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Executives

L. Hugh Redd - Chief Financial Officer and Senior Vice President

Jay L. Johnson - Chairman and Chief Executive Officer

Nicole Shelton -

Analysts

George D. Shapiro - Access 3:42, LLC

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Robert Spingarn - Crédit Suisse AG, Research Division

Joseph Nadol - JP Morgan Chase & Co, Research Division

Michael S. Lewis - Lazard Capital Markets LLC, Research Division

Peter J. Skibitski - SunTrust Robinson Humphrey, Inc., Research Division

Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division

Jason M. Gursky - Citigroup Inc, Research Division

Heidi R. Wood - Morgan Stanley, Research Division

Carter Copeland - Barclays Capital, Research Division

Ronald J. Epstein - BofA Merrill Lynch, Research Division

Cai Von Rumohr - Cowen and Company, LLC, Research Division

General Dynamics (GD) Q3 2011 Earnings Call October 26, 2011 9:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 General Dynamics Earnings Conference Call. My name is Gina, and I will be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today, Nicole Shelton, Manager of Investor Relations. Please go ahead.

Nicole Shelton

Thank you, Gina, and good morning, everyone. Welcome to the General Dynamics Third Quarter Conference Call. As always, any forward-looking statements made today represent our estimates regarding the company's outlook. These estimates are subject to some risks and uncertainties. Additional information regarding these factors is contained in the company's 10-K and 10-Q filings.

With that, I would like to turn the call over to our Chairman and Chief Executive Officer, Jay Johnson.

Jay L. Johnson

Thank you, Nicole. Good morning, everyone. General Dynamics delivered another solid operating performance in the third quarter, with sales of $7.9 billion and operating earnings of $998 million. Company margins improved 60 basis points from last year's third quarter and 70 basis points from last quarter to 12.7%. Earnings per share from continuing operations were $1.83 on a fully-diluted basis, $0.13 better than last year's third quarter.

Third quarter free cash flow after capital expenditures was $15 million. This result was largely a timing reality caused by working capital growth and inventory at Gulfstream, associated with preparations for initial G650 green deliveries. We expect significant G650 cash payments in the fourth quarter in conjunction with the plane certification which will substantively reverse this trend.

In our Defense businesses, I expect them to deliver their largest cash quarter of the year in the fourth quarter as we progress toward our annual goal of a 1:1 conversion. In terms of capital deployment, we repurchased 5.8 million shares of GD common stock this quarter. Year-to-date, we spent $1.4 billion to repurchase 20 million shares. Through share repurchases and dividends, we have returned over 200% of year-to-date free cash flow to shareholders. In addition to share repurchase and dividend payments in the quarter, we also deployed capital to pay down $750 million in notes that came due in July and to further enhance our IS&T product portfolio through several accretive acquisitions totaling $1.1 billion, which I will describe in more detail later in my remarks. All together, these actions clearly reflect our balanced approach to capital deployment.

Backlog increased $1.4 billion in the third quarter to $58.5 billion, as 3 of the 4 operating groups exceeded 1:1 book to bill. At the end of the quarter, total estimated contract value, which includes backlog and the value of unexercised options in IDIQ contracts, stood at $85.8 billion, up over 9.5% from last quarter.

Now let me turn to the results and outlook for each of our groups beginning with Combat Systems. Combat Systems sales and earnings improved again when compared with both last quarter and the year-ago quarter. Sales totaled $2.14 billion, reflecting growing Foreign Military Light Armored Vehicle Sales, increased axle work and somewhat lower U.S. vehicle and engineering volume. Earnings were $319 million, resulting in a 14.9% operating margin, reflecting sound execution across the group's portfolio of mature, fixed-price production programs. In addition to good operating performance, profitability continues to be enhanced by the group's efforts to cut costs and prepare for the realities of a reduced defense budget environment.

Total backlog for Combat Systems was $10.4 billion at the end of the quarter, including $2 billion of orders received throughout the period. Notable orders in the quarter included $315 million for 115 Stryker Double-Vs and vehicle support services; $440 million for the Army's Ground Combat Vehicle development program; $200 million for MRAP upgrade; and $195 million for Canadian, U.S. and nonstandard ammunition programs.

