Good morning, and welcome to the General Dynamics Third Quarter 2021 Earnings Conference Call. [Operator Instructions] 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.

Thank you, operator, and good morning, everyone. Welcome to the General Dynamics Third 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. 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, our earnings press release and our filings with the SEC, all of these which are available on the Investor Relations page of our website, investorrelations.gd.com. With that completed, it's my pleasure 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. Earlier this morning, we reported earnings of $3.07 per diluted share on revenue of $9.6 billion, operating earnings of $1.08 billion and net earnings of $860 million. We beat consensus by $0.09 per share on somewhat lower revenue than anticipated by the sell side. However, operating margin is up about 40 basis points more than anticipated. This led to the earnings beat. Revenue is up 1.5% against the third quarter last year. Operating earnings were up less than 1%. Net earnings are up 3.1%, and earnings per share are up 5.9%. This is all reasonably good, but the real story for us is the sequential results. Here, we beat last quarter revenue by 3.8%, operating earnings by 12.6%, net earnings by 16.7%, and EPS by 17.6%. On a year-to-date basis, revenue is up $733 million or 2.7%. Operating earnings are up $137 million or 4.8%, net earnings are up $140 million, and earnings per share are up $0.64, a strong 8.5%. We had a powerful quarter from a cash perspective. Cash flow from operating activities was $1.47 billion. That is 171% in net earnings. Free cash flow was $1.275 billion, 148% of net income. This follows a very strong cash quarter performance in the second quarter. In summary, we enjoyed a good quarter in almost all important respects. So let me move right into some color around the performance of the business segments, have Jason give you additional color around cash, backlog, taxes and deployment of cash and then answer your questions. First, Aerospace. At the outset, let me remind you that in April of last year, we announced that we were cutting production as a result of certain supply chain issues. Shortly thereafter, it became clear that…

Thank you, Phebe, and good morning. I'll start with our cash performance in the quarter. Operating cash flow was $1.5 billion in the quarter, once again on the strength of Gulfstream orders and from continued strong cash performance from our Technology segment. Including capital expenditures, our free cash flow was $1.3 billion or a 148% net earnings conversion. Through the first 9 months, our conversion rate is 91%, approaching our full year outlook for free cash flow conversion in the 95% to 100% range. For those of you who followed us for some time, this performance through the first 9 months of the year is better than we've seen in the past several years and gives us good line of sight to achieving the upper end of our target cash range for the year. Looking at capital deployment. Capital expenditures were $196 million in the quarter or 2% of sales. That puts us a little under the 2% of sales for the first 9 months, so trending somewhat below our forecast for the year. We're still projecting full year CapEx in the range of 2.5% of sales. So that obviously implies an uptick in spending in the fourth quarter. We also paid $332 million in dividends and spent $117 million on the repurchase of 600,000 shares in the quarter. That brings year-to-date repurchases to 8.5 million shares at an average price of just under $174 per share. We repaid $500 million of notes that matured in July. And although there were no new issuances, we ended the quarter with $2 billion of commercial paper outstanding. We expect to fully retire that balance before the end of the year. So we ended the third quarter with a cash balance of just over $3.1 billion and a net debt position of $10.5…

Thank you, Jason. [Operator Instructions] Operator, could you please remind participants how to enter the queue?

[Operator Instructions] Our first question today comes from Myles Walton of UBS.

Phebe, I wonder, could you talk a bit about the transition potential margin impact of the new generation of the 400 and the 800 coming online? It seems like the 800 is a pretty advantageous move for the 650 engine with the 700 engines. And you usually would expect some level of reset on margins, but I'm curious if that reset will be materially lighter than we'd normally expect with the new entry into service.

