通用動力 (GD) 2014 Q4 法說會逐字稿

Good day ladies and gentlemen, and welcome to the fourth-quarter 2014 General Dynamics earnings conference call.

My name is Shantelay, and I will be your facilitator for today's call.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Ms. Erin Linnihan.

Please proceed.

Thank you Shantelay, and good morning everyone.

Welcome to the General Dynamics fourth-quarter conference call.

As always, any forward-looking statements made today represent our estimates regarding the Company's outlook.

These estimates are subject to some risks and uncertainties.

Additional information regarding these factors is contained in the Company's 10-K and 10-Q filings.

With that.

I would like to turn the call over to our Chairman and Chief Executive Officer, Phebe Novakovic.

Thanks, Erin.

Earlier today we reported fourth-quarter earnings from continuing operations of $2.19 per fully diluted share on revenue of $8.36 billion and earnings from continuing operations of $737 million.

It was our strongest revenue performance in the past 12 quarters, the highest operating earnings ever, and the highest earnings from continuing operations.

For us, it was a powerful quarter.

Incidentally, we beat analyst consensus by $0.06.

For the year we had fully diluted earnings per share of $7.83 on revenue of $30.85 billion and earnings from continuing operations at $2.7 billion, a return on sales of 8.7%.

It was a year of solid achievement from both an operating perspective and the development of significant backlog.

As you can see from Schedule H to the press release, funded backlog grew from $38.3 billion at year-end 2013 to $52.9 billion at the end of last year.

The story for total backlog is much the same.

We were at $45.9 billion at the end of 2013 and sit at $72.4 billion at the end of 2014.

As a result, we are well positioned for growth in 2016 and 2017.

Free cash flow from operations was a negative $254 million in the quarter.

However, for the year we had free cash flow from operations at $3.2 billion, or 120% of earnings from continuing operations.

This out-paced 2013 by $532 million.

Let me give you some detail on the quarter and the year in each of the business groups.

First Aerospace.

Revenue and earnings were up nicely over the year-ago quarter.

Sales were up $105 million, 4.9%, and earnings were up $64 million, a significant 18.4%, on very strong margin improvement.

This is particularly impressive when one considers that G&A and net R&D were up $40 million over the year-ago quarter.

On a sequential basis, sales were off $49 million, but earnings were up $1 million on a 40 basis point improvement in operating margins.

I should add that jet remained nicely profitable in the quarter, with a better contribution on both a year-ago and sequential comparison basis.

The order activity in the quarter was robust, as one would expect with the announcement of two new aircraft.

As you can observe on Exhibit H, funded backlog, total backlog, and total potential contract value, including options, are all up significantly.

Even if we were to ignore the orders related to the two new aircraft, total orders from current production aircraft were the highest of the year.

All large-cabin aircraft had a dollar-based book-to-bill greater than 1 to 1.

For the year revenues were $8.65 billion in operating earnings, or $1.61 billion on an operating margin of 18.6%.

This is a year-over-year improvement of 6.5% on sale, 13.8% on earnings, and 120 basis points on operating margin.

All in all, a very good year at Aerospace with strong operating leverage.

At Combat Systems, sales were up $23 million, or 1.4%, and earnings were up $21 million, or 8.4%, on a 110 basis point improvement in operating margin over the year-ago quarter.

Sequentially, the story is similar.

Sales were up $219 million and earnings were up $39 million.

For the year, sales were down $100 million, or 1.7%, and earnings were down $46 million, or 5.1%.

This compares quite favorably to the guidance we provided at this time last year.

You may recall that we guided to a 4% to 4.5% revenue decline as opposed to the 1.7% decline that occurred.

We also guided to operating margins of 14%, which we beat by 100 basis points.

Overall, Combat Systems is a story of solid additions to backlog, better than anticipated revenue, and outstanding cost and margin performance.

This is a business group that has clearly stabilized.

Marine group revenue in the quarter exceeded $2 billion for the first time ever.

Operating earnings of $193 million were the second highest ever recorded.

Revenue was up $410 million, or 25.2%, compared to the year-ago quarter, and up $220 million, or 12.1%, sequentially.

Revenues for the year were up $600 million, almost 9%.

Very nice growth.

Operating earnings were up $34 million, or 21.4%, against the year-ago quarter, and up $23 million, or 13.5%, sequentially.

