通用動力 (GD) 2017 Q2 法說會逐字稿

Good morning, and welcome to the General Dynamics Second Quarter 2017 Earnings Conference Call.

(Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Alison Harbrecht, Staff Vice President of Investor Relations.

Please go ahead.

Thank you, Amy.

And good morning, everyone.

Welcome to the General Dynamics Second Quarter 2017 Conference Call.

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.

As you can discern from our press release, we enjoyed a solid second quarter with revenue of $7.68 billion and net earnings of $749 million.

We reported EPS of $2.45 per diluted share, $0.15 a share better than the year-ago quarter and $0.02 per share better than consensus.

With respect to consensus, it would appear that the sell side anticipated somewhat more revenue but lower margins and a somewhat higher tax rate.

Operating earnings were about as forecast by the sell side.

All in all, pretty close.

Compared to the year-ago quarter, revenue of $7.68 billion was $99 million or 1.3% lower.

However, net earnings of $749 million were up $35 million or 4.9% on a 60 basis point improvement in operating margins and a 160 basis point lower effective tax rate.

This led to EPS that was 6.5% better than the year-ago quarter.

Sequentially, revenue was up $234 million or 3.1% and operating earnings were up $21 million or 2% on a 10 basis point lower operating margin, a still very respectable 13.8%.

Let me turn briefly to the first half of 2017 compared to the first half of 2016.

Revenue was down $134 million, less than 1% against the first half of 2016.

On the other hand, operating earnings were up $140 million or 7.2% on lower costs.

Operating margins were 100 basis points better.

Earnings from continuing operations were up $144 million or 10.5%.

EPS was $0.55 better.

In short, we had a very good first half, somewhat ahead of both our internal plan and external expectations and well ahead of last year.

This quite -- this leads quite naturally to the guidance increase reflected in the press release.

I'll provide additional color on that guidance in a minute.

But first, 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 wrap that into our EPS guidance.

First, Aerospace.

Aerospace had a very good quarter in all important respects.

Revenue of $2.08 billion was $206 million lower than the year-ago quarter.

However, operating earnings of $425 million were $1 million more on a 190 basis point improvement in operating margin.

On a sequential basis, revenue was up $4 million and operating earnings were down $18 million on a 90 basis point reduction in margin, but remaining in excess of 20%.

For the first half, revenue at $4.15 billion is up $87 million against last year.

Importantly, operating earnings at $868 million are up $112 million or 14.8% on a 230 basis point improvement in margin.

In short, at $868 million in operating earnings for the first half of the year, Aerospace is well-positioned to achieve its earning goals for the year.

By the way, recall we previously told you that the new revenue recognition rule which helped us in the first 2 quarters of the year would have a negative impact in the second half, particularly in the fourth quarter.

So expect lower operating margins in the second half, especially in the fourth quarter.

You'll see this reflected in our guidance.

Let me give you some commentary about order activity in the quarter and then some observations about the current state of the market, insofar as it impacts Gulfstream.

First, in the quarter, the dollar-based book-to-bill was 0.9 to 1, which is very good.

The mix was particularly advantageous, with over 80% of the orders for large cabin aircraft.

The G500 and G600 continued to build backlog in advance of their entry into service, sufficient to ensure the success of these programs.

Interestingly, the G550 built backlog as well in the quarter.

While we read the reports of weak demand and reduced deliveries across the industry, our experience is reasonable and steady demand for our products.

We will deliver as many airplanes this year as we did last, on an entry-into-service basis.

Commentators frequently speak of weakness in the large cabin market.

Let me say that it is misleading to speak of a highly differentiated marketplace as if it were one market.

Parts of the market are very active, particularly those market segments where there is new product.

There are also market segments that are slow, largely because of the absence of product introduction, so we believe that the market is not only differentiated by segment, but also by the innovative offerings within the segment.

We believe this is why demand for our products remains fairly consistent.

We are comfortable with anticipated third quarter orders based on early contract activity and contract discussions.

The interest in the G650 and 650ER as well as the G550 remains quite good and supportive of next year's operating plan.

In short, we expect a good third quarter and a second half from an orders perspective.

Now let me say a few words about our progress towards certification of the G500 and G600.