So we get a fair number of questions on this, so I think it's worthwhile walking through each element here. And first, let's take a look at margins. I'll make some comments that I'd like, Jason, to maybe elucidate a couple of points, and then we'll get into a little bit of earnings. So when you think about margins and the new product development, at present, we have about 3 models in production, soon to be joined by the 700. The 800 replaces the 650, and the 400 comes later. Importantly, we have all the modern plant property and equipment to do everything we need to do. We need to add some more CapEx to undergird the increase in wing production. Remember, we're doing all of our wings. But here's the important part, and it goes to the design for producibility that we built into these airplanes and the implied productivity that's embedded in that design for producibility. And remember, too, we are seeing margin improvement in every single one of our airplanes in services. This now tells you -- and again, I think it shines the spotlight on the operating leverage of Gulfstream. But to amplify all of that and really give an additional uplift, remember, all these aircraft are related. They all have the Symmetry flight deck. The G700 and 800 are the same engine and wings and the same basic fuselage. The G400 and 500, 600 have the same engines or similar engines from the same family from 1 supplier and the same basic fuselage. So this commonality align -- allowed us to design for producibility, which is going to be an uplift to our margins. Now if we unpack that a little bit, we get an awful lot of questions about R&D. And I'd like Jason to talk a little bit more, and perhaps not for all but for some, a bit of a tutorial on R&D accounting.

Yes. So to Phebe's point, we get a lot of questions around will this new product investment have any impact on the overall R&D spend and what does that do to margins over time. And as a reminder, we have a long-term steady commitment and demonstrated performance of investing in Gulfstream's product development and new technologies over time. So I think if you look over a multiyear period, we've averaged company-sponsored R&D in the call it, roughly 1% of sales range, and we don't expect that to change. Largely, the 800, I wouldn't say it's behind us, but it's been part and parcel to that spend over time. R&D is spent as a period expense over time. As Phebe mentioned, the G400, while a clean sheet airplane is part of the 500 and 600 development, and so the commonality among those helps keep that spend down. And so both of those airplanes are right within that profile of R&D spend. I think to the extent you see any lumpiness in R&D as we did this quarter, and we'll expect to see a little bit next quarter, that has more to do with supplier offsets that we receive. You're probably familiar with those where suppliers contribute to the program development efforts. And those come in lumps and chunks, so that tends to create the quarterly perturbations and R&D spend. But overall, the period expense for these programs, including the 2 that were announced this month, are right inside that line of company-sponsored R&D. So we don't expect that or the -- frankly, the introduction once they come to have an overall impact in the margin improvement trajectory that we see for Gulfstream over time.

So what does all that mean if you step back? So margins this year are at their low point in aerospace. Next year margins will improve, and '23 margins will improve. Earnings were better in '21 than they were last year. They're going to be better in '22 and '23. And by the way, when we give you guidance on the next call, we're going to give you some color and some insight into both of those years to help explain and amplify again what we're looking at, at Gulfstream. So I hope that helps answer your question, Myles.

We'll now move on to our next question, which will be coming from David Strauss.

Phebe, I wanted to ask you, you highlighted that the Gulfstream backlog is the highest it's been in about 6 years. I think if I just take kind of the aircraft revenue, you've got something like 2.5 years in backlog based on today. So how -- and at the same time, you also comment on supply chain challenges. So how do you balance all that as you think about where production rates go at Gulfstream?

So the increased demand supports increased production. We'll get into all of that specificity on the next call. But as I noted, after we reduced production last year in response to COVID, supply chain challenges that were in large part driven by COVID and COVID demand, the supply chain needs to gear back up. So there's a little bit of a headwind. But that's why I wanted to give you the color around the margin and earnings performance.

Okay. But all that being said, we should see higher production in '22 and '23?

We're anticipating that to drive a higher revenue. So as I said in my remarks, this is a rich problem to have. I wanted to be as transparent with you as possible to tell you, hey, look, we've got this. There's a nice strong backlog. We've got very good demand, a continuing demand. But as we ramp up, and we will be ramping up, there are some challenges. We can manage those challenges and manage through them, but I thought it was important that you guys understand that.

We're now going to move over to Robert Stallard of Vertical Research.

Phebe, I was wondering if you could elaborate on these challenges. You obviously face some chip issues in Mission Systems, but it seems you're also conscious of some potential headwinds in the aerospace division that ramps up. And one of your peers also talked about broader supply chain challenges in its Defense business. I was wondering if you could comment on this topic generally and what you could be seeing in the future.

