Earnings Labs

General Dynamics Corporation (GD)

Q4 2014 Earnings Call· Wed, Jan 28, 2015

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Transcript

Operator

Operator

Good day ladies and gentlemen and welcome to the Fourth Quarter 2014 General Dynamics Earnings Conference Call. My name is Shantelay and I will be your facilitator for today’s call. At this time, all participants are in listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Erin Linnihan. Please proceed.

Erin Linnihan

Analyst · Stifel

Thank you Shantelay and good morning everyone. Welcome to the General Dynamics' fourth 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.

Phebe Novakovic

Analyst · UBS

Thanks, Erin. Earlier today we reported fourth quarter earnings from continuing operations of $2.19 per fully diluted share on revenue of $8.36 billion and earnings from continuing operations of $737 million. It was our strongest revenue performance in the past 12 quarters, the highest operating earnings ever and the highest earnings from continuing operations. For the year we had fully diluted earnings per share of $7.83 on revenue of $30.85 billion and earnings from continuing operations of $2.7 billion, a return on sales of 8.7%. It was a year of solid achievement from both an operating perspective and the development of significant backlog. As you can see from schedule H to the press release, funded backlog grew from $38.3 billion at year end 2013 to $52.9 billion at the end of last year. The story for total backlog is much the same. We were at $45.9 billion at the end of 2013 and sit at $72.4 billion at the end of 2014. As a result, we are well positioned for growth in 2016 and 2017. Free cash flow from operations was a negative $254 million in the quarter. However for the year we had free cash flow from operations of $3.2 billion or 123% of earnings from continuing operations. This outpaced 2013 by 532 million. Let me give you some detail on the quarter and the year in each of the business groups. First, aerospace. Revenue and earnings were up nicely over the year ago quarter. Sales were up 105 million, 4.9% and earnings were up 64 million, a significant 18.4% on very strong margin improvement. This is particularly impressive when one considers that G&A and net R&D were up $40 million over the year ago quarter. On a sequential basis, sales were up $49 million but earnings were up…

Jason Aiken

Analyst

Thank you, Phebe and good morning. I will take just a minute and cover a few miscellaneous financial items before the question and answer period. Net interest expense in the quarter was $19 million versus $23 million in the fourth quarter of 2013. And for the year interest expense was $86 million, consistent with the year before. For 2015, we expect net interest expense of around $82 million, a decline from 2014 resulting from the repayment of $500 million of fixed rate notes that matured last week. At the end of the year, our balance sheet reflects a net cash position, that’s cash in excess of debt of $477 million. This was down by about $1 billion from the end of 2013, reflecting the cash we used from the balance sheet for capital deployment activities which I will address in just a minute. Our effective tax rate was 29.5% for the quarter and 29.7% for the year, and that’s a bit lower than we had been forecasting. As you will recall our most recent projections were in the neighborhood of 30% to 30.5%. Lower outcome is attributable to the R&D tax credit extension in late December. For 2015, as Phebe mentioned, we expect an effective tax rate of around 30.5%. And finally, on the income statement, you will notice we took a charge in the quarter in discontinued operations. This is related to the sale of our AxleTech business which we first reported in the second quarter when we made the decision to sell that business. The charge we took at the time was predicated on the 2014 closing of the sale. The regulatory review process for the transaction delayed the closing until the 5th of January and as a result we were not able to take advantage of some tax benefits we’d anticipated. So we adjusted the loss on the sale in the fourth quarter. Switching gears, we contributed $515 million to our pension plan in 2014 and for 2015 we expect that amount to decline to approximately $185 million as a result of the interest rate relief from the Highway and Transportation Funding Act of 2014. On the capital deployment front, to summarize our activities for the year. We delivered on our commitment to return capital to our shareholders while maintaining a strong balance sheet. In total we expended approximately $3.4 billion on share repurchases in 2014 and when you combine our share repurchases with our dividend payments, we spent $4.2 billion in shareholder-friendly actions in 2014 or 1.3 times our free cash flow from operations for the year. Erin, that concludes my remarks and I will turn the time back over to you for the Q&A.

