General Dynamics Q1 2008 Earnings Call Transcript

Apr.23.08 | About: General Dynamics (GD)

General Dynamics (NYSE:GD)

Q1 2008 Earnings Call

April 23, 2008 11:30 am ET

Executives

Ray Lewis – Staff VP IR

Nick Chabraja – CEO

Hugh Redd - CFO

Analysts

George Shapiro – Citigroup

Cai von Rumohr – Cowen & Co.

Heidi Wood – Morgan Stanley

Howard Rubel – Jefferies & Co.

Analyst for Joe Campbell – Lehman Brothers

Myles Walton – Oppenheimer & Co.

Steve Binder – Bear Stearns

David Strauss – UBS

Ron Epstein – Merrill Lynch

Doug Harned – Sanford & Bernstein

Troy Lahr – Stifel Nicolaus

Joe Nadol – J.P. Morgan Securities

Gary Liebowitz – Wachovia Securities

Rob Spingam – Credit Suisse

Operator

Good day ladies and gentlemen and welcome to the first quarter 2008 General Dynamics earnings conference call. My name is Carissa and I will be your coordinator for today. (Operator instructions). I would now like to turn the presentation over to your host for today’s call, Mr. Ray Lewis, Staff Vice President of Investor Relations, please proceed.

Ray Lewis

Thank you very much Carissa and welcome everyone in the investment community as well as the financial media who are on the call today. As always I want to remind you that any forward looking statements we make today represent our best estimates as to what the future may hold, but obviously are subject to the uncertainties that face any business. And those risk factors are dealt with at some length in our 10Qs and 10Ks, I would recommend you take a look at those if you haven’t already. With that said, I would like to move on and turn it over to our Chief Executive Officer, Nick Chabraja.

Nick Chabraja

Thanks Ray and good morning. I think our results are pretty straightforward so I can be pretty brief. If you’ve seen the press release for the quarter you can understand why I’m extremely pleased with the performance of General Dynamics. Sales were up 11.2% and earnings from continuing operations were up 30.2%. Earnings per share were $1.42 on a fully diluted basis, well ahead of everyone’s expectations including my own.

We obviously enjoyed tremendous operating leverage in the quarter. Margins improved 150 basis points year over year. Each business segment improved margins significantly over both first quarter 2007 and maybe more importantly to me, fourth quarter 2007. Arguably, the best thing about the quarter from a forward looking perspective was the strong order intake. As a result of nearly $10 billion of orders, our backlog grew by $3 billion to almost $50 billion. The growth in backlog was most dramatic in the combat systems and IS&T segments. But each of our four segments ended the quarter with more backlog than at the beginning of the quarter.

The company generated $346 million of cash, after capital expenditures which is about 60% of net income from continuing operations. I think that’s kind of typical for first quarter. In my 15 years here, we’ve had two great first quarters, happened to be last two years, but as I look back, first quarter’s traditionally been weaker. But I can say that it’s stronger in any event than our plan provided for and I’m fully confident that we will meet or exceed our bogey of 100% conversion of net earnings into cash in the year. Overall, performance was spectacular with each segment having a good quarter, some in painfully obvious ways and others in more subtle ways.

I’d like to give you a little color on each of the four segments, maybe I’ll begin with Gulfstream. Sales increased 17% year over year and margins improved 270 basis points. Gulfstream’s book to bill expressed in dollars was 1.18 times for the quarter. This is the eighth consecutive quarter with a book to bill greater than 1. As a result, backlog at Gulfstream increased 200 million during the quarter. Let me make very clear that this increase in backlog and order intake is with respect to airplanes currently in production. As you know we launched the G650 product on March 13th but did not begin taking letters of intent and initial refundable deposits until this quarter, until April 15th. I’m pleased to say that the G650 has been well received in the marketplace and we are now engaged in the process of converting letters of intent into contracts which will result in orders in the second quarter.

Gulfstream operating margins were spectacular to say the least at 18.5%, aided in part by some launch assistance payments, but nevertheless, a very strong performance. Combat systems, this was another great quarter for them with revenue increasing by 27% year over year. Margins improved 190 basis points resulting in a nearly 50% increase in operating earnings. Backlog improved 1.4 billion during the quarter. The largest single stimulus to revenue growth this quarter and frankly to earnings growth was the MRAP program which ramped up quickly and will also ramp down rather quickly. Fortunately demand for our other products will replace this volume as the year progresses. Margins were great at 13% but let me say not sustainable at that rate throughout the year. Nevertheless, combat systems will have a great year and I think clearly outperform our earlier guidance.

