Good morning and welcome to the General Dynamics First Quarter 2020 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'd now like to turn the conference over to Howard Rubel, Vice President of Investor Relations. Please go ahead.

Thank you, Chad and good morning, everyone. Welcome to the General Dynamics second quarter 2020 conference call. Any forward-looking statements made today represent our estimates regarding the company's outlook. These estimates are subject to some risks and uncertainty. Additional information regarding these factors is contained in the company's 10-K, 10-Q and 8-K filings.

Thank you, Howard, and good morning, all. Before I address the company's performance in the quarter, let me briefly discuss how COVID-19 is continuing to impact us. We continue in a professional and proactive way to create a safe work environment for our people adhering to CDC guidelines, encouraging social distancing and instituting a company-wide mandatory mask policy. We temperature screen our employees and send those home who fail. These procedures have ensured that we have lower infection rates than the locales in which we operate. Of our over 100,000 employees globally, we have had 515 cases to date—less than one-half of 1%. As you would expect, we continue to incur significant program impacts which we estimate to be around $127 million by the end of the second quarter. The most significant impact appears later in my remarks. On the good news front with respect to Congress, all of our major programs are well supported in the congressional markups of the defense funding bills. As we turn to our results in the quarter, I will date comparisons that are well stated in the exhibits to the press release and focus my remarks on the operations and the significant non-recurring items in the quarter. Regarding the company's second quarter performance as you can discern from my press release, we reported earnings of $2.18 per fully diluted share on revenues of $9.26 billion, operating earnings of $841 million, and net income of $625 million. As one would expect, revenue was down $291 million or 3% against the second quarter last year. Operating earnings were down $249 million or 22.8%, and net earnings were down $181 million. The defense side of the business was down very modestly against the year-ago quarter and even less year-to-date. For the defense business, in the first half, revenue is down only six-tenths of a percent and operating earnings are down 3.7% on a 30 basis point lower operating margin. Most of the revenue and earnings challenges in shortfall occurred at GDIT and in our aerospace segment which was particularly impacted by jet aviation. I will comment on this in considerable detail later in my remarks. We experienced solid growth at combat systems and marine systems in both the quarter and the first half, along with declines in revenue at GDIT and mission systems in part caused by the divestiture of our business mission systems. However, mission systems had growth in operating earnings for both the quarter and the half on significantly improved operating margins.

Thank you, Phebe, and good morning. I will start with some observations about our balance sheet and liquidity position following our first full quarter of operations influenced by the pandemic. We generated free cash flow of $622 million in the quarter, a 100% net earnings conversion, and ended the quarter with a cash balance of $2.3 billion. Importantly, operating working capital remained essentially flat during the quarter even as we've advanced in excess of $1.1 billion to our suppliers to support their liquidity compared with approximately $360 million advanced to us by our customers over the same period.

Now let me do my best to give you an updated forecast as I promised at the end of the first quarter in an effort to be as granular as possible in the midst of significant uncertainty. Our aerospace forecast given to you at the end of the last quarter appears to be holding fairly well. We expect about $100 million less in revenue than forecasted 90 days ago, roughly $8.4 billion, and operating earnings of $1.13 billion that is about $20 million less than I gave you 90 days ago. Given everything at work here, these are very modest changes. With respect to the defense businesses, the impact is now more apparent. We're holding our full-year targets for combat systems for both revenue and earnings. Marine systems has about $200 million of sales pressure, but it is holding its earning target even assuming an extended strike at Bath. Mission systems is also holding its revenue and earnings forecast with the exception of the $150 million of divested revenue that Jason discussed. Finally, GDIT has identified between $300 million and $400 million of revenue degradation and a $130 million reduction in forecasted earnings, including the $40 million charge on the international program I discussed previously. So on a company-wide basis, we see annual revenue of about $38.4 billion and operating earnings of about $4.2 billion. This rolls to an EPS of $11 to $11.10—about a $0.30 reduction from what we forecasted at the end of the first quarter. All in all, we weathered the storm of the second quarter reasonably well. This will be the low point of the year as we and many of the analysts had anticipated. Finally, as you can see from the highlights pro forma chart we've provided with the earnings release, absent COVID, the underlying operations of the company are quite solid with double-digit first half EPS growth. That concludes my remarks and I will turn the call back to Howard for questions.

