通用動力 (GD) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2012 General Dynamics earnings conference call.

My name is Jeff, and I will be your coordinator for today.

(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. Amy Gilliland, Staff Vice President Investor Relations.

And you have the floor, ma'am.

Thank you, Jeff, and good morning, everyone.

Welcome to the General Dynamics second-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, Jay Johnson.

Thank you, Amy.

Good morning, everyone.

General Dynamics' second quarter delivered $7.9 billion in sales and $970 million in operating earnings at a 12.2% operating margin, improvement from last year's second quarter and this year's first quarter.

Earnings-per-share totaled $1.77 on a fully diluted basis, $0.20 ahead of last quarter.

Second-quarter free cash flow after capital expenditures totaled $703 million or 111% of earnings from continuing operations.

This result was particularly strong considering that it includes approximately $100 million in pension fund contributions, two quarterly Federal tax payments and continued investment in Gulfstream's Savannah campus.

We plan to contribute about $500 million in total to our pension plans this year with most of the remainder in the third quarter.

Year-to-date free cash flow is $1 billion or 86% of earnings from continuing operations.

On the capital deployment front, we took advantage of our healthy balance sheet and tough market conditions to repurchase 7.8 million shares of common stock this quarter.

Through the first half, we have repurchased 9.1 million shares.

Additionally we announced the acquisition of IPWireless, an excellent bolt-on addition for our IS&T business.

IPWireless further expands our tactical communications portfolio into the public safety first responder market with advanced broadband technology that improves first responders' effectiveness and safety by providing them with greater access to information.

Orders this quarter were approximately $5.2 billion, reflecting continued sluggishness in defense award activity and some slower than anticipated order timing in Aerospace.

I do anticipate improved second-half orders, particularly in Aerospace.

At the end of the quarter, funded backlog was $43.9 billion, while total backlog stood at $52.4 billion.

Total estimated contract value, which includes opportunities to provide products and services under ID/IQ contracts and options was $78.6 billion.

Before I turn to the results and outlook for each of our groups, I want to comment on what we are seeing in this dynamic aerospace and defense business environment.

In our US defense market, visibility remains somewhat limited by three principal factors -- the upcoming elections, a likely 2013 continuing resolution and the sequestration trigger.

The uncertainty and anxiety spawned by these second-half events continues to impede Department of Defense and Federal government acquisition program execution.

As was the case last quarter, our shorter cycle IS&T business is experiencing the most pressure, due primarily to award delays on several of our key tactical communications contracts.

In most cases, these are funded programs of record.

While there was improvement in activity from first to second quarter, this order activity did not meet our expectations.

As anticipated, we are witnessing increased rhetoric as the summer progresses and the political process prepares to navigate the final months of the campaign trail.

As we steam toward the sequestration fog bank, many members of Congress have begun talking more seriously about sequestration and its potential impacts.

We remain hopeful that a bipartisan solution can be brokered.

However, as a practical matter, it seems increasingly unlikely that we will see additional detail on implementation or resolution before the November elections.

We are focused on what we can control.

Specifically we are executing on our backlog, working with our customers to jumpstart the expenditure of previously appropriated funds, talking with our suppliers, analyzing our contract terms and conditions and judiciously husbanding our capital resources.

Nevertheless, forecasting our customers' behavior has become increasingly difficult.

Given this uncertainty, we have adjusted our expectations somewhat for the year.

Our outlook does assume the obligation of previously appropriated funds on several of our programs where delays have been prominent.

With that said, the 2013 defense budget request is proceeding through the Congressional approval process.

We have been pleased with the support our programs have received to date.

In the likely event that the 2013 Pentagon budget is funded at least for some period of time through a continuing resolution, our programs would reflect relatively healthy 2012 funding levels.

In our Aerospace group, Gulfstream continues to enjoy a sizable, multiyear, large cabin backlog and a robust order pipeline.

The stability of our backlog is evidenced by the extremely limited default activity this quarter.

In point of fact, this was the lowest default quarter since the economic downturn began in 2008.

We are seeing, however, some elongation of our business jet order cycle with a number of factors causing deal closure times to increase.

In part, order delays, most of which materialized late in the quarter, reflect the decline in global economic sentiment.

We continue to believe that we will realize many of these orders, although their timing and in some cases their scope may vary from initial discussions.

Now let me turn to each of our groups, starting with Combat Systems.

Combat Systems' sales and earnings improved this quarter when compared with last quarter and the second half of 2011.

Sales totaled $2.15 billion, reflecting growing FMS volume for vehicles and tanks, initial progress on the Ground Combat Vehicle program and the addition of Force Protection.

