General Dynamics Corporation (GD) Q2 2008 Earnings Report, Transcript and Summary

We're doing well on the program, and we're getting, ready, obviously, for increased volume there, which will, I think, help efficiency, so we're doing well on that program. Bath, you know, I don't quite know what to say. We've got late-breaking news not officially confirmed to me, but I believe what I'm reading in the press reports about the Navy's posture with respect to the program of record, the DDG 1000, and stopping that build at two and building instead more DDG 51s. You know and I don't know how that will play out. This morning I had to look at a piece that you wrote, and your view or speculation would be about mine at this point in time. I don't know. You know, it’s—there might be a slightly less volume for Bath in building DDG 51s but probably more margin. We just don’t know all the answers yet. Howard Rubel – Jefferies & Company: No, I appreciate it. I mean I know it’s a hard thing to …

We’ll find that out as the Navy tells us what their plan is and as we see how their plan is received by particularly the appropriators right now and whether they will, you know, get the funding they want for what they want. But one thing’s for sure. We stand ready to build it, whatever it is, and we’ll work with our customer and the Congress to ensure that Bath Iron Works is well supported. You might know that we were predicting that the Marine group would be our fastest grower over the next three, four years. We still are of that view. Embedded within that view was no increase and a slight decrease in volume at Bath, so this could be a plus, but I don’t just know enough yet to really comment, but I can’t see it being too much downside. Howard Rubel – Jefferies & Company: Thanks, Nick. Appreciate it.

Our next question will come from the line of Myles Walton of Oppenheimer and Company. Please proceed. Myles Walton – Oppenheimer and Company: Thanks, good morning and great quarter Nick.

Thanks, Myles. Myles Walton – Oppenheimer and Company: Question for you. We touched on the high-end large cabin market within Gulfstream. Just curious if you can make some commentary on the midsize and in particular two kind of questions. One is the accelerated depreciation if you’re seeing it tougher to fill some of the 2010 slots across your portfolio and also just general commentary on the demand within the midsection—midsize. Obviously, I know you have less risk there but would be curious for your comments.

On the large cabin we’ve blown through the 2010 point a long time ago, so I think the answer to that question is no. And I think with respect to mid-cabin, we haven’t got there yet. Maybe in the G200 I think we are probably into 2010, selling 2010 airplanes for—I don’t think it’s a factor. Yes, we’re into selling entry-into-service aircraft, the G200 now. We’re not there yet on the G150 but will be soon. I don’t think I have enough data to comment on the midsize market. I had heard that Textron indicated that they might see some softening. We’re doing very well with the G200 product, and I might have detected some softness in the G150 product in the first quarter. On the other hand, we had quite a number of sign-ups soon as the quarter ended, so I would say that it was timing. I don’t have any data which would cause me to change my production planning. Let me put it that way, Myles. Myles Walton – Oppenheimer and Company: OK, that’s fair.

Without commenting on the market, I don’t have anything that would suggest that I’m going to ratchet down production, but you know we’ll be quick to do it if we ever get any data because, particularly at the G150, we don’t have the backlog that we do on the very large aircraft where current demand is completely disassociated with my production rate. Myles Walton – Oppenheimer and Company: That’s great and as a quick follow-up if I could. On the 650 order intake, the 100 or so that’s implied, could you give us some geographic breakdown? Is it consistent with the trend that we’re seeing towards 50% to 60% international?

It is not at the moment. Let me give you one hint. There’s an odd number, and there are one more North American aircraft order so far than international, so let’s call it 50. And if I had to guess about that, I would say that the North American guys worked the wire transfer jungle drum better than the international guys did. And you can check with me after each quarter, and my suspicion would be that the international number will grow faster than the North American number. Myles Walton – Oppenheimer and Company: Fair enough. Thank you.

By the way, Myles, you didn’t ask that question about the existing business in the first quarter, and there the international content was ahead of North America in very much the same proportions that we’ve seen in prior quarters. Myles Walton – Oppenheimer and Company: OK, that’s helpful.

Next question.

Our next question will come from the line of Doug Harned of Stanford Bernstein. Please proceed. Doug Harned – Stanford Bernstein: Good morning.

