Phebe N. Novakovic - Chairman and CEO Jason W. Aiken - SVP and CFO Erin Linnihan - Director, Investor Relations.

Jason Gursky - Citigroup Robert Stallard - RBC Capital Markets Myles Walton - Deutsche Bank Joseph Nadol - JPMorgan Ronald Epstein - Bank of America Doug Harned- Sanford C. Bernstein & Co.

Peter Arment - Sterne Agee Sam Pearlstein - Wells Fargo Securities Carter Copeland - Barclays Capital Robert Spingarn - Credit Suisse Cai von Rumohr -- Cowen & Company David Strauss – UBS George Shapiro - Shapiro Research Howard Rubel - Jefferies & Company John Godyn - Morgan Stanley Peter Skibitski -- Drexel Hamilton.

Good day, ladies and gentlemen, and welcome to the Q1, 2014 General Dynamics Earnings Conference Call. My name is Adrienne, and I'll be your operator for today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference.

(Operator Instructions) As a reminder this call is being recorded for replay purposes. I would now like to turn the conference over to Erin Linnihan, Director of Investor Relations. Please proceed, ma'am..

Thank you, Adrienne and good morning, everyone. Welcome to the General Dynamics' first quarter conference call. As always, any forward-looking statements made today represent our 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. With that I would like to turn the call over to our Chairman and Chief Executive Officer, Phebe Novakovic..

Thanks, Erin. I will keep my remarks relatively brief today. I think the numbers are pretty straight forward and largely speak for themselves. Earlier today we reported first quarter earnings from continuing operations of $1.71 per fully diluted share on revenue of $7.3 billion, operating earnings of $871 million and net earnings of $595 million.

We beat analyst consensus by $0.07 and were ahead of analyst expectations on revenue as well. We were also somewhat better than our previous guidance and ahead of our own expectations. I should point out that the diluted weighted average shares outstanding was $347.2 million for the quarter, $7.4 million shares below the fourth quarter of last year.

I’ll ask Jason Aiken to give you a little more insight into our share repurchase activity when I complete my remarks. Free cash flow for operations was $341 million, approximately 57% of net income. This is typical to the first quarter.

But I should add that we expected particularly robust second quarter from a free cash flow perspective driven in part by advance payments on international orders. In many respect the story for the quarter is about the order book, particularly in defense.

We ended the quarter with the total backlog of $56 billion, up approximately $10 billion over the last quarter with particularly impressive growth in combat systems backlog. Marine systems backlog grew and IS&T had a modest gain after adjusting for some of the backlog in the UK that was transferred to combat systems.

Interestingly we have more funded backlog at the end of this quarter than we've had any time in the last three years, the same is true for total backlog.

We also look forward to a strong second quarter intake, particularly marine system with the anticipated booking of the Block IV Virginia class multi-year contract, the underpinnings of our defense businesses are clearly solidifying. Compared to the first quarter 2013 revenue was down less than expected $80 million or 1.1%.

On the other hand operating earnings were up $24 million or 2.8%. Our operating cost and expenses were $104 million less than the year ago quarter leading to a 50 basis point improvement in margins at 11.9%, this is very strong operating leverage. Net earnings were up even more than operating earnings, 4.2% versus 2.8% primarily due to lower tax rate.

EPS was up 5.6% over the year ago quarter as a result of better operating earnings, lower tax rate and lower share count. Let me provide some commentary and a little bit of perspective around the results of our operating segments, first Aerospace. Sales are up over Q1, 2013 by $347 million, 19.5% and essentially flat sequentially.

Earnings outpaced the year-ago quarter by $94 million about 30%. Compared to Q4, 2013 operating earnings are up $56 million or 16% principally due to mix shift and continuous improvement on 650 production and completion efficiency. This resulted in 19% margin for the group. Again Jet Aviation's continuing profitability made a nice contribution.

Orders were not strong in the quarter but need to be viewed in the context of a very robust fourth quarter 2013 order book. We are off to a very good start in the Aerospace group Marine systems, revenue was off 1.5%, $25 million compared to the year ago quarter. The sequential story is similar with respect to revenue.

However, operating earnings were up $7 million 4.4% against the year ago and the same sequentially. The real story in the quarter is a 10.4% margin rate which is really top notch and better than expected. All of the shipyards performed well in the quarter.