For the full year, earnings were up $37 million, or 5.6%, on a 30 basis point decline in operating margin, attributable to mix shift, which was consistent with our guidance to you.

In the Marine group we guided you at this time last year to a revenue increase of 2.5%, which we obviously exceeded.

We forecasted margins at 9.5% and wound up at 9.6%.

All in all, a very good year for the Marine group.

IS&T is a business group where we saw less than expected revenue decline and improved operating performance.

Revenue in the quarter was $2.47 billion, down $223 million, or 8.3% against the year-ago quarter.

Revenue was up 9.8% sequentially and down $1.1 billion, or 10.8% for the year.

Remember that this is dramatically less than the 20% revenue decline we forecasted in our guidance to you at this time last year.

Operating earnings of $212 million in the quarter were 8.2% better than the fourth quarter a year ago.

On a sequential basis, operating earnings were up $10 million, or 5%.

For the year, earnings were down only $10 million, or 1.3%, which is very good performance in the face of a 10.8% revenue decline.

On this call a year ago I gave you guidance with respect to operating margins in the 8.2% range, which we beat by 40 basis points.

All in all, we beat forecasted revenue by $1 billion and operating margins by 40 basis points.

When that happens, the result is a very pleasant upside surprise.

So Company-wide, on this call a year ago our guidance for 2014 was to expect revenues of $30 billion, operating margin rate of 12%, a tax rate of 31%, and a return on sales of 8%.

We wound up the year with revenues of $30.85 billion, an operating margin rate of 12.6%, and a effective tax rate of 29.7%, and a return on sales of 8.7%.

We provided EPS guidance of $6.80 to $6.85.

We wound up at $7.83.

About $0.62 of the improvement came from better than planned operating performance, $0.13 from a slightly lower than planned tax rate, and the balance from a share count as a result of share repurchases.

Let me provide you some thoughts about 2015, initially by business group and then on it Company-wide roll-up.

In Aerospace, we expect revenues to be approximately $9.4 billion, up about 8.3%.

Margin rate should be approximately 18%, somewhat down from 2014, attributable in part to less favorability at jet.

Nonetheless, up about 4.5% in earnings.

In Combat Systems we expect both revenue and earnings to be essentially flat, with growth resuming in 2016 and beyond.

The Marine group is expected to have revenue growth of 2% to 2.5% and a margin rate in the 9.5% range, resulting in a very modest improvement to operating earnings.

Finally in IS&T, we expect a revenue decline of about 5.5%, but improved margin rate of slightly more than 9%.

This will result in improved operating earnings year-over-year.

We expected last year to be our low water mark for revenue.

In part, we are seeing some of the decline we anticipated last year being delayed into this year.

Once again, we should see revenue growth in 2016 and 2017.

All of this rolls up to an operating plan of about $31.3 billion to $31.5 billion of revenue, EBIT rate around 12.8%, and a return on sales of roughly 8.7%.

This plan is purely from operations, assumes a 30.5% tax rate, assumes we buy enough shares to hold the share count steady with year-end figures so as not to permit dilution from option exercise.

This rolls up to an EPS guidance of $8.05 to $8.10 per fully diluted share.

This compares with last year's guidance of $6.80 to $6.85 at the same time on the same basis.

So much like last year, beating our guidance must come from outperforming the operating plan and the effect of share repurchases.

So how should one think about the quarterly progression of EPS?

Whatever your model is for the year, divide by four.

And the first and second quarters will be light by about $0.10.

The third quarter about right on, and the fourth quarter about $0.20 better.

By the way, quarterly progression is notoriously difficult.

With respect to capital deployment, we anticipate using all of our free cash flow in 2015 for dividends and share repurchases.

While we don't anticipate a robust year from a free cash flow perspective in light of the advance payments on international orders that we have received last year, we intend to treat the free cash available for dividends and share repurchases on some normalized basis.

In short, we will use balance sheets cash as necessary to normalize the year.

I would now like to turn the call over to our Chief Financial Officer, Jason Aiken.

Thank you Phebe, and good morning.

I'll take just a minute and cover a few miscellaneous financial items before the question-and-answer period.

Net interest and expense in the quarter was $19 million versus $23 million in the fourth quarter of 2013.

And for the year, interest expense was $86 million, consistent with the year before.

