通用動力 (GD) 2003 Q2 法說會逐字稿

Good day and welcome to the General Dynamics second quarter 2003 earnings teleconference.

Today's conference is being recorded.

For opening remarks and introductions I'd like to turn the conference over to Mr. Ray Lewis.

Please go ahead, sir.

Thank you very much, Erica.

I'd like to welcome our shareholders, members of the financial community and members of the press that are listening today.

As always, we may well make some forward-looking statements during this conference call, I'd like to remind everyone that these are our best estimates, that they are subject to the normal risks of any business and I would recommend that people look at our 10-Q's, 10-K's and annual report for a more explicit explanation of what those risks might be.

Having said that, I would like to turn it over to Mike Mancuso our chief financial officer for a quick review of the results of the second quarter.

Thank you, Ray.

Good morning ladies and gentlemen.

For those of you of that have our press release you will notice there are several exhibits attached.

We have provided, in addition to the comparative second quarter data, variance percentages, operating margin rates, selected financial data, backlog by segment, and aircraft deliveries by our aerospace unit.

Now, let me offer a few general comments on the financial data.

On Exhibit A, the consolidated statement of earnings, you will note that interest expense of $19 million is $8 million higher than one year ago.

Our net debt was higher in this quarter, as a result of the February 2003 purchase of GM defense for approximately $1.1 billion.

We have a slightly lower tax rate, 33% in the quarter, versus 34.5 a year ago.

There is no one significant settlement or issue affecting the rate.

Average shares outstanding are some 5.3 million lower this quarter.

This is the result of our share repurchase activity.

During the quarter, we repurchased 438,000 shares at an average price of about $60.

Year to date, we have repurchased a total of 4.7 million shares at about $64 per share.

A total expenditure of $300 million this year.

On Exhibit F, in addition to the break down of funded/unfunded backlog by segment, we have also included ID/IQ contract value.

As many of you know, indefinite delivery, indefinite quantity contract awards are not included in backlog by their very nature.

However, as you can see, our IS & P segment has been competitively awarded several large contracts where they are the soul provider of the products or services and there is a very high probability that the total sales value of the contract will be realized.

And, therefore, should be considered.

And finally, the lower part of Exhibit F breaks down aircraft deliveries.

Both green and completed aircraft by size.

This quarter, we have also added pre-owned deliveries.

It's our hope that you find these exhibits helpful.

With that said, let me introduce our chairman and chief executive officer, Nick Chabraja.

Thanks, Mike, ladies and gentlemen, I think I could keep my remarks brief.

The results here are pretty straightforward.

We had a very solid quarter marked by double digit sales growth, strong cash flow, a key strategic acquisition, and three very important long-term contract awards with very significant potential sales value as Mike has suggested in his remarks.

First let's talk about the cash.

In this quarter, free cash flow from operations net of capital expenditures, the way many of you seem to measure cash performance, is 221 million. 51 million above last quarter.

At the midyear point of 2003, we are just shy of 400 million of cash, on that same basis, and that's substantially ahead of our first half 2002 performance, almost 170 million.

Ahead.

Our strong sales growth is the result of continuing strong performance at both the Information Systems & Technology and Combat Systems, IS&P grew by over 19%, substantially all of that growth was organic.

Combat Systems increased by 45%, 11% of the growth is pure organic.

Now, by now, most of you know that in early June we signed an agreement to acquire Veridian in a transaction valued at 1 1/2 billion which we expect to close during this third quarter.

It will be immediately accretive to earnings.

Veridian is strategically important because it's significantly broadens our IS&P customer base, not only in defense but also in the intelligence world.

To remind you, Veridian has a 2 1/2 billion dollar backlog, and forecast sales for next year of approximately $1.4 billion.

The three major contracts awarded to us during the quarter, as outlined in our press release, have a potential sales value of $8 billion over a 10-year period.

These competitive awards provide -- to provide leading-edge technology, secure communications and ruggedized IT equipment to our DOD customers further establish General Dynamics is an industry leader in the C4ISR systems products and services areas.

Let me sum it up this way: In a quarter we strengthened up our overall business with important contract awards and a key acquisition, while maintaining our focus on cash generation and a strong balance sheet.

IS&P and Combat Systems have recorded yet another quarter of very significant, very profitable growth.

Our aerospace segment relative to its industry has performed very well in a difficult environment, and is firmly positioned to gain market advantage in a recovering economy.

