通用動力 (GD) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2012 General Dynamics earnings conference call.

My name is Grant and I'll be your event operator for today.

(Operator Instructions).

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

And now, I would like to turn the call over to Ms. Amy Gilliland, Staff Vice President of Investor Relations.

Please proceed.

Thank you, Grant, and good morning, everyone.

Welcome to the General Dynamics third-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.

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

Thank you, Amy.

Good morning, everyone.

General Dynamics' third-quarter sales totaled $7.9 billion, up modestly from last year's third quarter on strong aerospace volume.

Operating earnings were $905 million, while earnings per share from continuing operations were $1.70 on a fully diluted basis.

Third-quarter free cash flow after capital expenditures was $594 million, nearly 100% of earnings from continuing operations.

This result is particularly strong, given the $321 million of pension contributions we made in the quarter.

Year to date, free cash flow conversion is a healthy 90% of earnings from continuing operations, and I expect the fourth quarter to be another strong cash quarter.

In terms of capital deployment, we remain cautious, given the unprecedented uncertainty in the coming months caused by the threat of sequestration.

For that reason, we did not repurchase any shares this quarter and may not do so until we see more clearly what happens at the start of 2013.

We did take advantage of opportunities to deploy $261 million this summer to enhance our defense portfolio with four bolt-on acquisitions.

These new businesses, which I will detail later in my remarks, better position each of our three defense segments for significant future opportunities.

In addition to these accretive acquisitions, our multiyear Gulfstream campus investment project continues.

Year to date, we've returned approximately 70% of free cash to shareholders through share repurchases and dividends.

Orders this quarter were the strongest of the year, driven by improved award activity at Aerospace and IS&T.

At the end of the quarter, backlog was $51.5 billion, while total estimated contract value, which includes backlog and the value of unexercised options in ID/IQ contracts, stood at $77.5 billion.

Let me briefly address what we're experiencing in today's aerospace and defense environment, defense bottom line up front.

There's been very little change to the situation for our US defense businesses since my last update on the second-quarter call, except that, as predicted, we are now in a continuing resolution through March of next year and we are closer to the fiscal cliff.

The same uncertainty regarding the defense budget adjustments that has challenged our industry for the past year continued to impact our customers' behavior in the third quarter, particularly in our shorter-cycle businesses where bids awaiting awards are at record levels and descoping actions are becoming much more common practice.

We are likely to see more of this in the fourth quarter.

We would hope to receive some clarifying details over the next two months as this election cycle ends and the Congress returns to address the many important fiscal issues confronting our country.

In light of the significant legislative workload and the limited lame-duck timeline, however, it remains difficult to predict whether sequestration will be resolved before January.

With that said, discussion about the negative implications of going over the fiscal cliff at year-end has escalated in recent weeks.

We hope that a bipartisan solution can be brokered to address these serious issues before they take effect in 2013.

With limited detail on how sequestration would be implemented, planning for next year is difficult, at best.

Our government customer continues to assert that there are no ongoing planning efforts to prepare for implementing sequestration, should it be triggered.

The indiscriminate across-the-board nature of sequestrations cuts are troubling for defense, as well as other federal agencies.

Given the lack of planning to date, however, we are also extremely concerned about the profound disruption and paralysis that implementing these cuts will likely have on our customer and thus our entire industry.

We continue to focus on managing for earnings and cash, cutting costs, and positioning our businesses to better navigate further defense cuts.

In Aerospace, we remain encouraged by Gulfstream's sizable large cabin backlog and healthy order pipeline.

Several multi-aircraft orders from North American customers, which we had originally expected in the second quarter, materialized in the third quarter.

Relative to other periods, however, the order cycle remains somewhat protracted, with a number of factors causing deal closure times to increase.

Global economic sentiment, particularly in Europe and Asia, and political uncertainty here and abroad, continue to influence the velocity of order activity.

We continue to believe that we will realize several multi-aircraft international orders in the coming months, although their exact timing, for all the factors I just explained, is difficult to predict.

Now let me turn to the results and outlook for each of our groups, beginning with IS&T.

IS&T sales were $2.5 billion in the third quarter, off somewhat from our expectations, but relatively flat compared to this year's second quarter.

Sales through the first half of 2012, as in 2011, reflected continued pressure in our tactical communications business.

In the third quarter, however, tactical communications volume was close to our forecast as encryption demands stabilized, albeit at lower levels.

Common Hardware Systems-4 program awards improved, and development program contract awards, including JTRS and WIN-T, progressed.

Volume at our IT service business, on the other hand, was somewhat lower than expected, due to delayed award activity, scope reductions, and award losses spawned by renewed customer interest in lowest price technically acceptable solutions that favor price over experience and product quality.

The group's third-quarter operating earnings and margins were $201 million and 8.1%, respectively.

