通用動力 (GD) 2005 Q3 法說會逐字稿

Good day and welcome to General Dynamics third quarter 2005 financial results conference call.

Today's call is being recorded.

For opening remarks and introductions I'd like to turn the call over to Mr. Ray Lewis.

Please go ahead, sir.

Thank you very much.

I'd like to welcome the members of the investment community and the business press that are on the call with us today.

I would like to remind you that you are likely to hear forward-looking statements today.

They represent our best estimates of potential future performance, but they are subject to the normal risks that all businesses face and if you have an interest in more detail on that subject it's outlined at a rather lengthy report in our 10-Qs and 10-Ks, and with that I'd like to turn it over to our Chairman and CEO Nick Chabraja.

Thanks, Ray and good morning.

As our press release and its appended schedules would indicate, we had a very strong quarter.

Our earnings per share of $1.84 are up 15% over the year ago quarter, and I think substantially exceeded analysts' expectations and to some degree our own.

Whether one compares this quarter's performance to the same quarter a year ago or to the preceding quarter this year, the results are equally impressive.

And for that matter so are the first nine months of this year when measured against the comparable period in 2004.

Let me see if I can give you my perspective on the quarter in each of the major categories.

First addressing sales.

Net sales of almost $5.4 billion are up 16% over the same quarter a year ago and up 3% over our second quarter this year which was really a very powerful quarter for us.

Growth at IS&T, Combat Systems and Gulfstream was all very good, and sales at the shipyard have held steady, both year over year and quarter over quarter.

From an earnings point of view I was pleased that operating earnings were up 19% over the year ago quarter, despite a $31 million charge that we took in the quarter at NASSCO on the commercial ship building program that we've discussed together so many times.

Margin performance was robust, and IS&T, Combat and our Aerospace segments, and the overall average margin in the quarter was 10.9%.

Net earnings were strong -- $374 million.

ROS, return on sales is 7%.

Some of you might be aware that's a performance point that I have been targeting in my public remarks, and been been driving us internally so I'm pleased that we got there.

Just as important as the strong earnings, we delivered very strong free cash flow of $527 million for the quarter.

About 140% of net income.

The result was driven primarily by reduction in working capital in addition to the strong earnings.

We had a good quarter from a business development perspective.

We secured 5.1 billion in new orders an overall book-to-bill ratio of almost one-to-one.

That's particularly impressive when you consider the fact that our Marine orders come typically in large chunks, in sometimes multi-year contracts, but until we get to that season of the year we are burning about 1.1 billion a quarter.

So very good.

We showed particular strength in the IS&T segment, which reported a book-to-bill ratio in the quarter of almost 1.4 to 1.

Gulfstream order activity remained very strong.

Once again on a dollar and a unit basis, Gulfstream's book-to-bill ratio exceeded 1 to 1.

That resulted in a $43.4 billion backlog.

For all practical purposes about same as last quarter and significantly higher than where we were at this time a year ago.

In summary we had another outstanding quarter.

I'm especially pleased by the revenue growth, margin expansion, and cash generation.

I suspect you would like me to address my thoughts on the fourth quarter, and how that brings us out for the year.

I think on balance we would have to increase our guidance, which was $7.05 the last time I talked to you and we are looking internally at $7.15, and I encourage the analysts not to run away from us.

Just my global view on this i,s IS&T will give us good volume in the fourth quarter, maybe slightly less than they did in the third, which was outstanding and we should see a modest degradation in their margin performance.

I'm not talking about a lot, but I'm not looking forward to repeating this 11.5% in the fourth quarter.

Combat systems will see increased volume, significantly increased volume, maybe not to the degree they had planned earlier in the year when we had been predicting 18 to 20% growth.

You should think about 15 to 16% now overall.

We've run into delays, timing issues.

And they ought to hold their margin performance similar to what it was in the quarter.

Gulfstream will have a good fourth quarter.

Their margin rate a little hard to predict but it will look like this quarter.

Maybe not quite as good.

And I think you'll see improvement in the Marine group going forward.

I think we've kind of cleaned them up in the quarter.

And you probably ought to look for margins from them in the 6.5 to 7% range in the fourth quarter.

Given all of that, I think $7.15 is a reasonable and appropriate guidance.

With that having been said, I'll turn it over to our Chief Financial Officer, Mike Mancuso to add some additional detail.

Thanks, Nick, and good morning, ladies and gentlemen.