I might add that sales activity was very good in June, and that has continued here in the first two weeks of July.

Our marine segment under new leadership is improving, albeit not reflected in the margins.

Electric Boat, the largest business within the segment, continues to perform very well.

Bath, under new leadership is improving.

While NASSCO continues to experience some difficulty with its commercial ship-building contracts.

The important message I think is that this business is very healthy, problems are few, and I see ample opportunity to add value for our shareholders.

Now, I think we'd be policed -- pleased to take your questions.

Erica, if you would, explain to folks how they can get into the Q&A queue.

Certainly, the question-and-answer session will be conducted electronically.

If anyone in our audience does have a question, please shall by pressing "star 1" on your touch-tone telephone.

If you are on a speaker phone, please make sure your mute function is turned off to allow your shall to reach our equipment.

Once again, "star 1" if you do have a question and we'll pause for a moment to assemble the roster.

Our first question will come from Sam Pearlstein with Jeffries and company.

Good morning.

Nick, in this upcoming third quarter is when the furlough is going to be taking place, I guess at Gulfstream.

I'm wondering, can you just talk about how, and maybe it's more for Mike, how the absorption should look in this third quarter in terms of what that does to the revenues and margins as we move from the second quarter into the third quarter?

The revenues won't be affected by the furlough, Sam, in that the production levels in the deliveries for the year have been set and obviously contemplated so the furlough -- so the issue of third quarter revenue has to do with program deliveries in the third quarter and sales activity, not a function of furlough.

Furlough's got to do with the rate of production, Sam, instead of lowering rate, we just took a month out.

Okay.

And then in terms of the Marine, I guess the new president has been there for a couple months now, in terms of an assessment and where you thought the plan had been, in terms of what the revenue and earnings potential of the next couple years of Marine is, has that changed?

You mentioned problems on the commercial side of the ships, I guess at NASSCO.

Were there any further, I guess, reserves taken in the quarter?

Look, I think we didn't expect the world to change dramatically in two months with major ship-building programs but Electric Boat which Mike Toner ran before he became the group executive and still runs, is a high-level performance organization by any standard and it continues to run smoothly.

We put new leadership or Mike did, installed new leadership at Bath, and we're seeing modest improvement.

Which is what we'd like to see.

And we expect that to continue as they develop the processes to take full advantage of their new land-level facility.

You'll recall at NASSCO that we had a difficult time with Tote and we had from time to time taken charges in connection with those two ships.

There are no additional charges in the quarter.

However, we changed our booking rate on the follow-on for tankers and that's a part of the margin that you see in the marine group.

So we're looking at that program very carefully, we're approaching it cautiously, trying to make sure that the problems we incurred in Tote don't overly infect, affect and infect the follow-on program.

I think you see relatively cautious approach here in the marine end of our business.

Okay.

Thank you.

Next we'll take a question from Cai Von Rumohr with SG Calin.

Yes, it looks like the used aircraft loss was about 28 million in the quarter.

Is that correct?

And did you take any additional write-downs on the used aircraft inventory?

It's wrong.

The number was 24.

Okay.

And it was 18 on transactions, six with respect to existing inventory,.

Cai, let me amplify a little bit here, I think it will be helpful to you.

We've had $24 million of losses on pre-owned activity in both the first and the second quarter for a total of 48.

We're cautiously optimistic that we have worked our way through this problem.

We're down to 10 pre-owned planes in inventory with a value of 118 million, 5 of those are under contract, three of them are under lease agreement, two remain unsold.

We will receive a fair amount of inventory in the last half , more than half of it has been pre-sold.

The market for us, we're finding it stabilizing.

So we have better predictive ability going forward, and we see the total year coming out somewhere in the neighborhood of $60 million of losses on the pre-owned.

So we don't expect a $24 million loss or anything like it in the third or the fourth quarter, but a little more.

Great.

And could you amplify on your comments that you saw business pick up in June and continue strong in July, maybe give us some color on that as well as some metrics?

You know, I guess April and May were abysmal, but in June, the buyers returned to the marketplace.

We had quite a number of contract executions in the quarter.

You can pretty much tell that by comparing, you know, our backlog quarter-to-quarter.

It's stayed relatively stable.

And all of the activity was almost all in June.

But the more important thing was we refreshed the pipeline significantly in June.

