General Dynamics Corporation
Q4 2010 Earnings Call Transcript

Published: 26 Jan 2011

[Operator:]

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2010 General Dynamics Earnings Conference Call. My name is Katie, and I'll be your coordinator for today. [Operator Instructions] I would like to now hand the call over to your host for today, Amy Gilliland, Staff Vice President of Investor Relations. Please proceed.

[Amy Gilliland:]

Thank you, Katie, and good morning, everyone. Welcome to the General Dynamics fourth quarter conference call. As always, any forward-looking statements made today represent our best estimates regarding the company's outlook. These estimates are subject to some risks and uncertainties. Additional information regarding these factors is contained in the company's 10-K and 10-Q filings. And with that, I'd like to turn the call over to our Chairman and Chief Executive Officer, Jay Johnson.

[Jay Johnson:]

Thank you, Amy, and good morning, everyone. General Dynamics' fourth quarter was marked by strong operating earnings and the efficient conversion of those earnings into cash. Sales on operating earnings in the quarter increased in each of our four segments from the fourth quarter of 2009. Sales were $8.6 billion, up nearly 9%, driven by 9.2% growth in our Defense businesses and 7.4% growth at Aerospace. Operating earnings totaled nearly $1.1 billion, the first billion-dollar quarter in the company's history. Net earnings from continuing operations were $729 million or $1.91 per fully diluted share, a year-over-year improvement of 18% and 21% respectively. Disciplined execution across the company lead to a 12.5% operating margin, the best quarterly performance in 2010. For the year, sales were $32.5 billion, a modest increase over 2009, with three of our four business groups enjoying growth. Operating earnings totaled $3.95 billion in 2010, with Combat Systems and IS&T both topping $1 billion of EBIT. Aerospace lead earnings growth, delivering a nearly 22% improvement. 2010 net earnings from continuing operations were $2.6 billion or $6.82 per fully diluted share. Free cash flow, after capital expenditures, totaled $1.3 billion in the quarter, a healthy 174% of earnings from continuing operations. For the year, free cash totaled $2.6 billion or 100% of earnings from continuing operations. We deployed $1.2 billion of that cash to repurchase 18.9 million of our shares, including 7.8 million shares in the fourth quarter. Through both share repurchases and dividends, we returned 69% of free cash to shareholders in 2010. Total company orders in the fourth quarter were $6.6 billion. Our order book included somewhat lighter Defense bookings in line with our expectations, and the Aerospace segment's best quarterly intake since the third quarter of 2008. For the full year, Defense orders were 9% better than 2009, and our aggregate Defense book-to-bill improved. General Dynamics finished 2010 with a total backlog of $59.6 billion. Total potential contract value, which includes backlog, unexercised options and indefinite delivery, indefinite quantity contracts, totaled $81.3 billion. I'd now like to focus on the performance and outlook for each of our businesses, starting with our three defense groups. First, let's talk about Combat. Combat Systems enjoyed a robust fourth quarter, as each of the groups' four businesses delivered their largest sales and earnings results of the year. Sales were nearly $2.7 billion, 8.4% higher than the fourth quarter of 2009 and 30% higher than the prior quarter. Earnings were $400 million in the fourth quarter. This represents 9% growth from last year's fourth quarter and nearly 29% growth from the third quarter. Margins were 14.8%, reflecting excellent manufacturing performance and program management. For the year, the group's sales were $8.9 billion. This represents a decline in sales from last year, the result of lower volume at our U.S. and European Vehicle businesses. More than 2/3 of this contraction resulted from less MRAP vehicle volume and lower U.S. engineering development work due primarily to the cancellation of the Army's future combat systems program and less activity on the Marine Corps Expeditionary Fighting Vehicle. Cost reduction and productivity improvements enabled Combat Systems to maintain operating earnings at nearly $1.3 billion despite the year's decline in sales. Margins were 14.4%, 130 basis points higher than 2009 due to excellent execution and a higher percentage of mature program volume relative to engineering and development work. Year end, total potential contract value for Combat Systems was $16.5 billion, including $11.8 billion in backlog and $4.6 billion of unexercised options and IDIQ contracts. Those IDIQ contracts include two notable additions in 2010

[L. Redd:]

