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General Dynamics Corporation (NYSE:GD)

Q1 2010 Earnings Conference Call

April 28, 2010 11:30 AM ET

Executives

Amy Gilliland - Staff VP, IR

Jay Johnson - President and CEO

Hugh Redd - SVP and CFO

Analysts

Robert Spingarn – Credit Suisse

Robert Stallard – Macquarie

Cai von Rumohr – Cowen & Co.

Richard Safran – Buckingham Research Group

Peter Arment – Broadpoint Gleacher

Sam Pearlstein – Wells Fargo Securities

Joseph Nadol – JP Morgan

Ron Epstein – Merrill Lynch

Heidi Wood – Morgan Stanley

Troy Lahr – Stifel Nicolas

Howard Rubel – Jeffries & Company

Noah Poponak – Goldman Sachs

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2010 General Dynamics Earnings Conference call. My name is (Shamika), and I will be your operator for today. (Operator Instructions).

I would now like to turn the presentation over to your host for today’s call, Ms. Amy Gilliland, Staff Vice President of Investor Relations. Please proceed.

Amy Gilliland

Thank you (Shamika) and good morning, everyone. Welcome to the General Dynamics’s first quarter conference call. As always, any forward-looking statements made today represent our best 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.

And with that, I would like to turn the call over to our President and Chief Executive Officer, Jay Johnson.

Jay Johnson

Thank you Amy and good morning everyone. General Dynamics delivered a good first quarter marked by strong operating performance across our businesses. Revenues in the quarter were $7.8 billion down from the first quarter of 2009. You may recall that in last year’s first quarter revenues were unusually high. In fact it was the company’s single largest revenue quarter ever.

Unlike last year’s experience we expect sales to continue to increase as the year progresses more consistent with our historical pattern. Operating earnings were $918 million in the quarter, up slightly from last year’s first quarter resulting in an 11.8% operating margin. A favorable program mix and disciplined execution contributed to the 80 basis point year-over-year margin improvement with particularly strong performance at aerospace and combat systems.

Earnings from continuing operations were $599 million, up slightly from last year’s first quarter. This drove 7.7% return on sales 50 basis points better than last year. Earnings per share from continuing operations were $1.54 on a fully diluted basis flat when compared with first quarter 2009. Free cash flow after capital expenditures totaled $150 million somewhat light but better than last year’s first quarter. In the quarter, we experienced some growth in operating working capital at our IS&T in general and at C4 Systems in particular.

This is largely a timing issue that will reverse itself as the year progresses. We should be around 100% net earnings to free cash conversion again this year. First quarter orders totaled $7.2 billion, significantly higher than last year with robust award activity across our business portfolio. Backlog totaled $63.9 billion at the end of the quarter, down modestly from year end. Funded backlog however was up 3% at $47 billion. Total potential contract value which includes backlog, unexercised option in indefinite delivery and definite quantity contracts reached nearly $81 billion.

Now I’d like to focus on the performance of each of our business segments starting with our three defense groups and I’ll begin with the Combat Systems. Sales were $2 billion, down $400 million or approximately 17% from last year’s first quarter. The volume decline resulted from several factors. A significant decrease in MRAP volume when compared with the first quarter of 2009, the absence of deliveries of weapon systems that protects soldiers from roadside explosive threats, lower small-caliber ammunition volume, and last year’s cancellation of the Future Combat Systems program.

Higher volume on Abrams, Stryker and several European vehicle programs somewhat offset these decline. Our Combat Systems businesses delivered $269 million of operating earnings in the first quarter. Down just $10 million from last year on significantly less volume. Consequently, the groups operating margin was 13.4%, 180 basis points higher than last year. This performance was the result of a favorable program mix and strong execution on several vehicle and ammunition programs.

Combat Systems backlog declined modestly from year-end to $12.9 billion, despite the decline in backlog award activity was healthy in the quarter. We received new orders on our core programs and also on several new opportunities. These new opportunities include an additional 250 RG-31 MRAP vehicles and MRAP (inaudible) awards beyond the retrofit work we had expected this year.

The MRAP deliveries are scheduled largely in the second half of the year. In March we were selected as the preferred vehicle provider for the United Kingdom FRESH program. This opportunity includes both the Scout variant and the Common Base Platform for up to 580 specialist vehicles. The FRESH program also anticipates several other blocks of vehicles for which we will provide the common base platform. We are working with the United Kingdom on the initial FRESH contract and we expect to add it to backlog later this year.

The FRESH program provides good upside to Combat’s outlook over the next five years. There are several other opportunities that could generate additional awards this year, including the Canadian lab upgrade program for which we expect to receive a contract in the second quarter and the Spanish eight by eight vehicle competition which we expect to be awarded in the second half. Other potential 2010 awards include the ground combat vehicle competition, the next phase of the Saudi Tank program, additional Iraqi tank options and the opportunity to enhance Stryker Combat vehicle protection.