These results were negatively impacted by a $25 million charge taken on ruggedized computing equipment inventory at our tactical communications business.

We are re-orienting that portfolio to focus on -- less on volatile lower-margin commoditized products and more on cutting-edge solutions that better align with our core customers' current and emerging priorities.

Without the charge, group margins would have been 100 basis points better at 9.1%.

This return on sales reflects an overall portfolio mix shift toward service work, an altered mix and lower level of tactical communications volume, and continued competitive pressures in this segment as more bidders pursue fewer contracts.

Although delayed award activity impacted group sales through the first three quarters, IS&T enjoyed its strongest order quarter in two years in the third quarter, causing backlog to increase by approximately $800 million to $10.1 billion.

Award activity was particularly notable in our tactical communications and IT service businesses.

Several of the awards received are long awaited and exemplify the customers' continuing focus on network modernization.

These included a $346 million award to continue fielding the Warfighter Information Network, WIN-T, Increment 2 capability and a $54 million award for an additional 13,000 JTRS HMS Rifleman radios and accessory kits.

Subsequent to the quarter, we also received an award for another 3,700 JTRS HMS Manpack radios.

Awards in our IT service business included a significant opportunity to provide supply-chain management services to a relatively new customer, the Department of State, as well as myriad other contracts to provide critical IT support capabilities to existing customers across the federal government.

Additional details about contracts received in the quarter are included in today's earnings press release.

IS&T's total estimated contract value, which adds the potential value of ID/IQ contracts to total backlog, increased $1 billion to over $32 billion at quarter-end, an improved opportunity set both year over year and sequentially.

We further enhanced our IS&T portfolio in the third quarter with two acquisitions that bolster our presence in priority areas.

Open Kernel Labs, now a part of our tactical communications division, brings to our portfolio solutions that enable the secure separation of corporate data from a user's personal data stored on the same device.

This technology has wide-ranging commercial and government applications as employers increasingly look to better manage IT costs through bring-your-own-device policies.

And Fidelis Security Systems, now a part of our industry-leading cyber business, offers highly regarded software capable of identifying network intruders and preventing hackers from stealing proprietary information.

Fidelis' product complements our unique portfolio of cyber incident response capabilities and better positions us for new opportunities as cyber investments grow.

Looking ahead, fourth-quarter sales will be the group's largest this year as the tactical communications and IT services businesses begin to realize revenues associated with the delayed award activity added to backlog in the third quarter.

For the full year, I expect group sales to be down around 8% to 9%, a reduction from my previous guidance.

Volume will depend in large part on how rapidly our recent orders translate to sales.

Margins for the year will be around 9%.

Next, Combat Systems.

Combat Systems' third-quarter sales totaled nearly $2 billion, reflecting growing foreign military light armored vehicles sales and ground combat vehicle volume, offset by lower Stryker, Abrams, MRAP, and European vehicle work.

While the decline in these vehicle programs was expected, the group's volume in the quarter was somewhat lighter than we anticipated, due to the delay in several anticipated awards.

With many of these awards now in hand or imminent, we expect to realize this incremental volume in the fourth quarter.

The group's earnings were $274 million, resulting in a 14% operating margin.

This margin continues to reflect excellent performance across Combat's portfolio of domestic businesses.

Our European Land Systems business continues to confront profitability pressures driven by delays in international awards, which reflects the group's challenged indigenous markets and absorption impacts from lower-than-anticipated volume.

ELS is aggressively going after costs and has already reduced 20% of its workforce, consolidated or closed numerous facilities around Europe, and implemented a variety of continuous improvement and business optimization initiatives.

Total backlog for Combat Systems was $9.4 billion at the end of the quarter.

Notable orders in the quarter included $50 million to provide additional Foxhound vehicles to the United Kingdom, $135 million to supply ammunition to Canada, and $400 million for research and development efforts to enhance the Abrams tank.

Over the next few quarters, we will continue to track several meaningful international order opportunities, including tank upgrades for Morocco and Middle Eastern customers, Eagle vehicles for Germany, and light armored vehicles for several international customers.

Although it does not add to today's manufacturing workload, the sizable eight-year Abrams R&D contract received this quarter clearly demonstrates the Army customer's long-term commitment to improving the tank's capabilities.

Per its current planning documents, the Army envisions incorporating Abrams improvements arising from this R&D contract in the 2017 timeframe.

Consequently, it's important to preserve a healthy and reliable tank industrial base in the interim.

The Congress continued to support this notion in the 2013 budget process, with all four committees adding tank manufacturing funding to the President's budget request.

Looming future budget cuts have inhibited the ability of the Pentagon and, in turn, our Army customer to solidify the size and shape of the future force.

We remain confident, however, that our incumbency in the force will yield a wide range of opportunities to provide our customer affordable, enhanced warfighting platforms.

