General Dynamics Q3 2021 Earnings Report

General Dynamics EPS Results

• Actual EPS: $3.07
• Consensus EPS: $2.97
• Beat/Miss: Beat by +$0.10
• One Year Ago EPS: $2.90

General Dynamics Revenue Results

• Actual Revenue: $9.57 billion
• Expected Revenue: $9.86 billion
• Beat/Miss: Missed by -$287.07 million
• YoY Revenue Growth: +1.50%

General Dynamics Announcement Details

• Quarter: Q3 2021
• Date: 10/27/2021
• Time: Before Market Opens
• Conference Call Date: Tuesday, October 26, 2021
• Conference Call Time: 8:00PM ET

General Dynamics (NYSE:GD) (NYSE:GD) is an aerospace and defense company that develops and delivers products and services for government and commercial customers. Its operations are organized across four principal business areas: Aerospace, Marine Systems, Combat Systems and Technologies.

Through its Aerospace business, General Dynamics manufactures Gulfstream business jets and provides aircraft maintenance, repair and refurbishment services. Its Marine Systems businesses design and build nuclear-powered submarines and surface ships, while Combat Systems produces military vehicles, weapons systems and munitions. The Technologies segment provides information technology, cybersecurity, intelligence, communications and mission-support services.

General Dynamics traces its history to 1952, when Electric Boat and other defense-related operations were combined under the General Dynamics name. The company is headquartered in Reston, Virginia, and serves customers primarily in the United States, with business activities and customers in international markets. Its work is conducted for the U.S. Department of Defense, other government agencies, allied governments and commercial aviation customers.

General Dynamics Q3 2021 Earnings Call Transcript

Key Takeaways

• EPS beat consensus with $3.07 per share on $9.6 B revenue and a 40 bp margin lift, driving 3.8% sequential revenue growth and free cash flow at 148% of net income.
• Gulfstream backlog is at a six-year high with a 1.7:1 book-to-bill ratio, supporting plans to boost deliveries despite near-term supply-chain headwinds from ramping production.
• Combat Systems achieved an 80 bp operating margin improvement and 2.2% earnings growth on stable U.S. demand and new international prospects, while resolving vibration issues in the UK AJAX vehicle tests.
• Marine Systems revenue grew 9.6% YoY—the 16th consecutive quarter of gains—with all shipyards contributing and Electric Boat’s Columbia program on cost and schedule.
• Technologies saw a 4% revenue decline from chip shortages in Mission Systems but expanded operating margin to 10.5%, kept EPS guidance intact, and trimmed revenue outlook by $400 M.

Presentation

[Operator]

Good morning, and welcome to the General Dynamics Q3 2021 earnings conference call. All participants will be in listen-only mode. If you would like to ask a question, that'll be star followed by one on your telephone keypad. 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.

[Howard Rubel, VP of Investor Relations at General Dynamics]

Thank you, operator, and good morning, everyone. Welcome to the General Dynamics Q3 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.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

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 Q3 last year. Operating earnings are 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.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

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% of net earnings. Free cash flow was $1.275 billion, 148% of net income. This follows a very strong cash quarter performance in the Q2.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

In summary, we enjoyed a good quarter in almost all important respects. 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 there was a reduction in demand related to COVID. That resulted in additional cuts to production. Those production cuts were preplanned and implemented slowly over the ensuing months and reached their low point in the Q2 of this year.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

We had anticipated renewed post-COVID demand in the H2 of this year and planned increased production for the H2, with 32 planned deliveries in the Q3 and 39 in the Q4. In fact, demand accelerated in mid-February a full four months earlier than we had anticipated. This created opportunities but also operations and supply chain challenges for us, particularly for 2022. On balance, it is a rich problem to have. With that, let me turn to the Aerospace results in the quarter. Aerospace had revenue of $2.07 billion and operating earnings of $262 million, with a 12.7% operating margin. We managed delivery of 31 aircraft as opposed to the 32 planned. One slipped into the Q4 on customer preference.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Revenue is $91 million more than the year-ago quarter, up 4.6% on 1 fewer aircraft delivered. On the other hand, operating earnings are down $21 million on a 160 basis point degradation in margins. This was the result of an additional $28 million in G&A expenses driven by higher R&D expense and around a $20 million settlement of a supplier claim related to the allocation of warranties after the end of G550 production. This was offset, but only in part, by improved gross margins on delivered aircraft and better margins in the Gulfstream service centers. The real story here is the quarter-over-quarter sequential improvement. Sales, earnings, and margins are ramping up as planned. I will not dwell on these numbers. They are available in the charts attached to the press release.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