The G500 and G600 flying continues to go well.

The aircraft are performing reliably and on schedule.

The G500 testing includes 4 test aircraft and 1 production aircraft with a full interior.

The 4 test aircraft have entered the Type Inspection Authorization or TIA flying phase.

This phase is for actual certification credit.

FAA pilots have joined Gulfstream flight crews on these TIA tests.

We continue to work collaboratively with the FAA to ensure optimal safety and efficient use of resources.

We expect to complete certification flying in Q4 '17.

Additionally, we continue to work closely with our suppliers to complete all component-level testing this year.

Once we have completed certification, the interior test aircraft, P1, will enter service as our G500 demonstrator.

It is important to note, however, that the G500 will not have any impact to revenue and earnings this year.

That is the result of the new revenue recognition rule.

The G600 now has 4 test aircraft flying, and the interior is being installed in the first production aircraft.

We remain on schedule to certify in 2018.

Let's now turn to the defense side of the house.

First, Combat Systems.

Combat had a very good quarter, as the relevant comparisons clearly indicate.

Revenue of $1.41 billion was $117 million more than the second quarter last year, up 9%.

Similarly, operating earnings were $225 million, up $20 million, almost 10% better than second quarter 2016.

On a sequential basis, the story is similar.

Revenue was up $127 million or almost 10%.

And operating earnings were up $20 million against -- again, almost 10% better.

For the first half, revenue was up $159 million or 6.3% against the first half of 2016.

Operating earnings were up $38 million, 9.7% on a 50 basis point margin expansion.

Our U.S.-based programs continue to perform well across our platforms, ordnance and ammunition portfolios.

We continue to move nicely from engineering to production on our 2 large international orders.

We also continue to win programs, particularly out of our European Land Systems business.

We are obviously trending in the right direction at Combat Systems.

With respect to the Marine group, revenue of $2.08 billion was $101 million higher than Q2 a year ago.

Operating earnings were up $6 million against the year-ago quarter.

On a sequential basis, revenue was up $145 million, and operating earnings were up $17 million on the higher revenue and a 30 basis point improvement in operating margin.

For the first half, revenue of $4.01 billion was down $87 million or 2.1% against the first half of 2016.

Operating earnings were also lower by $17 million on a 30 basis point contraction in margin.

Work on our submarine programs, that is, production on Blocks III and IV for the Virginia class and engineering on the Columbia ballistic-missile submarine replacement, continued to perform nicely.

With respect to our Bath shipyard, the challenges on the DDG 1000 and DDG 51 restart ships are largely behind us.

And our auxiliary ship and commercial businesses continue smoothly.

In addition, we have seen an uptick in demand for repair across our repair yards, primarily in San Diego and Washington State.

Marine Systems has been a compelling growth story for us and will continue to be so.

Our operating margin should continue to improve over time.

Turning to IS&T.

The group continues to perform well on the bottom line despite some revenue headwinds.

Revenue of $2.1 billion was down $111 million against the year-ago quarter.

On the other hand, operating earnings of $240 million were up against the year-ago quarter by $6 million.

There was an 80 basis point improvement in operating margin, which was particularly impressive.

Sequentially, revenue was lower by $42 million or 2%, but operating earnings were up $4 million on a 40 basis point improvement in margin.

This quarter's 11.4% operating margin is exceptional, in my view.

The story for the first half is much the same.

Revenue was down $293 million or 6.4%, but operating earnings were up $5 million on an 80 basis point improvement in margins.

So once again, very strong operating leverage.

For both our IT services and tactical communication and intel business, our cost performance and market positioning have driven very nice win rates.

Not surprisingly, our IS&T backlog grew $175 million in the quarter, with a book-to-bill of greater than 1 to 1 once again.

In short, we believe the segment results leave us positioned to do well in the second half.

Before I move on, let me give you a sense of the defense environment, at least from my perspective.

There is clear intent in the administration and in parts of the Congress for increased defense spending.

We believe this intent will manifest in some level of increased defense spending in the procurement and R&D accounts.

The question is how much, and when?

Relevant considerations include the dispatch with which Congress approves a higher defense budget and how soon the administration can propose and the Congress can approve the department senior leadership appointments.

