通用動力 (GD) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2014 General Dynamics earnings conference call.

My name is Glenn and I will be your operator for today.

At this time, all participants are in listen-only mode, and later we will conduct a question-and-answer session.

(Operator Instructions)

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

I would now like to turn the conference over to your host for today, Ms. Erin Linnihan.

Please proceed.

Thank you, Glenn, and good morning, everyone.

Welcome to 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, Phebe Novakovic.

Good morning.

I am pleased to report that we had a very strong quarter at General Dynamics with revenues of $7.47 billion and income from continuing operations of $646 million.

We reported EPS from continuing operations of $1.88 per diluted share, $0.07 ahead of the year-ago quarter and $0.11 per share better than consensus.

While revenue was $360 million lower, 4.6%, than the year-ago quarter, income from continuing operations was $6 million higher on the strength of 12.7% operating margins, a 40-basis-point improvement.

Sequentially, revenue was up $209 million and earnings from continuing operations were up $50 million on a 70-basis-point improvement in operating margins.

You will note in this quarter that we took $105 million after-tax charge in discontinued operations to the planned sale of our axle business.

Let me turn briefly to the first half of 2014.

Revenues were down modestly, 2.7%, against 2013; however, earnings from continuing operations were up over 2.6%, and diluted earnings per share from continuing operations were up $0.17, or 5%.

In short, we are off to a good start, ahead of our internal plan and ahead of external expectations, leading to an improved outlook for the year.

With respect to cash, we had $791 million of free cash flow from operations in the quarter, about 122% of net income from continuing operations.

We had $1.132 billion for the first half, 91% of income from continuing operations, and we fully expect a very strong third quarter.

With respect to share repurchases, in the quarter we repurchased slightly less than 10.7 million shares for approximately $1.2 billion.

We have purchased somewhat in excess of 25 million shares in the first half; however, do not expect share repurchase activity at this level in the second half of the year.

We front-end loaded the share repurchase program.

We will be in the market but at a more moderate pace.

An important part of the story in the quarter, and for that matter, in the previous quarter, as well, was a substantial intake of orders resulting in significant increases to backlog.

We ended the quarter with the total backlog of $71.1 billion, up from $55.9 billion at the end of the last quarter.

Most of the growth occurred in the Marine group, with the award of the Block IV of the Virginia-class submarine.

The IS&T group also enjoyed a $468 million increase in total backlog.

You may recall that the story in the first quarter was the tremendous growth in backlog in Combat Systems.

In short, the Company's backlog and total potential contract value is at its highest point in the last four years.

This provides a solid bedrock upon which growth will be built.

Let me give you some perspective on the segment reporting for the quarter and for the half.

I'll then conclude with some comments on the outlook for each segment for the remainder of the year and give you our updated EPS guidance for 2014.

First, Aerospace.

Aerospace had a good quarter, with modestly lower revenue, 2.8%, on mix shift, timing and deliveries, and absence of pre-owned sales.

However, stronger-than-anticipated margins at 19.2%, 30 basis points better than the year-ago quarter, kept operating earnings down only $5 million, or 1.3%.

Let me provide you with some complexion on the quarter.

Gulfstream enjoyed continued improvement in 650 green manufacturing completion margins that more than offset continued makeshift.

Jet aviation again made a good contribution with double-digit operating margins.

For the first half of 2014, Aerospace revenues were up $289 million, or 7.5%.

Operating earnings were up $89 million, 12.7%, a further manifestation of jet aviation's contribution and the continued performance improvement at Gulfstream.

This is all reflected in a 90-basis-point improvement in operating margin for the first half of the year versus the first half of 2013.

All in all, a really superb first half with a very nice order take in the second quarter.

There was particularly strong interest in the G550 in the quarter.

Combat Systems once again demonstrated disciplined performance, reporting 15% margin on revenue only a 0.5% less than a year ago, resulting in modest increase in operating earnings over the year-ago quarter.

Our domestic businesses had particularly strong margins on cost-reduction initiative and program performance.

ELS, which had been impacted in the first quarter by additional restructuring charges, returned to profitability with double-digit operating margin that we expect to improve on an accelerating basis through the remainder of the year.

All in all, a strong performance in a tough market environment.

For the first half, revenues are off 7.2% against the first half of 2013.

Operating earnings are down 16.5%, principally as a result of the restructuring charge at ELS in Q1; however, we expect operating earnings to be very strong in the second half.

More on that subject when I provide guidance.

Marine group revenues were higher than in Q2 2013 by $92 million, 5.2%, but operating earnings and operating margins were down 2.2% and 70 basis points, respectively, entirely as a result of mix shift in the quarter.