Marine systems, sales improved 9.6% over the same quarter a year ago, nice up. Earnings improved 25% and margins 110 basis points. Backlog increased over 500 million during the quarter. This quarter’s performance marks the fourth straight quarter of margins above 8%, evidence of stability, completion of our turnaround and of our continuous improvement. IS&T, the story in the information systems and technology segment is a little more subtle than the other three segments but encouraging nonetheless. Consistent with a constrained market, strong competition, revenue in the North American market was flat year over year.

Meanwhile the Bowman program continued its slow ramp down. We have however reached what we think is steady state for our business in the United Kingdom. And while revenue for the whole segment declined 1%, margins improved 60 basis points resulting in 4% improvement year over year operating earnings. Total backlog, a real good story, increased 800 million while IDIQ contract balances increased over 400 million. Importantly for us, this is the third straight quarter of increased backlog for IS&T. The growing backlog will result in good revenue growth in the second half of the year but at margins lower than the first quarter and more consistent with last year.

In summary, by almost any measure, this was a great quarter. Given this quick start, it is apparent to me that our original guidance to you was conservative. However, we will make a comprehensive analysis during the second quarter and provide detailed guidance on the second quarter earnings call consistent with our practice the last few years. I’d like Hugh Redd our Chief Financial Officer to provide some additional color and to fill in some of the details and then we’ll deal with your questions.

Hugh Redd

Alright, thank you Nick, let me start with interest expense which is down $7 million or 27% compared to the first quarter of 2007 and that’s primarily due to increased earnings on our cash balances. I should say that the impact of interest income however was less than we expected and that’s for three reasons. First, we saw disruptions or as we saw disruptions in the capital markets early in the quarter, we moved towards more secure investments. We weren’t alone in the flight to quality and accordingly yields on the highest quality investments dropped.

Second, during the quarter we accrued approximately $6 million of interest expense related to the settlement of a dispute in the aerospace segment, the principle amount of which we had substantially reserved in prior periods. The third reason was lower than expected cash balances due to share repurchases. Taking these factors into consideration, we see the interest expense for the full year to be in the $55-$65 million range. Speaking of share repurchases, during the quarter we spent $519 million to repurchase 6.3 million shares at an average price of $82.96. Taxes for the quarter were 32.2% and that’s consistent with our expectations of 32.5% for the full year.

Nick mentioned backlog and discussed the strong order intake and resulting backlog, I should point out that we adjusted orders and backlog downward to reflect our expectations for the Pandur vehicle program in the Czech Republic. Discussions with the customer are progressing well and are expected to result in a definitive agreement for a lesser quantity of vehicles but on terms and conditions that will be favorable to both parties. Ray that concludes my remarks.

Ray Lewis

Thank you very much Hugh. Carissa, if you will once I have set down the ground rules explain once again how to get into the queue for Q&A. As we have for some time, we ask that you ask one question so that everyone has a chance to ask questions. If you have more than one question please get back into the end of the queue after you’ve asked your one question. Okay, Carissa if you could explain now how they can get into the queue once again.

Question-and-Answer Session

Operator

(Operator instructions). And your first question comes from the line of George Shapiro of Citigroup, please proceed.

George Shapiro – Citigroup

Good morning. If you could go through a little more color on how on the Gulfstream margin I mean you mentioned a supplier payment so maybe if you could talk about how much, how R&D as a percentage of sales was and maybe if there was any issues with SG&A, so I can kind of get a feel for what may be the real incremental margin might have been because on the surface they were great numbers and it looked like the mix was somewhat unfavorable with more of the lower, mid-sized aircraft too.

Nick Chabraja

George, we got about $15 million in launch assistance in the quarter. It was a little more than is typical. So our R&D was down a touch. I don’t think we’ll have a major impact in the second quarter. But as the year goes by, we don’t see the margins for the first and second quarter repeating. That having been said, I’m going to tell you that there’s some moving parts, it’s slightly unpredictable but my earlier guidance to you all in this segment is going to be conservative, because I was looking for margins in the low 17% range for the year.