For 2015 we expect net interest expense of around $82 million, a decline from 2014 resulting from the repayment of $500 million of fixed-rate notes that matured last week.

At the end of the year our balance sheet reflects a net cash position, that's cash in excess of debt, of $477 million.

This was down by about $1 billion from the end of 2013, reflecting the cash we used from the balance sheet for capital deployment activities, which I'll address in just a minute.

Our effective tax rate was 29.5% for the quarter and 29.7% for the year, and that's a bit lower than we had been forecasting.

As you recall, our most recent projections were in the neighborhood of 30% to 30.5%.

The lower outcome is attributable to the R&D Tax Credit extension in late December.

For 2015, as Phebe mentioned, we expect an effective tax rate of around 30.5%.

And finally on the income statement you'll notice we took a charge in the quarter in discontinued operations.

This is related to the sale of our AxleTech business, which we first reported in the second quarter when we made the decision to sell that business.

The charge we took at the time was predicated on the 2014 closing of the sale.

The regulatory review process for the transaction delayed the closing until January 5, and as a result we were not able to take advantage of some tax benefits we had anticipated, So we adjusted the loss on the sale in the fourth quarter.

Switching gears, we contributed $515 million to our pension plans in 2014.

And for 2015 we expect that amount to decline to approximately $185 million as a result of the interest rate relief from the Highway and Transportation Funding Act of 2014.

On the capital deployment front, to summarize our activities for the year we delivered on our commitment to returning capital to our shareholders while maintaining a strong balance sheet.

In total, we expended approximately $3.4 billion on share repurchases in 2014.

And when you combine our share repurchases with our dividend payments, we spent $4.2 billion in shareholder-friendly actions in 2014, or 1.3 times our free cash flow from operations for the year.

Erin, that concludes my remarks.

And I'll turn the time back over to you for the Q&A.

Thanks, Jason.

(Caller Instructions)

Shantelay, could you please remind participants how to enter the queue?

(Operator Instructions)

David Strauss of UBS.

Good morning.

Phebe, could you give us a little bit more detail on the free cash flow outlook?

It sounds like it's going to be lower.

Could you maybe peg it as a percent of net income in 2015, and what exactly -- how much of that is in advanced drawdown in terms of the pressure on free cash flow?

Thanks.

So we tend not to give you specifics as a percentage of net income on our free cash flow, but suffice it to say it's going to be less robust as a result of our drawdown in our deposits.

But we will intend to normalize our free cash flow using our cash on the balance sheet to affect any capital deployment.

I think that's about as much color as we usually give you, and as much as we're prepared to give you.

Ron Epstein of Bank of America Merrill Lynch.

A quick question for you on Gulfstream.

How do you expect the sales profile for the business to go when you are leading into the ramp-up of the new models, right?

Maybe a better way to say it, the transition between kind of the old models and the old models, would you expect the profile of the business to continue to grow?

Yes.

We do expect the profile to continue to grow in the near years, but at less of a rate than it will grow when we introduce an entry into service of the new airplanes.

So we have growth between now and entry into service of the G500, and we expect accelerated growth going forward from there.

Okay.

Great.

Thank you.

Robert Spingarn of Credit Suisse.

Good morning, Phebe.

I wanted to talk a little bit about Marine and the strengths you talked about there -- very strong fourth quarter and how things do trend as we go through 2015, especially on some of the development work you're doing on upcoming programs.

Okay.

2014 growth was driven by higher than expected volume on Block IV Electric Boat, more unplanned repair work, and additional commercial volume.

And we anticipate that those growth elements to continue into next year, albeit at a less great -- less of a rate of increase.

Our developmental work, primarily on the higher replacement ballistic missile submarine, continues apace.

We're the sole source on that contract, and we're year over year increasing work on that contract.

And it's going very well.

So we like where we're positioned there.

And would you say the fourth quarter itself, you said the strongest quarterly revenues you've seen.

How do we think about just the timing there?

We'll continue to see growth this year at about 2% to 2.5%, which is I think very good in this environment.

And that growth will continue into the out years as we get more volume on Block IV, additional -- we continue to do additional work on our commercial volume.

Repair work fluctuates, but has year over year been growing.

And we begin work on the fourth [ML] piece.

So we've got growth engine for Marine group.

We did obviously last year, we do into this year, and we do in the future.