Backlog grew $837 million in the quarter with significantly more to come in the second quarter, as I mentioned a few minutes ago. At Combat Systems, compared to the first quarter of 2013 sales were down $236 million or 15.2% and earnings were down $79 million or 36.7% on a margin of 10.3.

It is important to note however that these results were impacted by a $29 million restructuring charge at ELF as a result of reduction in our Austrian operations which were consolidated into Spain and Switzerland. If we disregard that charge margins would be 12.5%.

Despite the restructuring charge ELF is expected to have operating margins around 10% for the year. The big story here is the large international order that finally came through. Total backlog is up $10.2 billion over the year-end number. Each of the combat systems businesses filled backlog in the quarter.

You should see steady revenue, earnings and margin rate performance improvement throughout the year in this group. IS&T, The revenue in this business group is holding up well in this difficult environment. You might recall that our guidance to you was to expect a revenue decline of 20% year-over-year but it didn't happen in first quarter.

Revenue in the quarter was up $166 million or 6.8% against a year ago quarter. It was off 15.2% sequentially. Operating earnings of $183 million in the quarter were only $2 million less than the year ago quarter on a 40 basis point improvement in margins.

On a sequential basis operating earnings were $13 million lower or 66.6% on a 70 basis point improvement in margins, once again exhibiting nice operating leverage. Total backlog for the Group was down $43 million from year-end but that includes a $248 million transfer of backlog from our UK business to combat system.

Absent that transfer IS&T backlog actually grew. So once again IS&T is off to a good start. And thinking about the rest of the year we are increasing our EPS guidance to $7.05 to $7.10 from our initial expectation of $6.80 to $6.85.

The increase assumes currently anticipated operating performance and the share count reduction realized in the first quarter. Think about the quarterly performance is lower in the second, flat in the third quarter with a strong Q4 finish. I'd now like to turn the call over to our CFO, Jason Aiken. .

Thank you, Phebe and good morning. I will take just a few minutes to review some financial items with you before we start the question-and-answer period. Net interest expense in the quarter was $22 million versus $23 million in the first quarter of 2013. For 2014 we expect net interest expense to be approximately $90 million.

At the end of the quarter our balance sheet reflects the net cash position, that’s cash in excess of debt of $385 million, a decrease of $1 billion from the end of 2013. This decrease is due in large part to our activities on the capital deployment front which I will address in just a minute.

We don't have any scheduled debt repayment until January of next year when $500 million of fixed rate notes will mature. Our effective tax rate of 30.1% for the quarter, slightly lower than expected, primarily as a result of the close out of the 2012 tax year. For the full year we still expect our effective tax rate to fall between 30.5% and 31%.

We expect cash contribution to our pension plan 2014 to be around $550 million to fund our obligation. The bulk of funding is scheduled to occur in second half of the year, specifically during the third quarter. As an update to our capital deployment plan I would like to address our activities in the first quarter.

As you will recall we entered into an accelerated share repurchase plan in late January to repurchase 11.4 million of our shares. This exhausted our remaining repurchase authorization and in early February our Board authorized repurchase of an additional 20 million shares. Since then we repurchased 3 million more shares during the quarter.

In total we deployed approximately $1.7 billion on share repurchases and divided payments in the quarter. In March our Board declared a dividend increase of more than 10%, that's the 17th consecutive annual increase. Our intent in 2014 is to return essentially all of our free cash flow to shareholders while maintaining a strong balance sheet.

At the end of the first quarter we have $4.3 billion of cash on the balance sheet and are well positioned to execute our capital deployment strategy during the coming quarters and achieve the objective of [inaudible] 2014. Erin, that concludes my remarks. I will turn it back over to you for the Q&A. .

Thanks Jason. As a quick reminder we ask participants to ask only one question so that everyone has a chance to participate. If you have additional questions please get back into the queue.

Adrienne, could you please remind participants how to enter the queue?.

(Operator Instructions). And the first question comes from the line of Jason Gursky of Citi Group. Please go ahead..

Good morning. Thanks for taking the call. Good morning. Just a quick question on Gulfstream. You mentioned the bookings there being down quarter-on-quarter after a really nice finish to last year.