So I tried to give you some measured look at the Aerospace issues. But on supply chain, the chip shortage impacted Mission Systems. I would note how -- and we do expect that to go into next year somewhat. I would note, however, even since the close of the quarter, they have begun to significantly mitigate some of those chip impacts. But across the portfolio of our defense businesses, we are not seeing significant or even material supply chain challenges. So we've been able to manage through that pretty well. So for us, and I can only speak for us, that hasn't been a significant issue other than its impact at technologies and driven by Mission Systems.

Yes. And in aerospace, the challenge is there. Is that just a lead time issue with suppliers? Or is it specific parts that you're finding particularly tight?

It's primarily a lead time. The fact that we pulled down last year adds a little bit of headwind to the increase in production that we see on a going-forward basis. But I don't see any particular problems at the moment impacting that. This is really just a timing issue and getting folks back up to speed.

We're now going to move over to Cai von Rumohr of Cowen.

Yes. So Phebe, could you give us some color on demand at Gulfstream, specifically high net worth versus corporate versus fractional? And most importantly, are you seeing any opportunity for improved pricing in this sector?

Let me answer those in the inverse order. We have seen some upward pressure on pricing, and then let me unpack your demand. So look, our own view of our increased demand is a combination of factors. One, the very attractive product mix, a strong economy, the return of the Fortune 1000, increase high net worth individuals. And in fact, COVID did create in pockets some wealth creation and the pent-up demand that's built up during the pandemic. The demand is -- and I think importantly is spread evenly pretty much across our product line. And there's nothing unusual to report on customer mix or geographic distribution other than the North America was quite, quite strong.

And we're now going to move to Ron Epstein of Bank of America.

Just maybe changing gears a little bit. I think everybody is going to focus on bizjet, so I'm going to maybe not do that. A while back, there was some discussion...

Oh my, how innovative.

Imagine that, right? There were some discussion in the press around the Polish defense ministry purchasing some Abrams tanks and 1 Abrams. I think maybe 250 of them, if I remember right. Where does that stand? And if you can give some color on that and maybe some of the other international business going on in the Land Systems business.

Yes. So we're working very closely with our customer as well as the Department of Defense to support a potential order of 250 tanks out of Poland. If we -- and frankly, this is a powerful system for the polls to have given their geographic location and their historical experience, particularly with folks stream and West. So if we think through again the FMS process, and this is an FMS sale, we're looking at somewhere between maybe in the 2-year period. But just to give you a little bit of additional color we see increased demand signals coming out of Czech Republic, Romania, Denmark, Switzerland, Spain and, of course, the Middle East. The world hasn't gotten any safer.

We'll now move over to our next question from Richard Safran of Seaport Research Partners.

Phebe, Jason, Howard, with such great cash flow performance, I wanted to get an update on how you're thinking about capital deployment, invest in the business, dividends, repurchases, commercial paper. Now, Jason, I heard your remarks about retiring commercial paper. But as we look ahead, are you thinking about maintaining your current strategy? Or are you considering any changes? I think in the past, you've stated you invest in the business depending on need and that dividend should be repeatable. But I was just curious if there's any update here on how you're thinking about it.

So let me give you the strategic framework, and then Jason can fill in any specifics. But essentially, our capital deployment strategy remains unchanged. We invest opportunistically in small acquisitions or in investments to grow the business where we can get a good capital return, return on our capital. Dividends and opportunistic share repurchase. This has been our strategy from the day 1 and the advent of this management team. Jason?

Yes. I think the only thing I'd add to your point on the commercial paper repayment and future priorities around debt is that commercial paper will mature here in the fourth quarter. We've got more than sufficient cash on hand, so we'll just repay that in normal course as it comes due. The next debt maturity is in late next year. I think it's around $1 billion that will come due. So no real imminent issues there, so we can focus on the priorities Phebe mentioned. And then as those elements of the debt ladder do mature, we'll pay those down in due course up to a point until we get to a comfortable place that we think long term continues to support our target mid-A credit rating for the company.

We'll now be taking our next question from Seth Seifman of JPMorgan.

Phebe, when you think about the certification timeline for the 700 and the 800, I guess, is there anything you'd point out to as a long pole in the tent? And thinking specifically about the engine certification, which you mentioned today, and then also the changes in ODA that Steve Dickson outlined last week testifying before Congress.

