General Dynamics Corporation (GD) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2012 General Dynamics Earnings Conference Call. My name is Jeff, and I'll be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Amy Gilliland, Staff Vice President, Investor Relations. And you have the floor, ma'am.

Thank you, Jeff, and good morning, everyone. Welcome to the General Dynamics second quarter conference call. As always, any forward-looking statements made today represent our estimates regarding the company's outlook. These estimates are subject to some risks and uncertainties. Additional information regarding these factors is contained in the company's 10-K and 10-Q filings. 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' second quarter delivered $7.9 billion in sales and $970 million in operating earnings at a 12.2% operating margin, improvement from last year's second quarter and this year's first quarter. Earnings per share totaled $1.77 on a fully diluted basis, $0.20 ahead of last quarter. Second quarter free cash flow, after capital expenditures, totaled $703 million or 111% of earnings from continuing operations. This result was particularly strong, considering that it includes approximately $100 million in pension fund contribution, 2 quarterly federal tax payments and continued investment in Gulfstream's Savannah campus. We plan to contribute about $500 million in total to our pension plans this year with most of the remainder in the third quarter. Year-to-date, free cash flow is $1 billion or 86% of earnings from continuing operations. On the capital deployment front, we took advantage of our healthy balance sheet and tough market conditions to repurchase 7.8 million shares of common stock this quarter. Through the first half, we have repurchased 9.1 million shares. Additionally, we had announced the acquisition of IPWireless, an excellent bolt-on addition for our IS&T business. IPWireless further expands our technical communications portfolio into the public safety first responder market with advanced broadband technology that improves first responders' effectiveness and safety by providing them with greater access to information. Orders this quarter were approximately $5.2 billion, reflecting continued sluggishness in defense award activity and some slower-than-anticipated order timing in Aerospace. I do anticipate improved second-half orders, particularly in Aerospace. At the end of the quarter, funded backlog was $43.9 billion while total backlog stood at $52.4 billion. Total estimated contract value, which includes opportunities to provide products and services under IDIQ contracts and options, was $78.6 billion. Before I turn to the results and outlook for each of our groups, I want to comment on what we are seeing in this dynamic aerospace and defense business environment. In our U.S. defense market, visibility remains somewhat limited by 3 principal factors: the upcoming elections, a likely 2013 continuing resolution and the sequestration trigger. The uncertainty and anxiety spawned by these second-half events continues to impede Department of Defense and federal government acquisition program execution. As was the case last quarter, our shorter-cycle IS&T business is experiencing the most pressure, due primarily to award delays on several of our key tactical communications contracts. In most cases, these are funded programs of record. While there are -- excuse me, while there was improvement in activity from first to second quarter, this order activity did not meet our expectations. As anticipated, we are witnessing increased rhetoric as the summer progresses and the political process prepares to navigate the final months of the campaign trail. As we steam towards the sequestration fogbank, many members of Congress have begun talking more seriously about sequestration and its potential impacts. We remain hopeful that a bipartisan solution can be brokered. However, as a practical matter, it seems increasingly unlikely that we will see additional detail on implementation or resolution before the November elections. We are focused on what we can control. Specifically, we're executing on our backlog; working with our customers to jump-start the expenditure of previously appropriated funds; talking with our suppliers; analyzing our contract terms and conditions; and judiciously husbanding our capital resources. Nevertheless, forecasting our customer's behavior has become increasingly difficult. Given this uncertainty, we have adjusted our expectations somewhat for the year. Our outlook does assume the obligation of previously appropriated funds on several of our programs where delays have been prominent. With that said, the 2013 defense budget request is proceeding through the congressional approval process. We've been pleased with the support our programs have received to date. In the likely event that the 2013 Pentagon budget is funded, at least for some period of time through a continuing resolution, our programs would reflect relatively healthy 2012 funding levels. In our Aerospace group, Gulfstream continues to enjoy a sizable, multi-year large cabin backlog in a robust order pipeline. The fidelity of our backlog is evidenced by the extremely limited default of activity this quarter. And point of fact, this was the lowest default quarter since the economic downturn began in 2008. We are seeing, however, some elongation of our business jet order cycle with a number of factors causing deal closure times to increase. In part, order delays, most of which materialize