I am just wondering if you can remind us of the seasonality that we typically should expect with bookings at Gulfstream just to kind of help everybody get prepared for the rest of the year kind of based on what you see in your pipeline at this point.

What do bookings look like on a quarter-to-quarter basis throughout the rest of the year?.

So the new aircraft sales opportunities continue to look very good and we got strong customer interest but we are still seeing extended negotiation periods in order to get that order closed and what that drives is some difficulty in being very specific and precise about the quarterly progression.

So our orders have intended to be a little lumpier like in the first quarter building with a strong fourth quarter finish. That’s the pattern that we have been looking at for a while and this year looks about the same with no material difference. But the order interest, the activity is very-very strong.

It’s just when we get to closure and that’s what makes it difficult for us to be real clear and specific on quarter timing..

And the mix that you are seeing at this point, is it still favoring the large cabins versus the mid cabins?.

Yes. We talk the last couple of call about understanding our mix and our order activity and when you have got a four year backlog on the 650s, you are not likely to see and in fact it's somewhat impossible to get a one-to-one book-to-bill.

So what we follow very carefully is the order activity and sign-ups for large cabin, mature aircraft, 450 and 550 and 60% of the orders in the quarter were for those two models. So again, very, very strong for the 450 and 550..

That's helpful. Thank you very much..

The next question comes from the line of Robert Stallard of Royal Bank of Canada. Please go ahead..

Thanks so much. Good morning..

Good morning..

Phebe, I have just a follow-up on that. I was wondering if you could comment on the sort of pricing.

You are saying in the new and used jet market and also if you have seen any impact from the recent activity over in Ukraine and Russia?.

Yes. So, pricing is holding up nicely in the pre-owned market and looks to be stabilizing in the large cabin market, particularly on the 550. In the mid-cabin, we see a little bit more pricing pressure but that is nothing new. This is consistent with what we have seen in the past.

And so far the activities in Ukraine and Russia have not affected our operations. Our Moscow operations are continuing and Gulfstream hasn't seen any material activity..

Great, thanks so much..

The next question comes from the line of Myles Walton from Deutsche Bank. Please go ahead..

Thanks. Good morning, good quarter.

Phebe, if I could go through one-by-one but may be the segments and your outlooks have been revised, much particularly on the margin if you want to extricate the kind of the margin guidance you are looking for as well as aero guidance for margins and maybe IS&T sales?.

Yes. So we didn't give specific update for the segment guidance and we are holding to it at the moment. We will update it in the second quarter when we've got more clarity about where exactly the puts and takes are across the business, but we are confident enough to increase our overall guidance. So we are very comfortable with that.

With respect -- and I will just tell you, with respect to combat in particular we are still holding to our low to mid 14% range in aerospace we are still looking at the 17% margin range. So nothing has changed and we are very confident in both of those numbers..

Okay. And the upper IS&T sales? Phebe N. Novakovic IS&T sales were stronger in first quarter then we had anticipated and we have good order activity.

But again, IS&T sales are pretty lumpy, driven in large measure by our healthcare business, which is highly seasonal and we usually only get about a quarter advance notice when it comes to the customers interest and increasing the sales volume..

Okay, good luck. Good quarter. Thanks..

Thanks..

Next question come from the line of Joe Nadol from JPMorgan. Please go ahead..

Hi, Joe..

Thanks. Good morning Phebe. Just wanted to dig into the aerospace margin a little bit. I hear you on maintaining the guidance for now since it's early but you beat December by a couple of basis points, last year obviously Q1 was a very strong start.

May be if you could give us a couple of reasons why we shouldn't get too far in front of you on aerospace margin side..

Let me talk a little bit about margins in quarter versus our budget and they are attributable to two primary factors, lower than anticipated pre-owned sales and better than expected G650 cost performance. So going forward we don't see that margin performance repeating for a whole host of reasons mix shift, supplier cost, timing of other expenses.

So when we factor all of those into our thinking at the moment we don’t see that kind of upside to margins over our guidance. .

Okay. Thank you..

The next question comes from the line of Ron Epstein of Bank of America. Please go ahead..

Good morning, Phebe..

Hi. Ron..