A lot of activity.

Our sales campaign with respect to the G200 where we went around the country showing the plane, attracted a lot of attention, and a number of very good prospects.

And we've continued to have very good sales activity here in the first two weeks of July.

So while it's not red hot, I am cautiously optimistic, and I might add that we think what we're seeing here in June and early July is some pent up demand, and it's now evident that the president's tax stimulus package is being helpful.

The 50% first-year depreciation is quite attractive to a number of corporate buyers and individual buyers, and they have mentioned that specifically in connection with their purchase activity.

So we're cautiously optimistic that this business is, from a sales perspective, getting a little bit better, from a cost perspective we're getting a lot better.

And we're looking forward cautiously to modest improvement quarter-over-quarter as we go through the remainder of the year.

That's a great answer, I'll let someone else go.

Thanks.

Our next question is from Steve Binder with Bear Stearns.

Good morning.

Good quarter.

Nick, can you touch on Gulfstream with respect to your point about cost performance and your obviously taking out a lot of overhead down there.

You talked about the used aircraft side losses diminishing over time, I'm wondering on the new equipment side, you know, do you get the sense that pricing, given the increased activity is starting to stabilize and as overhead's coming down, do we actually start seeing some improvement going forward assuming we get to some level of stability in production, should we start to see incremental improvement in margins on new equipment sales?

Yeah, I think so, Steve.

The pricing has stabilized on the 5 model, now our 550, and probably I can be a little more aggressive than stable.

It's modestly improving.

Prices are going up slightly.

In the four side of the house it's stable now, but not yet seeing the uptick we have on the 5.

So we've been pleasantly surprised, our margins are actually up on the completion side of the business, relatively stable on the service side, maybe off a point year-over-year, and, you know, it's been on the green aircraft, the manufacturing side, where we have, you know, had the most difficulty.

And that difficulty wasn't related, frankly, to our cost performance, it was related to pricing in the marketplace.

And we have had very good absorption out there on competitive products.

And, you know, I see a lot of studies floating around, some from regular sources, some sell-side folks pick those sources up and attempt to decipher them, but this isn't a global problem for us, it is highly specific with respect to highly specific products, and the picture's improving for us.

In the areas where it is important to us.

So we're working our way through this year, we don't expect the kind of pre-owned problem that we had this year to revisit us next year.

We're getting our costs in order, it's been pretty dramatic the way we've been able to take out overhead and some structural costs, and we're paying for it as we go.

We've been regularly including severance in our reporting results and closure costs of facilities, and we have those in this quarter.

So we'll have worked our way through that by the end of the year so I'm cautiously optimistic about next year, even without a dramatic upturn in the market.

Just a couple things.

Cancellations which were a bigger issue in the first quarter, were there many cancellations in the second quarter?

No.

None?

I -- maybe one, Steve.

And back in the end of the quarter, the first quarter, you did have a work in process six large green aircraft and 11 unsold mid-sized aircraft.

What's that number to at the end of the quarter?

Steve, we had three large unsold aircraft, 2G550's, 1G500, 1G550, and 1G4SP, that number would be very different today ok because we've had some activity post-close, and at the end of the quarter, we had 9G200's but recall that while we carry that inventory, there's a payable to our partner that's not due until we receive funds, and since the end of the quarter, we've made some progress there as well.

So all in all, both pre-owned and green inventory has been reduced and rather significantly.

So it's was Gulfstream is a pretty large cash generator this quarter?

Gulfstream did a real good job on cash, particularly in June.

Right.

Okay, thanks very much.

Heidi Woods of Morgan Stanley has our next question.

That's a nice quarter, guys.

Nick, can you give us a little more color on the performance at IS&P?

Were there one-time items or adjustment that is contributed to the margin performance?

No, not really.

I think there were some warring in Iraq related volume here on the secured coms side, but the margin activity was just pretty strong.

And I don't see anything here aberrational.

You've done 11.7% margins in IS&P in the first half, so are you inclined to think the 10 to 11% you talked about for the year might be too low now?

Well, certainly, it isn't going to be 10, Heidi.

My range was probably wrong.

The top end of that range is still in the range of reason, but they're going to do very well.

Okay.

Can you -- this major change in thrust at IS&P and now we sort of see it as a primary driver, can you fill us in on your strategy here?