The Stryker Double-V Hull is an excellent example of GD leveraging our experience to bring cost-efficient solutions to the customer.

The lifesaving benefit of the Double-V was established in Afghanistan over the course of the past 18 months.

However, prior to the customer's second-quarter conversion order, we had not demonstrated our ability to transform flat-bottomed Strykers into the Double-V Hull configuration.

I'm pleased to say that the very first Double-V Hull exchange program vehicle is on exhibit at AUSA in Washington as we speak.

Production of our initial conversion vehicles is running on time and budget, and we have decisively established the Double-V Hull exchange program's value proposition, creating more durable combat vehicles at a far lower cost.

The Army is currently analyzing the benefits of this program and working towards solidifying additional Double-V Hull requirements in conjunction with broader force structure studies.

Given the success of the program to date, we anticipate additional conversion orders.

Similarly, our Combat Systems group remains involved in a variety of development programs for our Army and Marine Corps customers.

Our work on these development programs will help the customer identify and incorporate key technological advancements into today's vehicles and tomorrow's fighting force.

GD's focus on bringing affordable solutions to our customer is also evident in our acquisition of Gayston Corporation's defense operations this quarter.

Gayston expands our critical manufacturing capability to more cost-efficiently produce high precision parts on core franchise programs, such as the Hydra rocket, and provides us with more opportunities to participate in high-performance weapons programs.

Looking ahead, sales in the fourth quarter will be this year's strongest, with each of the businesses contributing their largest volume of the year.

Margins will be somewhat lower due to mix shift as our newer international vehicle and development programs accelerate and our mature domestic vehicle production work slows.

For the full year, the group remains on track to deliver around $8.5 billion in sales and mid-13% margins.

Now I'll discuss Marine Systems.

The Marine Systems group delivered another quarter of strong operating performance.

Sales of nearly $1.7 billion were relatively stable when compared with the prior year period as destroyer, mobile landing platform, and repair volume grows, and the T-AKE program winds down.

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

Earl Industries, which we acquired in the third quarter of 2012, also enhanced the Group's repair sales.

Earl provides General Dynamics a role as prime contractor for nuclear aircraft carrier multi-ship, multi-option, MSMO, contracts, and extends the reach of our repair capabilities in the two major East Coast Navy ports, Norfolk and Mayport.

Earnings totaled $186 million, up modestly when compared with both last year and last quarter.

The group's third-quarter operating margin was 11.1%, driven primarily by continued strong performance on the T-AKE program, which will see delivery of the 14th and final ship this week.

I also want to highlight the performance across several of our newer programs has been very good.

In September, NASSCO completed the structural assembly and weldout of over 26,000 tons of steel to erect the entire structure of the first MLP.

Construction of this first-of-class ship is progressing on schedule and under budget, with delivery planned for the second quarter of 2013.

At Bath Iron Works, progress continues on Zumwalt, the first DDG 1000, which is 70% complete in manufacturing and provides a most impressive sight on BIW's waterfront.

Fabrication and unit assembly on the initial DDG 51 restart ships are also under way as we demonstrate our ability to simultaneously produce two different types of destroyers in our Maine shipyard.

Marine's backlog totaled nearly $16 billion at the end of the third quarter, while total estimated contract value, including backlog and unexercised options, was $17.3 billion.

Orders this quarter included a $94 million award for planning activities on USS Miami, which you may recall was badly damaged by a fire earlier this year.

The Navy has valued the total repair bill for this submarine at several hundred million dollars, and we anticipate additional repair work following the planning activities.

Third-quarter 2012 orders are well down from the year-ago period when Marine Systems booked three destroyers and several substantive engineering and development contracts.

But as you know, this merely reflects the very lumpy nature of Marine's award activity where shipbuilding awards come periodically in large tranches and provide several years of backlog.

We expect several of these sizable awards next year, including the Navy's DDG 51 multiyear program and the Block 4 Virginia-class submarine program.

Other meaningful order activities on the horizon include the Ohio replacement class design contract and a fourth MLP ship, planned for procurement in 2014.

Marine Systems' fourth-quarter volume will be lower than the previous three as the T-AKE program concludes, while margins will approximate year-to-date profitability.

For the full year, the group remains on track to achieve 2012 sales slightly below last year with margins in the mid-11% range.

Next, I'll move to Aerospace.

The Aerospace group enjoyed a very successful third-quarter, marked by improved order activity and the achievement of FAA Type Certification on our G280 and G650 aircraft.

Group sales were $1.8 billion, up 30% from the year-ago period, due to higher green G650 deliveries, while earnings were $261 million.

Margins were 14.2%, down year over year and sequentially, due primarily to lower Gulfstream R&D supplier payments.

As a reminder, these payments vary from quarter to quarter and therefore can distort profitability comparisons.