Erin Linnihan

Analyst · Stifel

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

Operator

Operator

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

David Strauss

Analyst · UBS

Phebe, could you give us a little bit more detail on the free cash flow outlook? It sounds like it’s going to be lower. Could you maybe peg it as a percent of net income in 2015 and what exactly – how much of that is in advance drawdown in terms of the pressure on free cash flow?

Phebe Novakovic

Analyst · UBS

So we tend not to give you specifics as a percentage of net income on our free cash flow. But suffice it to say it’s going to be less robust as a result of our drawdown in our deposits. But we will intend to normalize our free cash flow using our cash on the balance sheet to effect any capital deployment. I think that’s about as much color as we yearly give you and as much as we are prepared to give you.

Operator

Operator

Your next question comes from the line of Ron Epstein of Bank of America Merrill Lynch.

Ron Epstein

Analyst · Ron Epstein of Bank of America Merrill Lynch

Just a quick question for you on Gulfstream. How do you expect I guess the sales profile for the business to go when you are leading into the ramp up of the new models, right, so maybe a better way to say, the transition between kind of the old models and the new models, would you expect the profile of the business to continue to grow?

Phebe Novakovic

Analyst · Ron Epstein of Bank of America Merrill Lynch

Yes. We do expect the profile to continue to grow in the near years, but at less of a rate than it will grow when we introduced an entry into service of the new airplane. So we have growth between now and entry into service of the G500 and we’d expect accelerated growth going forward from there.

Operator

Operator

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

Robert Spingarn

Analyst · Robert Spingarn of Credit Suisse

Hi. Wanted to talk a little bit about marine and the strength you talked about there, your very strong fourth quarter and how things do trend as we go through ’15 especially on some of the development work you’re doing on upcoming programs?

Phebe Novakovic

Analyst · Robert Spingarn of Credit Suisse

Okay. 2014 growth was driven by higher than expected volume on Block IV electric boat, more unplanned repair work in addition of commercial volume, and we anticipate that those growth elements to continue into next year albeit at a less of a rate of increase. Our developmental work primarily on Ohio replacement ballistic missile submarine continues at pace for the sole source on that, on track and we’re year over year increasing work on that contract. And it’s going very well. So we like where we are positioned there.

Robert Spingarn

Analyst · Robert Spingarn of Credit Suisse

And what you said, the fourth quarter itself – you said, I think the strongest quarterly revenues you’ve seen, how do we think about just the timing there?

Phebe Novakovic

Analyst · Robert Spingarn of Credit Suisse

Well we have continued to see growth this year at about 2% to 2.5%, which is, I think, very good in this environment, and that growth will continue into the outyears as we get more volume on Block IV – now we continue to do additional work on our commercial volume, repair work fluctuates but has year over year been growing and we began work on the fourth MLP. So we’ve got growth engines for marine group. We did obviously last year, we do into this year, and we do in the future. We have been telling a growth story for the last two years at marine group and you saw it manifest itself in 2014. It’s going to continue to 2015 and into the foreseeable future.

Operator

Operator

Your next question comes from the line of Cai von Rumohr of Cowen and Company.

Cai von Rumohr

Analyst · Cai von Rumohr of Cowen and Company

Yes, so I guess I am a little confused at GulfStream, if your sales go up to 9.4, a nice sales gain, and we’re getting improving profitability on the 650, why are the margins down? I mean Jet just isn’t that big a part of the business and what’s – maybe give us a little more color on the delivery mix if you could?

Phebe Novakovic

Analyst · Cai von Rumohr of Cowen and Company

Sure. So we have a slightly – so there are couple of things that are compressing margins slightly in 2015. We have a slightly unfavorable mix shift in green production between large cabin and mid cabin. We are keeping large cabin production about the same rate as we did last year, at about 115 units. We are increasing mid-cabin by 10 units. And so there is a somewhat unfavorable mix shift between large and mid-sized green. It’s got less of a contribution at Jet primarily and exclusively driven by mix shift. We’ve got higher R&D in this upcoming year. Remember that we are building multiple test aircraft to carry with them no revenue and earnings. And in the final – the final issue that’s impacting margins somewhat in 2015 is we have higher pre-owned. So those are the four components that are driving the margin variability.

