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General Dynamics Corp. (NYSE:GD)

Q4 2007 Earnings Call

January 23, 2008 11:30 am ET

Executives

Ray Lewis - Staff Vice President of Investor Relations

Nick Chabraja - Chairman and Chief Executive Officer

Hugh Redd - Chief Financial Officer and Senior Vice President

Analysts

Robert Spingarn - Credit Suisse

Joe Nadol - J.P. Morgan

Cai von Rumohr - Cowen

Robert Stallard - Banc of America

David Strauss - UBS

Joe Campbell - Lehman Brothers

George Shapiro - Citigroup

Heidi Wood - Morgan Stanley

Steve Binder - Bear Stearns

Howard Rubel - Jefferies

Ronald Epstein - Merrill Lynch

David Gremmels - Thomas Weisel Partners

Troy Lahr - Stifel Nicolaus

Doug Harned - Sanford Bernstein

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2007 General Dynamics Earnings Conference Call. My name is Maria and I will be your audio coordinator for today. At this time all participants are in listen-only mode, and we will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions). I would now like to turn the presentation over to, Mr. Ray Lewis, Staff Vice President of Investor Relations. Please proceed.

Ray Lewis - Staff Vice President of Investor Relations

Well, thank you very much Maria, and greetings to the members of the Investment community, as well as, the business press that are listening today. We had a great quarter; I would like to remind everyone that there may be some forward-looking statements made today. These will represent our best estimates of future performance but they are subject to the risks of any normal business. And as I remind you each quarter, you can get a more detailed exposition on what those risks are, if you look at our 10-Qs and 10-Ks.

With that said, I'd like to turn it over to our Chief Executive Officer and Chairman, Nick Chabraja.

Nick Chabraja - Chairman and Chief Executive Officer

Thanks, Ray and good morning. I'm pleased to report that fourth quarter 2007 is obviously a very strong finish to what has been a spectacular year for us. The fourth quarter results represent the highest revenue, earnings per share and free cash flow we have ever been pleased to report to you.

Earnings per share from continuing operations were $1.42 for the quarter compared to $1.13 for the fourth quarter 2006 at 25.7% increase. And for the full year, earnings from continuing operations were $5.10 for fully diluted share, an increase of almost 21.5% over 2006. This growth in earnings in both the quarter and for the full year was driven by strong revenue growth and significantly improved margins, we achieved terrific operating leverage.

Let's take a brief look at both, revenue and operating margins. Revenues for the quarter grew to $7.5 billion from $6.5 billion this $1 billion increase represents 15.4% growth over the fourth quarter of 2006. At the same time operating margins increased 80 basis points to 11.6%.

Full year revenues were $27.2 billion, up 13.2%. Operating margins for the full year increased 50 basis points to 11.4 from 10.9 in the prior year. Free cash flow from continuing operations in the quarter was approximately $900 million, for the full year free cash flow from continuing operations totaled approximately $2.5 billion, which represents a 119% of net income from continuing operations, about 19% better than I've been guiding you through the course of the year until maybe the fourth quarter.

As a result of this strong cash generation, we ended the year with cash and short-term investments, nicely in excess of our total debt, in fact in excess by almost $270 million. We also ended the year with funded and total backlog at all time highs.

Obviously, we could not be more pleased with the earnings and the cash generated by our business segments this year and the strength of our balance sheet leaves us in a powerful position to add value during the course of the year.

Let me now address the segment detail and lay a little ground work by segment for the 2008 guidance that I gave you in the press release. I'll start with Aerospace, Gulfstream. I was obviously very pleased with Gulfstream's performance in the first three quarters of the year, and I am further impressed by what they accomplished in the fourth quarter. Sales increased 17.2% for the quarter and were up a similar amount for the full year. Operating margins continue to improve. Both fourth quarter and full year margins improved 120 basis points over last year.

As a direct result of the 17% revenue increase and improved margins, earnings were $212 million in the quarter and $810 million for the full year, an all time record. Both increases are about 26% greater than last year. The book-to-bill ratio for the quarter was 2.14 times resulting in a further significant increase in backlog. So, as we look into 2008, we're forecasting revenue growth of 13% to 15% for Gulfstream with margins improving yet again between 20 to 40 basis points over 2007. In other words, I'll look for operating margins for the full year between 17% and 17.2%.

Alright, let's move to Combat Systems. Revenue in Combat Systems segment grew 46.5% for the quarter and a full 30.3% for the year. Growth in this segment has been absolutely phenomenal and is attributable in large part to growth in combat vehicle market worldwide. However, we experienced growth across each and every product line within the segment. Margins for the quarter were 12.2%, up a 150 basis points over the fourth quarter of 2006. For the full year margins increased 40 basis points to 11.7%.