Abrams tank volumes and European Land Systems volume were down somewhat as expected.

The group's earnings were $322 million, resulting in 15% operating margins.

This operating margin reflects excellent performance across Combat's portfolio of mature domestic vehicle production programs.

In addition, profitability continues to be enhanced by ongoing continuous improvement and business optimization initiatives.

Combat Systems' backlog totaled $9.8 billion at quarter-end.

Although the group's orders improved from last quarter, orders in Combat's weapon systems and European vehicle segments were somewhat lighter than anticipated due to several international program delays.

Notable orders that were received included approximately $270 million for Hydra rockets, $170 million for Abrams upgrades and support, and $115 million for Stryker double-V-hull conversions and logistics support.

The Stryker double-V-hull conversion order is particularly significant as it reaffirms the customer's acceptance of the life-saving benefit of the double-V-hull and begins the process of converting another brigade of Strykers to the double-V configuration.

In the second half, we expect order activity to improve with additional awards for Strykers, MRAP enhancements and international tank upgrades for several Middle Eastern customers to include 200 tanks from Morocco.

We also expect a significant Abrams award that will fund tank research and development activities over the next several years.

This investment is proof of our customer's long-term commitment to investing in and modernizing this integral component of the Army's fighting force.

The Abrams tank also continues to receive staunch Congressional support with each of the three committees that has marked thus far adding funds to sustain Abrams production.

This support will help ensure that the US maintains a healthy and reliable tank industrial base.

Combat is on track to achieve my guidance of around $8.5 billion in sales this year.

A variety of drivers in our European Land Systems business, including reduced profitability on several vehicle programs, delays in several international awards and absorption impact from lower than anticipated volume, will cause the group's earnings to be somewhat lower than anticipated.

Consequently the group's operating margins will likely be closer to the mid-13% range.

Next, Marine Systems.

Marine Systems delivered another very solid quarter.

Sales and earnings at $1.7 billion and $183 million respectively were up for the group collectively and at all three shipyards when compared with the prior year periods.

Marine's stronger sales performance reflects higher submarine and destroyer volume, partially offset by lower T-AKE volume when compared with last year's second quarter.

The group's repair-related sales also increased in the quarter, due primarily to our third-quarter 2011 acquisition of Norfolk-based Metro Machine now known as NASSCO-Norfolk.

Integration of this acquisition is going well, and we continue to be excited about naval ship repair opportunities.

In order to better leverage this growth market, in the second quarter we announced our intent to acquire the ship repair and coatings divisions of Earl Industries.

Earl will provide General Dynamics a role as prime contractor for nuclear aircraft carrier multi-ship, multi-option contracts, MSMOs; further enhance our ability to deliver cost-effective repair and maintenance service on both coasts; and extend the reach of our repair capabilities in the two major East Coast Navy ports, Norfolk and Mayport.

Group margins in the quarter improved 90 basis points over last year's second quarter to 11.1%, driven primarily by strong performance on the T-AKE program.

Our three shipyards were busy delivering ships to our Navy customers in the second quarter, including T-AKE 13, the USNS Medgar Evers; DDG 112, USS Michael Murphy, the final ship in the original DDG 51 program; and SSN-782, the USS Mississippi, the 9th Virginia-class submarine.

The group's backlog was $17 billion at quarter-end, including several key new orders such as a $65 million contract to provide planning yard services for DDG 51 class destroyers and FFG-7 class frigates, and an $80 million contract to purchase long lead materials for the next block, Block IV, of nine Virginia-class submarines.

We are currently preparing our bid for Block IV, expected next year, and the SSBN replacement program design contract, which should be awarded by year-end.

We also recently submitted our bid for the Navy's DDG 51 multiyear program.

This nine-ship contract, which includes an option for a 10th ship, is expected to be awarded early next year.

Other opportunities for the group include additional repair work and the potential for some Jones Act commercial ships.

Overall 2012 sales should be modestly below 2011, consistent with my prior guidance.

Given the group's performance through the first half, Marine margins for the year should be in the low 11% range, somewhat better than my earlier guidance.

Now to IS&T.

As I mentioned earlier in my remarks, our IS&T group was challenged again in the second quarter as customer award activity continued to fall short of expectations.

Group sales were $2.5 billion, while earnings were $226 million, up modestly from first quarter but off slightly from our expectations.

Similar to the first quarter, volume weakness was driven by shortfalls in our tactical communications business.

Last quarter I highlighted the three areas which were causing weakness in our communications business -- award delays in our shorter cycle products, especially encryption hardware; a slower than anticipated transition to the Common Hardware Systems-4 Program; and the sluggish ramp in several programs moving from development to production, most notably JTRS and WIN-T.