From an order perspective, the quarter bordered on the spectacular. In dollar terms, aerospace had a book-to-bill of 1.6 to 1. Gulfstream alone had a book-to-bill of 1.7 to 1. The Q2 was the strongest order quarter in the number of units that we had seen in quite some time. This quarter was slightly better. As previously discussed, sales activity truly accelerated in the middle of February and continued on through the remainder of the Q1. The pipeline that developed in that quarter rolled over into the Q2 and increased demand continued through the Q3. We continue to experience a high level of interest, activity, and a solid pipeline. As a result of the order activity, Gulfstream backlog this quarter is the highest in the last six years.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

From a new product perspective, the G500 and G600 continue to perform well. Margins are improving on a consistent basis and quality is excellent. We have delivered 131 of these aircraft to customers through the end of the quarter, with 20 scheduled for delivery in the Q4. These are the metrics of a successful program building further momentum. The G700 has approximately 1,800 test hours on the five-test aircraft. The new Rolls-Royce engine is performing well, but much remains to be accomplished. We remain on track for entry into service in the Q4 of 2022, with the G800 to follow in six to nine months. As I mentioned earlier, we had planned 32 deliveries in the Q3 and came up one short. The slip was attributable to customer preference.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

We had planned for 39 in the fourth and allowed one that slipped into the quarter. If everything goes as planned, we will deliver 40 aircraft in the Q4. The story in Combat Systems quarter-over-quarter, sequentially and year-to-date is all about operating excellence and continued strong margin performance. Combat Systems had revenue of $1.745 billion, down 3.1% from the year-ago quarter. However, earnings are up 2.2% over the year-ago quarter on the strength of an 80 basis point improvement in operating margin. Yet another example of strong operating leverage from Combat Systems.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Further that theme, on a year-to-date basis, Combat Systems revenue is up $201 million or 3.8%, while operating earnings are up a significant 7.4% on a 50 basis point improvement in operating margin. Demand for our combat vehicles remains stable in the U.S. with a brigade of Abrams main battle tanks per year and a half a brigade of Strykers per year. Domestic upside is possible from the MPF program where our vehicle is performing well. In the near term, we are stable internationally, but opportunity-rich in the intermediate period with order potential in Poland, the Czech Republic, Romania, Denmark and Switzerland. You may have read in the press about some noise and vibration issues in Ajax that have emerged during the program's test phase.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

We are working very closely with both the British Army and the Ministry of Defence and are confident that both technical issues can be resolved. In summary, this quarter was an impressive operating performance once again by the Combat Systems Group. Turning to Marine Systems. Revenue of $2.64 billion is up $232 million, a solid 9.6% over the year-ago quarter. The current quarter revenue growth was distributed fairly evenly across the three shipyards. It is also up sequentially in year to date. Year to date revenue is up 7.5%. This is very impressive, continued growth. In fact, revenue in this group has been up for the last 16 quarters on a quarter over year ago quarter basis.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Operating earnings are $229 million in the quarter, up $6 million or 2.7% on an operating margin of 8.7%. On a sequential basis, operating earnings are up $19 million on a 40 basis point improvement in margins. Electric Boat's performance remains strong and while still early in the Columbia first ship construction contract, the program remains on cost and schedule. We had a particularly strong quarter in our ship repair business, continuing to support our Navy customer. Throughout the group, we have a solid backlog of new construction and repair work, and our programs are well supported in the FY 2022 budget. In summary, revenue growth is clearly visible. The real opportunity, given this steady revenue visibility, is margin improvement over time. Moving to technologies.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

This segment had revenue of $3.12 billion in the quarter, down $130 million from the year-ago quarter or 4%. The revenue decrease was attributable to Mission Systems from timing on several programs, in part driven by chip shortages. On the other hand, Information Technology grew revenue against the year-ago quarter at a rate of 1.4%. Operating earnings of $327 million are up $13 million or 4.1% on a 10.5% operating margin. EBITDA margin is a truly impressive 14.4%, including state and local taxes, which are our 50 basis point drag on that result. Most of our competitors carry state and local taxes below the line.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

