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Executives

Amy Gilliland - Vice President of Investor Relations

Jay L. Johnson - Chairman & Chief Executive Officer

Hugh Redd - Chief Financial Officer

Analysts

Myles Walton - Oppenheimer & Co.

Noah Poponak - Goldman Sachs

Cai von Rumohr - Cowen & Company

Howard Rubel - Jefferies & Co.

Carter Copeland - Barclays Capital

Ron Epstein - BAS-ML

David Strauss - UBS Securities

Robert Stallard - Macquarie Research Equities

Sam Pearlstein - Wells Fargo Securities, LLC

Joseph Nadol - J.P. Morgan

Peter Arment - Broadpoint AmTech

[George Alar] - Stifel Nicolaus

George Shapiro - Access 342

James McIlree - Collins Stewart LLC

Doug Harned - Sanford Bernstein

General Dynamics (GD) Q2 2009 Earnings Call July 29, 2009 11:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2009 General Dynamics earnings conference call. (Operator Instructions)

I will now turn the presentation over to your host for today's call, Amy Gilliland, Vice President of Investor Relations. Please proceed.

Amy Gilliland

Thank you, [Nikita], and good morning, everyone. Welcome to General Dynamics second quarter conference call.

I want to remind listeners that any forward-looking statements made today represent our best estimate 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'd like to turn the call over to our President and Chief Executive Officer, Jay Johnson.

Jay L. Johnson

Thank you, Amy, and good morning.

General Dynamics delivered a strong second quarter performance. Our sales totaled $8.1 billion, up nearly 11% from the prior year period. Operating earnings were $945 million, the highest result in company history. This led to earnings per share of $1.61 on a fully diluted basis, $0.01 ahead of last year's second quarter result.

The year-over-year EPS comparison is imperfect as a result of tax, interest and share count variances, and we'll talk more about those a little later. This quarter, however, was the stronger on an operating earnings basis.

Year-to-date sales are up 14% and operating earnings are up around 4% when compared to the first six months of 2008. This year-to-date performance is particularly attractive on top of the very strong growth we experienced in the first six months of 2008 compared to 2007. You may recall 2008's six-month sales were up 11% and operating earnings were up 24%.

The key driver behind this quarter's results was the continuing ability of our businesses to deliver operationally. Their disciplined execution is evidenced in the better than anticipated operating margin in each of the businesses in the quarter, particularly at Marine Systems. Companywide margins improved 70 basis points from the first to the second quarter and our ROIC increased to nearly 19%, 100 basis point improvement over second quarter 2008.

Let me turn to cash. Second quarter free cash flow after capital expenditures was $520 million, which represents 84% of earnings from continuing operations. Year-to-date, free cash flow is $593 million. As in years past, I expect strong cash generation in the second half, particularly in the defense businesses.

Orders this quarter were close to $6 billion, with particularly strong activity in the Information Systems and Technology group. At the end of the quarter total backlog was nearly $68 billion, down approximately 5% from the first quarter but up 22% over the second quarter of last year.

Now I'd like to spend some time on the outlook for each of our businesses, beginning with defense.

Our defense businesses have all experienced strong support in the ongoing 2010 budget deliberations. While there is still more work remaining until the 2010 defense bill becomes law, I am confident that GD's programs will come through the process with solid support by the Congress.

As you all know, the Department of Defense is in the middle of its Quadrennial Defense Review. When complete, this document should shape the outlook for the future year's defense plan. Until the QDR decisions are completed and communicated to the public, there's really not much that can be definitely said about the long-term defense spending trends; however, Secretary Gates has been very clear about his intention to have a budget with, and I quote, "a steady, sustainable and predictable rate of growth." The Secretary has also stressed the importance of providing our military with weapons systems that have the flexibility to confront both conventional and asymmetric threats.

Current threat levels, my previous experience with these types of internal deliberations, and the relevancy of GD's programs to the warfighter lead me to believe that our company will emerge from this review well supported. Understandably, there'll be both puts and takes in the QDR results, but I believe that our combat vehicles will continue to comprise a significant portion of the Army's order of battle, our surface combatants and submarines will be pivotal in addressing conventional and strategic threats as well as tactical intelligence requirements, and our IS&T portfolio will continue to be integral to meeting the Pentagon's tactical communications, ISR and cyber warfare needs.