We made some progress on encryption orders in the second quarter, although we did not completely meet our forecast.

We do expect good third-quarter encryption volume, particularly as the government's fourth fiscal quarter has historically been a strong award period for our short cycle products.

The CHS-4 program was, again, a driver of the group's volume weakness in the second quarter, although improved somewhat from the first quarter.

As a reminder, this is a $3.7 billion five-year single source ID/IQ contract that purchasers from across the military and other government agencies can use to acquire the latest ruggedized commercial computing and communications technologies.

Slowing operational tempo has impacted demand when compared with the prior contracts.

However, current customer demand far outpaces the orders we have received year-to-date.

We have lowered our full-year expectations for this contract, but believe that orders will improve somewhat in the second half.

On development programs, our JTRS HMS and WIN-T programs continued to demonstrate their capability in the quarter, including participating in the Army's recent network integration evaluation.

While test reports are still preliminary, we have every reason to believe that our HMS Manpack and WIN-T Increment 2 products performed extremely well.

Similarly, our HMS Rifleman Radio received Pentagon approval for procurement of another 13,000 radios.

Despite the demonstrated success and progress of our programs, the obligation of funding and awards for these programs continues to fall behind program of record timelines.

We are working closely with our customer on these issues and continue to expect to receive FY12 funded awards for WIN-T, as well as Rifleman and Manpack radios in the second half.

Volume in our IT service business was essentially flat this quarter as the addition of several businesses in 2011 offset lower workload on several major IT infrastructure support projects which have concluded.

IS&T operating margins were 8.9% in the second quarter.

This result reflects the lack of award activity in our higher return product-oriented tactical communications business and the overall portfolio mix shift towards service work that I mentioned in the first-quarter call.

IS&T, like the rest of our businesses, remains focused on profitability and competitiveness.

The group continues to be aggressive in targeting costs to include facility consolidations, restructuring of business units and staffing reductions.

These actions should afford some operating leverage when delayed volume returns.

The group's backlog totaled $9.3 billion at the quarter-end, while total estimated contract value, which includes backlog and potential ID/IQ awards, totaled $31 billion.

Order activity was particularly healthy at our IT services business this quarter with several new opportunities captured to serve a wide range of customers, including the Centers for Medicare & Medicaid and NATO.

Even amidst a slower order cadence, our tactical communications business captured several key adjacent market wins, including a $365 million 10-year ID/IQ contract to replace the FAA's air to ground radios and a $385 million 10-year ID/IQ contract to replace the Army's outdated fleet of range radar systems.

These wins diversify our tactical communications end markets moving forward and highlight our focus on seeking new opportunities where we can apply our core competencies.

IS&T's proposal activity remains quite robust, and we are maintaining our new capture rates.

While forecasting remains extremely challenging in this market, we anticipate book-to-bill to improve in the second half and full-year book-to-bill to approximate 1 times.

In light of the group's first-half results, I expect full-year sales to be down 7% when compared with last year.

This revised outlook, which assumes just over $500 million of incremental volume in the second half, reflects the realities we experienced in the first half and our best estimate of how our customers will behave in the second half.

Most of the incremental volume will come from our IT services business, including a significant portion that is in backlog today.

As tactical communications volume improves in the second half, I would expect margins to expand from the 9% level achieved in the first half to yield full-year group margins around 9.3%.

Now let's move to Aerospace.

The Aerospace group's second-quarter sales were $1.6 billion, up 16% from the year ago quarter, due primarily to green G650 deliveries.

When compared with the first quarter, revenues were down modestly due to the timing of several large cabin aircraft deliveries.

Earnings totaled $257 million, resulting in a 16.1% group operating margin.

The group's operating margins improved 90 basis points when compared with last year's period due to both improved results at Jet Aviation and excellent performance at Gulfstream.

A variety of factors including mix and right-sizing actions taken at Jet caused margins to contract 60 basis points sequentially.

Jet Aviation continues to make positive progress.

In the quarter, we delivered the remaining two narrowbody, wide-body aircraft that had experienced significant cost growth.

And in an effort to continue improving its competitiveness, Jet reorganized its Basel operations, which resulted in further employee reductions.

The Jet leadership team remains focused on capturing new completions opportunities.

Jet's service operations continued to do well to include modest volume improvement from the year ago period and flat revenue sequentially.

This performance reflects the dichotomy of increased demand across some markets such as Asia and decreased maintenance repair demand in Europe as the region copes with continued economic uncertainty.

We have taken a hard look at our European service operations and are taking appropriate actions to reshape that footprint.