This quarter revenues decrease will impact the year, and we now expect revenue to be around $12.6 billion or $400 million less than our Q2 update. Earnings will, however, remain the same on better margins. Total backlog remains relatively consistent over all comparator periods. Good order activity in the quarter with a book-to-bill of 1:1 and good order prospects on the horizon. The book-to-bill at GDIT was a little better than 1:1 and somewhat less at Mission Systems. The pipeline remains active at both businesses. From an opportunity perspective, cybersecurity is a top priority throughout the government, and the budget calls for tens of billions of dollars in unclassified spending in both the defense and civil spaces. This is a significant opportunity for which we are well-positioned to support our customers' needs, particularly as more and more customers move toward a Zero Trust model.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

That concludes my remarks with respect to a very good quarter and first nine months. As we look toward the end of the year, we expect performance to be in line with the update to guidance that we gave you on the last call, except as I referenced in my remarks about Mission Systems. However, EPS guidance remains unchanged. I will now turn the call over to our CFO, Jason Aiken, for further remarks.

[Jason Aiken, SVP and CFO at General Dynamics]

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 Technologies segment. Including capital expenditures, our free cash flow was $1.3 billion, or 148% net earnings conversion. Through the first nine 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 nine 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.

[Jason Aiken, SVP and CFO at General Dynamics]

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 nine 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 Q4. 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.

[Jason Aiken, SVP and CFO at General Dynamics]

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. We ended the Q3 with a cash balance of just over $3.1 billion and a net debt position of $10.5 billion, down more than $800 million from last quarter and down $1.4 billion from this time last year. With the scheduled CP repayment in the Q4, we expect to end the year with a net debt balance below $10 billion for the first time since 2018. As a result, net interest expense in the quarter was $99 million, down from $118 million in the Q3 of 2020.

[Jason Aiken, SVP and CFO at General Dynamics]

That brings the net interest expense for the first nine months of the year to $331 million, down from $357 million for the same period in 2020. The tax rate in the quarter was 15.3%, bringing our rate to 15.9% for the first nine months, consistent with our full-year outlook, which remains around 16%. Order activity and backlog were once again a strong story in the Q3, with a 0.9 times book-to-bill for the company as a whole, bringing us to a 1:1 ratio for the first nine months and a 1.2 times ratio for the trailing twelve months. As Phebe mentioned, the order activity in the Aerospace group led the way with a 1.6 times book-to-bill in the quarter, while Technologies recorded a book-to-bill of 1:1.

[Jason Aiken, SVP and CFO at General Dynamics]

Foreign exchange rate fluctuation resulted in a $300 million reduction in backlog in the quarter, with the majority of that impact in Combat Systems. We finished the quarter with a total backlog of $88.1 billion. That's up 8% over this time last year, and total potential contract value, including options and IDIQ contracts, was $129.6 billion. That concludes my remarks, and I'll turn it back over to Howard to start the Q&A.

[Howard Rubel, VP of Investor Relations at General Dynamics]

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

[Operator]

Thank you. If you would like to ask a question, that will be star followed by one on your telephone keypad. If you do change your mind, that will be star followed by two. Our first question today comes from Myles Walton of UBS. Myles, please go ahead.

[Myles Walton, Managing Director at UBS]

Great, thanks. Phebe, I wonder, could you talk a bit about the transition, potential margin impact of the new generation of the G400 and the G800 coming online? It seems like the G800 is a pretty advantageous move for the G650 to the engine with the G700 engines. You know, usually would expect some level of reset of margins, but I'm curious if that reset will be materially lighter than we'd normally expect with the new entry into service. Thanks.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

We get a fair number of questions on this, so I think it's worthwhile walking through each element here. 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. When you think about margins in the new product development, at present we have about 3 models in production, soon to be joined by the G700. The G800 replaces the G650, and the G400 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.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

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 improved producibility. Remember, too, we are seeing margin improvement in every single one of our airplanes in services. This now tells you, again, I think it shines a spotlight on the operating leverage of Gulfstream. To amplify all of that and really give it additional uplift. Remember, all these aircraft are related. They all have the Symmetry Flight Deck. The G700 and G800 have the same engine and wings and the same basic fuselage. The G400 and G500, G600 have the same engines or similar engines from the same family, from one supplier, and the same basic fuselage.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

This commonality alliance 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.