Without these appointments, it is difficult to process contracts and get authorized and appropriated funds obligated to contracts.

At this juncture, both are proceeding more slowly than we thought would happen.

Nevertheless, we remain confident in the direction of defense spending.

So turning to guidance, let me provide some guidance for the year for each segment, compare it to what we told you in January and then wrap it up into our EPS outlook.

For Aerospace, our guidance was to expect revenue of $8.3 billion to $8.4 billion, up 6.4% from 2016; operating earnings of approximately $1.6 billion with an operating margin rate of 19.1% to 19.2%.

We now expect to be approximately $8.1 billion of revenue with margins of 19.5% to 19.6%.

This implies pressure on margins in the second half, particularly in the fourth quarter.

This will result in no change to the operating earnings forecast, still a very strong industry-leading performance.

For Combat, our previous guidance was to expect revenue to be up 6.6% to 6.7% over 2016, with operating earnings of $920 million to $925 million.

We now expect revenue of somewhat over $5.9 billion, just slightly above the 7% growth over last year; and operating earnings of $925 million to $930 million.

So pretty close to the original guidance, with a slight upward bias.

For the Marine group, we previously guided to revenue of $7.9 billion, margins of around 8.6% and operating earnings of $680 million to $685 million.

We now expect revenue to be up another $160 million to $165 million, with margins consistent with previous forecast, resulting in a modest improvement in operating earnings.

For IS&T, we guided to revenue up modestly over 2016, operating earnings of $1 billion to $1.05 billion with a margin rate around 11%.

It now appears that our revenue forecast is essentially flat and that operating earnings will be somewhat better at about 11.2% to 11.4%.

So all of this rolls up into revenue for General Dynamics of about $31 billion and operating margins of 13.3 to 13.5 -- 13.4% to 13.5%.

Compared to our initial guidance, we will have somewhat lower revenue, operating earnings at the higher end of the forecasted range, a somewhat lower tax rate and a lower share count, which permits us to increase our EPS guidance to $9.70 to $9.75.

To help you further, our EPS guidance was $9.50 to $9.55.

The $0.20 difference is $0.05 from operations, $0.05 to $0.06 from a lower tax rate and about $0.09 to $0.10 from share repurchases.

The EPS progression for the remainder of the year is down slightly in Q3 versus Q2, with Q4 looking similar to this quarter.

I'd now like to turn the call over to our CFO, Jason Aiken.

Thank you, Phebe.

And good morning.

Our net interest expense in the quarter was $24 million versus $23 million in the second quarter of 2016.

That brings the interest expense for the first half of the year to $49 million versus $45 million for the same period in 2016.

The increase in 2017 is due to a $500 million increase in our outstanding debt last year.

For 2017, we expect interest expense to be approximately $105 million.

Our effective tax rate was 27.4% for the quarter and 26% year-to-date.

As Phebe mentioned, we're lowering our target for the full year to a rate of 27.5%.

That reflects a greater benefit associated with employee stock option exercises than originally anticipated.

On the capital deployment front, in the second quarter, we purchased 2.7 million shares, bringing us to 4.6 million shares in the first half of the year for $900 million.

In total, when combined with the dividends we've paid, through the first 6 months of 2017, we've spent $1.4 billion in shareholder-friendly capital deployment, more than 1.5x our $857 million of free cash flow for the first half.

This left us at the end of the quarter with a cash balance of $1.9 billion and a net debt position of $2.1 billion.

We continue to anticipate free cash flow this year to approximate 100% of net earnings and in turn, deploying 100% of that free cash flow to share repurchases and dividends.

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

Thanks, Jason.

(Operator Instructions) Amy, can you please remind participants how to enter the queue?

(Operator Instructions) The first question comes from Ronald Epstein, Bank of America Merrill Lynch.

Maybe just a big picture question for you, Phebe, in terms of the Land Systems business.

We've seen a lot more press lately on the Russian T-14 Armata tank.

When you look at the Land Systems business and you kind of look into the tea leaves, is there an opportunity there for you guys in terms of some sort of equipment response from the U.S. in terms of either yet another upgrade to the Abrams or something new?

If you can add any color there.

Yes, so the U.S. Army is anticipating upgrading the Abrams to the next version, in part to meet the changing and evolving threat, frankly, worldwide.

