通用動力 (GD) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the second quarter 2010 General Dynamics earnings conference call.

I will be your coordinator for today's call.

As a reminder, this call is being recorded for replay purposes.

At this time, all participants are in listen-only mode.

(Operator Instructions).

I would now like to turn the presentation over to Amy Gilliland, Staff Vice President, Investor Relations.

Please proceed.

Thank you, Ann, and good morning everyone.

Welcome to the General Dynamics second quarter conference call.

As always, any forward-looking statements made today represent our best estimates regarding the Company's outlook.

These estimates are subject to some risks and uncertainties.

Additional information regarding these factors is contained in the Company's 10-K, and 10-Q filings.

And with that, I'd like to turn the call over to our Chairman and Chief Executive Officer, Jay Johnson.

Thank you, Amy, and good morning, everyone.

General Dynamics' second quarter performance was solid, delivering $8.1 billion in sales, and record operating earnings of $985 million.

This led to earnings per share of $1.68 on a fully diluted basis, $0.07 ahead of last year's second quarter, and $0.14 ahead of last quarter.

Operating margins in all four groups were very strong in the quarter, driving 12.2% Company margins, 50 basis points better than last year's second quarter, and 40 basis points better than last quarter.

Second quarter free cash flow after capital expenditures was $414 million, approximately 64% of earnings from continuing operations.

Year-to-date, free cash flow is $564 million, relatively consistent with last year's performance.

I expect strong cash generation is in the second half.

We deployed $190 million of cash in the quarter to make two acquisitions that complement our core Combat Systems and IS&T businesses.

We also took advantage of market conditions to buy 5.5 million shares of GD common stock in the open market.

Orders this quarter exceeded $7 billion.

Over $1 billion more than last year's second quarter, with robust activity in the Combat Systems and Information Systems and Technology groups.

At the end of the quarter, total backlog stood at $62.5 billion.

Now let me turn to the results and outlook for each of our groups.

And first, let's talk about Combat Systems.

Combat Systems' second quarter was marked by excellent operational performance across the business.

Sales volume totaled $2.1 billion, up from the first quarter, but down from the same period a year ago due to less MRAP volume, the cancellation of FCS and Stryker timing.

In the second half, we anticipate stronger MRAP and Stryker volume.

Earnings were essentially flat when compared with last year's second quarter, despite the decline in sales, as margins expanded across the portfolio.

The 150 basis point margin improvement is the result of better program mix with volume concentrated in more mature procurement programs, and improved operating performance.

Compared with last quarter, earnings grew nearly 10% to $295 million.

Total backlog for Combat Systems decreased modestly to $12.8 billion in the quarter.

Order activity outpaced sales at three of the four businesses, including European Land Systems, which had its strongest order activity since the second quarter of last year.

Notable orders in the quarter included approximately $500 million for Stryker vehicles and Abrams tanks, $200 million for United Kingdom's Scout vehicle development work, $35 million for the development phase of the Canadian lab upgrade program, and nearly $300 million for Hydra rockets.

We expect several additional large international orders this year.

Looking forward for the group, sales in the remainder of the year will be higher than both year-to-date and last year's second half, with particular strength in the fourth quarter.

That said, my overall assessment now shows sales in 2010 to be essentially flat to slightly below 2009.

As I mentioned on the first quarter call, the growth originally projected in 2010 was influenced heavily by international work in the second half of the year.

A confluence of factors, including the European sovereign debt crisis, prolonged contract negotiations, and the decline in the Euro has changed our international sales outlook for this year.

The sovereign debt crisis has delayed the award of the Spanish 8X8 program until 2011.

However, the Spanish government remains committed to this program, having stated publicly that it remains a top defense priority.

Prolonged contract negotiations slowed the award of our Canadian lab program, which will now transition to production in 2011 rather than this year.

A several hundred million dollar lab award will also push out until late this year or early next year.

Additionally, at current exchange rates, the decline in the Euro would reduce sales by nearly $150 million by year end.

This is translation rather than meaningful economic impact, and obviously could vary depending on where the Euro settles relative to the dollar at year end.

Our US core business received some unanticipated awards in the first half, to include 250 RG-31s, stronger than expected Axle awards, and Stryker development work.

These positives have been somewhat offset by delays in awards at our weapons systems business and some reduction in contract scope in other programs.

Notwithstanding the adjusted sales outlook for 2010, full year earnings will be consistent with my original expectations.

Margins will be in the mid-13% range, up approximately 50 to 60 basis points from my prior guidance, due to the favorable mix mentioned earlier.