I really don't have a lot to add to what Nick has already said.

We had another very strong quarter with almost across the board improvement in every important metric, notwithstanding the fact that the bar was high to begin with.

As was our practice included with the press release is several financial exhibits including a breakdown of our backlog by [inaudible], aircraft deliveries out of Gulfstream, and a reconciliation of year to date cash flow to net debt.

Focusing on cash flow for the moment you can see from Exhibit H, that our net debt at the end of the quarter is $1.5 billion, half of what it was at this point last year.

Free cash flow from operations is $168 million ahead of last year.

Also you should know there were no share repurchases in the quarter.

Our tax rate in the quarter was 32.7%.

The year to date rate is 28.7%, influenced by the $66 million tax credit we recorded in the first quarter.

I expect the rate to approximate 33% in the fourth quarter, which should average the full year at just about 30%.

That having been said I'll turn it back to Ray to begin the Q&A.

Thank you, Mike.

As we've made our practice in recent quarters, we are asking you to have one question and if you want to ask another question, get back into the back end of the queue so that gives more people opportunities to ask questions on these calls.

And with said, Operator, if you will instruct people how to get into the queue?

[OPERATOR INSTRUCTIONS].

We'll take our first question from Cai von Rumohr with SG Cowen.

Yes, excellent quarter, Nick.

You've changed your guidance for Combat for the year.

You've mentioned some delays.

Could you be a little bit more specific in terms of what the delays are, and what that means for next year?

We're a little bit slow in Europe, slower than we anticipated.

We'll have a very good fourth quarter.

Land Systems will meet all of our expectations.

It will be up all the way around over what we anticipated.

We're a little slower in our ATP business with deliveries of the Hydrorocket.

But mostly Europe.

Thank you.

We'll take our next question from Steve Binder with Bear Stearns.

Nick.

Maybe just touch on over Marine, I know you're looking to get some recovery, potential recovery on the submarine contracts, you were talking to the Navy about that and also with respect to the tanker program as far as vendor related issues.

Any progress there?

I gather you didn't basically book any income from that.

Maybe just touch on that, and also, just on the tanker program, any change in the delivery schedule, which was Q4 for the third boat, I think, and third quarter of '06 for the last boat?

Steve, the most significant claims have to do with the tanker program.

The request for equitable relief and adjustments that we've made with BP and those are under discussion.

I'll have nothing to say on those.

The color I want to give you is we were at 98% complete on the third boat, at 67% complete on the fourth boat.

We've seen nice improvement in the fourth boat but not good enough to make our EAC.

We've got new management, a new leader down there soon and it was a good time to sort of do all we could from a bookkeeping perspective out there.

I think going forward, while we're not without risk, you shouldn't see -- this is my personal belief, charges from us in the near term.

That program will be what it is until the very end, I think, until the fourth boat is delivered, and then we'll either make our labor hour nut or we won't, and you may well see us report income, instead of charges depending on how we do in our discussions with our customer.

The thing you mentioned at electric boat is not a request for equitable adjustment.

It's a notification of change to our repair customer indicating to that customer that the scope of the job was greater than had been anticipated, and that's being reviewed with the customer and doesn't result in any action taken in the quarter.

So I think, Steve, that as we make recoveries on these matters, we'll report it but up until then we won't speculate about it.

Thank you.

We'll take our next question with George Shapiro with Citigroup.

Good morning, Nick.

Good morning, George.

In Gulfstream, if you make the adjustments for pre-owned aircraft, the incremental margin was more like 16-17%, and you had said that the second quarter was particularly robust in terms of mix.

Is there anything that was a little weaker in mix this quarter?

I mean, it's still a good number, it's just not the same degree of strength we saw in the second quarter.

I don't think that's true, George.

Let me go back and look at some numbers.

When we were -- just at the reported line and I'll adjust it for you.

In the second quarter, we were at 15.1 and this quarter 16.1.

When you adjust the second quarter to eliminate both volume and profit on pre-owned we were at 15.6.

When you do the same thing this quarter we're at 16.2.

So we crept up a little bit.

I agree with that.

I was sitting there and when I looked, year over year, I'm not looking sequentially right now.

Yes.

Year over year -- oh, you're talking about a 16.2 when adjusted for the losses in the year before, yes.

You had a little profit.

Made the correct adjustments to the pre-owned.

That is unique they are about the same, George.