We've been telling a growth story for the last two years at Marine group, and you saw it manifest itself in 2014.

It's going to continue to 2015 and into the foreseeable future.

Okay.

Thank you.

Cai von Rumohr of Cowen and Company.

I guess I'm a little confused at Gulfstream.

If your sales go up to 9.4%, a nice sales gain, and we're getting improving profitability on the 650, why are the margins down?

I mean, jet just isn't that big a part of the business.

And what's -- maybe give us a little more color on the delivery mix, if you could.

Sure.

We have a slightly -- so there are couple, I think, that are compressing margins slightly in 2015.

We have a slightly unfavorable mix shift in green production between large-cabin and mid-cabin.

We're keeping large-cabin production about the same rate as we did last year, at about 115 units.

We are increasing mid-cabin by 10 units.

So there is a somewhat unfavorable mix shift between large- and mid-sized green.

It's got less of a contribution at jet primarily, and exclusively driven by mix shift.

We've got higher R&D in this upcoming year.

Remember that we're building multiple test aircraft that carry with them no revenue and earnings.

And then the final issue that's impacting margins somewhat in 2015 is we have higher pre-owned.

So those are the four components that are driving the margin variability.

But the R&D, is that up as a percent of sales?

Because if the -- is the G650 still improving in profitability, or is the profitability declining on the 450 and 550?

So that's a kind of two-part question.

Net R&D is up slightly.

The 650 profitability continues to increase, and the 450 and 550 profitability staying exactly where it has been.

We have a greater mix shift this year, mix up mid-cabin which carries with it lower earnings, lower margins.

Okay?

Thank you very much.

I think you need to think about it that way.

We've talked before about the variability of margins at Gulfstream, and this is an example of it.

There's nothing unexpected from our point of view.

There's nothing systemic.

This is simply the ebb and flow of production, R&D, and pre-owned.

Thank you very much.

Myles Walton of Deutsche Bank.

You mentioned that the -- all the large-cabin programs had book-to-bill above 1. The question is really twofold.

One is, where are the demands you're seeing the biggest pockets of strength, and whether you're seeing any dilution of strength in the oil-rich countries, or Russia in particular?

And the other piece of it is, is 2015 the year where you are delivering more G650 than the 450 and 550s in the mix?

Let me talk a little bit about demand and give you a little bit of color there.

The demand for our end product, [early] in production airplanes was quite handsome for the last quarter.

The 650 and the 280 increased.

And interesting but not surprisingly, when we got inside the demand curve for the 650, inside the three-year delivery window, Q4 orders were particularly strong.

280 was again strong.

The 450 and 550, demand has slowed slightly.

It's okay, not superheated but good enough.

And we continue to see strong demand, primarily in North America and somewhat in Asia and also in the Mideast.

Heretofore we have seen no impact on oil prices on our backlog, or frankly in our demand.

If you're asking what percentage of our backlog may have some exposure to energy-related -- or have some energy-related exposures, about 5% but we haven't seen any impact yet.

I would add, we're seeing historically low operating costs, which is a -- usually drives increased flight hours, and that's a potential upside for our service business.

So we tend not to give you deliveries with any more specificity than we already have with respect to models.

We break it up by large-cabin and mid-cabin.

And I don't to intend to change that in the moment.

Okay.

Thanks.

Doug Harned of Sanford Bernstein.

Thank you, good morning.

I wanted to just follow-up on that, on the G450 -- excuse me, on the G550.

When you look forward here, where are you today in terms of months of backlog, something that you've given us in the past?

And how are you thinking about pricing as you approach the G500 and G600 coming into operation?

I think you know that we don't talk about pricing.

That's competitively sensitive.

But let me give you a sense of where we are in first available.

In general, for new customers for the G650 and G650ER, first available is fourth quarter 2017.

That moved to the right a quarter from third quarter of last year as a result of our good order activity.

The G550 is about 12 months out.

The G450, late this year.

That moved a couple of months, just a few months into the left.

The G280 is also available, first available, late this year.

And not than anybody asked, but the G150 is first quarter 2016.

It's important to recall the deals are often in the works that move customers around in the backlog for earlier slots, but the above is about a proximate window for new buyers.

I hope that helps you.

And you can't really comment on the trajectory on pricing with the model change, I guess?

No.

Look, we have continued to hold price on our products.

And you could expect that over time there is some price variability, but we're not about to get into any specifics.