As we look to the future, Combat's portfolio is well positioned.

Let me briefly review four key components of this group's business.

First, US vehicles.

Comprised just over 50% of 2009 combat sales, obviously driven by the Stryker and Abrams programs, which are core to today's Army and will remain so for years to come.

Current backlog, continued vehicle enhancements, and reset opportunities will sustain these two mature programs.

We are also competing on an array of next generation vehicle programs, including the ground combat vehicle, and the joint light tactical vehicle, which could offer upside in the longer term.

In the event that any of these developmental programs are delayed, we see continued opportunity for our current vehicles.

Secondly, US weapons systems and ammunition.

At approximately one-third of 2009 combat sales, they provide an array of critical systems and ammunition products to a wide range of US and international customers.

The core programs in these businesses remain well-supported in the mid-term, while new opportunities in precision munitions, armor, commercial axles, demil, and international ammunition bode well for the longer term.

Thirdly, international FMS and export vehicles.

We expect to grow substantially over the next four years as we begin delivering light armored vehicles and tanks to a variety of Middle Eastern customers.

We are currently working four contracts, totaling close to $4 billion with deliveries between 2011 and 2014.

Two of those contracts worth nearly $2.5 billion for FMS labs and Iraqi tanks are now in backlog.

The other two contracts for additional FMS labs and tanks could add $1.4 billion to backlog before year-end.

These FMS sales present a meaningful opportunity, around $800 million to $1 billion of volume per year between 2011 and 2014.

And finally, international indigenous vehicles.

One of our key market discriminators here is we are a resident in many of the countries we manufacture and sell vehicles, thus making our employees an important component of local GDP.

There have been several recent positive developments in this business, including solidifying the first component of the Canadian lab upgrade program, which, when added to backlog next year will contribute another $850 million to sales between 2011 and 2013.

Selection as the preferred supplier for a five year, $100 million deal to sustain Australia's armored fighting vehicle fleet, and finalizing a contract worth several hundred million dollars over the next three years to develop and deliver Scout specialist vehicles to the British army.

Clearly, the sovereign debt crisis has added some uncertainty to our European business over the past quarter.

In June, I visited our European businesses.

While their situation remains dynamic, it was clear that in spite of time lines moving to the right, our programs remain in high demand.

No programs have been eliminated or taken off the table.

National security remains an important spending priority, even when times are austere, and our workforce provides an important economic engine in many of these economies.

We are setting the international standard for the next generation of armored vehicles, and I feel confident in our opportunities to provide best-in-class vehicles at affordable prices for years to come.

In summary, the Combat Systems portfolio of products is well placed in today's fighting force, and it's complemented by a healthy set of near and long-term opportunities.

These opportunities, combined with the current backlog, provide relative stability in our core domestic businesses, and growth in our international workload.

This will result in attractive margins and cash flow for the next several years.

Marine Systems.

Marine Systems group delivered another solid quarter.

Revenues were up slightly, while earnings were consistent with last year's second quarter, at $1.6 billion, and $167 million, respectively.

This is a particularly good performance, as last year's results reflected 17% sales and 32% earnings growth.

Sales in the quarter were up at Electric Boat and Bath Iron Works, reflecting increased Virginia and DDG-1000 volume and expanded SSDM replacement design efforts.

This growth was somewhat offset by a decline in NASSCO sales due to repair volume timing and the ramp-down of the commercial product carrier program.

Marine's margins in the quarter were 10.2%, up 40 basis points from the first quarter.

The Marine group's backlog totaled $21.3 billion at the end of the second quarter, down 3.6% from the first quarter.

We anticipate adding the second and third DDG 1000 ships to this backlog, either later this year or early next year, pending final contract negotiations with our customer.

In the second quarter, the group received funding for long lead materials for these ships.

Group sales will grow progressively through the second half, driven by the continued ramp to two per year Virginia class submarine production.

Overall, sales should be up approximately 5% compared with last year, somewhat below my prior guidance.

This change reflects continued weakness in the commercial shipbuilding business.

We are, however, seeing renewed interest across the range of commercial shippers, including the dry cargo market, container ships, and some tankers.

Our excellent performance on the current five ship product carrier program positions us to capitalize on a number of these contracts, most likely starting next year.

Group margins for the year should be around the mid-9% range, consistent with my earlier guidance.

Margins will decline as the year progresses, due to the surface combatant workload mix shift, which will escalate in the second half.

Given the group's consistently excellent operating performance in managing for profitability, there may be some upside to my 9.5% margin guidance.