late in the quarter, reflect the decline in global economic sentiment. We continue to believe that we will realize many of these orders although their timing, and in some cases, their scope, may vary from initial discussions. Now let me turn to each of our groups, starting with Combat Systems. Combat Systems' sales and earnings improved this quarter when compared with last quarter and the second of 2011. Sales totaled $2.15 billion, reflecting growing FMS volume for vehicles and tanks, initial progress on the Ground Combat Vehicle program and the addition of Force Protection. Abrams tank volume and European Land Systems volume were down somewhat as expected. The group's earnings were $322 million, resulting in 15% operating margins. This operating margin reflects excellent performance across Combats' portfolio of mature domestic vehicle production programs. In addition, profitability continues to be enhanced by ongoing continuous improvement and business optimization initiatives. Combat Systems backlog totaled $9.8 billion at quarter end. Although the group's orders improved from last quarter, orders in Combats' weapon systems and European vehicles segments were somewhat lighter than anticipated due to several international program delays. Notable orders that were received included approximately $270 million for Hydra rockets, $170 million for Abrams upgrades and support, and $115 million for Stryker double-V-hull conversions and logistics support. The Stryker double-V-hull conversion order is particularly significant as it reaffirms the customer's acceptance of the life-saving benefit of the double-V-hull and begins the process of converting another brigade of Strykers to the double-V configuration. In the second half, we expect order activity to improve with additional awards for Strykers, MRAP enhancements and international tank upgrades for several Middle Eastern customers to include 200 tanks from Morocco. We also expect a significant Abrams award that will fund tank research and development activities over the next several years. This investment is proof of our customer's long-term commitment to investing in and modernizing this integral component of the Army's fighting force. The Abrams tank also continues to receive staunch congressional support with each of the 3 committees that is marked, thus far, adding funds to sustain Abrams production. This support will help ensure that the U.S. maintains a healthy and reliable tank industrial base. Combat is on track to achieve my guidance of around $8.5 billion in sales this year. A variety of drivers in our European Land Systems business including reduced profitability on several vehicle programs, delays in several international awards, and absorption impact from lower-than-anticipated volume will cause the group's earnings to be somewhat lower than anticipated. Consequently, the group's operating margins will likely be closer to the mid-13% range. Next, Marine Systems. Marine Systems delivered another very solid quarter. Sales and earnings at $1.7 billion and $183 million, respectively, were up for the group collectively and at all 3 shipyards when compared with the prior year periods. Marine's stronger sales performance reflects higher submarine and destroyer volume, partially offset by lower T-AKE volume when compared with last year's second quarter. The group's repair-related sales also increased in the quarter, due primarily to our third quarter 2011 acquisition of Norfolk-based Metro Machine, now known as NASSCO-Norfolk. Integration of this acquisition is going well, and we continue to be excited about naval ship repair opportunities. In order to better leverage this growth market, in the second quarter, we announced our intent to acquire the Ship Repair and Coatings Divisions of Earl Industries. Earl will provide General Dynamics a role as prime contractor for nuclear aircraft carrier, multi-ship, multi-option contracts, MSMOs; further enhance our ability to deliver cost-effective repair and maintenance service on both coasts; and extend the reach of our repair capabilities in the 2 major East Coast Navy ports, Norfolk and Mayport. Group margins in the quarter improved 90 basis points over last year's second quarter to 11.1%, driven primarily by strong performance on the T-AKE program. Our 3 shipyards were busy delivering ships to our Navy customers in the second quarter including T-AKE 13; the USNS Medgar Evers; DDG 112; USS Michael Murphy, the final ship in the original DDG 51 program; and SSN 782, the USS Mississippi, the ninth Virginia-class submarine. The group's backlog was $17 billion at quarter end including several key new orders such as a $65 million contract to provide planning yard services for DDG 51 class destroyers and FFG 7 class frigates and the $80 million contract to purchase long lead materials for the next block, Block IV, of 9 Virginia-class submarines. We are currently preparing our bid for Block IV, expected later this -- next year, excuse me, and the SSBN replacement program design contract, which should be awarded by year end. We also recently submitted our bid for the Navy's DDG 51 multiyear program. This 9-ship contract, which includes an option for a 10th ship, is expected to be awarded early next year. Other opportunities for the group include additional repair work and the potential for some Jones Act commercial ships. Overall, 2012 sales should be modestly below 2011, consistent with my prior guidance. Given the group's performance through the first half, Marine margins for the year should be in the