Let's talk about Combat Systems. Combat Systems experienced healthy year-over-year growth in both sales and earnings this quarter. Sales were over $2.4 billion, a 19% increase over the same period last year. Of that growth, 14% was organic. While our organic growth was principally driven by increased Stryker and Abrams volume, each of our three domestic businesses increased their sales year-over-year. The remaining growth came from the addition of AxleTech to the group's weapons systems business.

The group's earnings totaled $300 million, a 6% year-over-year increase. This is a particularly good result on top of the 18% sales growth and 48% earnings growth the group had in the second quarter of 2008 versus the same period in 2007.

Margins were down 150 basis points year-over-year primarily because of the higher-margin second quarter 2008 MRAP work that drove the group's margins to an uncharacteristic 14%. Sequentially, the group increased earnings on similar sales volume, resulting in a 90 basis point margin increase. These improved margins are the result of productivity improvements across all of our North American Combat Systems operations.

European Land Systems revenues were down slightly this quarter compared with last year. Year-to-date, revenues and earnings have been steady. ELS continues to improve their operations and I expect their results to be better in the third quarter and even stronger in the fourth quarter, a patter consistent with their past performance.

Total backlog for Combat Systems decreased by approximately $1.6 billion in the quarter. Nearly 60% of this decline is the result of de-booking the mostly unfunded backlog for future combat systems, in line with the Pentagon's cancellation of the manned ground vehicle portion of FCS. As you know, the Secretary of Defense and the Army remain committed to developing a replacement ground combat vehicle program.

Our Army customer is currently reevaluating the structure of brigade combat teams. Because the revolutionary next-generation vehicle program is delayed, the Army is now modernizing and evolving current vehicles. Frankly, we see the cancellation of FCS as an opportunity. We are well positioned to evolve our combat vehicles, including Stryker and Abrams, to address the changing threats faced by our soldiers.

Combat Systems received several notable orders in the quarter, including approximately $320 million for the production of Strykers and approximately $450 million for the production of wheeled armored vehicles for a Middle Eastern customer. Additionally, subsequent to the quarter end the group was selected by the Canadian Department of National Defense for a sole-source contract with potential value of over $850 million to upgrade Canada's light armored vehicle fleet.

Looking forward for the group, sales in the remainder of the year will be higher than both year-to-date and last year's second half, particularly in the fourth quarter. Overall sales in 2009 will be up about 22% over 2008. Earnings will also be stronger in the second half. Margins for the year will be 12.3% to 12.5%, comparable with our original expectations.

Marine Systems group had another very strong quarter. Sales were up nearly 17% for the quarter at approximately $1.6 billion. Earnings were up over 32% at $168 million. This growth in sales and earnings was across all three shipyards, but was particularly driven by increased Virginia class volume and engineering work at Electric Boat and increased commercial ship and repair volume at NASSCO.

Earnings growth outpaced sales growth across all three Marine businesses, causing operating margins to expand 120 basis points year-over-year and 50 basis points sequentially. Marine's margin improvement comes from strong operational performance and in turn increased booking rates on all of the group's major programs.

The Marine group's backlog totaled approximately $24 billion at the end of the quarter, down slightly from the first quarter but up over 100% from the same quarter last year. There are a number of notable opportunities on the horizon, which may add further to the group's backlog once the 2010 budget is approved, including two additional DDG-1000s and one additional DDG-51 mentioned by Secretary Gates as part of his budget preview remarks in April; development work on the next generation ballistic missile submarine program, which was well supported in the President's 2010 budget request; additional Littoral Combat Ships - quarter end backlog includes the group's second ship; the group is also currently bidding on the next two ships in the class.

Looking forward, sales for the remainder of the year will improve over the same period last year but will not be quite as strong as the first half of 2009. Overall, sales should be up a little over 16% compared with last year, well ahead of our earlier guidance. Margins for the year are anticipated to be 9.8% to 9.9%, an improvement of 40 to 50 basis points over last year.

In our IS&T group sales were approximately $2.7 billion, up 3.5% over second quarter 2008 and 9.6% year-to-date. Organic growth for the first six months of 2009 totaled nearly 7%. The group's second quarter operating earnings were $284 million, down slightly year-over-year. year-to-date earnings were up 4% compared to first half 2008, primarily volume related.

Operating margins were 70 basis points less year-over-year but exceeded by expectations. To that point, second quarter margins were 10 basis points better than those in the first quarter on slightly lower volume. This still appears to us to be industry leading performance.

Backlog for the group increased to $10.5 billion because of strong order activity across the IS&T businesses, including $180 million in orders under the common hardware/software program and $375 million to upgrade the Bowman Tactical Communications system in the United Kingdom. Book to bill totaled 1 time for the quarter, the seventh of the past eight quarters in which the group has met or exceeded 1:1.

