Good morning, and welcome to the General Dynamics Second Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. After the 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, operator, and good morning, everyone. Welcome to the General Dynamics second quarter 2021 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. With that completed, I would like to turn the call over to our Chairman and Chief Executive Officer, Phebe Novakovic.

Thank you, Howard. Good morning, everyone, and thanks for being with us. Early this morning, we have reported earnings of $2.61 per diluted share on revenue of $9.2 billion, operating earnings of $959 million, and net income of $737 million. Revenue was essentially flat against the second quarter last year but operating earnings are up $125 million and net earnings are up $112 million, earnings per share are up $0.43. To be a little more granular, revenue on the defense side of the business is up against last year's second quarter by $308 million or 4.2%. Aerospace is down $352 million, pretty much as planned. Operating earnings on the defense side are up $98 million or 14.3%, and operating earnings in aerospace are up $36 million on a 390 basis point improvement in operating margin. The operating margin for the entire company was 10.4%, 140 basis points better than the year ago quarter. From a slightly different perspective, we beat consensus by $0.07 per share on somewhat lower revenue than anticipated by the sell side. However, operating margin is 20 basis points lower than anticipated coupled with a somewhat lower share count, this led to the earnings feed. On a year-to-date basis, revenue is up $596 million or 3.3% and operating earnings are up $129 million or 7.3%. Overall margins are up 40 basis points. The defense numbers are particularly good with revenue up $752 million or 5.2%, and operating earnings up $143 million or 10.3%. On the aerospace side of the business, revenue on a year-to-date basis is down $156 million or 4.3%, but earnings are up $16 million or 4% on a 90 basis point improvement in operating margins. The quarter was also very strong from a cash perspective; free cash flow of $943 million is 128% of net income. Cash flow from operating activities was 151% of net income and had a very solid quarter from an earnings perspective across the board. The year-to-date results give us solid start to the year and enabled us to raise our forecast for the full year which I will share with you at the end of these remarks.

Thank you, Phebe, and good morning. I'll start with our cash performance in the quarter. From an operating cash flow perspective, we generated over $1.1 billion on the strength of the Gulfstream order book and additional collections on our large international Combat Vehicle contract. Including capital expenditures, our free cash flow as Phebe noted was $943 million or 128% net earnings conversion. You may recall that for the past several years, our free cash flow has been heavily weighted to the back half of the year, so the strong quarter derisks that profile somewhat and reinforces our outlook for the year of free cash flow conversion in the 95% to 100% range. Looking at capital deployment; I mentioned capital expenditures which were $172 million in the quarter or 1.9% of sales, that's down from last year but our full year expectation remains in the range of 2.5% of sales. We also paid $336 million in dividends and spent approximately $600 million on the repurchase of 3.3 million shares; that brings year-to-date repurchases to 7.9 million shares at an average price of just under $173 per share. We have 279.5 million shares outstanding at the end of the quarter. We repaid $2.5 billion of notes that matured in May, in part with proceeds from $1.5 billion in notes we issued in May. We also issued $2 billion of commercial paper during the quarter to facilitate the repayment of those notes and for liquidity saving purposes, but we expect to fully retire that CP before the end of the year.

Thank you, Jason. Now let me do my best to give you an updated forecast. The figures I'm about to give you are all compared to our January forecast, which I will not repeat. In Aerospace, we expect an additional $200 million of revenue with an operating margin of around 12.4% which is 10 basis point below what we previously forecast; this will result in an additional $10 million of operating earnings. There could be some upside here if we can squeeze out a few more planes in the year. With respect to the defense businesses, Combat Systems should have another $100 million of revenue and add another 10 basis points of operating margin; so total revenue of $7.4 billion and operating margin of around 14.6%. Marine Systems has an additional $300 million and 10 basis points of improved margin, so annual revenue of $10.6 billion with an operating margin around 8.4%. Technology revenue will be down $200 million from our previous forecast but add 30 basis points of operating margin, so annual revenue of $13 billion with an operating margin of around 9.8%. So on a company-wide basis, we see annual revenue of about $39.2 billion and an overall operating margin around 10.6%, this rolls up to EPS around $11.50, $0.45 to $0.50 better than our forecast going into the year.

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.

Absolutely, sir. Today's first question comes from Peter Arment with Baird. Please go ahead.

Hi, yes. Good morning, Phebe and Jason.