low 11% range, somewhat better than my earlier guidance. Now to IS&T. As I mentioned earlier in my remarks, our IS&T group was challenged again in the second quarter as customer award activity continued to fall short of expectations. Group sales were $2.5 billion while earnings were $226 million, up modestly from first quarter but off slightly from our expectations. Similar to the first quarter, volume weakness was driven by shortfalls in our tactical communications business. Last quarter, I highlighted the 3 areas which were causing weakness in our communications business. Award delays in our shorter-cycle products, especially encryption hardware; a slower-than-anticipated transition to the Common Hardware Systems-4 program; and the sluggish ramp in several programs moving from development to production, most notably JTRS and WIN-T. We made some progress on encryption orders in the second quarter, although we did not completely meet our forecast. We do expect good third quarter encryption volume, particularly as the government's fourth physical -- fiscal quarter has historically been a strong award period for our short-cycle products. The CHS-4 program was again a driver of the group's volume weakness in the second quarter, although improved somewhat from the first quarter. As a reminder, this is a $3.7 billion, 5-year single-source IDIQ contract that purchases from across the military and other government agencies and used to acquire the latest ruggedized commercial computing and communications technology. Slowing operational tempo has impacted demand when compared with the prior contracts. However, current customer demand far outpaces the orders we have received year-to-date. We have lowered our full year expectations for this contract, but believe that orders will improve somewhat in the second half. On development programs, our JTRS HMS and WIN-T programs continued to demonstrate their capability in the quarter, including participating in the Army's recent Network Integration Evaluation. While test reports are still preliminary, we have every reason to believe that our HMS Manpack and WIN-T Increment 2 products performed extremely well. Similarly, our HMS Rifleman radio received Pentagon approval for procurement of another 13,000 radios. Despite the demonstrated success and progress of our programs, the obligation of funding and awards for these programs continues to fall behind program or record time line. We are working closely with our customer on these issues and continue to expect to receive FY '12 funded awards for WIN-T as well as Rifleman and Manpack radios in the second half. Volume in our IT service business was essentially flat this quarter as the addition of several businesses in 2011 offset lower workload on several major IT infrastructure support projects, which have concluded. IS&T operating margins were 8.9% in the second quarter. This result reflects the lack of award activity in our higher-return, product-oriented tactical communications business and the overall portfolio mix shift toward service work that I mentioned in the first quarter call. IS&T, like the rest of our businesses, remain focused on profitability and competitiveness. The group continues to be aggressive in targeting costs to include facility consolidations, restructuring a business unit and staffing reductions. These actions should afford some operating leverage when delayed volume returns. The group's backlog totaled $9.3 billion at the quarter end while total estimated contract value, which includes backlog and potential IDIQ awards totaled $31 billion. Order activity was particularly healthy at our IT services business this quarter with several new opportunities captured to serve a wide range of customers including the Centers for Medicare and Medicaid and NATO. Even amidst a slower order cadence, our tactical communications business captured several key adjacent market wins including a $365 million 10-year IDIQ contract to replace the FAA's air-to-ground radios and a $385 million 10-year IDIQ contract to replace the Army's outdated fleet of range radar systems. These wins diversify our tactical communications end markets moving forward and highlight our focus on seeking new opportunities where we can apply our core competencies. IS&T's proposal activity remains quite robust, and we are maintaining our new capture rates. While forecasting remains extremely challenging in this market, we anticipate book-to-bill to improve in the second half and full year book-to-bill to approximate 1x. In light of the group's first half results, I expect full year sales to be down 7% when compared with last year. This revised outlook, which assumes just over $500 million of incremental volume in the second half, reflects the realities we experienced in the first half and our best estimate of how our customers will behave in the second half. Most of the incremental volume will come from our IST -- excuse me, our IT services business, including a significant portion that is in backlog today. As tactical communications volume improves in the second half, I would expect margins to expand from the 9% level achieved in the first half to yield full year group margins around 9.3%. Now let's move to Aerospace. The Aerospace group's second quarter sales were $1.6 billion, up 16% from the year ago quarter, due primarily to green G650 deliveries. When compared with the first quarter, revenues were down modestly due to the timing of several large-cabin aircraft deliveries. Earnings totaled $257 million, resulting in a 