We’re not going to do that, we’re going to be better than that. But I don’t see for the year that we’re going to be as good as we were in the quarter either. Although the second quarter will also be strong, I want to alert you to that right now. So I hope in general I’ve answered your question.

George Shapiro – Citigroup

Yeah if I could just follow just a little bit so if you looked at the percentage of the revenues for R&D this quarter, what was it 50 or 100 basis points less than what it was last year?

Nick Chabraja

No because otherwise we’d be ramping up George, it’s about the same.

George Shapiro – Citigroup

Same as a percentage of sales which means the R&D was higher?

Nick Chabraja

The amount is the same, we’re ramping up, I don’t have percentages here at the tip of my tongue. The amount was the same.

George Shapiro – Citigroup

Okay.

Nick Chabraja

On higher revenues.

George Shapiro – Citigroup

Right so as a percentage it was down, okay, thanks very much Nick.

Operator

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

Cai von Rumohr – Cowen & Co.

Yes, thanks an awful lot. Nick, could you comment on two things, first you know I gather you were going to start accepting orders for the 650 as of the middle of April, where are we on that process and give us a little update on the color of what you’re seeing on the big jet market.

Nick Chabraja

On April the 15th Cai, we began a process that included the acceptance of letters of intent from our customers supported by a $500,000 refundable deposit. We received a significant number of those, what some might call it an overwhelming response. We obviously can’t make everybody happy when you get sort of oversubscribed.

But we’re going to begin the process now in an orderly way and we’ve already begun it of converting those letters of intent into full contracts for the purchase of the 650 and orders. We’ll do that in an orderly and methodical way and I think you know it behooves us not to spend all of our time on the 650 because those represent orders for aircraft to be delivered beginning four years from now.

And the continue to focus on more current demand. The market continues to look good to us, we had a good quarter from an order intake point of view, we’re off to a good start. This quarter for orders unrelated to the 650, we had one cancellation in the quarter, we cancelled the customer who proved too difficult. I don’t see it as any harbinger of things to come. The dollar volume of orders we provide to you is a net of that cancellation. Market looks good, particularly strong internationally, in the first quarter I would say that, trying to remember I think 56-57% of the orders were international as opposed to North America. So that trend from last year is continuing.

So really a terrific response overseas. And our backlog for the large aircraft, the 550 and the 450 is problematic right now. We have with 550 we have entry at the service availability starting kind of in 2013, last quarter of 2012 and 2013. So sales guys have a tough job out there selling product that’s not available for four or five years.

Cai von Rumohr – Cowen & Co.

Thank you.

Operator

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

Heidi Wood – Morgan Stanley

Good morning Nick, I want to work off of Cai’s question for just a minute. Can you bandwidth for us a little more specifically you define an overwhelming response on the 650, I mean did you see something like 30 orders or 50?

Nick Chabraja

If you were listening carefully I made no mention of orders. The process and it is a process is to request letters of intent supported by deposits, refundable deposits. Those deposits were timestamps in an identifiable process and now we’re going through those in order, one by one, attempting to convert.

If you looked at the fact that we anticipated 17 aircraft for entry in the service in 2012 and 66 over the next two years, that was our initial plan, you have 83 aircraft in the first two and a half years of the program. The original response is a six to seven times that availability. So we’ll see how all that shakes out as we begin the process of converting. But it’s a very successful response.

Heidi Wood – Morgan Stanley

So then help us understand the, when you, the thought process you’re going through when you look at the struggles of your salesmen to sell airplanes out five years, ten, obviously an amazing response on the G650, how are you going to go about the decision about whether to raise your capabilities here?

Nick Chabraja

We’ll do our very best to ramp up production here. Our initial production planning is inconsistent with the demand. We’ll have to re-plan and pulse our supply chain and you know take them dragging and kicking with us, it’s going to be a successful program for all of us. So I think it’s fair to say we’ll produce more airplanes than that. But we’re at the very early stages of dealing with demand that we didn’t anticipate.

A lot of very good friends of mine are very unhappy about their number in the queue and all that will sort itself out as we work hard at improving production and also seeing who’s for real in this sign up process. So it presents us with a problem but a happy problem.

Heidi Wood – Morgan Stanley

Thanks, one last question if we break out the MRAP on combat systems, what do the normalized margins look like ex-MRAP.