For the year, I expect Combat Systems sales and earnings to grow each quarter. This trend is typical for Combat Systems as the group’s European vehicle business generally realizes a significant portion of annual sales and earnings in the third and fourth quarters. Much of the topline growth I’ve guided to for the year comes from international programs including the live FMS program and several European vehicle programs. Our plan anticipates these programs building in the second half.

That said it is worth noting that we have experienced the ways on international programs in the past. While our current international programs are still on track, it is too early in the year to predict uncertainty how they will unfold. I remain comfortable with the earnings implied in my guidance for the group, although they could come from slightly higher margins and lower revenue than originally forecast.

Marine Systems, the Marine Systems group had a solid first quarter. Revenues were $1.6 billion in the quarter, down very slightly compared to year ago. Operating earnings were $161 million and operating margins were 9.8% essentially flat when compared to first quarter 2009. This margin reflects improved performance on our auxiliary ship programs and negative mix shift in our surface combating programs as DDG-51 work declines and DDG-1000 volume increases.

Marine’s backlog totaled $22.1 billion at the end of the quarter, down slightly from year end 2009. We added orders for two T-AKE’s in the quarter as well as long leave funding for another DDG-51 destroyer. I anticipate orders for two additional DDG-1000 later this year which will again increase the size of the backlog. Marine Systems will see growth in volume as the year progresses, although mix shift in the Destroyer program will continue to pressure the group’s margins. Given their excellent execution to-date however I think there is a chance that they will outperform by mid 9% margin guidance for the year.

IS&T, the Information Systems and Technology Group began 2010 with their largest sales quarter ever at $2.8 billion. Earnings were $290 million and operating margins were 10.5%. Margins were particularly strong at our IT services business which enjoyed a favorable program mix in the quarter. IS&T’s backlog was $10.3 billion at the end of the quarter and once again the group achieved a book-to-bill of one times.

This reflects continued demand for the group’s products and services particularly in light of their robust first quarter sales. this quarter’s order activity was very strong at our tactical communications and IT services businesses reflecting our success in capturing business in faster growing market segments such as tactical networks and communication, healthcare services, simulation and training and IT infrastructure. We had a number of notable IS&T awards in the quarter, some of which you’ll find at exhibit G of our press release. Work on these contracts will help drive the group’s revenues this year especially in the second half.

IS&T’s estimated potential contract value under IDIQ contracts grew 3% in the first quarter to $13.2 billion. When combined backlog and estimated potential contract value totaled $23.5 billion providing IS&T ample opportunity for continued growth. IS&T remains well positioned to achieve my guidance of approximately 8 to 9% sales growth in mid 10 margins this year.

Now let's move to Aerospace. The Aerospace Group is off to a very good start in 2010. when compared to last year’s first quarter the group’s revenues were down 6.7%. However first quarter 2009’s results reflected a higher annual production rate including three additional green deliveries and 17 additional completions. Of those 17 additional completions 15 were mid-cabin aircraft. You may remember that we reduced Gulfstream’s annual production in March of 2009 as a result of the change in market conditions.

The most significant production cut was in the mid-cabin aircraft. On the other hand, first quarter revenues were $1.4 billion, up nearly 15% over the fourth quarter of last year, due to additional Gulfstream new aircraft volume. Gulfstream green deliveries in the first quarter included seven additional midsize jets when compared to the last quarter and one additional large cabin aircraft.

The groups operating earnings were $218 million and margins were 16.1%, improved when compared with both last quarter and the prior year period. Last year’s cost cutting efforts helped to drive some of the margin improvement in the quarter. We continued to see gradual improvement in the business aviation market in 2010, including healthy customer interest particularly for our largest jets. We also see declining pre-owned inventory levels and healthy aftermarket demand.

Gulfstream enjoyed their largest order intake since mid 2008 in the first quarter with international orders dominating the order book. Orders were representative of every major international region and demand was particularly strong for our large cabin aircraft. Gross new aircraft book-to-bill was 1.2 times on a dollar denominated basis. Despite green take, new aircraft deliveries in default activity led backlog to decline modestly from year end to $18.5 billion.

Orders outpace defaults for the fourth consecutive quarter and with continued economic recovery, I expect orders to increasingly outpace defaults as the year progresses. Pre-owned inventory levels continued to decline. We sold three pre-owned aircraft this quarter, took none in trade and have one aircraft remaining in inventory. For the remainder of 2010, we have no more than four trading commitments. Aircraft maintenance, repair and overhaul demand was solid in the quarter although the first quarter does tend to be somewhat lighter than other periods of the year.

Jet Aviation’s global FBO aircraft management and charter businesses were particularly strong. As we expected it appears the groups services business will be up for the year in the low to mid-single digit range. We continue to make great strides in our product development programs in the first quarter. Both the G250 and G650 have two aircraft in flight test at this time and we are extremely pleased with the results we’ve seen.