International orders included $44 million to procure long-lead materials for 102 FMS tank upgrades and $50 million for FMS LAV training and field service support.

We expect good award activity again in the fourth quarter, particularly from our international customers. We just announced the award to upgrade 550 Canadian LAV vehicles, a contract valued at $1 billion. Other key foreign orders should include funding to upgrade 60 FMS tanks, 73 FMS LAVs and another 125 Egyptian tank kits. Domestically, we've just finalized an order for another 177 Stryker Double-V hull vehicles and are working with the Army customer on an order for 100 Stryker nuclear, biological and chemical reconnaissance variants. We also anticipate several hundred million dollars in funding for other Stryker upgrades and logistic support services.

Looking ahead, sales in the fourth quarter will be this year's strongest, with most of the businesses contributing their largest volume of the year. For the full year, the group remains on track to deliver around $9 billion in sales at 14% margins.

Now let's talk about Marine Systems. The Marine Systems group delivered another successful quarter. Sales of $1.6 billion resulted from higher Ohio class replacement and MLP volume, offset by lower destroyer volume when compared with the year-ago quarter. The lower destroyer volume is really a timing issue as we received several new destroyer awards late in the third quarter that will drive incremental sales moving forward. Earnings totaled $173 million, up when compared with both last year and last quarter. The group's third quarter operating margin was 10.7%, driven primarily by continued strong performance on the T-AKE program.

Marine's backlog totaled $18.9 billion at the end of the third quarter, reflecting $2.1 billion in new orders, the group's largest order quarter since the Virginia Block III contract was awarded in the fourth quarter of 2008. This significant order flow resulted in a book to bill of 1.3x.

Bath Iron Works, won the 2 largest awards in the quarter, which together totaled $2.4 billion for the construction of 2 DDG 1000 Zumwalt-class destroyers and one DDG 51 Arleigh Burke-class destroyer. As part of the Arleigh Burke destroyer award, BIW was awarded an option for a second ship, which is funded in the Navy's FY '12 budget request. Electric Boat also received several engineering and development contracts in the quarter, including an award to continue development of the common missile compartment for the next-generation SSBN program.

Total estimated contract value, including backlog and unexercised options, was $20.9 billion, up over 7% from the end of last quarter. This represents a stable, predictable and enduring workload. In the fourth quarter, group sales will be at their highest for the year due to higher submarine and destroyer revenue, while margins will be slightly lower due to mix shift. For the full year, sales should remain near the 2010 result, and margins will be around 10%. Looking to the future, Marine Systems has an experienced workforce, a durable backlog and an excellent reputation for delivering affordable, high-quality ships and repair services.

We've reported several positive developments in our ship repair business in recent weeks, including the announcement of our intent to purchase Metro Machine, a Norfolk-based naval repair yard, and NASSCO's successful bid for LPD 22 work. Metro Machine provides General Dynamics the opportunity to extend our surface ship maintenance footprint to the East Coast. The acquisition of Metro also complements the repair work that NASSCO is already executing in San Diego and we believe will enhance our competitive positioning for future repair opportunities. The Marine group's proven ability to take cost out of this business and its dedication to continuous improvement, as evidenced in program learning curves across the portfolio, position the group for continued great service to our Navy customer.

Next, I'll address our IS&T group. IS&T sales were $2.7 billion in the third quarter. Sales continued to reflect 2 key realities: growth at our IT service business due primarily to large IT infrastructure support projects; and pressure on our tactical communications business. Year-to-date, our IT service business has grown mid single-digits and continues to succeed in capturing new business opportunities. The group's tactical communications business, on the other hand, continues to experience lower volume driven by prolonged award activity, particularly in the shorter cycle, ruggedized and mobile computing division.

The group's third quarter earnings were $310 million, up modestly both year-over-year and sequentially. Operating margins were 11.6% in the quarter, 120 basis points better than last year's third quarter and 90 basis points improved from the last quarter. This margin improvement reflects the group's ongoing reengineering and cost-cutting actions made necessary by the slowdown in the businesses' acquisition cycles.