Do you see yourself getting increasingly active on the deal front or in IS&P or are you inclined to sort of spend the next year or so digesting Veridian?

I want to talk about the quarter today, Heidi and I think we're going to get Veridian closed and get some of these things integrated, make sure I'm happy with where we are, all the way around, then I'll address the strategic.

I think, you know, if you really want to take a look, this is a business that next year is going to be $18 billion-plus.

And IS&P will probably be 6 billion more or less of that volume.

So and Gulfstream that has played large in folks' minds will be one-sixth of that volume.

Somewhere around 3 billion, give or take.

So we've reshaped the nature of this entity and I want to have a little time to give it some thought before I launch off and describe to you our next approach strategically.

Okay, that's fine.

Turning to combat, you gave us a breakdown on the sales for the GM defense.

Can you give us a little color at the operating profit contribution and you talked about Iraq contributing a little bit to IS&P did it also like-wise contribute to combat this quarter?

A little bit on the guns and ammo side.

But, you know, this was a pretty steady performance across all three of the businesses, they all did very well.

I would say that GM Canada may be surprised a little bit on the upside, but there wasn't anything dramatic here.

Stryker program continues to move along quite nicely.

And the profit contribution of GM defense?

It was a little more than we anticipated.

Okay.

And what about the -- for Gulfstream, the slots available for '03 and '04, can you give us a little color?

I know in the first quarter of '03, I think I recall that you had two large aircraft and 14 mid-sized unsold.

Where do you stand now for this year and next?

Heidi, I don't know that as I sit here.

We're running out of short-term pressure.

I mean, we kind of are getting where we need to be for the year, couple of manufacturing slots open with respect to each of our products.

I suppose we could add one or two if we had to.

You know, we could accelerate production if we needed to.

But mostly we're thinking about next year right now.

Okay.

And just one final question, Nick, just a little clarification on Other.

The profits were pretty substantial last year at this time.

And a little lower this year.

What brought it down?

Because I think I recall when you spoke last year about this time that this was going to be the new profit run rate rate?

Heidi, in the quarter last year, we adopted FAS143, which not to bore you, is -- was a new standard on how we calculate and record depletion allowance.

We had a one-time gain in the second quarter of last year.

It's not fanest -- manifesting itself this year.

But I point out on year to date, it's almost an 18% profit rate in the Other segment.

It's very -- doing very well.

It will swing seasonally, as you know.

I think there's really that and a couple of other things, Heidi.

It is seasonal and material service ran into an all of lot of rain this spring.

Whether -- weather and rain which affects construction projects so they were down a little bit.

And also, we don't take pension income on the government side, but we have been reporting a little bit over on the commercial side, not surprisingly, that's less significant than it was before, which wasn't terribly.

So a bunch of things caused that to be a little less.

Okay.

Great, thanks very much, guys.

We'll move next to Joe Nadol with JP Morgan.

Thanks, good morning.

On the IS&P side first, I was wondering if you could dig a little more into the revenue growth, the organic revenue growth, I know that Bowman was a big piece, more than half of your organic revenue growth last year.

Is that still contributing to growth or has that kind of settled in?

Bowman's still going up, secured coms, we experienced some organic growth across each and every one of the five business units that make up IS&P so it's very hard for me to parse it for you.

Okay.

Is it possible to parse out in any way or to bracket what the surge, the war surge might have been?

It wasn't enough to get excited about.

Okay.

So big picture, you know, is this a 12% internal growth business this year or is this a 20%-plus internal growth business?

I mean, it's really the major driver, I think, of your earnings year to date, and I --

I don't know, we'll see.

Okay.

And on the margin side, you had said I believe last quarter, and certainly in your 10-K that you expected sequentially declining margins due to contract mix.

You just said that 11% was still the high end of your range.

No, I didn't say that.

I said that the high end of that earlier range has become the low end.

Oh, okay.

I misunderstood you.

So you anticipate in the back half of the year, you know, you stepped up sequentially 100 basis points which is terrific.

Do you see continued gains or are the -- is the contract mix going to work a little bit against you?

I have -- I'm not ready to speculate about that, Joe, and, in fact, I wanted to set 11% kind of as a -- to give me something on the cautious side because we're now significantly more than that.

Right?

Yes.

So we'll see.

Okay.

This unfortunately for me isn't stuff that comes from my lips onto the profit and loss statement.