And that was, that quarter a year ago was uniquely high, because throughout adjusted they were 11.4, 13.6, 16.2 and 13.9.

I don't know what it was in the third quarter a year ago, I really don't.

This quarter, if you were to change the question just a little bit, to what what would I attribute about 600 basis point improvement?

I would say it had a lot to do with price, because in terms of our manufacturing costs, we were somewhat over budget on the big aircraft in terms of the green deliveries in the quarter, as we struggled with new product and beefing up the supply chain for increased volume, but we did better than budget on the completion side of the business, and will continue to do so but that left me a little bit high in cost in the quarter and that was more than offset by the firming prices, so I think that gives you a snapshot, George, of the dynamics in the quarter.

But the mix was okay.

It was good.

It was appropriate not unusually heavy in low margin aircraft.

It was a balanced quarter.

Okay.

That's good color.

Thanks.

We'll take our next question from Heidi Wood with Morgan Stanley.

Good morning.

Nice quarter.

Nick, you talked about European land combat sliding a little bit to the right, but I seem to recollect some of your guidance was that future combat systems had been restructured and that contributed to the delays earlier in the year.

I wanted to get a sense as to how that is tracking, and there had been discussion about a possible PBD-754, and that included a question about cuts to future combat systems.

Can you talk about in terms of the range of cuts you've been privy to with your customer, how much you contemplate that might change your share of work next year?

Future combat system restructure, I think was part of the reason that first quarter volume was a little soft.

The program in fact got restructured.

And money added to the program ultimately, but it resulted in our having very satisfactory but somewhat less than anticipated volume.

That was more than offset by growth in many programs at Land Systems, all of which in fact happened in the year.

Striker volume is up.

M1A [to set] volume is up, reset volume or AIM volume is up.

Medium weight vehicles in Canada, up.

So Land Systems had a powerful year, more powerful than was anticipated, but in fact we didn't get, we don't think we're going to get all of the deliveries that we anticipated in Europe.

And they'll fall into the next year.

For one, the Portuguese program was slow to mature.

We won it in getting it in the contract and into production where we could begin the report sales and earnings has been slow.

Okay, with respect to the probability of a PBD-754.

You know, Heidi, I don't pay attention to that at this time of the year.

We have very real activity.

Facts on the battlefield right now today for us, and that happens to be called the Joint Conference of the House and Senate Appropriations Committee.

There are very real dollar differences in their '06 appropriations number and in the '06 supplement.

That is real.

That will be a fact and it will be discernible by November.

And as you know, we're now in the cost-cutting drill that happens every year at this time, and you can't in the fall of the year find any human alive, either on the Congress or up in the Pentagon, we'll tell you there will be an increase in defense spending, and we'll just have to wait until probably February of this year or March when the president's budget comes down, and after we see a QDR.

Right now it is just the rankest kind of speculation.

Usually it's not fit for publication in general media, but appears regularly in trade press.

So I don't want to speculate on future combat systems and how it will be.

I think the Secretary of the Army and Chief of Staff of the Army have continued to assist that it is their most important program, their number one priority and I have no reason to believe that Army won't fight as hard as they can for their funding line.

Okay, great, Nick.

Thanks much.

I'll get back in queue.

We'll take our next question from Sam Pearlstein with Wachovia.

Good morning.

Nick, I think it's been several years since you've ended with a balance sheet with a net debt to cap under 14% like you are now.

You certainly didn't buy stock in this quarter.

You did earlier in the year.

But I guess, can you talk about how you're thinking about using that balance sheet given these potential budget issues and other things like that going forward in terms of acquisitions versus buyback?

We're going to use it the way we've always used it.

We're going to buy our shares when we deem it appropriate, and we're going to make our acquisitions to help us, help our businesses, strengthen our overall strategic posture and help us make money.

We'll take our next question from Joe Nadol with JP Morgan.

Good morning.

Nick, on IS&T, sales obviously were very strong for the second straight quarter.

Nice high teens sort of growth.

I know you already gave your guidance for the fourth quarter, which is volume down a bit.

Thinking more about next year.

What's been driving this type of growth specifically, has it been across the business, has it been specific to certain segments, and what conclusions can we draw from next year?

From a volume perspective next year looks okay.

I think that the Street has anticipated that the rate of growth in IS&T declines next year.

I can't remember what -- right now what Street expectations is but we're having a relatively significant organic growth rate into double digits.