Despite the impact of delayed award activity on group sales through the first 3 quarters, IS&T enjoyed its strongest order quarter of the year in the third quarter, causing backlog to increase by approximately $1 billion. In particular, award activity in our IT service business, which was selected for an array of IDIQ contracts and task orders, was particularly healthy again. We also received a handful of key tactical communications awards, which position the business for improved results moving forward. These included the Common Hardware Systems-4 program, with a potential value of $3.7 billion; the joint Global Broadcast Service program, with a potential value of $900 million; and the Wideband Networking Waveform Software In-Service Support program valued at $65 million. Additional details about many of these contracts are included in today's earnings press release.

IS&T's total estimated contract value, which adds the potential value of IDIQ contracts to total backlog, stood at over $32 billion at quarter end. This represents almost 3x expected 2011 sales and is a 27% increase above last quarter's value.

We further enhanced our IS&T portfolio in the third quarter with a number of acquisitions, including: Fortress Technologies, a provider of secure, wireless networking equipment that fits nicely into our tactical communications portfolio; and Vangent, which complements our healthcare and federal civil IT service businesses and significantly expands our opportunity pipeline. With Vangent onboard, we now have a health IT business with over $800 million in annual sales and a customer footprint spanning the Centers for Disease Control, Centers for Medicare and Medicaid, Military Health System, Veterans Affairs and commercial health services. Given this critical mass and diverse customer exposure and experience, we will compete effectively as a Tier I health IT provider.

On the fed civ side, we plan to leverage our existing customer relationships to export Vangent's proven services to other agencies. Vangent will be nicely accretive in 2012 and offers IS&T growth opportunities, as health and federal civilian customers inevitably seek to automate processes and gain smarter IT solutions.

Fourth quarter sales will be the group's largest yet this year, as the tactical communications business begins to realize revenues associated with several of the delayed awards added to backlog in the third quarter, and we add Vangent's volume to the fold. Margins will be in the mid-10% range. For the full year, I expect group sales to be down 2% to 3% from last year, a reduction from my previous guidance, due primarily to the year-to-date pressure on our tactical communications business top line as previously discussed. Margins for the year will be in the mid-10% range.

Next, I'll move to Aerospace. The Aerospace group's third quarter was marked by continued emerging market customer interest and improved aircraft service volume. Sales and earnings improved from both last year's third quarter and from last quarter. Group sales were $1.4 billion, driven by more aircraft deliveries, both green and completions, and higher services volume when compared with last quarter, while earnings were $217 million. Margins were 15.4%, up modestly from last quarter.

Emerging market demand drove Gulfstream's order book again in the quarter, with Asia Pacific representing nearly 50% of the order book. This includes a 20-unit order from Minsheng, the Chinese financial leasing company of Minsheng Bank, for the Memorandum of Understanding we signed earlier this year. In addition to emerging market demand, we continued to see improvement in our North American markets, including the gradual return of Fortune 500 customers.

On an absolute basis, dollar-denominated book to bill was 1.5x, causing backlog to increase by over $300 million to $18.6 billion. While third quarter orders spanned our product line, the large-cabin business continues to dominate. With that said, we've been pleased to see demand for mid-cabin aircraft gaining traction, particularly as it relates to our new G280 offering.

In terms of preowned aircraft, modestly declining inventory levels continued to help foster a healthier business jet marketplace. Gulfstream took no preowned in trade this quarter and sold 2 aircraft at breakeven. At the end of the quarter, we had no preowned aircraft in inventory.

Gulfstream's installed fleet has now surpassed 2008 flying hour levels, a reality that helped our service facilities enjoy another record volume quarter. Year-to-date, Gulfstream's service business is up nearly 19%. In part, this double-digit growth reflects Gulfstream's #1 ranking in worldwide product support. In the quarter, Gulfstream product support was voted #1 for the ninth consecutive year in the annual Aviation International News product support survey. Similarly, Gulfstream received first-in-class product support recognition in the yearly professional pilot survey.

Our improved service network is particularly timely as we prepare to deliver our new G650 and G280 products to customers around the world. Both of these aircraft made significant strides toward entry-into-service this quarter. The G650, which had -- has amassed over 2,000 flight hours at the end of the third quarter, and I think today is just under 2,200, is performing well in flight testing and remains on track to receive provisional type certification in the fourth quarter. We expect to deliver 10 to 12 green aircraft before year end, with entry-into-service on track for second quarter 2012.