Certification plans for both models remain on-track. For the year, we remain on pace to achieve our delivery plan which includes approximately 77 large cabin aircraft and 14 midsized. Large cabin deliveries will be slower in the third quarter as we are planning a two week furlough at Savannah. Slight improvement in the mid-cabin market could provide upside to plan deliveries. I remain optimistic on the outlook for the business aviation market and am encouraged by the generally positive trends we’ve seen thus far in 2010.

Aerospace is well positioned to achieve low to mid-single digit sales growth with some upside to the 14% margin guidance I’ve provided. With regard to capital deployment, our solid balance sheet affords us ample flexibility to enhance shareholder returns. In the quarter we continued our balance strategy repurchasing 2.9 million shares at attractive prices. We also expanded our tactical communications portfolio with the acquisition of a software company that facilitates battle field information collection and dissemination for soldiers, a capability at the forefront of defense spending priorities.

The Board also increased the quarterly dividend by 10.5%. The 13th increase in as many years. In summary, we’ve hit the deck running in the first quarter and we’re on our way to another successful year. The year is still young, so I am going to reiterate my full year guidance to 640 to 650. I think I’ve provided some indication of where I believe there maybe upside to that guidance, but it would imprudent to make any adjustments at this point.

The improving business jet market and 2011 defense budget request provide a good foundation for the company moving forward. And with that, I’ll now ask Hugh Redd to touch on several key financial highlights, Hugh.

Hugh Redd

Well thank you Jay and good morning everyone. Although interest expense was up for the first quarter compared to a year ago, we expect full year interest expense to be down slightly from 2009 somewhere between $150 and a $160 million. This estimate of course does not assume any extraordinary capital deployment activities throughout the remainder of the year.

Over the past 12 months we’ve cut our net debt, by net debt I mean debtless cash, cash equivalents and marketable securities. We’ve cut our net debt in half, from $2.6 billion to $1.3 billion. This improvement can be attributed to our strong cash performance that comes after deploying Fox shipment, $700 million in acquisitions of new businesses, $600 million in payment of debt dividends – excuse me, in payment of dividends, $500 million in company sponsored resource and development, $400 million in capital expenditures and $300 million in share repurchases.

Over this period our debt-to-equity ratio has dropped to 30.2% from 37.8% and our debt-to-capital ratio is 23.2% down from 27.4%. our next scheduled debt repayment is $700 million of fixed rate notes due in August of this year. Finally I would also like to remind everyone that we planned to make a bona fide contribution to our pension plan of about $217 million in the third quarter of this year.

That completed my remarks, Amy I’ll turn it back to you to begin the Q&A.   

Amy Gilliland

Thank you. As a quick reminder, we ask participants to ask only one question so that everyone has an opportunity to participate. If you have additional questions please get back into the queue. And (Shamika) if you could just please remind participants how to enter the queue.

Question-and-Answer Session

Operator

Sure. (Operator Instructions). Your first question comes from the line of Robert Spingarn of Credit Suisse. Please proceed.

Robert Spingarn – Credit Suisse

Good morning.

Jay Johnson

Good morning, Rob.

Robert Spingarn – Credit Suisse

Jay could you talk a little bit more about the flow in Combat as you progress through the year, you certainly started to in your monologue but you really do need to see some kind of substantial ramp to get to the revenues and I do note that you said you might not quite get there, but how should we think about that relative to the margins as well, where it looks like we’ll see some decline, how should we think about the mix and the flow?

Jay Johnson

I think the way I’d characterize it Rob, at the top is that our core programs are stable and have some potential to build as the year progresses and I would relate that specifically to Stryker. But the big growth if you will as the year progresses will come as I alluded in my remarks from the international programs and we have a number of those as you know. So it will be gradual as it usually is, heavily weighted if you will to the third and fourth quarters which is not at all unusual for Combat Systems but fairly substitute in its elements across both US franchise and international, that’s the general description I would offer.  

Robert Spingarn – Credit Suisse

Without ask you to go too far into the future, would you say this is going to be the most revenue challenge segment over the long term, but of course we’d see upside or off side I should say from aerospace and elsewhere?  

Jay Johnson

I got to say Rob that I pump the answer a little bit in the following way, what I see there is potential for that, but what I see for example in the 2011 budget summit is very strong support for the US franchise programs, AKA Stryker, Abrams. We’ve got grand combat vehicle competition that will lay itself out later this year, JLTV is still playing, Stryker is in play right now, reset modernization all of those elements is not just new production. So it’s multifaceted and very robust as we forward. So I don’t see a big tail off if that’s perhaps the implication here, because our core programs are being very well supported.  

We also have on the international side things that perhaps more realities the last time we talk like as I mentioned in my remarks the FRESH contract which will be significant add to the portfolio for Combat Systems.  

Robert Spingarn – Credit Suisse

Jay, thank you very much.  

Jay Johnson

Okay.  

Operator

Your next question comes from the line of Robert Stallard of Macquarie. Please proceed.

Robert Stallard – Macquarie

Good morning.  