Looking ahead in 2009, IS&T is in an excellent position to leverage its current and expanding capabilities to capture new business in fast-growing market segments. In particular, the group's ISR business had heavier volume in its signals collection and cyber products in the second quarter and I expect that trend to continue. In fact, subsequent to the quarter this business was selected as a participant in two significant IDIQ awards in this arena - a $600 million five-year contract to perform signals intelligence for the Air Force National Air and Space Intelligence Center and a $400 million contract to secure critical federal and private sector networks.

The ISR business will also benefit from the addition of Axsys, an acquisition we announced in the quarter. Axsys is a leading provider of surveillance and imaging technologies, including state of the art lens and gimble technologies. From a strategic standpoint we plan to leverage Axsys products into our sensing and algorithm exploitation capabilities to enhance our product offerings and expand our footprint in this fast-growing market space. I expect that the deal will close later in the third quarter, be neutral to earnings for the last quarter and accretive in 2010.

For the rest of the year IS&T volume will be stronger than the first half and stronger than the same period a year ago. Overall, I anticipate a little above 8% sales growth. Margins will likely decline in the second half as a result of mix shift toward lower-margin services business, but I expect full year margins to be consistent with our previous guidance - in a range of 10.3% to 10.4%.

Aerospace. The Aerospace group executed extremely well again this quarter amid a difficult, albeit gradually improving, business jet market. The group's sales were $1.4 billion, up 6.5% from the prior year quarter due to the addition of jet aviation.

Organically, Gulfstream sales were down 16% year-over-year as unit deliveries were reduced in line with our revised production plan. Sales were also impacted by continued pressure on the services business, which is off 21% year-over-year and 15% year-to-date. This decline is the result of customers deferring optional maintenance and intensified price competition triggered by current market conditions. Though I wouldn't characterize this as a trend, we are seeing some increased service activity this month.

The group's operating earnings were down 10% year-over-year to $215 million; however, compared with last quarter earnings were up 7.5% on somewhat lower volume, a very good result that is clearly indicative of how well the group is managing through this down cycle.

The group continues to target cost reductions, including eliminating almost $45 million of indirect costs in the first half of 2009. You may recall from an earlier report that we anticipated $60 million in savings for the year; we expect to achieve that and more.

This strong earnings result led to 150 basis points of margin improvement over the first quarter. A favorable mix of large aircraft deliveries and continuous improvement initiatives combined to push Gulfstream margins to 17.9%. These margins include a $2 million loss on two pre-owned aircraft sold in the quarter, $13 million in severance costs, and $10 million in warranty reserves, offset in part by $15 million in liquidated damages. We have six remaining pre-owned aircraft in inventory, including one under contract, and we anticipate receiving no more than three additional aircraft before year end. We have no white tails.

Jet aviation also showed some operational improvement in the quarter, although they still have a significant way to go. The Aerospace group is leveraging its completions experience and seasoned leadership team to make some meaningful changes to Jet's completion's business. These management and process changes are already making a difference in Jet's performance. I expect that this business will continue to make incremental improvements in the second half.

There continue to be several encouraging signs that the business jet market is stabilizing. In recent months Gulfstream flying hours have increased and new order interest has improved. On an absolute basis dollar-denominated book to bill this quarter was a healthy 1 time. This does not include the impact of defaults. Another positive sign was that customer defaults were down almost 50% from last quarter and orders handily outpaced defaults in the quarter. In fact, excluding G-650 orders, this is the most orders we have taken since the second quarter of last year. Despite this, we did see a marginal drop in the group's backlog, but at nearly $20 billion, they continue to have a very robust base of work.

In March the company provided 2009 and notional 2010 aircraft production guidance. I feel very comfortable with our 2009 large cabin production estimates. Our large cabin spots are sold out through the end of this year. For 2010 I anticipate the large cabin production number to be in the low 70s. Midsize production may further decline, however, as that end of the market continues to struggle with large inventories and considerable pricing pressure. We are closely monitoring this situation and will make further midsize cuts as necessary, although I don't anticipate they'll impact my expectations for the group's performance.

On the product development front, Gulfstream continues to progress on schedule. We look forward to both the G-250 and G-650 making their first flights this year.

