通用動力 (GD) 2007 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2007 General Dynamics financial results conference call.

(OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr.

Ray Lewis, Staff Vice President Investor Relations.

Please proceed, sir.

Thank you very much.

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

As always, I would remind you that any forward-looking statements that may be made today represent our best estimates for future performance and results, but are subject to the risks of any business and that those risks are outlined more fully in our 10-Q's and 10-K's.

A couple of ground rules.

As usual, we are going to limit you to one question.

If you have a second question, we'd remind you to get into the queue at the end of the line.

We know today is a very busy day for everyone, including ourselves, unfortunately.

And we will have to limit our time a little bit today.

The good news is that it was a very straightforward quarter, I don't think there's a lot of complexity here.

But we will be closing the call at about a quarter to 12.

With that said, I'll turn it over to our CEO, Nick Chabraja.

Thanks, Ray and good morning.

Consistent with Ray's remarks, I'll keep mine very brief.

This was obviously a good quarter with earnings per share of $1.07.

Gives us a strong start to the year.

Sales, to state the obvious, were $6.3 billion, that's up 13.6% from the first quarter a year ago.

Operating earnings of $681 million increased 14.3% from a year ago, reflecting operating leverage, obviously.

Operating margins expanded 10 basis points to 10.8%.

I think importantly we experienced solid earnings performance across all of our four business segments and that always pleases me.

I'm equally pleased with our cash performance.

We generated $469 million of free cash flow from operations, about 107% of net earnings from continuing operations.

Let me spend a minute on Gulfstream.

Gulfstream revenues rose 17.8% over the first quarter 2006.

The sales growth and a 20 basis-point margin expansion drove a 19.3% growth in operating earnings.

Total backlog increased 9.8% from the end of 2006 on the strength of a very robust order book during the quarter.

For those of you that are struggling with a calculation here, the book-to-bill ratio expressed in dollars was 1.78 times for the quarter.

I should mention that Joe Lombardo has succeeded Bryan Moss as Executive Vice President of General Dynamics for Aerospace and is President of Gulfstream.

Joe was most recently Vice President, Chief Operating Officer down at Gulfstream and has been a Corporate Vice President for some time.

His operations and manufacturing expertise should enable him to capitalize on the very strong backlog at Gulfstream.

Joe, I might add, had served for quite some time as the Chairman of our manufacturing counsel company-wide here and distinguished himself in that position and extended his leadership well beyond Gulfstream's operations.

As with Gulfstream, Combat Systems had strong sales growth and margin improvement over the first quarter of 2006.

Sales were up 14.5% and earnings were up 18.4%.

Margins improved 40 basis points, and I think Combat Systems is well-positioned to improve its margins as we go forward during the year.

Backlog increased some $400 million during the period as a result of strong orders across the segment.

Turning to Marine Systems, sales were down slightly over the year-ago quarter, I think about 1%, margins rose 20 basis points indicating that the significant margin improvement we witnessed last year is continuing.

Our experience this quarter tells me that the year is shaping up in Marine consistent with our expectations.

We see essentially flat sales and a real opportunity to exceed 8% margins for the year.

Finally, the information systems and technology segment, I think, performed very well in the face of some modest headwinds.

As you know, the Significant Bowman program in the United Kingdom is now ramping down and we had relatively significant volume decrease in the United Kingdom.

Not withstanding Bowman, sales increased 20.7% and earnings grew 13.6%.

Margins are somewhat down from the first quarter a year ago in part due to the Anteon acquisition.

While the sales increase of 20.7% is robust, it is largely attributable to the acquisitions we made and closed later in the year last year, including Anteon.

In anticipation of George Shapiro's question, we did close calculations on this issue.

The organic growth overall through this segment was 2.9%.

I want to give you a little slightly different slice of this, however.

If we were to exclude General Dynamics' United Kingdom and the impact of Bowman, the organic growth rate for North America was 6.7%.

So we're starting to see a little traction here in our organic growth rate in the United States and Canada.

So in summary, the first quarter 2007 was very strong, frankly better than we had expected.

Two of our segments are right on, consistent with my guidance that I gave you last quarter.

The other two outperformed our expectations.

I'd like to conclude by telling you that I'm extremely proud of our people.