Nick Chabraja

I can’t tell you Heidi because I haven’t done that calculation. We’re going to get a mix shift later in the year as MRAP which is a highly profitable program declines and it’s replaced by good business at good margins but now the way MRAP was. You’ll see some degradation of that margin. But here again, combat systems, we’re going to beat our guidance. We will in all four segments. And I just need to take some time to calibrate where that is and give you some good advice.

Heidi Wood – Morgan Stanley

Okay, thanks very much Nick.

Operator

Your next question comes from the line of Howard Rubel of Jefferies, please proceed.

Howard Rubel – Jefferies & Co.

Thank you very much. To talk about something on the ground instead or maybe in the water, Nick, tell us a little bit about what’s going on in marine? The numbers are better, you’ve got a new full carrier you know that you’re working on in NASSCO, you were starting on [somewalt] and LCS, kind of package it all, where are the puts and takes? And then clearly DDG is reaching the final stages of being a successful program.

Nick Chabraja

Well yeah look I think Howard, volume was up nicely in the quarter, that helped for efficiency’s sake, they had I think surprisingly good margins, better than anticipated. NASSCO has turned around, they’re not reporting great earnings but they’re reporting earnings and they’re poised to get better. And the yard is full of work, they’re doing very well on the T-AKE program, learning is outstanding. They’re doing very well on the first product carrier tanker and starting the second one. So far we’re well within our budgets and things are progressing nicely.

And I think that over time they’re going to be a significant contributor to the profit potential of the group. Things at Electric Boat are very good. Efficiency on the Virginia class program continues to improve, everyone whose participating is doing well. We’re pleased with our relationship with Northop Grumman Newport News, cooperation is good, performance is good across the board and we now see the second submarine in the navy’s plan for FY11 and we’ll begin to see revenue from that in calendar year 10 if not somewhat before. So you have two shipyards in very good shape and getting better. And one in transition that we need to watch, it’s not without transitory risk.

That’s BIW, high performance facility doing extremely well on the DDG program. But we have five left to deliver. They’re highly profitable. We’ll replace that work with the DDG-1000 and have maybe some LCS work and some other work that we’re undertaking now. But we have a period of change where the mix is shifting and we’ll have to be careful there, that’s the watch item. But I think we’ll get through it and hold our own on volume, I’m not so sure we’ll hold the margin rate that they currently enjoy. But the bigger pieces of the puzzle are the other two shipyards and they’re both full speed ahead. So I like the way the marine group is shaping up. Mike Toner and his operating guys have done a great job.

Howard Rubel – Jefferies & Co.

Thanks Nick.

Operator

Your next question comes from the line of Joe Campbell of Lehman Brothers, please proceed.

Analyst for Joe Campbell – Lehman Brothers

Good morning, it’s actually Carter Copeland, good morning Nick. Good quarter. I wondered if you might talk to us just briefly in sort of general terms about the issue of finding your successor and see if you could give us some general color on the process and how that’s going and things you’re looking for just to help us think through this issue a bit.

Nick Chabraja

I don’t know that you have to do a whole lot of thinking Carter, I think we’ll have an announcement for you sometime next month. So I think the decision has largely been made or will have its final deliberations either at their May Board meeting or if they don’t conclude it’ll be in June, but you’ll have an answer very soon.

Analyst for Joe Campbell – Lehman Brothers

Great and then one quick one, on IS&T in the North American revenues being flat, it seemed that the GDUK piece would have been about where you expected but North America, any chance you could provide some color on how far short that may have fallen of your expectations?

Nick Chabraja

It’s pretty much the same old same old Carter, we were down in IT services from our expectations a little bit on weakness in the commercial market where we provide infrastructure for a number of telecom companies. And that’s been persistent over the last several quarters. And we’ve had not quite as much infrastructure work as we’ve enjoyed in the past from our own net, what used to be called network systems business. We also have been pointing out weakness in our advance information systems business from a revenue perspective in the classified world that remain the same.

And we had a little bit of outperformance at C4 systems. So all in all, we were okay, I’d say a touch behind our revenue plan. Our revenue plan and the guidance I’ve given you always provided for a ramp. And we indicated if I remember correctly that we’d have about 5-6% organic revenue growth for the year, I think that’s still a very good piece of guidance. I think the upside in this particular segment could come from margin expansion.

Analyst for Joe Campbell – Lehman Brothers

Great, thank you very much, it’s very useful.