Needless to say, the combination of 30% revenue growth and 40 basis point margin improvement resulted in powerful growth in operating earnings up 35.3% for the year. So, what do we do for non-core? For 2009, we believe revenues will continue to grow somewhere between 9% to 10% and margins should improve again another 30 to 50 basis points. So, continuing healthy bottom line growth out of Combat Systems.

Marine Systems. In Marine Systems Group, revenues were modestly up for the quarter and for the year. I'm very pleased, however, by the margin improvement this year, better than I thought it would be. Margins were 8.3% for the quarter and 8.4% for the full year. As a result, operating earnings improved a little bit over 20% for the quarter and over 12% for the entire year.

Next year, we expect revenues to increase between 3% and 4% and margins to improve another 10 to 20 basis points. Let me tarry a minute here. You notice, we are forecasting relatively modest growth next year and some continuing slugging it out in the trenches for a little more margin improvement, really good hard work by these guys. What you don't know is that in the out years and throughout the course of our plan, Marine Systems is forecasted to be the strongest grower in terms of compound annual growth rate through 2011 and you will see that hit in each of the years, '09, '10 and '11. So in '09, we're looking for something in excess of 9% growth here and we feel pretty confident about that.

Lastly, Information Systems and Technology, sales were off about 2% for the quarter, but up 6.6% for the full year. This requires some normalization. As you know, we are experiencing the slow but steady ramp down of the BOWMAN program in the United Kingdom, a very large program.

Additionally, the year-over-year comparison is somewhat skewed by the acquisition of Anteon during the course of 2006. So adjusting for these events, we calculate a modest 3% increase in North American based revenue year-over-year.

Margins have declined slightly, 20 basis points in the quarter and 10 basis points for the year. You may recall of my earlier guidance to you, anticipated declines in margins closer to 50 basis points. So, it is a very good job to close the gap. I would like to have seen more growth and improved margins, but the year was better than we had expected. Importantly, the group's backlog increased nicely during the fourth quarter.

As we look at 2008, we see top line growth, organic growth between 5% and 6%. And further modest pressure on margins. Taken together, operating earnings should grow year-over-year by 3% to 5%.

In summary, we had a good quarter and a great year. We had two businesses, Aerospace and Combat Systems that really hit it out at the ball park. The Marine Systems Group had a solid year with margins back to levels we haven't seen in some time. And the IS&T Group has done a good job managing a pause in portions -- identifiable portions of its market.

By the way, Information Systems and Technology is the first line of business of General Dynamics to top 1 billion of operating earnings in a year. No small feat. It should be joined in 2008 by Combat Systems with Gulfstream not far behind. In my view, all four of our lines of business are well positioned. Accordingly, we see earnings per share in 2008 increasing to a range of $5.55 to $5.65, which is between 9% and 11% earnings per share growth.

As I pointed out earlier, our relatively powerful balance sheet leaves us some opportunity to improve this because the guidance I gave you does not take into account any potential deployment of capital.

I think Hugh Redd has some additional detail that might not be apparent in the attachments to our press release. So, Hugh?

Hugh Redd - Chief Financial Officer and Senior Vice President

Thank you, Nick. Let me start with taxes. The effective tax rate for the quarter was 32.8%, which included modest true ups and discrete items. But the effective rate for the full year was 31.7% in line with our expectations. Backing out extraordinary items, the run rate for the full year was 32.5%. We expect the run rate in 2008 to be about the same, 32.5%.

Nick mentioned that free cash flow from operations for the quarter was approximately $900 million that represents 154% of net income from continuing operations for the quarter. Furthermore, that $900 million reflects the reduction for a voluntary contribution of $100 million that was made to our pension plan during the quarter.

The strong free cash flow this year put us in a net cash position as Nick mentioned and accordingly, we see next year's net interest expense to be minimal. With respect to share repurchases, we used $505 million last year to repurchase 6.5 million shares at an average price of $77.88.

Total backlog grew $300 million in the quarter and $3 billion for the full year. As a result, we ended 2007 with the largest backlog in company history. And my comments were focused on total backlog, because this represents work which is under firm contract with the defiance scope of work. The total estimated contract value which we have reported in our attachments on the other hand includes total backlog plus our options and management's estimates of future awards under IDIQ contracts.