Good morning, Doug. Doug Harned – Stanford Bernstein: I wanted to ask about combat systems and just get an understanding of how the mix is shaping up there. You described that you’ll see some water growth. You expect some water growth in the back half of the year. Can you sort of give an idea of where you’re seeing that growth, aside from Emrab?

Yes, you watched the passage of the supplemental not too long ago here. We expect orders emanating from that legislation of which I think you’re pretty much aware. Doug Harned – Stanford Bernstein: Yes.

So I think we’ll in the ordinary course of business have additional orders to report to you here. Doug Harned – Stanford Bernstein: But it’s not critically growth coming out of European.

You’re going to see some growth out of European Land Systems, too, and we’ll make those announcements as we receive the orders. Doug Harned – Stanford Bernstein: So then there’s some of each then. There’s what you would expect …

There’ll be some of each, yes. Doug Harned – Stanford Bernstein: OK. OK, thank you.

Our next question will come from the line of Harry Nourse of Bank of America. Harry Nourse – Bank of America: Good morning.

Good morning, Harry. Harry Nourse – Bank of America: I was just wondering, obviously, you had a very good second half last year in Combat Systems. It’s going to look pretty flat for the second half looking at the guidance, and then great – it’s going to pick up again. It could even be at the beginning of next year. Could you just walk us through that a bit?

I think you have it about right. I wouldn’t call it flat. I think we will be up. We will have more sales in the second half in Combat Systems than we did in the first half. But in the second half we were competing against a very strong third and fourth quarter last year, and I believe our sales will be up over last year but not significantly. Harry Nourse – Bank of America: OK.

And then we’ll pick up again, and you’ll be – we had been forecasting 5% to 6% growth, and I don’t have a better number for you now, but there’s some early indication for optimism. But I’ll do more with you on that subject, Harry, when I’m prepared to give you some more guidance on 2009. Harry Nourse – Bank of America: OK and for a follow-up the buyback slowed down a bit in 2Q. Perhaps you might just tell us about using the cash and perhaps the outlook for M and A?

Let me address sort of forthrightly the issue of buyback. We bought the stock significantly in the first quarter because the price was low. In the second quarter after we announced earnings, the price popped back up, over $90 for most of the quarter. It fell out of bed with the rest of the market sometime in June, late May or June, and we got right back in. And then we came into our blackout period. Harry Nourse – Bank of America: Sure.

So I wouldn’t make much of, you know – if the market gives me a reasonable price for the stock, as it is right, as it has been, we’ll buy it. If it trades up where I think it ought to be, I’ll leave it be. We will continue to pursue acquisitions across a variety of fronts, some indication that things are breaking lose in that area, and we’ll continue to repurchase shares on an opportunistic basis. And we’ll continue to reexamine our dividend policy, which we’ve tended to ratchet up from time to time but then, you know, so we’ll visit that again Spring of next year I suspect. But, Harry, I don’t think anything changed much on our view of capital allocation and deployment. Harry Nourse – Bank of America: Thanks very much.

Our next question will come from the line of Rob Spingarn of Credit Suisse. Please proceed. Rob Spingarn – Credit Suisse: Hi, Nick.

Hi, Rob. How are you this morning? Rob Spingarn – Credit Suisse: Pretty good, thanks. Very good quarter. I thought I’d change the topic a little bit to IS and T and ask if you could walk us through the sub-segments there a little bit, perhaps talk about the ICE2 contract. It looks like you got re-upped there a bit at the early part of this month, latter part of last month if you could just give us some more color. You already talked about margins but …

I think it’s a very happy story. I think over on the IP services side the renewal of the ICE2 contract was, you know, very good for volume. I think that Advanced Information Systems shows signs of doing well. And of course, our tactical communications business has been really powerful. And I think, to me, the most important thing maybe that occurred was the selection of C4 Systems as part of the team which will provide the provide the airborne, maritime and fixed – the AAMF version of the joint tactical radio system. They’re a significant player on the Lockheed team there. This for us leverages our market-leading position in software-defined radios and places IS and T in principal roles for two of the three JTRS variance, so I think that’s where I would, you know, if you’re looking for a little color across those three segments, that’s what I’d have to say. Rob Spingarn – Credit Suisse: Anything else you could tell us about the BIFS [ph 0:41:43] acquisition, the strategy and how you’re thinking there?

