add all those up the total annualized revenues were somewhere slightly in excess of $1 billion so that was to Phebe's point, a roughly $250 million a quarter impact.

Okay. That’s great. Thanks for the clarification.

And Rocco this will be our last question coming up now please.

Absolutely. Our final question today comes from Jonathan Raviv of Citigroup. Please go ahead.

Hey, thank you for the timing. Good morning.

Good morning.

Phebe in terms of supporting that GDIT ramp into 2020, can you give us some color on how the personal recruiting site is going? I know it's a very important part of the people business.

So those management teams have gelled. We took leaders from both legacy businesses and they have really gelled into one team one fight throughout the first three quarters and during this acquisition and integration we have kept almost every single key leader that we wanted to keep, I believe every leader we wanted to keep. And we are reducing our staff turnovers. So all of that to me is very wholesome sign that we are building a cohesive team that is -- at GDIT up and down their leadership chain that can maintain a very long-term robust and successful business. I'm very pleased with what I've seen there both in terms of the energy level, the cohesion and the culture that they have established, it's really quite impressive.

Great, thanks. And then just thinking about that pickup. I mean, some peers in the market tend to talk about mid single digit organic growth. I know market share is not as important to you guys, but is that how we should think about the potential and should EBITDA growth accelerate in line with sales growth in 2020?

Well, I think we're growing about 3% this year and we'll see some nice growth in 2020. But beyond that we're not going to piecemeal 2020 at this point. We'll give you our 2020 estimate and outlook and detailed view of the business as we always do in the fourth quarter call after our fall review where we do in-depth analyses and bottom up operations reviews of each one of our businesses and we'll let you know then. Fair enough?

That’s right. Thank you.

You did. Thank you.

And thank you for joining our call today. As a reminder please refer to the General Dynamics website for the second quarter earnings release and highlights presentation, which will now contain our earnings outlook to the balance of the year. If you have any additional questions I can be reached at 703-876-3117. Thank you very much.

And thank you sir. Today's conference has now concluded and we thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.