Looking longer term, our shipyards are poised for slow, steady top line growth, predicated on a healthy backlog and opportunity set.

While the group faces a margin headwind in the near term, I see opportunity to expand margins as surface combatant fixed price work builds, commercial shipbuilding opportunities materialize, and two per year Virginia is realized.

IS&T.

Our IS&T group had its highest ever revenue and earnings quarter.

Sales were nearly $3 billion, up 12% over second quarter 2009, and 6.3% year-to-date.

Sales growth was driven by continued demand for our ruggedized mobile computing and Tactical Communications products, and increased intelligence, IT, and infrastructure support work.

The group's second quarter operating earnings were $312 million, up 10% year-over-year, and 7.6% sequentially.

Operating margins were 10.5%, in line with the first quarter, and my expectation for this year.

Backlog for the group increased by over $300 million this quarter, as book-to-bill exceeded one times again.

Awards were particularly strong in our Tactical Communications and IT services businesses.

The businesses were also selected to compete on several large multi-year IDIQ contracts, which contributed to a 28% increase in our potential contract value.

Many of these awards are detailed in our press release.

IS&T's volume in the second half will exceed both last year's second half and this year's first half.

Overall, I expect group sales to be up 8 to 9%, perhaps closer to the midpoint of that range.

And margins will remain around 10.5%, both consistent with previous guidance.

Looking beyond 2010, IS&T's highly diverse portfolio positions the group to leverage its current capabilities to capture new business in fast-growing market segments.

Tactical Communications and battlefield management remain high customer spending priorities.

Two weeks ago, many of our Tactical Communications products including WIN-T and JITTERS were part of a US Army Brigade Combat Team integration exercise that showcased their technical maturity and critical networking capabilities.

As these programs transition to production over the next several years, they will enhance sales growth and margins.

IT intelligence, infrastructure, and healthcare support represent some of the other faster currents in the group's marketplace.

Sales growth will also be driven by the rapidly expanding cyber market, where IS&T has a very strong position with an array of government and commercial customers.

Aerospace.

The Aerospace Group's results were marked by excellent operational performance and new product development progress.

Order intake was somewhat slower than anticipated, but year-to-date orders are in line with expectations.

The group's second quarter sales were $1.38 billion, down modestly from last year's second quarter, due to fewer preowned aircraft sales at Gulfstream and less completions volume at Jet Aviation.

The group's earnings were up 8.4%.

Margins were 16.8%, a 160 basis point improvement, resulting from expanded Gulfstream services volume and margins, improved jet aviation completions margins, and lower SG&A and R&D costs.

We continue to see signs of gradual improvement in the business jet market.

Gulfstream flying hours are up, and we enjoyed a 16% improvement in the group's services sales versus last year's second quarter and a 7% improvement year-to-date.

Additionally, market-preowned aircraft levels continued to decline.

At the end of the second quarter, Gulfstream had one preowned aircraft in inventory and it is under contract.

We anticipate receiving no more than three additional preowned aircraft before year end.

Customer interest in Gulfstream aircraft remains healthy, despite a slowdown in the order intake in the second half of the quarter.

Orders outpaced defaults by three to one, while defaults were at their lowest level of this downturn.

On an absolute basis, dollar denominated book-to-bill was 0.6 times.

At $17.8 billion, our backlog includes nearly 200 G-650 orders and approximately $6 billion in orders for our in service aircraft.

This is a very solid and sustaining backlog.

Orders in the quarter spanned the entirety of our product portfolio, with roughly two-thirds for the large cabin aircraft and one-third for the mid-cabins.

Second quarter orders also reflected renewed interest in our North American markets, which were essentially dormant following last year's financial crisis and ensuing anti-business jet rhetoric.

We also continued to see relative order strength across several emerging markets, including the Asia-Pacific region, one of the strongest markets for business aviation and for Gulfstream in particular.

In addition to current backlog, we have a healthy pipeline of new opportunities, which we believe will translate to orders as the financial markets recover from a turbulent second quarter.

Large cabin deliveries remain on track and will total 76 this year.

As you may recall, Gulfstream completed a two week furlough in July, which will result in fewer large cabin deliveries in the third quarter.

The mid-cabin business continued to show improvement in the second quarter, and now exceeds my original expectation for 14 deliveries this year.

I expect to deliver a total of 21 mid-sized jets this year, with some further upside, if second half demand mirrors what we've seen in the first half.

For the full year, I expect the group's sales to be up low to mid single digits, consistent with my prior guidance.