Yes. So our estimate at the moment still remains late next year for the 700, with the 800 to follow 6 to 9 months later. For those of you who have followed engine certification for years and decades, some of you, you'll know that they are always challenging. This engine is performing extremely well in terms of its capability in either meeting or outperforming its design specification. We've got a lot of test growth on a going-forward basis to get through. So we don't see any particular issues at the moment, but we are mindful that these are always complex and challenging processes to work through. And we've adapted to changes in the -- in our regulators in the FAA's game book before. And at the moment, we don't see any reason to adjust our estimates. But if we do, we'll let you know.

Great. And then maybe just as a follow-up for Jason. If you could update us on where you expect to be on working capital at the end of this year and then kind of maybe without specific guidance, just what the opportunity buckets are in working capital for '22.

Sure. I think as you can see from the exhibits this morning, working capital was a benefit, call it, in the couple of $300 million or $400 million in the quarter. That is largely from the performance at Gulfstream, the significant order activity that we've seen throughout the year and the quarter as well as the continued sale of the last of the test articles from the 500 and 600 program. So that really is the big benefit in the quarter. Working capital is still a bit of a headwind year-to-date, just as the business grows and we work through some of that. But I think as you look ahead, we would expect to see working capital to continue to be a benefit in the fourth quarter and beyond as we get back to that 100% conversion level this year. We're approaching that level this year and certainly expect to get above 100% conversion next year. So part of that is the continued demand cadence at Gulfstream. Once we get through the 700 program, we would look to sell off those test articles as well. And then, of course, you've got the ongoing benefits at Combat Systems. You've seen us achieve a regular order on the large international program there in Combat Systems. And that will continue to be a tailwind, really even more of a tailwind, I think, into '22 as well as into '23. So those are some of the major movers. The other side of it, of course, is where we should be peaking this year in terms of the capital expenditure investment profile in Marine Systems. So that will start to come down next year and return more to the normal historical level we see by 2023. So those are really the big movers there and should give you a sense of where we ought to see the working capital moving over the next 2, 3 years.

Our next question will be from Kristine Liwag from Morgan Stanley.

Phebe and Howard and Jason. Phebe, how do you anticipate the vaccine executive order will affect labor and production? And also, do you have a sense of the percentage of GD employees that are currently vaccinated?

Yes. So before I get into the mandate, I'd like to take the opportunity to reiterate again our acknowledgment of our workforce. I think it's important to remember that we were declared a critical national infrastructure business early in the onset of the pandemic. And as a result of that, our workers stayed on the factory floor in the shipyards and in places where they were needed, frankly, throughout the pandemic. They stood their watch and, from my perspective with courage and fortitude, to produce the goods and services that are necessary for our national security. I personally am fully cognizant of the sacrifices they made, and I'm proud of the courage they showed. Now let me turn to the mandate. As you well know, as a federal contractor, we are covered by the executive order on the mandate. The corporate office mandate has been fully executed. Two of our largest businesses are in the process of executing the mandate, and many others are set to implement accordingly. And because of our customer, operational and geographic diversity of many of our businesses, we are working with our customers as contract modifications are received that could trigger an implementation. So we keep a pretty running tally. We're at, we believe, in some form of either full or partial vaccination in the 75% range or so. And then yes, so we understand the mandate.

And then maybe if I could add one on supply chain and aerospace. We're seeing that some of the suppliers also have to comply with the mandate. How are you mitigating potential supply chain issues in aerospace if you're not able to get parts? And how do you think about that with regards to your production rate plans for Gulfstream?

Well, frankly, to the extent that there is an impact in the supply chain of this mandate, it will affect a lot of lines of business throughout the defense aerospace world. So I don't see a particular challenge at Gulfstream or in the moment at any of our other large lines of business. But we will certainly be mindful and deal with any workflow perturbations should they emerge. Look, we have a history of dealing with challenges methodically, systematically and thoroughly. So you'd expect us to approach that operating discipline and apply that operating discipline to any emerging issues that may or may not arise.

We'll now move to our next question from Peter Arment of Baird.