Cai von Rumohr

Analyst · Cai von Rumohr of Cowen and Company

But the R&D, I mean, is that up as a percent of sales because -- is the G650 still improving in profitability or is the profitability declining on the 450 and 550?

Phebe Novakovic

Analyst · Cai von Rumohr of Cowen and Company

No, so that’s a kind of two-part question. Net R&D is up slightly. The 650 profitability continues to increase. And the 450 and 550 profitability being exactly where it has been, we have a greater mix shift this year – of mid-cabin which carries with it lower earnings – lower margins. I think you need to think about it that way. We’ve talked before about the variability of margins at GulfStream, and this is an example of it. There’s nothing unexpected from our point of view. There is nothing systemic. It’s just simply the ebb and flow of production, R&D and pre-owned.

Operator

Operator

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

Myles Walton

Analyst · Myles Walton of Deutsche Bank

You mentioned that all of the large cabin programs had book to bill above 1. And the question is really two fold. One is where are the demands you are seeing the biggest part of the strength and whether you are seeing any dilution of strength in the oil-rich countries or Russia in particular? And the other piece of it is, is 2015 a year where you are delivering more G650s than the 450 and 550s in the mix?

Phebe Novakovic

Analyst · Myles Walton of Deutsche Bank

So let me talk a little bit about demand and give you a little bit of color there. The demand for our in product – in production airplanes was quite handsome for the last quarter. The 650 and 280s increased, and interestingly but not surprisingly, when we got inside the demand curve for the 650 inside the 3-year delivery window, Q4 orders were particularly strong. 280 was again strong. The 450 and 550 demand has slowed slightly; it’s okay. Not super heated but good enough. And we continue to see strong demand primarily in North America and somewhat in Asia and also in the Mid-East. Heretofore we have seen no impact on oil prices on our backlog, or frankly in our demand. If you are asking what percentage of our backlog may have some exposure to energy related or have some energy related exposures, it’s about 5% but we haven’t seen any impact yet. I would add, we are seeing historically low operating cost which is -- usually drive increased flight hours, and that’s a potential upside for our service business. So we tend not to give you delivery with any more specificity than we already have with respect to models, when you break it up by large cabin and mid cabin. And I don’t intend to change that in a moment.

Operator

Operator

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

Doug Harned

Analyst · Doug Harned of Sanford Bernstein

Hi, I wanted to just follow up on that. On the G450 – excuse me, on the G550, when you look forward here, where are you today in terms of months of backlog, something that you’ve given us in the past, and how are you thinking about pricing as you approach the G500 and G600 coming into operation?

Phebe Novakovic

Analyst · Doug Harned of Sanford Bernstein

Yes. So I think you know that we don’t talk about pricing, that’s competitively sensitive. But let me give you a sense of where we are and first available. In general, for new customers, for the G650 and G650ER first available is fourth quarter 2017, that moved to the right a quarter from third quarter of last year as a result of our good order activity. The G550 is about 12 months out, the G450 late this year, so that moved a couple of months – a few months into the left. The G280 is also available – first available late this year and not that anybody asked, but the G150 is first quarter 2016. So it’s important to recall that deals are often in the works that move customers around in the backlog for earlier squad [ph] but the above is about approximate window for new buyers. So I hope that helps you.

Doug Harned

Analyst · Doug Harned of Sanford Bernstein

And you can’t really comment on the trajectory on pricing with the model change I guess, is that –

Phebe Novakovic

Analyst · Doug Harned of Sanford Bernstein

No, look, we have continued to hold price on products and you could expect that over time there is some price variability but we are not about to get into any specifics. That’s just not good a competitive place to be in a highly competitive market.

Operator

Operator

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

Robert Stallard

Analyst · Robert Stallard of Royal Bank of Canada

Phebe, on IS&T you’ve guided down 5.5% for this year. Can you give us an idea of how much of that is already in the backlog and sort of level of conservatism you might have based into that given the fluctuating situation with the DoD budget?

Phebe Novakovic

Analyst · Robert Stallard of Royal Bank of Canada

Given the what situation?

Robert Stallard

Analyst · Robert Stallard of Royal Bank of Canada

Fluctuating?

