General Dynamics Corporation (GD) Q2 2021 Results - Earnings Call
General Dynamics Corporation (NYSE:GD) Q2 2021 Earnings Conference Call July 28, 2021 9:00 AM ET
Company Participants
Howard Rubel - Vice President of Investor Relations
Phebe Novakovic - Chairman & Chief Executive Officer
Jason Aiken - Senior Vice President & Chief Financial Officer
Conference Call Participants
Peter Arment - Baird
Seth Seifman - JPMorgan
Kristine Liwag - Morgan Stanley
Operator
Good morning, and welcome to the General Dynamics Second Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After the presentation, there will be an opportunity to ask questions. [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, sir.
Howard Rubel
Thank you, operator, and good morning, everyone. Welcome to the General Dynamics second quarter 2021 conference call. Any forward-looking statements made today represent our estimates regarding the company's outlook. These estimates are subject to some risks and uncertainties. Additional information regarding these factors is contained in the company's 10-K, 10-Q and 8-K filings.
With that completed, I would like to turn the call over to our Chairman and Chief Executive Officer, Phebe Novakovic.
Phebe Novakovic
Thank you, Howard. Good morning, everyone, and thanks for being with us. Early this morning, we have reported earnings of $2.61 per diluted share on revenue of $9.2 billion, operating earnings of $959 million, and net income of $737 million. Revenue was essentially flat against the second quarter last year but operating earnings are up $125 million and net earnings are up $112 million, earnings per share are up $0.43.
To be a little more granular, revenue on the defense side of the business is up against last year's second quarter by $308 million or 4.2%. Aerospace is down $352 million, pretty much as planned. Operating earnings on the defense side are up $98 million or 14.3%, and operating earnings in aerospace are up $36 million on a 390 basis point improvement in operating margin. The operating margin for the entire company was 10.4%, 140 basis points better than the year ago quarter. From a slightly different perspective, we beat consensus by $0.07 per share on somewhat lower revenue than anticipated by the sell side. However, operating margin is 20 basis points lower than anticipated coupled with a somewhat lower share count, this led to the earnings feed.
On a year-to-date basis, revenue is up $596 million or 3.3% and operating earnings are up $129 million or 7.3%. Overall margins are up 40 basis points. The defense numbers are particularly good with revenue up $752 million or 5.2%, and operating earnings up $143 million or 10.3%. On the aerospace side of the business, revenue on a year-to-date basis is down $156 million or 4.3%, but earnings are up $16 million or 4% on a 90 basis point improvement in operating margins. The quarter was also very strong from a cash perspective; free cash flow of $943 million is 128% of net income. Cash flow from operating activities was 151% of net income and had a very solid quarter from an earnings perspective across the board. The year-to-date results give us solid start to the year and enabled us to raise our forecast for the full year which I will share with you at the end of these remarks.
So let me move right into some color around the performance of the business segments, have Jason add color around cash, backlog, taxes and deployment of cash, and then I will provide updated guidance and answer your questions.
First, aerospace. Let me put the aerospace results in some recent historical context, so as to put our performance into a perspective where it could be understood. As you recall, then in April of last year, we told you we were cutting production as the result of certain supply chain issues. It subsequently became clear that there was a reduction in demand related to COVID-19, that resulted in additional cuts to production. Those production cuts were implemented slowly over the ensuing months and reached their low point this quarter. You may also recall, that I told you last quarter that the second quarter would be the most challenging for Gulfstream because of these pre-planned production cuts.
On the good news side of the story, we had anticipated renewed post COVID-demand in the second half of this year and plan increased production for the second half. In short, you will see more deliveries, revenue and operating earnings in the second half as a result.
With that, let me turn to the aerospace results in the quarter. Aerospace had revenue of $1.6 billion and operating earnings of $195 million, with a 12% operating margin. Revenue was $352 million less than the year ago quarter at 17.8% as a result of fewer planned aircraft deliveries. On the other hand, operating earnings are up $36 million or 22.6% on a 390 basis point improvement in margins. From a pure operating perspective, we did very well.