So we have factored a lot of that into our thinking.

And if you think about it, we went from one tank production a month for several years, just keeping that plant on life support.

And we're now looking at nice, nice improvement in the throughput for that plant.

So we see demand increasing for the Abrams in various configurations both domestically and outside the U.S. as well.

So the Abrams is, we -- I think, positioned quite well to do -- to continue to grow.

The next question is from Samuel Pearlstein at Wells Fargo.

I was wondering if you could talk a little bit about IS&T has been running down for the first half of the year.

If I just look last year, it's a little bit of a tough comparison.

You're still expecting to get to flat.

I mean, how do you get there?

What do you need to win?

Or what's happening with IS&T in terms of being able to get to growth in the second half of the year?

So let's talk about that in 2 respects.

First, both of these businesses are shorter-cycle businesses.

And they are more affected by an extended CR.

Recall we had a 7-month extended CR, which had a impact on our products business and the execution of obligated funds, execution of appropriated funds in terms of obligation.

So that's pretty much a question of timing as the military services gear back up on their execution.

The second side is on our services business.

We had very slow execution on programs in several civilian agencies, primarily driven by uncertainty, and in some cases, reduction in funding levels.

I suspect some of that will obtain through the course of the year until the administration sorts out some of the funding for some of the civilian agencies.

But that said, we believe that our products business is poised for growth for the remainder of the year.

Recall we have a very nice backlog in this business, so it's simply a question of timing, when our customers execute programs.

The next question is from David Strauss at UBS.

Wanted to ask on cash flow.

I think, Jason, you commented that you're still targeting 100% free cash flow conversion for the year.

Through the first half, a little weaker than I expected.

Can you just talk about what's going on there, the billed and unbilled receivables?

And does that stabilize through the rest of the year, or partially reverse?

And what exactly is driving that?

Sure.

I guess at a macro level, what we've seen through the first half of the year is really on par with what we planned for the year, so nothing out of the ordinary.

We expected a bit of a ramp to the second half, so as I mentioned, still targeting at or around 100% conversion.

The buildup in working capital you mentioned was actually anticipated in connection with the Land Systems international programs.

Really what we're seeing there is as we're moving from what we experienced in the past couple of years with large advanced payments and then the burn-down of those advanced payments, which we've talked about ad nauseam at this point, as we move into production, you're seeing a more typical buildup of the unbilled receivables prior to delivery.

And as we then move into a ramp-up of deliveries, we'll begin to liquidate that unbilled receivables.

And we expect to see that to start to turn in the second half and hence a bit more of the ramp in the cash flow in the second half.

So all part and parcel of moving from the development phase of that contract into production and a subsequent ramp in deliveries.

So we'll see that unwind, beginning in the second half.

The next question is from Doug Harned at Bernstein.

On Gulfstream, you've -- Phebe, you've talked in the past about your pipeline being very strong.

And I think you're reiterating that today, but one of the things that you've raised is the fact that it's been a little slower converting interest into firm orders.

Could you give us a sense from the discussions you're having, and I would say both in the U.S. and abroad with customers, are there things that are slowing them down?

In other words, are they looking for signals, economic signals?

You had mentioned Brexit a while back, when that happened.

What are you seeing holding people back?

Nothing, actually, no substantive issue in particular.

It's simply more rigor as they move into the contracting process.

So I don't see any macro reasons, we have identified none, that we've got potential customers who are waiting on the sidelines.

It's simply just taking longer, for a whole series of reasons, everything from the introduction of brokers, to additional board approvals, so for fleet aircraft purchases.

Those are constants, but there is nothing in particular that's driving this other than, I think, this is just the new regular order.

It's going to just take longer from the time you enter the pipeline to the time you sign the contract.

And presumably, your transition to the new models, I would think, will be a part of this, too.

Yes, I don't think that there's anything particular about those new models that would change the lengths of time that we're experiencing.

I think that's a structural change, and it's simply around timing, taking a little bit longer, and we've learned to adjust to it.

The next question is from Myles Walton at Deutsche Bank.

Was hoping to follow up on Gulfstream.

I think, Phebe, you mentioned that there would be no G500 deliveries in '17.

