通用動力 (GD) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2007 General Dynamics earnings conference call.

My name is Carma and I'll be your coordinator for today.

At this time all participants are in a listen-only mode.

We will be facilitating a question-and-answer session towards the end of conference.

(OPERATOR INSTRUCTIONS) I would now like to turn the presentation over to your host for today, Mr.

Ray Lewis, Vice President of Investor Relations.

Please proceed, sir.

Thank you very much, Carma.

I would like to welcome members of the investment community as well as the business press who are listening today.

I want to remind everyone that there may be some forward-looking statements made today.

These represent our best estimates as to what may occur, but are subject, of course, to the same risks that always face any business and I would recommend that anyone who's interested in those risks take a look at our 10-Qs and 10-Ks for a more expansive description of them.

With that said, I would like to turn things over to our Chairman and Chief Executive Officer, Nicholas Chabraja.

Thanks, Ray, good morning.

The quarter was pretty straightforward, so I think I can be relatively brief and spend more of my time on forward-looking things with you in each of our business segments.

In the quarter, as is obvious from the press release, we had earnings per share of $1.34, which exceeded analysts' consensus by some $0.09 and frankly exceeded our expectations.

Earnings per share are up 24.1% over the third quarter of 2006.

The increase is a result of strong revenue growth coupled with marked improvement margins.

By the way, this is the 15th consecutive quarter of double digit growth in earnings per share on a quarter-over-prior year quarter basis, something I think we're pretty proud of.

Our revenue in the quarter is up 12.6% year over year to $6.8 billion and operating margin increased 50 basis points to 11.7%, and frankly the strongest margins in my memory.

Free cash flow from continuing operations was 152% of net income, which put us over 100% year-to-date, so very good conversion in the quarter and for the year.

I think in brief, the quarter was excellent in almost all respects, from my point of view.

Let me spend a few minutes discussing the performance in each of the segments, what we expect from each of them in the fourth quarter, and then take your questions.

And I think Hugh has a couple of points to make as well.

Aerospace -- Gulfstream, they continue to perform beautifully.

Revenue exceeded $1.3 billion on volume growth across all of our models, including, I'm pleased to report the G150, which is gaining considerable traction in the marketplace.

We're very pleased with that product introduction.

Total revenue from Gulfstream is up 21% year over year and 10% over the second quarter this year, last quarter.

Margins improved 200 basis points, largely from productivity improvements and in part from favorable pricing.

As a result of revenue growth and margin improvement, operating earnings grew to $226 million, a 37% increase year over year.

In addition to current excellent performance, Gulfstream orders continue at a strong pace, resulting in a dollar denominated book-to-bill ratio of 1.67 to 1 for the quarter.

So 1 and two-thirds to 1.

Gulfstream obviously had a great quarter, but I don't anticipate that the 17.2% margin rate will be repeated in the fourth quarter.

I expect fourth quarter sales and earnings to come in between the second and third quarter results.

In other words, we expect the fourth quarter to be stronger than the second quarter, but not quite as strong as the third.

Turning my attention now to combat systems, their revenues increased 37% year over year to almost $1.9 billion.

Additionally, Combat Systems improved margins 20 basis points year over year, generating operating earnings of $228 million.

That represents a 39% increase in earnings year over year.

Order intake during the period was strong, resulting in a $700 million increase in total backlog for the group.

For the fourth quarter, I expect revenue to increase significantly, but margins will be back down in the mid-11% range.

Notwithstanding the reduced margins, I expect a significant increase in operating earnings on the strength of really quite a significant increased volume.

You might recall that earlier in the year we had been forecasting a 40 to 50 basis point improvement in margins for the Combat Systems Group.

As the year went by, we changed that guidance to 10 to 20 basis points.

I think it's now fair to forecast that the year over year improvement will be on the high side on the 20-basis point mark, which will give us a very nice operating earnings increase given the very, very strong increase in revenue that we're experiencing.

Our Marine Systems Group revenue grew a modest 2% over the same quarter last year, but I am pleased with the 8% growth in earnings.