16.1% group operating margin. The group's operating margins improved 90 basis points when compared with last year's period, due to both improved results at Jet Aviation and excellent performance at Gulfstream. A variety of factors including mix and rightsizing actions taken at Jet caused margins to contract 60 basis points sequentially. Jet Aviation continues to make positive progress. In the quarter, we delivered the remaining 2 narrow-body wide-body aircraft that had experienced significant cost growth. And in an effort to continue improving its competitiveness, Jet reorganized its Basel operations, which resulted in further employee reductions. The Jet leadership team remains focused on capturing new completions opportunities. Jet's service operations continue to do well to include modest volume improvement from the year ago period and flat revenues sequentially. This performance reflects the dichotomy of increased demand across some markets, such as Asia, and decreased maintenance repair demand in Europe as the region copes with continued economic uncertainty. We've taken a hard look at our European service operations and are taking appropriate actions to reshape that footprint. As we look forward, Jet's global service footprint remains a strategic advantage for our Aerospace group. In the very near term, Jet's London Biggin Hill FBO, the closest business aviation airport to the Olympic Park, has already seen an increase in traffic from visitors to the 2012 Summer Olympic Games. Broader aerospace market indicators were mixed this quarter. As I mentioned earlier, orders were softer than expected due to the timing with second quarter gross new aircraft book-to-bill at 0.6x on a dollar-denominated basis. When combined with continued G650 deliveries, this elongation of the order cycle caused the group's backlog to decline to approximately $16.3 billion. While lower, this healthy backlog continues to keep us in an 18- to 24-month delivery window for our G450 and G550 products, and G650 backlog remains approximately 5 years in duration. As I've mentioned previously, because new orders for the G650 currently have this 5-year entry into service date, we do not expect new orders to match planned deliveries the near term. Through the first half, orders reflect the relative resilience of the large-cabin market when compared with mid-cabin. North American customers comprised 60% of the order book year-to-date, reflecting the return of some of our North American customers and some cooling of international demand, particularly in Asia. Gulfstream flying hours were at prerecession levels, pretty healthy, consistent with the first quarter. Year-to-date, Bellstream and Jet Aviation services are up almost 5%. We continue to work diligently to ensure that our service network remains well-positioned to serve customers in the growing install global fleet. In pursuit of this goal, we continue to improve our Field and Airborne Support Teams, our FAST teams. These teams, which were created a decade ago to provide 24/7 customer service support, just celebrated their 3,000 mission flight. In the quarter, we announced the addition of mobile maintenance vehicles to the FAST capability set. These vehicles will provide a range of services to customers in targeted markets. Preowned aircraft on the market continued to slowly decline in the quarter. We had 1 aircraft in inventory at the beginning of this quarter, took 1 additional preowned in trade during the quarter and had both aircraft available for sale at quarter end. On the product development front, the G650 and G280 development programs continued to make progress in the second quarter. Both aircraft set city-pair records en route to EBACE in Geneva in May. The G280 has now completed all of its FAA flying and we're working through the final stages of certification. We are nearly complete with the FAA's required G650 flight testing and remain on track to obtain a third quarter type certification. We continue to believe that we can attain our objective of delivering about 24 green G650 aircraft this year and around 17 completions with most of these completions happening in the fourth quarter. For the year, I expect the group sales to grow approximately 15% in line with my prior guidance, as large- and mid-cabin in-production green deliveries plan for the year remain on track at just over 100 and 10 to 15, respectively. Margins will be in the mid-15% range, somewhat higher than previously expected given Gulfstream's strong performance through the first half. In summary, General Dynamics executed very well this quarter and I expect that performance to continue in the second half. However, given first half results and the difficult reality of forecasting for IS&T in this uncertain period, I'm adjusting my EPS range to $7 to $7.10. As is our practice, this guidance does not presume further deployment of capital. We have a lot of work to accomplish in the second half as we deal with the defense uncertainties before us, achieve G650 and G280 type certification and begin detailed planning for 2013. With these tasks ahead, Phebe Novakovic, who, as you know, will assume my role as Chairman and CEO at the beginning of next year, is concentrating her efforts on the operation of this corporation and our 2013 planning process. Amidst this decidedly dynamic business climate, all of us at General Dynamics remain laser-focused on the things we can control and on doing what we do best: executing. And with that, I'll ask Hugh Redd to touch on some additional financial details. Hugh?