We are performing well on our contracts, resulting in steady financial performance as we have witnessed not only this quarter but over quite a period of time, and continuing to demonstrate our commitment to our customers.

Let me call on Hugh Redd, our Chief Financial Officer, to give you a little additional insight on some of these numbers.

Thank you, Nick, I've just got three additional points, the first one being interest expense, which is 9 million higher than it was in the first quarter of last year.

Due because -- due to the increase in net debt of about 600 million.

And that net debt increased with the acquisitions in the IS&T and Combat Systems groups.

The second point is the effective tax rate for the quarter was 32.9%, which is at the higher end of our expectations.

And I just want to note that we still see the effective tax rate for the year to be consistent with what it was last year.

And then finally, during the quarter, we repurchased just over 2 million shares at an average price of $76.01.

That concludes all I have to add.

Ray, I'll turn it over to you.

Well, thank you, Hugh.

We're about to do Q&A.

I would remind people that we're limiting it to one question at a time.

If you have more than one question, please get back in the queue.

Because of the constraints we tried to make our comments as concise and brief as possible to leave ample room for questions.

And with that said, if you would, please explain to folks how they can get in line to ask questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Steve Binder with Bear Stearns.

Good morning.

Could you maybe just touch on R&D and SG&A as a combined bucket at Gulfstream in Q1 versus Q4, what did that bucket of expense look like?

Up a little bit.

As a percent of sales.

Up a little bit in all respects.

Okay.

Just as a follow-on, CapEx is pretty light, you talked about $500 million in your 10-K for 2007 because of what's being done at Gulfstream.

Is that number going to be -- does that ramp-up significantly in the next three-quarters?

It's going to go up.

It looked light in the first quarter to me, too.

It will go up.

You expect to stay with that plan of $500 million?

More or less, yes.

All right.

I'll get back in the queue.

Your next question comes from the line of Byron Callan with Prudential.

Good morning, gentlemen.

Nick, it's come up on the other calls, do you just want to share your perspective on the defense environment, what kinds of needs have changed and dialog or lack thereof between the industry, Congress, and different parts of the DOD?

I don't think I really have much to say on that subject, I think we're having what I view to be constructive and wholesome dialog with our customers as we always have.

I don't see a major issue here.

So I don't think there's anything I can contribute to enlighten you on that subject.

Okay.

I'll get back in the queue.

Your next question comes from the line of Joe Campbell with Lehman Brothers.

Good morning, it's actually [Carter Copeland].

Nick, it looked like IS&T was, excluding the Bowman decline, much stronger than anybody would have anticipated given the sort of weaknesses that we expected and have referenced in the past regarding AIS.

Did something surprise you there in the quarter?

And has anything changed in terms of your outlook for at that business for the rest of the year?

Carter, let me break your question into two parts.

One is surprise with the results and then outlook, okay?

Yes.

I think I was a touch surprised on the revenue side.

We have been struggling with organic growth and we're a little mystified by that because we did have a robust, both opportunity set and a nice backlog.

We won a lot of programs and it just seemed to be a lot of trouble breaking money loose.

So I was surprised on the revenue point.

Not by an enormous amount but by some.

As far as outlook is concerned, I guess I want to say I'm encouraged.

But I don't have enough insight at this point in time to offer a prognostication here.

I'm just pleased with the results for the quarter, I think they're fighting hard, doing a good job.

And AIS has been struggling and is, in terms of revenue from its customer set.

But the other guys, obviously, picked it up.

So it was GD UK, and AIS on the light side, strong performance, C4 systems and General Dynamics IT.

So is it fair to say that since you haven't updated the outlook based on this quarter, which was positively surprising, is some of that conservative because of the current budget situation and whether or not we know if there's going to be some reprioritization there?

Carter, I'm not sure the thrust of the question.

I mean, if it's a left handed request for further guidance, I think I won't be doing that this quarter.

I think there is enough uncertainty in the budget and supplemental environments that it's a little foolhardy.

And I think my prior practice in the last couple of years has been to give you a bottoms up analysis at the end of the second quarter.

I think I'll do that again here.

There are enough moving parts that I'm not certain of all of the implications of this very good quarter.