Thank you, Jay, and good morning, everyone. You can see in Exhibit E to our press release that we finished 2010 with just over $2.6 billion in cash which, when added to our marketable securities, resulted in a net debt balance at the end of the year of just under $400 million. This is down almost $800 million from last quarter and $850 million from 2009. As a result, interest expense in the fourth quarter was down 23% from a year ago. We expect interest expense for the full year 2011 to decline to around $135 million. That's due largely to the $700 million debt repayment we made in the third quarter and is also based on the assumption that we will not roll the $750 million of fixed-rate notes which become due next July. Obviously, we will make the decision to refinance the notes or retire them with cash on hand when we get closer to the due date. Moving on to the income taxes. The fourth quarter effective tax rate was 30.1%, obviously below our previous expectation of 31.2%. The reduction was due largely to the late year. In fact, entirely to the late year extension of the Army tax credit. This lowered our full year tax rate by 26 basis points, but reduced the fourth quarter rate by just over one full percentage point. We expect the 2011 full year tax rate to be 31% at the high end and probably some opportunity to outperform that mark. But with respect to corporate operating expense, which is primarily stock option expense, we're projecting a 2011 number between $90 million and $95 million. Finally, a quick note on pension contributions. We're planning to make a voluntary contribution of approximately $350 million to our pension plans in 2011, and that's slightly larger than our 2010 contribution. That completes my remarks. And Amy, I'll turn the time back to you for the Q&A.

[Amy Gilliland:]

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

[Operator:]

[Operator Instructions] Your first question comes from the line of David Strauss from UBS.

[David Strauss:]

Jay, could you address, specifically, does your guidance incorporate the potential for a full year continuing resolution or even maybe something worse than that in fiscal '11? And how do you see that, if that's the scenario we get, how would that potentially impact the business?

[Jay Johnson:]

The direct answer to your question, David, is no, it does not anticipate the full year CR or really even a modified CR of any kind. But I would tell you and I would opine that if you did have a full year CR indeed, there would be impact, which I'm not going to try to quantify right now. The important note I would put forward though is that in the CR environment we are dealing with right now, there are programs that would be affected should the CR continue. Significant programs, Virginia class to a year, for example, is one. But in every instance, I would tell you that the customer and our folks are front and center working these with all invested stakeholders so that it's not passing by anyone's scan that we've got a deal with these as they're presented one at the time. So it's getting the attention it deserves. It's a different way of doing it, but we're working hand-in-glove with the customers to make sure that we come to a satisfactory outcome.

[Operator:]

Your next question comes from the line of Rob Spingarn from Credit Suisse.

[Robert Spingarn:]

Sort of on the heels of that last question, Jay. You did talk about pressure on Defense budgets before. How would you classify the risk at GD by segment? And directionally, how should backlog move over the course of next year or so in each segment? And I'm focusing on the Defense side here.

[Jay Johnson:]

Well, you know, Rob, let me put it this way. You know that the Marine group, and I talked about this, the Marine group is very lumpy in terms of its backlog. It comes in big slugs. We work off the slug for a number of years, it comes in other big slugs. I mean that that's the most lumpy of any of our defense groups. And you heard me mention also that we had contract delays in significant programs, which are reflecting in the backlog that we see right now

[Robert Spingarn:]

Well see, Jay, this is why asked about it. Sort of a couple of your framework, knowing that it's volatile, looking at Marine going from $9 billion and change the beginning of '10 after the first quarter down to $7 billion now, we know you've been eroding on -- having not gotten the new orders in. But even if you have a CR for the rest of this year, assuming everything comes back in the fiscal '12 budget, at two years from today, would you say Marine's got higher or lower backlog? And the same question on the other two segments.

[Jay Johnson:]

Two years from today, I'm not prepared to answer the question. But I would tell you, I mean, if you look at Marine by itself here, I've already mentioned the major platforms that are being dealt with as we speak. Those will come into backlog, I believe, this year. They're being worked as one offs as I've mentioned before even with the CR. So they were delayed largely because of, in our view, I believe, the incredible workload of the program offers inside the Pentagon as they redid the LCS strategy and now that, that has been delivered, we're working very diligently with our customer on both the DDG 1001 and 1002 and the 115 and the MLP contracts. So we're getting inject back into that backlog this year. In two more years, what it will look like? Well, I'm not going to get speculative, but I mentioned in my remarks that we've got another block of Virginia class submarines coming, which will certainly be nontrivial in terms of backlog. That was the huge inject the last time we had a backlog. So we've got that, we've got SSBN development work, et cetera. So you're going to see increase in the Marine backlog as we go forward. Combat is probably, honestly, going to be down a bit, flat to down, not unexpected on the U.S. domestic side. On the international side, I think we're going to see growth there. We are seeing growth there, and I believe that, that will continue. IS&T should be good on their backlog, flat to a little nose up perhaps. But as I said, that's usually inside the year, and it refreshes itself annually. So that's probably more than you wanted, but that's where...