As we look forward, Jet's global service footprint remains a strategic advantage for our Aerospace group.

In the very near term, Jet's London Biggin Hill FBO, the closest business aviation airport to Olympic Park, has already seen an increase in traffic from visitors to the 2012 Summer Olympics Games.

Broader Aerospace market indicators were mixed this quarter.

As I mentioned earlier, orders were softer than expected due to the timing with second-quarter gross new aircraft book-to-bill at 0.6 times on a dollar-denominated basis.

When combined with continued G650 deliveries, this elongation of the order cycle caused the group's backlog to decline to approximately $16.3 billion.

While lower, this healthy backlog continues to keep us in an 18- to 24-month delivery window for our G450 and G550 products, and G650 backlog remains approximately five years in duration.

As I mentioned previously, because new orders for the G650 currently have this five-year entry into service date, we do not expect new orders to match planned deliveries in the near-term.

Through the first half, orders reflect the relative resilience of the large cabin market when compared with mid-cabin.

North American customers comprise 60% of the order book year-to-date, reflecting the return of some of our North American customers and some cooling of international demand, particularly in Asia.

Gulfstream flying hours were at pre-recession levels, pretty healthy, consistent with the first quarter.

Year-to-date Gulfstream and Jet Aviation services are up almost 5%.

We continue to work diligently to ensure that our service network remains well positioned to serve customers and the growing installed global fleet.

In pursuit of this goal, we continue to improve our Field and Airborne Support Teams, our FAST teams.

These teams, which were created a decade ago to provide 24/7 customer service support, just celebrated their 3,000th mission flight.

In the quarter, we announced the addition of mobile maintenance vehicles to the FAST capability set.

These vehicles will provide a range of services to customers in targeted markets.

Pre-owned aircraft on the market continued to slowly decline in the quarter.

We had one aircraft in inventory at the beginning of this quarter, took one additional pre-owned in trade during the quarter and had both aircraft available for sale at quarter-end.

On the product development front, the G650 and G280 development programs continued to make progress in the second quarter.

Both aircraft set city-pair records en route to EBASE in Geneva in May.

The G280 has now completed all of its FAA flying, and we are working through the final stages of certification.

We are nearly complete with the FAA's required G650 flight testing and remain on track to obtain a third-quarter type certification.

We continue to believe that we can attain our objective of delivering about 24 green G650 aircraft this year and around 17 completions with most of these completions happening in the fourth quarter.

For the year, I expect the group sales to grow approximately 15%, in line with my prior guidance as large and mid-cabin in-production green deliveries planned for the year remain on track at just over 100 and 10 to 15 respectively.

Margins will be in the mid-15% range, somewhat higher than previously expected, given Gulfstream's strong performance through the first half.

In summary, General Dynamics executed very well this quarter, and I expect that performance to continue in the second half.

However, given first-half results and the difficult reality of forecasting for IS&T in this uncertain period, I'm adjusting my EPS range to $7 to $7.10.

As is our practice, this guidance does not presume further deployment of capital.

We have a lot of work to accomplish in the second half as we deal with the defense uncertainties before us, achieve G650 and G280 type certification and begin detailed planning for 2013.

With these tasks ahead, Phebe Novakovic, who, as you know, will assume my role as Chairman and CEO at the beginning of next year, is concentrating her efforts on the operation of this Corporation and our 2013 planning process.

Amidst this decidedly dynamic business climate, all of us at General Dynamics remain laser-focused on the things we can control and on doing what we do best, executing.

And with that, I will ask Hugh Redd to touch on some additional financial details.

Hugh?

Thank you, Jay, and good morning, everyone.

Really just three quick points before the question-and-answer period.

First, net interest expense was $37 million for the quarter versus $31 million in 2011.

For 2012 we expect net interest expense of approximately $155 million, reflecting the full-year impact of our fixed rate notes issued in July of 2011.

At the end of the quarter, we had just over $1 billion of net debt.

Second, I would like to point out an item impacting the comparability of our results, that being the sale of the detection systems business in the second quarter of 2011.

This sale resulted in a pretax gain of $38 million or about $0.07 in other income.

Finally, the effective tax rate was 31.5% for the first six months compared with 30.8% for the same period in 2011.

For 2012 we expect an effective tax rate of approximately 32%, rising slightly over the 2011 amount and due primarily to the absence of the R&D tax credit for 2012, but also due to less income from international locations where the tax rates are lower.

Amy, that concludes my remarks, and I will turn it back over to you for the question-and-answers.

Thank you.

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

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

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

(Operator Instructions).

Myles Walton, Deutsche Bank.