Hi, Peter.

Nice results. Phebe, maybe just to start with Combat and my follow-up will be related to that. Just -- maybe, could you just talk about, I think there is really strong performance that you're seeing, but also, we're seeing a lot of activity in the international market that -- for some of your key platforms. Just how you think about Combat growing in what is a domestically flatter budget environment but based on how you're doing in terms of a lot of your works ? Thanks.

So domestically both of our large platform programs, and Stryker and Abrams are continuing to grow, particularly Stryker, as the army assigns new missions and capabilities to that platform. There are also, as you all know, a number of developmental programs that factor into our longer-term thinking. Externally, outside the United States, demand is increasing, primarily driven by Europe. And again, that is focused and centered on our Combat vehicles, both -- both of our wheeled vehicles, as well as our track vehicles, most specifically, the Abrams main battle tank.

And just as a follow-up. Just as you talked about, I guess, some of that activity , have you -- do you expect that the discussions around recent comments around Poland, will that would be closing this year potentially?

So, you know, Poland's been a very dangerous neighborhood. And I think there is no stronger deterrent than the Abrams main battle tank. I think press reports have suggested that they want 250 tanks for working very closely with the U.S. government to ensure we meet whatever ultimately United States and Poland determine that they want. I think our initial estimate to close is probably good solid year plus out; but again, more to be -- more to come, and then we'll keep you informed as that program unfolds.

Appreciate it. Thanks a lot for the color.

And our next question today comes from Seth Seifman with J.P. Morgan. Please go ahead.

Thanks very much, and good morning.

Hi, Seth.

Hi. I wanted to follow up on something you mentioned in the remarks, Phebe, about what needs to be done on the engine for the G700. And I wonder if you could tell us specifically what milestones we should be looking for? And what risks that the engine poses to the schedule for the program?

So as I noted, we continue to make progress on both, the airplane and the engine development; but as I'm sure you know being a student of new engine development programs, they are always difficult to get through certification, and while there is no particular issue at the time, we still have a ways to go with respect to that certification process. But at the moment, we don't have any particular issues that would impact our overall estimation of timing.

Okay, great. Thanks very much. And then, just as a follow-up. There's been a lot of discussion in the press about the AJAX program; how that's going and that it doesn't really seem to be having too much of a negative impact on the segment's financial results but -- the way that it's playing into financial performance of Combat?

So, our U.K. customer is constructively and actively engaged in this program, and we're working very closely with them on two issues that were identified during customer test; one is noise and one is vibration. And given our long decade-long history of Combat vehicles design and production, you know, interestingly enough, this is a transformational vehicle for the U.K. army, and with many transformational programs it has emerged during the testing process. So, we will then are dealing with both of those issues quite closely with our U.K. government customer.

Hey, great. Thanks very much.

Next is Kristine Liwag with Morgan Stanley. Please go ahead.

Hi, Phebe and Jason. Phebe, can you provide more color on the type of our profile at Gulfstream or the demands from corporate or individual of U.S. versus international?

Sure. All in all we see a reasonable balance across the broad cross section of buyers. The U.S. had a particularly strong quarter, generating more of this quarter's orders, some of the new customers and a broadening of the market and importantly, our core Fortune 500 customers have re-engaged. So in all that the markets we are looking at the moment is robust.

Thanks. And my follow-up is on pricing. Since there doesn't seem to be too many used jets in inventory, are you getting more pricing power for new orders?

Well, let's just say as a matter, of course, we never talk about pricing. So, I am not about to break my discipline, but let me let me give you a little context here. Gulfstream has always been extremely disciplined about its pricing and that long history of disciplined control around pricing will continue. Price is precious and once you on rely on your discipline around pricing, it's a long way back up the hill.

Great. Thank you, Phebe.

And our next question today comes from Robert Stallard with Vertical Research. Please, go ahead.

Thanks so much. Good morning.

Good morning.

Phebe, just a follow-up on that topic and the strength of the demand environment in the order intake at aerospace. At what point would you feel comfortable raising business jet production?

Well, we're increasing our business jet Gulfstream production rates throughout the remainder of this year. We've got 71 deliveries to go and we will, as you well know, set production for next year, in the fall of this year and then report fully to you on those production levels in next year.

Okay. And just a follow-up on the pricing issue. Are you seeing -- you might call maybe irrational -- on the new pricing front?