The guys got to earn it out there in the field and I've decided we're going to do a lot less forecasting and a lot more earning.

Okay.

One more question, in terms of - you some big orders in the quarter, a couple of IDIQ's but a good addition to your backlog.

What do you foresee as opportunities for the rest of the year?

Well, one of the big ones that jumps out and stairs you right in the face is whatever happens to the Virginia class submarine, that is right now winding its way through the Congress and will be resolved probably in joint committee.

The house did not include a multiyear, the house appropriations committee, the senate appropriations committee included a five-ship multiyear.

By, you know, we'll see whether the House cedes to the Senate's position, if they do, that will be a very healthy growth to our backlog.

But we did very well so far in both appropriation committees.

And we should see some activity through the rest of the year.

Okay.

Can you talk about Stryker a little bit in the same context?

Yes, Stryker was fully funded as best I can tell.

Remember, the House appropriations committee has acted, they have marked their bill and passed it.

And they included -- let me see here for a moment on Stryker, I think they added to the administration's request about $35 million.

And the Senate defense appropriations committee, not the full committee, included the same amount as the House.

That is, more than the president's request.

And they each added effectively $35 million long lead for brigades 5 and 6 together with strong supporting language and direction to the department of the Army.

So you've got to feel pretty good about the Stryker.

And frankly, you've got to feel pretty good about the tank, too, with money for the third ACR in the house appropriations committee bill, and no money in the Senate mark so far at least, but strong Senate language which indicates that that's a pretty ripe opportunity when the conferees get together they're philosophically identical.

The issue will be whether they find the money.

So triple-A V all funded consistent with the administration's request both for procurement and research and development for us.

So on the Combat Systems side of the ledger, pretty strong support.

The ammo is all plussed up, the ammo accounts where we live, and the munitions and the arm amounts both experienced what we -- I would call very good congressional support.

Okay.

Thanks, Nick.

We'll move next to Howard Rubel with SoundView Technology.

Hi, Nick.

Hi, Howard, how are you this morning?

Fine, thank you.

A couple things.

I want to understand first, based on your comments would that mean that the furlough that you have set aside for Gulfstream could be shortened?

No, I don't think so, Howard.

We're going to go ahead and do what we've planned to do.

It was -- it's just another way, Howard, instead of taking out heads.

It's more humane for the work force to get to the same result.

If we need to step up the pace, we can do it we think without adding people or without shortening the furlough.

I think we've pretty much established that it's a four-week furlough and that's the way it will go.

Okay.

And then when we realized that your sort of it looks like you're kind of getting orders in at the rate of about 12 a quarter, that's probably not a bad way to think about the business for the time being in that general range?

You know, we don't want to tell you that, Howard, except at the end of the year in units.

We report it in dollars but you can't be very far off, right?

Well, I'm just trying to ask leading questions to see if you'll answer them.

Actually doing a touch better but we don't want to tell you.

The Tote ship, I want to make sure I understand, is Tote finished and we're done with any more risk associated with that?

It's not finished.

It will be delivered the last one this summer, August, and the performance of the first ship has been very good so we havent, you know, incurred any sort of warranty-type claims, and I don't think that's the issue going forward the last Tote, at least I hope it's not.

I think the question for us is whether it's infected the follow-on program, the four tankers.

So we're watching that very carefully.

And as I indicated earlier, we've changed our approach to booking profit in -- on that.

And that happened in the quarter.

That's what I wanted to follow on as well.

Maybe Mike could help me with this, is that this will mean going forward you'll assume a lower level of profitability associated with the -- those tankers; is that correct?

Yeah, zero.

Until we see where we are.

But on the other hand, when we see what happens with the submarines, there's some opportunity for upside at some point because of the -- you'll then know what the loadings of the yard are at EB?

Yeah, we have upsided EB.

We have upsided Bath, and when we work our way through the existing problem, Howard, we should have terrific upside at NASSCO.

But they've got to fight their way through this thing.

And we'll get there.

I just can't tell you when.

No, I understand.

And then last with respect to Veridian, where do you stand with respect to Art Scott Radino and I guess going to the rating agencies?

I think that we have filed all the necessary papers, had our meetings with the Department of Justice, and as best I can tell, it is following a normal course.

The lawyers haven't given me any reason to believe that we won't complete this by the end of the quarter, which is, I think, what we said.

And if we get it done earlier, it will be a blessing.