So focusing on total backlog, the four segments ended the year with backlog to sales ratios as follows: Aerospace 2.6 times, Combat 1.7 times, Marine 2.4 times and Information Systems and Technology 1 times.

I think it's noteworthy that to point out that Marine Systems Group tends to get orders in large drops consistent with large long-term construction projects, particularly submarines and surface combatants. Now consequently, backlog fills up in one year and that steadily depletes over the next several years. That steady run-off is what we are experiencing now in Marine Systems Group. IS&T on the other hand tends to go out and fill their book-of-business each year. This year, the book-to-bill was 1.2 times indicating support for the revenue growth in 2008, that Nick has just outlined for the IS&T Group.

Ray, that concludes my remarks.

Ray Lewis - Staff Vice President of Investor Relations

Okay. Thank you very much, Hugh. Maria, before we get into the Q&A, I'd like to reiterate that we would like each of you to ask one question, if you want to ask more than one question please then get to backend of the queue, so that we give everyone the opportunity to ask question during the time. Now, Maria, if you would explain to them how they can get into the queue?

Question-and-Answer Session

Operator

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

Robert Spingarn

Good morning, Nick, Hugh.

Nick Chabraja

Good morning, Rob.

Robert Spingarn

First some general question on Gulfstream, sort of a hybrid question, but if you could give us some more color on what's driving the very impressive backlog growth there book-to-bill? And then, you gave us revenue targets for '08 does that anticipate the same existing unit guidance that you've give before? And if you could also just talk about the margin strength and what's driving that, is it pricing, is it execution?

Nick Chabraja

Yeah, okay, Rob, we'll try and give you some color, I think 58% of the orders in the quarter were international, that is outside of North America, 53% for the year. Let me speak to the year for a minute. Domestic orders were up from 92 in 2006 to 121 in 2007. But the percentage decline from 58% to 47%, so we were faced with robust demand by any reasonable standard in the United States and Canada, an up market for us, but the percentage of orders declined in the face of powerful growth across the rest of the world.

In the fourth quarter, we experienced particularly strong growth in Asia, which was nice to see. The growth I suspect will continue at least through the first quarter, where we've experienced the steady contract activity early in the year and a number of funded memorandum of understanding not yet reduced the contract but of to a good start in the quarter in terms of sales activity.

Margin question, if we compare year-to-year and it differs a little bit for each product, so I'll generalize here. About 50% of the margin growth was attributable to price and basically planed for, most of that was in our plan with a few exceptions because we could get some relatively near-term pricing on mid-size that we couldn't plan for because we weren't a year out at the time. And the other 50% of the margin improvement was through clear productivity gains and the productivity gains had to offset some increase in our purchase material in systems cost. So, if you could see the metrics that I look at, Gulfstream really beat quite handsomely their budget for labor hours on all size aircraft and then really did a bang up job on completion which enabled us to make greater margins on the mid-sized aircraft, so, all-in-all, spectacular performance there.

Robert Spingarn

Any update on the new programs?

Nick Chabraja

No, I don't have anything to say about that, Rob. I think I've announced pretty loudly that we are going to have some major announcements in the year, one of them in the first half. So, I don't want to steal Gulfstream's thunder on that. Those announcements, frankly, are for the benefit of customers and analysts and shareholders should bask in the warmth of additional orders rather than getting the information in advance.

Robert Spingarn

Thanks very much for the color.

Operator

Your next question comes from the line of Joe Nadol with J.P. Morgan. Please proceed.

Joe Nadol

Thanks. Good morning, Nick.

Nick Chabraja

Good morning, Joe

Joe Nadol

My question is on Gulfstream as well, but it has to do with your guidance. You've given some nice sales growth guidance for Gulfstream, but your margin guidance appears, from my standpoint to be conservative. And certainly you've been conservative during the up-cycle the last few years. What's holding you back from doing a little better considering all the pricing you got in the last 18 months to 2 years? The productivity improvements you're making, what's going on with R&D etcetera?

Nick Chabraja

Well, you know, the pricing is embedded, Joe, I mean, we are going up again and you've got learning curves, it should be starting to flatten. I mean these guys have extracted enormous earning out of their production schedules. So, I don't know that I'd regarded it as conservative or I think its steady improvement, continuous improvement and…

Joe Nadol

Can you share, you broke down very nicely what happened this past year with margin improvement; can you say how those two different factors play into your guidance for 2008 roughly?

Nick Chabraja

Yeah, sure, it's relatively easy. Most of the improvement is on price, which we know and is embedded and we have what would be viewed as normal learning relatively late in a production line, a [material] line. So, if they beat it, it will be a lot of Lean Six Sigma effort that they did this year, but I think doing another 100 basis points it is tough slogging. So, we don't have that embedded.