Well, that's your word, not mine. Hey look, we tend not to -- first of all we don't compete on price most importantly and I never comment on other people's behavior. That's a wise injudicious stance to adhere to.

Okay, fair enough. Thanks so much.

And our next question today comes from Sheila Kahyaoglu with Jefferies. Please, go ahead.

Hi, good morning and thank you for the time, Phebe, Jason and Howard. Maybe, on mission. If we could just talk about what's going on there for a second. I appreciate the divestiture in the semiconductor chip issue, but it seems like it was flat year-over-year organically and then the book-to-bill is slightly below one. So, maybe Phebe, can you talk about what the drivers in that business are and what you're seeing?

Well, I think you need to look -- as you well noted, our divestiture of our SATCOM business. But I believe absent that and given the chip issue that we and others have had and that we are working assiduously to address, we have seen some growth and we anticipate some additional growth going forward. But it will be best measured.

And I think to add on to Phebe's point, assuming that business can overcome some of the supply chain issues that they've seen, which at this point they're getting good signals, that they'll be able to do in the second half. We ought to see some modest organic growth out of that business for the full year.

Okay. And then maybe just one on Combat, that was also a really good quarter there and the first half is up, I think, 7%. It implies a deceleration into the second half. What's may be falling off there?

Well, I think it's a only slightly in percentage terms. We think we had originally guided to an increase burst what impetus behind growth in the first half will repeat in the second half and that's logic and vehicle production deliveries in both the United States and outside the United States.

Okay, thank you so much.

And our next question today comes from George Shapiro with Shapiro Research. Please go ahead.

Yes, Phebe. Could you commented on what services did in the quarter? I imagine it was up and what you expect for the rest of the year?

You mean in aerospace services?

Yes in Gulfstream.

Yes, well, our services include both jet aviation services as well as Gulfstream. So, we saw some nice order, nice recovery in the United States, but here in Middle East and Asia recovering a little more slowly. So, I think we had anticipated about $0.5 billion increase in revenue. I think that is a bridge too far in the moment and I think we're looking more along the lines of...

Call it $375-ish million for the year at this point.

So, not tremendously off our original estimate, but as I said, it's the international recovery. That's been just a touch slower than we anticipated, but the U.S. has been very, very strong. Jason?

And George, on to that point, I think it's driven a nice rebound this year, I think to the tune of around 25% growth over last year and importantly, I think that some people are watching the levels we've seen through the first half of this year or within, call it 95-ish percent of where we were at this time in 2019. So, I think that's a good initial indication of the strength of the recovery in that business here in 2021.

Okay. I'll stick with my one. Thank you.

Thanks, George.

And our next question today comes from Doug Harned with Bernstein. Please, go ahead.

Good morning. Thank you.

Good morning.

I wanted to go back to Gulfstream because when you talk about the demand where it's obviously very good, you talked a little bit about where they're coming from. But can you give us a sense of the psychology of your customers? By that I mean, are you seeing these orders come in really as kind of pent up demand that's been slowed recently? Or are you seeing people actually think about the use of business jets differently coming out of ?

So, we have no evidence that there has been any fundamental shift in thinking about the use of business aviation, I think that it would be way, way, too premature to get real clarity about that. You're kind of getting a question that we've received a number of times and that goes to kind of, is there a structural change as a result of this pandemic in business aviation? And if you think critically about change, what we know is that structural change is almost never apparent prospectively. It almost always is apparent retrospectively. And so, I believe that it is premature to assume any pronouncements about structural change. Now that said, we've seen our customers are the same kinds of customers that we've had historically back in -- I think there was some slowing obviously. There was some slowing of demand last year and a number of our customers, particularly in the Fortune 500 are on their aircraft replacement cycle. That remains unchanged. We did see some new entrants into the market as some industries have expanded in the COVID environment, creating opportunities for those companies. But yes, I think psychology is an interesting word, but I think I've gotten to the essence of your question.

And a little bit related to that, you described the unit book-to-bill is higher than the revenue book-to-bill. Have you seeing a mixed shift towards a smaller aircraft and what do you see driving that difference in unit versus revenue book-to-bill right now?