Good morning, guys.

Jay, your comments on the second-half book-to-bill improvement that you expect in Aerospace, can you give a little more color as to the level of confidence there in terms of if you are seeing more pre-order traffic or kicking the tires, and specifically what regions are showing that pickup?

And then as a caveat to that, at least I interpreted that there was some -- I'm not sure it is process or procedural delays maybe in the quarter in terms of orders getting over the finish line.

If you can clarify that a little bit?

Okay.

I would be happy to.

We did -- let me say it this way, we believe the second-half order activity will be stronger, as I said in my remarks.

Example, let me just talk to demographics.

60% of our first-half orders came from North America.

Within that set, we had several, shall we say, multi-aircraft fleet buys, if you will, that moved out of the quarter, not off the page just out of the quarter, and we anticipate those to be with us in the order book before the end of the year.

Really that probably had as much to do in North America with the order circumstance, if you will, as anything.

So last year, just to further comment on North America, last year at the midyear, about 28%, as I recall, of our orders were North American and, as I said before, 60% this year.

So the North American market writ large is becoming a bigger part of our order book, which we like a lot.

Conversely we saw great softness in Europe, not unexpected by anyone, and some in Asia, which, frankly, we attribute at this stage more to timing than anything.

What does that mean?

That means this year -- I don't have the exact percentage in my head -- but last year's midyear order book was like 49% Asia-Pacific, and this year it was down in the high teens, as I recall.

So there has been some cooling, as I said in my remarks.

But, again, we had a lot of fleet activity last year that has not manifested itself yet this year, but because of ongoing discussions, etc., we believe that there will be more activity coming out of Asia in the second half is probably the cleanest way to say it.

Do you think it is enough to make book-to-bill 1 for the second half?

Probably not.

Remember, too, as I said in my remarks, the 1-to-1 book-to-bill is going to be challenged right now because we are working off the 650 backlog.

So I look primarily at what my delivery window is, and I'm still very comfortable today in the 18- to 24-month for the 450 and the 550 and, as I said, well out in excess of that for the 650.

So I think that answers your question.

Noah Poponak, Goldman Sachs.

Good morning.

Jay, I wanted to ask you two questions on two specific programs.

First, I wondered if you might speak to why you think Textron won the TAPV program?

And then secondly, following up on your IS&T tactical comm comments, can you elaborate on WIN-T?

Is there anything materially unexpected or sort of out of line on that program going on?

Okay.

I don't really have a comment on TAPV.

I don't know, I mean, but I wish them well.

And I would say that we are in the hunt to compete for the CCV, and we are already in execution on $1 billion of the last three upgrades with the Canadian DND.

So we have got plenty of work to do, and we see more work out ahead.

In terms of WIN-T, look, it is the stated number one priority for our Army customer.

So in macro terms, we feel very good about WIN-T, and the performance of our pieces based on the NIE 12.2 are very encouraging.

So it is back to my T word, which is timing, and we anticipate getting awards in the second half of this year.

We just don't have them yet, okay?

We expect a full-rate production decision, I think it is in September, either late August or September.

So best we can tell, that is still on track, but it has not obviously come yet.

But we are very pleased and I believe the Army customer is very pleased with the performance of our pieces of WIN-T.

Have there been any design or specification issues with any other contributors to the program?

I am just trying to discern why this is getting held up.

None that I am aware of.

Honestly and I may be -- I don't want to presume to speak for the Army customer here, but maybe I will a little bit.

And I will just give you my impression of some of this is that they are trying to align all of these programs, WIN-T and JTRS, into the NIE sequence, and those don't happen but every so often.

So I think honestly that has caused some of the delay in some of the award activity.

That is my best sense of it.

Okay.

Thanks for taking my questions.

Richard Safran, Buckingham Research.

Good morning.

Jay, just a question on the Aerospace and business jets.

I just wanted to know, you noted some pretty strong pricing previously.

I just want to know if you can discuss maybe pricing for large cabin and mid-cabin jets, especially since you are thinking about stronger order activity in the second half.

The way I would characterize it is that the large cabin pricing is very resilient, and the mid-cabin pricing -- I think this is industrywide -- is very competitive and, shall we say, less resilient.

Okay.

Fair enough.

Thanks, Jay.

Peter Arment, Sterne, Agee.

Good morning, Jay.

Just a question on IS&T, just thinking about the different buckets that you are involved in.

I know that you commented on the delays within some of the products in the networking area.

What are you seeing -- on the services front, we have seen a lot of delays.

Can you bucket it in terms of the customer mix, DOD or Intel, or is it all across the board within civil agencies also?