Phebe Novakovic

Analyst · Robert Stallard of Royal Bank of Canada

So we have about three quarters of our guidance for IS&T in our backlog. That’s exactly where we have been historically including recently. We’ve got good – we’ve got a high level of RFP – request for proposal activity and are bidding on a number of contracts. So we are pretty comfortable that we can hit our revenue guidance. And from our point of view, we’ve seen less fluctuation in the DoD budget with respect to our IS&T units recently than we had a couple of years ago. So we think that, that’s somewhat stabilized and as I told you, we anticipated 2014 would be our low watermark – it was better than we thought it was going to be, and I think some of that decrease bled into 2015.

Operator

Operator

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

Sam Pearlstein

Analyst · Sam Pearlstein of Wells Fargo

Hi. Can you talk I guess – I am going to try and put two things in there – but first on marine, I am somewhat that you are not seeing more margin pressure given what I would think would be more Bloc IV work and more Ohio replacement work in the year just in terms of the mix, so I guess what are you doing to offset that? And then just related to combat, you talked about growth resuming in 2016. Is this a business that we should now expect to see kind of growth in this still 15% kind of margin runway far into the future?

Phebe Novakovic

Analyst · Sam Pearlstein of Wells Fargo

Let me address your questions in the order that they were asked. We’ve talked frequently about margin variability at the marine group. There is really a mix shift and you quite accurately point out that we are experiencing a mix shift really frankly across our portfolio, more Block IV, less Block III, more commercial work coming off of the MLP program and first of class ships on the DDG1000 and DDG51 restart. That said, these businesses have continued to perform very very well on cost cutting, efficiency and their performance have been quite good, and I frankly expect to see margin expansion which is primarily driven by Block IV, we have increased margin potential and earnings potential from our profitability and efficiency as we move down our learning curve. So marine group continues to function very very well and I like their growth story. Combat systems growth, we have that significant backlog and now for us it’s all a question of performing on that backlog and I think this group has demonstrated its operational excellence and will continue to do so. So I expect – I have given you my guidance for 2015 but as I project out into the future and think about the business, it’s just going to be – we are going to see some growth in combat and I would expect to fully anticipate given the operational excellence of this group to see margin expansion but I am not going to bake any of that in now, on some of these programs. We are still in fairly new starts and low rate production but everything we see, this is a group that will continue to cut costs and improve its efficiency.

Operator

Operator

Your next question comes from the line of Hunter Keay of Wolfe Research.

Hunter Keay

Analyst · Hunter Keay of Wolfe Research

Phebe, can you talk a little bit about the variables that drive the decision to take up rate, as you look here across the global landscape, questions about global economic growth possibly decelerating particularly in emerging markets, a very strong US dollar right now that might be having an impact on some of your operating expenses. And sort of as that filters into potential cannibalization within the product lines, more of a G650 question anything else, but can you talk about maybe at a higher level for what factors you guys look at when deciding how to think about taking up production rates?

Phebe Novakovic

Analyst · Hunter Keay of Wolfe Research

So we have historically and as we talked about before, we’ve historically set our production rates and we’ve continued that practice based on what we see in demand, and to optimize around our economic efficiency, our supplier base and we’ve been very judicious year over year in setting our production rates and deliveries. So as I mentioned, we continue to see a very strong demand, particularly for the 650 – as our pipeline on the 650 is very good, the 280 also. So we really haven’t seen much impact on emerging markets, certainly not this year. North America remains very strong with us, Asia Pacific and we are also seeing some increased demand in the Middle East. I would also tell you that about 60% of our backlog is with public and private companies including Fortune 500, they may tend to be very stable and reliable and predictable. And as I said our pipeline continues to show interest on their part. So I hope that kind of addressed it, if you look at a complex number of factors, what our demand is, what our goals are for our operating efficiency, our supply chain, we manage prudently.

Operator

Operator

Your next question comes from the line of Peter Arment of Sterne, Agee.

Peter Arment

Analyst · Peter Arment of Sterne, Agee

Phebe, quick question on just the international demand, I know you gave us some good color on GulfStream’s impact, particularly tied to the energy end markets. You won a lot of orders in terms of combat this past year. How are we thinking about the international demand first under the defense business, I think that you have, and any risk tied to see some of the lower price of oil on that?