Jay Johnson

Good morning.  

Robert Stallard – Macquarie

Jay I was wondering if you could go to aerospace and if you could comment on the operating margin in the quarter, it’s clearly coming ahead of your full year guidance. Has it been any unusual items in this quarter?  

Jay Johnson

Okay, we’ll talk about aerospace a bit. To your point on margins, I started off by saying I am very pleased with the performance that aerospace both in Gulfstream and in Jet Aviation. So let's just get that on the table at the start and it’s reflected in the margin performance that you saw. There are several thing, have been several things that play in realizing those margins relative to both year-over-year first quarter ’09 and the sequential from last quarter, example year-over-year our margins this quarter were positively impacted certainly by mix as I mentioned I think in my remarks. So we have 15 fewer midsized completions this year than we did last year.  

Also we had a – we didn’t have pre-owned charges this year which we had last year. And as is usually the case when we’re talking about aerospace here, they lowered their SG&A this quarter through great discipline, continuous improvement in cost savings. So those are three I’d say elements that differentiate this quarter from year ago quarter on the margin side.  

Let's talk about sequential now from fourth quarter ’09 to first quarter ‘010 and the positive influencers if you will are somewhat different this quarter. I’ll leave the lower SG&A in there because indeed that made a big different again this quarter as it did in the year-over-year comparison but we also had improvement in Jet Aviation which is consistent with we’ve been telling you was happening and would continue to happen. We saw that quarter-over-quarter here and we’re very pleased with that and I would also say as I mentioned in my remarks I think that we did have some liquidated damages.  

So that’s kind of the summation if you will of elements that I think impacted the differentiation quarter-to-quarter and year-to-year. Now that said I would caution not to get too far ahead I mean on margins this year because we have something’s to thing about going forward. One is that we are planning a furlough at Gulfstream in the third quarter, not as long as we had last year but nonetheless we’ve got a furlough in the plan which will impact us and also the midsize mix is still a little bit uncertain in all of this, it depends on how the market recovers, depends on how many completions etcetera, etcetera. So that will definitely have an impact, it could definitely have an impact on the margins going forward.  

And then I would also say that we expect the liquidated damages to be less of a factor going forward and we can talk about the backlog later but in point of fact what we see didn’t surprise us and we see less of it in the next and subsequent quarters going forward. So that’s probably more than you asked for but that’s kind of my rundown on the margins side and I hope it’s responsive to your question.

Robert Stallard – Macquarie

That’s great, thanks very much Jay.  

Operator

Your next question comes from the line of Cai von Rumohr of Cowen & Co. Please proceed.      

Cai von Rumohr – Cowen & Co.

Yes, thank you Jay.  

Jay Johnson

Good morning Cai.  

Cai von Rumohr – Cowen & Co.

Looks like your cancellations were, yes hi, looks like your cancellations were up a bit from the fourth quarter at about billion, can you give us some color on A, what was the size of the LD in the quarter and kind of where do the cancellations come from and kind of what’s your prospect for cancellations over the next couple of quarters?  

Jay Johnson

You bet, I would be happy to. First of all, in terms, I’ll just go in terms of orders and defaults, just sort of lumping together here, the way I got it stacked in my head. It was on the order side, the best quarter we’ve had since the third quarter of 2008, across the product line and as I mentioned orders did outpace default for the fourth consecutive quarter. So we feel very good about that. $18.5 billion is a very robust backlog by any measure so I feel very good about that even though it moves around a little bit. Now the default activity in this quarter, we’ll talk about it little. A couple of things, for example it was greater than, it was the quarter before when we surprised by that honestly, not really, OK? And here are couple of reasons why.  

Let's talk about 650. we had actually by number five 650 defaults in the quarter, OK? They were all tied to the -- you recall the first flight payment milestone, anyway that’s the fourth quarter event that manifested itself in activity in the first quarter. So we lost five of those, not surprisingly they were instantly back filled and we’re still taking orders in the 650 backlog is still just south of 200 aircraft. So but it did in fact impact us on the liquidated damages side.  

In addition to that Cai, we had a number of defaults frankly that we've been working with the customer for a while and you could have brought some of them to default in the fourth quarter and end the year, we got payment milestones moved to the first quarter. And so some of that just triggered as a result of timing and folks we've been working with for a while. So, again, not a big surprise.

Having said all of that, as we told you before Joe Lombardo, Larry Flynn, the Gulfstream team and I spent a lot of time together going through the backlog, customer by customer and we still do that almost weekly. And what we see ahead of us is an order book that is still very robust and a default activity that would decrease as the year progresses and I would expect spread between orders and defaults to continue to increase as the year goes forward. I hope that answers your question.

Cai von Rumohr – Cowen & Co.

Except for the amount of liquidated damages in the quarter. 

Jay Johnson 

No, I won't provide that to you this morning, sorry. 

Cai von Rumohr – Cowen & Co.

Okay. 