Operating margins will be better than previously anticipated, probably in the mid-15% range, with some upside.

On the Product Development front, there are now three G-250 aircraft and four G-650 aircraft in flight test and 2011 FAA and IASA certification for both aircraft remain on track.

As we look toward the next several years, the group will enjoy steady top line growth as we begin G-650 deliveries in the second half of 2011, and the services business continues to expand, commensurate with the growing installed base.

Our current order book and a healthy pipeline of potential new customer orders bode well for sustaining production of our G-450 and G-550 aircraft at or near current levels.

The group's margins should continue to expand, driven in part by continued improvement at jet aviation, and the transition to full rate production on our new aircraft models.

We will continue to aggressively manage this business for profitability on the up, as we did through the down.

In summary, General Dynamics executed well on the first half of 2010, and is well positioned for similar success in the second half.

For the year, I expect earnings per share from continuing operations to be $6.60 to $6.65, an increase from my prior guidance.

Before concluding my remarks, I'd like to comment on today's dynamic business environment, particularly as it relates to our defense businesses.

Within this environment, the Pentagon's commitment to maintaining current force structure levels, which are sized to address the evolving threat environment, remains unchanged.

While the post 9/11 world allows for little near term defense budget reduction, pressures to manage discretionary spending will undoubtedly increase in the out years.

I certainly appreciate the challenge the deficit reduction emphasis represents for future defense spending.

Over the past quarter, Secretary of Defense Gates and his senior leadership team have aggressively embarked upon a series of initiatives, focused on making the Pentagon a more cost effective, efficient organization.

Improving efficiency is particularly important to achieving the Pentagon's goal of preserving force structure.

To appropriately organize, train, and equip today's force to fight, weapon spending will have to show some growth in the years ahead.

In a flat budget environment, the Defense Department must extract savings from within its own budget to achieve this required growth.

Having focused on achieving savings in the weapons accounts last year, the Pentagon now appears focused primarily on extracting overhead savings from operations and maintenance budget, the tail, to support investment account requirements, the tooth.

The specifics of the Pentagon's efficiency initiatives are not yet evident, but what is clear is that the environment is changing and that all stakeholders will have a role to play.

I am personally involved with other CEOs in a cooperative dialogue to develop procedures that will achieve needed results, while protecting the viability of the defense industrial base.

I am encouraged that the Pentagon has engaged the industry as it embarks on shaping these measures.

General Dynamics is already a very lean and efficient operator.

We will continue to support our customer in pursuing even greater value for the defense dollar.

Our defense businesses have all experienced strong support in the ongoing 2011 budget deliberations.

While there are several steps remaining before the 2011 Budget Defense Bill becomes law, I remain confident that GD's core programs will receive solid Congressional support.

General Dynamics is particularly well positioned to excel in this fast changing environment.

Low cost and quality production continued to enhance our competitiveness.

Our streamlined business model limits overhead expense and empowers our business unit Presidents to remain entrepreneurial and agile.

With that, I'll now ask Hugh Redd to touch on additional financial details.

Hugh?

Thank you, Jay, and good morning everyone.

I'd like to start with a couple of notes on capital deployment in the second half of the year.

We have $700 million of fixed rate notes that are set to mature in August.

We plan to satisfy that obligation with cash on hand.

As a result, we'll see lower interest expense in the second half of the year, and we expect full year interest expense to be somewhere between $155 million and $160 million.

We are also scheduled to make a voluntary contribution to our pension plans of approximately $270 million in September.

I would like to also point out that we recently renewed our 364-day bank line, increasing it by about $200 million, and extending the term to three years.

This increases our commercial paper capacity to approximately $2 billion.

The increased commercial paper capacity, along with the debt repayment in the third quarter further bolsters our strong balance sheet and gives us capacity to execute on future opportunities.

Finally, an update on our expectations for our effective tax rate.

I had previously guided you to a rate of 31.5% with some 20 to 30 basis points of exposure, meaning risk that the rate could be as high as 31.8%.

Given our experience in the first half and what we see ahead of us for the remainder of the year, the rate is still looking like 31.5%, but with the opportunity to come in 20 to 30 basis points lower rather than higher.

Jay, that completes my remarks, and I'll turn it back to Amy to begin the Q&A.

Amy?

Thanks, Hugh.

As a quick reminder, we ask participants to ask only one question, so that everyone has an opportunity to participate.

If you have additional questions, please get back into the queue.

And Ann, could you please remind participants how to enter the queue?

Certainly.

Thank you.

(Operator Instructions).

And our first question comes from the line of David Strauss with UBS.