Joe Nadol

Wasn't there also some operating leveraging that should help you out?

Nick Chabraja

Do they have an opportunity? Yeah, sure they do. They have an opportunity to be better, but I think its Joe the way I look at this isn't a 50-50 plan. I see as much risk in it, as I see opportunity for them, maybe not quite as 50-50 as we have on some of the defense units, because some elements of risk are gone. For example, there will be no question about the volume. The number of planes to be delivered will -- their plan will be precise within one unit probably. The prices are identifiable across the entire product line now, because they are more than year out for every product.

And the issue then is the productive question, some variables having to do with pre-owned aircraft sales and what we do over on service side of things. So all in all, I'd probably say here's slightly more opportunity than risk.

Joe Nadol

Okay.

Nick Chabraja

I can run away with the upside on the opportunity.

Joe Nadol

Okay. Thanks. I'll get back in queue.

Operator

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

Cai von Rumohr

Yes, Nick. Good quarter.

Nick Chabraja

Thank you, Cai.

Cai von Rumohr

It looks like you delivered one few in large Gulfstream in two few in midsize then your -- I guess most recent guidance. Why the miss and could you give us some color on what you expect for unit deliveries in 2008 out of two models?

Nick Chabraja

Yeah. Cai, yeah, I am going to take it in two parts, first the large and then the small. On the large, in fact, I had guided 80 and we slipped one and delivered 79, the other airplane delivered at 3rd and 4th of January and we could have delivered at the end of the year, we had a willing enable customer, FA certification, but it would have required a fair amount of overtime in the completion centre and we chose efficiency and the customer accommodated us.

With respect to the mid-size deliveries, we have a little conundrum here in basic terms, and I will get tricked up every now and then. What I was giving the Street were our production estimates. The delivery estimates and guidance are very similar but they can be off by one or two. We in fact produce the number of mid-sized aircraft that I had indicated but we delivered 59 of them; the other two are in the service as demos.

So every now and then I get caught in the switches between production and delivery, but as far as next year is concerned, we plan to produce and deliver same number, 90 of the large cabin aircraft. We plan to deliver 67 mid-size, but we'll probably produce 69 to 70 of them. And again that is the variability between test items or demos which we need in the course of our business. So -- but, we'll deliver 157 aircraft next year, up from 138 this year and that's what's embedded in our revenue guidance to us -- to you.

Cai von Rumohr

But the thing I don't understand, if you are up this 13% or so in terms of units with equivalent mix, how come we're not up more in terms of sales, because isn't the price hike around 4%?

Nick Chabraja

Cai, you can't count on that, because costs go up as well, right? It's the net and we haven't been netting 4%. And your -- in percentage terms, the mix isn't identical. And as I pointed out to you, I am producing more than I am delivering. There's a cost associated with that. In the year, when those two meet perfectly -- I am not trying to trick you here, Cai. We are giving you our honest plan here and the variability that's embedded in it.

Cai von Rumohr

Terrific. Thank you very much.

Operator

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

Robert Stallard

Good morning. Nick, there's obviously been some concerns about the impacts of the slowing U.S. economy and possibly a global economy. How do you get comfortable with the [backlog of the economy spends] for Gulfstream as this is a really firm backlog? And how far can you now look out in terms of availability for a new plane today?

Nick Chabraja

Yeah. Rob, obviously, we can't ignore what's going on in the world around us. And what's most apparent in the market that you watch everyday. On the other hand, we are scanning this backlog as a result of that. We started scanning it monthly. We are probably scanning it weekly now. Looking for any infirmity and we can't find any. We have not had a cancellation. And we don't have any customer in discussions with us today for a slip. And we are in discussions with many customer who are in that backlog about opportunities for a move up, which we can't give them other than through increased production.

So, we will continue to scan that like a good cyclical will, because that backlog is critical to us. But we have very significant deposits associated with that backlog and particularly closer in for the next several years as we make -- as we move along the production of the green aircraft we get more and more deposits. So, a lot of cash sitting in the bank to support that backlog and so far, backlog holding very, very well and a lot of blue chip customers. So, all makes you feel pretty good.

