General Dynamics (GD)

Q2 2011 Earnings Call

July 27, 2011 9:00 am ET

Executives

Amy Gilliland -

Jay Johnson - Chairman and Chief Executive Officer

L. Redd - Chief Financial Officer and Senior Vice President

Analysts

Cai Von Rumohr - Cowen and Company, LLC

Robert Stallard - RBC Capital Markets, LLC

Michael Lewis - Lazard Capital Markets LLC

Howard Rubel - Jefferies & Company, Inc.

Joseph Nadol - JP Morgan Chase & Co

Heidi Wood - Morgan Stanley

Robert Spingarn - Crédit Suisse AG

Noah Poponak - Goldman Sachs Group Inc.

Samuel Pearlstein - Wells Fargo Securities, LLC

Myles Walton - Deutsche Bank AG

Troy Lahr - Stifel, Nicolaus & Co., Inc.

David Strauss - UBS Investment Bank

Presentation

Operator

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Good day ladies and gentlemen, and welcome to the Second Quarter 2011 General Dynamics Earnings Conference Call. My name is Caris, and I will be your coordinator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. And I would now like to turn the call over to your host for today, Ms. Amy Gilliland, staff Vice President of Investor Relations. Please proceed.

Amy Gilliland

Thank you, Caris, and good morning, everyone. Welcome to the General Dynamics second 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 performed well in the second quarter, delivering $7.9 billion in sales and $949 million in operating earnings. Sales and earnings improved from last quarter, with Combat Systems volumes leading the top line growth. Excellent performance across our 3 Defense groups in the quarter drove 12% company operating margins. Earnings per share totaled $1.79 on a fully diluted basis, $0.11 ahead of last year's second quarter and $0.15 since ahead of last quarter.

Second quarter free cash flow after capital expenditures was $658 million, nearly 100% of earnings from continuing operations. Year-to-date, free cash flow is $924 million, well ahead of last year. I expect this robust cash performance to continue in the second half.

Regarding capital deployment, we took advantage of our healthy balance sheet and market conditions to repurchase 11.1 million shares of GD common stock this quarter. Through the first half, our EPS growth has been enhanced by the repurchase of 14.2 million shares. Subsequent to the quarter, we also took advantage of favorable market conditions to issue $1.5 billion in new debt. This issuance increased the average maturity of our debt, reduced our average coupon rate, covered $750 million of notes that matured 2 weeks ago and provided additional flexibility for future capital deployment.

Orders this quarter were nearly $7.5 billion, $300 million more than last year's second quarter, due to particularly strong demand for our Aerospace products and services. Defense bookings were more modest than anticipated because of slower than expected award activity, following the delayed passage of the 2011 defense spending bill in late April. With that said, I anticipate healthier order activity across our Defense segments in the second half.

At the end of the quarter, funded backlog was $44.3 billion up $400 million from the first quarter, while total backlog stood at $57.1 billion. Total estimated contract value, which includes opportunities to provide products and services under IDIQ contracts and options, was $78.3 billion.

Now let me turn to the results and outlook for each of our groups. First, let's talk about Combat Systems. Combat Systems sales and earnings improved this quarter when compared with last quarter and the second quarter of last year. Sales totaled $2.1 billion, reflecting growing international vehicle volume, particularly foreign military sales of light armored vehicles and somewhat lower U.S. vehicle and engineering volume. Earnings were $299 million, resulting in 14.1% operating margins. This healthy operating margin reflects excellent performance across the group's portfolio of mature production programs. In addition, the group's profitability has been enhanced by ongoing continuous improvement and business optimization initiatives, aiming at ensuring that we remain a competitive, high-quality provider in a tightening market. These efforts were illustrated by several actions taken in the quarter, such as the decision to relocate our European Defense business headquarters to Spain by year-end and the consolidation and resizing of our Guns and Weapons businesses to align with anticipated demand. We also continued our focus on core businesses by divesting the successful but non-core detection business.

Combat Systems' backlog totaled $10.8 billion at quarter end. Orders in some of Combat's businesses were somewhat lighter than anticipated this quarter, in part due to the impact of the sluggish contracting environment on our Ordinance and Weapons Systems businesses. Notable orders that were received included approximately $286 million for Hydra rockets, $124 million for MRAP upgrades and $62 million for Stryker Double-V hull engineering. In the second half, we expect additional U.S. awards for more Strykers, additional MRAP upgrades and a Ground Combat Vehicle development contract.

We also expect international production contracts in the second half, including the Canadian LAV upgrade program, 2 awards for an FMS tank upgrade program and a possible launch customer for the newest upgrade to our PIRANHA family of vehicles. Additionally, requests for the next increments of 72 FMS LAVs and 125 Egyptian tank kits are now proceeding through the appropriate approval channels. In total, these international awards could add approximately $1.5 billion to backlog before year-end. Given year-to-date performance, current backlog and anticipated orders, Combat remains on track to achieve my guidance of around $9 billion in sales this year and a 14% operating margin.

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