That's just not a good competitive place to be in a highly competitive market.

Okay, great.

Thank you.

Robert Stallard of Royal Bank of Canada.

Phebe, on IS&T you've guided down 5.5% for this year.

Can you give us an idea of how much of that is already in the backlog?

And the sort of level of conservatism you might of based into that, given the fluctuating situation with the DOD budget.

Given the what situation?

Fluctuating.

Fluctuating.

We have about three-quarters of our guidance for IS&T in our backlog.

That's exactly where we've been historically, including recently.

We've got good -- we've got a high level of RFP, Request for Proposal activity, and are bidding on a number of contracts.

So we are pretty comfortable that we can hit our revenue guidance.

From our point of view, we've seen less fluctuation in the DOD budget with respect to our IS&T units recently than we had a couple of years ago.

Okay.

Thanks very much.

So we think that's somewhat stabilized.

And as I told you, we anticipated 2014 to be our low watermark.

It was better than we thought it was going to be, and I think some of that decrease bled into 2015.

Great.

Thanks.

Sam Pearlstein of Wells Fargo.

Can you talk -- I guess to -- and I try and put two things in there, but first on Marine.

I'm somewhat surprised that you're not seeing more margin pressure, given what I would think would be more Block IV work and more Ohio replacement work in the year, just in terms of the mix.

I guess what are you doing to offset that?

And then just related to Combat, you talk about growth resuming in 2016.

Is this a business that we should now expect to see kind of growth, and this still 15% kind of margin runway kind of far into the future?

Let me address your questions in the order that they were asked.

We've talked frequently about margin variability at the Marine group is really a mix shift.

And you quite accurately point out that we are experiencing a mix shift, really frankly across our portfolio.

More Block IV, less Block III.

More commercial work coming off of the MLP program.

First-of-class ships on the DDG-1000 and DDG-51 restart.

That said, these businesses have continued to perform very, very well on cost-cutting efficiency, and their performance has been quite good.

And I frankly expect to see margin expansion, primarily driven by Block IV.

We have increased margin potential and earnings potential from our profitability and efficiency as we move down our learning curve.

So Marine group continues to function very, very well and I like their growth story.

Combat Systems growth, we have that significant backlog.

And now for us it's all a question of performing on that backlog.

And I think this group has demonstrated its operational excellence and will continue to do so.

So I expect, and I've given you my guidance for 2015, but as I project out into the future and think about the business, this is going to be -- we're going to see some growth in Combat and I would expect, fully anticipate, given the operational excellence of this group to see margin expansion.

But I'm not going to bake any of that in now.

On some of these programs we're still in fairly new starts and low rate production, but everything we see, this is a group that will continue to cut costs and improve its efficiency.

Thank you.

Hunter Keay of Wolfe Research.

Thanks for taking my question.

Good morning.

Phebe, can you talk a little bit about the variables that drive the decisions to take up rate?

As we look here across the global landscape, questions about global economic growth possibly decelerating, particularly in emerging markets, and very strong US dollar right now that might be having an impact on some of your operating expenses.

And so as that filters into sort of potential cannibalization within the product lines, this is more of a G650 question than anything else.

But can you talk about, maybe at a higher level if you prefer, what factors you guys look at when deciding how to think about taking up production rates?

Thank you.

So we have historically, and as we've talked about before, we've historically set our production rates, and we've continued that practice based on what we see in demand and to optimize around our economic efficiency, our supplier base, and we've been very judicious year over year in setting our production rates and our deliveries.

As I mentioned, we continue to see very strong demand, particularly for the 650.

Our pipeline on the 650 is very good, the 280 also.

We really haven't seen much impact on the emerging market, certainly not this year.

North America remains very strong with us.

Asia-Pacific, and we're also seeing some increased demand in the Middle East.

I would also tell you that about 60% of our backlog is with public and private companies, including Fortune 500s and they tend to be very stable and reliable and predictable.

And as I said, our pipeline continues to show interest on their part.

So I hope that kind of addressed it.

We look at a complex number of factors.

What our demand is, what our goals are for our operating efficiency, our supply chain.

So we manage prudently.

Thank you.

Peter Arment of Sterne Agee.

Good morning, Phebe.

A question on just the international demand.

I know you gave us some good color on Gulfstream's impact, particularly tied to the energy end market.