Yes, look, I think it’s doing the very same kinds of things that we do. We’re very interested in that growth market, and we see that we can move the BIFS [ph 0:42:02] product and what they do into some of our existing marketplaces, so it’s an effort to move into a growth area. Rob Spingarn – Credit Suisse: Any numbers for us there, rough color?

No, I don’t want to do that right now. Rob Spingarn – Credit Suisse: OK, thanks.

Our next question will come from the line of David Strauss of UBS. Please proceed. David Strauss – UBS: Morning, Nick.

David, how are you? David Strauss – UBS: Good. I don’t know if you talked about this already. I was a little late in joining, but Gulfstream margins obviously moving up. The guidance range for this year 18.5 to 18.6. I know in the past you’ve talked about not expecting to get to the kind of margins that Gulfstream that you sold during the last cycle at over 20%. Given the, you know, given the improvement that you’ve seen in margins at Gulfstream, what are you thinking about kind of the long-term target over the course of this cycle?

I don’t think about it that way, David. I think we’re going to keep pushing them to get better, and I think that’s in their souls, so I expect continuous improvement. If you look for a snapshot of Gulfstream next year, I would tell you that production probably won’t go up anywhere near as much as it did this year, not because we wouldn’t like to. It’s because we’re getting increasingly close to our efficient capacity there. But when we do improve production – and we will slightly – on the large-cabin aircraft, it implies improvement in productivity because we can’t do it any other way. That implies the in turn improved margins. So I would tell you I expect our guys to get better next year, so we’re getting awful close to the margins we once enjoyed in 2001 before we had midrange, midsized aircraft and before we had the ambitious research and development program today. So, frankly, I’m surprised. I knew we’d make progress. I didn’t believe we’d make this kind of progress, but it also took some aid from the market where we’ve enjoyed some price growth over a period as well, so a lot of good things have happened to this company. David Strauss – UBS: Right and then as far as R and D, you’ve been level loading that, so there wouldn’t be any anticipated spike up in 2009 or 2010 for the 650, right?

Yes. No, we’ve been ramping up, and I think we’re about there, and I think it’d be reasonably level. David Strauss – UBS: OK and any update on the Saudi order in combat?

Our guys are with them negotiating those positions right now, so al the back and forth is going on that needs to make that happen. David Strauss – UBS: OK, thanks a lot.

Our next question will come from the line of Gary Liebowitz of Wachovia Securities. Please proceed. Gary Liebowitz – Wachovia Securities: Good morning. Nick, is there any update on the UK FRES program? I guess you started negotiations with the customer there with respect to scope? Any color on the magnitude or the timing of deliveries onto that program?

No, they’re just talking away. I mean I don’t know where we are. Gary Liebowitz – Wachovia Securities: Would it be sometime beyond 2010?

Well, I think the program contemplated deliveries in 2012, which was ambitious I think, but I think they’re sticking to it. If they’re going to get there, we’d better get the contract pretty soon. So I can’t tell you when. That’s not within my grasp. These are discussions occurring in the United Kingdom. Gary Liebowitz – Wachovia Securities: OK, thanks.

Our next question will come from the line of Ronald Epstein of Merrill Lynch. Please proceed. Ronald Epstein – Merrill Lynch: OK, just a quick follow-on, back to Marine for a minute. Just if you could just give us a quick update on how everything’s going with the Daewoo JV?

Absolutely terrific, Ron. We’re producing that first boat. It is together now. It will go to sea before the end of the year. It’s completely enclosed. All the modules are in place. The second one is well along in the same dock, and we’ve commenced construction of the third boat. We’ve found that we’re able to execute against the Daewoo design very well. They’ve been very good partners, very helpful. We have a great relationship. We’re looking at expanding that relationship into other products, very optimistic about it. Ronald Epstein – Merrill Lynch: And then just one more quick Naval follow-on if I can. I think this is kind of following on Howard’s question. If we do see more interest in DDG 51s and only two DDG1000s get built, what do you think it means for CDX?

I don’t have any idea. Ronald Epstein – Merrill Lynch: OK, thanks.