But I don't see any problem rearing its ugly head here, Howard.

Thank you very much.

George Shapiro with Smith Barney has the next question.

Good morning.

Good morning, George.

A follow-up one-minute on Howard's question, in the first quarter, I think you had said there was about a $16 million charge you took on the Tote program and the if he could Tote was going to deliver in August.

So now that you've lowered the margin to zero on the tankers is it fair to say we probably don't get the second half margin pickup in the marine business that you might have thought with the Tote delivering?

I think if there's a pickup in the second half, George, it's just kind of modest.

It's fighting its way back a little bit.

But I think for anything significant, we're going to wait until we have a complete assessment on this tanker program.

And we're not there yet.

Is there a time frame like when was the -- is the first tanker supposed to be delivered that we might look forward --

We'll finish that tanker shortly after the first of the year.

So, as we move forward in the year, you know, whether it's at the end of the third quarter or the end of the fourth quarter, we'll be able to make a far better assessment.

But you kind of put your finger on it, we kind of got to get that first ship done or have it on a trend line that makes it predictable, and then we can apply learning curves and tell you how we think that program will turn out and for ourselves, determine how we'll book it going forward.

So right now I'm just not in that position, George.

Okay.

And on the pension income, I think you told us last quarter or Mike told us that 35 million had been the annual run rate for pension income, which was in that Other sector.

Would it be fair to figure that this year is maybe half that?

35's too high, probably somewhere in the low 20s.

Yeah, that's what --

Four, five, $6 million a quarter, it's out of our commercial plan.

It's going to be in that ballpark.

What I meant, Mike, was last year, I thought 35 was the number for the year.

28.

28, okay.

And so this year will be in the low 20s?

A little bit less.

Okay.

Okay.

And the last one: Nick, you had mentioned that the Combat Systems, the organic growth was 11%.

When I worked through the numbers, assuming that GM defense added maybe 220 million and ATP added maybe 60 million, I come up with the organic growth more around 6% versus 11, I'm just wondering where I might be wrong.

God only knows, George.

I mean, if you want to share your model with us, we'll tell you where you're wrong, but I'm confident that the 11% is not only accurate, but slightly on the conservative side.

Okay.

Thanks a lot.

Our next question will come from David Strauss with UBS.

Good morning.

You talked about an order pickup or activity pickup in June.

Which specific area is that pickup coming from, from corporate bars or individual bars?

How is this different than kind of your -- is it any different than from your traditional mix?

About the same, a little bit of both.

What about, could you update us in terms of the trading commitments?

I think the number was around 400 million, where does that stand now?

We're down to, I think, 321 million, is that the right number, Mike?

That's correct.

321 million.

And now that you're seeing some stabilization on the Gulfstream business, are you -- will you update delivery guidance for the full year?

Not particularly.

I think I'm comfortable with the guidance I've given you, which is none.

Because I'm tired of a flurry of articles and telephone calls about whether or not I'm accurate.

I don't think that's the issue.

We're working it as hard as we can work it, it's getting a little bit better and we'll see what it is.

Are you hearing anything tall or what are your conversations with your fractional customer?

Are they -- what's the fractional business look like?

I have no idea, I'm not in the fractional business.

So with them from time to time, right now they're not taking large numbers of aircraft so not terribly relevant to our results in the year.

Okay.

Thank you.

Chris McCray with Deutsche Banc has our next question.

Nick, I feel like IS&P is still a little bit of a black box in terms of I will elucidating some of the sources of growth, obviously Bowman is contributing and you mentioned Secure Com a couple times.

Can you maybe just take a minute or so and give us a little more sense of where that business is coming from?

I'm sure it's broad-based but maybe some of the top five things?

And just a little more help there?

Well, I, you know, I mean it's broad-based program activity.

We've been announcing program win after program win.

You get press release after press release.

I mean, if that isn't organic, what is?

No, I'm sure it is, I had hoped maybe we could identify it by market segment or somehow break it down so that we could get a better feel.

We don't have that for you today, Chris, talk to Ray and he'll give you off-line a little help, if that helps you with your writing, we'd be pleased to do that.

All right.

On GM defense, a little better than expected.

Where might that be coming from?

Is it better productivity?

Yes.

Well, we're integrating it sooner, take cost out sooner.

Okay, great.

Taking more profit.