As you heard on our last call, we expect the group to have fewer aircraft deliveries in the third quarter because of the previously announced summer furlough at Gulfstream's Savannah manufacturing facility. Consequently, the group's third quarter sales will likely be off a little over 20% and operating margins will be down accordingly. For the full year I expect the group's sales to be down about 5%. Operating margins I anticipate to be between 13.3% and 13.5%.

In summary, General Dynamics has performed very well in the first half of 2009, positioning the company to do well in the second half. The third quarter will be somewhat softer as a result of the Gulfstream furlough; however, the second half should be very strong for our defense businesses. For the year we anticipate sales growth of 11% and operating earnings margins slightly in excess of 11%. I expect earnings per share from continuing operations to be $6.05 to $6.15, an increase from our prior guidance. From today's perspective I would guide you toward the midpoint of that range, with some potential upside and some risk in each of our groups.

With that, I'll ask Hugh Redd to touch on several key financial highlights. Hugh?

Hugh Redd

Thank you, Jay. There are a few items I'd like to point out that impact the comparison our 2009 to our 2008 earnings per share.

The first is interest expense, which was up $26 million in the quarter and $46 million for the first half of the year. This is driven by an increase in our net debt as we completed five acquisitions and repurchased almost 14 million shares since the end of the second quarter of 2008. To be clear, no transactions were completed nor shares repurchased in this quarter but rather in the three preceding quarters.

As you may recall, in December of 2008 we issued $1 billion of five-year notes at a coupon of 5.25% and more recently in June we issued $750 million of two-year paper at a 1.8% coupon. At the end of the quarter our net debt is down almost $400 million compared to the end of the first quarter and is at a level consistent with the end of 2008. Taking into consideration our net debt position and the interest rates on our new debt, we continue to expect full year interest expense of approximately $150 million.

Next I'd like to draw your attention to our effective tax rate. In the second quarter of 2008 we resolved tax litigation dating back to the early 1990s. This resulted in a one-time benefit of $35 million, which reduced the 2008 second quarter tax rate by 385 basis points and it also increased earnings per share by $0.09. We received the cash associated with that settlement in the fourth quarter of last year. Our tax rate for 2009 in both the second quarter and for the first six months of 2009 was approximately 31.5%, consistent with our full year expectation.

Finally, return on invested capital improved 18.8%, a 100 basis point improvement over second quarter 2008, and return on equity improved to 22.3%, a 190 basis points improvement.

That concludes my remarks and, Amy, I'll turn it back to you for the question-and-answer session.

Amy Gilliland

Thank you, Hugh.

Before we move to the question-and-answer period I'd like to remind participants to ask only one question so that everyone has an opportunity to participate. If you have an additional question, please get back into the queue.

[Nikita], could you please remind participants how to enter the queue?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Myles Walton - Oppenheimer & Co.

Myles Walton - Oppenheimer & Co.

A question for you on the QDR as it portends to potential changes that could come out of that. One of the decisions that's certainly getting floated is to move away from a two-peer adversary or two conventional conflicts simultaneously and the implications that that will have on force structure and resources. I know you quoted Gates' comment about a stable, potential growing defense budget, but how do you think that that decision in particular could impact GD relative to what it's selling into the defense markets? How do you think it'll impact and over what time?

Jay L. Johnson

Well, Myles, I wouldn't try to pre-guess the QDR outcome, as you might expect, but I would tell you that from our perspective my sense is if you look at our defense portfolio, we've got a lot of diversification in there. And to the point I made in my remarks about needing to deal with conventional threats and asymmetric or unconventional threats, we cover that space.

So the two major war scenario is something they'll have to work their way through, but in any outcome that I can imagine with the QDR the diversity of our portfolio I think puts us in a very strong position.

Operator

Your next question comes from Noah Poponak - Goldman Sachs.

Noah Poponak - Goldman Sachs

Jay, you gave us a lot of very good color on what you're seeing in the business jet markets and things sort of stabilizing. I guess you guys had previous alluded to the potential for large cabin rates to actually go higher in 2010 versus 2009. Is that something that's still on the table and that you're thinking about, and can you just kind of update us on that?

Jay L. Johnson

Well, I like your thinking, Noah, but at this point I think the prudent statement is the one I made. We feel quite comfortable looking at 2010 in the 70s, the low 70s, for large cabin. As you know, also, we have the capacity and the wherewithal to ramp that up if we need to or ramp it down, but we don't see that as an outcome here. So we'll see how the market develops.

We're encouraged by what we're seeing. I mentioned it in my remarks. But the large cabin market is drawing great interest and the order book is very healthy and getting more so, so we're confident that we can ramp it up if we need to.