We're also extremely pleased by the performance of the G280, and recently announced that it will exceed the capabilities originally stated at the program's public launch. Following extensive flight testing, the G280 has demonstrated a 200-nautical-mile increase in range to 3,600 nautical miles and a shorter balanced field length, providing this aircraft unsurpassed flexibility for a business jet of its size. We now anticipate Israeli type certification by year end, with FAA type certification and entry-into-service to follow in the first part of 2012.

Jet Aviation's aircraft service-related revenues continue to grow in the third quarter. Volume is up nearly 16% year-to-date, driven by demand for Jet's MRO and FBO services. Regarding completions at Jet, the new management team is in the process of restructuring and rightsizing that business. Decreased OEM volume and several challenging widebody completions continue to impact operating performance. In the quarter, Jet Aviation announced significant overhead initiatives and personnel reductions at Basel in response to these conditions. This is an area of continuing management focus.

Looking to the fourth quarter, the Aerospace group expects provisional G650 type certification in the next several weeks, which will enable the group's sales, earnings and cash flow to reflect delivery of green G650s. Planned 2011 deliveries for our existing large-cabin and mid-cabin aircraft are also on track at 80 and 15 to 20, respectively. For the full year, I expect Aerospace group's sales to be up approximately 13% and operating margins to be around 15%. As we look to next year, Aerospace is well-positioned for growth, given our robust large-cabin backlog, planned new product deliveries and improving service volume.

In summary, General Dynamics is positioned for a very productive fourth quarter. Given our year-to-date performance, I expect earnings per share from continuing operations to be at the high end of my prior $7.15 to $7.20 guidance. As we plan for 2012, the defense market is shrouded by the uncertainty of the continuing resolution and the activities of the congressional super committee. While we continue to have no special insight as to what the super committee will determine between now and Thanksgiving or what will happen to defense budgets beyond 2012, we are encouraged by the dialogue that the Secretary of Defense is leading regarding the national security and economic impact of a potential defense budget sequester for our nation. It is clear that defense spending will be part of addressing our nation's economic problems. However, the manner and degree to which cuts are made will dictate how they impact our industry.

In our planning estimates, defense spending will decline at a moderate pace in the coming years. However, persistent global threats, election year politics, defense industrial base consequences and outlays from existing budgets must mitigate significant declines. Additionally, GD's mature, diverse portfolio and our solid defense incumbency, particularly with our Army and Navy customers, position us well. We can leverage our incumbency, innovation and experience to either bid as prime contractors for new development programs or provide customers with steady and dependable proven solutions. Amidst this uncertainty, we are focused on managing the downward pressure by shaping what we can control. This includes continuous improvement, restructuring, headcount reductions and various other cost-cutting initiatives essential to driving profitability as the top line becomes pressured. We are divesting those businesses that are no longer core to our portfolio and identifying areas in our business where acquisitions would shore up our outlook or improve our competitiveness in faster-growing market channels.

On a positive note, our core defense programs were well funded in 2011 and would, we believe, be largely supported under a protracted continuing resolution. Additionally, our backlog already includes a good order book for next year, and we are encouraged by the congressional support our programs have received in the 2012 defense budget appropriations process.

The Aerospace segment remains a key element of our company's value proposition over the next few years. Volume associated with our new aircraft programs will drive substantive incremental sales, earnings and cash. All of us at General Dynamics are acutely aware of the realities of today's uncertain and dynamic environment on a global scale. However, we will not allow ourselves to become distracted from delivering results. We are aggressively managing our businesses for profitability, with continued emphasis on execution, earnings growth and efficient conversion of earnings to cash. Our strong balance sheet and excellent cash outlook afford us the flexibility to continue deploying capital in a balanced fashion in order to create the greatest long-term value for our shareholders.

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

L. Hugh Redd

Thank you, Jay, and good morning. I'd like to cover a few miscellaneous items before the questions and answers period. First, interest expense was $38 million for the quarter and $103 million for the full year. This puts us on track for expense of $140 million for the full year. We recorded $8 million of other operating expense, primarily associated with transaction expenses for acquisitions, and most particularly the Vangent transaction.