Big picture question for you. If you stand back and observe the operating profit of the company in the quarter, nearly about 46% of it was from [inaudible]. So General Dynamics now looks like it’s almost a half a commercial aerospace company and half a defense contractor.

How do you think about that strategically about the positioning of the company? And when you think about deploying capital and that sort of mix?.

So we like our strategic positioning. I like that balance between aerospace and defense, and that our defense business is as I pointed out and we’ve seen now quarter-over-quarter through the last year are holding up very, very nicely.

With implicit growth in the marine group, which we don’t talk of a whole lot about, it doesn’t get a lot of attention but in addition to block IV we’ve got considerable suitable revenue upside for the next several years as we move increasingly into a higher replacement and we gear up even more on the two year of Virginia class construction.

So there is some upside in our first of our current sort of sales profile on the defense side driven primarily by marine group but not exclusively. So stabilized combat and IS&T is continuing to hold the trend. So I like where we are with respect to our balance between our commercial aerospace and business jet market and defense.

When you think about capital deployment I think clearly we need to -- we will and we do make investments where we believe we are likely to get a good return and you will see over the last, frankly almost decade now, we’ve been heavily investing in Gulfstream and that investment is beginning to pay-off with very purposeful our capital deployment strategy at Gulfstream, because we believe and history has proven us correct that it was a business jet market and our place in that market was a good market to invest in.

So I think that the rectitude of that, the series of positions many years ago that we're continuing to follow makes it an awful lot of sense. So I think going forward you can expect the same kind of behavior for us so we see an opportunity to grow very accretively and profitably we will..

Okay, great. Thank you very much..

Next question comes from the line of Doug Harned of Sanford Bernstein. Please go ahead..

Thank you, good morning. I am interested in the Minsheng order which was just announced. And I think it’s a very interesting situation but I am trying to understand the majority of the airplanes in your previous, the 2011 order those have still not been delivered.

And I am curious what your expectations are regarding the timing of the deliveries in this very large order in the next several years. .

So I think the underlying assumptions in your -- in the beginning of your questions on Minsheng we have delivered a number of those airplanes. Going forward we have conservatively booked that order, the order was for 60 aircraft and another 20 options and we were very conservative in our bookings of those firm orders.

So as we go forward and we like -- that’s a terrific business for us Minsheng is a close partner. We have a very good relationship with them and we see that as steady. It will come in episodic orders, speed orders but so far we like where we are..

I am assuming that this is something.

This is really a long term situation that’s very tied to what happens in China in terms of demand, is that fair?.

Yes, it is fair. But we have a history with Minsheng that when they place an order they mean it. And when we declare it when we move it from estimated potential contract value in to firm orders we have got a lot of deposits and we have a slot and a delivery profile. So, so, that's again we are -- this isn't a big pop with no substance.

When we announced these orders with Minsheng the full intension is to execute and with -- you know our commercial exposure right, it's going to be driven by macroeconomic factors but so far there's considerable demand for these airplanes in China..

Okay, very good. Thank you..

Next question comes from the line of Peter Arment of Sterne Agee. Please go ahead..

Yes, good morning and nice quarter Phebe.

Phebe, can I just ask kind of a back to kind of Ron's question, more of a big picture now that the budgets out the green book out, could you maybe give us a little, how do you think GD is positioned domestically here both combat and marine on some of those core programs? You touched upon it on the Virginia-class and the Ohio class replacement but maybe just how you are thinking about given the DoD outlook..

So a couple of things. Absent a significant change in the threat environment, or a return to the sort of self-destructive government behavior across the board spending type, we believe that we have crossed at least in our programs and I would point you to the strong backlog as a harbinger of our sales performance.

The majority of our programs are programs of record and as we talked before they tend to fare better in a funding constrained environment. So combat, combat's going forward profile is, is heavily dependent and tied to international orders. We have seen those orders begin to come in. There are more out there in our pipeline, frankly fairly robust.

The investments spending on both army and the marine core is at sustainment levels and we factored back into our plan and we are comfortable with that those programs that we have on our plan are executable and that the funding is available. And to marine I touched on the two big drivers of Ohio replacement and the Virginia-class through the year.

We also see continued interest in commercial containership and tanker market. So those again, those orders for the commercial during that ship building tend to be a little bit more of the products but we still have a healthy pipeline that we are continuing to explore with our customers.