But I will do a bottoms-up with my unit presence towards the end of the second quarter and I'll get some -- what I think will be a very, very reliable forecast and guidance for you for the rest of the year at that time.

Great, that's helpful.

Thank you very much.

Your next question comes from the line of David Strauss with UBS.

Good morning, hi Nick.

Hi David.

I apologize if this has been asked or you commented, I'm switching back and forth between two calls.

Obviously Gulfstream order activity very strong in the quarter.

Could you just give a breakdown between domestic and international and how you feel about both parts of the market right now?

They're both strong and growing, and I'll flip, because I can't remember with great certainty -- yes, now I have it -- in the first quarter, 56% of the orders were from the United States and Canada, North America.

Which is relatively consistent with last year.

The remainder from international markets, which continue to grow in percentage terms more rapidly than the North American market, although in absolute terms, the North American market continues quite robust growth.

Thanks.

Am I allowed a follow-up?

Not supposed to but everybody else is.

EMRAP, can you just comment on EMRAP, obviously Force Protection got a big order a couple days ago, your part of the JV.

Have you assumed anything as far as EMRAP in the guidance you've given previously?

I don't know how to pair that with the guidance I've given you.

I'd have to go down in the LAN systems plan and see what their forecast is with respect to that.

I don't know the truth of that matter.

This looks to me to be about $240 million of revenue recognition for us in the year, assuming that they get it funded and off to us in a timely way.

Okay.

Thanks.

Your next question comes from the line of Rob Spingarn with Credit Suisse.

This is [Pete Kovitzky].

Hi, Nick.

Hi, Pete, how are you?

Good, good.

Nick, last year you had a sequential sales decline in the second quarter at Marine.

I'm just wondering if you have any expectations that will happen again this year, being that I think SSGN is supposed to wind down?

No, I don't think so, Pete.

I don't know that I've gone into it quite that deeply.

I think I see it pretty steady Eddie.

While the sales in the first quarter were down against the year-ago quarter, they were up against the third and fourth quarters.

So I think the business base is pretty much the same business base that we were enjoying a year ago.

What bops around a little bit quarter-to-quarter is the volume of repair work.

And even that's fairly steady at NASSCO but a little bit unpredictable at Electric Boat and even more so at Bath.

So that's the variability there I think, at this point.

Got you.

I'll get back in the queue.

Okay, thanks, Pete.

Your next question comes from the line of David Gremmels with Thomas Weisel Partners.

Good morning, Nick.

David.

With respect to potential delays in the supplemental, how concerned are you regarding disruption and if it is delayed is there a point in time at which it starts to become a more significant issue for you, if that -- if it's not signed?

David, these are things I'm not given to worry about.

They are beyond my control.

I should worry about the things that are under my management authority and we do the best we can with what we're given by the Congress and by our customer.

I think -- I'm always cautious about my expectations from supplementals and I've cautioned all of you many times.

So I think we don't expect a whole lot of upset in the second and third quarters at least as a result of this process, very important, highly visible political process, and we'll watch it with great interest, not only as defense contractors, but as Americans and Patriots.

We'll all watch this, it's important to the Nation.

Fair enough.

And I'll sneak a follow-up in as well.

On capital deployment, even with the share repurchase in the quarter, it looks like your net debt to capital probably goes below 10% in the current quarter.

Can you just talk about what you're thinking regarding share buybacks versus M&A and maybe the status of the M&A pipeline?

We tend to buy stock on what we think is softness and we had a good opportunity in the first quarter and we bought a couple million shares, the market gives us a good chance second quarter we'll do it again.

We're always looking to strengthen our businesses across the four segments.

And when we find M&A opportunities that make sense to us, we can move very rapidly, as you correctly point out that the barrel is fully loaded here.

Thanks very much.

Your next question comes from the line of Myles Walton with CIBC World Markets.

Thanks, good morning, guys.

Good morning, Miles.

On Gulfstream, obviously strong order demand seems to be quite persistent.

Nick, can you remind us what your production outlook is for '08 as well as as you see it.

Are you satisfying the demand that's out there, or are you having to give up some business because of capacity constraints?

Myles, let's see if I can't cover first the facts.

This year -- and I'm going to limit myself to the large numbers because they're more readily at the tip of my tongue.