You won a lot of orders in terms of Combat this past year.

How are we thinking about the international demand for some of the defense business that you have, and any risk tied to some of the lower price oil on that?

Thank you.

The lower-priced oil.

I've been a big believer, and I think history has demonstrated, that demand for defense products is driven by threat and perceived threat.

And you just have to open up the paper to see that the world is an increasingly unsafe place.

So we see an increased level of interest in parts of Europe and the Middle East, as you might anticipate.

Governments begin to rethink their spending priorities in light of some of the threats that they see, both actualized and potential.

So we have a pretty robust pipeline that's continuing in our IS&T unit and for Combat.

Now I will tell you that the Marine group has almost no and never has had much international exposure.

Just the nature of our Navy shipbuilding program.

Okay.

Thank you.

George Shapiro of Shapiro Research.

I want to pursue the margin at Gulfstream a little bit more.

This quarter effectively you had 60% incrementals, and if I add back the $40 million higher R&D and G&A you had, you would have had 100% conversion.

So can you tell me what was so strong this quarter that all of next year's probably going to decline, if your numbers are right, to 15% kind of incremental margins?

And also you had no pre-owned this quarter, you had 3 for the year versus 11 in 2013.

So why does 2015 pre-owned go up?

Thanks.

Well, that's a compound question, George.

So let me see if I can at least address what I think the essence is.

The same -- having less pre-owned this year clearly was an upper to our margins.

Pre-owned tends to carry no revenue.

And we forecast pre-owned demand based on what we see in our backlog, and sometimes that comes to fruition and sometimes not.

So this has been a pretty sustained pattern over time with respect to pre-owned.

It tends to be lumpy.

And we won't know until the quarter of execution whether in fact anticipated pre-owneds come into our market or they are sold before they get to Gulfstream.

So that makes pre-owned a little bit tougher to articulate.

We had -- the performance at Gulfstream this year was extremely strong.

And we had a favorable completion mix in the fourth quarter that we are reversing somewhat going into next year.

So we've talked multiple times about the fallacy of being able to predict with great specificity the Gulfstream or Aerospace margins.

And I will tell you, jet had a very strong year this year.

And that contribution will be less next year, primarily driven by mix shift as they move into some additional completion work and they come down their learning curve.

So all of these factors are -- play into Gulfstream and Aerospace margins.

Could you point to some unique things in the fourth quarter that cause such an extraordinarily high conversion that won't repeat?

Well, I think, again -- gosh, George, I've tried.

We've got less contribution from jet.

And we had a favorable delivery mix on large-cabin to mid-cabin and that's a pretty -- those are pretty big movers.

And less pre-owned.

And that's a big one.

Pre-owned tends to carry very little, if no -- or negative margins.

So that's, in my mind, explains it.

It's the reality of (inaudible) Okay, George?

Okay.

Thanks very much.

Howard Rubel of Jefferies.

Good morning, Phebe.

Thank you.

Rather than be too granular here, I want to take a step back.

As you look at your outlook and what you've asked your senior executives to do, where -- as you look at the various risks might you see either challenges or opportunities?

And I'll use two examples, and then hopefully you can add to that.

One is some of your operations have European or Canadian-based costs, and you sell in dollars.

So there may be up some upside there, although I know you hedge some.

And then also you're embarked on a very aggressive research and development campaign at Gulfstream.

And how have you assessed the risk, and where have you felt like you've made progress?

It's a bit of specifics, and then wrapped in a little bit of -- the 805, day 10 is a nice start for the year, but I'm sure we won't end there.

So just to reiterate, we've given you guidance based on the same assumptions that we used last year.

And our ability to do better is simply going to be as a result of share repurchases and outperforming our plan.

If you look at our outlook, it's informed by the last two years where we focused on operations, reduced our cost, and the result built our backlog.

So we are poised for growth as a result of that backlog for several years to come.

It's a very nice position to be.

We are going to see some good growth in 2016 and 2017, and the business is poised for that.

And we've been focusing on operations and what we basically call the back to basics, which is blocking and tackling.

That work is never done.

So we're going to continue to attack our costs.

It's a relentless focus on our cost performance and reengineering our business.

That will make us more competitive, reduces our cost, makes more competitive.

And that too will help growth.

We have positioned ourselves nicely, and I think we'll continue to do so going forward.