Thank you, Jay, and good morning, everyone. Really just 3 quick points before the question-and-answer period. First, net interest expense was $37 million for the quarter versus $31 million in 2011. For 2012, we expect net interest expense of approximately $155 million, reflecting the full year impact of our fixed rate notes issued in July of 2011. At the end of the quarter, we had just over $1 billion of net debt. Second, I'd like to point out an item impacting the comparability of our results, that being the sale of the detection systems business in the second quarter of 2011. This sale resulted in a pretax gain of $38 million or about $0.07 in other income. Finally, the effective tax rate was 31.5% for the first 6 months compared with 30.8% for the same period in 2011. For 2012, we expect an effective tax rate of approximately 32%, rising slightly over the 2011 amount, but due primarily to the absence of the R&D tax credit for 2012 but also due to less income from international locations where the tax rates are lower. Amy, that concludes my remarks, and I'll turn it back over to you for the question-and-answer.

[Operator Instructions] Jeff, could you please remind participants how to enter the queue?

[Operator Instructions] Our first question comes from the line of Myles Walton with Deutsche Bank.

Jay, your comments on the second half of book-to-bill improvement that you expect in Aerospace, can you give a little more color as to the level of confidence there in terms of you're seeing more pre-order traffic or kicking the tires, and specifically what regions are showing that pickup? And then kind of as a caveat to that, you -- at least I interpreted that there were some, I'm not sure, it's process procedural delays maybe in the quarter in terms of orders getting over the finish line, if you can clarify that a little bit?

Okay, be happy to. We did -- let me say it this way. We believe the second-half order activity will be stronger, as I said in my remarks. Example, let me just talk to demographics: 60% of our first quarter -- our first-half orders came from North America. Within that set, we had several, shall we say, multi-aircraft fleet buys, if you will, that moved out of the quarter; not off the page, just out of the quarter. And we anticipate those to be with us in the order book before the end of the year. And really, that probably had as much to do with North America with the order circumstance, if you will, as anything. So last year, just to further comment on North America, last year, at the midyear, about 28% as I recall, of our orders were North American. And as I said before, 60% this year. So the North American market, at large, is becoming a bigger part of our order book, which we like a lot. Conversely, we saw great softness in Europe, not unexpected by anyone and some in Asia, which frankly, we attribute at this stage more to timing than anything. What does that mean? That means, this year -- I don't have the exact percentage in my head, but last year's midyear order book was like 49% Asia Pacific and this year it was down in the high teens, as I recall. So there has been some cooling, as I said in my remarks. But again, we had a lot of fleet activity last year that hasn't manifested itself yet this year, but because of ongoing discussions, et cetera, we have -- we believe that there will be more activity coming out of Asia in the second half is probably the cleanest way to say it.

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

Probably not. Remember, too, Myles, in my -- as I said in my remarks, the 1:1 book-to-bill is going to be challenged right now because we're working off the 650 backlog. So I look, primarily, at what my delivery window is and I'm still very comfortable today in the 18- to 24-month for the 450 and the 550, and as I said, well out in excess of that for the 650. So I think that answers your question.

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

Jay, I wanted to ask you 2 questions on 2 specific programs. First, I wondered if you might speak to why you think Textron won the TAPV program. And then secondly, following up on your IS&T technical comments, can you elaborate on WIN-T? Is there anything materially unexpected or sort of out of line on that program going on?

Okay. I don't really have a comment on TAPV, Noah. I don't know, I mean. But I wish them well and I would say that we are in the hunt to compete for the CCV and we're already in execution on $1 billion of the LAV III upgrades with the Canadian DND so we've got plenty work to do, and we see more work out ahead. In terms of WIN-T, look, it's the stated #1 priority for our Army customer. So in macro terms, we feel very good about WIN-T and the performance of our pieces based on the NIE 12.2 are very encouraging. So it's back to my T word -- my T word, which is timing and we anticipate getting awards in the second half of this year. We just don't have them yet, okay? We expect a full rate production decision, I think, it's in September, either late August or September. So best we can tell that's still on track, but it hasn't, obviously, come yet. But we are very pleased and I believe the Army customer is very pleased with the performance of our pieces of WIN-T.

Have there been any design or specification issues with any other contributors to the program? Just trying to discern why this is getting held up.

None that I'm aware of. Honestly, I -- and I may be -- I don't want to presume to speak for the Army customer here, but maybe I will a little bit and my -- I'll just give you my impression of some of this, is that they're trying to align all of these programs, WIN-T and JTRS, into the NIE sequence and those don’t happen but every so often. So I think, honestly, that's caused some of the delay in some of the award activity. That's the best -- my best sense of it.

Our next question comes from the line of Richard Safran with Buckingham Research.

Jay, just a question on the Aerospace and business jets. I just wanted to know -- you noted some pretty strong pricing previously. I just want to know if you could discuss maybe pricing for large-cabin and mid-cabin jets, especially since you're thinking about stronger order activity in the second half?

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

Our your next question comes from the line of Peter Arment with Sterne Agee. Peter J. Arment - Sterne Agee & Leach Inc., Research Division: Just a question on IS&T. Just thinking about kind of the different buckets that you're involved in. I know that you've commented on the delays within some of the products in the networking area. What are you seeing -- I mean on the services front, we've seen a lot of delays. Can you bucket it in terms of the customer mix, DoD or intel or is it all across-the-board within civil agencies also?