Phebe Novakovic

Analyst · Peter Arment of Sterne, Agee

The lower price of oil. I have been a big believer and I think history has demonstrated that demand for defense products is driven by threat and perceived threat, and you just have to open up the paper to see that the world isn’t increasingly unsafe place. So we see it in increased level of interest in parts of Europe and the Middle East, just as you might anticipate. Governments begin to rethink their spending priorities in light of some of the threats that they see both actualized and potential. So we have a pretty robust pipeline that’s continuing, in our IS&T unit and for combat now, I will tell you that the marine group has almost no and never had much international exposure. Just the nature of our Navy shipbuilding program.

Operator

Operator

Your next question comes from the line of George Shapiro of Shapiro Research.

George Shapiro

Analyst · George Shapiro of Shapiro Research

I want to pursue the margin at GulfStream a little bit more. This quarter effectively you had 60% incrementals and if I add back the 40 million higher R&D and G&A, you would have had a 100% conversion. So can you tell me what was so strong this quarter that all of next year’s probably going to decline if your numbers are right to 15% kind of incremental margins? And also, you had no pre-owned this quarter, you had three for the year versus 11 in ’13. So why does ‘15 pre-owned go up?

Phebe Novakovic

Analyst · George Shapiro of Shapiro Research

Well, that’s a compound question, George. So let me see if I can at least address what I think the essence is. The same, having less pre-owned this year clearly wasn’t upper to our margins. Pre-owned tends to carry no revenue. And we forecast pre-owned demand based on what we see in our backlog and sometimes that comes to fruition and sometimes not. So this has been a pretty sustained pattern over time with respect to pre-owned, it tends to be lumpy and we won’t know until the quarter of execution whether in fact anticipated pre-owneds come into our market or they are sold before they get to GulfStream. So that makes pre-owned a little bit tougher to articulate. We had the performance at GulfStream this year was extremely strong and we had a favorable completion mix in the fourth quarter that we are reversing somewhat going into next year. So we’ve talked multiple times about the fallacy of being able to predict with great specificity the GulfStream or aerospace margins and I will tell you Jet had a very strong year this year. And that contribution will be less next year primarily driven by a mix shift as they move into the additional completion work and they come down their learning curve. So all of these factors are planned at GulfStream and aerospace margins.

George Shapiro

Analyst · George Shapiro of Shapiro Research

Could you point to some unique things in the fourth quarter that caused such an extraordinarily high conversion that won’t repeat?

Phebe Novakovic

Analyst · George Shapiro of Shapiro Research

Well I think again gosh, George, I have tried, we’ve got less contribution from Jet and we had a favorable delivery mix on large cabin to mid cab and that’s a pretty – those are pretty big movers. So – and less pre-owned and that’s a big one. Pre-owned tends to carry very little with no or negative margins. So that in my mind explains.

Operator

Operator

Your next question comes from the line of Howard Rubel of Jefferies.

Howard Rubel

Analyst · Howard Rubel of Jefferies

Rather than be too granular here, I wanted to take a step back. As you look at your outlook and what you’ve asked your senior executives to do, where – as you look at the various risks might you see either challenges or opportunities and I use two examples and then hopefully you can add to that. One is some of your operations have European or Canadian based costs and you sell in dollars, so there may be some upside there, although I know you had some. And then also you embarked on a very aggressive research and development campaign at GulfStream and how have you assessed the risks and where have you felt like you’ve made progress? So it’s a bit of specifics and then wrapped in a little bit of the 805 to 810 is a nice start for the year but I am sure we won’t end there.