Operator

Your next question comes from the line of Myles Walton of Oppenheimer, please proceed.

Myles Walton – Oppenheimer & Co.

Thanks, good quarter. Nike a question for you on M&A, you’ve been reasonably quiet here for a little while, has the deteriorating credit environment coupled with probably lower cash interest rates made you more interested in deals and could you comment on availability in pricing as well.

Nick Chabraja

You know we’re always looking for deals Myles, we have a strong balance sheet and we’re always looking at strengthening our business and growing it. When we don’t see opportunities, we sit tight. The opportunity in the last quarter was obviously we repurchased our own shares when the market made them extremely attractive and accretive for us. We keep looking and talking to folks and harder to borrow money for large transactions I think but transactions of reasonable size I think given our balance sheet, it’s not an issue.

I think the question of pricing is yet to resolve itself. It’s moving around here. People don’t quite understand what pricing is like. I mean there’s some competing elements out here and one thing is if you can get financing it’s at lower rates which has the effect of increasing pricing. The tightness of money and the general squirmishness of the market suggests PE multiple compression which can have an impact on pricing. But it’s too hard to generalize about that right now. We just keeping working it and see what happens.

Myles Walton – Oppenheimer & Co.

That’s fair enough if I could squeeze in one on the 650 order interest could you qualify how much of that interest is from legacy Gulfstream customers and how much you might be pulling over some share from your other competitor in the market?

Nick Chabraja

I can’t right now Myles but we intentionally made this an open process. In other words we didn’t favor long term Gulfstream customers, which I’m sure some of them in their hearts will say is unfair. On the other hand when you do that, you don’t take share. So this is our intention to get customers from all kinds of aircraft. Myles, look, there’s another way to look at this.

In this segment, at least at the moment I think we have all of the share because there isn’t a competing aircraft in my view. Now there may well be some day but right now it’s not a share issues, it’s trying to get folks who are in the family, in the loyal family of our competitors into our aircraft so that they are exposed to the entire line and that they begin with our flagship, the 650, we’re pleased with that.

Myles Walton – Oppenheimer & Co.

Fair enough, thanks for taking my questions.

Operator

And your next question comes from the line of Steve Binder of Bear Stearns, please proceed.

Steve Binder – Bear Stearns

Nick, I think maybe I didn’t hear you correctly but George had asked earlier about kind of the overall SG&A and R&D bucket on a year over year basis because in your K you nicely parse out kind of incremental gross margin versus how much SG&A and R&D hurt or helped you. So can you maybe touch on a year over year basis how much that total bucket in absolute dollars moved?

Nick Chabraja

Yeah maybe Hugh can help you.

Hugh Redd

The same quarter last year we were at $23 million in R&D and we’re $23 million this quarter so that’s I think like 2.1% for the first quarter of 07 versus 1.8% the first quarter of 08. And you know it bounces around in a band that you know, it’s fairly tight but you know in some quarters when we have a lot of launch assistance which would net against that, then we could go down as low $5-$10 million and in some quarters we’ve been as high as $30 million. So last year we ended up the year at $85 million of R&D at Gulfstream and we’re kind of on that pace again this year. So.

Steve Binder – Bear Stearns

Right that’s just R&D, how about SG&A though?

Hugh Redd

SG&A, you know I think this quarter is about $75 million additional because I think we’re up around a little over $100 million for the quarter. That goes up with launches, or excuse me with selling expense, a little bit higher this quarter because of selling expense related to the 650. Other quarters if we have large order intakes or milestones on aircraft under order then we have commissions to the sales force. So I suspect that didn’t totally answer your question.

Steve Binder – Bear Stearns

I’m trying to get a handle on incremental gross margins because it looks like you know if SG&A is up you had probably better than 35-40% incremental gross margins and I’m just wondering is that pretty much all on new aircraft, did you see expansion of the service business?

Hugh Redd

You know margins are improving across the new aircraft and across service business and then you have a mix issue across the two. So it’s a little hard to answer the question with a single answer.

Nick Chabraja

Steve, you can’t solve this, I’ll help you by telling you you had a great mix quarter. There were no 350’s, there were no 500’s, there was great growth in the pure fleet of the large aircraft and you also had improving margins in the smaller ones. So all of that contributed and that won’t be the same every quarter.