Jay Johnson 

But it was not -- I mean it's not the highest nor the lowest we've ever seen, I mean it's kind of in the middle and if you took some of the actions that I described that became first quarter events that were kind of actually could have been fourth quarter events I could almost draw you a straight line across the last four quarters. 

Operator 

Your next question comes from the line of Richard Safran of Buckingham Research Group. Please proceed. 

Richard Safran – Buckingham Research Group

Hi good morning. 

Jay Johnson

Good morning. 

Richard Safran – Buckingham Research Group

I think you first -- I'm thinking maybe you touched on this at the very beginning but on combat systems, book to bill still less than one it was below one for 2009 and I was wondering if you looked out beyond 2010, if you can comment on what you think that might mean for sustained growth of combat systems and I think one of the things, I think you were saying is that look you're expecting book to bill maybe to improve later on in the year possibly driven by these increased European orders. Is that essentially correct?

Jay Johnson 

Yes it is, you got it. I mean we see again in the U.S. franchise programs there is opportunity for growth, okay. They're stable as they can be right now but there is growth opportunity particularly with the other elements that we talked about like reset, modernization vehicle improvements etcetera. But on the international side indeed that is a portfolio that will build as we go, we can see it. I just can't time it out to the day that's the reality and it's not a surprise.

So, we can talk about backlog a little bit just as it applies across the corporation. It's not a one size fits all package; what do I mean by that? Let's just talk about the defense businesses. The aerospace backlog we talked about but in the defense businesses you've heard us say before I think in the marine systems group, the backlog is very lumpy and we usually talking big lumps when they come, okay. We're at $22 million or so right now and when we don't have the next two DDG-1000s in the backlog yet etcetera, you understand that. 

Richard Safran – Buckingham Research Group

Yes. 

Jay Johnson 

On the IS&T side relatively speaking, it’s pretty steady eddy, okay. Now that over simplifies how difficult it is to sustain a 1X book to bill as they're very good at doing but they're very disciplined and very accomplished with that. So that's pretty steady. On the combat side, it's almost in between those two that I just described but it tends to come particularly when you see some of this international business in pretty lumpy orders. So all that said, we can see a lot out ahead of us but how it comes and in what size lumps I think is something we're just going to have to work our way through. But clearly for combat systems, the bill will be throughout the year and the programs that we see on the international side, for instance I mentioned the labs in Canada, there's another vehicle competition that we anticipate in Canada called the Tactical Armored Patrol Vehicle that we're partnered with Oshkosh that will realize itself we believe based on what they're saying now.

Next year and stream out for several years, we’ve got the FMS Labs at great scale, $2.2 billion that are just coming into design work right now that will play out for the next several years. We have got more labs from that customers country that we believe will come in the second half of this year. We've got Iraqi tanks, we've got Saudi Arabian tanks. So there's lots of business that we can see building over the next five years probably longer than you wanted. 

Operator 

Your next question comes from the line of Peter Arment of Broadpoint Gleacher. Please proceed. 

Peter Arment – Broadpoint Gleacher

Good morning Jay. 

Jay Johnson 

Good morning Peter. 

Peter Arment – Broadpoint Gleacher

Thanks for all your great color on Gulfstream but maybe you could just give us an update on the flight testing of G-650 and the 250, how things are going there? And then also just the overall activity on the 250, you got about 15 months I guess before you're going to start maybe delivery? So any color there would be great. Thanks. 

Jay Johnson 

Okay, I alluded to -- I mentioned it in my remarks but I would just tell you that we're doing lots of flying on both sides of the ocean with the 250 and the 650. They're in all corners of the flight envelope and we love what we see. That's the best way to say it. These are sweet machines. We are not being surprised by anything and the pilots can't get enough of them. So as a pilot I'm envious.

Anyway, those programs are proceeding as they need to. Right now I think we'll have the third 650 flying here within a matter of days if not weeks. So all those preceding at pace for certification next year and I see no speed bumps in our way at this point. 

The 250 order book honestly is a manifestation of the mid cabin market. So it is not robust at this point I would tell you but I'm okay with that because as you mentioned we've got 15 months until it becomes an entry into service reality. And when people see, touch and fly in this airplane, they won't be able to get enough of it. So that is my profound belief and it also will give us the pacing right now, puts us I think in good shape to match the market as it recovers, the mid cabin market recovers because we are seeing activity in that market and I think you're hearing that from the other OEMs as well. 

Peter Arment – Broadpoint Gleacher

Yes absolutely, thank you, Jay. 

Jay Johnson

Okay, I might add one other thing to that Peter is that we don't build flight tales on the 250s because we match demand with supply but we're very excited about the 250 as we are about our 650 and I believe the sales will become very robust, it’s just not time yet. 

Operator

You have a question from the line of Sam Pearlstein from Wells Fargo Securities. Please proceed. 