From an order perspective, the quarter border norm [ph] is spectacular. In dollar terms, aerospace had a book-to-bill of 2:1. Gulfstream alone had a book-to-bill of 2.1:1, even stronger if -- it did not include any fleet sales. As previously discussed, sales activity truly accelerated in the middle of February and continued on through the remainder of the first quarter. The pipeline that developed in that quarter rolled over into the second quarter as was obvious from these results. We continue to experience a high level of interest, activity and a growing pipeline. From a new product perspective, the G500 and G600 continue to perform well. Margins are improving on a consistent basis and quality is superb. We have delivered a 115 of these aircraft to customers as we speak. The G700 has approximately 1,600 test hours from the five test aircraft. We remain on-track for entry into service in the fourth quarter 2022, but much remains to be accomplished, particularly with respect to the certification of the new Rolls-Royce engine.
Looking forward, we have planned 32 deliveries in the third quarter and 39 in the fourth. If all goes well, we may be able to bring in a few more forward from the first quarter 2022 to meet current demand.
Turning to Combat Systems; all of the comparisons Combat Systems quarter-over-quarter sequentially and year-to-date are quite favorable. Combat Systems has revenue of $1.9 billion, up 8.3% over the year ago quarter, while Ordnance and Tactical Systems did well, the primary source of growth was Combat Vehicles at both [ph], Land Systems and European Land Systems. So, all in all very good growth. It is also interesting to observe the Combat Systems revenue has grown in 17 of the last 19 quarters on a quarter over the year ago quarter basis. For the first half of the year, Combat Systems revenue was $3.7 billion, it's $257 million or 7.4% over the first half of last year.
Operating earnings for the quarter at $266 million are up 11.3% on higher volume and then a 40 basis point improvement in margin. For the first half, Combat Systems earnings of $510 million are up $48 million or 10.4% over the last year's first half. The quarter was also good for Combat Systems from an order perspective with a 1:1 book-to-bill, leaving a modest increase in total backlog. Demand for our products, particularly our combat vehicles remained strong with Europe leading the way. Abrams main battle tank demand is also increasing and the Stryker remains the Combat Vehicle of choice for multiple U.S. army missions and operations; this was an impressive performance once again by Combat Systems.
Marine Systems; revenue of $2.54 billion is up $65 million over the year ago quarter. It is also up sequentially in year-to-date. In the quarter, the growth was led by the DDG-51 and T-AO volume. Submarine construction was stable with increases in Virginia Block V and Columbia offset by a decline in Block IV and engineering. For the first half, revenue was up $302 million or 6.4%; this is very impressive continued growth, in fact revenue in this group has been up for the last 15 quarters on a quarter versus the year ago quarter basis. Operating earnings were $210 million in the quarter, up $10 million or 5% on operating margins of 8.3%. You may recall that we experienced a strike [indiscernible] year. I'm pleased to report that our relationship with the union is strong and we are both committed to improving back performance.
NASSCO is coming down the learning curve on the ESVN [ph] is nearing completion on the first of the new oilers. Repair was also strong. Electric Boat performance remains strong and finally technologies. The segment has revenues of $3.16 billion in the quarter, up $98 million from the year ago quarter or 3.2%. Technology, mostly associated with the ramp up of new programs was almost 10%. Mission Systems experienced a modest decline in revenue, driven by the sale of our space and tenant business last year, and the shortage of chips for certain products which we are working to remedy in the second half. [Technical Difficulty] EBITDA margin is an impressive 13.7%, including state and local taxes which are [Technical Difficulty]. Most of our competitors carry state and local taxes below the line.
Total backlog grew $95 million, so 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 IT was a little better than 1:1 and somewhat less at Mission Systems. This is particularly good performance in light of the continued delays by the customer in making contract awards. In total, GDIT has nearly $34 billion in submittals awaiting customer decision with most representing new work. In addition to these submittals, our first half order book does not reflect approximately $4.6 billion of awards made at GDIT that are now in protest, including two sizable contracts challenged by a competitor. These delays are pushing work we anticipated delivering in the second half of 2021 to 2022. While new award activity has generally been slower, new requests for proposals to remain robust. GDIT's hefty submittal from the first half reflect significant customer demand for modernization and securing IT infrastructure in the wake of COVID. [Indiscernible] has the opportunity to submit another nearly $20 billion in proposal through the end of the year. This concludes my remarks with respect to a very strong quarter and first half.