[Jason Aiken, SVP and CFO at General Dynamics]

Yeah. 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? As a reminder, you know, we have a long-term steady commitment and demonstrated performance of investing in Gulfstream's product development and new technologies over time. 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 is behind us, but has been part and parcel to that spend over time. R&D spend is a period expense over time.

[Jason Aiken, SVP and CFO at General Dynamics]

As Phoebe mentioned, the G400, while a clean sheet airplane, is part of the 500 and 600 developments, and so the commonality among those helps keep that spend down. 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 in R&D spend.

[Jason Aiken, SVP and CFO at General Dynamics]

Overall, the period expense for these programs, including the two that were announced this month, are right inside that line of company-sponsored R&D. 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.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

What does all that mean if you step back? Margins this year are at their low point in aerospace. Next year, margins will improve, and 2023 margins will improve. Earnings were better in 2021 than they were last year. They're gonna be better in 2022 and 2023. By the way, when we give you guidance on the next call, we're gonna give you some color and some insight into both of those years to help explain and amplify again what we're looking at Gulfstream. I hope that helps answer your question, Miles.

[Myles Walton, Managing Director at UBS]

No, that's great. Thanks, Phebe. I'll stick to one.

[Operator]

Thank you, Miles. We'll now move on to our next question, which will be coming from David Strauss. David, please go ahead.

[David Strauss, Managing Director and Equity Research at Barclays]

Thanks. Good morning. Phebe, wanted to ask you highlighted that the Gulfstream backlog is the highest it's been in about six years. I think if I just take kind of the aircraft revenue, you've got you know, something like two and a half years in backlog based on today. And at the same time, you also comment on supply chain challenges. How do you balance all that as you think about where production rates go at Gulfstream?

[Phebe Novakovic, Chairman and CEO at General Dynamics]

The increased demand supports increased production. We'll get into all that specificity on the next call. 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. That's a little bit of a headwind, but that's why I wanted to give you the color around the margin and earnings performance.

[David Strauss, Managing Director and Equity Research at Barclays]

Okay. All that being said, we should see higher production in 2022 and 2023.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

We're anticipating that to drive the higher revenue.

[David Strauss, Managing Director and Equity Research at Barclays]

All right. Thank you very much.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

You know what 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 nice strong backlog. We've got very good demand, a continuing demand." 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.

[David Strauss, Managing Director and Equity Research at Barclays]

Very helpful. Thank you.

[Operator]

Thank you, David. We're now going to move over to Robert Stallard of Vertical Research. Okay, Robert, your line is now open.

[Robert Stallard, Partner at Vertical Research]

Thanks so much. Good morning.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Morning.

[Robert Stallard, Partner at 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. One of your peers also talked about broader supply chain challenges in its defense businesses. I was wondering if you could comment on this topic generally and what you could be seeing in the future. Thank you.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

I tried to give you some measured look at the aerospace issues, on supply chain, the chip shortage impact impacted Mission Systems. I would note 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. Across the portfolio of our defense businesses, we are not seeing significant or even material supply chain challenges. We've been able to manage through that pretty well. For us, and I can only speak for us, that hasn't been a significant issue other than

[Phebe Novakovic, Chairman and CEO at General Dynamics]

its impact at technologies and driven by Mission Systems.

[Robert Stallard, Partner at Vertical Research]

Yeah. In aerospace, the challenges there, is that just a lead time issue with suppliers, or is it specific parts that you're finding, particularly tight?

[Phebe Novakovic, Chairman and CEO at General Dynamics]

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

[Robert Stallard, Partner at Vertical Research]

Yeah, that makes sense. Thank you very much.

[Operator]

Thank you, Robert. We're now gonna move over to Cai von Rumohr of Cowen. Cai, over to you.

[Cai von Rumohr, Managing Director at Cowen]

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

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Let me answer those in the inverse order. We have seen some upward pressure on pricing and then let me unpack your demand. Look, our 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, increased high net worth individuals, and in fact, COVID did create in pockets some wealth creation, and the pent-up demand that built up during the pandemic. You know, the demand is, and I think importantly, it's spread evenly pretty much across our product line. There's nothing unusual to report on customer mix or geographic distribution other than North America was quite strong.