Sam Pearlstein – Wells Fargo Securities

Good morning. Jay, if I just think about everything you said so far other than combat coming in, you're saying sales could be a little bit lighter over the course of the year but margins higher. It sounds like marine is ahead of expectations there, aerospace is ahead. Perhaps interest is a little higher than you might have said in the past. But I mean what else causes you concern? I know it's only the first quarter but what causes you concern as you look towards the remainder of the year. 

Jay Johnson

Well, I guess, Sam, the timing in combat if there is a concern as I've talked about that maybe an issue but it's not a long term issue, it's not something I can control to the day. But other concerns, I mean if we have an economic relapse that would certainly impact us but right now what I see of the year and what I see of the defense sides, budget based on the submit for next year and still looking at the fit up as the fit up of record, we feel like or I feel like the plan is pretty solid right now and we can execute to that plan and with a chance to beat it. 

Sam Pearlstein – Wells Fargo Securities

If I can follow up just a quick question, can you talk about the DDG-1001 and DDG-1002 in terms of, is that still going to be fixed price anything and you can help us in terms of how that discussion is going?

Jay Johnson 

Sure. We expect that contract to be left here in the next couple of quarters, okay probably it'll be a second half. So in terms of impact if you will this year it won't okay, one way or another, it'll really be a ‘11 event but we should have the contract done here within the next couple of quarters. The fixed price is still there okay and we're excited about that so the cost plus boat is in the bill right now at Bath and going very well by the way. We're very proud of the work that's being done on that. So we're waiting for the fixed price boats and the contract will come. We have every indication that we are -- it's on track, it's just moving through the system. Did that answer your question?

Sam Pearlstein – Wells Fargo Securities

It does, thank you.

Operator

You have a question from the line of Joseph Nadol of JP Morgan. 

Joseph Nadol – JP Morgan

Thanks, good afternoon. 

Jay Johnson 

Good afternoon Joe. 

Joseph Nadol – JP Morgan

On IS&T, Jay, the organic sales looked like they were negative in the sort of 3% range in the quarter and you had a strong first quarter last year. So some of this might be comp. I'm just wondering that your guidance implies something along the lines of I think 6% organic growth for the year. So you have to be close to 10% for the rest of the year to get there. Any concern there or it's just the comp issue?

Jay Johnson 

No, I mean I think a lot of it, Joe, really is the comp issue. We had – this was our best revenue quarter ever and it comes off of what I'd say was an unusually strong Q1 ‘09. I think if memory serves, it was like 16% better than the ‘08 Q1. So we didn't help ourselves with the comp in that sense but it's really more to me – I feel very good about IS&T right now. They had a great performance quarter as we described. I anticipate more of that for the rest of the year. And the timing of the contracts okay, maybe not as dramatic as I described in combat systems but the sensing will be that that will build again throughout the year as we go forward.

So we've got as you know a very diverse portfolio, all elements of that portfolio are very active. We got tactical communications, battle space management, C-Square whatever you want to call it with WIN-T increment two, increment one, increment three is in play. We've got jitters, we've got common hardware/software working there. IT services was very strong as I detailed in my remarks. ISR is still very active. Access is busy within that space for us as we expected and throughout it all we've got cyber at scale. So we're very busy in IS&T, I don't expect that to change. Their year is a challenge but they're up to the challenge. 

Joseph Nadol – JP Morgan

That C-4 issue that you mentioned that cost you some cash flow, did that cost you some sales also in the quarter and maybe could you give us some different color on how that's going to be resolved? 

Jay Johnson

As I said in my remarks, we had a little OWC issue in the first quarter and it’s going to work itself out through the year. It's not even worth discussing beyond that except to say it was a timing thing and off we go. 

Operator 

Your next question comes from the line of Ron Epstein of Merrill Lynch. Please proceed. 

Ron Epstein – Merrill Lynch

You mentioned earlier that you were pleased with the performance of jet in the quarter. I was wondering if you could just give us a little more color around that and how much it’s contributing to the aviation segment.

Jay Johnson

Well, you know I am going to keep it at the group level. But I would just tell you that and I just spent a lot of Jet here about a week-and-a-half ago in Europe and took full reports and saw firsthand what’s happening. And Jet Aviation is giving us what we thought Jet Aviation would give us when we purchased Jet Aviation.

And we have had some operational challenges at the front end mostly to do with match volume and productivity, okay? But we have that well in hand and they are operating very well right now. And so we are excited about what we see and they will continue to be ever more important contributors if you will to the aerospace group’s contributions, okay?

MRO global footprint, it’s becoming – when you look at the – for example, when you look at the Gulfstream order book and look at how global it is, predominantly international certainly this quarter and more than 60% last year international and you look at the Jet footprint, global footprint, the two come together pretty nicely.

So we are very – that’s a long way around me saying I am very pleased with what Jet is putting forth right now and they will continue to improve as we go and become ever more important to the aerospace group.

Ron Epstein – Merrill Lynch

Are you seeing a pickup in volume in the business?

Jay Johnson

Yes.