Nevertheless, both revenues and operating earnings were up nicely on a sequential basis.

For the first half, Marine group revenues were up $67 million, or 2%, and operating earnings are up $3 million, almost 1% on slightly lower margins.

Margins were still a very respectable 9.8% for the first half.

IS&T.

IS&T is the place where we expect a tremendous revenue pressure for the year.

You may recall that our initial guidance was at 20% decline in revenue year-over-year.

Fortunately, we are doing somewhat better than expected.

Revenue was off by $387 million, or 15.2%, compared to the prior-year second quarter and also down somewhat sequentially.

On the other hand, operating earnings were down only $10 million, or 5.1%, a 90-basis-point improvement in operating margin.

The story for the first half is even better.

Revenues were down $553 million, 11.1%, but operating earnings were down only $12 million, 3.1% on improved margins.

This was very good operating leverage.

Let me provide you some guidance for the year for each segment, compare this guidance to what we told you in January, and then wrap it up with our EPS guidance for the year.

For Aerospace, our guidance to you in January was to expect revenue of approximately $9 billion and operating margins around 17%.

We now believe revenue will be off that figure by about $215 million; the largest single driver of which is lower-than-anticipated pre-owned activity.

On the other hand, margins are expected to be about 18% for the year, resulting in higher-than-anticipating operating earnings.

The 18% margin guidance for the year implies some pressure on margins in the second half, largely due to mix shift and increased R&D spending.

For Combat Systems, our previous guidance was to expect revenues to be off on unadjusted 2013 revenue by 4% to 4.5%, with margins around 14%.

We now expect revenue to be off 2.8% from adjusted 2013 revenue, or about $5.7 billion.

Margins will be higher, around 15%, resulting in higher-than-predicted operating earnings.

In Marine Systems, we have previously guided to revenue growth of 2.5% and a margin rate in the 9.5% range.

We now expect revenue growth over 2013 of 4.5% and a margin rate of about 20 basis points better than previously forecast.

Once again resulting in higher operating earnings.

For IS&T, we previously guided to a revenue decline of 20% and a margin rate of 8.2%.

It now appears that revenue will be down 15%, and the margin rate should be about the same as our previous guidance.

Once again, this will result in higher-than-previously-expected operating earnings for the year.

In summary, all of this rolls into revenue for the year around $30.2 billion and operating margin of 12.5% and a return on sales from continuing operations of 8.5%.

So higher-than-previously anticipated operating earnings, a somewhat lower tax rate, and a lower share count permit us to increase our EPS guidance for continuing operations to between $7.40 and $7.45.

The progression through the remainder of the year is that the third quarter will look a lot like the second with a very strong fourth quarter to finish.

I would now like to turn the mic over to Jason Aiken to give you some additional detail.

Thank you, Phebe, and good morning.

I'll touch on just a few miscellaneous financial items before the question-and-answer period.

As Phebe mentioned, the results for the quarter include a charge about $105 million in discontinued operations.

In the quarter, we engaged in the plan to sell the axle business in our Combat Systems group.

This action requires that we assess whether the price we expect to receive for this business is sufficient to cover the carrying value of its net assets, including an allocation of goodwill.

This assessment resulted in the charge you see in the quarter in discontinued operations.

The estimate will be trued up when the sale is completed, which we expect to occur by the end of the year.

Net interest expense in the quarter was $24 million versus $18 million in the second quarter of 2013.

We had additional interest income in 2013 that reduced the net interest expense in that period, and for 2014, we expect interest expense to be approximately $90 million.

At the end of the quarter, we are in a net-debt position, that's debt in excess of cash, of $69 million.

This reflects a $450 million swing from a net-cash position in the prior quarter due to our activities on the capital deployment front, which I'll address in just a minute.

As a reminder we have $500 million of notes maturing in January of next year, and we'll make a decision as we get closer to the end of this year as to whether to repay or refinance those notes.

Our effective tax rate was 30.2% for the quarter, slightly lower than expected as a result of higher international earnings, which carry a lower tax rate.

Based on our experience so far this year and the growing impact of international earnings, we're now expecting the full-year effective tax rate to be at the low end of our previous guidance of 30.5% to 31%.

We continue to expect cash contributions to our pension plans for 2014 to be around $550 million.

As a reminder, most of that funding is scheduled to occur in the third quarter of the year.

With respect to capital deployment in the quarter, we continued our commitment to deploy capital to our shareholders while maintaining a strong balance sheet.