Well, we have not seen a movement particularly into the smaller jets. I think the 280 was maybe about less than that 20% of the order book and really, it's demand for both the in-service airplanes, the 500, 600, 650 and of course in 700. So, really a strong demand pull across all of our airplanes. I don't think there's anything in particular discern from that. These are our regular customers back buying to replace the airplanes in the missions that they need and they have and the airplanes that they buy, then with each one of those missions since the way we think about it.

Okay, very good. Thank you.

And our next question today comes from David Strauss with Barclays. Please, go ahead.

Thanks. Good morning.

Good morning.

Phebe, on Gulfstream production, just to kind of level set us, you talked about it coming down in COVID. Are you taking Gulfstream -- I guess just looking at holistically on the large cabin side and adjusting for the G550. Are you taking large-cabin production back to where we were prior to all this or above that?

Follow-up, we are increasing on a reasonable basis. Our production of all of our existing now airplanes and we are not back at the 2019 production levels, but to-go basis we're looking at second half orders of 71 and so that in it of itself suggests that we've got solid production I will tell you and that production plan contemplates increased production in each and every one of our in-service large-cabin fleet.

Okay, all right. And Jason, quick follow-up. Just given the strength of Gulfstream order activity and advances you're seeing there, could you be looking at closer to kind of 100% or maybe even a little bit above that free cash flow conversion this year?

Yes, I think, David, as I alluded to in the remarks, I think the way to think about the strength of the first half and the strength of the activity at Gulfstream is it somewhat derisks the profile for the second half and getting to that 95% to 100% range. You'll recall over the past several years, we've had a pretty steep slope in the second half on our free cash flow generation with frankly at times most, if not all, of our free cash flow for the year coming in the second half is not even most in the fourth quarter. So, that's not anything I would put together by design and I'm really encouraged by the shift in that slope that we've seen this year. So, it does give us, I think even reinforced confidence to getting to that 95% to 100% range. I think if you think about that range as a percentage of net income and combine that with Phebe's guidance on increasing net income, you can imply increasing free cash flow to support that number. And frankly, if I'm going to lean a little forward, I think it could possibly put us towards the top into that range of the 95% to 100% range. I don't know, but I'd want to get out above 100% this year. I think we still look to next year and beyond to be nicely above 100%, but bottom line, I think this reinforces improvement in overall free cash flow and maybe pushes us up towards the higher end of that 95% to 100% range.

Great. Thanks very much.

And our next question today comes from Myles Walton with UBS. Please, go ahead.

Thanks. Good morning. Phebe, you talked about the 12.4% margins in aerospace and obviously in the first half, you're slightly under that, but the first quarter included a charge in the second quarter, I'm sure had production inefficiencies because of the manufacturing being close point. So I'm just curious, it would look like there is more upside in the second half, barring some pickup in in R&D or other expenses. Is that an area of conservatism that we should be ?

So, when we think about the second half margins, they will be better than our first half margins -- our first half margins were at low point. But we will see some negative impact from two factors. One is the absence of the 550 deliveries as that airplane is now out of service and a higher R&D as we move toward G700 certification.

Okay, all right. And then, maybe just give us some color if you can, if you want to on the first availability of delivery slots, particularly on the 500, 600 at this point?

We got out of the practice of doing that because it became a lot less meaningless with new airplane deliveries -- with new airplanes. So, we're not going to, I think, reinstitute that.

You can't go back to there?

Yes, go back to there, but I think if you think about the environment that we're looking at now and we think we've been very clear and consistent about this -- starting really, it was in mid-February, we saw an increase in demand and it was consistent and steady throughout that first quarter that led to the order quarter you saw this quarter and second quarter. And then, as we look at both the pipeline and the market, at the moment, it is robust. So, we're seeing a return as I said, of our Fortune 500 customers, as well as new entrants and North America is quite strong. So all in all, I think we're looking at about a pretty good market.

Thank you.

And our next question today comes from Matt Akers, Wells Fargo. Please, go ahead.

Yes. Hi, good morning. Thanks for the question. A couple on the IT business. I guess, anything in particularly you can point to that kind of drove the strength this quarter either by customer or product? And then I think you said you were seeing some delayed awards. Is that the comment, sort of the protest that you mentioned or is that kind of a broader statement about the market? Anything you can elaborate on there.