We plan to build and deliver 82 of the 550's and 450's, and that includes 500's and 350's in smaller number.

And our operating plan shows 83 next year.

Now, I had told all of you that the demand would enable us to produce more if we could efficiently do so.

And some of our supply chain struggles have improved considerably.

And our productivity in the first quarter was quite remarkable.

As a matter of fact, that's the reason, I think, we outperformed a little bit in Gulfstream.

We only delivered 30 airplanes when our internal plan kind of played at 32.

So we were a little short on volume, and that had to do with timing issues.

So we'll capture that.

But it was productivity that got us where we are and that suggests we have more internal capacity.

And right now we're working on an 88 number and we'll see if we can't lock that in.

But we think that that's within the range of reason, and certainly the backlog would support it.

Now, to your last question, has it cost us any business?

I don't know.

I think everybody, all of the manufacturers have at least in our segment of the market, are experiencing robust order growth and straining their capacity.

Right now, we're talking about deliveries on large aircraft well into 2010 for entry into service, if you began discussions with us today about a 550, you'd probably be looking at a third quarter 2010 entry into service.

Now, that's a longer than we'd like it to be and -- but we're doing the best we can to increase the production in an efficient way.

So that we satisfy customer demand and don't lose the productivity, which is required to satisfy our shareholders.

So I think we're balancing that pretty well on the up here.

I think you'd have to agree it's been a pretty successful ramp-up.

It definitely has and I'll stick to one question, thanks.

Your next question comes from the line of Joe Nadol with JPMorgan.

Thanks, good morning.

Good morning, Joe.

Nick, on Combat, you had a good quarter, you said margins, I believe, are going to go up through the year.

Your backlog is up 40% year-over-year, you mentioned earlier you might do 200 to $300 million of MRAP sales.

You said last call that you were looking at 7 or 8% working at gross here, I'm wondering if you're willing to bump that up a little bit?

There's cause for optimism here, Joe, but not all of the cards have been dealt.

And I'm going to hold off for a quarter.

I mean, look, if there's two businesses that really have some upside growth potential here it's Combat Systems and it's Gulfstream if we can execute.

Either we can get the planks out and delivered.

So I'm not at all pessimistic about Combat Systems' opportunity set, but we've got to get a few answers to a few more questions here.

And it would not surprise me at all for there to be relatively robust growth.

Let me take a look at the guidance I gave you.

I'm looking at it now.

I think you're off a little bit, Joe.

I think when I spoke last, when I gave guidance at the end of the year, I was talking about revenues that are up about 13%.

But that includes acquisitions.

Yes, yes, okay.

So but, you parse it however you want to parse it.

I'm still looking at revenues somewhere between 67 and 68 is the number, 6 billion 8, 6 billion 7.

And I -- is there some upside potential?

Sure there is.

But is there some possibility of some negative?

Yes, there is, too.

You just heard in one of the other questions the discussion about the supplemental and the budget all tied up right now in both tactical and strategic maneuvering between the administration and the Hill.

So we'll wait a little bit before we clarify.

Just a clarification to an answer to your last question on Gulfstream you're trying to get to 88 deliveries next year or this year?

That's next year, right?

Next year.

Thank you.

That will be up from a planned 83 on the large one.

I've limited my remarks to the large ones.

Understood.

Thanks.

Your next question comes from the line of Ronald Epstein with Merrill Lynch.

Good morning, Nick.

Hi, Ron.

A quick question for you.

About a year ago you guys announced the agreement you came with Daiwu to start doing the (Inaudible) again on the NASSCO.

I just wanted to follow-up, how's it going a year later?

It's going pretty well, we have completed all of the design work.

This May we're going to build some modules to test.

The practical application of those designs in our yard and we contemplate starting the first product carrier in August.

So right now all systems go and we like the way it looks.

And then, I guess as a quick follow-on, when do you expect the first actual delivery and the first ship to come out of the yard?

What, about a year later, Hugh?

Let's see.

First quarter, early second quarter 2009.

Okay, great.

Thank you.

And then, once we deliver that first one, you'll get a delivery every six, eight months.

Your next question comes from the line of Steve Binder with Bear Stearns.