Phebe gave you the details of our share repurchase a few minutes ago.

And in total, we expended almost $1.5 billion on share repurchases and dividends payments in the quarter.

And over the past 18 months, we've return over 115% of our free cash flow to our shareholders.

At the end of the second quarter, we have $3.8 billion on the balance sheet and are well-positioned to continue to execute our strategy and achieve the objective that Phebe has articulated for 2014.

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

Thanks, Jason.

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.

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

(Operator Instructions)

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

Please proceed.

Good morning.

Good morning, Rob.

I wanted to ask you, Phebe, on the aerospace -- you've done so well with the margins here, and you're guiding down a little bit on mix and R&D in the second half of the year.

But given that you've traditionally level loaded your R&D, even if you should come out with a new program in the fall, might we expect that this guidance continues to be a bit conservative, especially with continued improvement at jet?

Let me walk you through that a bit.

As you quite rightly point out, we're going to -- we anticipate seeing some margin compression from mix shift and higher R&D; and that's net R&D, because we do not anticipate the same level of launch assistance.

So that is -- we level load our R&D, but launch assistance drives some variability.

Okay.

And we anticipate fewer jet contributions going forward.

But I think it's a good opportunity to spend a moment on aerospace margins a bit, and to give you a little bit additional color on what drives the variability quarter over quarter in these lines of business.

The fundamental principle that I think we have to keep in mind is: The underlying operating performance at each of these businesses is getting better quarter over quarter.

And if it weren't, I would tell you.

So what does that mean?

This means that there are other factors in these very complex businesses that impact margins, not one of which is necessarily material.

But in combination, they can have some impact on a quarter-by-quarter basis.

You know, we have got mix shift between large cabin and mid-cabin, and service mix; also on volume, by the way.

And it depends on the kind of service volume.

The more complex service work you get, the higher margins you carry.

And for -- this is true both at Gulfstream and jet.

For Gulfstream as an OEM, the more parts that they sell out of warranty, the higher the margin.

So there is, even within the interservice business, some various margin variability.

With respect to jet aviation, you get margins that are, quarter over quarter, somewhat driven by where we are in contracts.

Think about jet as a construction contract and what they do, particularly with respect to completions.

With newer contracts, we start off with a lower margin and then build as we come down our learning curve.

So, again, that drives some variability.

Sales expenses at both businesses change, and as I noted, launch assistance is lumpy.

And, of course, as you all well know, pre-owned is almost always a zero-margin business.

So I think -- I thought it was worth just spending a little bit of time talking about why it is that we see some variability.

I emphasize again, though, that the operating -- the fundamental operating performance remains improving quarter over quarter.

So I hope that helps.

That's very helpful.

I wanted to ask if also, with the 650, are we at the point where that's margin accretive?

And you mentioned better order flow there.

Obviously, you've been sold out for a long time.

Is the order renewal or what I would consider new momentum -- maybe it's not -- is this a function of a change in the end market?

Or is it because the other guy is now probably fairly sold out, so availability is no longer a differentiator?

Well, availability is a differentiator to the extent that you actually have product.

I think the way to think about -- you had a couple questions here, but let me answer your last one first.

I think the way to think about 650 demand is that we continue to see demand in -- for that airplane, new demand.

And we have added, not in large quantities, as you would expect when there's a four-year wait, but we have added, almost every single quarter, 650 orders.

So that continues.

There's a lot of interest in that business.

And by the way, as we work through -- or on that line of business and that airplane -- as we work through the backlog, we have accelerated the availability dates by about two quarters.

So that's a benefit to our customers as well.

So that's higher rate?

It's a higher rate.

And you would expect that, as we have come down our learning curve and as we continue to move green airplanes through the manufacturing line and then into the completion centers.

With respect to margins, I believe that I -- 650 margins -- I believe I told you -- told the street maybe last quarter that we have exceeded the 450, and are working our way up to the 550, but that's probably several quarters away.

Thank you very much.

Your next question comes from the line of David Strauss with UBS.

Please proceed.

Good morning.

Hi.

Phebe, on IS&T, you did revise the revenue guidance of now down 15%, but it still calls for a pretty significant -- a larger decline in the second half of the year.

Can you just talk about what's driving that?

And then on combat margins, if I got it right, the 15% margin guidance looks like it's implying a pretty big tick up in the back half of the year.

If you could just comment on that as well.

Thanks.

Let me address your last question first.

I told you all in the first quarter that combat margins would significantly and quickly recover, and they did, and they will even more.

I mentioned in my remarks that we took a $29-million restructuring charge in Q1 at ELS.