I'll turn the call over to our CFO, Jason Aiken for further remarks to provide you some guidance.
Jason Aiken
Thank you, Phebe, and good morning. I'll start with our cash performance in the quarter. From an operating cash flow perspective, we generated over $1.1 billion on the strength of the Gulfstream order book and additional collections on our large international Combat Vehicle contract. Including capital expenditures, our free cash flow as Phebe noted was $943 million or 128% net earnings conversion. You may recall that for the past several years, our free cash flow has been heavily weighted to the back half of the year, so the strong quarter derisks that profile somewhat and reinforces our outlook for the year of free cash flow conversion in the 95% to 100% range.
Looking at capital deployment, I mentioned the capital expenditures, which were $172 million in the quarter are 1.9% of sales. That's down from last year, but our full year expectation remains in the range of 2.5% of sales. We also paid $336 million in dividends and spent approximately $600 million on the repurchase of 3.3 million shares. That brings year-to-date repurchases to 7.9 million shares at an average price of just under $173 per share. We have 279.5 million shares outstanding at the end of the quarter. We repaid $2.5 billion of notes that matured in May in part with proceeds from $1.5 billion in notes we issued in May. We also issued $2 billion of commercial paper during the quarter to facilitate the repayment of those notes and for liquidity saving purposes, but we expect to fully retire that [indiscernible] before the end of the year. After all this, we ended the second quarter with a cash balance of just under $3 billion and a net debt position of $11.4 billion consistent with the end of last quarter and down more than $900 million from this time last year.
As a result, net interest expense in the quarter was $109 million, down from $132 million in the second quarter of 2020. That brings the interest expense for the first half of the year to $232 million down slightly from $239 million for the same period in 2020. We repaid another 500 million of notes on July 15th, as we continue to bring down our debt balance this year and beyond. At this point, we expect our interest expense for the year to be approximately $425 million. The tax rate in the quarter and the first half at 16.3% is consistent with the full-year expectation, so no change to our outlook of 16% for the year. Order activity and backlog were once again a strong story in the second quarter with a 1:1 book-to-bill for the company as a whole. As Phebe mentioned, order activity in the aerospace group led the way with a two times book-to-bill while combat and technologies each recorded a book-to-bill of 1:1 on solid year-over-year revenue growth. We finished the quarter with a total backlog of $89.2 billion, that's up over 8% over this time last year. And total potential contract value including options and IDIQ contracts was $130.3 billion.
Finally, a quick note on the operating results in the technologies group. You'll recall in the second quarter of last year, we recognized a loss of approximately $40 million on an international contract that resulted from scheduled delays caused by COVID-related travel restrictions. We formally closed out this matter with the customer this quarter. And despite the fact that our activity on the contract has been dormant for over a year, the accounting rules required us to reverse approximately $45 million of previously recognized revenue in the quarter. Without this reversal, the technologies group would have seen organic growth of 6.4% in the quarter.
That concludes my remarks and I'll turn it back over to Phebe to give you guidance for 2021 and wrap-up remarks.
Phebe Novakovic
Thank you, Jason. Now, let me do my best to give you an updated forecast. The figures I'm about to give you are all compared to our January forecast, which I will not repeat. In Aerospace, we expect an additional $200 million of revenue with an operating margin of around 12.4%, which is 10 basis point below what we previously forecast. This will result in an additional $10 million of operating earnings. There could be some upside here if we can squeeze out a few more planes in the year. With respect to the defense businesses, Combat Systems should have another $100 million of revenue and add another 10 basis points of operating margin. So, total revenue of $7.4 billion and operating margin of around 14.6%. Marine Systems has an additional $300 million and 10 basis points of improved margin, so annual revenue of $10.6 billion with an operating margin around 8.4%. Technology revenue will be down $200 million from our previous forecast, but add 30 basis points of operating margin, so annual revenue of $13 billion with an operating margin of around 9.8%. So, on a company-wide basis, we see annual revenue of about $39.2 billion and an overall operating margin around 10.6%, this rolls up to EPS around $11.50, $0.45 to $0.50 better than our forecast going into the year.
That concludes my remarks and will be a pleasure to take your questions.