Phebe Novakovic

Analyst · Howard Rubel of Jefferies

So just to reiterate, we have given you guidance based on the same assumptions that we used last year, and our ability to do better is simply going to be as a result of share repurchases and outperforming our plan. If you look at our outlook, it’s informed by the last two years, where we focused on operations, reduced our costs and results, built our backlog. So we are poised for growth as a result of that backlog for several years to come. It’s a very nice position to be. We are going to see some good growth in ’16 and ’17 and the business is poised for that. We’ve been focusing on operations and what we basically call the back to basic which is blocking and tackling. That work is never done. So we’re going to continue to attack our costs through a relentless focus on our cost performance and re-engineering our business, that will make us more competitive, reduces our cost mix, more competitive and that two will help growth. So we have positioned ourselves nicely and I think we will continue to do so going forward. Our opportunities are because of our improved competitiveness, increased growth primarily both overseas and we’ve talked about that before. We’ve got another opportunity as margin expansion going forward as we focus on our continuous improvement. We’ve got – when I think about risks, you implicitly asked about foreign currency risk. We are less exposed to foreign currency variability than companies in other sectors for example and 60% of our business is with the US government and GulfStream’s exposures to the US economy. We have – there’s some translation difficulty year over year with respect to currency fluctuations, we’ve embedded those in our plan. We also have some nice natural hedges both…

Howard Rubel

Analyst · Howard Rubel of Jefferies

No, I actually meant the currency because of where you are building things is actually an advantage either in Europe or in Canada, that was a –

Phebe Novakovic

Analyst · Howard Rubel of Jefferies

Yes, in some instances, it is but we haven’t seen either up, nor down any particular impact in the moment.

Operator

Operator

Your next question comes from the line of Joe Nadol of JPMorgan.

Joe Nadol

Analyst · Joe Nadol of JPMorgan

So I have a couple but they are easy. One, once more, just on the clarification, on the combat side, you are seeing flat, you had these big orders obviously in your backlog that were from international customers last year. Can you give us some help with how much you expect international if it’s a case to be up and then US down in 2015? And the second one is just more broadly speaking, looking at the whole company, can you speak a little bit, whatever you feel comfortable, about the bookings that you are expecting across the company this year? I am particularly interested is, are there any of these larger combat opportunities that are still out there that might hit kind of $1 billion plus opportunities? And then also particularly interested in the 500 and 600 and what the tempo you expect on bookings there might be?

Phebe Novakovic

Analyst · Joe Nadol of JPMorgan

Okay. Complex questions. But let me address them in the order in which you asked them. We are seeing stabilization in our US land forces exposure at combat systems, directly in line with our expectations. And so we don’t really see any at least surprises that we can see in the near term. International orders are or international sales this year are comprised about in excess of 55% of combat sales, and we will increase to 60 over time not at the expense of our domestic activity but just as a revenue expansion. So we do – we still have a lot of I’d say number of international orders in our pipeline that are of decent size, that is our – it is our expectation that given our competitiveness in our cost structure we are going to be having some competitive in the competition. So we have additional upside in building our backlog at combat but I am not prepared to give you any specifics on whether that makes it a book to bill of 1 to 1 in any one given year, that will depend on a lot of things on when these competitions are decided but we’ve got a lot of proposal activity out there. And with respect to 550 or 500 and 600 tempo, both of those R&D programs are proceeding at pace, and no major changes since the last time we talked to about it. Our pipeline is very robust and I expect sales to increase as we orders to increase as we get closer and closer to the entry into service as a 500 and then the 600. So there is no – there have been no stumbling blocks heretofore and our profiles on R&D and production of the test airplanes remain right on plan. So we are very pleased with that and we are pleased with the interest that both of these models have generated.

Operator

Operator

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

Jason Gursky

Analyst · Jason Gursky of Citi

Similar to Joe, one clarification question and then one, on the growth for combat systems out into ’16 and ’17, can you offer a little bit of more insight on the type of growth that you might be expecting there? And then if you wouldn’t mind, just driving down into IS&T, where are you seeing relative areas of strength in ’15 and weakness in ’15, just what’s the mix doing there?