[Operator:]

Your next question comes from the line of Carter Copeland from Barclays Capital.

[Carter Copeland:]

The first Gulfstream question. I wonder if you might talk a bit to the backlog growth and how it may break out between the 650 and 450, 550 and midsize and how that's driving production decisions when you look beyond '11. And within that, can you address in more descript terms, what you're thinking about the 650 production plan beyond 33 a year as we look well out on the horizon?

[Jay Johnson:]

The backlog is really being enhanced by all -- by the large cabin, obviously, all three of the large-cabin aircraft and the mid cabin. So a pretty good spread there, Carter. We're still taking orders for 650s, okay. The 550, 450 book, you've heard me talk about the 18- to 24-month backlog sweet spot, okay? We're in the sweet spot, looking good. I feel very confident about that, and we're taking mid-cabin orders. That activity continues to grow, I think is probably an accurate term. It's not what I'd call robust, but it's clearly coming back and we're getting more activity as we go month by month and we're taking orders for 250s, we're taking orders for 200s, and so I see that in very optimistic terms. The number I gave you, the production numbers I gave you for green deliveries are consistent on the large-cabin in production 450, 550 with I think what I've been signaling pretty much throughout the year, based on looking at that 18- to 24-month backlog. We feel pretty really good about that. And the mid cabin, 15 to 20, give me a little upside there. We anticipate, I think, that probably that market may return, but I'm giving you kind of a conservative number there and we'll see how it goes. But every indication we have in the mid-cabin is that, and I think you may hear this from some of the other OEMs, that the mid-cabin market is coming back. So as it applies to the 650, and I know you know very well my numbers on '12, '13 and '14 in terms of completions, that 17, 33 and 33, I'm going to stick with those numbers right now. But we're going to turn out about a dozen 650 greens as I mentioned in 2011. And you can probably add 10 or so a year to that to deliver those completions that I just described. And then as we get closer to full production here, we'll wick it up and anticipate being able to do so, but I'm just not ready to write that check yet.

[Operator:]

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

[Douglas Harned:]

Staying on Gulfstream. Could you comment on the G650 in terms of margin? And what I'm getting at is should we expect in the early stages of production that this would be somewhat dilutive to margin? And if so, when would you expect that to turn the corner and be helpful to margin?

[Jay Johnson:]

Well, I would characterize it this way, Doug. On the initial blush, I would characterize it as dilutive to large-cabin, new aircraft margin, okay, because it's brand, spanking new. And we're going to -- anyway, you understand that. But as I've said repeatedly, as we hit stride with that airplane and look at the purpose-built facility we've got, the design for manufacturing that's existent within that platform, those margins will grow handsomely, and I expect them to be the margin setters for Gulfstream, pace setters for Gulfstream. When that will occur, I can't tell you, but I would expect continuous improvement as we go. We're very bullish on the 650 as you probably can tell and are very excited about getting it operational.

[Douglas Harned:]

But you can't give a sense of when you may be able to at least hit the margins that you're getting on the 450 and 550? Sort of what timeframe?

[Jay Johnson:]

No, I mean it will be several years, but I'm not going to try to pin it down. Joe Lombardo would be mad at me if I tried.

[Operator:]

Your next question comes from the line of Myles Walton from Deutsche Bank.

[Myles Walton:]

What is exactly the Marine sales guidance? I think I might have missed it.

[Jay Johnson:]

Essentially, it's flat. The way I characterize it, I said, they're going to be challenged to maintain their sales this year. And Myles, it's strictly a function of timing on those contract delays.

[Myles Walton:]

And then given the comments on the flat outlook for Defense spending, which you see in the backdrop, is this the environment where, Jay, you think it's more important to be opportunistic in buying defense properties that might otherwise be under-distressed or certainly a negative sentiment overhang? Or are you more inclined to say, "You know what, I have a commercial entity. I'd like to increase the scale and/or buy my own shares."

[Jay Johnson:]

Well, I mean I think you know, Myles, we look at all of that. And I haven't changed my direction to any of the business unit presidents out there, the 13 of them that within your sphere of business look for opportunities to grow that business with acquisitions, be it core, additive core, which I believe in this Defense environment, there will be opportunities that come available, and adjacency and/or dual use or commercial. You bet. We're looking at all of those things. And then in addition to that, of course, we have the Aerospace growth engine that we intend to take advantage of.

[Myles Walton:]

But just to clarify, is there anything in that environment that could change to make you change that thinking?