I thought there was going to be one.

And then also, the sales guidance ticking down, is that the slippage of a few deliveries?

Or is that just the G500 and maybe used aircraft in isolation?

Well, there are a couple of things that are affecting the revenue.

We have -- we anticipate lower -- now, would anticipate lower preowned.

That carries with it -- with lower preowned sales, that reduces revenue but increases margin.

We have a few -- fewer G450 deliveries and then just lots of other puts and takes.

Nothing on the certification, EIS of the G500, though?

No, no.

We're good with that.

We're on track.

The certification is -- and flight test program is proceeding very, very well.

Jason can give you just a little bit more color on the -- this is a -- this really is the essence of the change of the impact of revenue recognition.

Sure.

I mean, we had talked about for a while, dating back, entry into service this year.

And that's still, as Phebe pointed out in her remarks, the demonstrator aircraft will enter service this year.

So we'll complete certification, get type certification, enter that aircraft into service, but that, of course, won't have a revenue implication.

That's what she was referring to in her remarks.

But nothing otherwise off schedule or off plan from what we'd anticipated this year.

The next question is from Robert Spingarn at Crédit Suisse.

Just sticking with Aerospace and Gulfstream.

You still, despite the sequential downtick, the margins are still excellent.

And if -- I would think that mix is trending away from some of the more mature programs.

And so how -- Phebe, where would you say the G650 margins are today relative to G450, G550 at peak maturity?

And how much more runway do you have there to offset the mix of the new aircraft as they come in?

And then will there be any margin support at some point from reduced R&D?

Or are you going to keep that level?

So the G650 margins have exceeded the G450, G550 at their peak.

And that's -- you asked a question that I ask Gulfstream frequently: How much better can we do?

And we will do better, the quantum of which we'll have to see, but we've come down our learning curve.

That purpose-built facility has turned out to be an operating mitzvah for us.

We've -- it's been really nice for our guys to be able to get sequential airplane-over-airplane improvements.

So I suspect we have more to go.

You're never done on a continuous improvement.

The R&D, you can anticipate our R&D spending to be about the same level.

We have a very robust R&D pipeline, product pipeline, so obviously, that is that.

The next question is from Cai Von Rumohr at Cowen.

Phebe, so GD always has kind of prided itself on focus on return of capital.

With stock prices moving up and your own moving up, reducing the leverage of stock repurchase, at what point does it make sense to shift the focus from repurchase to M&A?

Well, when attractive, accretive and strategically important targets cross our path.

So that, heretofore, has yet to happen, but nonetheless, we don't really comment on this, as you well know.

But we're certainly not -- we're certainly predisposed to be interested, should our criteria be met.

The next question is from Jason Gursky at Citi.

Phebe, I was wondering if we could spend a few minutes back on Marine, and have you talk a little bit about your view of the world on undersea unmanned, kind of what that market looks like and what you think GD's strategy might be and maybe what some of the challenges are in that market.

And then maybe just add on some comments here at the end about the demand out at NASSCO, with Jones Act and the LNG, products that you can produce out there, kind of what the pipeline looks like for those ships.

Sure, sure.

So as you well know, we are fully embedded in the undersea warfare element of the navy shipbuilding budget.

We are -- we've been very encouraged to see the Navy's interest in additional SSNs, Virginia class.

I think they increased recently their shipbuilding plan by 18 SSNs.

That's about a 38% increase from 48 to 66, [consists] of Virginia class.

So that would be very, very encouraging if that comes to pass.

We will see.

We're positioning ourselves, as you well know, for the Columbia ballistic-missile submarine.

The design is going extremely well, and we're on track to begin the build process exactly when we thought we would.

So we see the undersea deterrent and the undersea war-fighting capability of the U.S. Navy as a key national security imperative, as clearly evidenced by the Navy's interest in increasing subs.

With respect to NASSCO, interesting to speculate for a moment.

NASSCO has continued to perform very, very well.

We have the potential for an additional ESB.

I think that will be ESB 6. That's a program formerly known as MLP.

And we'll see if that comes to pass.

We also have -- the Navy has given us long lead funding for the second oiler.

And there is an opportunity to accelerate that program to 2 ships a year, should the Navy so choose.