And with that behind them, that business hit 10% margins this quarter.

And it -- we expect them to continue to improve over the course of the year.

And both of our other businesses continue their strong performance.

So it's pretty much in line with what we had anticipated.

Going forward, they're just doing better than we had thought, and that's why we are raising our margin guidance for the year.

With respect to sales, on IS&T, we had believed that the front end would be -- that the first half of the year would be somewhat frontloaded, and it does imply some sales slowdown in the second half, and that's consistent with what we had anticipated.

We were pleased that the sales decline was less intense than we had thought.

And by the way, that was across an entire spectrum of the businesses, at both our IT business and our intel business and coms business.

That was a nice sales performance in the first half.

And then, some of the decline in sales that we anticipated -- I think I told you guys before that this was -- we were risk adjusting our plan for Army exposure, and that has happened.

But I would note that some of those -- we're seeing indications that some of those lines of business are beginning to stabilize.

For example, in our tactical ISR coms, computing, modeling and simulation are all -- we took our declines, but they're holding up pretty well.

IT services work for the Army is also holding up nicely.

What continues to be a weakness, and a weakness that there isn't a whole lot that we can do anything about, is in the sustainment and repair business.

The Army is taking all their work into the public depo's.

So as a result, we are doing almost nothing for the Army in that line.

So I think that addresses both of your questions.

Great.

Thank you.

Your next call comes from the line of George Shapiro with Shapiro Research.

Please proceed.

Good morning.

Hi.

Phebe, two quick questions.

Mix was worse in Q2 than Q1, but the margin was a little higher in Q2 versus Q1 in aero.

So I'm just wondering what your explanation for that was.

And then the other one is: I assume the book to bill would've been above 1 if I took out the fact that it was probably below 1 for the 650.

And you're still expecting 118 large delivery for the year?

Thanks.

Okay.

Let me -- I had a little trouble following the puts and takes on the first part of your question.

But let me address the orders, because I think that's what you were getting at a little bit.

We had a book to bill of about 9 times, and it was really a good, good strong order quarter for us.

We had said that what we're seeing is a lot of interest in the pipeline; it's just taking longer to close.

And so we have found that we have some variability in our order intakes quarter over quarter, and that's what has happened.

This quarter, a lot of those orders came to fruition, so it was a nice quarter.

By the way, I've been tracking for you all the 450 and 550, which is where we look for these -- where we would like to see in the moment the order activity.

And once again, for 450 and 550, they were 75% of the order book.

The 280 was also strong.

With respect to our green deliveries, we set a target every year; it's a plan around how many green deliveries that we intend to have in the quarter or in the year.

And it's primarily driven by -- it's driven by a whole host of factors.

We have frequently taken it upon ourselves to sometimes re-phase those deliveries.

So you noted that we had slightly fewer deliveries in the second quarter than the first quarter, but that we were -- we anticipate upticks in large -- particularly the large cabin orders -- or deliveries in the second half of the year.

So all of that is meant to say that some of the timing -- some of the deliveries on green has been a question of timing, and we've re-phased that.

So I think we're looking at the moment, which could change at about 116 versus 118, and again, simply driven by timing.

You'd be surprised how frequently customers ask for slipping the green delivery or the completions delivery into the second quarter or into the next quarter, the subsequent quarter or the subsequent year.

So, again, it's nothing but timing.

Okay.

On the first quarter, what I was getting at was: You had 29 large and 6 mid-sized versus this quarter, 26 and 7. So I figured the mix was worse this quarter, yet the margin this quarter was 19.2% versus 19% in the first quarter.

So you overcame the mix maybe because of 650 productivity.

You got it.

That's it.

Improvement on the 650 and also on the 280.

But you got it, 650 did very well.

So why won't that continue in the second half?

Because of all the reasons I've just explained.

We've got a mix shift among those three kinds of categories: large cabin, mid-cabin and service.

And we've got higher R&D.

And jet's contribution, while good, is going to be less.

So those three factors are a compression on margins.

Okay.

Thanks very much, Phebe.

Good numbers.

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

Please proceed.

Good quarter, Phebe.

Thanks, Cai.

Could we shift to NASSCO?

Maybe tell us a little bit about the commercial ship-building business, how it's doing, and the prospect you have for new orders?

For a number of years, we talked about the impending return of the Jones Act market, and it came.

And since that market has picked up, we have contracted for 10 Jones Act ships.

It remains a very attractive market to us, and the pipeline remains fairly robust.

And we are in constantly in communication and dialogue negotiations with potential customers.

It's a good market.

It's a price-competitive market, as you might imagine.