[Jay Johnson:]

I can't think of anything off the top of my head. But I mean our Defense portfolio, you hear me say it repeatedly, one of the great strengths of our defense portfolio is that it's very diverse. And so it gives us lots of opportunities, and we've got ups in some places and downs in other places, and we constantly assess how each portion of our portfolio is performing. And we'll grow some of them. And dare say we'll probably divest some pieces of it as we did, for example, with Spectrum Astro last year. If it's better for somebody else than it is for us, we're not afraid to divest. So we shape the portfolio as we go.

[Operator:]

Your next question comes from the line of Peter Arment from Gleacher & Company.

[Peter Arment:]

Question on your European and back to Combat Systems on European Land Systems. We came into 2010 with, I think, with a number different contracts. And I think particularly the Spanish 8x8 that kind of you had to move to the right. Could you just maybe just give us a little bit of some color on -- you mentioned that you are expecting to see some stability here. How are these contracts looking right now? And is there anything that still needs to be signed up going for this year?

[Jay Johnson:]

I think the way I'd characterize it, Peter, is that it's still very active. There are still some soft spots in all of this. And I have no false expectations that some of the things won't continue to move to the right. But by and large, the European order book, both indigenous order book and the FMS export order book, are quite handsome, I believe. We've got the Canadian LAV, which I mentioned in my remarks, which is very active. We expect the production contract anytime here in 2011. You got the TAPV, you've got the CCV programs after that, that we're very competitive for. You got the Scout SV Specialist Vehicle in the U.K. We're in development right now on a $750 million contract. So that is proceeding a pace, and it will be years in stride with every indication that it's going to proceed per original intent. The Spanish 8x8 that you mentioned, the VBR, the Spanish government ministry is still working very diligently, given their circumstance, still working very diligently to bring that thing to contract this year. That's about the best I can say. They've been very consistent in that. Will it happen? We'll see. But they're certainly committed to making it happen as best they can. So we've got orders in Switzerland for platforms, dura platforms. We've got orders in Germany for EAGLEs, and the EAGLE just keeps getting better and better as it goes and more order activity around that. And then you move into the FMS work with our FMS customers, and you got two huge LAV orders that are already in play. You've got an FMS tank order in excess of $1 billion that's in play and will go into production this year, I believe. You've got the Iraqi tank order that we're already delivering to the Iraqis, and so it goes. I mean -- so it's very active. And I mentioned in my remarks, the Namer for the Israeli Ministry of Defense that we're working with them on right now at about I think a $300 million contract. So the international book will continue to be very active. There'll be puts and takes, I think, as I mentioned earlier because of budget realities in other countries. But the long term and the integrity of that book, I think, is very solid.

[Myles Walton:]

So what you're saying, I mean the $9 billion, I think your guidance, $9 billion, for this year, it sounds actually, and it kind of relates to, I think Rob's question, looking out over the next year or two, this is quite a sustainable business just given all that activity you ticked off?

[Jay Johnson:]

Yes. And I think you've heard me say it before, Peter, but I got my head around right now, this being a $9 billion business, plus or minus a little, and that's kind of what the way we're seeing it right now. That's the way 2011 looks to us. 2012 is not quite as clear just because of where we are in the budget process, but the going in position looks pretty good. So we'll see how it plays out. But I don't see any drastic motion, frankly, down or up, in Combat Systems right now.

[Operator:]

Your next question comes from the line of Jason Gursky from Citi.

[Jason Gursky:]

Just a quick question on the EFV. Given what you know about the mission and combine that perhaps with what the Secretary has said publicly about the program and then maybe what the program office has told you about our amphibious capabilities going forward, what do you envision the next potential program looking like? And how is it that General Dynamics may be able to step in and fill that need?

[Jay Johnson:]

That's probably a question to ask the Marine Corps. But honestly, I mean we believe the expeditionary fighting vehicle satisfies the requirement nicely. Decisions have been taken that said it's unaffordable, it's not a quality thing, it's unaffordable. We are working to make that program either wind down or reshape. We're being very responsive to lots of people's questions as you might answer. But I would to say this

[Operator:]

Your next question comes from the line of Sam Pearlstein from Wells Fargo.

[Samuel Pearlstein:]

Jay, I wanted to ask a question on the Marine segment. And just as things have been pushed out on some of these orders, whether it's DDG 1001 or 1002 or even the DDG 51s, just thinking about that in particular, how far out do these get pushed it somehow causes you to make some changes to your cost structure? And in terms of just what your long-term profitability in those contracts are, does that get shifted out as well with that timing?

[Jay Johnson:]

Well, to a point, Sam. But as you know, we're very disciplined in our ability to maintain profitability at our shipyards. So if the contracts delay much longer, there's no doubt about the fact that we'll have to reshape our business up there to deal with that. We did it in NASSCO because we've got a valley, if you will, in the order book coming out there. We'll do the same thing at Bath if we have to, without question.