For the moment, the -- and look, a lot of things could go wrong here in the economy and if Gulfstream would still look very, very powerful in '08 and '09, and probably '10 as well. So, it's a long-term view and I believe we'll have ample opportunity to behave like a good cyclical if we encounter a cyclical downturn here. But at the moment, we are pleased with where we are. We are also pleased with our relatively cautious decisions about how we ramped up production. We were under a lot of pressure from both customers and from analysts and shareholders to step up the pace, and I think we protected the business in the long run and have managed that wisely and I give enormous credit to my team down in Savannah, Georgia. They are in good shape and we'll continue to deliver for our shareholders.

Robert Stallard

Great, thanks, Nick.

Operator

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

David Strauss

Thanks, good morning, Nick.

Nick Chabraja

Good morning, David.

David Strauss

You gave us a bit of color in terms of the growth at marine looking even further out in '08. You've also I think talked about potentially $6.5 billion to $7 billion business on 2010 and 2011, is that correct and if so, can you give us a little bit of color, obviously you've got second Virginia-class coming in, but just a little bit color in terms of how you get to those kind of numbers?

Nick Chabraja

Yeah. We really start to see a 2010; we break 6.5 billion in that year. It's a lot of product carrier work continued strength in the T-AKE program and getting the two submarines a year and electric boat and that's the year when we should see the major impact of that. And then another boost again, in 2011, that gets us chasing 7.5 billion not quite getting there.

David Strauss

Okay. So, 2010 you do the math and you are applying close to 20% growth for that business?

Nick Chabraja

In that year that happens.

David Strauss

Okay.

Nick Chabraja

The year before a little bit more or like between 9% and 10%, 29, but you just going to see it start to ramp, and it will be of all of our businesses unless something happens that and it always going to happen. But in terms of embedded in their operational plans, Marine Systems is the largest grower.

David Strauss

And on that $6.5 billion in 2010, you're still looking at 10% margins?

Nick Chabraja

I think that's the year they could get there. And I don't know that we have it embedded in our plan, I mean they are not that bold. But you ask me what could you do? People frequently ask me that, particularly by Gulfstream, I mean, a question I always get is, when can you get the 19%? And I'll tell you, not for a while, it's not going to happen for a while. Here, I'm happy to tell you, I think they can get there whether they are bold enough to embed it in their plan there is another story but their plan keeps improving year-over-year in terms of operating margin. And I see opportunity there, they are a little gun-shy about the volume -- they're going to get the volume, they're little gun-shy about embedding what that efficiency can do for them in their plan. But I have a great deal of confidence here that they are going to do the job.

David Strauss

Great, thanks, Nick.

Operator

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

Joe Campbell

Good morning, Nick.

Nick Chabraja

Good morning, Joe.

Joe Campbell

I'd like to ask about Combat Systems, the other place besides Gulfstream that really knocked the cover off the ball. And then in your guidance, it's going to have another strong year certainly relatively to overall defense growth. And I wondered if you could just sort of go through the various vehicles in there or the various -- what is it that's driving it? You mentioned that across the board, all the vehicles contributed in 2007. Just give us a little update on how the combat stuff looks in '08? And maybe its sensitivity, if any, to what happens if the up tempo falls off, and then of course presumably there is reset behind that? Thanks.

Nick Chabraja

Joe, we have a very strong tank program, it has many facets. But it is embedded, it's in the backlog, it's well funded. I don't have any concern about it. If anything in our plan we've been a touch cautious about Stryker because there is some further Stryker potential growth in '08 that's in the supplemental, the next supplemental, maybe that's always a gamble, so we don't embed it. MRAP provides us with very nice volume in 2008 more than we had in 2007, and then we don't have it again, I mean, our view is that it goes away, if it doesn't or if more goodness occurs, well that's splendid, that's upside for us. Europe continues to grow.

So, the vehicle business and also the export opportunities are significant. They don't quite hit us much in '08, but they begin to hit us in '09, '10 and '11 and they will permit modest continuing growth throughout our planning horizon as the U.S. Army's combat vehicle programs, I think, normalize. So, that's sort of the way we see it. But we are also getting powerful growth out of our ordinance business and out of advanced technology and products, ATP. So, all-in-all I think still a strong business.

Joe Campbell

Thanks very much for the update Nick and then another good year for you guys.

Nick Chabraja

Thank you, Joe.

Operator

Your next question comes from the line of George Shapiro with Citigroup. Please proceed.

George Shapiro

Nick, yeah, just pursue a little more detail maybe the MRAP. I mean, I kind of figured that maybe had $500 million sales in '07 and probably goes to maybe $800 million in '08 and then your plan you have it going down to zero in '09. Just to clarify?

Nick Chabraja

Yeah.