The effective tax rate was 30.1, 3-0 point 1 percent for the quarter and 30.6% year-to-date. We expect the full-year rate to be very close to 31%. This quarter, we recognized a $13 million after-tax charge in discontinued operations resulting from the settlement of an environmental matter associated with the former operation of the company. Finally, during the quarter, we made voluntary contribution to the pension plans of approximately $300 million, consistent with our expectations at the end of last quarter.

Nicole, that concludes my remarks. I'll turn it back to you.

Nicole Shelton

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

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Carter Copeland from Barclays Capital.

Carter Copeland - Barclays Capital, Research Division

Jay, I wondered if you might elaborate on 2 things. The first on the 280, you said you expect Israeli type certification early next year with U.S. to follow. That sounds later -- correct me if I'm wrong, but that sounds later than what we were talking about earlier. And does that change the production profile there at all? Or is this -- you're continuing on the existing production plan, will just get certification and have more green airplanes to deliver in the future.

Jay L. Johnson

It's pretty much exactly as you said, Carter. It is a little bit later. It has to do with the sequencing of those certifications, and I don't expect that to impact the production rate. So we're working that with both -- obviously the Israeli regulators and the FAA. But we're on stream. And as I said in my remarks, we're thrilled with the airplane. It's just getting through the approvals.

Carter Copeland - Barclays Capital, Research Division

And what's the real source of the change in schedule?

Jay L. Johnson

I think it has to do, honestly, with software upgrades and when they feather in, and what's required by the Israelis and the FAA. And I think just flowing all of that, to be very pragmatic about it, pushes it into next year.

Operator

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

Jason M. Gursky - Citigroup Inc, Research Division

Just on Vangent, I was wondering if you could walk us through a bit more of the strategic rationale behind the price that you paid for it. And then lastly, some of the synergies that you would expect over some time.

Jay L. Johnson

Well, I talked to some of that, Jason. But I mean, basically -- first of all, we believe we paid a fair price for it. And we're very glad to have Vangent in the portfolio, most importantly. It allows us to compete as a Tier 1 healthcare IT provider, okay? That's the underlying foot stomper, okay? It puts us at scale where we really can compete. It also gives opportunity in serving the fed civ customer base, both back office and customer facing, in areas like student loans, Medicare and Medicaid. So we believe there will be lots of synergistic opportunities, as I said in my remarks, in the fast-current lanes that are becoming much more obvious in that space. So Vangent is going to be a good add for us. We've worked some -- we are working the integration right now with the existing GDIT organization, if you will, and we like the prospects we see ahead. We're very bullish on it. And as you heard me say, it comes into the financial fold here starting in this quarter, fourth quarter.

Jason M. Gursky - Citigroup Inc, Research Division

Are there any cost synergies associated with the transaction?

Jay L. Johnson

I mean, some elimination of some of the corporate expense perhaps. But it's mostly opportunity that we're after here.

Operator

Your next question comes from the line of Ronald Epstein, Bank of America Merrill Lynch.

Ronald J. Epstein - BofA Merrill Lynch, Research Division

Jay, just when you look at, I guess, the global economic backdrop and some of the uncertainty that we've seen in -- a slowdown in China. Maybe, maybe not. What impact have you seen or not in terms of demand on the large-cabin jet?

Jay L. Johnson

To be straight up with it, Ron, I mean, we've seen no negative impact whatsoever. And as I've said before and talked in terms of the bifurcation of the business jet market, our large-cabin business is very strong and just continues with that. This is the largest order -- albeit we've got a big Minsheng number in there, but it's the largest order book number we've had since 2008. So the large-cabin business is very strong. And it's really heavily weighted to Asia Pacific, as I said in my remarks. But honestly, if you take the Minsheng order aside and look at the rest of it, it's pretty well dispersed: some North America; some Asia Pacific, as we discussed; but also Europe, South America. So it's pretty global, notwithstanding the economic realities we're talking about.

Ronald J. Epstein - BofA Merrill Lynch, Research Division

Okay. And what incremental demand have you had for 650s, say, over the last quarter or 2?