So if I step back in IS&T, IS&T has again largely we believe stabilized itself. It's a growth engine there being GVIT, not surprisingly. Our ISR business is stable with long standing programs of record.

And our networking and communication business has downsized itself in response to the revenue decline and again has programs of record that they are continuing to execute on. So across the board I think that we are on the defense side very well positioned. Again I point you to our backlog. .

Thank you..

The next question comes from the line of Sam Pearlstein, Wells Fargo. Please go ahead..

Good morning. .

Hi, Sam..

Hi. I wanted to see if you can talk a little bit more about combat systems and I am just trying to understand a couple of things. One is you know an order of magnitude in terms of the advances benefit you expect to get in Q2. And then trying to just think about how do you go from a 10% margin now to a 14% margin for the year.

You mentioned the EOS restructuring charge even if you take that out, you still have to have some high teens type of margins and I am not sure what drives that..

Sure. So let me talk a little bit more about the Q1 margins. I mentioned our $29 million charge. We also have some contract mix, changes across the group that will normalize as we go through the year quarter-over-quarter.

And you will recall that we moved the specialty vehicle to UK Vehicle program out of the backlog in IS&T and in to combat and that is a conservatively booked program given the state that it was in at the beginning of 2013. So those were some of the margin pressures we saw in the first quarter.

With respect to going forward I think that this group has amply demonstrated their ability to reduce costs faster than revenues declined. So we've seen quite a bit of operating leverage from them.

As you think about Combat Systems at the height of their revenue and in 2009 kind of crowding 10 billion we've seen a 40% decline in margins and yet last year we had -- in revenue last year we had 15% margins and this year we are looking at 14% and I don't see anything in our backlog or in our performance year-to-date that would suggest that we're going to have headwinds on margins..

Okay.

And any sense in terms of the advanced benefit you mentioned in the second quarter?.

Yes so it's going to be in excess of $1 billion and but again much of that will be deployed quickly obviously to our subcontractors. .

Okay. Thank you..

Next question comes from the line of Carter Copeland of Barclays. Please go ahead..

Good morning Phebe and Jason. Quick question Phebe about your comment on the 650. You noted you had better cost performance there in the quarter, I wondered if you might give us some color on whether that was recurring or non-recurring in nature.

How should we think about the implications there for the learning curve relative to your prior comment?.

So we are continuing to come down that learning curve. And our 650 margin performance on both the green airplanes and outfitted the airplanes is improving quarter-over-quarter. So very nice operating performance on the 650, and we expect that to continue.

Certainly we're going to -- the learning curve will flatten out as we go forward but so far we expect to see additional margin improvement on both green and outfitted airplane..

But there wasn't anything in the quarter, specifically that the benefit is….

These are repeatable. .

Okay, thank you. .

Margins are repeatable. .

The next question comes from the line of Robert Spingarn of Credit Suisse. Please go ahead. .

Good morning. Phebe, if we could just dig into IS&T a little bit more obviously you did outperform the expectations and the guidance here in the quarter.

How much of that is -- it sounds like you think that's potentially sustainable or is it just the army pressure is somewhat delayed and may be not even fully a 2014 event and I guess I am speaking more to the C4 side. .

So C4 saw the largest decline in the quarter in-line with our plan and as you'll recall we talked quite a bit at the end of last year and beginning of this year about our attempt to de-risk our army exposures C4 has done that. So what we see right now going forward to C4 is they've got almost everything in all their revenue in their backlog.

So I think that they can see some stability from a revenue perspective based on our expectations going forward. And again their programs of records particularly when TR are really doing quite nicely. Each one of those businesses had a book-to-bill of 0.9 or greater. So that also tells me that there is support for our products.

So they've got C4 so let's recall has exposure to the UK and Canada and fairly robust exposure in both markets. So that helped offset some of the uncertainty we've had in the past about army spending. .

So the 33% reduction in sales you talked about in January, is that off the table or you're simply saying you are observing it well enough with strength elsewhere?.

Yeah, I thought I gave you around a 20% decline..

Well 20% overall for the unit, right?.

Yeah. It too soon for us to walk back from that decline.