But I would note that this is not a place -- not a market in which we compete solely on price, and are willing to use price as a differentiator.

It just puts too much risk in our profitability.

So we're in the midst right now of ramping up a number of our new commercial orders.

And that has some -- you didn't ask this question, but it's implied -- margin compression in the group.

But again, that's simply of question of moving from MLP, mature MLP, and coming up the learning curve or down the learning curve on commercial.

So it's a nice market.

It fills out NASSCO's workload very, very well.

We've learned to build these ships efficiently.

So it's -- I like it.

Given that basically you're building essentially the same ship, should we expect the margins there to improve, so this becomes a mix plus as opposed to currently a mix negative?

Over time, absolutely, but you'd expect that from those shipyards, right?

Yes.

Okay.

(multiple speakers)

By the way, these are not exactly the same ships, so don't think about it as a serial production on exactly the same specs.

There are differences.

But that said, this yard will perform -- better and better performance as the programs mature.

Okay.

Great.

Thank you.

Joe Nadol with JPMorgan.

Joe?

Hello, Joe.

Your line is now open, Joe.

Hi, good morning.

Phebe, on the AxleTech divestiture, this is, I think, one of the first portfolio decisions you've made after you mentioned last year you were overhauling the M&A procedures internally.

I was wondering if you could comment on the process you went through in deciding to divest?

Why you are doing it and whether, if you are looking at further divestitures, if this opens the gates to a little more portfolio activity?

Sure.

Just to give you a little bit of retrospective, AxleTech was, for us, for many years a very, very good business, as we were the merchant supplier for almost all of the variants of MRAP.

We made a lot of money on that acquisition years ago.

As the war wound down and the government decided not to initiate a program to repair or retrofit MRAPs, the fundamentals of that axle market changed dramatically.

And now what we see is -- think about it this way: a complete inversion of the demand curve on commercial with the demand curve of defense work.

So that told us that -- and we believe, by the way, that's a systemic change.

So that told us that the value proposition really no longer obtained for us, and that we believed, and I still do, that a commercial-facing owner could be a better steward of the company.

I think you can expect us to respond to the market when we believe that there have been systemic changes, and reacting according to our shareholders' best interest.

We have done a number of little pruning through -- more like very small lines of business, really limited in products, just as, again, we see changes in the market.

So when we put together ATP and OTS, we did a strategic analysis of every single one of our lines of business and what was core, and where we thought that we could add value.

And this was one of those businesses that we felt could do better with a different parent and a different home.

So I think you would expect us to react to our market.

I don't see any major divestitures on the horizon.

We've tinkered within the IS&T portfolio, but nothing that changes the nature of that portfolio.

These will be opportunistic as we proceed, and we make these decisions fairly deliberatively, and we have a very disciplined process for executing the sale.

I think this was a wise move, and it's good for all involved.

That's helpful.

Can you provide us with the expected level of proceeds from the divestiture?

Not yet.

Everybody who's a prospective buyer would be listening, so we will disclose how we do after we finish the transaction.

Fair enough?

Yes, thank you.

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

Please proceed.

Thank you.

Good morning.

Hi, Doug.

Hi.

You're in a position at Gulfstream now where you have got G650, unique position in the market.

You said that the 550 has strong interest, yet right now you're at the lowest level of backlog in aerospace in more than five years.

And I'm just trying to understand how to fit that level of backlog with the program strengths you have.

So, Doug, I've tried to articulate this before.

Think about our backlog as driven primarily by, and predominantly by, the 650 order book that we took in five or six years ago.

That backlog provided for five or six years of sales activity on the 650.

We are drawing that down, and I think that's indicative, as you would expect, and totally wholesome.

And I believe that that's implied from the acceleration in the availability times by about two quarters, which I just -- we just discussed a few minutes ago.

So we had a book to bill of 0.9.

I don't worry about the level of the backlog, given the duration of that large program.

I think it's very wholesome.

There's nothing that we see in the order activities that causes us concern.

Our pipeline is very robust.

It's robust on the 650 as well.

I think the customers and potential customers will be happy that they don't have to wait for quite such a long time for their airplanes.

So I don't worry about this.

This is not some harbinger of a market issue, at least with respect to us, that I think we need -- you need to be worried about or our shareholders need to be worried about.

Do you see a point here as you start to -- as you increase that availability, take rate up, should we expect the backlog to eventually turn up the other way as you start to increase rate?

Or is this something where you see this kind of level as sort of the right level going forward?

Well, look, it will all depend on a number of factors, right, including how we think about new airplanes that we may bring into the market.