[Operator:]

[Operator Instructions] Your next question comes from the line of Heidi Wood from Morgan Stanley.

[Heidi Wood:]

Jay, just an observation. Generally in the January call, you gave us the EPS breakdown for the year. Are you not doing that now because of the continuing resolution?

[Jay Johnson:]

You mean the $7 to $7.10?

[Heidi Wood:]

Yes. You usually give us a sense of what the spread is across the four quarters?

[Jay Johnson:]

No. Well, I don't remember doing that.

[Amy Gilliland:]

Heidi, I think we just generally usually try to give you a sense of how it's going to play out in the year. And you might've missed his remarks but right at the end, Jay did comment that in the second half of the year, that's where most of the EPS growth over 2010 will be. So it will get bigger each quarter with the second half being the largest.

[Heidi Wood:]

And then Jay, you've got the sense, a very strong balance sheet and in light of the value of the company, what's preventing you from being bolder on share repurchase?

[Jay Johnson:]

Well, I don't consider 18.9 million shares to be trivial. But we're opportunistic not programmatic in our share repurchase segment activity. And when the market suggests that we're undervalued and ought to buy it back, if that's the best use of the cash, we'll do it. But as you know, and I think we've talked before, Heidi, in terms of capital deployment, we've held back just because of the environment in which we've been operating to make sure we have plenty of cash. We have plenty of cash. I think you could expect now that the environment is improving to see us execute our balance preference in terms of how we deploy our capital to include more acquisitions and continue share repurchase as the market talks to us. So we'll deal with the dividend in March as we always do. We'll deal with share repurchases as it becomes opportunistic for us. And we're looking and working the M&A side very actively right now.

[Heidi Wood:]

You're right, 18.9 million is a lot, but from '09 to '10, the net decline was only 7 million. That's why I'm wondering whether you've got a determination to kind of keep chewing that down, that's what I was trying to say.

[Jay Johnson:]

Yes, we'll keep chewing it down as long as it makes sense to do so. But we're also about growing earnings around here. And so the capital deployment is going to be helping us tie to that very nicely.

[Heidi Wood:]

And then lastly, can you talk about slot availability in 2011? And there's a considerable debate, as you're well aware, about whether the G550 gets cannibalized by the 650. Can you give us any color advancing that debate one way or the other as you look out with the demand over the second half of 2010 and early inquiries into 2011?

[Jay Johnson:]

Yes. We have 18 to 24 months backlog in both the in-production, large-cabin aircraft. There is not cannibalization occurring. We're still taking orders for 650s. We're well out on 550s and 450s. We're very pleased with all of that. I do not see cannibalization as an issue. We're holding price very handsomely on the large cabins. So the 650 is not a replacement, as you know, Heidi, but for everyone, is not a replacement for any aircraft. It defines its own part at the top of the market. And that's exactly the way it's being presented and that's exactly the way it's being received. So it's not threatening at all to our 550 in terms of backlog or activity at all.

[Heidi Wood:]

And then just to reiterate, the 550 slots are full in '11?

[Jay Johnson:]

That is correct.

[Amy Gilliland:]

And Katie, I think we have time for just one more question this afternoon.

[Operator:]

Your next question comes from the line of Robert Stallard from Royal Bank of Canada.

[Robert Stallard:]

Jay, maybe looking at the OCO leaks to the FY '12 number suggests the administration is going to bring the OCO down quite considerably. I was wondering if you could clarify what your exposure still is there and whether you would see any negative impact from that.

[Jay Johnson:]

I think the general answer there would be not much. I mean in years past, I think as you know, the OCO, the supplementals, et cetera, included procurement, included MRAP, included things that were very elemental to us. But in the past few years, what we're seeing is really the best way to say it, I think, is our core programs have moved into the base budget, by and large, okay? So it's not something that is going to change our life much if the OCO comes down. That's probably the best way to say it.

[Robert Stallard:]

If you could give an estimate of the percentage of sales maybe in 2011?

[Jay Johnson:]

No, very small. I don't have a number in my head, but it's not -- let's put it this way, it's not something I worry about.

[Operator:]

At this time, I'd like to hand the call back over to Amy Gilliland for closing remarks.

[Amy Gilliland:]

Thank you for joining our call today. And if you have additional questions, I can be reached at [phone]. Have a great day.

[Operator:]

Ladies and gentlemen, thank you very much for your participation in today's conference call. You may now disconnect. Have a wonderful day.