Yes, sure. So, our growth in the quarter with shield across many of our 7,000 contracts, but notably proportionately a bit more from our new contract awards. So, contract awards for new work, I think which is significant, we have seen a delay in contract awards from two fundamental factors. One, there has been an increase and elongation in the customer decision cycle; and two, we've seen an increase propensity of many in the IT industry to protest repeatedly. Early and often seems to be the mantra. So, both of those have increased our expectations for when we can see that growth coming, but I think I mentioned that we've got about $34 billion already in customer hands awaiting some sort of decision and we've got about $20 billion in the pipeline. So, all of that drives growth. It's just given this elongated cycle and given this increased propensity to protest, it's going to make the recognition of that revenue a little bit lumpier.

Got it. Okay, thank you.

And our next question comes from Robert Spingarn with Credit Suisse. Please go ahead.

Hi, good morning.

Good morning.

Phebe, just maybe one on shipbuilding. A little bit strategic, but one of your peers in shipbuilding stated that the future of the Navy is going to be Platform Plus, where shipbuilding platforms will be tailored around capabilities and technologies that are key differentiators. Would you agree with this? I'm not sure it applies to submarines as much surface ships, but would you agree with this and would GD need to make any additional investments either organically or inorganically to position yourself from this?

Platform Plus. I'm not sure I can give you any real insightful color around that. I will tell you how we see our ships. Let's talk about the surface combatants first in the DDG . That is an extraordinarily versatile ship that has over the years had multiple instantiation of improvements and remains a very, very agile ship in terms of its ability to upgrade. So, we're already on the block. Our fight free upgrade which gave an additional capability, I suspect that that ship and others like it can be the type of platform that evolves over time to address different kinds of missions. I think that that's pretty much regular order. I don't know that that's a systemic change in the way the Navy has ever looked at it's combatant fleet. With respect to our auxiliary ships, I think that those tend to be , and I'm thinking the oilers, EPS, those tend to be purpose-built ships for a particular mission. And then submarines, submarines remain a pivotal competitive advantage for the United States and what we have historically focused on and will continue to focus on is integrating any new technologies or capabilities up that's submarine. I think it's very important when you're in a complex business like shipbuilding and particularly submarine design and construction, that you focus on the business of designing and building those ship and ensuring that you can successfully integrate any new capabilities that your customer wants, and we have a long history of that and I suspect us to continue that for some time to come.

Raquel , we'll just take one more call, please.

Yes, sir. And our final question today will come from Cai von Rumohr with Cowen. Please, go ahead.

Yes. Thanks so much. So GDIT, when do you expect those two protests to be kind of adjudicated? And secondly, you have an above-average exposure to fed civil, which where the funding is strong, Q3 normally is the strongest booking quarter for the sector's book-to-bill quarter. So, give us some color on what we should expect this quarter to the extent?

So, Cai, you got a glass to judge . We have very little insight, like none into the timing of protest resolution. That really is up to the reviewing authority. With respective to the federal civilian, I think we've been with many of those customers for 30 years and we have a lot of customer intimacy across several many key federal civilian agencies. And I would imagine that as they receive more funding and the ubiquitousness of IT infrastructure to all of their missions, I would see that is some additional upside and potential for us. When that comes, again, we'll depend on whole series of issues around timing. But you can rest assure that in that pipeline on a going forward basis that we're looking at, we've got some good work in there.

Great. And so a follow-up on the AJAX; you mentioned you're .

So far we've had -- I think we had two issues .

Okay, two issues. Good point. But I believe it's a fixed price contract and there has been call there that basically you pay for all the state-issue expenses. Do you see that jeopardizing profitability on the contract?

We have been able to make any changes here before in a very cost-effective and time-efficient manner to meet the needs of our customers for the testing program. But I do not see at the moment any impact on our EACs, or frankly on our ability to produce this vehicle efficiently. The kinds of changes we're likely to see that we anticipate, typically are cut into the production line. So, I don't see a whole lot of motivations from a cost or schedule impact from the changes that we can envision resulting from this -- from the resolution that we come to our customer with on these particular issues.

Terrific, thanks so much.

Thank you for joining our call today. As a reminder, please refer to the General Dynamics website for the second quarter earnings release and of course, the highlights presentation, which includes our revised guidance. If you have any additional questions, I can be reached at 703-876-3117. Thank you, Raquel. Thank you, everybody.

Yes, sir. Thank you as well. We thank you, all, for attending today's presentation. You may now disconnect your lines. You have a wonderful day.