Our opportunities are because of our improved competitiveness.

Increased growth, primarily both overseas, and we've talked about that before.

We've got another opportunity at margin expansion going forward as we focus on our continuous improvement.

We've got -- when I think about risks, you implicitly ask about foreign currency risk.

We are less exposed to foreign currency variability than companies in other sectors.

For example, in 60% of our business is with the US government.

Gulfstream's exposure's to the US economy.

We have -- there's some translation difficulty year over year with respect to currency fluctuations.

We've embedded those in our plan.

We also have some nice natural hedges, both in Europe and in Canada.

So has the strong dollar affected any of our demand?

Not really, and we certainly haven't seen it in our backlog.

We had a translation.

We had to adjust our Combat backlog as a result of a negative translation, but that's on work that's many years out.

But in terms of sales, we're not just seeing any particular impact.

Is it potential?

Sure.

But it's not affecting us.

Now, you asked about R&D as a risk.

The key when you introduce, I think, you invest in a business and in its new product development.

And you introduce new product is that you have managed that R&D and the engineering and development and design effectively.

And Gulfstream has a proven history of doing that.

And we are continuing to see that same kind of excellent execution in our design and engineering efforts at Gulfstream.

So we don't see any risk that's outside what we have always seen in the past with respect to R&D, but we manage R&D at Gulfstream in their design and engineering activities very, very closely.

And we've really have -- again, we've set the expectations accordingly and we have a great team there.

It's all about the execution.

And so far, so good.

I hope that that addresses where you were headed.

No, I actually meant the currency because of where you are building things is actually an advantage, either in Europe or Canada.

And that was a --

Yes, in some instances it is.

But we haven't seen either up nor down, any particular impact in the moment.

Thank you.

Joe Nadol of JPMorgan.

So I have a couple, but they're easy.

One is --

(Laughter) Which justifies a couple, I take it.

One's more just a clarification.

On the Combat side, you're saying flat.

You have these big orders, obviously, in your backlog that are from international customers last year.

Can you give us some help with how much you expect international, if it's the case, to be up, and then US down in 2015?

Then the second one is just more broadly speaking, looking at the whole Company.

Can you speak a little bit, wherever you feel comfortable, about the bookings that you're expecting across the Company this year.

Particularly interested if you -- if there are there any of these larger Combat opportunities that are still out there that might hit, kind of $1 billion-plus opportunities.

And then also particularly interested in the 500 and 600, and what the tempo you expect on bookings there might be.

Thanks.

Okay.

Complex questions.

But let me address them in the order in which you asked them.

We are seeing stabilization at -- in our US land forces exposure at Combat Systems, directly in line with our expectations.

And so we don't really see any, at least surprises, that we can see in the near term.

International orders are -- or international sales this year are comprised about in excess of 55% of Combat sales and will increased to 60% over time.

Not at the expense of domestic activity, but just as a revenue expansion.

So we do -- we still have a lot of, I'd say, a number of international orders in our pipeline that are of decent size, that it is our expectation that given our competitiveness and our cost structure, we're going to be highly competitive in those competitions.

So we have additional upside in building our backlog at Combat.

But I'm not prepared to give you any specifics on whether that makes it a book-to-bill of 1 to 1 in any one given year.

That will depend on a lot of things, on when these competitions are decided and -- but we've got a lot of proposal activity out there.

And with respect to, I think, the 550 -- or 500 and 600 tempo, both of those R&D programs are preceding apace.

No major changes since the last time we talked to you about it.

Our pipeline is very robust, and I expect sales to increase as we -- orders to increase as we get closer and closer to the entry into service of the 500 and then the 600.

So there is no -- there have been no stumbling blocks heretofore, and our profiles on R&D and production of the test airplanes remain right on plan.

So we're very pleased with that.

And we are pleased with the interest that both of these models have generated.

Okay.

Thank you.

Jason Gursky of Citi.

Thank you, and good morning.

Similar to Joe.

One clarification question, and then one in depth.

One on the growth for Combat Systems out into 2016 and 2017.

Can you offer up a little bit more insight on the type of growth that you might be expecting there?

And then if you wouldn't mind just driving down into IS&T, where are you seeing relative areas of strength in 2015 and weaknesses in 2015?

What's the mix doing there?