Well, our services business has been -- they've done pretty well in what I consider a really tough environment. Good award activity in the quarter, I think I mentioned that, but -- and we've got probably about -- I think I've got about 45% to 47% of our IS&T sales are coming out of services now. About 21 or 22% of that out of what I call pure IT services and then probably another 25% coming out of engineering services, but that segment has been pressured for 18 to 24 months now. But I'd say, as I started this answer, again, we're competing very well in a tough environment. We are seeing some of the awards move to the right. We are seeing some down-scoping or re-scoping of those awards, but we're maintaining our capture rates and I think we're very competitive. You've got, in addition to that, the lowest-priced technically acceptable reality, which I think we've talked about before that's out there, that puts a lot of pressure on the system. So in a pretty decent catfight, I think our IT services business is doing very well.

Yes. Do you need -- I know that you had presence in all 50 states and certainly internationally on the footprint side. Are there consolidation opportunities there to help preserve the margins?

Sure, sure. They're looking at that all, in doing that, all of them. It's interesting, the consolidations and the re-scoping and the reshaping that I mentioned in my remarks, I mean that is a reality across all of our businesses right now as they deal with the realities of the defense market that has taken a $487 billion reduction across the 10 years and that doesn't even get into the sequestration discussion, so that's just good business. So as I've always said, we manage for profitability. We are doing that right now in all of these businesses.

Our next question comes on the line of Howard Rubel with Jefferies. Howard A. Rubel - Jefferies & Company, Inc., Research Division: Just talk for -- about Gulfstream for 2 seconds. One is can you give us a sense what's left in terms of the challenges for the 650 cert and then also just talk a little bit about the service business, you did talk about all the expansion. How -- what kind of growth rate are you seeing?

Yes, okay. Howard, thanks. The 650 certification, as I mentioned in my remarks, we're getting very close to completion of the flight test activity. That'll conclude here very shortly. Once that occurs, then it becomes a matter of putting it all together, my word, not probably the proper word, administratively, if you will, in laying all that out and then getting with -- working with the FAA to get yourself to an agreed-upon time to execute the type certification. We're on track for that. I have no indication that we're not. So I'm getting excited about it actually. I try to throttle myself back, but that's on track. Once that happens and as that happens, okay, once the flying's done, then we'll -- they'll start training the crews for the aircraft to be delivered, et cetera, as we had talked before. And you'll see then entry into service within a matter, I should think, of weeks after the type certification occurs. So we're marching down that time line very aggressively and visibly, I would add. They're doing lots of flying right now, but we're almost done with it. The service business, Howard, I mentioned, I think, the service business was up like up 5% for the first half. I would expect it to probably stay kind of flat for the rest of the year. I don't -- and why do I say that? Because the lack of activity, for example, that we're seeing in Europe right now, I don't see that getting any better for the rest of the year. It's causing us to have to reshape our European business somewhat at Jet, as I mentioned earlier. So the service business is doing fine, but I don't expect it to outperform the first half in the second half. I'd love to be pleasantly surprised on that, but I just don't see it right now. And we measure that in lots of different ways, not the least of which is looking at what visibility our service centers have on their order books and it's still pretty close aboard. Not a lot of long-term appointments for discretionary repair and upgrade. So it's still a very strong business for us, but I don't see much more than flat for the rest of the year.

Our next question comes from the line of Michael Lewis with Lazard Capital.

Can you help us understand order flow a bit better? Where do bids submitted, pending approval, currently stand? And can you give us the mix of recompetes versus new opportunities in that number? And then finally, as we look out over, say, the next 6 months, what does -- what do you plan to submit to -- on new contracts?

Wow. Let me just put it in macro terms, Mike. I mean in IS&T space, as you know, we have thousands of contracts in the year. I would characterize the order activity as being quite healthy actually, okay? We don't quantify it inside of that because it's just, like I've said, they're just flat; too many moving parts. But we anticipate the funnel is still there and the funnel will need to get serviced. So as I said earlier, the order activity in IS&T, we anticipate to be fairly respectful and ending the year at probably 1x, which it needs to do. And you know in that short cycle business, they got to turn inside themselves at least inside the year. So that part is good. Where we're seeing the challenge right now, as I've mentioned, is in the actual converting that into -- converting orders into sales and execution, and we're working very hard with our customers to get the appropriated funds obligated and to execute the 2012 plan.

Our next question comes from the line of Robert Spingarn with Credit Suisse. Robert Spingarn - Crédit Suisse AG, Research Division: You sort of just touched on this, but what I was going to ask you is what level of bookings you need across the 3 segments, understanding that some are longer-cycle than others, in order to meet your targeted guidance for the year? I'm thinking about the third quarter, specifically, since no one knows what the fourth quarter is going to do.