Well, our services business has been -- they have done pretty well in what I'd consider a really tough environment.

Good award activity in the quarter.

I think I mentioned that.

We've got probably about -- I think I have got about 45% to 47% of our IS&T sales are coming out of services now.

About 21% or 22% of that are what I would call pure IT services and then probably another quarter coming out of engineering services.

But that segment has been pressured for 18 to 24 months now.

But I would say, as I started this answer, again, we are competing very well in a tough environment.

We are seeing some of the awards move to the right.

We are seeing some down scoping or rescoping of those awards.

But we are maintaining our capture rates, and I think we are very competitive.

You have got, in addition to that, the Lowest Price Technically Acceptable reality, which I think we have talked about before that is out there that puts a lot of pressure on the system.

So in a pretty decent catfight, I think our IT services business is doing very well.

Do you need -- I know that you had presence in all 50 states and certainly internationally on the footprint side.

Are there consolidation opportunities there to help preserve the margins?

Sure, sure.

They are looking at that all and doing that, all of them.

It is interesting.

The consolidations and the rescoping and the reshaping that I mentioned in my remarks, I mean that is a reality across all of our businesses right now as they deal with the realities of the defense market, that is taking the $487 billion reduction across the 10 years, and that does not even get into the sequestration discussions.

So that is just good business.

So, as I have always said, we manage for profitability, and we are doing that right now in all of these businesses.

Howard Rubel, Jefferies.

Jay, thank you very much.

Just to talk about Gulfstream for two seconds.

One is, can you give us a sense of what is left in terms of the challenges for the 650 cert, and then also just talk a little bit about the service business?

You did talk about all the expansion.

What kind of growth rate are you seeing?

Okay.

Thanks.

The 650 certification, as I mentioned in my remarks, we are getting very close to completion of the flight test activity.

That will conclude here very shortly.

Once that occurs, then it becomes a matter of putting it all together -- my word not probably the proper word -- administratively, if you will, and laying all that out and then getting with -- working with the FAA to get yourself to an agreed-upon time to execute the type certification.

We are on track for that.

I have no indication that we are not.

So I am getting excited about it actually.

I try to throttle myself back.

But that is on track.

Once that happens and as that happens, once the flying is done, they will start training the crews for the aircraft to be delivered, etc., as we have talked to before, and you will see them entering into service within a matter I should think of weeks after the type certification occurs.

So we are marching down that timeline very aggressively and busily, I would add.

We are doing lots of flying right now, but we are almost done with it.

And then --

The service business, I mentioned I think the service business was up 5% for the first half.

I would expect it to probably stay kind of flat for the rest of year.

And why do I say that?

Because of the lack of activity, for example, that we are seeing in Europe right now, I don't see that getting any better for the rest of the year.

It is causing us to have to reshape our European business somewhat at Jet, as I mentioned earlier.

So the service business is doing fine, but I don't expect it to outperform the first half in the second half.

I would love to be pleasantly surprised on that, but I just don't see it right now.

We measure that in lots of different ways, not the least of which is looking at what visibility our service centers have on their order books, and it is still pretty close aboard.

Not a lot of long-term appointments for discretionary repair and upgrades.

So it's still a very strong business for us, but I don't see much more than flat for the rest of the year.

Thank you very much.

Michael Lewis, Lazard Capital.

Good morning, Jay.

Can you help us understand order flow a bit better?

Where do bids submitted pending approval currently stand, and can you give us the mix of re-competes versus new opportunities in that number?

And then finally, as we look out over, say, the next six months, what do you plan to submit to fund new contracts?

Thank you.

Wow, let me just put it in macro terms.

In the IS&T space, as you know, we have thousands of contracts in a year.

I would characterize the order activity as being quite healthy actually.

We don't quantify it inside of that because it is just, like I said, there are just flat too many moving parts.

But we anticipate the funnel is still there, and the funnel will need to get serviced.

So, as I said earlier, the order activity in IS&T we anticipate to be fairly respectful and ending the year at probably 1X, which it needs to do, and you know in that short-cycle business they have got to turn inside themselves at least inside the year.

So that part is good.

Where we are seeing the challenge right now, as I mentioned, is in the actual converting that into -- converting orders into sales and execution, and we are working very hard with our customers to get the appropriated funds obligated and to execute the 2012 plan.

Robert Spingarn, Credit Suisse.

Good morning, Jay.

You sort of just touched on this, but what I was going to ask you is, what level of bookings you need across the three segments, understanding that some are longer cycle than others, in order to meet your targeted guidance for the year?

Oh.

I am thinking about the third quarter specifically since no one knows what the fourth quarter is going to do.