Howard Rubel
Thanks, Phebe. As a reminder, we ask participants to ask one question and one follow-up, so that everyone has a chance to participate. Operator, could you please remind participants how to enter the queue?
Question-and-Answer Session
Operator
Absolutely sir. [Operator Instructions]. Today's first question comes from Peter Arment with Baird. Please go ahead.
Peter Arment
Hi, yes, good morning, Phebe and Jason.
Phebe Novakovic
Hi, Peter.
Peter Arment
Nice results. Hey, Phebe. Maybe just to start with Combat and my follow-up will be related to that. Just maybe, could you just talk about, I think, the really strong performance that you're seeing, but also, we're seeing a lot of activity in the international market that -- for some of your key platforms. Just how you think about Combat growing in what is a domestically flatter budget environment, but based on how you're doing in terms of a lot of your awards? Thanks.
Phebe Novakovic
So, domestically, both of our large platform programs. And Stryker and Abrams are continuing to grow, particularly Stryker, as the army assigns new missions and capabilities to that platform. There are also, as you all know, a number of developmental programs that factor into our longer-term thinking. Externally, outside the United States, demand is increasing, primarily driven by Europe and again that is focused and centered on our Combat vehicles, both are wheeled vehicles as well as our track vehicles, most specifically Abrams main battle tank.
Peter Arment
And just as a follow-up. Just as you talked about, I guess, some of that areas activity, have you -- do you expect that the discussions around recent comments around Poland, will that would be closing this year potentially?
Phebe Novakovic
So, you know, Poland very dangerous neighborhood. And I think there is no stronger deterrent than Abrams main battle tank. I think, press reports have suggested that they want 250 tanks for working very closely with the U.S. government to ensure we meet whatever ultimately United States and Poland determine that they want. I think our initial estimate to close is probably good solid year plus out, but again more to be -- come and then we'll keep you informed as that program unfolds.
Peter Arment
Appreciate it. Thanks a lot for the color.
Operator
And our next question today comes from Seth Seifman with J.P. Morgan. Please go ahead.
Seth Seifman
Thanks very much, and good morning.
Phebe Novakovic
Hi, Seth.
Seth Seifman
Hi, I wanted to follow up on something you mentioned in the remarks, Phebe, about what needs to be done on the engine for the G700, and I wonder if you could tell us specifically what milestones we should be looking for and what risks that the engine poses to the scheduled program?
Phebe Novakovic
So, as I noted, we continue to make progress on both the airplane and the engine development, but as I'm sure you know being a student of new engine development programs, they are always difficult to get through certification, and while there is no particular issue at the time, we still have a ways to go with respect to that certification process. But at the moment, we don't have any particular issues that would impact our overall estimation of timing.
Seth Seifman
Okay, great. Thanks very much. And then, just as a follow-up. There's been a lot of discussion in the press about the the AJAX program. So maybe if you can update us on how that's going and it doesn't really seem to be having too much of a negative impact on the segment's financial results but -- the way that it's playing into financial performance of Combat?
Phebe Novakovic
So, our U.K. customer is constructively and actively engaged in this program, and we're working very closely with them on two issues that were identified during customer test. One, is noise and one is vibration. And given our long decade long history of Combat vehicles design and production, we're quite confident that both of those issues can be satisfactorily resolved. Interestingly enough, this is a transformational vehicle for the U.K. army and with many transformational programs, testing issues emerged during the testing process, so we will then are dealing with both of those issues quite closely with our U.K. government customer.
Seth Seifman
Hey, great. Thanks very much.
Operator
And our next question today comes from Kristine Liwag with Morgan Stanley. Please go ahead.
Kristine Liwag
Hi, Phebe and Jason. Phebe, can you [indiscernible] color on the type of our profile Gulfstream or the demands from corporate or individual of U.S. versus international?
Phebe Novakovic
Sure. All in all we see a reasonable balance across the broad cross section of buyers. The U.S. had a particularly strong quarter, generating over more than half of this quarter's orders. Saw some new customers and a broadening [Technical Difficulty].
Howard Rubel
Operator, this now ends our call. Thank you very much everybody for your time. And I will be available to answer your questions, and I can be reached in my office. Thank you very much.
Operator
Ladies and gentlemen, with that we'll conclude today's conference call. We do thank you for attending. You may now disconnect your lines.