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

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

Jason, Phebe, last quarter you highlighted a lot of details around just the health of the Gulfstream backlog. You also mentioned a couple of defaults that you expected that might come back. Maybe you could just give us an update on what you're seeing regarding the health of the customers and what are you seeing in terms of the sales cycle? I know you mentioned that there was quite a challenge this quarter.

So our backlog is holding up pretty strongly which is in marked contrast to 2008-09 for example, where the backlog experienced some significant erosion. While it's very difficult to sell airplanes—in fact, impossible—over the telephone. We were in constant contact with our customers who expressed the same needs and the same requirements as they had going into this downturn. However, implied in your question I think is a little bit about the demand environment. So let me talk to you a little bit about that. As I said, we've continued to talk to our customers and we continue to see their interests much the same. We rebuilt our backlog, but this isn't simply holding our backlog; we have rebuilt our pipeline. However, this is an interesting downturn. Unlike previous downturns, this one is not driven by anything in the economy itself or in the economies of the world itself. It's driven by an exogenous force impacting the economies with closure and summonses of entire sectors and certainly slowdowns among many others. So that means, I believe that it is very hard to predict with any level of certainty and assurance what that economic recovery looks like across the world, including most particularly the United States. So when we look at where we are right now at Gulfstream, we've seen the beginning of what would appear to be an increase in demand, but it's way too soon to be able to tell the slope of that recovery.

Yes. And just as a follow-up to that, Phebe, has there been any pickup in defaults or is it still holding as expected?

Holding as expected, but I think we had five in the quarter, but holding up pretty well. We haven't seen many defaults. That, as I said, differentiates this downturn from all of the other two that I've lived through—the 2001 tech bubble and then 08/09.

Thank you. Our next question today comes from Cai von Rumohr with Cowen. Please go ahead.

Hey, good morning, guys. Phebe, could you give us an update on what's going on at Bath Iron Works because I know there was some labor stuff and some work disruption if you could update us there?

So we are working quite closely with the federal appointed mediator. So I think it's best to be somewhat quiet at this time, silent at this time, but I would note that across our company we have many union partners, and in all respects, we have very strong decades-long positive working relationships with them. This union appears, unfortunately, to be the one exception. So we just need to work through this and as I said, because we're working with the mediator, I think we're best to sort of say nothing at this point. But in any case, given their size and the fact that they are all smart shipyards, they really had an immaterial impact on the quarter.

Got you, and then maybe the one follow-up on land systems. Have you seen much of an impact yet or are you expecting to see much of an impact on the COVID on the international portion of that business, given that for some countries the spending that they're doing to stimulate their economies could potentially impact spending?

Yes. So if you're talking about in the quarter, I think it was pretty clear about what those impacts were, but in terms of the demand, first of all, we don't see any of our in-production vehicles being impacted in the slightest. I mean, these are highly performing programs that are very much in demand by our international customers. On a going forward basis, we still see that the demand—it's interesting, it's been my long-held view that whether it's in the United States or in any of our allied nations, that demand is really driven by the perception of threat. In all respects, I think there's a general consensus that the threat has not dissipated. In fact, arguably some of our potential adversaries have raised additional questions. So I think with respect to our overseas markets, I see a fair amount of stability right now. We'll see going forward, but I'm not hearing a lot at the grassroots level about any pending economic or any pending defense cuts.

And our next question today comes from Cai von Rumohr with Cowen. Please go ahead.

Yes. Thanks so much. So Phebe, good for Gulfstream given the $42 million in severance. As I go through the mix, I have a little trouble getting to your number. Was there a big cut back in R&D and SG&A or were the accrual rates on any of the newer programs 500/600 increased in the quarter?