Please proceed.

Good morning.

Hey, David.

Jay, thanks for all the detail around Combat Systems.

I think previously you had talked about Combat Systems growing at a low single digit rate beyond 2010.

With all the stuff that's happened to your outlook for 2010, what do you now see as potential growth rate out, looking beyond that?

David, based on what I see today, I still consider the slow, steady growth sustaining to be appropriate.

What do I mean by that?

If you look at the core US businesses that I talked about, Stryker and Abrams in particular, that's going to be steady business going forward.

Okay?

Not all of that's apparent in the budget lines you see today but what we see in work right now for example with some of the Stryker development in DD hull, et cetera, it bodes well for stability in those programs going forward.

And then as I mentioned in my remarks, in the international space, we do see that as a growth business.

And I also alluded to the fact that some of what we saw originally projected to arrive in 2010 is now moving to the right into 2011 and perhaps in some cases even beyond.

So that to me bodes well for a stable to slightly nose-up growth opportunity in combat going forward.

And just as a follow-up, what do you assume low single digit growth, what are you assuming for the guns, bullets, stuff that has exposure to the supplementals and also what does that assume for EFV?

I would characterize the weapons systems and ordinance pieces as slow, steady growth as well.

And what was your last?

EFV.

EFV.

EFV as you know is in the SDD-2 phase right now and depending on what you read, it may or may not be a risk.

We're providing our seven vehicles for the Marine Corps to test.

For us, it's about $250 million I think a year going forward and it's not due to reach the LRIP until 2015 or 2016.

So it's not a major muscle mover in the sense that it impacts us heavily in the next couple of years.

So we'll see how it develops within the Pentagon.

Great.

Thanks for the color.

Okay.

Again, ladies and gentlemen, in the interest of time, the Company does request that you please ask only one question.

If you have additional questions, please re-enter the queue.

And our next question comes from the line of Myles Walton with Deutsche Bank.

Please proceed.

Thanks.

Jay, I was wondering if you could give us some color on the timing and the step-up in the G650 production rates over the next few years as you go towards three or four a month and also what we should think in terms of incremental margins of that mix coming in even in 2011 and beyond?

Okay, Myles.

First of all, let me just say since you opened the 650 door, let me just say that we're very pleased with what's happening with the 650 right now in test.

We've got four in flight test right now in all corners of the flight envelope.

They're performing exceptionally well.

We're very pleased.

So we're on track.

Okay?

Now, then, to your specific question, you know I believe you've heard me say before that in terms of production rates and margins, I'm a little less fulsome than you would like me to be at this stage because we're just not into full rate production yet but I would report that, and you know the facility we have and you know the production capability and capacity that's built into this airframe, so we're very bullish for the longer term.

But right now I'm going to stay with 17, 33 and 33 for production in 2012, 2013 and 2014 and the margins will be respectable margins but growing as we mature that program, and I'm very bullish on the longer term margins for the 650.

It's going to be a gangbuster airplane for both the customer and for Gulfstream.

Would the margins be accretive or dilutive to the mix that you currently have?

I would suggest -- I mean, just based on -- I don't know.

I mean, because we're not there yet, as I said before, but I would suggest that relative to the large cabin in production aircraft, they're probably going to be maybe slightly dilutive to that at the start and come through it as we mature.

Okay.

Great.

That's an early peek.

Our next question comes from the line of Joe Campbell with Barclays Capital.

Please proceed.

Actually, it's Carter Copeland.

Good morning, Jay.

And good quarter.

Thank you.

And Joe.

And Joe as well.

Quick question, regarding jet aviation and the improvement you noted there.

I know you at one point in time in terms of completions had some airplanes that were challenging to say the least and I think that was weighing on the margin in that business.

I wondered if you might provide us some more insight into what exactly is going on there to help out in terms of improving the completions margins and how far you have progressed in terms of improving the profitability at Jet, where do we stand in that process today?

We're progressing as we hoped to progress.

I'm very pleased with the performance, the completions performance that we're getting out of Jet right now.

I mentioned in my remarks about going to see our European businesses.

I did that on the European Land Systems side and I also went to Basil and Zurich and spent some time with Jet and went through some of the completion aircraft, et cetera.

So I would report that steady progress has been made.

We have indeed worked very hard on the front end processes for our completions business, and it's taking the desired and necessary effect.

The other remark I'd make, and you know this, Carter and Joe, but when you step into something like these wide body, narrow body completions, it's not a two month deal.

You know, these projects go for a long time, years in many cases.