The right level of backlog is the backlog that you can -- that sustains reasonable sales growth, and allows us to continue to be a very profitable Company, and I think that we've got that now.

And I don't see any sign that that's going to be particularly troubling.

I don't have a target backlog.

It ebbs and flows.

The 650 was such a large order that you have to think about it more like some of the big ship orders.

It was big and it was binary.

That's unusual in the business jet aviation market.

So it has perturbated that backlog.

But if you look prior to the 650 announcement, our backlog was pretty consistent, driven by the economic environment.

And as we've added more airplane models, we've increased that backlog.

And then the 650 just changed the nature of that backlog.

I think we've all gotten used to seeing it, but it was an anomaly.

Rarely do you ever see -- I don't think ever has anybody ever seen that kind of big and binary change.

More like the ships, right?

I understand.

It's just that when I look at the numbers today, and you think of backlog to revenues, the numbers are actually even lower today than they were prior to the 650 launch in terms of that ratio.

So I just wanted to understand if you saw an issue there, but it sounds like you are seeing things as pretty much where you want them to be in terms of demand.

Yes, absolutely.

And let me just also say that I think the entire industry -- right around the run-up to the great recession, the market was unhealthily overheated.

I look to see -- I look at backlog to ensure that we have enough in our order book to sustain a growth in sales and a growth in profitability.

I'm very comfortable where we are now, and I see no signs in our market that it's superheated or that we are -- experience any particular anomaly or something that we should be concerned.

That's why I've been reporting to you all, where we look every quarter in our backlog is the 450, 550 orders, because you can't add materially to the 650.

That dynamic with respect to the 650 will change as we shorten the availability times, right?

That absolutely makes sense.

Certainly that's one of the things that we've looked for is that you have this upward pressure, to see when you can take those rates up and even get more availability.

There you have it.

But we're not about to pre-announce that.

We do that -- we make our rate decisions based on very disciplined analyses of factoring a whole lot of independent variables, right?

So that's within our -- I think, in our to-do list, right?

Makes sense.

Thank you very much.

(Operator Instructions)

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

Please proceed.

Thank you very much.

Hi, Howard.

How are you, Phebe?

I'm good.

First, actually, I want to ask Jason a question.

I figured you didn't want him to be there neglected.

And it looks like the way you bought back stock, it was very much back-end loaded when you look at the share count, so that we should expect a fairly sharp decline sequentially in shares outstanding in the third quarter versus where you were in the second.

Is that correct?

When you say -- at the end of the third quarter or the end of the second quarter?

Excuse me, I apologize.

It appears as if you bought most of the shares towards the end of the second quarter, because the difference between the weighted share count in the period and the share end number is fairly significant.

I wouldn't necessarily go to that conclusion.

The activity was spread right throughout the quarter, and what you may be seeing is the offsetting impact of stock-option exercise activity and other factors that go into the weighted average calculation.

But no anomaly driving the share count -- or the re-purchase activity toward the end of the quarter.

Howard, we did a accelerated share repurchase in the first quarter, but the second quarter was just steady Eddie, consistent buying throughout the quarter.

Okay, that's helpful.

And then second, Phebe, you've focused a lot on making a difference in cost as an effective competitive tool.

Could you address a little bit of how that's helped you either win some business or position you to win some business both at combat systems and at IS&T?

Absolutely, one of my favorite subjects.

Let me give you the easiest and most glaring, frankly, examples.

At ELS, we had a cost structure going into 2013 that was so high, it made them anti-competitive.

They just couldn't win any orders.

So we needed to get after that cost structure, and we did it quickly and disciplined -- in a disciplined fashion.

We did the same thing at GD UK.

And the results we are seeing is, in GD UK, we actually had -- and C4 owns GD UK.

We actually had a contract, that we had been disqualified from because of high cost, reopened for us to go back into the competition, because we had lowered our cost so dramatically.

And in a head-to-head competition with multiple other suppliers, we won.

That is a simple and, I think, powerful example of what right sizing your business can do.

The right thing to do for your shareholders, for your customer, so that we can provide the services at competitive rates.

And the same thing is happening in European Land Systems.

So those are the two obvious examples, but we're seeing that throughout.

As C4 Systems has reduced its business, and restructured its business dramatically -- since the fourth quarter of 2013, they've increased their order activity, particularly in their overseas markets, Canada, the Mid East.

And to the extent that they're going in head-to-head competition, we've been doing very, very well in our capture rate.

The same thing is true with our intel business and the same thing is true with our IT business.

So I'm very pleased with the performance of these companies as we focused on getting back to the basics of operating excellence.