So look, we are in the quarter; we had the severance. We had lower R&D. We expect that to continue in the year really as a result of some of the right sizing we're doing, and we had disadvantageous, as I noted in my remarks, mix. There were several 650s to international customers that, entirely because of COVID travel-related restrictions, we couldn't deliver. So I think if you add those up along with the pre-owned, you'll see that sort of gets you to the number. That helps?

A little bit. Last question, when you look at—

Come on Cai, I missed the question somehow.

Well, no, I mean, so R&D was a lot lower; is that... I mean, because you did have the disadvantageous mix? What I am trying to say is that I was surprised the profit was as strong as it was given the severance, and I guess you answered it when you said lower?

Well, okay, I am sorry. I misunderstood. So the underlying operations are quite effective, and in fact on a production level, we are really humming nicely. So I think that was a significant contribution; I know it was a significant contribution to our costs. Like we've been—as you know we took some charges that we needed to take. We had some mix issues, but this company performed beautifully operationally, and that's reflected in what we consider to be, in the environment, a pretty good margin.

And just a quick follow-up, when you look at demand for your products, can you give us some characterization in terms of where the interest is coming from? For example, is it coming from international, from domestic, high net worth corporate buyers? Any color would be great.

So as I noted, Europe and the Far East have been pretty active. In the United States, we talk to all of our customers and potential customers quite frequently, but we've been a little slower to get back into the order execution phase, though the interest remains quite intense and their needs are the same; nothing has changed about that. This is just a question of timing. We've got to get some of the economic uncertainty behind us, but look, we entered this downturn in a very strong position with the best portfolio of products unmatched by any, with a great service, the best in the industry service and support business, and by far the strongest financial position. So given that, nothing has materially changed that we can see in the nature of the orders on a going forward basis, we expect to emerge out of this stronger even than when we went in.

Thank you. Our next question today comes from Seth Seifman with JPMorgan. Please go ahead.

Hey, thanks very much, and good morning. Jason, I was wondering what's the appropriate level of working capital across General Dynamics that you guys can potentially settle out on at some point in the future, and ideally if you could express it as a percentage of sales?

Yes. I don't know that I'd peg it as a percentage of sales so much. It’s clearly at this point at an elevated state. Probably, I think over the past couple of years about what we're seeing in the combat systems group, particularly on the large international program as you're well aware at the beginning of this year. We'll see that continue, I think, in a more accelerated way over the next two to three years. So that'll have a good tailwind to it in terms of reducing the working capital level. The other big piece, of course, is Gulfstream. As we've talked about, when you're in a mode of introducing new models, that naturally comes with a working capital build associated with the test articles as well as the initial production ramp and inventory of those models, and then as you get them into full rate production you start to see that inflection point and see that turn. We had been expecting that to happen this year, but of course with the disruptions that we've seen associated with the pandemic, that has caused the production and delivery schedule to move a little bit to the right. As a result, I think the inflection point with the working capital moves a little bit to the right, but we ought to see that start to come down reasonably starting at some point in the next year. Compounding that with the combat systems’ improvements in working capital, I think those two muscle movers will have a favorable impact on our free cash flow performance over the next two to three years.

All right. Okay. Thanks very much.

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

Thanks. Good morning. Phebe, maybe you could talk to the second half implied margin transit at aerospace—obviously pretty robust bounce back—and maybe talk about what that means for ‘21? Is this 15% that you're talking about in the second half a roadmap to ‘21 in any way?

So our margin performance this year and frankly into next will benefit significantly from the charges that we took and paid for in the quarter. So that is a significant benefit. We also see a more advantageous mix to our deliveries, particularly if I am assuming that we don't get a worsening of international travel restrictions or we get zero abatement in them. So a path where we implied we've got a clear path to 70 to 75 deliveries; as I said, our operations are performing well. We have a plan to deliver each and every one of those airplanes. So we're comfortable in the moment that trajectory, while steep, is quite achievable. So going into ‘21, all the benefit from this year's cost reductions and rationalization will clearly benefit ‘21 margins.

So you could maintain the second half margins into ‘21 or maybe is that—

Well, it's going to be a little lumpy and we're not going to, I am not going to start parsing ‘21, but you can imagine that they will benefit from them.