Phebe, maybe just to ask on the Technologies segment, just given the strong operating performance there. Is there any -- just a clarification, is there any onetimers in the 10.5% that you had this quarter?

No.

And just if not, do you view this segment being able to sustain its kind of 10% or a double-digit margin going forward or just any color around that?

Yes. Double-digit margin going forward. Okay?

Yes. No, I just -- any -- are you seeing any changes there or your ability to kind of manage that in terms of I know it's a very price competitive environment.

No. I mean not at the moment. We've been pretty consistent in our margin performance across this entity. So I don't see any systemic change that should impact that.

Our next question comes from Matt Akers of Wells Fargo.

I wonder if you could talk about for the G400, 800, just kind of early feedback. And how much, I guess, of the demand you're seeing there, sort of customers that are sort of incremental that wouldn't have bought some of your other platforms versus potentially kind of cannibalizing some of the other aircraft?

We have no instances of cannibalization to date. The 800 is ultimately a replacement for the 650. About 650 demand remains pretty steady. And the customer base is pretty much our typical customer base. There may be incremental adds here and there, but I would argue that we see that in both the 700 and 800 and frankly, the rest of that portfolio to the extent that there are incremental here and there. And this tend to be high net worth individuals or some new Fortune 1000 or 500 companies. But I think there's nothing particularly notable here in terms of being exceptional outside the norm. Other than there's a lot of good interest here. We've taken a good number of orders.

Our next question comes from Pete Skibitski of Alembic Global.

Phebe, I was wondering if you could share your thoughts on the fiscal '22 defense budget. There seems to be a lot of tailwind to the President's request in Congress. And I'm wondering if you could share with us if you see some of the support, incremental support, occurring to GD programs and maybe you'd wager odds if that budget could be signed into law by the end of this calendar year or not.

So I think you know as much as I do, given the fulsome and in-depth reporting on congressional budget processes about the likelihood of signing, so I'm not going to go speculate on hypothetical timing. But I think, importantly, all of our major and frankly all of our programs were well supported, and some are beneficiaries of increased spending on the part of the Congress. So all in all, we had no particular surprises, by the way, up or down. So we were quite comfortable on how this budget is being played out.

Our next question will be coming from Noah Poponak of Goldman Sachs.

Phebe, the -- in the business jet market at large, the end market and investors keep debating the sustainability of this recent uptick in demand and some people feel like it's...

I haven't heard a lot of that.

Yes. Exactly. Well, you've made, I guess, the pragmatic decision to kind of not wait in there. And I guess, I just wonder if you've had enough time or you speak to so many customers, if you've heard enough from real deal new customers to perhaps have more of a view on the sustainability of what we're seeing.

Well, I wouldn't be taken little about this. I think that -- and nor should anybody. I think the demand that we're seeing is, I tried to reiterate before, is across our existing customer base. The Fortune 1000 is back in force. There are, as I noted, new entrants into that market as some companies have increased their profitability over the last 2 years. And there are additional high net worth individuals who have entered into the market. So I think that the data -- and I can only speak for Gulfstream. The data would suggest that given our attractive product mix as strong, as I noted earlier, strong economy and the fact that our customers are back and broad-based demand, I'm not worried at the moment about sustainability. These are -- Gulfstream is in and business jet market is in a cyclical market, driven in part no small measure by the economy. But we have been the most resilient in terms of demand through most economic cycles. So again, I think we are [ very resilient ] and we've got a good pipeline going forward.

That's helpful. Do you have a sense, even if directionally, how many of your customers in the last 18 months are truly brand new?

We're not going to parse it, but it's pretty -- we've gotten a fair number of new folks, but also our regular and historic customers. They're back on some new customers from market share increases. So as far as I'm concerned, we had very, very good demand, and the pipeline remains robust. As that was our final question, I would like to hand back to Howard Rubel for any closing remarks.

Thank you, Melissa. Thank you, all, for joining us on our call today. As a reminder, please refer to the General Dynamics website for the third quarter earnings release and highlights presentation. If you have any other questions, I can be reached (703) 876-3117. That will now end our call.

This concludes the General Dynamics Third Quarter 2021 Earnings Call. Thank you, all, for joining, and have a great rest of your day.