And they've got more to go, but they've made progress.

Combat systems has had a long track record of disciplined response to their market and anticipating changes in their market and getting after their fixed costs quickly.

There is no such thing as, as we say, as fixed cost; they ultimately turn into variables.

They have right sized their business even in advance of the change in their market conditions, and I think you can see the result of that in their margin improvement, in their margin performance.

Just a follow-up on land systems or combat -- I'm still sort of looking at the market color for opportunities.

Can you either geographically or product line or some way characterize how there's been very specific interest?

We continue to see within our land forces, US land forces line of business, interest in terms of sustainment levels, right?

So we anticipated that and we see that; so not a lot of, I don't believe, new opportunities on that front.

We are, however, engaged in a number of international opportunities with all of the three businesses in our combat systems.

But the timing of -- the clarity around timing of international orders has been a little elusive, so I'm not about to speculate.

But we're in negotiation on several potential contracts and we will see how those turn out.

But there's still a lot of interest.

The world hasn't gotten any safer.

No -- thank you very much.

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

Please proceed.

Good morning.

Hi.

I just wanted to follow back up on the AxleTech discussion.

Can you size that business?

I'm trying to just think about how much of the original sales decline was because of that business, and then the absence of it -- how that's playing into the combat outlook for the year?

You can infer that from the restated sales numbers, but that business has, for the last, really, year, undergone a precipitous decline in sales and this inversion of demand.

I'm not going to parse out exactly the size, but you can -- when we get around to selling it, we will -- and disposing of it and finalizing the contract, we will give you a little bit more clarity.

But it was responsible for some of the decline; clearly, you can see that.

Okay, and then, you had mentioned about risk adjusting for the US Army business.

If I remember right, going into the year, you implied a 40% reduction year over year.

Can you talk about where you stand year to date and what you're expecting now from US Army business?

Yes.

That business is consistent, other than the sustainment end of that line of business, which really hits the IS&T business units more than it does the combat systems business units.

We are down to around 20% and declining.

Thank you.

For combat, by the way.

Your next question comes from the line of Carter Copeland with Barclays.

Please proceed.

Good morning, Phebe, and good quarter.

Thanks, Carter.

A question regarding announcements made by peers yesterday on two fronts.

The first, obviously, your partner on the Canadian maritime helicopter program took a pretty sizable charge with the completion of that renegotiation with the customer, and they've lengthened out the entry and the service dates on some of those aircraft.

I wondered if you could speak to the impacts that you may see from that, and how you'll go about evaluating that?

And then secondly, Lockheed, who I think is a sub-contractor on the scout vehicle to you, was talking about a pretty sizable award they were excited about from a potential standpoint from the UK.

I wondered if you could speak to timing and size, or just general color about that opportunity and what it could mean for GD UK?

Thank you.

Yes, let me talk about MHP.

For the first time in many years, this program has a stable way forward and has upside opportunity.

We did not take a charge on that program.

We don't intend to take a charge as a result of the renegotiation.

We are the supplier for Sikorsky.

We have developed, over the years, a very good relationship with our supplier.

We've been very supportive with our prime.

We've been very supportive of them, and this was a very significant risk-reduction result for us, and we have stabilized.

And going forward, there will be some upside.

That was very, very good news.

On the SD vehicle, Lockheed may have more information than we do.

This is one of the many, many markets that we continue to investigate.

And we're there.

We're the prime on the SV -- the development phase of the SV.

And how the British government and the Ministry of Defense chooses on a going-forward basis to think about the production contract is something we've got to work out with them, but they're going to make that call.

How would you think about the significance of that order, relative to some of the other big orders you've talked about in combat in the past?

It would be a nice order.

Again, that is entirely driven by the druthers of that customer and what they want to see in near-term production.

So the developmental program went from a very risky position to one that we've stabilized that, and we've gotten it back on track, technically, schedule-wise, and we've done a good job.

That land systems team did a very good job.

I'm a big believer that if you don't build the platform, you can't integrate it.

So they build those platforms; they know them; it's their core competency.

They're probably one of the best of the world, if not the best in the world at that, and they were able to turn around a very red program.

It's an opportunity going forward, but that will be dictated in its entirety by our customer.

Thanks, Phebe.

You're next question comes from the line of Ron Epstein with Bank of America.

Please proceed.

Good morning, Phebe.

Hi.

On Gulfstream, to follow-up on some of the previous questions, the increase in activity that you're seeing, you mentioned in your prepared remarks about the G550.

Can you speak about regionally where you've seen it?