Phebe Novakovic

Analyst · Jason Gursky of Citi

I don’t want to get into specifics about ’16 and ’17 other than we are – at combat, other than we have the backlog and are poised for reasonable growth, growth that we will manage according to our terms and conditions of our contract and also our supply chain. So I would expect growth but not of a double digit nature. We don’t think it that way. We are not going to burn off that backlog that quickly. It’s not efficient and it’s not in accordance with the terms and conditions of our contracts. The second part of your question –

Jason Gursky

Analyst · Jason Gursky of Citi

The mix at IS&T where you’re seeing –

Phebe Novakovic

Analyst · Jason Gursky of Citi

Mix in IS&T. So we have – as you know, over the last few years, our IT services business has composed a larger percentage of our revenues, that is somewhat changing as a percent of revenue. We, you may know, combined two of our non-IT businesses and AIS and C4 systems into mission systems. And over time there it is our anticipation that they will grow as a larger percentage of our IS&T sales than IT. But both of those businesses are poised very very well for – again no single digit growth but still growth and I would add that I am very pleased with their margin performance. It’s particularly interesting that’s a year that we had some revenue decline, considerable revenue decline, we outperformed on margins and this year we expect revenue decline and again higher margins and this time bring it with higher earnings than last year. So that’s a pretty wholesome story from my perspective.

Jason Gursky

Analyst · Jason Gursky of Citi

Phebe, on that, just point of clarification, do you anticipate then at the end of 2015 to be kind of in a flat revenue environment year over year or creeping into a positive territory on IS&T?

Phebe Novakovic

Analyst · Jason Gursky of Citi

We are projecting a positive territory, positive growth. In fact, with every single one of our businesses.

Operator

Operator

Question comes from the line of Carter Copeland of Barclays.

Carter Copeland

Analyst · Barclays

Just I will stick to one and I want to switch gears and go back to the cash flow and capital deployment discussion. And the question is, is there an upper bound to how much balance sheet you might use to normalize your free cash flow deployment, should we think of this as whatever the gap to 100% conversion is, is what you use in the balance sheet or could it be more extensive than that?

Phebe Novakovic

Analyst · Barclays

Every year we provided the same kind of guidance with respect to capital deployment and that is that, we at least in the two years and again this year, have anticipated deploying all of our free cash flow in share repurchases and dividends and we anticipate doing that again this year. But as with every other year, we give you the overall strategy and then the execution – the tactical execution comes during the course of the year. So think about in general terms that we will use our balance sheet to – and you quite I think accurately put it, normalize our cash flow for share repurchases. But I see no fundamental reason or a benefit from tapping into our balance sheet beyond that for share repurchases. Some of you have requested that we just – not necessarily you all but some out in the environment had requested that we go into our balance sheet early on and buy a significant number of shares. And I argued them and I will continue to argue now, I don’t think that’s judicious nor prudent, and I think that this year is a perfect example of why you don’t want to have expended all your bullets in prior years. Think about us as telling you what we are going to do at the beginning of the year and doing it and having very very reliable results and execution of our capital deployment in the year. So this year outlook very similar with respect to what our capital deployment intent is. Free cash flow and little bit or and some of the balance sheet depending again on where we are on free cash flow.

Operator

Operator

Your final question comes from the line of Joe DeNardi of Stifel.

Joe DeNardi

Analyst · Stifel

Phebe, maybe another one on the balance sheet, I appreciate your comments about not wanting to expend all of your bullets. But maybe longer term once the defense budget environment were to improve, would that change the way that you thought about using your balance sheet relative to some of your peers?

Phebe Novakovic

Analyst · Stifel

The way I think about the balance sheet is we have a strong balance sheet that gives us flexibility and agility and opportunity both in the year of execution and going forward. And I intend to preserve that flexibility and I intend to preserve the strength of that balance sheet with some variability in any given year, but not taken up cash off that balance sheet to change our overall firepower. So as I sit here today, that is our strategy and we will adapt accordingly in the future as circumstances may change.

Joe DeNardi

Analyst · Stifel

And then in terms of the fourth quarter guidance, the big fourth quarter, is there any particular segment that’s especially lumpy, are you waiting for any big awards to come in later in the year to hit that guidance?

Phebe Novakovic

Analyst · Stifel

No. The quarterly distribution of EPS that I gave you in my remarks is typical of our performance that we tend to start out light, build throughout the year and have a strong fourth quarter. So that’s very consistent with that ebb and flow of our business. End of Q&A

Erin Linnihan

Analyst · Stifel

Well, thank you all for joining our call today. If you have additional questions, I can be reached at 703-876-3583. Have a great day.