We had a good first quarter, a good book to bill but I don't want to get out ahead of that because as I mentioned earlier one of the big drivers is that the largest driver in IS&T revenue is going to be our healthcare business and that is very, very seasonal and we usually -- what our experience has been over the last year and half we only get a quarter worth of notice, the warning that we are going to have to up our activity.

.

Right.

Well maybe another way to ask the same question is was the President’s budget with the drawdown in army down to the mid-400,000 level, is that already contemplated in your guidance, does that match up with what you are planning for?.

Yeah..

Thank you..

No surprises there and no reason to adjust. .

Right, thank you..

The next question comes from Cai von Rumohr of Cowen & Company. Please go ahead..

Yes, thanks so much, Phebe. So if we can maybe get a little more color to help us reconcile the downtick in margins at Gulfstream from 19% to like 17% plus, 17.6% for the year.

I mean if in fact you are doing well on G650 with more learning curve improvement to come I would think that would be in margin plus as we move forward and you also have mentioned used biz jet sales being weak, I mean is there higher, I mean I assume they are not hugely -- the volume looked so good in that quarter.

I still have a little trouble understanding how you know your guide for the year isn't quite a bit low. .

So the pre-armed and let me give you a little bit more color on this. The pre-armed sales activity was lower in the quarter that we had anticipated but we still expect to take pre-armed and remainder of the year that obviously has margin headwind. We also going to have some mix shift that we are anticipating.

Timing and other expenses and we thought supplier cost that we are factoring into our thinking. So it is 650 performance continues to be good but as we go out to produce more mid cabins we are going to see those are lower margins particularly on both of those 280 and the 150 and that provides you know that causes some headwind in margin activity.

So it’s really the big shift, supplier cost and timing that make us properly cautious about the margin expectations for the year..

Okay but it looks like you know your guide, as I take it of large cabin deliveries you did 25 and aren't we looking for something like 118 for the year and so well yes we do have an uptick coming in terms of the mid-size. You know you also have on the larger planes in the mid-size you know are considerably less revenue.

So I guess I am still is it something at jet or services, you know that is changing the mix because I think you explained just on the surface the mix doesn’t look like it’s that much worse. .

You know the 450 is a lower margin airplane than the 550, in fact 650 margins have now exceeded the 450 margins largely because of the supplier cost that we talked about before and those increases in supplier cost hit the 450 pretty robustly. So the service activity we anticipate continued a good strong level of service activity.

It’s very, very strong in the quarter and going forward jet continues to be profitable. So I really go back to mix our shift on 450’s and mid-cabins and higher pre-owned, our supplier cost and then the timing of some other expenses.

So it really is premature from us to get out there and project -- I don’t see at it at the moment, 19% or 18% margins doesn’t mean we also…..

So your information is basically that within the large cabin the mix is shifting pretty sharply toward the 450 which is the lower margin product?.

That’s right. Well not pretty sharply but it is shifting. And those margins have been compressed for the reasons we….

Okay. .

The next question comes from the line of David Strauss of UBS. Please go ahead..

Good morning, Phebe?.

Hi, David..

Want to ask you about the balance sheet, even with the big quarter in terms of share repo you sit on net cash position I know you committed to returning 100% of free cash flow this year but would still be in a net cash position.

So can you just talk about thoughts from the balance sheet any kind of leverage levels you are thinking about just utilizing looking to utilize balance sheet little bit more? Thanks..

Let me give you sort of overarching view and then I’ll let Jason give you some more color. But we used our balance sheet when we believe that there's an appropriate opportunity to make accretive investments. We have sufficient cash flow for this year to support the kind of share repurchases and dividends that we anticipate.

So I frankly like where we are, and we like our credit rating we want to retain it. We don’t see any reason to leverage the balance sheet to get a quick path in share repurchases that aren’t necessarily repeatable in the next year. And this is too much of your future flexibility, not what we want to be..

Yeah and just to add to that maybe in the quarter you saw that we did essentially "use the balance sheet to the tune of a billion dollars" that was really the effect of the ASR and fulfilling the commitments that we made last year which earned free cash flow to shareholders.

So that was in effect our use of the balance sheet for this year and it really articulated both the plans just want to get efficient free cash flow forecasted and find that try to return that to shareholders through dividend and share repurchase. .

Thank you..