Is it out of the emerging world?

Is it out of Europe?

Is it out of the US?

Where are you seeing the tick up in demand?

In each one of our airplane models, what we've seen is North America is 50% of the orders for the last 18 months, so pretty consistent North America involvement and activity in ordering.

Sometimes that's small fleet, corporate fleet replacement or individuals.

I got to tell you, the vast majority of the orders are from Fortune 500s in both -- primarily North America public and private companies, but also international public and private companies.

Okay, and in the mid-size market, have you seen much of a pickup there yet?

Or is that still bouncing along?

Yes.

The 280, and thank you, the 280 had a nice quarter.

That airplane gets overshadowed by the 650, but it is a terrific airplane in its space and in its niche, and it's doing well.

It fits a discernible need with great capabilities.

Okay.

Great.

Thank you.

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

Please proceed.

Thanks so much.

Good morning.

Hi.

Phebe, also related to your peers, it does seem that a couple of them have been picking up their M&A activity since the start of the year.

Are you in any way tempted to get back involved in this game?

We've seen -- I'm not going to speculate on that.

We've seen a bit of a trickle, but a trickle does not a trend make.

So it's hard to know the maturity of the M&A market.

But so far, we're not there.

Okay.

And as a second question, really a follow-up to Ron's question, have you seen any changes in the pricing dynamic for new aircraft?

No.

Our prices are holding up nicely.

Great.

Thanks very much.

I'm sorry, but the corollary to your question is: We're not winning these airplane orders on price.

It's a factor, but it's one of many.

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

Please proceed.

Thanks.

Good morning.

Hi, Myles.

Maybe talk about the capital plan for just a second.

I know you made mention of the $500-million note coming due in January, and your decision hasn't been made to refi or repay it yet.

I wonder is that in anyway going to play into how you're going to deploy free cash flow for repurchase?

It looks like there's about $1 billion after dividends of free cash flow you'll have in the second half of the year to maintain this neutral position you have now on net debt.

I think about that as your repo target, unless I have to think about the refinance or repayment of the note as well.

So if you could -- are those two connected?

Well, I think, if you think about it, that note is due in January.

We really haven't gotten -- we really haven't focused our attention on 2015 capital deployment, but you can rest assured we intend to be shareholder-friendly as we have in this year.

And then clarification, are you still holding 40 mid-sized deliveries in 2014, or is it just picked up in the mid-sized in terms of demand, so maybe it's a little bit less?

We've had a couple move around, so nothing particularly material.

Okay.

All right.

Thanks again.

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

Please proceed.

Good morning.

Phebe, just a quick question on margins.

I was wondering if you could give us some updated thoughts on what you think normalized margins in jet aviation are going to be over the longer term.

And then the same for combat systems, long-term structural margins in that business over the next several years as you look at all the cost activities that you've taken over the past couple of years in the [mix of] business going forward.

Jet aviation has been a story all about walking out of the shadow of the valley of death.

And they -- their margin performance has been increasingly positive quarter over quarter.

They have some variability, but -- on a quarter-to-quarter basis -- but the underlying operations have done very, very well and will continue to do well.

From every indication we see, all of the metrics we watch, the EACs we build -- everything I see is on the upward trajectory.

I think it's too soon to have -- for me to give you a definitive -- where their sustaining margin to be.

I have an aspiration that I am fully confident that jet will make, but that's an internal discussion that we have to have.

But they are on the right path.

Now, combat, I think combat, it's all going to be about their orders, which they have stabilized their order and then their performance on those orders.

And these lines of businesses have demonstrated that they are very good operators.

So I don't want to get out of my -- ahead of myself for 2016, but we ought to see some nice margin improvement in combat.

There's nothing structurally that's keeping them from not continuing to build their operating efficiency and add to it.

Operator, I think we have time for one more call.

Your last question comes from the line of Pete Skibitski with Drexel Hamilton.

Good morning.

Phebe, I just wanted to ask you about 2014 guidance overall, especially the defense revenues you're forecasting.

It looks like all the Senate -- all the congressional appropriations committees have reported out, but it looks like maybe won't get a bill until after the November election.

I was wondering if you feel that there's any risk to your guidance from a CR that goes to November or December?

Not anything we can materially see.

Most of what we've got is in our backlog, upon which we have projected our guidance to you.

Okay.

Thank you.

All right.

I think that's it for today.

Thank you so much for joining our call.

If you have additional questions, I can be reached at 703-876-3583.

Have a great day.

Ladies and gentlemen, that concludes today's conference.

Thank you for your participation.

You may now disconnect, and have a great day.