Yes, I mean, I think I expect Combats' bookings to improve. I think I may have mentioned that. Marine, not much, but remember -- remember, Marine is very lumpy. So we'll get Marine orders in big slugs. We'll work them off, which we're doing right now and then we'll get another big slug. I'm not worried in the least about Marine. And then IS&T, as I said, it's got to turn itself inside the year and we anticipate, based on the funnel we see out there, still being close to 1:1 for the year. So I think -- I hope that's responsive. Robert Spingarn - Crédit Suisse AG, Research Division: Well, Jay, one other thing. Do I detect a shift towards service in the Marine business with the recent acquisitions? Is that a strategic thing that you're doing given the long-term outlook on production?

I wouldn't say it's a switch to service. I would say that we're adding service to a very robust platform portfolio, and the repair business is a wonderful thing to be in for the United States Navy with its global fleet. So we're trying to enhance our repair opportunities and I'd love to keep -- we will keep doing that, but it's not at the expense of because we've got 3 shipyards that are going to be very busy for as far as I can see.

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

This is actually Jon Raviv in for Jason. Just a quick question on cash deployment priorities, looking at dividends, buybacks, M&A -- where your priorities are given the current environment? And then just on the M&A question, where your M&A priorities might be? I know we've seen some defense acquisitions of late, perhaps there's some commercial opportunities on the horizon as well?

Okay. Thanks, Jon. We always pouch our capital deployment in terms of balance and I'm certainly not about to change that. I would caveat it, however, by suggesting that as you look at the rest of this year and you look at, the term we're using, the fogbank, is now ahead of us in terms of the sequester: how it's going to be dealt with, what the CR is really going to translate to, how all that gets dealt with here in the next 6 months. I would suggest that capital deployment would be dealt with very cautiously and that's certainly what our intent is here. I would rather keep it in my quiver right now and that's kind of where we are. Now there aren't a lot of M&A opportunities of large and I don't see any of really large scale out there. There are some and we've -- I just talked about one of them, that we took advantage of, in IPWireless. I just talked about another one in Earl Industries. Those good opportunities to add to our portfolio will still be out there and we would take advantage of such opportunities. But I think the operative word, certainly into next year in capital deployment, is caution and maintain your balance and keep the quiver as full as you can.

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

Jay, I thought maybe I'd ask a bigger picture question on the Marine side. When you look at the ops tempo, clearly the Navy is small for the missions being asked of it. You've got the Navy stretched thin over Central Command and at the same time being asked to cover significant areas in the Pacific Command. The pivot to the Pacific has been long in the making, but I don't think anyone foresaw how much the Navy would be tasked over Central Command. So it's clear that the Navy budget faces real strain in terms of the needs for more ships. And I'm just wondering if you could give us color on what kind of discussions you're having with your Navy as they wrangle with solving this problem. Is there kind of examination into, basically, maybe buying more lower-cost surface combatants? Or the Virginia-class sub was supposed to be a low-cost sub; could they downsize yet again and develop less costly subs? Can you maybe add some vibrancy to kind of how you're working with the customer kind of wrestle with this?

Well, I mean we've had this discussion before in the context of even before the Pacific pivot was announced. I mean, we are global Navy. Over 90% of the world's commerce moves by sea, by volume, as I recall. I don't think that will change, certainly not anytime soon. And with that as a reality, United States Navy must maintain a robust force structure. That robust force structure must include lots of ships. And as I've said before, presence really does make a difference, and so you have to be there particularly when you're dealing now with the realities in the Pacific where the tyranny of distance causes you to be unable to be in multiple places at the same time very easily. So all that bodes well when you're a Navy shipbuilder for your future opportunities. As to your comment about the Virginia-class, the Virginia-class submarine in that program, itself, is what I would call as close to a model program as the Department of Defense has and we're very proud of that and we bring those boats in at the price tag that was -- I think, the public price tag is like $2 billion a boat. In point of fact, we delivered the Mississippi $60 million under budget and a year early, so we know how to build Virginia-class submarines. There is no substitute for the Virginia-class submarine in my humble opinion, and I don't think the Navy would argue with that. We need them in number, that's why Block IV will become a reality and there'll probably be a Block V after that. So the customer is looking at costs all the time on things like SSBN(X), but we still must have a fleet of major platforms. LCS will have its role, but we're still going to be making -- manufacturing lots of, in Jay Johnson's humble opinion and I think the Navy would agree, lots of major surface combatants, aircraft carriers and nuclear-powered submarines and the auxiliaries that will be needed to service them around the globe. That will not change.