[Cai von Rumohr, Managing Director at Cowen]

Excellent. That's all I have. Thanks so much.

[Operator]

Thank you, Kai. We're now gonna move to Ronald Epstein of Bank of America. Ron, the line is yours.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Hi, Ron.

[Ronald Epstein, Managing Director and Equity Research at Bank of America]

Yeah. Hey, good morning, Phebe. Just maybe changing gears a little bit. I think everybody's gonna focus on BizJet, so I'm gonna maybe not do that. A while back, there was some discussion-

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Oh, my. How innovative.

[Ronald Epstein, Managing Director and Equity Research at Bank of America]

Imagine that, right?

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Yes, Ron.

[Ronald Epstein, Managing Director and Equity Research at Bank of America]

There was some discussion in the press around the Polish Ministry of National Defence purchasing some Abrams tanks, M1 Abrams. I think maybe 250 of them, if I remember right.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Right.

[Ronald Epstein, Managing Director and Equity Research at Bank of America]

Where does that stand? If you can give some color on that and maybe some of the other international business going on in the Land Systems business.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Yeah. 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. Frankly, this is a powerful system for the Poles to have, given their geographic location and their historical experience, particularly with folks, you know, streaming west. If we think through, again, the FMS process, and this is an FMS sale, we're looking at somewhere between maybe in the two-year period. 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. You know, the world hasn't gotten any safer.

[Ronald Epstein, Managing Director and Equity Research at Bank of America]

Great. Thank you.

[Operator]

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

[Richard Safran, Managing Director and Senior Analyst at Seaport Research Partners]

Phebe, Jason, Howard, good morning.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Good morning.

[Richard Safran, Managing Director and Senior Analyst at Seaport Research Partners]

Thanks. Phebe, Jason, Howard, good morning. How are you?

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Good.

[Richard Safran, Managing Director and Senior Analyst at Seaport Research Partners]

You know, well, that's good to hear. 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? You know, I think in the past you've stated, you know, you invest in the business depending on need and that dividends should be repeatable. I was just curious if there's any update here on how you're thinking about it.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Let me give you the strategic framework, and then Jason can fill in any specifics. 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 on our capital, dividends and opportunistic share repurchase. This has been our strategy from the day one and the advent of this management team. Jason?

[Jason Aiken, SVP and CFO at General Dynamics]

Yeah, I think the only thing I'd add is to your point on the commercial paper repayment and future priorities around debt is, you know, that commercial paper will mature here in the Q4. 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'll come due, so no real imminent issues there. So, we can focus on the priorities Phoebe mentioned. 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.

[Richard Safran, Managing Director and Senior Analyst at Seaport Research Partners]

Well, thanks very much.

[Operator]

Thank you, Richard. We'll now be taking our next question from Seth Seifman of J.P. Morgan. Seth, your line is now open.

[Seth Seifman, Executive Director at J.P. Morgan]

Great. Thanks very much, and good morning, everyone.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Hi, Seth.

[Seth Seifman, Executive Director at J.P. Morgan]

Phebe. Hi. Phebe, when you think about the certification timeline for the 700 and the 800, I guess or is there anything you can point out to as, you know, a long pole in the tent? 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.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Yeah. Our estimate at the moment still remains late next year for the G700, with the G800 to follow 6 to 9 months later. For those of you who have followed engine certification for years and decades, some of you'll know that they are always challenging. This engine is performing extremely well in terms of its capability and either meeting or outperforming its design specification. We've got a lot of tests to go on a going forward basis to get through. We don't see any particular issues at the moment. We are mindful that these are always complex and challenging processes to work through. Look, we've adapted to changes in our regulators in the FAA's game book before.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

At the moment we don't see any reason to adjust our estimates, but if we do, we'll let you know.

[Seth Seifman, Executive Director at J.P. Morgan]

Great. Thanks. Maybe just as a follow-up for Jason.

[Seth Seifman, Executive Director at J.P. Morgan]

If you could update us on where you know you expect to be on working capital at the end of this year and then kind of you know maybe without specific guidance, just what the opportunity buckets are in working capital for 2022.

[Jason Aiken, SVP and CFO at General Dynamics]

I think as you can see from the exhibits this morning, working capital was a benefit, call it in the $200 to 300 to 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 in the quarter, as well as the continued sale of the last of the test articles from the G500 and G600 programs. 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.