As you may recall, the third quarter of 2006, margins were 8.4%, which was very good last year, and that included the favorable conclusion of the BP tanker program, which added a one-time $11 million positive to earnings.

This quarter, the margins were 40 basis points higher yet at 8.8%.

Operating earnings were $110 million and backlog grew during the quarter, albeit, modestly.

All in all, another very solid performance in our Marine segment.

They have now had two back to back quarters with 8.8% margins, and I expect them to end the year with a good quarter, although at reduced margins.

For the year, we expect overall margins in this group to be between 8.2 and 8.4%, which is better than we started out the year anticipating, we were thinking about about 8.1.

I think I had given you that number repeatedly.

If they make it -- and we've got a few items hanging fire here, and that's why I give you a little bit of a range.

But if they make it to 8.4 for the year, that implies that the fourth quarter number would have an 8 in front of it, which I would find very satisfying.

IS&T.

Third quarter revenue in the IS&T group was essentially flat, although organic growth in the North American market was about 3% relative to the third quarter 2006.

I had told you previously that we expected IS&T margins to compress about 50 basis points for the full year against last year as a result of the acquisitions we had made last year.

However, margins were only 20 basis points lower in the third quarter and only 10 basis points lower year-to-date.

So from a margin perspective, IS&T is doing a better job than we had guided you, and they generated operating earnings in the quarter of an impressive $254 million.

We continue to have a favorable view of this business and are pleased that orders exceeded sales this quarter, resulting in backlog growth.

Although volume will be up in the fourth quarter, I think margins will compress further and dampen the effect of the top line growth.

Backlog overall -- with respect to backlog, I should point out that during the quarter, total backlog increased at each of the four segments for a total of $46.5 billion.

About 80% of our total backlog is fully funded.

With respect to cash, I'll make a quick comment and then conclude with a remark or two on guidance for the year.

Free cash flow from continuing operations for the quarter was $826 million, and I told you earlier that represents 152% of net income from continuing operations in the quarter and year-to-date cash flow is running closer to 106% of net income.

As is apparent in the press release, we are raising our guidance for the year to a range of $5 to $5.05 per share.

I should also indicate that free cash from continuing operations will exceed the net income rather nicely, which is also above the way I have been guiding you throughout the year, where I told you it would be the equivalent of net income.

In conclusion, let me say that I'm very pleased with our company's performance this quarter.

It was a great quarter.

But, Hugh, you have a couple of additional points to make, so this is Hugh Redd, our CFO.

Thank you, Nick.

I want to address the effective tax rate, first.

The effective tax rate for the quarter was 31.2%, which is 50 basis points lower than the same period last year.

This rate is also slightly lower than our expectations for either the fourth quarter of 2007 or the full year.

So absent any significant discreet events, we anticipate the fourth quarter rate to be closer to 32% and that would result in the full-year tax rate being closer to 31.5%.

As Nick mentioned, free cash flow from continuing operations was $826 million, which represents 152% of net income and year-to-date free cash flow approximates 106% of net income.

During the quarter, strong cash flow reduced net debt from $1 billion to $500 million.

Obviously, that lower net debt resulted in lower interest expense for the quarter.

Finally, during the quarter we repurchased slightly more than 4 million shares of common stock at an average price of $77.73.

This brings the year-to-date total to just over 6 million shares at an average price of $77.15.

And these repurchase activities were consistent with our activity and our behavior in the past.

We'll buy back shares opportunistically when market conditions permit.

That concludes my remarks.

Ray?

Thank you very much, Hugh.

Carma, we're ready to begin the Q&A session.

I would like to remind everyone that we would prefer each questioner to make one question and if you want to bring up another subject, get to the back of the queue.

This way we can give everyone a chance to ask a question during this session.

With that said, Carma, could you explain to folks how they can get into the queue?

(OPERATOR INSTRUCTIONS) Our first question comes from the line of George Shapiro from Citigroup.

Please proceed.