Profitability was also modestly lower at jet aviation this quarter as the business works aggressively to confront overhead absorption issues exacerbated by the European debt crisis, which is impacting aircraft utilization and service work across the continent.

With that said, jet aviation continues to take positive steps forward.

In the completions business, the jet team recently delivered the fourth narrow-body, wide-body aircraft of the year and added another narrow-body to the order book.

Jet service operations are seeing mixed demand, with pockets of strength in some regions and continued weakness in Europe.

The leadership team at jet is working aggressively to address this dynamic situation by optimizing our maintenance and repair footprint to better address the requirements of the installed base moving forward, with a particular focus on right-sizing facilities situated in slower markets and investing in our facilities and customer outreach in growth markets.

Gulfstream reported its best order quarter of the year, driven by several multi-aircraft deals placed by North American companies.

Year to date, North American customers represent nearly 60% of Gulfstream's order book.

This metric represents the resurgence of North American demand and some softening in the international demand, driven by political uncertainty in some regions and the overall negative impact of the European debt crisis on global economic sentiment.

Even so, Gulfstream's international customer interest remains very healthy, and we continue to expect to solidify several multi-aircraft international deals in the coming months, as I previously mentioned.

Customer defaults in the quarter were at their lowest since the economic downturn began in 2008.

On an absolute basis, dollar-denominated Gulfstream book-to-bill was a little over 0.8 times, reflecting the improved overall award activity, offset by continued G650 deliveries.

The group's backlog at quarter-end stood just over $16 billion, including approximately five years of G650 backlog and around 18 months of G450 and G550 deliveries.

As I have reiterated previously, because new orders for the 650 currently have this five-year entry into service date, we don't expect new orders to match planned deliveries in the near term.

That said, our sales force booked healthy orders for the G650 and each of our other aircraft models in the third quarter.

In terms of pre-owned, Gulfstream took two aircraft in trade this quarter, delivered one aircraft at breakeven, and brokered another one for a modest profit.

At the end of the quarter, we had three pre-owned aircraft in inventory.

Gulfstream's installed fleet flying hours were at pre-economic downturn levels again in the third quarter, a reality that helped our service facilities enjoy another record volume quarter.

In part, this continued success reflects Gulfstream's number one ranking in worldwide product support.

In the quarter, Gulfstream product support was voted number one for the 10th consecutive year in the annual Aviation International News product support survey.

Similarly, Gulfstream received the top service ranking in the yearly professional pilot survey.

To meet growing customer demand, Gulfstream continues to invest in its product support network, including plans to open new Company-owned service centers in Brazil and China.

Our enhanced global service network is particularly timely as we deliver new G650s and 280s.

Both aircraft are enjoying robust customer interest following Type Certification, and we are proud to showcase them at the NBAA convention in Orlando next week.

The fact that, together, these aircraft have already amassed six city-pair records, including one transatlantic record each, is a testament not only to the capabilities of these aircraft, but also to the entire Gulfstream team.

Entry into service, when we deliver these aircraft to our first customers, is just weeks away.

All necessary preparations to support EIS are proceeding apace, including retrofit work and pilot training.

Looking to the fourth quarter, the Aerospace group expects its strongest sales quarter of the year, including entry into service deliveries for the 650 and 280.

The composition of our planned 2012 deliveries has changed modestly.

For initial stage deliveries, green deliveries, we now expect to deliver 24 G650s -- that's really unchanged; 80 450s and 550s -- that's up modestly; and 15 to 20 mid-cabin aircraft -- that, too, is up modestly.

Planned completion deliveries for 450s and 550s and mid-cabins remain unchanged, while G650 completions will be somewhat lower than the 17 originally planned, solely as a function of the later than anticipated Type Certification.

For the full year, I expect Aerospace group sales to grow approximately 16% to 17%, up somewhat from my prior guidance, and operating margins to be in the mid-15% range.

In summary, General Dynamics made progress on several important fronts in the third quarter, including Gulfstream Type Certifications and JTRS and WIN-T orders.

These franchise programs are now set to realize their full market potential.

Given our year-to-date performance, I expect earnings per share from continuing operations to be $7.00 to $7.05.

However sequestration is resolved, all of us at General Dynamics will continue to aggressively manage our businesses for profitability, with primary emphasis on nailing execution in order to maximize earnings and cash.

We remain focused on affecting what we can control, to include leveraging our incumbency and experience to provide our customers with affordable, dependable, and proven solutions.

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

Hugh?

Thank you, Jay, and good morning.

I would like to cover a few miscellaneous financial items before the question-and-answer period.

First, net interest expense was $39 million for the quarter.

Based on our current net debt position of $900 million, we expect net interest expense of approximately $155 million for the full year.

Next, the effective tax rate.

The effective tax rate was 31.2% for the first nine months, compared with 30.6% for the same period of 2011.

