General Dynamics Earnings Call Insights: IS&T Margins and Number of 650s and Completions

General Dynamics (NYSE:GD) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

IS&T Margins

Myles Walton – Deutsche Bank: The question I had was on IS&T margins, and you talked about up 20 basis points on a clean compare in 2012. I just want to make sure that’s 8.2%; is that roughly the range?

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Phebe N. Novakovic – Chairman and CEO: Yes.

Myles Walton – Deutsche Bank: Could you talk about what the step-down has been structurally? Where is the long-term margin opportunity? And then maybe for Hugh, is there any amortization benefit that’s coming in ’13 to IS&T that’s in that 8.2%?

Phebe N. Novakovic – Chairman and CEO: Let me give you a little bit and then we’ll let Hugh answer. Let me give you a little bit of color on 2012 margins and then 2013 margins, alright. We had, as I mentioned, about 270 basis point compression in 2012 margins, and the way I think about margins is, is here’s what’s going on. We talked about C4 in ’12 and we are confident that their reset plan reflects their market reality and shows considerable improvement year-over-year. The IS&T services has become an increasingly large segment in IS&T; the IT services, and GDIT is a lower margin business in the other IT businesses. Going forward, there are two main drivers for 2013. C4 sales and earnings and margins are up in ’13 as against ’12 before non-recurring charges and their margin expansion is around 80 basis points. We’ve also addressed the operational problems at GD U.K. and we have some stabilization there as well. Offsetting that margin improvement is – IT services has about $350 million lower revenue target and margin compression of about 50 basis points. So, net-net, that’s how we’re rolling up to about 8.2% margins. Hugh, you want to address the amortization?

L. Hugh Redd – SVP and CFO: Yeah, Myles, there will be less amortization in 2013. I think the number is probably $25 million; maybe slightly more. That has been reflected in the projections that Phebe has and the guidance she’s given you.

Myles Walton – Deutsche Bank: I’ll stick to one, but Phebe is there a longer term margin expansion story for IS&T or is this kind of what we should think about is the business?

Phebe N. Novakovic – Chairman and CEO: There is a longer term and let me take this opportunity to explain that. One of the things that ought to be clear is that we have reset the IS&T plan across each one of the businesses and we haven’t done a very, very realistic program-by-program analysis that drove our revenue estimate by about 5% lower. To fire test those assumptions is part of our planning purpose, we used a parametric analysis based on several benchmarks including book-to-bill established budgets and backlog. So, the result what we’re guiding you to in IS&T seems reasonable to me in both program assumptions and by application to the benchmarks, because we tell there is reasonable parametric test of our assumptions. When I think about IS&T and let’s talk C4 in particular, this is a superb management team that given a realistic and reset plan and given their order book has margin potential I’m just not going to lead you there, margin expansion potential I’m just not going to lead you there yet and that goes into that’s relevant for ’13 and ’14. What we see over our long range plans for IS&T is margin expansion across the board but it’s going to be slow and deliberative.

Number of 650s and Completions

Cai von Rumohr – Cowen: So Gulfstream can you give us some color on how many 650s did you deliver in the year and how many completions? And give us some color around the delivery assumptions behind your comments on Aerospace for 2013?

Phebe N. Novakovic – Chairman and CEO: Yeah, look, as we highlight in our press release, we delivered 37 aircrafts to customers in the quarter, including 31 large cabins, and we’re not going to break out aircraft deliveries by model type, and I certainly don’t intend to going forward. I can tell you that based on what we reported before we had six G650s enter into service in the fourth quarter. Let me give you a little bit of background on margins. Let’s take ’12, okay. Starting in the third and fourth quarter, margins were impacted by higher cost of goods sold in connection with the completions and retrofit work for the G650. As a result, we had a temporary disequilibrium between green production and completions as we accommodate some retrofit work out of the cycle. We’ve got to work our way through that over the year. And so let me – that leads me into 2013, and let me talk to you about margins in 2013. There are two things driving; one of them, mix shift, with a larger proportion of 650 and 280s with lower margins at the moment compared with 450s and 550s. It’s also about 650 production, which I alluded to, and we have factored the green and completion production rate to account for this imbalance in production flow from green completions that will take a duration of a year to resolve. Let me give you – I think it might be helpful for you to understand where we are and I’ll give you some color; I think some real detail on how we’re seeing our rates and our margins. So, let’s talk about 650 manufacturing. Overall, the manufacturing of these aircraft is going well. However, not surprisingly, due to the prolonged FAA certification process and our decision to continue manufacturing G650s during that process there is currently disequilibrium between initial and final phase manufacturing and that disequilibrium is the result of retrofit work mandated by changes to the configuration of initial G650 green aircraft after they were manufactured to conform with FAA approved configuration. So, as I say, we’ve got through – the margin guidance we’ve got in 2013, anticipate taking the majority of the year to rebalance our initial phase and final phase production. We have some opportunity there but I’m not willing to call it yet.

A Closer Look: General Dynamics Earnings Cheat Sheet>>