[Jason Aiken, SVP and CFO at General Dynamics]

I think as you look ahead, we would expect to see working capital to continue to be a benefit in the Q4 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. Part of that is the continued demand cadence at Gulfstream. Once we get through the G700 program, we would look to sell off those test articles as well. Then of course you've got the ongoing benefits at Combat Systems.

[Jason Aiken, SVP and CFO at General Dynamics]

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 2022, as well as into 2023. 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. That'll start to come down next year and return more to the normal historical level we see by 2023. 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 two, three years.

[Seth Seifman, Executive Director at J.P. Morgan]

Great. Thanks. Thanks very much.

[Operator]

Thank you, Seth. Our next question will be from Kristine Liwag from Morgan Stanley. Khristine, over to you.

[Kristine Liwag, Executive Director at Morgan Stanley]

Good morning, Phebe, and Howard and Jason.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Morning.

[Kristine Liwag, Executive Director at Morgan Stanley]

Phebe, how do you anticipate the vaccine executive order will affect labor and production? Also, do you have a sense of, you know, the percentage of GD employees that are currently vaccinated?

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Yeah. Before I get into the mandate, I'd like to take the opportunity to reiterate again our acknowledgment of our workforce. You know, I think it's important to remember that we were declared a critical national infrastructure business early in the onset of the pandemic. 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.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

As you well know, as a federal contractor, we are covered by the executive order on the mandates. 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. Because of our customer operational and geographic diversity of many of the businesses, we are working with our customers as contract modifications are received that could trigger an implementation. We keep a pretty running tally. We believe in some form of either full or partial vaccination in the 75% range or so. We understand the mandate.

[Kristine Liwag, Executive Director at Morgan Stanley]

Thanks. Maybe, if I could add, one on supply chain and aerospace. You know, 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? How do you think about that with regards to your production rate plans for Gulfstream?

[Phebe Novakovic, Chairman and CEO at General Dynamics]

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

[Kristine Liwag, Executive Director at Morgan Stanley]

Thank you very much, Phebe.

[Operator]

Thank you, Kristine. We'll now move to our next question from Peter Arment of Baird. Peter, please proceed with your question.

[Peter Arment, Senior Research Analyst at Baird]

Yes, thanks. Yeah, good morning, Phoebe. Good morning, everyone.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Morning.

[Peter Arment, Senior Research Analyst at Baird]

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

[Phebe Novakovic, Chairman and CEO at General Dynamics]

No.

[Peter Arment, Senior Research Analyst at Baird]

Just, and if not, you know, do you view, you know, this segment being able to, you know, sustain its kind of 10% or a double-digit margin going forward or just any thought around that, thanks.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Yes, double-digit margin going forward. Okay?

[Peter Arment, Senior Research Analyst at Baird]

Are you seeing any changes there or your ability to kind of manage that in terms of-

[Phebe Novakovic, Chairman and CEO at General Dynamics]

No.

[Peter Arment, Senior Research Analyst at Baird]

I know it's a very price competitive environment.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

No. I mean, you know, not at the moment. We've been pretty consistent in our margin performance across this entity, so I don't see any.

[Peter Arment, Senior Research Analyst at Baird]

Okay.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Systemic change that should impact that.

[Peter Arment, Senior Research Analyst at Baird]

Great. I'll leave it at one. Thanks.

[Operator]

Thank you, Peter. Our next question comes from Matthew Akers of Wells Fargo. Matt, over to you.

[Matthew Akers, Senior Equity Analyst at Wells Fargo]

Hi, good morning. Thanks.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Morning.

[Matthew Akers, Senior Equity Analyst at Wells Fargo]

I wonder if you could talk about the G400, G800, just kind of early feedback and, you know, 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, you know, potentially kind of cannibalizing some of the other aircraft.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

We have no instances of cannibalization to date. The 800 is ultimately a replacement for the 650, but 650 demand remains pretty steady. 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 tends to be high net worth individuals or some new Fortune 1000 or 500 companies. 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.

[Matthew Akers, Senior Equity Analyst at Wells Fargo]

Great. Thanks, Phebe.

[Operator]

Thank you, Matt. Our next question comes from Peter Skibitski of Alembic Global. Pete, over to you.