For 2012, we expect an effective tax rate of slightly less than 32%, rising slightly over 2011's rate of 31.4%, due to less income from international locations where the tax rates are lower and the expiration of the R&D tax credit here in the US.

Finally, during the quarter we contributed approximately $321 million to our pension plans.

To date this year, we have contributed approximately $430 million to our plans, with full-year funding expectation of $500 million.

Amy, that concludes my remarks and I'll turn it to you for the Q&A.

Thanks, Hugh.

I'd like to highlight that a summary of the guidance provided this morning will be posted on our website alongside the webcast link.

Also, 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.

And Grant, can you just please remind participants how to enter the queue?

(Operator Instructions).

Robert Stallard, Royal Bank of Canada.

Jay, I'd like to follow up on your question that you felt that the uncertainty about the outlook held you back from buying back shares this quarter, yet you still felt confident enough to make a series of acquisitions.

And I could wonder how you could contrast those two decisions.

Well, I think I've been fairly consistent in saying that one of the things we're trying to do right now is shepherd our cash, and I'm trying to provide my successor with as much cash as I can.

So why the acquisitions?

I said before, and I'll repeat it here, that we always are looking for acquisitions that make sense for our businesses, and when you take a longer view of what these acquisitions can provide, it takes you through the trough we are dealing with here into another space where we believe these things, as I said in my remarks, will give us significant opportunities.

They were priced right.

When they come to market, you've got to take them if you want to build that business, and that's exactly what we did in all four cases.

So it's setting them up for longer-term opportunities, and we felt that was appropriate.

But isn't there a possibility these assets might have been cheaper if you had waited maybe a few more months, six months perhaps, until sequester kicks in?

Well, maybe, maybe not.

Or they may not have been there.

So they made sense for us at the time, and we took them with no apologies.

Okay.

Thank you.

Carter Copeland, Barclays.

Good morning.

And Jay, just want to wish you all the best as you, I'm sure, do something that's not just sitting around, but not doing what you're doing today.

So all the best from all of us.

Thank you, Carter.

I had a quick question and just a clarification on something you said earlier.

I think you'll recall the big contract that Vangent has with CMS is in re-compete.

I wondered if you might update us on where that stands and what the expectations are for award, and what sort of impact that may have.

And then, a clarification of your comments on Abrams, sort of short term, long term, and as you think about the Lima facility.

Is it correct to assume that, since you had committee support and we're operating under a CR, this is a sort of wait and see what happens with the election and a budget outlook before we know ultimately what will happen with that program?

Thank you.

Okay.

The latter first.

As I said, we're fairly -- well, let me back up.

The ECP1, as it is called, which I alluded to in my remarks, the long-term Abrams R&D contract, was very important to lock down, if you will, the long view on the Abrams.

So we'll be working that on the engineering and development side as we approach the 2017 timeframe.

But in the interim, as I said, it's really important to keep that facility and the industrial base intact, if you will.

The 2012 budget supports Abrams through 2013, and what we believe will come out of the 2013 budget will push that out at least another year.

That's kind of -- so are we taking it a year at a time in this instance?

Absolutely.

But we are all sight-lining to the 2017 longer view, so we're confident with the support we have, and so that will work itself out here in the coming months, okay?

In addition to that, and recall, I believe we've talked about this before, but we have international work that also will reside at that facility with the Moroccan tanks, which we expect the order by the end of the year or shortly thereafter, and we've got the Israel Namer Merkava hulls.

We've got the Egyptian kits, so we've got a number of international programs that work through that facility as well.

So our view is that we're getting the requisite support we need, and we'll do everything we can to keep that facility very functional for, as we've discussed many times, it's actually more about the supply chain than it is about General Dynamics, with the 560-some suppliers that are tied to the Lima facility that we cannot afford to lose.

So that, I think, perhaps answers the tank.

The Vangent beneficiary call center, I believe I'm correct here, and Amy nods her head, that this will take place now next year.

So we continue to work, we continue to execute, but the contract re-compete will be at some point in 2013, which is a change.

They pushed it out, but we continue to work since we're the incumbent.

Thank you very much, and again all the best.

Thanks, Carter.

Doug Harned, Sanford Bernstein.

I was interested on Gulfstream.

When you talk about the G650 and the fact that your backlog extends five years out, could you just refresh us on the rate plans for that because what I'm trying to understand is, when you look at that five-year backlog, what would lead you to raise rate?

Is that limited by demand, limited by operational considerations?

How do you look at that?

I mean, I guess my answer -- serious answer would be kind of all of the above.

But we have -- as I mentioned, we continue to take orders for the 650.

We are working through the production side now to get entry into service in the coming weeks.

So we are hitting our battle rhythm or our flow, if you will, and as I said many times, the production, the delivery schedule, if you will, of record has 24 green deliveries this year and adding nominally 10 to 15 a year for the next few years with completion deliveries at 17, 33, and 33.