Yes.

I mean I think I expect Combat's bookings to improve.

I think I may have mentioned that.

Marine not much, but remember Marine is very lumpy.

So we will get Marine orders in big slugs.

We will work them off, which we are doing right now, and then we will get another big slug.

I'm not worried in the least about Marine.

And then IS&T, as I said, it has got to turn itself inside the year, and we anticipate, based on the funnel we see out there, still being close to 1 to 1 for the year.

So I hope that is responsive.

Well, Jay, one other thing.

Do I detect a shift towards service in the Marine business with the recent acquisitions?

Is that a strategic thing that you are doing given the long-term outlook on production?

I would not say it is a switch to service; I would say that we are adding service to a very robust platform portfolio.

And the repair business is a wonderful thing to be in for the United States Navy with its global fleet.

So we are trying to enhance our repair opportunities, and I would love to -- we will keep doing that.

But it is not at the expense of because we have got three shipyards that are going to be very busy for as far as I can see.

Jason Gursky, Citi.

This is actually Jon Raviv in for Jason.

Just a quick question on cash deployment priorities.

Looking at dividends, buy-backs, M&A, what your priorities are given the current environment?

And then just on the M&A question, where your M&A priorities might be.

I know you have seen some defense acquisitions of late.

Perhaps there are some commercial opportunities on the horizon as well.

Thanks.

Okay.

Thanks, Jon.

But we always couch our capital deployment in terms of balance, and I'm certainly not about to change that.

I would caveat it, however, by suggesting that, as you look at the rest of this year and you look at -- the term we are using, the fog bank that is out ahead of us in terms of the sequester, how it is going to be dealt with, what the CR is really going to translate to and how all that gets dealt with here in the next six months, I would suggest that capital deployment would be dealt with very cautiously, and that is certainly what our intent is here.

I would rather keep it in my quiver right now, and that is where we are.

Now there are not a lot of M&A opportunities of large -- I don't see any of really large scale out there.

There are some and I just talked about one of them that we took advantage of in IPWireless.

I just talked about another one in Earl Industries.

Those good opportunities to add to our portfolio will still be out there, and we would take advantage of such opportunities.

But I think the operative word certainly into next year in capital deployment is caution and maintain your balance and keep the quiver as full as you can.

Heidi Wood, Morgan Stanley.

Jay, I thought maybe I would ask a bigger picture question on the Marine side.

When you look at the op tempo, clearly the Navy is small for the missions being asked so that you have got the Navy stretched thin over Central Command and at the same time being asked to cover significant areas in the Pacific Command.

You know the pivot to the Pacific has been long in the making, but I don't think anyone foresaw how much the Navy would be tasked over Central Command.

It's clear that the Navy budget faces real strain in terms of the need for more ships.

And I'm just wondering if you could give us color on what kind of discussions you are having with your Navy as they wrangle with solving this problem.

Is there an examination into basically maybe buying more lower-cost surface combatants?

Or the Virginia-class sub was supposed to be a low-cost sub; could they downsize yet again and develop less costly subs?

Can you maybe add some vibrancy to how you are working with the customer to kind of wrestle with this?

We have had this discussion before in the context of even before the Pacific pivot was announced.

I mean we are a global Navy.

Over 90% of the world's commerce moves by sea, by volume, as I recall.

I don't think that will change certainly not any time soon.

And with that as a reality, the United States Navy must maintain a robust force structure.

That robust force structure must include lots of ships, and as I have said before, presence really does make a difference.

And so you have to be there, particularly when you are dealing now with the realities in the Pacific where the tyranny of distance causes you to be unable to be in multiple places at the same time very easily.

So all that bodes well when you are a Navy ship builder for your future opportunities.

As to your comment about the Virginia-class, the Virginia-class submarine in that program itself is what I would call as close to a model program as the Department of Defense has, and we are very proud of that.

And we bring those boats in at the price tag that was -- I think the public price tag is like $2 billion a boat.

In point of fact, we delivered the Mississippi $60 million under budget and a year early.

So we know how to build Virginia-class submarines.

There is no substitute for the Virginia-class submarine in my humble opinion, and I don't think the Navy would argue with that.

We need them in number.

That is why Block IV will become a reality, and there will probably be a Block V after that.

So the customer is looking at costs all the time on things like SSBN(X), but we still must have a fleet of major platforms.

LCS will have its role, but we are still going to be making, manufacturing lots of, in Jay Johnson's humble opinion and I think the Navy would agree, lots of major surface combatants, aircraft carriers and nuclear-powered submarines and the auxiliaries that will be needed to service them around the globe.

That will not change.