Good morning.

Good morning, George.

Usual question to look at.

IS&T, you mentioned 3% organic growth in North America.

Do we start to see that in Q4 as the Bowman contract is kind of down?

I think you're going to see it in Q4, George, as a result of a little more volume, as I indicated in my remarks.

We expect increased volume in the fourth quarter.

Let me see if I can bound that for you.

Maybe another $150 million to $160 million of revenue.

So you'll see a little more growth here.

And do we get more organic growth next year in this business?

Look, it's always hard to predict that.

What is it that we're seeing out there?

The order book would suggest that we're going to have organic growth.

Whether funds get released to fund the contract is another story.

So let me just say I'm guardedly optimistic about that.

Okay, thanks.

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

Please proceed.

Yes, good morning.

It's actually Carter Copeland.

Good quarter, Nick.

Thank you, Carter.

A quick question.

I wonder if we could just talk really briefly about Marine.

I was surprised to see the margins come in at 8.8 again.

You had said that the -- you had concluded some -- expecting to conclude some SNG work and expecting the margins to come down there this quarter.

What is it that occurred to make them a little bit higher than you expected?

We had really strong performance at Electric Boat in the quarter that that I wasn't counting on.

I think it was as a result of efficiencies in the Virginia class program and some repair volume where they did well.

Are those one-time in nature, or is this sort of performance, can we count on this going forward?

I would say that the productivity improvements in Virginia aren't one-time in nature, but repair volume for us is spotty.

And I don't expect a recurrence in the fourth quarter.

And that's why I indicated that we should be looking in the fourth quarter to -- for some compression of the margins we've enjoyed in the first two quarters.

But still, it'll be good.

And I'm hopeful that it has an 8 in front of it.

Do you have any update -- also in Marine, do you have any sort of update on LCS?

No, I don't think there's anything to say about that one.

Fair enough.

Thanks.

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

Good morning.

Just wondering, the company-sponsored R&D rose $13 million from a year ago and $15 million from the second quarter.

It fair to say that's pretty much all Gulfstream, Nick?

I don't have any idea.

No idea, okay.

I haven't parsed the company-sponsored R&D accounts in a way that would be sufficient for me to give you a detailed response.

Because assuming -- I guess, I was going to say, assuming it was a chunk of it, or at least an increase, it seems like the incremental margins year over year were certainly better than they were in Q2.

They were better than Q2, even if you factor out any change in R&D.

Is that just more favorable mix, or -- if you back out pre-owned sales --

I can't -- I'm not at that level of weeds for you, Steve.

All right.

Then with respect to -- this one you can probably answer.

You were more aggressive in your share repurchase program, obviously, in the third quarter.

It looks like for the full year so far, it just annualize your dividend where you are on share repurchase, it looks like you're going to return at least half your free cash flow to shareholders, which is probably the most -- the largest percentage we've seen since '98.

I'm just wondering, what's your attitude on share repurchases these days?

I know you're opportunistic, but the stock averaged in Q3 where it was in Q2.

Do you think you're going to be -- are you looking to be, given an improving balance sheet, more aggressive now than you might have been in the first half?

Steve, I thought the market made a mistake in the third quarter and I took advantage of it.

Our prospects in the third quarter were better than they were in the second quarter.

We announced very strong earnings and we improved our guidance for the year.

The stock initially responded to that.

There was a hiccup that we all know about in the market that I didn't believe and I bought the stock aggressively.

All right.

When it returned to its appropriate level, we backed away.

I think we -- and I expect that to happen every now and then and when it happens, we'll be all over it.

Thank you.

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

Please proceed.

Good morning, Nick.

Good morning, Rob.

Going over to Aerospace, if you could give us a little bit more color perhaps on the fourth quarter comment you made earlier about numbers dropping to sort of between the 2Q and 3Q figures on sales and margins.

And perhaps you can update us on where you are with your latest aircraft development, what we can expect in terms of news there and ramp?