Now I've just mentioned the 17 will change a little bit because of the lateness of the Type Certification, but nonetheless, the point is that is the program of record, if you will.

To change that, to wick it up based on the demand, based on the five-year backlog, is certainly something we are desirous of doing, but we are not going to turn the rheostat up until we've hit, as I call it, our battle rhythm.

And we're just not there yet.

It looks like -- I mean, certainly internally, you would have the capability to do that.

And I just was trying to understand if you saw -- sort of what timeframe you might see supply-chain limitations, or when could the flexibility occur to take that rate up?

I mean, my view of that is probably, you know, if you look at what we've got now and the work that's taking place to complete the airplanes that have been green delivered and to get the flow going, okay, because of the late Type Certification, my sense of that is it will take probably another year or so to work that flow out smoothly, and then again hit what I would call a steady production rate that then is capable of being accelerated.

Okay.

Thank you.

David Strauss, UBS.

Good morning, Jay.

Best of luck to you.

Thank you.

If I look at Combat in the backlog, if I just look at what has been historically a backlog to sales ratio there, it's run well above one.

If you look at the backlog today in the sales, say it's right around one, which would seem to imply -- obviously you talked about orders that could come through through the rest of the year, but would seem to imply what could be a significant drop-off still to come over the next 12 to 18 months.

Can you just address that, Jay, and what we might be looking at at Combat here over the near term?

Yes, I mean, look, I'm not going to try to project the 2013 plan for Combat because that's what's being worked right now, as is our methodology every year.

But the comment I'd make ties back to what we were talking about earlier with Abrams.

We've got -- we know domestically, and I mentioned this in my remarks, what's the size and shape of the force ultimately going to be as things get re-cocked here as a function of the Afghanistan return and the reshape based on sequestration or no and all of these things get sorted out.

So how that force shapes itself will have impact on Combat, quite obviously.

So domestically, it comes down to Stryker, which we've talked about; Abrams, which we've talked about.

It comes down to ground combat vehicles, it comes down to AMPV replacement, things like that, that will -- we're an integral part of either competing for or already doing all of those things.

How that shapes itself is yet to be determined.

We're confident in the longer view, as I said earlier, on Abrams.

Stryker, we've got work to do, but we're very encouraged by the exchange program of the Double-Vs, as I mentioned in my remarks, and we're fairly confident that they're going to continue converting -- we will continue converting flat-bottoms to Double-Vs.

But the long-term opportunity on the domestic side will become more granular, I would say frankly, within the next six to eight months, as we determine what's going to happen at the end of the year or the start of 2013.

The international space, though, is really significant business for us, and as you've heard me say before, the projections there increase that as a part of Combat's portfolio going forward.

Both tanks, light-armored vehicles -- and those are the two primary movers, no pun intended, but we've got, between the Middle East, Morocco, Israel, the Canadian LAV program, there are significant opportunities there for us going forward.

So Combat is going to have -- as I mentioned before, we are integral to the force.

We will stay integral to the force.

Exactly how that shapes itself will be determined, I think, in the coming months and year.

And on 650, do you expect to have any completed deliveries this year?

And can you give us a little bit more color on exactly what's going on there?

Sure.

Yes.

I mean, it won't be 17.

It'll be slightly less than that, but yes, we will have 650s delivered here within the next few weeks.

I think the first two pilot classes, or first one, for sure, is done.

So then you have to go -- you know, there is more to do with the FAA.

You've got to get the Certificate of Airworthiness for each of the aircraft.

So we are marching along smartly, but yes, indeed, we'll be delivering aircraft here within weeks.

Anxious to do it.

Okay.

Thank you.

George Shapiro, Shapiro Research.

I was wondering if you'd give a little more clarity on what R&D -- how much lower R&D or higher R&D was this year versus last year, and also sequentially, just so I can get a feel for how much that hurt the operating margin.

And also, was the completions business worse than the second quarter in terms of its loss, and how did it compare year over year, because I know it lost money last year as well?

Yes.

I think -- my answer to the latter is, I think it was about the same; pretty nominally close, at least.

That's off the top of my head, George.

Your R&D question, it's interesting.

If I look at the stream of R&D at Gulfstream across the year, it sounds like the way I describe the backlog at the Marine group.

It's very lumpy, and that's exactly what this is.

And, oh, by the way, it just happens that the year-ago quarter and the sequential quarter were the lumpiest.

So, just what can I do?

That's just the way it hit and almost by a factor of, like, 3.5 or 4 to 1. So that really is it.

I mean, the margin impact derives -- there's a little bit, as I think I said in my remarks, that you could attribute to jet absorption costs and some for liquidated damages, but that's in the noise, quite honestly.

It really is the R&D and purely a function of the comparators.

Okay.

Why don't I get one last one in here?