I had computed about 10.5 but hard to compute because of things we bought we blended and integrated fairly quickly and it's hard to separate them once you've made porridge.

But I think the business will continue to grow at a slightly lower rate.

We'll be in the single digits for our growth rate.

The growth has been driven by a number of enormous program wins, and in particular, in the recent quarter in the prior quarter support for our troops in the field.

There have been significant sales of encryption products, operating centers, theater operating centers, JNN has been a very active and robust program and, of course on the service side, we're supporting many of our systems in the war against terror throughout the intel community, both in the active theaters and in other places in the world.

So to some degree the pace of the war on terror and in other respects the deployments in Afghanistan and Iraq have contributed some added volume in the second and third quarters, but I think we'll see growth in IS&T, and I'll say more about that I think when I get an operating plan that I've approved, which will be mid-November and then we'll take the first opportunity we can to give guidance for next year, not just at the bottom line but throughout the operating units.

But you know, Joe, there's a lot hanging fire as I mentioned earlier in my response to Heidi's question, the gossip and the rumor is all about the '07 budget, the fiscal '07 budget.

Well, for us that's a long way away.

There is an awful lot of programmatic detail and money that's hanging fire in the Joint Conference and when we have an appropriations bill, both the bill and the supplemental, then I'm in a lot better position to talk about what volumes should look like next year.

Okay.

Thanks, Nick.

We'll take our next question from Howard Rubel with Jefferies.

Thank you very much.

Nick, on that note about the Joint Conference, talk a little bit about the strategic issues you face with Marine.

We all recognize there can't be one shipyard.

How do you sort of influence the debate so that you can earn a fair return in the business going forward and support what the customer wants longer term?

From a Naval ship building perspective, even at the really low rates of production we're operating at now, most of our facilities, we've been able to do reasonably well on Naval ships.

We've been beat up on commercial ship building, but the key to electric boat returning to the kind of profitability that the financial community is accustomed to from us is two submarines a year, and I think we're getting to the place where the nation is beginning to recognize the need for more attack submarines and I expect that to happen sooner rather than later.

Surface combatants, a little hard to tell right now, right?

We've, we're coming towards the end of a long and successful class of ships for the Navy, the DDG Bourque class and we have not gotten a start on the next class, the Navy clearly would prefer to build DDX, we are very supportive of that, together with our partner, Northrup Grumman, and we all know about the expense associated with this boat that is really a marvel of technology.

It moves the state-of-the-art and hopefully the Navy will be able to afford that.

We'll support them in that regard.

If not I'm confident that they'll find another course, another way forward, and that we'll be building surface combatants both in Bath, Maine and Pascagoula, well into the foreseeable future.

On the transport or auxiliary ship side, I think if you've been following the remarks of the CNO, it's almost a Clarion call for vast C-lift ships, and we remain poised to help in that regard at NASSCO so I don't see the picture as bleak at all on the marine side.

I think we've had performance issues, and gotten our noses bloodied, but I think we fought our way through those, largely, and I think you'll see improvement, little by little, and I also think that strategic positioning of these businesses, both ours and Northrup Grumman's will improve.

I think that's reasonable.

I mean, I just think there's a lot of noise and a lot of fire and brimstone and the reality is going to be that strategically what you've got is fairly valuable.

I think that's right and I think that we have a Naval customer that recognizes the strategic necessity of these great shipyards and what they bring to the game so we are comfortable with where we are.

Thank you very much.

We'll take our next question from Robert Spingam with Credit Suisse First Boston.

Good morning.

I wanted to ask you if we could just revisit Gulfstream for a moment.

Could you comment on the sellout ratio for '06 and '07 given the strong book-to-bills we continue to talk about, and also the Q4 margin guidance, what does this anticipate, more used aircraft or perhaps a mixed shift?

Let's see.

Gulfstream at the end of the quarter speaking as of the end of the quarter, on large aircraft was somewhat over 90% sold out.

They have 72 production slots and they had 7 remaining to sell, no deliveries, green deliveries available until the fourth quarter of '06.

Since that time, we have received five orders in the first two weeks of the year, and have -- I mean, of the quarter, and have taken 19 letters of intent funded with deposits so I can't tell you how that percentage has changed but I'm confident that it has.

On the mid-sized craft, we were a little bit over 62% sold out at the end of the quarter, and that is also moved forward since then.