I think in terms of margin -- in terms of volume difference, it's insignificant, and it has principally to do with pre-owned activity and whether or not we deliver a plane or not at the end of the year and I would say on the -- with respect to margin, we just had an unusually good quarter.

And one of the things I should point out to you.

This is mix-sensitive.

We didn't deliver any 500s in the quarter or any 350s, which are of the large aircraft, our lower-margin airplanes.

So we had a exceedingly good mix and we did reasonably well on pricing of the light -- or the mid-sized aircraft.

But our forecast, I think, is perfectly clear, that our margins won't be strong -- as strong in the fourth quarter, but still very good compared to a year ago and still leaving us well ahead of our plan and our earlier guidance to you.

And I feel particularly good that when we look at it as compared to our plan and as compared to a year ago, about 80% of the improvement is not from pricing, it's from performance, productivity.

That leaves us nicely positioned to continue to improve as time goes by.

How about on the new aircraft front?

We'll make an announcement when we make an announcement.

Thank you.

And the next question comes from the line of Heidi Wood from Morgan Stanley.

Please proceed.

Good morning, Nick.

Hi, Heidi.

Can you give us greater granularity on the margins at Combat Systems?

And talk about the percentage of international at Combat Systems year-to-date in '07 and remind us what it was in '06?

If I remember correctly, Heidi, we anticipate that the growth in our European land systems business will be about 20% year over year.

The remainder of the growth will come out of North American operations.

All right.

I want to go back to aeronautic for a second, the G150, can you talk about pricing there?

The bottom end of the market -- we're seeing an increased number of players, is that affecting pricing for you?

Our pricing is strengthening as that airplane -- it's into the market and the introductory pricing is over.

I think -- I'm surprised at how well it's taken off, how many orders we had in the quarter, and it's -- it's going to be a good airplane for us and it's -- pricing is up considerably over its introductory price.

All right, great.

Thanks very much.

And the next question comes from the line of Howard Rubel from Jefferies.

Please proceed.

Thank you very much.

A couple things.

First, Nick, you talked about productivity being an important part of the results and I would think that -- and you kind of indicated you were surprised or pleased.

So does that set you -- set the stage for you being able to ship more aircraft next year than you originally had expected, given how late you were on this year?

Look, Howard, what I think -- where I think we are is we'll do 82 of the large aircraft this year, which is right in accordance with plan, and it could be one more or one less, depending on the vagaries of --

Customers and -- yes.

Yes.

And next year, as I'd once said, we were planning to do 83.

We've upped that to 88.

It looks to me like in the following year we'll go over 90.

Maybe as many as 92 or 93.

And that is all as a result of productivity gains.

It is enabling increases in volume as well as improving margins.

So, yes, to your question, Howard, you're right on the money.

Thank you.

Then just, MRAP has been on the fastest tear imaginable, and while I know that's only a modest part of your business, can you talk about how you've dealt with getting up to speed so fast?

I think you were ahead of schedule there.

And what you've done in the supply chain to make it happen and does that translate anywhere else in the Combat Systems area?

MRAP, we've had more volume this year than we anticipated.

I think I was telling people $300 million to $400 million.

Now it looks $400 million to $500 million, and I can't get it with a fine-toothed comb.

But in fact we're pleased that we're building out what we have for our customer more rapidly than the schedule they've given us, and that's with respect to both products, the RG-31 and the Cougar.

I think we've had a lot of cooperation in the supply chain and have good partners and we have a lot of capacity in our facilities that we've managed to bring to bear on that whole supply chain management and production problem.

So for us, this is a very nice thing.

We very much appreciate the order we received recently in MRAP II together with our partner, Force Protection, for our joint venture, Force Dynamics, and we look forward to having a good year in 2008 with MRAP.

Thank you.

I'll let it go there.

And the next question comes from the line of Joe Nadol from JPMorgan.

Please proceed.

Thanks.

Good morning, Nick.

I would like to ask about -- follow-up on the balance sheet.

You've paid down almost all your debt, at least on a net debt basis.