George Shapiro

And with the zero in '09 you are still able to see sequential revenue growth between '08 and '09 for the whole sector and if so, what's making up for that $800 million loss?

Nick Chabraja

The amount of growth in other program activity, I mean, it's a very big business today, George. And there is an enormous amount of activity here EFV, JLTV, Stryker growth, tank business, reset business, European sales, export the Saudi program hits us in 2009, two different programs, ammo, strong. So, a lot of growth opportunity here. If anything this is one that I think is a tad conservative in the out years, next year I think is fine.

George Shapiro

Okay. But when you say you are predicting modest growth in '09 and 10 so modestly, I assume is 5% or so?

Nick Chabraja

No, 4ish.

George Shapiro

Okay. Thanks very much.

Operator

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

Heidi Wood

Nick, I wanted to ask a question from the international perspective on Gulfstream and Combat. Can you layout for us, in your deliveries in '08 and '09 what is the percentage of deliveries that will be international for Gulfstream and again on that international…

Nick Chabraja

I can't Heidi. I don't have that data. It trails the orders and trails them considerably. So, it will still be less than half, I believe in '08, when that turns I can't tell you.

Heidi Wood

Okay. So, you don't know, whether it is '09 or 2010 when you…

Nick Chabraja

No.

Heidi Wood

Okay.

Nick Chabraja

No. I don't know.

Heidi Wood

That's fair. Then, on combat, on international, can you talk just about what was the percentage of international content in '07 and then what does that look like '08 and '09 and 2010?

Nick Chabraja

I can't, Heidi you have a sense for that, I really don't.

Redd Hugh

Because you've got the European business and you've got exports both international, plus Canada…

Nick Chabraja

I don't have that data for you, Heidi.

Heidi Wood

Then maybe you can help me, I mean, to me that's, I'm trying to understand the growth in sales you're talking about in the modest margin expectations when it seems to me like the mix of business should be getting better and it seems to me from the orders that you should be getting a lot more international content both non-European as well as European and to me that would be a margin plus, so I'm trying to understand what the offsets are, that….

Nick Chabraja

Yeah, look I think what is probably embedded in our plan is some conservatism about U.S. Army Resources in out-years and we could be wrong with respect to that, and that's why I said earlier, there is probably more upside opportunity in our out-year plan for Combat Systems than we have embedded in it. For example, we don't take Stryker beyond the seventh brigade other than reset opportunities in our plan. I think there is both an eighth brigade opportunity and there are opportunities to use Stryker in other ways. So, if you want to bet that in your forecast, you can do that. We have some very nice pieces of export business, both out of Canada and out of the United States, lined-up, and as we always do with export businesses, we discount those a little bit in our plan because they have a way of slipping to the right overtime and being for a fewer vehicles than initially announced.

As our country struggle with their own budgets, so maybe you could see the detail on our plan, you would see us applying discount factors to well established programs, even where the probability of win for us is almost sole sourced or extremely high, we'll discount the program just on what nature and history tells us things slip and get a little smaller as they go through time but plenty of upside opportunities.

Heidi Wood

No, absolutely. Good, thanks very much Nick.

Operator

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

Steve Binder

Yeah, Nick. Can you maybe touch on IS&T, and I know you've said last quarter that you felt the fourth quarter being modestly higher year-over-year in revenue, and obviously it came up a little short. Can you may be touch on where that variance was from?

Nick Chabraja

Yeah. I am not quite sure, Steve, they came up short, I think more on the services side than anywhere else. But I think we look good going forward. I mean, we're seeing the pipeline starting to fill-up. We saw in the quarter some programs that we had under contract go from unfunded to funded. And we saw some IDIQ orders in relatively significant numbers in past quarters were issued and went to funded. So, all of that was an indication to me that the pipeline was getting a little better. And Hugh, do you have some detail on that you could give him?

Hugh Redd

Well, just to your point, the orders under the computing hardware systems, 113 million at the end of the year, and the WIN-T orders of $663 million were significant.

Nick Chabraja

So, those were the things that went to funded and task orders issued and we're seeing more of that. So, it enabled us to support an organic revenue growth across the sector. That's in the 5% to 6% range next year, and I am pretty comfortable with that.

Steve Binder

I don't mean to be nitpicky but your total backlog grows over $300 million Q3 to Q4, but the IDIQ contract value did decline to $800 million from Q3 to Q4. So, if you look at your table, you provide total estimated contract value it's down $500 million from Q3 to Q4.