Operator

Your next question comes from Cai von Rumohr - Cowen & Company.

Cai von Rumohr - Cowen & Company

Jay, could you give us some more color on Gulfstream in terms of the mix of order and demand between the U.S. and foreign buyers?

Jay L. Johnson

Actually, Cai, I would characterize it as quite balanced by both geography and the types of buyers within that - the demographic within that geography. It's a mix almost across all segments, I would say. Probably a little more international than North America right now, but pretty close to a balance, and I would categorize it as a higher percentage of private company individuals as opposed to public companies. But it's a pretty good mix across the spectrum. We're not singled up on any one sector that causes us an issue.

Operator

Your next question comes from Howard Rubel - Jefferies & Co.

Howard Rubel - Jefferies & Co.

Could you, Jay, talk to us a little bit about foreign military sales - there are substantial offers outstanding - and where are you in terms of closing on some of them, please?

Jay L. Johnson

Okay, Howard, I'd be happy to. The foreign military sales - we'll have a Combat discussion here. We feel that we have great opportunity in the FMS arena. As you alluded, some of it's ongoing right now. We see opportunity in Saudi Arabia. Those contracts, the same contracts for brigades four and five, are in work right now, so that's still coming; we anticipate it'll be here this year. We've got FMS business working in Iraq already; we expect more. That's a work in progress, as you might have known. So we think there's great opportunity there.

I mentioned the Canadian piece, but there's great opportunity for Combat in Canada with the LAV-3 upgrade, as mentioned, but also in follow to that, the Canadian National Defense Department is putting forth requirements for three different tactical vehicles or armored vehicles that we think will be something we will participate in as well.

So there's lots of opportunity out there.

Howard Rubel - Jefferies & Co.

But the Iraqis are sort of short on cash and some of this looks like it's being pushed back a little bit. Could you just talk about how you're addressing those challenges?

Jay L. Johnson

Well, as you know, Mr. Maliki was here last week and so those discussions are ongoing right now. And we work all of that through FMS, so we're not dealing directly with the Iraqis, as you'd expect.

But we still remain confident that that is going to get worked out. Don't ask me exactly what that means, but we will come to a decision point here in the not-too-distant future and we believe we're going to get a considerable amount of business through FMS in Iraq.

Operator

Your next question comes from Ron Epstein - BAS-ML.

Ron Epstein - BAS-ML

You mentioned that orders for Gulfstream in the quarter were greater than [break in audio].

Amy Gilliland

Operator?

Operator

Yes.

Amy Gilliland

I think we dropped Ron Epstein, so perhaps he can try to get back in the queue and you can get someone else on the line?

Operator

Your next question comes from Carter Copeland - Barclays Capital.

Carter Copeland - Barclays Capital

A bigger picture question for you. There's at least some modest speculation that one or more of your competitors may need to sell or spin some businesses as a result of changing language around OCI. I wondered if you'd speak to your views about what this might mean for your portfolio of business? Can they be appropriately secluded? Is it a material amount of business? And if some of these things were to happen among some of your peers would there be an opportunity to buy or would you be precluded from ownership of some of these assets? Just in very general terms, how is GD thinking about these issues?

Jay L. Johnson

Well, Carter, I know there's a lot of discussion and a lot of print about the OCI issue right now, but for us it really comprises - the SETA-type work is really a very small part of our IS&T portfolio. And, frankly, we deal with it customer by customer and probably the best example of that is when Antheon came aboard and the SETA work at Antheon was divested. So I know it's out there a lot, but for us it's not a big deal.

Carter Copeland - Barclays Capital

Do you think it's something, I mean, if you were to look broadly at the rest of the industry, is it something that can appropriately be fenced off or is this the direction that we're headed? Are these assets going to come out? Do you have a view?

Jay L. Johnson

For us it's not, as I alluded already, it's not a part of the business that we particularly yearn for. We're more of a product and a services house in that regard, a product house. So I would say it's not something that's high on our go-to list.

Carter Copeland - Barclays Capital

So if something were to come out of your peers, it's not a business you'd be particularly interested in?

Jay L. Johnson

Not necessarily, no. No is probably my best answer.

Operator

Your next question comes from Ron Epstein - BAS-ML.

Ron Epstein - BAS-ML

Jay, you mentioned that defaults in the quarter were less - orders were greater than defaults for Gulfstream. Did you see any trend in the defaults and can you give us any more color around that because some of the other jet OEMs have had huge numbers of defaults in the quarter and you guys have done a lot better, so I'm just trying to get a feel for maybe why.