So working through that inventory, the legacy inventory, and getting them back in the air and returned to their customers in good shape has been an ongoing evolution and in fact it still goes on.

But I would tell you that they've definitely turned a corner and the future looks very bright in the completions business, both skyline-wise and how we execute on that skyline.

And our next question comes from the line of Doug Harned with Sanford Bernstein.

Please proceed.

Good morning.

Hey, Doug.

Could you talk about Marine and the margins were quite good this quarter, but you're facing challenges at NASSCO in terms of volume and you're going through a transition at Bath.

Could you talk about what you need to do to keep margins?

I know you said that they'll come down a little bit, but what are the things you're doing to try and keep margins as high as you can in those situations?

Okay.

Let's talk about Marine and margins.

And you captured it, and I said it in my remarks.

I mean, I'm very pleased with the performance at all three of our shipyards, the margins are representative of the excellence of those yards and doing what they do best.

And really, the margin guidance that I'm giving is purely reflective of the mix shift, predominantly at Bath Iron Works.

But also somewhat as we move block to block with Virginia-class.

We're now into block three I think, as you know.

And then also coming to the end of the product carrier line, if you will, at NASSCO.

So what does all that mean?

In the Bath instance, you know we're in the build on the first, and it's cost-plus DDG 1000, it's about I think like 17% complete, okay.

No big surprises.

We're pleased with what we've got.

We like it a lot.

We're in contract negotiations for the next two fixed price 1001 and 1002 by hull number and so that will work itself through.

And so you'll see the DDG-1000 fits in the build becoming more of Bath's portfolio here as the year advances, and the DDG-51s, the mature, fixed price, we know how to build these babies better than anybody and you'll see all of that tailing down a little bit as the last two boats are in the build right now and the next one comes in, in the 2011 budget, DDG-115 by hull number.

Beyond that, the DDG-51s will arrive in some number, but it's just not parted out in the budget beyond the 2011 budget, as you well know.

The point of all that is you're going to see the margins come down as that cost plus boat dominates if you will relatively speaking Bath Iron Works and then as we get into the fixed price DDG-1,000s and back into the fixed price DDG-51s you're going to see those margins go back up again.

I would also in terms of Electric boat, I mentioned the transition.

We're still doing block 2s and we're now starting block 3s.

So the margins I would expect as we mature into block 3, I would expect given that we continue to perform as a team the way we've performed right now and going forward, we can enhance the margins in Virginia class and that's going to be, as you know, the major muscle mover for the Marine group.

I would also add in terms of margin opportunity, the SSBN at Electric Boat and I think you know we're doing early engineering and development work on the SSBN replacement, which is time lined into about a 2019 start to replace the Ohio class SSBNs some years later.

But that will also provide opportunity there.

At the NASSCO side, you know that the TAKE line, 14 in number, will complete at the end of 2012.

The product carrier's complete at the end of 2010, and that's why I changed the guidance because the product carriers are going away and that's a great margin opportunity that will tail out here very shortly.

On the maybe side, we've got the MLP coming in on the 2011 budget to enhance that side of it as the TAKEs run out, if you will.

And then on the commercial side, as I mentioned in my remarks, we're very encouraged by the discussions we're having right now, the commercial market is coming back, and I believe if it times up the way we think it will, you're going to see contracts here for 2011 in that market, okay?

And I would also comment at NASSCO, as it applies to all the shipyards but the most relevant current example is at NASSCO.

We manage those businesses for profitability and we're very disciplined in so doing.

We just let go close to 600 people at NASSCO, because the volume was not appropriate to keep them.

And we'll continue to do that as necessary, down and up, to make sure that we maintain profitability.

So that's probably more than you asked for but that's kind of my Marine view.

That was very helpful.

Thank you.

Okay.

And our next question comes from the line of Howard Rubel with Jefferies.

Please proceed.

Thank you very much.

Jay, backlog as you pointed out at Gulfstream is off a little bit.

It looks like it's in the larger jets.

Could you provide a little bit of color regarding discussions and do you think that by the end of the year, book-to-bill will be back to one?

Okay.

Good morning, Howard.

Or good afternoon.

Yes, thank you.

Look, the order book at Gulfstream for this year is essentially where we thought it should be.

I mentioned a little softness here in the latter part of the second quarter.

I'm not disturbed by that, okay?

I could call that just summer softness or seasonal.

However you want to characterize it.

But we're already looking -- taking orders now, you know, in this quarter, so I see the order book pretty stable as we progress throughout the year.

I also see the default activity as being very small as we step through the rest of the year.