Hugh Redd

You know that column that you are referring to is management's best estimate of what their future awards under IDIQ contracts can be and that -- and so, it's subject to management revising competition, and other people who have IDIQ rewards and --

Nick Chabraja

It can be wholesome too, Steve. I mean they can revise. My suspicion is that that $800 million is a combination of two things. Some revised estimates on programs that are very slow to take off. And second, that number goes down when things to the left, when they go into the funded category and we had some particularly good opportunities there this quarter that happened. So, I'm pretty comfortable with that. I am happy to have you arguing the other side of the coin though Steve, because most of you have been outpacing me in your growth estimates for this IS&T group for the last couple of years. I think this is a conservative estimate next year and they can achieve these growth opportunities.

Steve Binder

Okay. And you had a great cash year, I mean 120% of net income and you did get $1 billion of advances in deposits helped out by the strength out of Gulfstream. If you do have some tail off in activity in '08, are you still confident you will be seeing free cash flow equal or better than net income?

Nick Chabraja

I think we are -- our plan provides for me giving you that guidance and I hadn't done it and I think it's equal to not better than. I think equal to is very good, what we have accomplished recently is extraordinary and in part that's been helped by the advanced deposits on aircraft by Gulfstream.

Steve Binder

And one other thing on the Czech, there's been obviously a lot of news reports about the carrier contract with the Czech Government. Do you want to give an update on that and is there any potential earnings impacts from that, considering, I think you still have some inventory there?

Nick Chabraja

I don't think so, Steve. If it is, it's not material. There really is not much to say, we are in the midst of discussions with the Czech Government. They would like to restructure that contract. We would like to restructure it. They probably bit off more than they can chew. We had a couple hundred million probably in revenue forecast for this year. If we don't have it, we'll cover it. It's not significant for us. It's something we are just in the midst of working out with them. So, I don't really know how to comment or want to engage in much speculation. I think my guidance to you considers all possibilities in that area.

Steve Binder

Okay. Thank you.

Operator

Your next question comes from the line of Howard Rubel with Jefferies. Please proceed.

Howard Rubel

Thank you very much. Nick, with the cash that you have today there gives you an off a lot of opportunities, how would you sort of -- I mean in the past, you have used some of it to buyback stock. Is that still a reasonably high agenda item?

Nick Chabraja

Howard, I think where that particular item appears on the agenda is directly related to the stock price. I think you have all known, I'm an opportunist and I think you should make your assumptions about our behavior in direct correlation to the opportunity that exists in the stock market. This is a market in full retreat and not necessarily in intelligent retreat. So, you can draw your own conclusions.

Howard Rubel

And then as one follow up, as you've looked at what has been funded in the supplemental and what's yet to be funded, how would you sort of -- how would you handicap your opportunities? You clearly talked about the 8th Stryker Brigade as one opportunity. Is there jump ball things or --?

Nick Chabraja

Yeah, I think, there's some jump balls out there, Howard. I think the first supplemental was largely O&M and everybody who services who might have had their hands out for other kinds of money didn't get that satisfied. And so, we'll either see it in a second supplemental or it will slip into the next year's budget. But we are cautious about the way we handicap these supplementals. We'll work hard with the customer if they want our help to develop their requests. But we'll start to increase our view of things when it happens.

Howard Rubel

I think that's fair. Thank you very much.

Operator

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

Ronald Epstein

Hey, good afternoon, Nick. On Gulfstream, in terms of their ramp up, I mean how they are going with the supply chain and your suppliers? Are you seeing tightness in any specific areas? Did it -- are you working through it? How is that going?

Nick Chabraja

No, they are actually doing pretty well now. I mean, we have to work that constantly and it was a problem much earlier in the ramp up. The reports I'm getting is that they are doing well. We had isolated issues that we had to work through. And sometimes, it was in the supply chain of our supplier. But I think that the industry, as best I can tell, is doing fairly well in terms of meeting their commitments and they are to us.

Ronald Epstein

Okay, great. Thanks.

Operator

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

David Gremmels

Thanks. Good afternoon, Nick and Hugh. You talked about new development activity at Gulfstream and you mentioned it again this morning. Just wondering if you could give us a little bit of color on Gulfstream R&D trends as a percent of sales? Directionally, was it up in '07 and I don't know if you can say anything about '08?

Nick Chabraja

Yeah. It was in fact up and it will be up again, a tad, in '08. It I don't think will be a major driver. It is starting to approach 2% of sales on a net basis. And it moves around quarter to quarter as not because of our spend rate, but because of the cash we receive from our partners and participants in the program as they fund some of our advance research. So, I think its 2% or slightly below but moving steadily towards 2% and that's on a net basis and it's been satisfactory to fund the robust program.