Ron Epstein – Merrill Lynch

Okay, thank you.

Operator

Your next question comes from the line of Heidi Wood of Morgan Stanley. Please proceed.

Heidi Wood – Morgan Stanley

Yes, good morning.

Jay Johnson

Hi Heidi.

Heidi Wood – Morgan Stanley

Hi. A question for you on aerospace. You were talking relatively bullish, but you are acknowledging it’s the first quarter. So can you talk to us about what do you need to see to take the prediction rates up higher and also talk to us about the percentage of slots that are sold out for 2011?

Jay Johnson

Well, I am very happy, very bullish on what I say on the large cabin. And I think in terms of production to your first point, I think it really is going to be paced by what the mid cabin market brings to us. We can adjust, I can adjust, Joe can adjust the large cabin production somewhat. But we have got a pretty robust plan in execution right now for that, but there is some room I think on the mid cabin. So –

Heidi Wood – Morgan Stanley

Actually Jay, I am more referring to 2011. I mean as you look across the metrics in 2010, is ‘11 flattish or are you sort of, do you see cause for ‘11 going higher or what would you needed to see?

Jay Johnson

Yes, it’s pretty early in year for me to get clairvoyant on that in terms of giving you numbers and I won’t do that. But I will say Heidi, back to my comment earlier about familiarity with the backlog and what we see with our customers, right now, based on what 2011’s backlog looks like frankly from a production standpoint, especially large cabin, I don’t see much change at all, okay? Certainly not on the down.

Heidi Wood – Morgan Stanley

Great. And then on the – you talked about seeing a decline in SG&A, talk to us about what is the sustainability of SG&A when volumes return?

Jay Johnson

I mean, we pride ourselves on our my word agility, okay? On the down and on the up. So we will ramp appropriately as the market takes us to different production levels. I mean and Joe Lombardo and his aerospace team kind of wrote the book on that. So we know how to do it very well. We right size the business at the time it needs to be right sized. We are very proud of that and we are very disciplined about making sure we never falloff that.

Heidi Wood – Morgan Stanley

What I was trying to understand better was as volumes return, is the SG&A going to come back on a one-on-one basis or have you changed the business enough you are going to get added leverage on the up from what you did on the down?

Jay Johnson

My answer to that would be to take you to your latter rather than your former statement.

Heidi Wood – Morgan Stanley

Alright, great. Thanks very much.

Jay Johnson

Okay Heidi.

Operator

You have a question from the line of Troy Lahr of Stifel Nicolas. Please proceed.

Troy Lahr – Stifel Nicolas

Thanks. I am wondering if you guys could help me understand the changes to your LCS partnership and what the future opportunities are for you there on LCS?

Jay Johnson

Okay Troy. You know that we are – we have delivered LCS to the Navy. We are in the build down at Ostile on LCS-4, Bath Iron Works is the prime, Ostile is the sub. We have submitted – well, the fiscal year ’10 proposals have been submitted and Ostile is priming that for good and sufficient reasons, okay?

What do I mean by that? These ships are being built in their shipyard. They are clearly ready to prime and quite frankly to be as competitive as we could be with the Ostile boats, we felt that having them solo if you will rather than having them and Bath Iron Works in there would make them cost competitive, because you don’t have two yards, you are only working with one.

Embedded in all of that for us is the fact that the core mission system of that great ship is ours, okay? It comes from our IS&T team, AIS in particularly and it’s working beautiful and it’s open architecture and we are very excited about that. So that’s a long way around saying we felt that that for this round it was most appropriate for Ostile to prime this. They felt that way and we are in complete alignment with them on that.

By the way, it also for round two that the way they are appears set up by the Navy for round two, it also then would give us the opportunity to put – to bid for the second source in 2012 should we choose to do so. But that’s a long way down range. But I hope that answers your question.

Troy Lahr – Stifel Nicolas

Okay, yes, that's great. And just one other side note, could you just give us the numbers for the sales and the income associated with some of those pre-owned sales on the aircraft side?

Jay Johnson

I will make it real easy, it was $31 million, okay? No up, no down, breakeven.

Troy Lahr – Stifel Nicolas

Great, thanks.

Jay Johnson

Okay.

Operator

Your next question comes from the line of Howard Rubel of Jeffries & Company. Please proceed.

Howard Rubel – Jeffries & Company

Thank you very much. Jay, as we wind down in Iraq and sort of pick up the pace in Afghanistan, it looks like some of your combat business is seeing some different changes in demand. Could you address your comments on small Cal and also on the Chameleon in particular or was there something else that I am just missing?

Jay Johnson

No, Chameleon was a program that basically it got replaced. I think that’s my non-technical way to describe that. But at any rate, the program is no longer a factor for us as it was initially and that’s what I was alluding to in my remarks. The small Cal frankly was just a contract lying down and that was the impact there.