Buying back more stock, but you're still looking at it opportunistically.

I'm wondering if you're sort of looking a little harder for acquisitions then maybe you had.

I'm wondering, also, even more importantly, if the pricing environment has gotten more favorable since the credit crunch?

Joe, you correctly identified the fact that probably by the end of the year we'll be at zero net debt or thereabouts.

So we have a powerful balance sheet.

We're always looking hard at acquisitions.

This was a company that was built through acquisition, so we're always looking.

Pricing, I don't know.

Pricing is such an individual thing.

It depends on how badly somebody wants a business, who all is in there competing for it, how it fits them.

So I don't know whether pricing is better or worse.

There have been a couple of prices announced in the marketplace that caused me to catch my breath, transactions I won't mention, but I think it's catch or miss.

I don't know that there's a trend yet that I can identify.

If nothing were to happen, would you be comfortable going relatively indefinitely with a net cash positive balance sheet, or would you feel pressure on sort of maximizing your -- the opportunities from your balance sheet?

Well, we're going to maximize opportunities over time, Joe.

But I don't feel any particular pressure.

I get a lot of questions, but that's okay.

It's a rich problem to have.

I understand the need to deploy the capital and we in fact will over time.

Okay.

Thank you.

And the next question comes from the line of George Shapiro from Citigroup.

PLease proceed.

Yes, Nick.

Just to follow up.

Along the big growth in Combat, was the bulk of that growth in the quarter then from the MRAP program?

And then that would I think be higher in the fourth quarter, and that's kind of what you're alluding to in having substantial higher growth in the fourth quarter.

No, not true, George.

We grew across the product line.

The tanks -- the tank line might strike you as a strange one, but it is -- was the second largest growth product in the quarter.

Stryker -- and between Stryker and the tank, they were considerably larger than MRAP, but MRAP was obviously a plus.

We had good increases in soldier protection systems, namely, Chameleon.

Munitions were up significantly, even absent the effect of the acquisition of SNC.

And Europe was up significantly.

And in Europe that's four products, Piranha, Pandur, the Eagle, and the Duro, slightly offset by some reduction in Leopard sales to the Spanish government.

So it was pretty much across the product line.

The largest item was MRAP, but not -- it was just spare change between MRAP, soldier protection systems, tanks, and Strykers.

So pretty strong all the way across the board.

Okay.

And when you said you'd be way up in the fourth quarter, the fourth quarter's always a seasonally strong quarter with the European business.

Yes.

And that'll be a lot of European sales, but on the other hand, land systems will be up, way up on units of delivery.

Each one of the businesses is going to be up significantly in volume and the volume growth will be in the magnitude of $700 million over this quarter, give or take a little bit.

Okay.

Binded between $650 million and $750 million.

I can't be that fine, because it's units of delivery.

But if we said $700 million on average, I think we'd be pretty close.

Couple that with reduced margins, and you'll have a pretty good handle on it.

And then you expect continued strong growth next year?

I mean, you're going to get closer to 20% more growth next year?

George, I don't know.

I don't know yet.

We won't make a call on that until after we've gotten through our budget cycle.

There are a lot of moving parts right now in the Army discussions with the Congress, in the supplemental.

So I want to do what I've done in the past and that is get through our own budget cycle, which will end by mid-November and then look for an opportunity to make a forecast for next year.

Most of the time I've waited until the first quarter -- I mean, the fourth quarter's earning announcement, so mid-January.

But occasionally there'll be an investor conference somewhere in the year and if that gives me the opportunity, I'll do it then.

But I think I couldn't give you a good forecast.

We're going to have a good year next year in Combat Systems, but the question is how good.

God, I've been desperately wrong.

One year I predicted 22% growth and we got 12.

The next year I predicted 12, we got 20.

So I see that this is not a good game to play until I have a little more information.

Well, you always attributed that jumping around more to the European business than the North American business.

Yes.

But the North American business is obviously right now extremely dynamic.

And there are programs moving around, a lot of issues out there.