That's based on what I see right now.

So the long and sort of it is, I would expect the book-to-bill to increase as we go forward, Howard.

Thank you, Jay.

And our next question comes from the line of Heidi Wood with Morgan Stanley.

Please proceed.

Yes, hi, Jay.

Hello, Heidi.

How you doing?

Good.

I have a question on Gulfstream.

I want to tear apart a little the operations.

When we back out the jet aviation and the used volumes, looks like the Gulfstream, the manufacturing operations did about 19.8% margins which was really solid and then we look at the reported margins in the first half, you did 16.5.

Presumably Jet is going to continue to do well.

You gave us color on used.

And yet you're presuming 14.5% margins in the second half of this year.

So what are the gating elements that are representing headwinds in your mind for Gulfstream going forward?

Okay, Heidi.

Let's talk about margins at Gulfstream.

Let's see.

What's the best way to shape this?

I'm going to give you more of the tutorial than you asked for, okay?

Awesome.

Okay.

Because this is the way I've got it stacked in my head.

Forfeiture profits, liquidated damages, were not a margin driver for us, because it was as low as it's been since the downturn.

So let's just take that off the table at the top.

If you look at the margins year-over-year, okay, this time was better, positively impacted, because of the aircraft services volume improvement, okay, which I talked to in my remarks, less preowned aircraft sales and, frankly, those that did sell sold at a modest profit versus the loss they sold at a year ago.

And then the things you would expect me to say, lower SG&A and then less in this instance R&D expenditure because we had larger supplier payments in the quarter.

Okay?

That's kind of the year-over-year up to the 16.8.

If you look at it sequentially against the first quarter of 2010, really the difference there is the R&D expenditure.

Okay?

So that's the lift that they got there.

Looking forward for the rest of the year, why am I not sticking my nose up in the 16s like I think you're implying in the question.

And the answer is, we've still got -- we had the two week furlough at Gulfstream.

The overhead absorption attached to that.

I do expect the forfeiture profits, the liquidated damages or whatever to continue to decline.

Okay?

With fewer anticipated defaults in the second half, and I expect this -- the R&D expenditures to increase.

Normally, historically, I guess you'd say, the R&D expenditure net is more weighted in our favor on the second half of the year.

In this year, it was favored to the first half of the year.

So anyway, I think that's -- those are probably the major margin factors I would have for you today.

Just to be clear, Jay, are you saying that the second half R&D is heavier weighted than it was in the first half?

Yes.

Okay.

So that -- sounds like that's the most significant.

Yes, I would say so.

I mean, and again, the supplier injects into the R&D if you will were more heavily weighted to the first half of this year which is not the way it usually happens but it happened this year.

So we would expect to absorb more of the R&D in the second half ourselves.

All that said, remember, that we still sort of sight line ourselves, Heidi, at about 2% of sales for our R&D and we're roughly in line with that.

We go up a little.

We go down a little.

But that's still the sight line.

We're very disciplined about that, as you know.

It also sounds like services can be a potential tailwind as well as it has the first half.

Yes, exactly.

Excellent.

Thanks, Jay.

Our next question comes from the line of Noah Poponak with Goldman Sachs.

Please proceed.

Good morning, Jay.

Hey, Noah.

Recognizing that the backlog and order flow for the Company can be particularly lumpy and that you have different dynamics in each of the businesses, if I just take a step back and look at the total backlog of the Company, it's declined for I think six or seven quarters in a row.

The book-to-bill metrics are on the weaker side.

Why should I not look at those numbers and translate that to think that the Company has an organic growth problem going forward?

Well, let me look at it one business at a time.

I mentioned in my remarks that I was very pleased with the Combat Systems and IS&T growth and all that is true.

Better than one to one in IS&T, and close to it in combat.

If you add the IDIQs to that, it goes in excess of one to one.

So those two, okay, better than okay.

On the Marine side, that -- I think you used the word, but I'll use it again.

That's the lumpiest of all in terms of how you add to the backlog.

It comes in big slugs and then it doesn't for a while and then it comes in big slugs again and what you're seeing right now, quite honestly, is the impending but not yet arrival of the two number two and number three DDG-1000s.

That's really what you're seeing there.

On Aerospace, look, it's $17.8 billion worth of backlog.

Yes, it came down.

But here's the way I look at it and we look at it.

If you take the 650 and give that let's say $12 billion of that $18 billion, put that aside, you've got almost $6 billion in backlog on your in production aircraft, largely in the large cabin.

That's a very robust backlog.