Steve Binder – Bear Stearns

Alright and then Nick you said you’re going to recalibrate in all your sectors in Q2 but combat systems you touched on it about the strength and the great performance in the quarter, I don’t think I remember a quarter where the first quarter margin represented the highest margin for the year of any quarter for combat systems. So is that going to hold true again this year?

Nick Chabraja

I have never had a program like MRAP that was a quick start quick finish. You begin booking, starts in the second half of last year for us effectively, you begin as you would keeping warranty reserves and everything conservative and prudent and now you’re well on your way and you’ve got to begin taking your profit. And it’ll end so if you didn’t get that, you weren’t listening very well.

Steve Binder – Bear Stearns

Thanks so much.

Operator

Your next question comes from the line of David Strauss of UBS, please proceed.

David Strauss – UBS

Good afternoon, thank you. Nick, is part of the reluctance to raise guidance at this point to kind of see how the supplemental works out and when that comes in?

Nick Chabraja

It’s a piece of it but I think you know the supplemental for us is probably more risk than upside. Some of its baked into our plan, that which we will enjoy this year and it’s the out years where this is some upside for us. I really want to understand fully the implications of this performance. Before I go and give you guidance.

I don’t want to, as I’ve told you in prior years, I don’t want to give you water torture, I would rather give you a good number and kind of stick with it. If we beat that number it’s because we performed great and if we miss it it’s because we ran into some risks that I didn’t see. But I’d rather give you a good number than just be noodling it little by little here. There’s some pieces of the puzzle that I’m missing right now.

David Strauss – UBS

Okay and then as far as combat systems, kind of thinking beyond 08, I don’t know if you’ll want to go there but you talked in the past I think about you know obviously a moderating growth rate in 09 versus 08 given MRAP’s rolling off but I think you’ve talked about a 5-6% kind of top line growth rate for combat, is that something that you’re still comfortable with?

Nick Chabraja

Yeah, next year you’re talking about?

David Strauss – UBS

Yeah, 09 for combat.

Nick Chabraja

Yeah, that’s where we think we’re going to go. We think you’re going to have a 5ish growth rate in 09 and 10.

David Strauss – UBS

Okay, great, thanks a lot Nick.

Operator

Your next question comes from the line of Rob Epstein of Merrill Lynch, please proceed.

Ron Epstein – Merrill Lynch

Good morning guys. Just a question Nick on what you’re seeing in terms of international activity in defense business. You know there’s been talk about potential orders from the Saudis and some other things so if you could just give us some color on what’s going on in the international community and in your defense business.

Nick Chabraja

Yeah, you know our international business has been stable for the last three years at about 18% of our overall revenue. Now Gulfstream’s international business is growing but it hasn’t yet found its way in significant parts into our revenue numbers, right, that is to come because we’ve been talking about quarters together. So while their international revenues have been going up marginally year over year, it’s not been big.

And our non-US government commercial work or defense work is the better way to put it, has been stable over the last three years at about $3 billion a year. That should go up as we you know begin to deliver at [Elks] on our backlog. And as we begin to enjoy the Saudi program which we believe will reduce to contracts this year, but that’s kind of a little bit in 09 and a lot in 10 and 11. So that’s where we should see some growth in our international defense business. Whether it will be a overall growth in percentage terms I’m not quite certain.

Ron Epstein – Merrill Lynch

Okay, okay and just one follow on on the commercial ship JV out at NASSCO, how is that proceeding?

Nick Chabraja

Great, I think I’ve talked to that a little earlier. I said that we’re a little over 50% done with PC1, it’s shaping up in the doc real good. We’re beating our internal budgets and forecasts. It’s a little too early to declare victory, we’ll get through some tougher parts of the ship a little later but so far it looks very good. We plan to deliver that ship I guess early in next year and then start to deliver one every six to eight months thereafter. So we’re doing well with that program.

The second ship is under construction now and our build strategy seems to be working out beautifully. Every week I get pictures of the progress of product carrier 1 and it’s really remarkable how quickly that ship’s coming together.

Ron Epstein – Merrill Lynch

Great, super, thank you.

Operator

Your next question comes from the line of Doug Harned of Sanford & Bernstein, please proceed.

Doug Harned – Sanford & Bernstein

Hi, good morning. On IS&T again you talked about why the revenues are flat this year, US revenues. But when you look at the backlog growth that you mentioned earlier I mean that’s quite substantial. Can you talk about where that’s coming from, AIS, C4 Systems, information technology?