You've got an eight Stryker brigade in some of the [marks] in the Congress.

Is that going to happen or isn't it going to happen?

You've got some interesting plans, people discussing about Strykers.

You've got MRAP, you've got JLTV, you've got EFV.

I've got a lot of moving parts here.

And to predict how all that's going to come out without seeing this bill come out of the Congress, both appropriation and the authorizer's bill, I think, is foolhardy.

I don't think there's -- I have ever seen a time where there has been more money in play, and the delta on some of these programs as pronounced as it is this year, and the supplemental opportunities and risks.

So I think this year it's more North America than Europe.

Europe for next year is reasonably predictable because they have a very, very handsome backlog and are working now to deliver in Portugal and Czechoslovakia and Spain.

Very good situation in Europe -- that is the piece I can predict continued growth on, but North America is up in the air.

Okay.

Thanks very much, Nick.

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

Please proceed.

Good morning.

Good morning, Ron.

Back to Aerospace just for a minute, what percentage of the activity this last quarter was international?

Let's talk about orders first.

Because that's the best way, I think, to measure the demand.

53% of our orders were outside of North America, 47% in.

Year-to-date, 51% of the orders are what you call international, not from North America, and 49% North America.

So increasing the trend to more of a export order book.

On the deliveries side, the numbers look just about flipped.

We're still delivering 53 to 54% of our product into North America.

Okay, okay.

And just if you -- I don't know if you have a feel for this or not, but sustainable a trend do you think that is going to be?

I really don't know the answer to that.

These are obviously emerging markets.

They're taking advantage of strong economies and growth in economies in certain countries.

They're taking advantage of a rather handsome exchange rate.

I can tell you, however, we think enough of these markets that we are moving out very fast to strengthen our support in these areas for our customers.

So this is a double blessing in some ways.

Our service business is increasing to match the sale activity.

Our service business this year is going to have a very, very handsome increase in revenue and margin.

It's getting to be a business well north of $600 million for this year and I expect continued growth next year.

Great.

Thank you.

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

Please proceed.

Yes.

Thanks, good morning.

On IS&T, it does seem like the revenue recovery has been delayed a bit from what we were originally expecting.

And I'm wondering if that is to any extent tied to what you've been talking about in terms of the dynamic budget environment.

Is IT funding being diverted to support war fighting, and is there any risk with the delayed passage of the budget that that could hit some of the IT services businesses?

Oh, I don't know.

I think this is a very large business now.

It's over $10 billion.

It has experienced very rapid growth until we got to this year.

Things don't grow rapidly indefinitely and they pick up again, as I would say that the current emphasis on spending and the priority is given to those things that can be introduced immediately to the war fighter, that are very current requirements.

So we've seen some slowdown in some of the networking activity, although recently picked up again, and some of the IT services activity.

But these things tend to be cyclical and I don't think it's anything we're particularly disturbed about.

The positive indicators are the order book and the activity, the program activity.

The negative, I would say, is the rate at which funds are being released to support those programs.

Thanks.

If I could just squeeze a Gulfstream question in as well, orders obviously have stayed very strong in the third quarter.

But I'm wondering, as we get deeper into Q4 and you're talking to customers, are you seeing any evidence at all of a slowdown given some of the broader market uncertainties that have been causing some worries lately?

Nothing untoward there, David.

We continue to take contracts in the fourth quarter and LOIs.

We expect we will have a very good quarter from an order perspective in the fourth.

That is, it will be, in my view, equal to or exceed our billing rates.

The book-to-bill will be 1 or slightly better.

And I've said for a long time, we could do with a little easing of demand here.

It is far outstripping our capacity to service it in an efficient way.

For example, a 550 customer -- a new 550 customer that would enter into serious discussions today would be looking at the second or third quarter of 2011 for entry into service of their aircraft.

And a 450 buyer would be looking at the third quarter of 2010.

Those are relatively extended times for delivery of new aircraft to a new customer.

I would expect that alone to temper some of the order rate.

But we continue to do very well.