David Gremmels

Okay. And I believe that's higher than it's been in the past, as you look out longer term, do you anticipate that it stays around this 2% number? Is there some room that it could tick back down a bit?

Nick Chabraja

It's going to stay that way forever, if I have anything to say about it.

David Gremmels

Very good. Thanks very much.

Operator

Your next question comes from the line of Troy Lahr with Stifel Nicolaus. Please proceed.

Troy Lahr

Thanks. Just a question on IS&T. You talked about margin pressure next year. Is that just because you had a strong second quarter this year? And then when you say pressure, are you talking maybe 10-20 basis points or could it be more than that and why?

Nick Chabraja

Yeah. I think we are talking about maybe 20-30 basis points and it's a business mix question. We expect the growth in the IT services business where they have lower margins.

Troy Lahr

Okay. So, you are looking at kind of repeating what you did in the fourth quarter. So, fourth quarter is kind of more of a steady run rate for you going into next year, it sounds like, at 10.4%?

Nick Chabraja

I don't know. Yeah, I think that's closer to us.

Troy Lahr

Okay. So, there's no additional margin erosion. Okay. Thanks guys.

Nick Chabraja

And I think I was as explicit as I would care to be about that and I think I have given you, you can do the math, I had given you a 5% to 6% revenue increase and a 3% to 4% bottom line increase organically depending on how we do on the margins. So --

Troy Lahr

No, that's good. It's helpful. Thanks guys.

Nick Chabraja

Yeah, I think we will be as good or better than we were in the fourth quarter and you should always see maybe a 20 basis points of loss in the year.

Operator

Your next question comes from the line of Doug Harned with Sanford Bernstein. Please proceed.

Doug Harned

Good morning. I have a question also on IS&T. When you look at the individual units, could you talk a little bit about AIS and C4 Systems in terms of growth going forward in those two?

Nick Chabraja

C4 Systems has continued to enjoy strong growth, as it did in this year. And it offset what we didn't get in AIS, had some declines. AIS has a very large space segment, both small to midsize satellites and payloads. If you follow, you know where the space program is particularly with respect to new starts and commitments -- new commitments in their segment of the market and even at the larger end, where we are a supplier, the level of activity has been dramatically slow. So, that's why they have been a slow grower. And the IS&T or the Information Technology segment has been slow as you can observe at many other public companies where they do that exclusively. And C4 has been the power and will continue to be a power and its programs have been well funded. They are in very good shape. So, we would look them -- for them to continue to lead. We see IT services getting some traction and starting to have some growth for us. And at AIS, there's not a lot I can say about it, because they draw from classified budgets. But for the moment, their growth is slower than the other segments.

Doug Harned

Okay, and then just separately, can you comment at all on the timeline for the Saudi vehicle contracts? How that's going?

Nick Chabraja

Yeah. I think on the labs, we should see contract activity in the first half of '08. We should see revenues and there are two different contracts. One for the Saudi National Guard, the SANG, and one for the Ministry of Defense and Aviation. They total 724 vehicles for SANG and 120 some -- 124 for the Ministry of Defense. And you should see revenues beginning in '09, but the strength of the program probably in '10, '11 to little bit '12. We should see tank activity, also, maybe an order later this year. And work there probably revenue streams hitting in '10 and '11, some revenue in '09 but stronger in the out years. These are among the programs that are going to provide our out year growth that we were talking about.

Doug Harned

But those are now very much set, is what you're saying. I know this has been a long process.

Nick Chabraja

I think the program is now well scoped. The requirement is fairly cleanly identified. Size adjusted. We know what our content is. We are in the midst of contract discussions. And I think our level of confidence here is fairly high.

Doug Harned

Okay, great. Thank you.

Ray Lewis

Okay and Maria, I believe we have sort of hit the end of our allotted time here. I would like to remind folks that if any of your colleagues have not heard the entire call, it will be rebroadcast beginning at 1:30 this afternoon. The number is 866-713-8395, the passcode is -- no, I am sorry, that's 888-286-8010. The passcode is 9754127. I am Ray Lewis. My direct line is 703-876-3195. My colleague, Amy Gilliland is at 3427, and after we get a quick good bite to eat, we will be available for any further questions you might have. Thank you very much for being on the call, and good afternoon.

Operator

Thank you for your participation in today's conference, ladies and gentlemen. All parties may now disconnect. Enjoy your day.

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Source: General Dynamics Corp. Q4 2007 Earnings Call Transcript
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