Nick Chabraja

It’s kind of spread all around. Let me see if I, I’ve got a list of program wins and so forth. Notable contract awards during the quarter, we got $374 million at AIS which has been part of the problem. And you know look I’ll give you a list Doug of contract wins, it’s a lot of different things, it’s a long, long list and I think that we’re addressing our shortfall. But these are the things that give me encouragement that we’re proceeding as we planned to have 5-6% growth in the year which suggests the growth in the latter half of the year is going to be much stronger than that.

Doug Harned – Sanford & Bernstein

But C4 Systems has been pretty strong relative to the others. Do you expect going forward that there’ll be any shift in mix given the program wins you’re seeing elsewhere?

Nick Chabraja

No I don’t think so. I think C4 looks powerful. If anything, some of their programs that they’ve won years ago are maturing now and can be significant contributors. That business looks very powerful to me. I think we’ll do ok here but again I want to say that our guidance, our earlier guidance on revenue in this segment is not changing. I don’t expect that to go up. In fact I think they’ll fight like hell to get it to 5-6% revenue growth.

What I want to explore before I give you guidance in considerable detail is the possibility of margin expansion. It’s suggested by the first quarter performance and I want to run that to ground. We could do a little better there for margins then we can beat the 3-4% growth over last year which is what I had given you in our earlier guidance. I told you that the operating earnings would grow in the 3-4% range. And we’ll see if we can’t do better and I’ll have an answer for you next quarter this time.

Doug Harned – Sanford & Bernstein

Okay, great, thank you.

Operator

And your next question comes from the line of Troy Lahr of Stifel Nicolaus, please proceed.

Troy Lahr – Stifel Nicolaus

Thanks. Can you talk a little bit about margins at IS&T, a little stronger than we were looking for this quarter, pretty nice compared to last couple quarters. Anything going on there in particular and is this a sustainable level around this 11%?

Nick Chabraja

Look I think I just talked about that more than a little bit. It was a good quarter, surprised me a little bit. There was nothing unusual in the quarter. You know, no strange one off items. They are telling us internally that this is not sustainable at this level. But I have indications that for the year, they will outperform their plan where I had previously guided you, that would be 3-4% operating earnings growth or EBIT growth over the course of the year. If their margins improve as I believe they will, not over this 11% but over the forecast, we have some upside opportunity at IS&T and I want to quantify that and give you more careful guidance.

Troy Lahr – Stifel Nicolaus

Is it just a mix in the back half of the year on why it’s not sustainable?

Nick Chabraja

The 11% wasn’t predicted. So we have to go to the root cause of the improvement before I can tell you how we’ll turn out. We don’t have a mix shift here going on, we just probably had some good performance on programs in the quarter. But see if we can’t repeat it, instead of guessing about it.

Troy Lahr – Stifel Nicolaus

Okay and update on JLTV, kind of where your team stands and kind of how, what you’re thinking about the down select coming up.

Nick Chabraja

I don’t think anybody’s put in an RFP yet. Yeah we have, okay. So it’s coming up in July, what do you want me to do, handicap?

Troy Lahr – Stifel Nicolaus

I’m just wondering how you guys are progressing on that.

Nick Chabraja

[Overlay] that puts stuff in the newspaper. I don’t, the customer is going to make that decision not me. I think if we put in a response to the RFP we’ve got a good team, like our partner, strong capable people. We’ll see what happens. They’re going to down select to what three I think. Let’s wait till the customer announces.

Troy Lahr – Stifel Nicolaus

Sure, thanks.

Operator

Your next question comes from the line of Joe Nadol of J.P. Morgan, please proceed.

Joe Nadol – J.P. Morgan Securities

Good morning. On Gulfstream Nick, I’m wondering if there was some service revenue decline or some disruption in the quarter, because the shift of your mix was good. And so what happened there?

Nick Chabraja

I think that the service people did okay too. Let me take a quick look at it. Yeah, no, they did a good job. They were, Joe let’s think because you and I had a little debate about what the revenue would ultimately be. You know I think I was suggesting 680 and you were about 700. You look a little better than I do right now.

Joe Nadol – J.P. Morgan Securities

Okay. Well then overall for Gulfstream I guess I’m a little surprised that revenues weren’t a little higher given the delivery mix, the service grew, is there something else going on. Obviously you gave us pre-owned sales numbers but anything else?