The next question comes from the line of George Shapiro of Shapiro Research. Please go ahead..

Good morning. .

Hi George..

Phebe since you are not changing any guidance at this point on the sectors is it fair to assume that the increase in your EPS is coming primarily from the share buybacks because you historically don’t ever factor that into your guidance?.

It comes from three things. The maintaining or at least anticipating the EPS-based on our current share count. We see operating improvements that are driving about half of our current increase in our estimates on EPS. And but that we are not in a position to parse that, those operating improvements with any details among the four units.

That’s why I think I am far more comfortable in giving you that kind of color on the second quarter when we’ve got more clarity about where we’ve been through the half of the year and how the rest of the year shapes up..

Okay and one follow-up. The 650 it's been lots of discussion in the paper is it used planes are commanding like a $10 million premium to what you are selling them for.

I mean what’s your plan as far as increasing the rate on that 650?.

You mean the -- what you mean the production rate?.

Increase in your production rate given that demand seems to be so strong..

So we want to as you know our past behavior will influence us going forward. We raise our production rates when we are confident that we can execute efficiently, green deliveries and profitable, green deliveries and outfitting.

You will recall on the 650 we spent a majority of last year working through the -- what we call the dis-equilibrium on the retrofit. So that's -- we're mindful that we had a pretty detailed plan that we effectively put behind us.

But it seems to me a bit -- I guess imprudent to get up there and begun to pump up the production rate until we have got more experience on a quarter-by-quarter basis on both the green deliveries and outfitting. So we are properly balanced at the moment. We will consider increases in rates.

We do that at the end of every year and then that's how we set our guidance for you in the following year..

Okay. Thanks very much..

The next question comes from line of Howard Rubel of Jefferies. Please go ahead..

Good morning..

Hi..

Phebe, I think last year you might have termed 2013 as a back-to-basics year..

Yes..

And so, what's 2014 going to be about?.

More back-to-basics. I don't think you can ever get away from absolute requirement to improve your operating performance quarter-over-quarter, year-over-year. You never got enough, you're never done. So that is going to be a strategic focus and tactical execution of this management team going forward.

In addition we are -- I think that's been clear from our behavior heretofore in the year that we anticipate the deployment of all if -- most if not all of our free cash flow in dividend and share repurchases. So that's something we were not able to accomplish last year that we will.

So increased focus on the shareholder friendly cash deployment and more blocking and tackling on operation, return in invested capital, expanding margin and managing for cash. It's just never done..

Just a follow-up on that and I agree that makes a lot of sense, but somewhere in here, you need to make that there is the right investment for the future of each of the businesses. So you don't want to harvest too much to, and you clearly talk about whether it -- ships or Ohio class or this new opportunity internationally.

But could you be -- could you give us a couple of other examples where in the couple of other business units where you are seeing new product that also going to provide some of this basic or organic growth?.

Yes. So you quite rightly pointed out that in the marine group we have organic growth potential and therefore as you would expect we have invested in the marine group, largely in infrastructure and capital structure since those are capital intensive businesses.

In combat, what we have really our raise on that the last year and for this year as well is to size that business accordingly. But we make investments as we go along in those lines of business where we see a profitable return. So I think you can see that and our expectations on ELS.

We have invested by fairly significant investments in restructuring, why to make that business more competitive and we're beginning to see fruits of that labor. That's also true in the UK.

You have had significant restructuring charges in the UK to make us more competitive, and position ourselves for again organic growth and that's in the IS&T business. Our Intel and ISR business, we continue to invest in appropriate with the returns we expect in the market. Our IT Services business is a low investment business by definition.

So I don't really see an organic requirement to invest in the IS&T business in C4. We invest appropriately Canada and the UK and right size the business in the United States with the demand. .

Thank you very much. .

The next question comes from the line of John Godyn, Morgan Stanley. Please go ahead..

Hey thank you for taking my question. We heard a lot of questions on the Aerospace segment but I wanted to ask one more. Phebe last quarter you mentioned that there would be a dramatic rise in fourth quarter margins as you thought about the cadence throughout the year.

Just given with the performance in the first quarter and what we've heard about your guidance for the full year, I am not sure if that is still valid. .