But frankly, all of this takes money, so we're going to have to see how the budget process shakes out and what programs receive what funding and when.

The next question comes from Howard Rubel at Jefferies.

So you've got a whole host of opportunities in front of you, Phebe, and 2 sort of stand out.

One is there is a lot of FMS deals that have been announced but not yet contracted.

And then the G550 platform clearly has a number of military applications that range from domestic to international.

Could you put a fence around it or bracket some of this and help us a little bit with timing?

So on the FMS, for those programs that flow through FMS, we expect the Kuwaiti tanks and the tanks for the Kingdom in the fourth quarter.

The tanks for the Kingdom have already received congressional approval.

Primarily, we see the FMS used for tanks, less so on the wheeled vehicle side.

We also see FMS for our munitions and armaments business.

And that has been proceeding quite nicely, not in the big-ticket items that we've -- that the tanks represent, but nonetheless nice, steady volume.

With respect to the G550, the G550 is, as I'm sure you know, in service in a number of non-U.

S. air forces in the ISR mission.

And when -- by the way, when we talk about special mission, we mean the ISR mission and we mean medevac, primarily.

So -- but on the ISR front, the G550 has been in service, in some cases, for many years in a couple of countries and performed extremely well.

To the extent that there are opportunities for the G550 in the U.S. Air Force market, the Air Force will tell you -- tell us that they want our airplanes.

If they don't, they don't.

We're -- Air Force programs, that we're not that intimate with the Air Force, so I tend to defer any questions on the big Air Force programs to the primes, but with respect to the G550, I think it stands on its own merit.

I think there are also some opportunities moving away from the ISR front, if we look at the U.S. Air Force, and for some potential opportunities to refresh some of the executive transport airplanes, but that is a longer-term potential program.

I would note that a number of the airplanes are getting a little old in the Air Force executive transportation fleet.

So that's again their call, and we'll be prepared to respond to whatever their requirements are of us.

The next question is from Seth Seifman at JPMorgan.

Phebe, I wonder if you could talk to us about the review of WIN-T that General Milley is undertaking and the decision by the Senate authorizers to reduce funding and kind of how you see the future of the program from here?

Sure.

The Army is, as has been widely reported, reviewing its networking and communications strategy, including but not limited to WIN-T.

And as you can well imagine, we're working very closely with our customers to respond to any changing requirements.

And those will play out over time, to the extent that there are any.

We don't see any significant risks, by the way, in this year to our WIN-T estimates.

To give you just a little bit more color, we have a long-standing 20-year networking expertise in land forces -- tactical land forces networking.

We -- and we think that positions us very well to work with our army customer now and in the future.

The next question is from Peter Arment at Baird.

Phebe, on Aerospace in particular, I guess it's been a while since we've talked about Jet Aviation.

Maybe you can just give us an update on how that business is doing.

And is it growing?

And what are the prospects you're seeing out there for that?

Yes, so Jet Aviation is doing quite well.

Their services businesses are up, again, primarily driven by increased flying hours.

And their completion revenue and earnings are down a bit due in part to reduced inductions from Bombardier in St.

Louis, but we're doing very well in Basel on our completions programs, as we transition from engineering to production on several airplanes.

So Jet Aviation, both on its services side and its completion side, continues to perform very nicely.

The next question is from Robert Stallard at Vertical Research.

Phebe, in your commentary you mentioned that the margin in IS&T was exceptional in the quarter.

Does this imply that you don't expect this level of return to be sustained over the medium to long term?

No, I think I meant exceptional in the sense that it was noteworthy, not that it was rare.

As I think we, we're guiding you to margins in the 11.3% to 11.4% range, I anticipate that we will have no trouble in meeting that, spot on.

I don't expect any upside beyond that.

But these businesses have performed very, very well.

Our attention to cost, focus -- costs, schedule and performance has really driven the bottom line in both the services business and the products business in communications, networking and intel.

The next question is from Hunter Keaf -- I'm sorry, Hunter Keay, at Wolfe Research.

Phebe, a little more on G650.

Can you comment on how you're thinking about rate there in the next year, given the comment on strong demand, and how the sales efforts for the ER conversions are progressing?