Jay L. Johnson

I think I'd characterize it just by saying there's continued interest and activity, and the backlog number continues to increase somewhat. I mean, when you got over 200 in the backlog to start with, you don't expect a lot of add to that. But by golly, it's adding, okay? So there's still great attractiveness out there for the 650 and our in-production 450s and 550s. And you've heard me talk about the backlog sweet spot, if you will, of 18 to 24 months. Hey, we're still there, okay, with the in-production large-cabin. So it's a very bullish large-cabin market right now.

Operator

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

Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division

I'm interested on the cost side, actually 2 aspects of this. One is, if you could talk a little bit about the cost initiatives that you're driving from corporate across the businesses and how you're pushing that, because that sounds like a big theme here, given your discussions about the defense budget outlook. But in particular, Marine, you've gotten very impressive margins there, even with product -- program transitions underway. Is this being driven heavily by cost? Or how is that -- how have you done that?

Jay L. Johnson

Cost and performance, I mean, that's the best way to say it and particularly to the last part, to your Marine question. You know, Doug, from watching our Marine group operate over the years, that they are very disciplined in managing those yards for profitability. And they do it extremely well. And that, plus the performance on the contracts that they're executing, allow those kind of margins. Now we talked about mix shift coming, and that will be a factor. But we've -- we also -- we still believe this is a business that will show us, even with the mix shift in DDG 1000 versus 51s, and MLPs versus T-AKEs, and Block III versus Block II Virginia-class submarines, we are still talking about a 9% to 10% margin business at least.

Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division

But this sounds considerably better than, I think, you saw the business, say, 6 to 9 months ago in terms of performance. What's happening that has really improved that?

Jay L. Johnson

It's back to cost management and performance and T-AKE, as we get to the end of the T-AKE line. And it's also -- I would add that it's also their ability to outperform their CEO's somewhat conservative lay-down in the start of the year.

Operator

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

Cai Von Rumohr - Cowen and Company, LLC, Research Division

So the Minsheng order, I guess some other guys who have orders from Minsheng have provisions that that's cancelable. Are there -- can you give us some color on that transaction? I mean, are there any outs for them? And secondly, is there additional potential from either Minsheng or others that you see near-term in China?

Jay L. Johnson

Well, I think the answer to the last, Cai, is yes. We see the opportunity set in China continues to grow as the Aerospace business in China, the business -- Aerospace business continues to grow. And as to the first, I mean, we have very good terms and conditions on our contracts and liquidated damages clauses, et cetera. So we feel very adequately protected, if you will, with this order and frankly, the rest of them we have in our book. We're very mindful of that, particularly when you have numbers like we're talking about here. But it's spread across the product line, and they're very eager to get their airplanes. So we feel good about it right now.

Operator

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

Heidi R. Wood - Morgan Stanley, Research Division

Jay, a question on the international markets. Again, I just want to get a little bit more bead on how you would characterize the Asia-Pacific demand in commercial. Is it as strong in '11 as it was in '10? Do you see it ramping up? And then the second part is on defense. We've obviously seen a lot happening in the Middle East. And how is this affecting the pace of international competitions? And which would you highlight as the most imminent or important for you to land?

Jay L. Johnson

As to your first, Heidi, I would say yes and yes to your questions. I mean, we are seeing increased activity, pretty steady in Asia Pacific, with Minsheng being fairly typical of that. But you and I, we've talked before about things like the projections for airport growth in China, for example. And the earlier projection I saw in the year had like -- I think it was 10 airports a year that they were projecting to build. The number I'm seeing now is higher than that. I don't know if that tracks with what you see. But it could be like 15 a year. So the point of it all is that we are seeing increased activity in Asia Pacific, and as I mentioned earlier, from a large-cabin perspective, and really now starting with the 280 from the other areas of the globe as well. The defense side, international is kind of a -- let's see, how would I characterize that? The growth area right now in international is in the Middle East. I mean, that's unequivocal, okay? Our European business is mixed. Not surprising. We've talked about that before, because of the fiscal conditions in which they're operating. Their requirements are fairly well -- very well-defined, but the fiscal realities are preventing some of the contract lay-downs that they need and we would like to see executed. That gets pushed to the right. But having said that, our indigenous business, as I highlighted with Canada on the LAV contract, the production contract that just got laid down, is very good. The TAPV is proceeding right after that with -- for selection within the Canadian forces. And so there are mixed messages perhaps in some of what I'm suggesting, from Europe in particular. But the Middle East market continues to grow and continues to execute very well for us. And that's in more than one place, as you probably know. So we see that as probably key to our international book of business in the Combat Systems group, going forward. As the U.S. market flattens to declines, the indigenous European market stays flat, the ammunition market comes under some challenge in the short term just to burn off inventory that it has right now. You're going to see the growth coming out of the Middle East.