Nick Chabraja

I don’t, no. I can’t strike up your revenue expectations with the results. I don’t think we had very much pre-owned in the quarter at all.

Joe Nadol – J.P. Morgan Securities

No. Okay and then on free cash flow could you give maybe by segments where, and I’m splitting hairs a little bit, but where maybe some of the shortfall might have been?

Nick Chabraja

Well from our plan there wasn’t a shortfall but it was in combat systems if you want to think about a big needle mover here. We have about $200-$225 million of inventory in the Czech Republic program. And while we’ve made significant progress with them and entered into a memorandum of understanding about restructuring that program, we didn’t get the vehicles delivered or the money collected. That would have been a major driver. So I would say that of the performance of all the groups, combat systems had the weakest cash performance relative to plan because of that.

Joe Nadol – J.P. Morgan Securities

But it should bounce back in Q2?

Nick Chabraja

Well one would hope, yeah, I mean they’re going to go through some tests of those vehicles and some adjustment of them to suit the Czech army but I think we’re making considerable progress there and that the parties are working together in a harmonious way to restructure that program.

Joe Nadol – J.P. Morgan Securities

Okay. Thank you.

Operator

Your next question comes from the line of Gary Liebowitz of Wachovia Securities, please proceed.

Gary Liebowitz – Wachovia Securities

Thank you, good morning gentlemen. Nick has the timing of the Saudi vehicle order expectations changed relative to three months ago, like LAVs you still expect in the first half of the year.

Nick Chabraja

If anything it slipped a quarter.

Gary Liebowitz – Wachovia Securities

Okay and also you gave for and by the way are the semi-tanks, is that a second half event still?

Nick Chabraja

I think we’re looking at both of them in the second half. We have three different things going right now. The Saudi National Guard LAVs, the tank for the army and LAVs for the army as well. So we have three different programs all at work here, all being negotiated and it is a process, let me say. It takes always longer than one would think. But we think everything looks good. It looks very good as a matter of fact.

Gary Liebowitz – Wachovia Securities

Okay also did you give, you said fourth quarter 2012 for quoting service entry now for new G550’s, what is the period for G450’s?

Nick Chabraja

A year short of that.

Gary Liebowitz – Wachovia Securities

Okay, thank you.

Ray Lewis

Carissa I think we have time for one more question.

Operator

Your final question will come from the line of Rob Spingam of Credit Suisse, please proceed.

Rob Spingam – Credit Suisse

Hey guys. Nick, going back to the backlog and maybe you just answered this question, but the unfunded portion that combat systems had a nice uptick since last quarter, $1 billion plus, is there anything there that wasn’t in the press release?

Nick Chabraja

I think it’s the Abrams SEP multi-year.

Rob Spingam – Credit Suisse

Okay and then on the same topic, any update at this point on UK FRES?

Nick Chabraja

No, I mean it’s just where it was the last time we talked. It’s there for decision in the MOD.

Rob Spingam – Credit Suisse

Okay and then you brought up something earlier that prompts another question going back to Gulfstream, you’re currently delivering largely domestic aircraft I guess, you said the international order flow doesn’t really convert to deliveries for a while. At what point will your deliveries be over 50% international if and when that happens?

Nick Chabraja

Probably three years from now. I’m guessing but that’s about what it, you know today’s orders become deliveries in three or four years, so that’s what you’re looking at.

Rob Spingam – Credit Suisse

Okay, excellent, thank you Nick

Ray Lewis

Okay I want to thank everyone for being on the call today. Many of you know this, some of you don’t. I will be retiring in June so this is my last earnings conference call. The very capable Amy Gilliland will be my successor coming in June. And I just want to take an opportunity to say what a great privilege and pleasure it has been for the last 16 years to be working here. All of that time in one way or another with Nick and how much I’ve appreciated the staff here at corporate headquarters and the support they’ve given me over the years throughout.

And I have to say something about the operating people and the way they deliver for the customer and for shareholders and the cash generation that has been such a driver for shareholder value the time I’ve been here. So my 40 years of laboring in the corporation communications vineyard this has certainly been the highlight of my career. And with that Amy and I are going to get a quick bite to eat. My number is 703-876-3195, Amy’s is 703-876-3748 and we’ll be happy to take your questions this afternoon and good 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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