The pipeline remains strong.

So I don't have yet any indication of what you are asking me.

And last one, you commented on your large cabin production plans.

Wondering if you would be willing to share your plan for the mid-sized jets?

That's a little more variable, but I don't remember those offhand, but let me take a look and see if I can tell you.

No, I can't lay hands on it, but the production rates are going up on both.

Thanks very much.

Wait a minute, wait a minute.

I might just have a piece of paper.

Yeah, we did 42 of the mid-sized a year ago and we'll do 61, more or less, this year and 68 next year.

So if you want to think about it this way, think about going total from 143 aircraft deliveries in 2007 to 156, about a 9% increase, but a greater portion of the increase is in the mid-sized.

Great.

Thanks, Nick.

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

Please proceed.

Thanks.

Good morning.

Good morning, Myles.

A question for you.

You brought up the spares in maintenance sales and mentioned year-to-date it does look quite strong.

I'm just wondering, Nick, could you put it in buckets of what's driving that, whether it's the service facility expansion, some coming off warranty, or are you actually capturing greater percentage of your fleet?

I think that it's all of the above, except capturing a greater percentage of the fleet.

It's hard to imagine that we could have a greater percentage.

But what you have is more airplanes in service, more coming off of warranty that are still vital airplanes to the service.

The expansion of our facility has been a great enabler and our outreach out of the United States -- all of those things contribute to a rapidly growing service business and improving margins.

So we're looking forward to continuing that.

And you mentioned the profitability there improving.

Is it still between large cabin and mid-sized in terms of gross margin profitability?

Within the service sector?

Yeah.

I can't tell you that, Myles.

I don't know for sure.

But I wouldn't think so.

Would it be higher or lower?

I'm guessing that it's the same, using the same labor rates and --

Myles, Ray Lewis, it can bounce around from quarter to quarter depending on mix, considerably.

As I tell people sometimes, my dad was a car dealer and we'd change oil for someone at a low margin so we'd get their transmission work when they were ready for that.

So it can move about --

It would depend in a particular quarter whether you have any refurbs or high-margin opportunities.

And you get those on G200s just the way you do on 4s and 5s.

But I think on balance, the service opportunity and margin opportunity for all the planes is similar.

Great.

Thanks.

The next question comes from the line of Cai von Rumohr from Cowen and Company.

Please proceed.

Yes.

Thanks an awful lot.

Nick, could you provide some color on kind of the tone of demand -- you said you would expect book-to-bill to be greater than 1, but where are you getting the better price hikes and is there any opportunity to kind of switch some folks out, like some folks who maybe have a 550 near end will kind of give that slot up and you can move a better priced plane forward?

Cai, not really.

The backlog has had very little activity in it.

That is, I hear occasionally that some people have traded their spot to someone else, but that's not apparent to us.

It's to the clear that that happened.

But most of our -- in fact, all of our customers have just hung right in there.

We've had very few cancellations in the year.

I think one, there was one in the first quarter.

But we had none in the second or third.

And so I don't know that I can make anything of all of that, Cai.

And could you comment a little bit on relative pricing?

I think out of MBAA, folks got the impression that the larger, long-range planes were the ones that were -- where the pricing was the strongest.

Which of the models where --

I think we've enjoyed price improvement across our models, and probably the one's that's improved the most is unique, right, it's the 150.

It's gone from an introductory price to what is now probably a mature price.

So in percentage terms, it may have been grown the most rapidly, but the 550 is enjoying a very, very strong price environment.

Carma, if we could take two more questions and I think we'll be wrapping things up.

The next question comes from the line of David Strauss from UBS.

Please proceed.

Good morning, Nick.

Good morning, Dave.

Could you talk about the performance at the European land systems business?

I think you've changed management out there or you're talking about margins in the fourth quarter being lower.

I know that business is lower margin, but how is that business performing relative to your expectations?

It's performing very well.

It's still not at the level of our North American operations, but we've made a significant improvement there.