Nick, just getting back to the question about the large cap and then the supply chain issues you kind of talked in the past, you have given '08 guidance but you kind of give more restraints of maybe kind of the mid-90s in this decade on large cabin deliveries.

Can that change given some of those supply chain issues subsiding?

I'm really kind of addressing more in the '09 time frame which I know you haven't calibrated yet.

I think it's a couple of things, Steve.

It's supply chain, which seems to be doing, hold your breath, doing pretty well right now.

And it's our own efficient capacity.

And we've estimated that to be 95 airplanes.

We haven't tested it yet, but, you know that we are building another factory.

It is intended to build another airplane, but it will relieve pressure and increase our total capacity early in the next decade.

The factory will be done sometime early '08 but we'll be producing test items in that factory for years, so.

All right.

Thank you.

And your next question is a follow-up from Mr.

Carter with Lehman Brothers.

Nick, I wondered if you could provide us an update on LCS as it pertains to GD given the recent events that have affected Lockheed Martin?

Carter, our first ship is about 50% complete, roughly.

We're doing all right.

One would expect to do okay at this point.

We're in what Mike Toner likes to call the sweet spot of building the ship.

And you start finding out whether you have cost growth that's unpredictable when you're somewhere between 70 and 80% complete.

As some of the difficult integration issues begin to rear their head, we've tried our best to identify those and put containment measures in place, but we'll have to see, as we go on.

There's no arrogance here about the difficulty of building a first of class ship in a shipyard that had never before been mobilized to built a Combatant, that is a challenge not just for us but for anybody else who would like to do that.

But so far I think we're doing okay.

I think the best thing I could say, trying hard.

Just to expand on that just briefly, if you would, has your relationship with the customer changed as a result of what's happened on LCS 1 or is there more oversight?

Is the environment the same for GD as it was two or three months ago?

Yes, I think essentially the same.

We have a good working relationship with the Navy.

I think that the Navy is putting more people, NavC people into the facility.

One would expect that when they've experienced growth, you know cost growth, unanticipated growth anywhere in the system.

So I think in that connection we're working well with the Navy.

The Navy has an earned value management system and we're implementing that in a shipyard that's never used that tool before.

So we're all working it together.

General Dynamics, [Austel] and the Navy and I think we're all learning and trying to get better as we go along with this thing.

But the best I can tell, the relationship is wholesome.

Great, thank you.

Your next question comes from the line of Ferat Ongoren with Citigroup.

Yes, Nick, it's George, actually.

George, how are you.

I took your question away from you, George.

I got another one for you though, so that was nice.

I thought you might.

In the IS&T area, what quarter does the Bowman comps get a lot less of a problem so that we'd actually see the underlying growth come through a little bit more?

And then also, how do you factor in your thinking what you get from the recent IWIN contract?

George, I think on Bowman, it's going to be next year.

It kind of played out through the year.

It held up last year kind of better than we thought it would, and it started to weaken in the fourth quarter, significantly weaken.

So maybe fourth quarter you get a fair comparison, but I'll be sensitive to that question as we go through and identify it for you.

The second part of your question had to do with IWIN?

Right.

Yes, that's a very nice win George and it happened after the end of the quarter so it didn't reflect itself in backlog yet.

And I can't quite tell just yet how quickly that program will get up and running, but for us it's a very nice win.

And I think that -- that was a long and difficult competition.

There had been a number of competitors and then narrowed down to two.

And I think that the period during which the losing party can protest or appeal the decision has not yet expired.

So it's a little difficult to predict when things will start and when that will result in positive revenue.

But certainly this year it will be a nice thing for IS&T and helpful, I think.

Okay, thanks, I'll get back in the queue.

Your next question comes from the line of Robert Stallard with Banc of America.

Good morning.

Good morning.

On Gulfstream, Nick, you talked about productivity improvements coming through and clearly there's still a good strong demand in the market.

Does this lead you to be more optimistic about where operating margins could go over the next couple of years?

I think, Robert, that yes, I am.

I'm surprised, frankly, that the Lean Six Sigma initiatives at Gulfstream are taking us below what I would view to be ordinary learning.

And they're running right now well ahead of their labor hour manufacturing budgets, both in the production facility, the green production, and in the completion facility.