Jay L. Johnson

Well, the defaults, I would characterize it, Ron, as fairly balanced across the whole Gulfstream portfolio, but the order book was, as I alluded to earlier, heavily weighted to the large cabin, so that's good for us.

Ron Epstein - BAS-ML

Can you put a number on defaults or no?

Jay L. Johnson

I could but I won't. Sorry.

Operator

Your next question comes from David Strauss - UBS Securities.

David Strauss - UBS Securities

Could you touch on the outlook for Combat Systems beyond 2009, specifically from the domestic side of things, based on what you see in the fiscal 2010 budget? It looks at is Abrams and Stryker funding in '10 is down significantly.

Jay L. Johnson

Well, I alluded to it earlier, but let me just say, David, that going into the 2010 budget deliberations we felt cautious optimistic, shall we say, on those two programs in particular. And I think coming out that will be validated and more. You're asking me my sense of it; that's exactly what it is. Both of those, the Stryker and the Abrams, are relevant to the warfighter and I keep coming back to that, the relevance to the warfighter at a time when we are at war. I believe that our customer is going to demand more and we're prepared to give it to them.

David Strauss - UBS Securities

Jay, are you thinking specifically Congress is either going to plus up these programs in particular or are you expecting a second fiscal '10 supplemental?

Jay L. Johnson

Well, if you look at some of the marks, the HAC-D mark, for example, there is plus up in there. So we're encouraged by the dialogue that's going with that, so I would hope that we'll come out of the budget itself with it.

You've also read some people are already talking about a supplemental for next year. I'm not prepared to comment on that except to say that it's out there and we're going to do whatever it takes to service the warfighters out there. That's my belief.

Operator

Your next question comes from Robert Stallard - Macquarie Research Equities.

Robert Stallard - Macquarie Research Equities

Just a follow on from David's question, I was wondering if you've seen any impact flowing through your business from the finalized FY '09 supplemental, which was down year-on-year?

Jay L. Johnson

I missed the last part of that, Robert.

Robert Stallard - Macquarie Research Equities

I'm saying if you've seen any impact of the FY '09 supplemental on your business, either positive or negative, but it's down year-on-year.

Jay L. Johnson

Yes, we got some lift out of it, but I don't think I have much more to comment on it than that.

It was positive for us, the supplemental. We got some Stryker add in there, so it was fine. I'm not sure what more you're looking for.

Robert Stallard - Macquarie Research Equities

I was wondering if you could give us any additional granularity because there's some pretty big captions in the supplemental - and we have seen some of the line items trend down year-on-year - and just looking to see whether any of that has impacted on your equipment or services businesses?

Jay L. Johnson

No, the supplemental is embedded in the numbers I gave you so I think we're well heeled for the year in that regard.

Operator

(Operator Instructions) Your next question comes from Sam Pearlstein - Wells Fargo Securities, LLC.

Sam Pearlstein - Wells Fargo Securities, LLC

In your opening remarks you didn't really talk at all about the cash flow and I just wanted to make sure, what are your views on free cash this year? Is it still going to approximate net income? And then can you just talk a little bit about the moving pieces that we'll see in the second half because certainly customer advances and deposits, with what went on with Gulfstream, was a pretty big negative in the first half. Does that start to reverse as we move forward in the year?

Jay L. Johnson

Well, I think you've hit upon the essential ingredient here to second half cash flow and that has a lot to do with Aerospace/Gulfstream.

But I would say to your first comment that our objective is always to get to 100% with our cash, but I would also be less than candid if I didn't say that it's going to be a tough, tough go this year, as you might expect. But the defense businesses are strong in the second half; we like the trending that we're seeing in the Aerospace side, so we remain very aggressive and very optimistic there.

Operator

Your next question comes from Joseph Nadol - J.P. Morgan.

Joseph Nadol - J.P. Morgan

My question is on the two Gulfstream development programs. You gave a bit of color in your comments but just wondering if you could give maybe a little bit more, maybe on timing of first flights for each of them? How are the development programs going, more specifically, is there anything that's more challenging than expected and how are you working through it? And what's the demand picture been looking like in recent quarters since all this turmoil has started - cancellation activity, new orders, etc.

Jay L. Johnson

We are taking orders for the 250. The 650 book is solid. There have been a couple puts and takes on the far end of that, but both aircraft we expect to be very eagerly received, so that part of it looks good to us.