[Peter Skibitski, Director, Aerospace and Defense Equity Research at Alembic Global Advisors]

Hey, good morning, everyone.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Good morning.

[Peter Skibitski, Director, Aerospace and Defense Equity Research at Alembic Global Advisors]

Phebe, I was wondering if you could share your thoughts on the fiscal 2022 defense budget. There seems to be a lot of tailwind to the President's request in Congress. I'm wondering if you could share with us if you see some of the support, you know, incremental support accruing to GD programs. You know, maybe you'd wager your odds on if that budget could be signed into law by the end of this calendar year or not.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

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. I'm not gonna go speculate on hypothetical timing. I think importantly, all of our major and frankly, all of our programs were well supported, and some were beneficiaries of increased spending on the part of the Congress. All in all, we had no particular surprises, by the way, up or down. We were quite comfortable in how this budget is being played out.

[Peter Skibitski, Director, Aerospace and Defense Equity Research at Alembic Global Advisors]

I'll leave it at that. Thank you.

[Howard Rubel, VP of Investor Relations at General Dynamics]

Operator, we'll just take one more question. Thank you, please.

[Operator]

Of course. Our next question will be coming from Noah Poponak of Goldman Sachs. Noah, over to you.

[Noah Poponak, Managing Director and Equity Research at Goldman Sachs]

Thanks. Good morning, everybody.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Good morning.

[Noah Poponak, Managing Director and Equity Research at Goldman Sachs]

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

[Phebe Novakovic, Chairman and CEO at General Dynamics]

I haven't heard a lot of that.

[Noah Poponak, Managing Director and Equity Research at Goldman Sachs]

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

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Well, I wouldn't be chicken little about this. I think that, and nor should anybody. I think the demand that we're seeing, as 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 two years. There are additional high net worth individuals, who have entered into the market. I think that the data, and I can only speak for Gulfstream. The data would suggest that given our attractive product mix, the 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.

[Phebe Novakovic, Chairman and CEO at General Dynamics]

Gulfstream is in the business jet market, which is in a cyclical market driven in part in no small measure by the economy. We have been the most resilient in terms of demand through most economic cycles. Again, I think we are very good.

[Noah Poponak, Managing Director and Equity Research at Goldman Sachs]

Do you have a sense to-

[Phebe Novakovic, Chairman and CEO at General Dynamics]

We've got a good pipeline going forward.

[Noah Poponak, Managing Director and Equity Research at Goldman Sachs]

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

[Phebe Novakovic, Chairman and CEO at General Dynamics]

We're not gonna parse it, but it's pretty. We've gotten a fair number of new folks, but also our regular and historic customers are back, and some new customers from market share increases. All, you know, so as far as I'm concerned, we had very good demand and the pipeline remains robust.

[Noah Poponak, Managing Director and Equity Research at Goldman Sachs]

Great. Okay. Thanks a lot.

[Operator]

Thank you, Noah. As that was our final question, I would like to hand back to Howard Rubel for any closing remarks.

[Howard Rubel, VP of Investor Relations at General Dynamics]

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 Q3 earnings release and highlights presentation. If you have any other questions, I can be reached at 703-876-3117. That will now end our call.

[Operator]

This concludes the General Dynamics Q3 2021 earnings call. Thank you all for joining, and have a great rest of your day.

Participants

Executives

• Howard Rubel, VP of Investor Relations
• Jason Aiken, SVP and CFO
• Phebe Novakovic, Chairman and CEO

Analysts

• Cai von Rumohr, Managing Director at Cowen
• David Strauss, Managing Director and Equity Research at Barclays
• Kristine Liwag, Executive Director at Morgan Stanley
• Matthew Akers, Senior Equity Analyst at Wells Fargo
• Myles Walton, Managing Director at UBS
• Noah Poponak, Managing Director and Equity Research at Goldman Sachs
• Peter Arment, Senior Research Analyst at Baird
• Peter Skibitski, Director, Aerospace and Defense Equity Research at Alembic Global Advisors
• Richard Safran, Managing Director and Senior Analyst at Seaport Research Partners
• Robert Stallard, Partner at Vertical Research
• Ronald Epstein, Managing Director and Equity Research at Bank of America
• Seth Seifman, Executive Director at J.P. Morgan