I think I will anticipate where you are headed in this quarter. We pulled some of the margin performance into the first quarter so I expect the fourth quarter to be lighter than the first quarter. That is different than we anticipated when we gave the guidance which was light in the first quarter and then building with the strong fourth quarter.

We still expect a strong fourth quarter but not at the same level for all the reasons that we've articulated this morning. .

And perhaps the more important kind of takeaway from this is I think that had given some investors confidence that as we thought about 2015, the exit rate was robust and we would be set up for continued margin expansion in Aerospace. Is that framework still right? [Technical Difficulty].

Do we still have an analyst with a question?.

Hi, this is John can you hear me?.

Yes it's a good thing our communications products are more reliable than this thing, who knows what happened. .

Glad to have you back. What I had asked was I think the comment about fourth quarter seeing a ramp has given some confidence on continued margin expansion in aerospace in 2015.

Is that still the right framework to use today with the new guidance?.

So I think as we think about 2015 it's obviously too soon to tell and we'll -- there are lot of factors that will emerge during the course of the year that will influence and inform our margin guidance but we anticipate that aerospace will continue to have very strong margin performance, both at Gulfstream, both this year and but equally important in ’15 at Gulfstream as the 650 continues to come down its learning curve, and also at Jet Aviation which is increasingly profitable.

So nice performance at jet and they are positioned to increase their order book. They solved their operating challenges and so I expect more upside margin ignition from jet. .

Great, thank you..

Just thoughts about the future..

Adrienne, I think we have time for one more question..

The next question comes from Pete Skibitski of Drexel Hamilton. Please go ahead..

Yes, good morning. I just want to ask one on Marine and maybe a follow-up. Phebe It looks like marine repair that business has been a real great growth driver for you over the last four or five years. I know you got done some deals there.

But I am just wondering you know with the navy fleet staying at a pretty low level and being kind of tasked increasingly around the world.

Is repair kind of an ongoing growth story for you from that perspective?.

Yeah, so you know I think somebody asked that question earlier about investments. Kind of this was the place where we made an investment, I was EDP at the marine group and I felt very strongly at the time that we needed to expand our repair footprint and we did that, so that we are now bi-coastal.

In fact we are heavily represented in four of the five maybe home ports and we did that purposely with the expectation that as the fleet ages repair workflow increase. I frankly like repair work in general. It’s steady, it’s fairly predictable performance and very predictable performance if you know what you are doing and we do.

So it’s been a nice on the surface side, it’s been a nice growth engine for us. We also just recently won up in the Pacific North West a very large repair contract for CVM. So that again expands our footprint b-coastally.

On the submarine side, submarine repair work tends to come from two sources, one excess workflow from the public yards and second emerging demand that as the fleet experiences issues well under sea, so in both of those instances we have seen fairly lumpy but when we get it pretty profitable submarine repair work..

Got it..

Your assumption is quite correct that we have liked those investments, the return on those investments that we made in surface repair business..

Got it, thank you.

And just one follow up on marine, I am just wondering as you ramp in commercial volumes you guys won a lot of orders there, if there’s going to be any negative impact to marine margin and then a similar issue on marine margin, similar question about this recent Virginia sub marine pay load marginal issue, if that would be any impact to margin rate. .

So for very high performing shipyards, which our three shipyards are, margins change quarter-over-quarter and year-over-year almost entirely based on mix. So you would expect that when we get increase we get a new order we are going to see some margin compression, as we come down our learning curve you will see margins expand.

That’s true on both the Naval, ship building side as well as the commercial ship building side. So NASSCO had very, very good margin performance on both its navy and commercial ship building work revenue, largely driven by just performance improvement quarter-over-quarter, day-after-day.

The pay load issue we don't anticipate any margin compression on the issue that has come up with the North Dakota. We discovered that in concert with our navy customer and are addressing their requirements to do a complete inspection. So no real I mean it was a surprise and unfortunate.

But we are [nearly set back] with our flow under control and it's frankly it's a supplier issue and we will address that. .

Got it, very helpful, thank you. .

Thanks.

And Adrienne, thank you so much. Thank you everybody for staying with us through the technical difficulties. If you need to reach me I am at 703-876-3583. Thank you so much. Bye-bye. .

Thank you for today's participation in the conference. This concludes the presentation. You may now disconnect. Have a good day..