As far as the jets themselves, they look like jets; they look like real airplanes now. They're coming together nicely. They're working hard at it. As you might expect, there are some challenges inside the lifelines there, but we still are very much confident that we'll fly these airplanes later this year. If you ask me to pin that down, I'd say probably early in the fourth quarter, but that could move around a little and that's okay.

You know the process. You basically take a static article, you build a static jet, and then you run that static article through very grueling tests on the ground, and before you can take the flight article, if you will, and put it in the air, the static article has to pass. So process-wise that's happening down in Savannah right now with the 650. It's happening in Israel with the 250. And those things are coming along apace and we're very confident that we'll fly both of those airplanes this year and I'm really looking forward to it.

Joseph Nadol - J.P. Morgan

Can we extrapolate from that that the certification programs are also on schedule for both aircraft?

Jay L. Johnson

If I had Joe Lombardo here he'd give you a more precise answer, but my answer to that is yes. But we're in the process now. We're just starting to test the test articles, the static articles, if you will, so it'll be awhile. But I don't see any showstoppers in front of us, if that's what you're asking me. These are going to be wonderful machines and we're going to get them airborne here in the not too distant future.

Operator

Your next question comes from Peter Arment - Broadpoint AmTech.

Peter Arment - Broadpoint AmTech

Just quickly on cyber, it continues to be talked quite a bit about and since last quarter I think there's been some further movement in terms of funding. How does GD look at this? As a significant booking opportunity in the second half or is it more of a 2010 event?

Jay L. Johnson

No, I mean, here we're already into cyber to the tune of probably $1 billion a year and for us, as you probably know, it's spread across all of the lines of business in IS&T. So we've got the forensics, we've got the encryption, we've got the information management and security, we've got the infrastructure piece across our lines of business, so we're well into cyber and we'll continue to be there.

We see that as a very handsome long-term growth opportunity within IS&T.

Operator

Your next question comes from [George Alar] - Stifel Nicolaus.

George Alar - Stifel Nicolaus

Could you guys talk a little bit about the mix that you mentioned and kind of bringing down margins at IS&T? Should we generally view this as kind of a low 10% margin business or do you plan on quickly returning back up to kind of the mid to high 10% margins beyond some of the near-term mix shift issues?

Jay L. Johnson

Well, we've said for the year we're going to be low 10s and we're confident in that, so going forward I think you could expect that, maybe a little more. Is that what you're asking me?

George Alar - Stifel Nicolaus

You guys did about 10.6% - 10.7% in the first half and then you dropped down to about 10% margins, so I'm just wondering kind of long-term is this about a 10% margin business or kind of in between there and what are the near-term issues, also?

Jay L. Johnson

The service mix is what you're really seeing here, I think, and as the mix changes more to IT services, which is a lower-margin business but a wonderfully steady and long-term business, we think where we are is in the low to mid 10 range, and that's probably as precise as I want to get it right now.

Operator

Your next question comes from George Shapiro - Access 342.

George Shapiro - Access 342

In Combat Systems you're expecting to sustain - actually even accelerate a bit - the growth in the second half versus the first half, yet you've got a big decrease in MRAP revenues in the second half versus the second half of last year. What programs are actually ramping up substantially in the second half to offset that?

Jay L. Johnson

Probably the biggest is - and this is as it goes through most of the years - the European, as you know, is a first to fourth quarter building business, so I would expect a lot of the second half to be reflective of the growth that we would normally and always see in Europe, European Land Systems.

George Shapiro - Access 342

But you're probably losing maybe $500 or $600 million of revenues for the MRAP in the second half versus last year so I just wonder if you could maybe be a little more specific as to what programs European Land Systems might be increasing that much to offset the MRAP?

Jay L. Johnson

Program specific, it's really all the programs over there. That’s the way the European model is working, such that it comes to you late in the year - sometimes real late in the year, but it comes.

We've also got - ATP has got a significant amount of work. And so, I mean, Europe is the big mover in the second half, I guess, is probably the cleanest way to say it, George.

Operator

Your next question comes from James McIlree - Collins Stewart LLC.

James McIlree - Collins Stewart LLC

In the second half it looks like you have Marine revenues up substantially over the first half revenues, but margins not expanding at all. What's the reason for that?

Jay L. Johnson

We're pulling pretty handsome margins out of Marine across the year. I mean, 10.3% this quarter was superb and we're targeting ourselves to the high 9s across the year. I'm pretty confident and comfortable and pleased with that.

James McIlree - Collins Stewart LLC

Is there any change in mix in the second half that we should be aware of?