Our next question will come from the line of George Tabaro [ph 0:48:21] of Citi. Please proceed. George Tabaro – Citi : Nick, a couple of quick follow-ups. You mentioned that in combat that ammunition grew. Now, is that the second source with ATK or is it pretty much across the broad scope of ammunition that you provide?

No, it wasn’t the second source other than small amounts. We had – it was across the breadth, but we had some big growth in medium cal, and we had a big win in Canada that caused growth in the company that we acquired there so pretty much across the board. It’s getting to be a good sized business. To give you a little color, George, it’s slightly larger than either Bath Iron Works or Nasco. George Tabaro – Citi : Oh, it has gotten quite big then.

Yes. George Tabaro – Citi : And if I just switch to Gulfstream quickly, would it be fair to say that given the low investment that you have on the midsize that you’re still running margins at the large jets, probably twice what you are on the midsize?

Let me think about that for a minute. It’s close, George. You’re close. Without having data right in front of me, I wouldn’t say yea or nay, but it’s close there, half the margins of the large caliber is a close guess. George Tabaro – Citi : So then realistically at this point from the large planes you’re actually doing better than what you did in 2001.

Oh, yes, of course, way better. George Tabaro – Citi : Right.

And I would have expected that, but the mix shift was what was pulling me down. George Tabaro – Citi : Right.

And the recognition, George, that we weren’t sufficiently supporting research and development, and we had to get going. And also we’ve spent a lot of money in facility now that adds to depreciation expense. But you’re right. Your essential point is correct. The margins are higher on the G550 today than they were on the G5 in 2001, and they’re higher on the 450 than they were on the G4SP, which was being produced at that point in time. George Tabaro – Citi : OK, thanks very much.

Our final question will come from the line of Cai von Rumohr of Cowen and Company. Please proceed. Cai von Rumohr – Cowen and Company: Yes, another follow-up on Gulfstream. Nick, you know, you revised margin guidance is about 150 basis points higher than your prior guidance and looks like most of it’s coming in the second half so roughly 200, 300 basis points. And you talk of price, and yet, my recollection is that you were sold out at the end of the first quarter, so I’m a little confused how price can be a factor. And kind of related to that, could you comment on the impact of pull forward of profitable planes possibly from 2009, the negative impact possibly of G650 orders because I understand you have to pay commissions for part of them at the time firm contracts are signed, and thirdly, the potential for supplier participation payments on the 650 as a plus. Thank you.

Boy, that’s a mouthful, Cai. Let’s see. You saw in the quarter the effect of commissions paid on the 650, so I think we’re managing that nicely. Margins I predicted were going to be up 20 to 40 basis points at the beginning of the year, 17% to 17.2%. I’m desperately wrong. As far as price is concerned, some of the pricing is embedded in the backlog, and we knew it and could respond to it. That was not true with respect to some of the G200 and G150 sales where we got improved margin. It was not true with respect to government aircraft, special purpose and special mission aircraft where we were new to the business. We began with the notion that we would sell the platform, and then we started doing the engineering work to modify the aircraft. And finally, we took on the modifications themselves, and we’re cautious about how we do on that. Turns out to be quite a handsome line of business for us. So I think for all of those reasons, price contributed. I think we didn’t experience some of the cost increases we were anticipating. We did gain some efficiencies in productivity that we didn’t think we would or did better than we thought we would. We had some breakthroughs. I think for a whole lot of those reasons we’re doing better than we anticipated. Cai von Rumohr – Cowen and Company: But given that you did pay, you do pay commissions upon the signing of firm contract and given that you are likely to get additional G650 firm contracts in the third and possibly the fourth quarter, isn’t it true that commission payments this year are going to be higher than you anticipated at the end of the first quarter?

Modestly. Cai von Rumohr – Cowen and Company: OK. I’ll follow up. Thank you.

I mean I don’t think it’s – it’s not such a big issue. We’ve managed that reasonably well. Cai von Rumohr – Cowen and Company: Great.

Ladies and gentlemen, this concludes the question-and-answer portion of today’s conference. I’ll turn the call back to Ms. Amy Gilliland for closing remarks.

I want to thank you for joining the call today. If you have additional questions, I can be reached at (703) 876-3748. Have a good day.

Thank you for your participation. You may now disconnect. Have a great day.