So we're further along than we were a year ago at this time by quite a bit, and I don't have percentages for you on '07 but I can tell you that there isn't must have availability in the first two quarters for green aircraft in '07.

And on the fourth quarter?

Margins?

Fourth quarter we just think that we have a couple more lower margin rate aircraft in the mix and slightly increased research and development spending in the quarter.

We're ramping up.

So they're predicting at the moment a modest decline in the overall operating margin.

We'll see what happens.

Thanks very much.

We'll take our next question from Nick Fothergill with Banc of America.

Nick, I'd like to follow up on the strategic question regarding the US Navy.

How are your thoughts evolving on the Navy now, particularly after the CNO's guidance.

Do you think we might get to a greater than four ship delivery program for '06 and in '07 and beyond what's the chance of getting to a 7-8 ship run rate?

I suspect that the CNO's guidance can't hurt much with respect to '06 to the extent that it still hangs fire but it's a little late.

There is the possibility if you look at the way the conference is postured of coming out of that with five boats instead of four.

If I remember it right, it's in the house mark, there's two PAKEs.

If that were to happen, that would be five ships instead of four.

I guess there's more upside, even, than that, because in one of the marks there's two LCSs, where there are none in the budget which would drive that to seven, if all of that happened.

I suspect when the compromising is done, if I had to guess it would be more than four and fewer than seven.

But I think a good thing to watch is that bill as it comes out of conference, and the next thing to watch is the QDR, and what it says about the nation's need for ships and then, of course, next year's budget and that sequentially will be the things that we need to look at to move along in ship building, and then, next, the Congress's response.

When does the CNO reveal his ship building guidance?

Is that going to be within the QDR or the '07 budget?

I don't know.

I think it will be embedded in the QDR.

Great, thanks, Nick.

We'll take our next question with Byron Callan with Prudential.

Good morning, Nick.

Just you mentioned the robust business activity in the quarter and I'm curious looking over the next two or three quarters, can we sustain that pace?

Is there still out there to bid on new contract awards, where do you see this going?

I think it will be okay going forward, there's plenty of activity.

Anything we can point to in a large program category?

I don't think so, Byron.

What you're going to be looking at is contracts for PAKEs, contracts for vehicles that come annually, extended contracts on large program wins in IS&T, increased ammunition contracts, I think you're going to see plenty of contracting activity.

That doesn't mean that it flows out of competitions.

Okay.

Great.

Thank you.

And our next question will come from David Strauss with UBS.

Good morning, Nick.

Can you touch on the '05 supplemental, and how you're doing on sign-up contracts on it, and update us on how you think that will flow through?

I really don't know, David.

It's slow, slow to mature in the contracts.

It's coming, but all kinds of fire drills.

So at this point you're not seeing anything from it?

I don't want to say that, either.

I just, I think we'll announce it as it comes, is the better way to put it.

Okay.

Thanks.

Our next question will come from Troy Lahr with Legg Mason.

Thanks.

There's been a lot of positive news from the Army on Striker performance in Iraq.

Has this sparked interest from the international community on the program and if so are you relying on international activity on Striker to fill a potential gap between striker and EFV?

One of the things that I can point to is the Canadian government ordered an order for, I think, 64 mobile gun systems.

The gun variant of the Striker.

The opportunity for lab sales is extraordinary throughout the world.

That doesn't mean it will be the Striker.

Right now we can't deliver Strikers because we are doing all we can to give them to the U.S.

Army and to Canada, but from Moag in Switzerland and we are in fact selling Lavs, which is a related product.

They call it Piranha there.

The Striker is a U.S. army modification to the LAV3 platform, there is a robust market for that vehicle and we'll shift the production around to suit us.

Does that extend out until EFB starts picking up?

I don't see any end in sight for this kind of vehicle production.

Okay.

Thanks.

Take our next question from Doug Harned with Sanford Bernstein.

Good morning.

On Marine, Nick, can you talk a little bit about change in leadership at NASSCO and what you're trying to accomplish there and if it has any effect as well on electric boat.

One thing specifically you've talked about the tanker program, but at NASSCO the PAKE program, given some concerns on schedule that have been expressed by the Navy, how is that progressing?

I didn't get the last part of that.

It was the third or fourth question.

You want to sneak it in again?

Okay, I'll sneak it in again.

I was interested in just how PAKE as part of NASSCO is progressing?

Okay.

Well, Dick Vortmann who has been the longtime president of NASSCO well before we acquired the shipyard and a ship builder of distinction, has retired or will retire effective, I guess, December 1.