And you said you are not the least bit worried about Marine.

Does that mean that the second sub and the second destroyer in FY13 will be executable?

And lastly, if you don't mind me squishing this in, Jay, there are some smaller ships that are clearly struggling, and I just wondered if you could touch on whether that creates some M&A opportunities for you?

On the last, I'm not particularly looking at any of that.

On the smaller ship side, I think I know what you are talking about, but we have got plenty of work right now with the platforms we have.

And the second submarine and the second DDG, I think the Navy and everyone is working very hard to keep that rate as the reality because it is the most cost-efficient and smartest move for everybody.

So we are confident there.

Cai von Rumohr, Cowen and Company.

Yes, thank you.

So a two-part question on profitability at Gulfstream.

The first part is, you did 16.1% close to the first quarter, even though forfeitures were down, and you had the problems at Jet.

How come?

And secondly, you had said that G650 should have above average margins.

Given that volume will be up in the second half, presumably with the G650s in your guidance, how come the margins are not better in the second half?

Well, they are better than I guided to earlier.

But I would say I'm being a little bit conservative here.

I have got a product mix at Gulfstream.

We delivered, I think, like four of the mid-cabins in the first half, so we are going to be delivering more of the mid-cabins in the second half.

And so I'm at the mid-15%s right now, and as is usually the case, I am hopeful they will outperform that.

But we have got Jet -- you touched on it.

But if you compare it to the first half -- first quarter, I'm sorry, we have got -- I think we are down like 60 basis points.

But a lot of that had to do with timing from Jet absorption expenses related to their resizing effort, which I touched on but did not really elaborate.

They are on track to be about breakeven for the year, but they have got a lot -- they had a lot to take out here in the first half, so.

But it is not even -- if Jet is going to do better in the second half, you have more 650s, basically your volume on the midsized given the price differential just is not that big, it still looks like on paper the margins in the second half should be better than the 16.1%.

Are we missing something here?

No, I don't think so.

I am probably hedging.

As I said, I'm being a little conservative with it, Cai, partly because of the restructuring and the market that Jet is seeing in Europe right now and partly because I am just hedging myself a little bit on product support, which, as I mentioned in an earlier question, I expect to be flat, and that remains to be seen.

Sam Pearlstein, Wells Fargo.

Good morning.

In Combat Systems, if I look at that you did about $4 billion in revenues in the first half to get to $8.5 billion for the year, it would certainly imply a stronger second half.

Can you talk a little bit about what is driving that pickup in that second half?

And then just secondly, unrelated, was, OT&E recently talked about the HMS Manpack as not being performing as well, and I just wanted to know if you could comment on that.

Actually I think I know on the last what you are referring to, Sam, and that was basically some old news that has already been taken care of.

The Manpack is -- they are quite happy with the Manpack right now.

As to the first, it is really -- hit me with it again.

You did $4 billion in revenues in the first half.

You are saying $8.5 billion for the year, so it has got to pick up.

Yes.

Some of that, I think, will have to do with ELS, which we expect to be stronger in the second half than in the first half.

And Land Systems' international programs, which as I've said, they have had some program delay, but we expect more pickup in the second half.

ELS and Land -- I mean Combat Systems has been historically rather back-weighted to the year.

I don't expect that to change, but I am quite confident in our $8.5 billion number.

And Jeff, I think we have time for one more question.

Joe Nadol, JPMorgan.

Thanks.

Good morning.

Just a couple of clarifications.

Jay, could you be specific on the number of flight hours or test points or whatever that have been achieved on the 650 versus what is necessary?

And then on the IS&T side, we are looking for a margin pickup in the second half, but I thought I heard you say that the services side of the business was what you believe is going to provide the incremental revenue pickup.

And so that would suggest an adverse mix shift.

What amendment is in there?

Thanks.

To your last, of the $500 million in incremental that we need to get to where we are guiding in the second half, two-thirds to three-quarters of that comes from IT service.

Your point is well taken.

The tactical communications piece of that, though, is about 20% to 25% of that, and assuming that happens, which we have every indication that it will, that will give us the margin lift that I talked about.

Okay.

As to your first, I'm not going to get test point specific.

Let's just say that we are down to a very reasonable number of flights that remain, and we are on track for the third-quarter certification.

There is no mystery in any of that that I am seeing, and quite honestly, I cannot remember the precise figure.

But I have been tracking it virtually every day or every other day, and we are marching down the flight test point burn-down chart quite nicely, and I am very confident that we are going to be wrapping it up very soon here.

Thanks.

Thank you for joining our call today.

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

Have a great day.

Ladies and gentlemen, that concludes today's conference.

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