So on our -- I don't want to get into specifics about 2016 and 2017, other than we are -- at Combat, other than we have the backlog and are poised for reasonable growth.

Growth that we will manage according to our terms and conditions of our contract, and also our supply chain.

I would expect growth, but not of a double-digit nature.

So don't think about it that way.

We're not going to burn off that backlog that quickly.

It's not efficient and it's not in accordance with the terms and conditions of our contract.

The second part of your question?

The mix at IS&T, where you're seeing strength.

Mix at IS&T.

So we have, as you know, over the last few years our IT services business has composed a larger percentage of our revenues.

That is somewhat changing as a percent of revenue.

We, you may know, combined two of our non-IT businesses and AIS and C4 systems into Mission Systems.

And over time there, it is our anticipation that they will grow as a larger percentage of our IS&T sales than IT.

But both of those businesses are poised very, very well for, again single-digit growth, but still growth.

And I would add that I'm very pleased with their margin performance.

It's particularly interesting that the year that we had some revenue decline, considerable revenue decline, we outperformed on margins.

And this year we expect revenue decline, and again higher margins.

And this time bring with it higher earnings than last year.

So that's a pretty wholesome story from my perspective.

Phebe on that, just one point of clarification.

Do you anticipate, than, at the end of 2015 to be kind of in a flat revenue environment year over year, or creeping into a positive territory on IS&T?

We're projecting a positive territory, positive growth, in frankly every single one of our businesses.

Okay.

Great.

Thank you.

Carter Copeland of Barclays.

Good morning and good results.

Thanks, Carter.

Just, I will stick to one.

And I want to switch gears and go back to the cash flow and capital deployment discussion.

And the question is, is there an upper bound to how much balance sheet you might use to normalize your free cash flow deployment?

Should we think of this as whatever the gap to 100% conversion is, is what you'll use on the balance sheet or could it be more extensive than that?

Every year we have provided the same kind of guidance with respect to capital deployment.

And that is that we, at least in the last two years and again this year, have anticipated deploying all of our free cash flow in share repurchases and dividends, and we anticipate doing that again this year.

But as with every other year, we give you the overall strategy and then the execution, the tactical execution, comes during the course of the year.

So think about, in general terms, that we'll use our balance sheet to, as you quite accurately put it, normalize our cash flow for share repurchases.

But I see no fundamental reason or benefit from tapping into our balance sheet beyond that for share repurchases.

Some of you had requested that we -- not necessarily of you all, but some out in the environment, had requested that we go into our balance sheet early on and buy significant numbers of -- a significant number of shares.

And I argued then and I'll continue to argue now, I don't think that's judicious nor prudent.

And I think that this year is a perfect example of why you don't want to have expended all your bullets in prior years.

Think about us as telling you what we're going to do at the beginning of the year and doing it.

And having very, very reliable results and execution of our capital deployment in the year.

So this year ought to look very similar with respect to what our capital deployment intent is.

Free cash flow and a little bit -- and some off the balance sheet, depending again on where we are on free cash flow.

Great.

Thank you, Phebe.

Shantelay, I think we have time for one more question.

Joe DeNardi of Stifel.

Good morning.

Phebe, maybe another one on the balance sheet.

I appreciate your comments about not wanting to expend all of your bullets.

But maybe longer term, once the defense budget environment were to improve, would that change the way that you thought about using your balance sheet relative to some of your peers?

Okay.

Now, the way I think about the balance sheet is we have a strong balance sheet that gives us flexibility and agility and opportunity, both in the year of execution and going forward.

And I intend to preserve that flexibility.

And I intend to preserve the strength of that balance sheet.

There's some variability in any given year, but not taking off cash off that balance sheet to change our overall fire power.

As I sit here today, that is our strategy.

And we will adapt accordingly in the future as circumstances may change.

Okay.

And then in terms of the fourth-quarter guidance, the big fourth quarter.

Is there any particular segment that's especially lumpy, or are you waiting for any big awards to come in later in the year to hit that guidance?

No.

The quarterly distribution of EPS that I gave you in my remarks is very typical of our performance, that we tend to start out light, build throughout the year, and have a strong fourth quarter.

So that's a very consistent with the ebb and flow of our business, all right?

Great.

Thank you all for joining our call today.

If you have additional questions, I can be reached at 703-876-3583.

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Thank you for your participation in today's conference.

This concludes the presentation.

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