So yes, I think that that bodes well for the possibility of expanded margins, even though you know we're fighting a little bit of a headwind and that is the introduction of more and more mid-size aircraft into the mix with slightly lower margins.

But, yes, the overall answer to your question is yes, I'm -- over time, I expect Gulfstream to continue to raise its margins.

Do you think you can get back to where you were a few years back at the peak of the last cycle?

I've always said that that's very hard.

We're kind of fighting this out 10, 20, 30 basis points at a time.

It won't be in the next year or two, that's for sure.

Okay, thanks.

Your next question is a follow-up from Pete with Credit Suisse.

Nick, sort of as a follow-up to the IWIN question now that that's almost in the bag, as you look out over the next six to nine months, what are kind of your top three or four new competitive opportunities that the guys at IS&T are looking at?

I don't even know, they've got such a full pipeline of alphabet soup that I'm not sure I try to keep up on these opportunities that I would venture to tell you what our top two or three or four, I don't even think Gerry DeMuro thinks about it that way.

Got you.

Understood, understood.

How about there's a lot of press a few months back about some of the potential orders you guys were going to get out of the Middle East for Combat to the Saudis, I think for LAV's and ones, and then a couple of other customers.

How close are you guys getting to closing those deals?

Well, it seems to me it's moving along in an orderly way.

I don't know that I want to make any prediction, we're engaged as we speak in serious negotiations with respect to LAV's and tank orders.

But it's not done.

Governmental approvals have been sought and obtained, but the ink is not dry on the contracts.

Okay.

Thanks.

Your next question comes from the line of Cai von Rumohr with Cowen & Company.

Yes, Nick, could you tell us a little bit about new programs at Gulfstream, how if anything does the continuing strength in the market make you feel?

Are you more anxious to get products to market and I think you've talked of not wanting to kind of announce something without a two-year -- without being able to deliver within two years.

Is there any chance you could announce something here at NBAA or in this calendar year?

Cai I'm not going to make an announcement today, I'm not even going to make an announcement about when we're going to announce.

I think that the current market condition doesn't cause us to either accelerate or decelerate the pace of our new product development.

We're going to do that on a steady stream basis and bring them to market in an orderly way.

So I -- let's just say we're spending a fair amount of money and making good progress and we'll report to you in the ordinary course.

Okay.

And I think we can take one more question in order to complete on schedule.

Okay.

Your last question is a follow-up from David Gremmels with Thomas Weisel Partners.

Thanks.

You responded to an MRAP question earlier and you mentioned your joint venture contract win there recently but you also have a separate GD stand-alone bed with the RG31 vehicle, wondering if you can update us on how that testing is going and just your level of confidence in future orders for that vehicle?

That also is a joint venture arrangement but with a different partner.

And I don't think I'd care to comment with respect to what's happening in test.

This is a wonderful opportunity for us in MRAP.

It's an opportunity to move into and participate in an adjacent market where we had never participated before.

We're enjoying our relationships with new people, highly imaginative, industrious, skilled people and we're enjoying our participation in this adjacent market.

We'll see what comes of it.

With respect to the two teams, do you have a preference between the two?

I mean, does one offer you better economics than the other?

There's good friends all.

We'll help our colleagues and partners win as much business, each of their entries into this competition as best we can.

I think there are room for many participants here to satisfy the requirements of principally the Army and the Marine Corps but the Air Force and the Navy will also need some of these vehicles.

And I suspect that they may have different preferences and like different configurations and I like to view our participation here as very wholesome.

We're going to do our very best with each of our partners right now.

Thank you.

I would like to, as we wrap up, remind everyone that we've -- if you didn't have a chance to hear the very beginning of the call, or if you have colleagues that you'd like to have listen to the call beginning at 2:00 p.m.

Eastern Time today there will be a replay that will run through May 2, at midnight.

The number for that is 888-286-8010, that's 888-286-8010, there is a pass code, 58734122.

I'm Ray Lewis, staff Vice President, Investor Relations, I'll be available for any additional questions right after lunch.

My number is 703-876-3195 and my colleague, [Amy Gillen] will also be available.

Her number is 703-876-3748.

Thank you all for being with us today and we'll look forward to talking to you either later today or on our next call.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect, and have a great day.