If you took out the 650, was the book to bill for the other planes -- the 550, 450 -- at one or above one because you had mentioned the backlog was 18 months, and I think in previous times you said 18 to 24 months?

So I was looking for some clarity on that.

Yes.

I mean, I'll put it this way.

And you know, I always -- I look at it in backlog months, as you just described.

And we really are kind of closer to the 18 side of it right now.

But I'm not that concerned.

I mean, I'm not concerned at all about that, but it's interesting.

We expect, as I mentioned in my remarks, back to my favorite word today -- lumpy.

But we expect some multi-aircraft orders that were there last year about this time that haven't manifested themselves this year at this time, which will help put that backlog out even further.

But I'm very comfortable kind of at the 18-month point right now.

And we're selling the mix of aircraft.

I mentioned this was a great orders quarter for us.

The mix of aircraft covered the spectrum of all of them, really, but almost equally weighted in the 450, 550, 650, 280, and a little lighter on the 150.

So that's a good story, as far as I'm concerned.

Okay.

Thanks very much.

Okay, George.

Thanks.

Ron Epstein, Bank of America Merrill Lynch.

In your prepared remarks, you mentioned that it's taking longer for deals to close and the global environment is a little bit different.

Can you give some color around that because I guess globally, corporate profits are pretty good, right, and it seems like North America is getting a little bit better?

If you can just give some more detail, maybe just around the broad business jet environment.

Yes.

I mean, North America has been very -- is very strong this year, and we're at about -- 59%, I believe I said, of the backlog for this year to date is North American.

So the pent-up demand in North America is being serviced.

Within that, I should add, consistent with earlier comments I've made, that the Fortune 500 as part of that is back, which is, I think, very good for everyone.

We are seeing, internationally, if you look at the whole backlog, backlog writ large, it's still about 60% international, okay.

I was talking about 2012's inject into that.

(Multiple speakers) 60% international.

But it's fair to say that we're seeing, not surprisingly, less activity in Europe and less activity in Asia-Pacific, believing that to be, frankly, I think, tied to things like the government transition in China and just some slowness in bringing orders to the fore.

We anticipate, as I said in my remarks, getting several multi-aircraft orders out of the international space in the coming months.

So the dialogue and the interest level is still there.

It's the translation into orders that's not occurring.

And as I think maybe we mentioned the last call, there's also -- in the financing world, there seems to be more of a requirement if you're going to finance your aircraft, that you have to get the financing locked in before you order the aircraft, which wasn't the case in earlier times.

So those are the big points.

Okay.

And then, can I ask just a follow-on on defense, if that's okay?

Sure.

When you look at the current budget environment and all the uncertainty, maybe I'll put you on the spot, right, what do you think the odds of sequestration actually playing through are, and how do you think about that when you plan for the Company?

I wouldn't even place that bet with your money, Ron.

Okay.

I mean, there is no one on earth who can answer that question with any precision right now.

As I mentioned in my remarks, there's a lot of activity and chatter and hand wringing and concern and angst and you pick the word, but until we sit down as a government and decide we're going to solve this before January 2, 2013, it's the law of the land and it will execute.

So planning for that is very difficult, as I mentioned.

So our team, you know, I'm sure is working with Phebe to develop the plan for 2013, based on all the information we have at our disposal, and then you have to be prepared, I think, to be able to stay agile enough to recock if you have to.

And what that means right now, nobody really knows.

So you've heard me talking, and I think I said it in my remarks this morning, it's still about, for us, you prepare for that strange outcome that nobody can define just a few months ahead by staying agile, staying lean, cutting costs, and not losing your discipline in terms of your ability to execute.

And then, you're as prepared as anybody can be, and that's what we are.

Great.

Thank you.

Okay, Ron.

Jason Gursky, Citi.

Hey, Jay.

Best of luck to you as well.

Thank you.

From the guys here at Citi.

One question on just a clarification, and then one on the IS&T business.

On the clarification point, the guidance, I just want to make sure, includes the charge that you took in IS&T this quarter.

Affirmative.

I'm sorry.

That's affirmative.

Okay, great.

And then, on IS&T, lots of commentary here, the charge being related to a specific program.

You also made some commentary about maybe some changing strategy or approach to the IS&T business.

Can you just give us a sense of whether this changing strategy is going to have an impact on revenues as well as margins?

Because it sounds like, from a margin perspective, it's going to have a positive impact, but the revenue outlook on this kind of changing tack wasn't quite as clear.

Well, the write-down didn't have to do with a specific program, if that's what you're alluding to.

I mean, it was -- we're moving out of that commoditized, ruggedized computer business and putting our efforts where it makes more sense for our customers right now.

That was a business that was driven by price with lots of big competitors, and frankly, it's not a space we need to stay in.

That's what that was all about.