Can you remind us of -- I think when you did the deal, it was about a 10% type of margin.

Should we be expecting better than that going forward?

Yeah, I think so.

I think we're going to do better.

I think we're going to continue to do better.

Stryker, there have been some articles about international interest there.

What do you think about timing?

Is that something that could happen in the next year or is it a longer term issue?

I'm not prepared to speculate on that.

We don't have any international Stryker in our plan going forward.

I mentioned earlier a sales forecast for next year.

There's no international Stryker in that.

So when that happens, it will be a blessing.

We'll be pleased and we'll service the business.

But we're not going to forecast it now.

And lastly, the guns and ammo side you mentioned, are you getting contracts there that are three and five-year in nature or are they really just one off supplementals that might wind down?

How would you characterize that?

Sure, they're replenishing stores, some during the conflict, some subsequent.

They're relatively modest increases in volume.

Some of which can turn into programmatics, others go away away.

Okay.

Good, thanks.

Byron Callan with Merrill Lynch has our next question.

Good morning, nice quarter, gentlemen.

Good morning, Byron, how are you?

Good, good.

A couple of things, Nick, just a very general question on the overall environment.

The OMB came out with these budget deficit estimates yesterday, 4.2% of GDP.

Are you at all concerned about the overall availability of government funding next couple of years to fund the president's plan?

Do you think this is really kind of locked down and it's something we shouldn't lose much sleep over?

Byron, it's always our concern for our products there has to be a strategic requirement of the nation to spend on its national security.

And there has to be to the wherewithal to afford it.

I take the administration at their word that this is a national priority and that it's supported by the will of the people.

And even OMB usually is cautious as can be, as they announced the anticipated deficit, the head of OMB indicated that it was very manageable.

So I think that the administration's budget forecast still shows defense and national security the broader context, at about 3.6% of gross domestic product.

That is not excessive and certainly not at the level of the Reagan buildup, for example.

So I'm cautiously optimistic that national security enjoys the will of the American people and that they will fund it.

Okay.

Great.

The -- back to the marine segment, I know we talked about Tote but you did mention this difference between the House and the Senate on the Virginia class multiyear.

I assume that's still an important driver to cost savings, margin growth in marine over the next couple of years.

Should we assume that this is going to be another dryer, once we get this rectified in conference, then maybe you'll have more visibility or be able to comment more on the marine margin?

Yeah, I think we'll know more as we work our way through the Virginia class issue, some of the contracting activity with respect to SSGN, and as we see some of the improvements we're making at Bath, take traction, these things take a while.

So look, Byron, you know what I think I am, last year we were probably guilty of delaying our sort of guidance for the following year.

We did that because we go through a discipline drill in October, early November, and you might remember that last year we were faced with a market that was really quite dynamic at Gulfstream.

And it moved around.

We didn't quite know what we were looking at.

We had trouble digesting the data.

So we wanted to give Gulfstream as long as we could to lock in their budget.

And that didn't complete until the first week in December.

And interestingly enough at that, by the time I was reporting results at year-end, and we were wrong.

We waited until December to lock them in to their operating performance, and a month, month 1/2 later, when we gave you the guidance, we were wrong.

But we don't have that kind of market today.

It is much more stable, it's less than dynamic.

And we're going to undertake to get out to the street sooner about next year.

We feel pretty comfortable on the revenue side already, otherwise I wouldn't have mentioned the figure.

But we'll go through our regular drill here in the fall, we'll get at it a little earlier because we want to get out a little earlier with respect to our anticipated earnings.

Good.

Okay.

The last thing, Nick and it's kind of a nit but we all kind of look at the same data on at least what's available for sale in the business jet market, and G5's have been relatively few, G4SP's have been really holding fairly steady, frankly declining lately but the G4's, there still seems to be a fairly high number available.

Are you just seeing in the market that the new buyers of airplanes really aren't interested in the G4's, the SP's or maybe the newer models are they what's being competitive here?

Look, I don't think a G4 which has got some age on it now, is attractive to most new airplane buyers.

It could give us some trouble against our G200, a midsized buyer might say to himself or herself, I'll at a similar price point, I think I'm going to take that G4 and spend a million bucks dialing it up.

So it's competitive at a different price point.

It provides an alternative to a mid cabin or jumbo mid buyer.

It is not really impacting us on our G400 sales.