And our next question today comes from Jon Raviv with Citi. Please go ahead.

Hey, thank you. Good morning. Jason, following up on the cash generation question, can you talk about how the rest of the year shapes up and kind of what brings you into that range? And then also, obviously things should get better going forward to get back to the more consistent 100% with all that cash coming towards you. What is the capital allocation thought and decision process going forward? You purchased any in the second quarter, but how's the capital allocation conversation going at this point?

So as it relates to the outlook on cash, I think you'll see this year frankly look quite similar to the way it's looked over the past couple of years. It's a fairly steady and steep improvement in the free cash performance in the third and fourth quarters. That's become a more frankly typical pattern for us over the past several years, and so you'll see a particularly strong fourth quarter. Again, I think that has to do with some of that working capital starting to unwind in the fourth quarter, and I think, as I described in the earlier question, we expect to see some of that working capital unwind in a more meaningful way into 2021 and frankly even ‘22 and ‘23. So those are really the underpinnings of where we see the free cash flow start to get back—not only back to 100% but we've been expecting it to get up above 100% as we look at it in the next couple of years, and it really is all about unwinding those elements of working capital. As it relates to capital deployment, I will turn it back over to Phebe perhaps to answer that question.

So I think in periods of great uncertainty, preserving liquidity is the most important thing. We did not buy any shares in the quarter, and we'll hold pat for now. With respect to that, we'll continue to honor the dividend as we've told you for years. Our dividend is the one part of capital deployment that is repeatable and predictable. So that's all I think we're going to say about capital deployment at the moment.

Thank you.

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

Good morning. Thank you. Phebe, when you talk about right sizing the operations at Gulfstream in order to get the margins, how do you think about this medium to longer term? In other words, you're right sizing to a level, but I would expect you certainly want the flexibility to take that rate up when demand re-emerges. So how do you balance the two things?

So let me give you a little bit of color on how we set in any given year the production rate, and then we can talk a little bit more in detail. So if we talk specifically about ‘21, the production rate in ‘21 will depend on the number of airplanes we have in the backlog for delivery in ‘21. The number of airplanes, particularly in the third quarter of 2020, that we sell for delivery into the third or into 2021, and then how we see demand when we set our plan. All of this is done in the fall and it's part of a long-standing disciplined process that we have had for a long time. So look, that will give us some time if we need to increase our production schedule. We've got some flexibility around that. Our production plan for next year, but it is way too soon to speculate about that. But in any case, the right sizing that we’ve done in many instances is permanent. This was a good opportunity to just cut costs, and I don't expect under any scenario for all of those costs to come back when revenue increases.

So this is something that would allow you to hopefully move margins up higher. One of the things that also I wonder if we could understand a little better is when you think about the G700 and compare that to the G500, the G650. Can you talk about how you're leveraging past designs, manufacturing processes, and should we see margins rise on the G700 more quickly than these other new programs?

I would expect that. That is unlike the other two a modification of an existing airplane. So all those lessons learned on the 650 we can apply to the 700, and you can expect us to do quite well as we come down a learning curve which will be obviously less steep. We know how to build this type of airplane. We've done it before.

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

Thanks. Good morning, everyone.

Hi David.

Phebe, on GDIT, what proportion of the business contracts or people actually need access to customer facilities and can actually just do the work from home?

So let me put it to you this way. We've got about 10% of our workforce that is either idle or underutilized, and a significant portion of that workforce is in classified areas, which has been a long-standing series of relationships we've had for many years and a good solid partnership with our customers. However, as it's impossible to do classified work from home, as our customers sort through how they judiciously and prudently bring back employees in this COVID environment, that determination will dictate how we manage moving forward. Right now, those costs are being covered by the CARES Act, but with no margins. So they've been very dilutive to margin, but ultimately this will resolve. It all depends on when our customers believe that they can get back to full steam once some of the COVID uncertainties have been eliminated.

Okay. Great. And could you give a little bit more color on the loss of jet? I guess what was unique about this situation jet as compared to the rest of your service business, and then also the exposure to pre-owned that loss there? How does that mitigate going forward? Thanks.