And then maybe to that a little more, can you talk about the margin profile in the ER variant?

Is that really a whole lot different than the non-ER model?

Well, I'll take the questions in inverse order.

I'm not going to parse the differences in margin between the G650 and the G650ER, but as we've been talking about for some time, G650 production is going to come down somewhat in each of the next 3 years.

We increased the production to help us in the transition period as we move from the G450 to the G500 in particular.

And so as -- so our expectation, a balancing that we've been doing this year and into next, is that as the G650 revenue begins to decline, the G500 and G600 will offset that decline.

I might note that the interest in the G650 and G650ER continue to be quite robust.

In this quarter, we had the highest number of orders that in the -- that we've had in the last 6 quarters for the G650 and G650ER.

So that airplane continues to generate an awful lot of interest in the marketplace.

So there's no thoughts of maybe pushing out the rate cut?

Pushing up the rate?

No, pushing out the rate cut, putting it off.

No, I think that as we look at the -- where the G500 is in terms of orders and our production schedules on the G500, we're comfortable that we can offset the somewhat-reduced G650 sales.

But then I think that's just prudent business.

The next question is from Peter Skibitski at Drexel Hamilton.

Phebe, I was wondering if you can go further on your thoughts on the fiscal '18 defense budget, just in terms of the markups and the signals you're getting out of Congress.

It still seems a bit muddled over there, especially on the Senate side.

And I'm wondering if you see a good path to getting -- to eventually getting a budget that's above the President's request.

Or it's just too fuzzy right now?

Well, I -- if you go back a number of years, I think we used to have insights into the defense budget process, both within the -- any given administration and on Capitol Hill, that weren't necessarily widely shared or available.

But given the ubiquitous amount of information that flows today, I think you all know as much as I do in terms of specificity.

But the President's budget exceeded budget -- or his request exceeded the budget caps by $54 billion.

OCO, the overseas contingency fund, has often acted as a relief valve for the caps.

So perhaps Congress will consider doing something like that in addition to being able to, if we can ever adjust those caps.

Both the Senate and the House authorization bills are significantly in excess of the President's budget.

And the House Defense Appropriations Committee is about 100 -- or $35 billion, I think, over the President's request.

So look, what does all that mean?

That right now it's a giant fur ball, and we're going to have to work through the process and see what comes out the other side.

As I noted, I believe that there is real interest and desire in additional defense spending, which will manifest itself in some more additional funding and budget for defense.

It's just a question of how much and what accounts and when.

So we still have a ways to work through this process.

The final question is from George Shapiro at Shapiro Research.

Phebe, a typical question for you.

If you look at the Gulfstream margin in Q3 and assume it's like it was maybe this quarter, it implies the fourth quarter has got to really drop to 16% or so to get to your guidance.

And if you're not going to deliver a G500 in the fourth quarter, so what happens in Q4 to get that big a contraction in the margin?

I'll let Jason attack that one.

Yes, George, I mean, obviously, we can try to reconcile the math.

I don't think ours works out exactly as yours is suggesting.

That's probably not totally unusual, but I think the bigger -- the 2 bigger issues are a little bit of a downtick in the number of deliveries in the fourth quarter.

We've talked about that as it relates to outfitted deliveries under the new standard versus our old revenue recognition model.

So that is baked into our plan.

And then it's somewhat a bit of a mix there.

So more significantly, the volume of deliveries, but a little bit of mix issue affecting the margin.

But I don't think it's down quite as dramatically as you're suggesting.

It is definitely off, as implied in Phebe's guidance.

But let me follow up, Jason.

I mean, you said deliveries for this year would be about equal to last year, and the first half is pretty close to the first half of last year.

So is the Q3 deliveries then going to be a lot bigger and the Q4 ones down?

Or how does the deliveries going to spread out over Q3 and Q4?

Yes, I don't have the Q3 in front of me directly.

I do know that Q4 is off a little bit.

I also know that last year was particularly lumpy.

The second quarter was a bit of a spike.

So we can parse through the quarterly deliveries, but 4Q is definitely off slightly.

And that's what's -- the largest impact driving the margin difference.

Thank you for joining our call today.

If you have additional questions, I can be reached at (703) 876-3311.

Have a great day.