And you said you're not the least worried about Marine. Does that mean that the second sub and the second destroyer in FY '13 will be executable? And lastly, if you don't mind me squishing this in, Jay, there's some smaller ships that are clearly struggling and I just wondered if you could touch on whether that creates some M&A opportunities for you?

On the last, I'm not particularly looking at any of that. On the smaller ship side, I think I know what you're talking about, but we've got plenty of work right now with the platforms we have. And the second submarine and the second DDG, I think the Navy and everyone is working very hard to keep that rate as the reality because it's the most cost-efficient and smartest move for everybody. So we're confident there.

Our next question comes from the line of Cai Von Rumohr with Cowen and Company.

So a kind of 2-point question on profitability at Gulfstream. The first part is you did 16.1% close to the first quarter, even though forfeitures were down and you had the problems at Jet. How come? And secondly, you had said that G650 should have above-average margins. Given that volume will be up in the second half, presumably with the G650s in your guidance, how come the margins aren't better in the second half?

Well, they are better than I guided to earlier, Cai, but I would say I'm being a little bit conservative here. I've got a product mix at Gulfstream. We delivered, I think, like 4 of the mid-cabins in the first half so we're going to be delivering more of the mid-cabins in the second half and -- so I'm at the mid-15s right now. And as is usually the case, I'm hopeful they'll outperform that. But we've got Jet, you touched on it, but if you compare it to the first half -- first quarter, I'm sorry, we've got, I think, we were down like 60 basis points. But a lot of that had to do with timing from Jet absorption expenses related to their resizing effort, which I touched on but didn't really elaborate. They are on track to be about break-even for the year, but they've got a lot -- they had a lot to take out here in the first half.

But isn't that even if Jet is going to do better in the second half, you have more 650s, you basically -- your volume on the mid-sized given the price differential just isn't that big. It still looks like, on paper, the margins in the second half should be better than the 16.1%. Are we missing something here?

No, I don't think so. I'm probably hedging. As I said, I'm being a little conservative with it, Cai, partly because of the restructuring and the market that Jet's seeing in Europe right now and partly because I'm just -- I'm hedging myself a little bit on product support which, as I'd mentioned on an earlier question, is I expect to be flat and that remains to be seen.

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

In Combat Systems, just if I look at that you did about $4 billion in revenues in the first half to get to $8.5 billion for the year, it would certainly imply a stronger second half. Can you talk a little bit about what's driving that pickup in that second half? And then just secondly, unrelated, was OT&E recently talked about the HMS Manpack as not being -- performing as well and I just wanted to know if you could comment on that.

Actually, I think I know on the last what you're referring to, Sam, and that basically is some old news that's already been taken care of. So the Manpack is -- they're quite happy with the Manpack right now. As to the first, it's really -- hit me with it again?

You did $4 billion in revenues in the first half, you're saying $8.5 billion for the year, so it's got to pick up.

Yes. Some of that, I think, will have to do with ELS, which we expect to be stronger in the second half than in the first half in Land Systems international programs, which as I'd said, it had some program delay but we expect more pickup in the second half. ELS' and -- I mean Combat Systems has been, historically, rather back-weighted to the year. I don't expect that to change, but I'm quite confident in our $8.5 billion number.

Our final question comes from the line of Joe Nadol with JPMorgan. Joseph Nadol - JP Morgan Chase & Co, Research Division: Just a couple of clarifications. Jay, could you be specific on the number of flight hours or test points or whatever that have been achieved on the 650 versus what's necessary? And then on the IS&T side, looking for margin pickup in the second half, but I thought I heard you say that the services side of the business, which was what you believe is going to provide the incremental revenue pickup and so that would suggest an adverse mix shift. What am I missing there?

To your last, of the $500 million in incremental that we need to get to where we -- I'm guiding in the second half, 2/3 to 3/4 of that comes from IT service. Your point is well taken. The tactical communications piece of that, though, is about 20% to 25% of that. And assuming that happens, which we have every indication that it will, that will give us the margin lift that I talked about. As to your first, I'm not going to get test point-specific. Let's just say that we're down to a very reasonable number of flights that remain and we're on track for the third quarter certification. There's no mystery in any of that, that I'm saying. And quite honestly, I can't remember the precise figure, but I've been tracking it virtually every day or every other day and we're marching down the flight test point, burndown chart quite nicely and I'm very confident that we're going to be wrapping it up very soon here.

And thank you for joining our call today. If you have additional questions, I can be reached at (703) 876-3748. Have a great day.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect, and have a wonderful day.