Our competition there was earlier from our own G4SP's, and of course from DESO (phonetic) and we ran into a lot of very attractive pricing from Challenger 604's and Falcon 2000's.

While they're lesser aircraft, in my view and I think in the view of the purchasing public, you know, at a certain price point they get awful attractive to even a G400 buyer.

So we have kind of fought our way through a lot of that, I think, and a little more stable right now.

Okay.

Anything new on A12?

We couldn't have a conference call without an A12 question, right?

Well,I think you know or at least it's been in the press that after we won our victory in the court of appeals, and, you know, at least privately the Justice Department lawyers were saying that they'd won, even though it was reversed, it's a mere technicality, they have filed a relatively Vituperative petition for rehearing in enBanc, so we've got the ouch, we'll see what the federal circuit does with that, but it's not yet back before Judge Hodges.

He had called for a conference of the lawyers and then realized that he didn't have the mandate returned to him from the federal circuit.

As a result of the petition for rehearing enBanc.

And as we go through that, we'll know more when it gets back before the trial court.

Great.

Thanks a lot.

Our next question will come from Eric Hugel with Stevens Incorporated.

Good afternoon, guys.

Good quarter.

Nick, can you give me your thoughts on when you look at your free cash flow that you're going to generate this year and next year, about possibility of deploying more of it towards dividend side?

You know, Eric that's a good question, but we in many ways we're creatures of habit.

And it is at our March board meeting that management makes a relatively extensive presentation to the board on dividend consideration and the board jealously guards dividend policy as a progressive of the board and I wish not to interfere with that today but it's kind of interesting.

There have been some tax changes, I'm sure we don't see any compelling reason to accelerate consideration of that issue and I think we'll face it at the March meeting.

Okay.

Can you give us an insight into sort of the health of your Gulfstream, I guess the services side of the business, the after-market side?

Yeah, it's been good.

Their volume is down slightly year-over-year, but not bad.

You know, it's marginal.

And margins have held up reasonably well.

I'd say they're down a point maybe.

Not a big deal.

They've struggled with not having as much backlog as they're accustomed to, but they've managed to fill.

And it's pretty good.

It's a business we're interested in.

I like it very much.

We would -- this is an area where we could help them if we had some capital to deploy.

This would be an attractive place to add to this business business.

Can you give us I guess the tax rate for this quarter, is that a tax rate that we should expect going forward?

Or is that in the ballpark or a little higher?

Eric, it's in the ballpark but let me point you back to something we said in the first quarter, and that was while we expected 33-ish to be the run rate, there are a number of issues and settlements under discussion with the Internal Revenue Service.

So there's always the opportunity perhaps for a one-time benefit that would lower the tax rate.

But as we look out today, it's an appropriate guide to use in your model.

Great.

And Nick, one last question, when you were talking about your IS&P margin numbers, you were obviously not including any dilution from the Veridian deal; correct?

Absolutely.

I don't see isn't it true dilution from the Veridian deal.

To the margins?

Oh.

Margin rate.

Yeah, I'm not referring to Veridian in any respect.

Right, okay.

Thank you.

Okay.

Erica, I think we can only take one more call, then we'll have to wrap this up.

Our final question will come from Lloyd Zeetman with Bernstein Investment Research.

Hi folks, Nick, some months ago I recall you made a statement concerning the level of the Standard & Poor's 500 relative to demand in aerospace.

And I was just wondering, essentially what your thoughts are on that?

You mentioned one of the drivers being the change in tax policy.

And do you see -- how important do you see the stock market as a driver in aerospace?

You know, I'm not so sure I have an ability to assess that.

Because the customers don't talk to us about the stock market much.

I see it more as corporate earnings.

This tax thing is much talked about now by everybody.

And a little pent up demand, and one of the things I didn't expect, Lloyd, in fact, happened.

And that's the whole subject of corporate governance.

Caused our customers to be more cautious than they might otherwise be.

CEO's taking transactions that are well within their capital expenditure authority, waiting to discuss them with the board.

More concern about optics than I would have imagined.

But I think some of that's abating.

Okay.

Thank you very much.

Okay.

I want to thank everyone for joining us today.

I'm Ray Lewis, staff Vice President investor relations I'll be ready to take calls as soon as I have a bite to eat.

My number is (703)876-3195.

And good day.

That does conclude today's conference, thank you for your participation, you may now disconnect.