The topline impact of all of that has, I think, been reflected in our results over the last year or so.

So I don't see any strategic shift, other than what I've just described there.

Okay.

So what was the revenue run rate of that business that you're now exiting?

We don't even -- I don't even break it down that way.

Okay.

So not material.

Okay.

Thanks, guys.

I appreciate it.

Okay.

Thank you.

Joe Nadol, JPMorgan.

Jay, on the Aerospace margins, I hear you on the lumpiness of the R&D.

It strikes me that that's probably lumpiness of the offsetting supplier contributions, rather than your engineering spend.

That's affirmative.

That is correct, Joe.

And so the question is, since that's probably fairly predictable, it's contractual, and you have your R&D plans set looking forward, can you give some color on the profile?

Is it going to look more like Q2 or more like Q3?

Have we ended some chain of payments?

Or any kind of color you can provide on that.

I'm smiling because I wish it were so in terms of the predictability of the supplier launch assistance, as we call it.

But it really isn't that predictable.

I don't have a stream I can give you, except to say that our R&D investment, as well you know, is constant and committed, and they feed into that at varying intervals and we just saw two big lumps to comparators this time.

But I don't have a stream out ahead of me that I can describe for you today.

There will be more, obviously, as we go, and we are always in product development, so targeting 2% to 3% of Gulfstream sales as our benchmark.

And that's for net R&D.

Affirmative.

Okay.

And then, just on the 550, 450 rate.

You're at the lower end of your -- but confident, like you say, in the orders coming.

If those orders don't come, would there be any consideration to lowering that rate of 80 aircraft, or are you just lock set, no problem at all, for 2013 right now?

Oh, no.

Well, first of all, we are not giving 2013 guidance, but in general terms, to your point, we're not going to keep producing airplanes if we don't have the demand for them.

I mean, we believe the demand will be there, and so we rate to that.

But we don't keep the rate going if the demand isn't there.

But I'm very confident in both the 450 and the 550.

I'd say 2013 looks pretty good.

I'm just not prepared -- and it's not fair, frankly, to Phebe for me to say, well, here's what I think it's going to be in numbers.

We're just not there yet.

But I anticipate, when I listen to the earnings call next time, I anticipate hearing that the Gulfstream projection is a good one.

And Grant --

Okay.

Thanks, Jay.

Good luck to you.

Thank you, Joe.

And Grant, I think we have time for just one more question this morning.

Okay, thank you, Amy.

Our final question, then, comes from the line of Heidi Wood from Morgan Stanley.

Oh, good.

Batting cleanup here.

So Jay, I'm going to add my sentiments for good luck to you as well.

Thank you, Heidi.

A question I have is on IS&T.

I was wondering if you could give us some -- flesh out a bit kind of the color that you are seeing on contract terms and margin outlook.

How should we think about the trends that you see emerging ahead, sort of division by division, if you don't mind putting a finer point on it?

Just again, I know you don't want to provide guidance, but just so we can kind of think about it looking ahead.

Well, let me --

(Multiple speakers) most competitively vulnerable division that you have.

Well, let's take a whack at it this way, Heidi.

We've got -- the most impact we are seeing right now is in the short-cycle businesses, a.k.a.

IS&T.

That's a blinding flash of the obvious.

But in point of fact, within that, you recall earlier discussions we talk about the mix within IS&T and the service mix has increased from, my memory thinks, maybe it was in the 20% -- 20s back some couple, three years ago is now almost half of IS&T's business.

So there's a margin reality that's attached to that.

Oh, by the way, our IS&T folks in that space have done a tremendous job of executing at good profitability.

But that's a reality that's there, okay.

There's more service work.

The tactical communications business, which is significant for us, most out of our C-4 systems business, I alluded to it, I think, once or twice in my remarks, but what we're seeing there now all of a -- not all of a sudden.

We are finally getting the volume coming back to us, but the mix within that volume is less on the higher-margin encryption-type products and more on more moderate margin things.

But we do have the franchise programs in there of WIN-T and JTRS, which have taken perhaps longer than originally anticipated, but in both cases those franchise programs are building now, and within the next year will build even further.

So we're very encouraged for that.

And that will be significant business going forward for C-4 systems, but for IS&T and General Dynamics.

So we've had -- you know, we've seen award delays.

I've talked about that.

We've seen descoping.

We've seen a lot of the lowest price technically acceptable, which is, in Jay Johnson's opinion, not very helpful to anybody in the long term, and then we've seen increased competition.

So those are all factors that are upon the IS&T world.

The long-term view for IS&T, for us, is a very healthy one.

They are just, as short-cycled business, the most impacted by kind of where we are in the world right now, dealing with what's right ahead of us in the next six months.

All right.

Great.

Jay, thanks very much.

Thank you, Heidi.

And thank you for joining our call today.

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

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Thank you for your participation in today's conference.

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