Jay L. Johnson

None that I could think of except one of the realities in the second half of the year has to do with repair work. I mentioned in my remarks about repair work at NASSCO specifically. Sometimes that comes to you in fits and starts as the customer goes through the end of their year, so there may be opportunity there that we haven't expected. It could work the other way as well, but I'm very confident in the high 9s for Marine, and we're very proud of that.

Operator

Your next question comes from Noah Poponak - Goldman Sachs.

Noah Poponak - Goldman Sachs

A lot of discussion on Combat here and there's obviously a lot of moving pieces, but you guys are on record as throwing out a couple of different mid single digit growth numbers in 2010. I just wonder if you're sticking by that given everything you see here or any comment there?

Jay L. Johnson

I would characterize it this way: Combat is a solid, steady growth business that - I actually characterize it in the terms of an Abrams - it's the Abrams tank, okay? It's very sturdy, it's very steady, and it proceeds as it needs to. And Combat will grow its portfolio in smart moves, but you're going to see slow, steady growth out of Combat.

Noah Poponak - Goldman Sachs

So it sounds like thinking something in the low to mid single digits for 2010 is still reasonable?

Jay L. Johnson

Yes. Yes.

Noah Poponak - Goldman Sachs

And, Jay, one more question for you. Given that you're kind of the new kid on the block here I wondered if you'd just take a minute from a very high level to talk strategy, maybe the two or three things that you're focused on the most in the near term for the company, things you might do a little different, any comments there.

Jay L. Johnson

Okay, strategy. It's interesting. Nick and I worked together for a long time on this transition. The objective was that when he walked out the door, as he did on the first of the month, it would be as seamless as it could possibly be. I believe that has happened, okay? I feel that way. I have great confidence and pride in this magnificent corporation and I'm proud to be its President and CEO.

The portfolio is diverse and very strong. We own on the commercial side, we manufacture the premier brand on this earth in Gulfstream, okay? On the defense side, our portfolio, as I've said before, is diverse, it's very strong, and it is relevant in today's world and the world we see out ahead. So that portfolio is pretty wholesome the way it is.

Static and status quo are never good things in this business, so we will continue to enrich and nourish that portfolio as opportunities present themselves. How do we do that? We do that the way Nick taught us and that's about earnings and cash and ROIC and margins. Those disciplines are in our DNA, as I've said before. That's the enabler. Those are the enablers to allow you to nourish and enrich this portfolio.

So that's where my focus of effort is. That's where my commitment is to both our customers and our wonderful men and women in uniform out there that we're serving and to our shareholders.

Amy Gilliland

[Nikita], I think we have time for one more question.

Operator

Your final question comes from Doug Harned - Sanford Bernstein.

Doug Harned - Sanford Bernstein

When you look forward at Marine - and I know you all have talked about expanding margins over time - there are two things ahead of you here, one is more work on the DDG-1000 and another one is the next DDG-51, which you had referred to earlier. When you look at those two ships, is this going to create a challenge in terms of expanding margins on the DDG-1000 or on the DDG-51 given that you'll have a gap here between current production and the start of that new ship?

Jay L. Johnson

New ship meaning?

Doug Harned - Sanford Bernstein

The next DDG-51 that you would start later.

Jay L. Johnson

I don't see that as an issue honestly, Doug, because we're well versed in the construction of DDG-51s, as you know. And the DDG-1000, I mean, you've probably had this conversation with Nick and/or me before, but that DDG-1000, going into that new build, the design work is more complete than with any other ship class start we've ever seen. So we have strong confidence in our ability to bring the DDG-1000s home the way we signed the contract to bring them home. So we have good confidence in the ability of our workers up at Bath Iron Works as well as the leadership up there to do exactly what we said we were going to do and deliver a quality product on time and on budget.

Doug Harned - Sanford Bernstein

You don't see the DDG-51, going to the next one, as being, I'd say first, significantly different in terms of the capability or cost of that ship?

Jay L. Johnson

My answer today, Doug, is no, I do not see that. I mean, if the customer changes something and wants to take it to a different place, that's a discussion that I'm certainly not privy to yet and we would adapt accordingly. But right now we do DDG-51s beautifully and we can continue to do that.

Operator

This concludes today's question-and-answer session. I will now turn the call back to Amy Gilliland for closing remarks.

Amy Gilliland

Thank you for joining the call today. If you have additional questions, I can be reached at 703-876-3748. Have a great day. Thanks.

Operator

This concludes today's presentation. You may now disconnect. Good day.

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