Dick will remain with us in a sort of nonexecutive capacity to help us prosecute various claims that we have, and work on some new business that he's been working on, and we had to make a decision about who was going to run that shipyard and we are very pleased with the NASSCO team as reconstituted, and we had several very attractive candidates there, one in particular.

Fred Harris is an executive in whom Mike Toner and I repose great confidence.

He has been a winner throughout his career at Electric Boat and I'm sure John Casey would tell you he hates to lose Fred Harris, who is his Senior Vice President - Programs.

Fred has had a number of jobs throughout the shipyard over time.

He grew up in the engineering end of the business, but then he took over innovation and then he took over programs, and for a while was the program manager of the Virginia class effort.

He's the guy that we tap to go to the West Coast and get the job done and create the kind of energy that we want to restore that shipyard to its former profitability and I have a great deal of confidence he'll do it.

Electric Boat now has sent leaders to all of our shipyards and that shouldn't surprise anybody.

It was and is a great shipyard with enormous talent, and we made the judgment that we can afford to give Fred up and we're grateful he's decided to move his family to the West Coast and get the job done there.

You asked about the PAKE program, it's really in its infancy, and we're not at the moment booking profit on that program until we see how it further develops but that's where we are and part of Fred's job is to get that to the place where we can start to record earnings on that effort.

We've got to get these BP tankers out of the yard.

Great.

Thank you.

Next from Lehman Brothers, we'll hear from Joseph Campbell.

Nick, you've answered just about every question I can think of, but I do have one, which is anything else going on in the conference besides the ship pluses and minuses you already talked about?

Thanks a lot.

I think that there are differences between the House and the Senate in both the bill and in the supplemental on a variety of our combat systems and IS&T programs as well as the shipyards, so we're watching that with great interest.

Nick, can you be more specific?

Joe, I'll tell you what, you can pick up a comparison of those two bills.

It's over 30 programs.

How much money is it for you at risk, or to gain?

It's not at risk.

It's what will it be?

Well, that's why I say.

THey're going to divide it in two, or one will give in to the other, but if it comes all your way, how much better is it, if nothing goes your way?

Joe, I don't know.

All right, I'll read it myself.

You got to go do your work on that one.

All right, Nick.

Classic conference call.

Thanks.

Thank you.

And we'll take our next question with Ron Epstein with Merrill Lynch.

Good morning.

Nick, I wanted to follow up on a comment you had earlier on when you were talking about production at Gulfstream.

You mentioned there were higher costs in the quarter having to do with the supply chain?

No, no.

I said we have higher costs associated with the ramp-up.

We've increased production, some of it with the product we receive, some of it with the work we do ourselves, that manifests itself with rework and overtime.

So our production costs to manufacture green aircraft has been up in the quarter somewhat.

The trend appears to be right down again, the last three aircraft ship sets show a trend back toward our budget line but not there yet.

On the completion side, the good news is we are running well under budget but when you put the two together we're still over budget on the cost side of production.

That's been offset by price improvement.

Okay.

So here's my actual question for you though, with the business jet market in general recovering and the commercial jet recovering, are you guys seeing pressure on your supply chain at Gulfstream?

I think every time you ramp up your production you put pressure on your supply chain.

Where are you seeing it or are they handling it pretty robust?

I think everybody is struggling with increased production.

You're a fool if you can't, if you can say I can tune this up 10-20% and it's no problem.

I don't believe it.

It's always going to be a problem.

We'll struggle and so will our suppliers.

But they'll get it done.

They want the business just like we do and we have a demand to satisfy and we'll satisfy it and I think they will, too.

Thank you.

And our next question will come from Myles Walton out of CIBC World Markets.

Thanks, great quarter.

A little more color, if you could, on the cash flow given the strength of the quarter.

Was it just the reversal of some of the working capital investment in Q2, and second on the FACS jury settlement.

I guess you have 150 days to respond.

Is there any anticipation to take reserves against that at the present?

Myles, the cash flow was just as I said.

Our guys were doing a good job converting working capital and bringing it down to cash.

We will, we didn't even get any consideration to taking a charge on that lawsuit.

It will be what it will be in the quarter when it occurs, it's six months away from judgment.

The court was quite emphatic.

He would not enter judgment on that verdict.

Invited the tax on that verdict a nd we're going to accommodate that request.