But here's the way I look at it.

I look at it in terms of who's in there and how long will it take for you to get an entry into service with an airplane you want to buy today and the answer to that in terms of the 450 and the 550 is 18 to 24 months, and in our thinking, in my thinking, that's kind of the sweet spot.

Okay?

If that backlog, given the production rates we have, if that backlog carries an 18 to 24 month delivery time with it, that backlog is sized appropriately.

If it gets less than that, okay, then we've got some sales work to do.

If it's more than that, then the customer base waits too long for their airplane.

So that's kind of where I am with that.

Okay.

So on the defense side in total, it sounds like if you get some of the international stuff you're expecting, get where you're anticipating in Marine, move some stuff in the firm, should see better book-to-bill there in the back half of this year?

I would expect so.

As I said with Marine in particular, we're working those two 1,000 contracts right now and whether that happens late this year or early next year is TBD, but it will happen, and IS&T will continue to be very strong.

Okay.

(Operator Instructions).

And our next question comes from the line of Cai von Rumohr with Cowen and Company.

Please proceed.

Yes.

Thank you very much.

Jay, with the changing defense environment we've seen a number of companies consider spinoff to meet OCI issues but also a focus on perhaps increasing shareholder value.

In the last down cycle when we had the last supper, GD was a leader in terms of doing creative things with its portfolio of businesses to create value.

Could you give us some thoughts in terms of as you go through over the next year or two the types of things you might be doing to enhance shareholder value that way?

Well, I think as you well know, Cai, we focus very much on profitability and enhanced shareholder value around here.

One of the ways we do that is to keep ourselves very lean and very efficient, and we I think set the standard for that.

Our corporate headquarters, I've got I think 35 officers in all of General Dynamics, 35 corporate officers.

So that's a pretty lean overhead organization.

But to your point, we look at all four of our businesses.

We look at the diversity of our portfolio.

We look at what we're engaged in and what environment we're operating in, back to the entrepreneurial and the agility of my business unit presidents, they're looking all the time to see how they can enhance the portfolio we have, in ensuring its relevance and also looking at adjacencies that may give us more opportunity, and Frankly, also, looking in new areas or harvesting things that are in our portfolio that aren't appropriate for us anymore that might do someone else something better and the classic example of that is Spectrum Astro, which we just divested.

That is ongoing work constantly here, Cai.

In terms of spinning something off or doing something like that, hey, right now we're getting plenty of value I believe and the future is pretty well-defined, I think, in all four of our businesses for the short term.

For the longer term, we'll see how things develop on the defense side.

But I don't see it appropriate at this time to do anything like spinning off a part of our business, if that answers your question.

Our next question comes from the line of George Shapiro with Access 342.

Please proceed.

Hi, Jay.

Just want to pursue the Gulfstream margin a little bit more.

If you adjust the first quarter for the forfeitures, looks like sequentially there's like a 200 basis point margin improvement, volume's the same, mix is about the same.

So be safe to say then that sequentially R&D was actually down by about $25 million, so R&D in the second quarter was pretty negligible?

It was down, George, but it was down net and the reason why it was down net is because we had more supplier R&D provided in the second quarter, yes.

That's the difference.

With the ballpark net like about $25 million?

I don't -- I'm not going to give you that, George.

And our next question comes from the line of Ron Epstein with Banc of America-Merrill Lynch.

Please proceed.

Just a quick one for you.

Were you actively buying shares during the quarter and if so, how much did you buy?

Yes, and 5.5 million shares.

Great.

Thank you.

I think we have time for just one more question.

Okay.

And our last question comes from the line of Sam Pearlstein with Wells Fargo.

Please proceed.

Jay, you talked about cash flow growing in the second half of the year and I guess I'm just looking at where you are through the first half and a pretty sizable use of cash on the customer advances and deposits and the CIP line and I guess, one, are you still targeting 100% free cash flow to net income at the end of the year and if some of the international awards and things have shifted out, does that allow you to really get the advances and the deposits that you need to get there?

At the midpoint of the year, Sam, my answer is that we always target 100%.

And I've got nothing that's got me backing away from that right now.

Will it be easy to get there?

No.

Because of some of the things you said and some of the things I talk about today but it's still a sight line we are proceeding upon.

I think we lost you, Sam.

Okay.

I think that ends the time that we have allocated for the call today.

Thank you for joining us.

If you have any additional questions, I can be reached at 703-876-3748.

Have a great day.

Ladies and gentlemen, we thank you for your participation in today's conference.

This concludes the presentation and you may now disconnect.

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