But the ammunition business is still very robust for us small, medium and large, large and medium propellant the precision stuff. So we are very active. I don’t – I didn’t mean to imply and maybe I painted it that way in my remarks. I certainly didn’t mean to imply that the ammunition business was suffering, because it’s not. We have got a great team and they are doing great work and they have got lots of it to do.

Howard Rubel – Jeffries & Company

And then could you explain the furlough at Gulfstream? I mean, if business is that good, why do you need to give them a couple of weeks off?

Jay Johnson

I got your point. The truth of it is it kind of helps us level load the year there. And I guess you could say that you didn't have to do it but we choose to and I think it works for us. At a two week plan right now, I think everybody feels pretty comfortable with that. So, we are going to less some drastically change, we are going to keep that in place.

Howard Rubel – Jeffries & Company

Just sort of, on the 650, how is – I mean you are talking about the third airplane and there is more to follow. I mean can you – I means it’s early days. Is there any way you can give us an indication of – are the planes starting to show a learning curve and is the factory starting to fill the way you expected?

Jay Johnson

Yes, and yes. When we get into the discussion about what are the margins going to be and what's the production rate.

Howard Rubel – Jeffries & Company

I will leave that for later.

Jay Johnson

I will stick to where I have been and that is 17.33, 33 is the production rate I have got stacked in my head but we designed that aircraft in that facility for manufacturing as you all know with the 3D (inaudible) of E5, the repeatability, the producibility, the 50% fewer parts, all of that, okay, and the riveting – I mean the bonding versus riveting, all that takes us to a place and by the way, as we go here with the flight test vehicles, we are already making subtle changes to the subsequent vehicles as you would expect – aircraft as you would expect. So, all of that bodes well for great producibility at scale and we intend to do that, it's just not time yet. We got to get ourselves up on the ramp and go more steady state. But we are encouraged by what we have seen, we are facilitized to deal with it, and we have got an order book that handles it.

Amy Gilliland

Operator, we have time for one more question.

Operator

And your final question comes from the line of Noah Poponak of Goldman Sachs. Please proceed.

Noah Poponak – Goldman Sachs

As I listen to you talk about mid-cabin business jet you sound more positive on that market and I think the last couple of times we have heard. And we just had Cessna report the other day and they talked about seeing some more cancellation activity than expected there and the potential for some downside to their production forecast there and just sort of having limited visibility. I wonder if you could maybe speculated on the difference in tone there? Are you taking a share or is it just at the bottom of the cycle and it’s tough to tell and what's your outlook for this business?

Jay Johnson

I kind of go with what you just said. I mean it’s a little tough to tell but I mean I can’t tell you from us, I won't speak to the others in the context with numbers and what else, but for us, we are seeing order activity in the mid cabin, not just tire kickers. People are actually buying airplanes. So that's good. We see it in the servicing side of our business where the services have returned, they are not skyrocketing but that's certainly stabilized in the mid cabin for us, okay. So the indicators are tending albeit slowly to a mid cabin recovery and some (inaudible) in the space out there that will bring the inventory back to what I would call right size to go forward.

Noah Poponak – Goldman Sachs

Okay, I am going to try to sneak in one more since I am last, and you haven't been asked about this in a while. Can you update us on your commercial ship building business, what’s the backlog add and what kind of revenue run rate is that experiencing today?

Jay Johnson

The commercial shipbuilding business which resides as you know out at NASSCO in San Diego, is doing very well in execution. In fact it’s doing superbly in execution. Every product carrier we put out has been ahead of schedule and below budget, okay. So we know how to build those ships better than anybody. That said the challenge there is the market space. And so you know we are building one through five in the product carriers, six through nine are not in the build and right now today’s answer is we don’t expect them to come to us anytime soon. They are not in our plan anymore, okay. But that market too shall return and we are getting some interest in commercial activity that could be resident at NASSCO and I don’t want to get much more specific than that except to say and I think we have talked about this before you have got Jones Act ships that are out there in some number that are getting very old and very tired and very inefficient and frankly, you have got environmental disciplines that are going to be kicking in here in terms of single haul versus double oilers, etcetera, etcetera. So there is a lot going on that will come, it's just a question of when it comes.

NASSCO’s navy side is coming out with 14 T-AKEs which are being done very well as you might expect and that will bring us out through 2012 there. The Mobile Landing Platform is being put into the ’11, we are already doing some of the front-end work on that. And so we expect at least three of those Mobile Landing Platform -- Mobile Landing Ships. And then we also got a significant book of business out there with repair. There is no navy shipyard, okay, in San Diego and there are over 50 navy combatants that need to be maintained out there. So that's – that I think last year was like I don't know 20 some percent, 24% I think of NASSCO’s revenues.

So there is plenty of work in that book of business. The commercial side just needs to have the market come back and we will be very competitive when it does.

Amy Gilliland

I just want to thank everyone for joining our call today. And if you have additional questions, I can be reached at 703-876-3748. Have a great day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: General Dynamics Corporation Q1 2010 Earnings Call Transcript
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