So I don't anticipate taking a charge until such time is there is a judgment.

Great, thanks.

And we'll take a follow-up question from Heidi Wood with Morgan Stanley.

Nick, can you give us some color and I'm sorry because I only started the call a little bit late, so maybe you already talked about it but give us some color on IS&T by division.

Were C4 Systems and networking some of the biggest drivers, and can you tell us what the blend of cost plus versus fixed price has been year to date at as IS&T?

I don't think I can, Heidi, with respect to the last.

But let's see if I look at it, AIS, our classified business has been pretty steady across each of the first three quarters throughout the year.

A little bit of volume improvement over a year ago.

Strong growth at C4 Systems quarter over quarter throughout the year and substantially over last year, but we've had some acquisitions in that business as well but very strong organic growth also.

And we have had strong quarter over quarter growth at Network Systems, but they're just a little bit up on a year ago, and we've had pretty good volume growth over the year at our UK business.

So a little bit across the board.

And you have $7.3 billion in backlog at IS&T and that is obviously a shorter cycle business than the backlog in Marine.

How should we think about how that backlog spends out?

When I look at that kind of backlog, just to play devil's advocate why shouldn't we assume that a lot of sales for '06 are already in hand?

You have to look at the backlog in the IDIQ contracts in this, and the interesting thing in this world is you always have to chase the funding.

Okay.

So I think they're in pretty good shape for next year.

But we'll see exactly when we know a little more about how some of these programs actually get funded by the Congress in this conference.

It's always much more entertaining to follow the rumor than it is to follow the real hard fact and that's you want to follow the money, that's where it is.

But if we back out, Nick, I'm just going to persist on this point, if we back out the IDIQ stuff, how should we think about when we look at, you've had a couple of years of IS&T now and you've had a chance to have some visibility on how this tends to spend out.

I mean, ex-IDIQ, does 60% occur in the year following?

Heidi, I don't have any notion.

I don't run that test.

They tend to have at the very most one year of backlog.

That would be extraordinary and that's about what they have.

It's been our history with these businesses that they've been running about six months of backlog, that's as opposed to the large platform businesses that have multi-year programs and multi-year awards that can have one to two times or more their annual volume as the marine group does.

But this for IS&T is robust a backlog and then the opportunities that are presented by the IDIQ contracts is just the best I've ever seen it.

Okay.

Good.

Thanks very much, Nick.

And, Operator, we have time for just one more call.

We'll take a follow-up question from Steve Binder out of Bear Stearns.

Nick, you were pretty forthright about some of the issues of Combat and manufacturing costs of Gulfstream, just wondering if you can do a walk through looking at the entire portfolio.

You've quantified and identified the tanker issue for the last couple years but other issues like submarine, the repair jobs, any EAC issues in the portfolio that make you feel queasy at this point?

You touched on Combat.

No, Steve.

I don't think so.

We don't over on the IS&T side we don't have a significant troubled program, when you have 2000 contracts it's hard to say you don't have one that's not red, but they are usually modest as to amount and don't represent significant risk in the quarter if they go bad for you, it's a matter of basis points, not -- doesn't change the game plan.

We don't have anything on the Combat Systems side that's disturbing to me in any respect, mature programs will ultimately restructure Europe, and we could have some charges there in terms of personnel dislocation and so forth, but I can't even predict when that will happen.

We have three businesses, four, really, and we have to decide how best to operate them together in the future but the other thing we've identified for you is PAKE.

I don't feel at risk in that program, but it's not performing in terms of producing profit for us and we want that to have, we want that to happen.

I think as we get additional boats, of course, as you're going down the learning curve that's helpful, so and I expect to either get one or two PAKEs and I think that will help the overall program EAC , and I expect that over time we'll make improvements to our own performance because the flight of ships is long enough to give us time to do that.

But I don't see anything, Steve, that the risks in our business I think are fairly well publicized because we are forth coming about them.

We have the A12 case that still is out there that we've disclosed quarterly.

But from a programmatic point of view I don't see anything that we haven't discussed with you.

Thank you.

And thank you all for being on the call with us.

This is Ray Lewis again.

My associate Carl Johnson and I will grab a bite to eat and then take your phone calls in our offices if you have any further questions.

My number is 703-876-3195.

Carl's number is 703-876-3172.

And good afternoon.

And that does conclude our conference.

Thank you for your participation and hope you enjoy the rest of your day.