So jet was really about absorption. That was a headwind that we tend not to have in our other businesses. Revenue went down very quickly; there's only so and we can only take the fixed costs out so fast by any given schedule. But as I said, that will return. That was a one-time impact, and they had disproportionately more higher severance charges given the nations in which they work. So that's I think an important element of that. And with respect to the pre-owned, we discipline our inventory of pre-owned very clearly and with very strict structures. So I don't see us having much material risk on this. This was in the quarter; we're not expecting any on a going forward basis, but we'll let you know.

Thank you. Our next question today comes from Hunter Keay with Wolfe Research. Please go ahead.

Hey, thank you. Good morning. Phebe, can you talk a little bit about how the virus is impacting the fractional biz jet market? How it has impacted so far and any potential changes that you see in the landscape going forward out of this? Thank you.

Look, let the operators of the fractional businesses talk about that, but on a going forward basis, we do not see any structural change in this market. We simply don't, and we see no evidence to suggest that there would be.

Okay, and I will just squeeze one more and just to follow up on the comment about the 700 margins. Are you suggesting that margins, just to clarify, can exceed peak margins on the 650?

I think that's a little too early to declare victory, but let's just put it this way: Everything about this airplane is performing exactly as we hoped—better, in fact. We have over 100 hours of test on that airplane and all indications in all respects are outperforming in some of our specifications. So why does that matter? Because we really understand this airplane. I think it's premature to say we understand how to build it, but it's very premature to say at this juncture that we're going to eclipse those margins. As we get closer to the in-service, we get this through tests and the certification process, we'll have a little bit more color about the timing of the margins and earnings associated with that airplane going forward, but this is going to be a very good airplane for us.

Thank you, and our next question today comes from Pete Skibitski with Alembic Global. Please go ahead.

Good morning, guys.

Good morning.

Phebe, it looks like you're expecting some back half of your margin expansion at combat relative to the first half. I am just wondering, is that the Spanish facilities coming online or is there some mixed benefit potentially?

So we always ramp in the last half of the year—that's that business's pattern—but really, as you quite accurately point out, it's at our European land systems. We've got those facilities up and they're at near peak production. So that's behind us with respect to that.

Okay, and just, I have lost track of this, but the big Spanish and Morocco combat vehicle programs, when do you expect to have those under contract if they're not yet?

Well, I have learned not to speculate on the timing of sovereign governments' decisions, but I will tell you that we're going to get this, and it'll be a nice addition to the backlog.

And then operator, we'll take one more question. This upcoming one will be our last, please.

Yes, sir. And our final question today will come from Robert Stallard with Vertical Research. Please go ahead.

Yes. Thanks so much. Good morning.

Good morning.

Phebe, just a couple of quick ones on aerospace. I was wondering if you could tell us what you've been seeing on some of the more short-cycle parts of this division such as the aftermarket services in terms of trends in recent months or the FBOs? And then secondly, pricing. You commented on what you've seen in this down cycle versus previous cycles. How has pricing held up this time compared to what you've seen in the past?

Well, let me answer that in the inverse order. We have seen really no degradation in pricing, and as you well know, we consider price pressure. So we do not compete on price; we never have, and that doesn't change in this kind of environment. So our pricing is holding up pretty well. With respect to the shorter cycle aerospace businesses, those are really volume driven, particularly at the FBO; it's volume driven. So the more flying hours we get across all models of airplanes, the better the FBOs do. Service was down but only slightly. It may be a little bit mercurial through the rest of the year, but we expect nice performance on service and we expect the mix to improve as well. It was hard in the second quarter for people to get some of their airplanes in for scheduled maintenance. Most of the scheduled maintenance we did, but some of these guys couldn't travel, so it was hard to get the airplane; that will resolve.

Thank you.

Thank you. Operator, we now end this call, and thank you all for joining us today. As a reminder, please refer to General Dynamics' website for the second quarter earnings release and our highlights presentation. If you have any other questions, I can be reached at 703-876-3117.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.