We've taken some charges, as you know, in earlier quarters on our commercial trading business.

That's part of the reason that Combat Systems Group is only going to be, say, 20 basis points better than a year ago for the full year.

But they've made marked improvement quarter over quarter and the fourth quarter will be their strongest.

And in the fourth quarter, they will be our margin rate leader.

So they've come a long way for the year.

For the full year, they will have the lowest margin rate of anybody in the group, but in the fourth quarter they will in fact be the margin rate leader if things play out the way we think they're going to play out.

So we're counting on them to do a good job in the fourth quarter.

Great.

That's great color.

You've kind of talked about what's in front of Congress on the armored vehicle side as they kind of finalize the '08 budget.

Can you talk about maybe from the ship building side, I know in conference they're looking at potentially accelerating multi-year procurement for Virginia class.

What do you see as the big issues in conference on the Navy side?

I don't know about from the Navy's perspective.

I can tell you from my perspective.

Sure.

Submarine, submarine, submarine, submarine.

One, two, three, four.

That is the issue.

We're also interested in T-AKEs and support of the DDG 1000.

I suppose the LCS at some level is important to us, but our number one priority as I've been saying for four or five years now is to get the two submarines a year.

And there's enough activity in front of all four committees, the authorizers in both the Senate and the House and good language in the bills and the appropriators that I think there's a fair opportunity that we're going to get the multiyear procurement and strong support for the submarine.

That is the key, I think, to the continued prosperity of the Marine group and growth again, and growth in revenue and in margins over time.

And just last one, is getting that potentially a year earlier than you might have thought, what impact might that have on the Marine business?

Well, it will start to grow earlier.

There'll be advanced procurement much sooner.

So you'll have additional volume and additional margin opportunities much sooner.

It'll be -- it'll fit into our planning -- our current planning horizon and we'll get a more robust plan out of us for a Marine system growth over the next three to four years.

Okay, great.

Thanks a lot, Nick.

And the final question comes from the line of Robert Stallard from Banc of America.

Please proceed.

Good afternoon.

Good afternoon.

Just a big picture question.

Your Combat System Division has clearly done well from the current military activities.

If the U.S.

forces were to start coming back from Iraq next year, what do you think the likely impact would be on General Dynamics?

I don't think that there'll be a lot of impact.

I just listened to Secretary of Defense Gates talk a week or two ago to the annual convention of the Association of the United States Army and their trade show and he made about four points about the army budget.

He said, first, he expects persistent conflict around the world, as far as his eye can see.

Second, he believes that the army was underfunded going into Iraq and that that cannot continue as a matter of share of the budget.

Third, he said the army and the Marine Corps must reset and they can't reset for the past, they have to reset for the future.

He made a fourth point -- the fourth point was, it's very vital for the Army and Marine Corps to proceed with their modernization or transformation programs with a look towards the future.

I think for all of those reasons, our Combat Systems business remains vital to the security of this country and our aspirations as a world power.

So I don't think that the end of the conflict will have a negative economic impact on us.

It will certainly change the mix of our work, but we have a lot of things going here in the near-term.

Okay.

Just to wrap things up, it was mentioned earlier that you've got a very strong balance sheet at the moment.

How has your pipeline for M&A changed over the last quarter?

People always talk about pipelines.

That's a word that's sort of foreign to me.

I think it's a word that probably has common parlance for venture capitalists where they work on a portfolio of transactions.

I kind of take them one at a time.

Look, there's activity out there.

There's companies out there that want to be sold and we're always looking.

Okay.

Thank you.

And I want to thank everyone for joining us today.

I know you have other calls you need to listen to, so we want to wrap this up.

My name is Ray Lewis, I'm Staff Vice President of Investor Relations.

After a quick bite, I'd take your questions if you'd like.

My number is 703-876-3195.

And my very able associate Amy Gilliland will be taking questions at 703-876-3748.

Thank you all for being with us today and good-bye.

This concludes your presentation for today, ladies and gentlemen.

You may now disconnect.

Have a wonderful week.