Heidi R. Wood - Morgan Stanley, Research Division

And just quickly on that, what percentage of Combat Systems, international, is it in '11? And what does it look like in '12?

Jay L. Johnson

The number I've got in my head is around 30%, I think, right now in '11, of international sales. And as you -- I don't have a '12 number, but the projection I looked -- out a few years, when we last -- when they last showed it to me, was in the mid- to upper 30s. So it's growing as a percentage of their book of business going forward.

Operator

Your next question comes from the line of Pete Skibitski from SunTrust.

Peter J. Skibitski - SunTrust Robinson Humphrey, Inc., Research Division

Jay, on the guidance for this year, are you guys basically factoring in 0 for the share repurchases?

Jay L. Johnson

I don't really factor share repurchases in when I do guidance. If that's what you're asking me, yes. So my answer would be yes. Now having said that, we have the authority and the wherewithal to do so tactically as we always do, if the market suggests that it's time to buy back some shares. But the answer to your question is yes.

Peter J. Skibitski - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And a question on margin. Fourth quarter in Combat sounds like it's going to be really, really strong from a top line perspective. It just seems like kind of 14% margin rate is really conservative. I mean, shouldn't we be thinking more like 15% or so for the quarter?

Jay L. Johnson

Well, I'm pretty comfortable, I think, with what I said overall. And it has to do with timing of, shall we say sunsetting of some programs that showed themselves in the third quarter. EFV comes to mind and perhaps FCS. So that's why I'm tamping myself back down to what I'd call more normal in the fourth quarter and for the year.

Peter J. Skibitski - SunTrust Robinson Humphrey, Inc., Research Division

Understood, understood. If I could sneak one last one in, because I'm really confused in IS&T margins. If services are doing really well and products poorly and yet margins were up to 11.6%, and given the margin differential there, I mean, shouldn't we be thinking 11.5% or so as sustainable given what you're doing on this type of mix?

Jay L. Johnson

It's another one where you've got some timing here in terms of the programs that delivered, that helped us deliver. You've got cost-cutting initiatives that I discussed in my remarks and performance that helped us drive the margin. But you've also got -- in this quarter, 3Q, you've got some program -- not termination -- I'll use the term sunsetting again, like WIN-T Increment 1 that gives you a margin lift there that you probably won't represent again in the fourth quarter. So I think I'm comfortable with the margins that I've laid down.

Operator

[Operator Instructions] And your next question comes from the line of Michael Lewis with Lazard Capital Markets.

Michael S. Lewis - Lazard Capital Markets LLC, Research Division

Jay, just to stay on the Combat Systems point. In your prepared remarks, you comment about the FMS LAV orders, also some pretty significant logistics work that's out there. Should we expect these orders to all book in Q4? And also, will the book at year end be enough to support flattish revenue moving into '12?

Jay L. Johnson

I'm not ready really to talk in any detail about '12. I mean, as I said in my remarks, I'm encouraged by what we've got in the order book and what's coming to the order book, even post Q3, that tees us up for 2012. But beyond that, I don't think -- I don't see a precipitous decline, as we've discussed in the past. But I'm not ready to give you any hard numbers for 2012 yet. But I do think that the order book that we've seen, we're expecting Q4 orders for more FMS tanks, for example. We expect the Egyptian Increment 11 to come to closure here -- I mean literally within days, perhaps. So these things are moving forward. We expect more Stryker consideration on the support side and/or the NBCRV that we talked about -- that I talked about in my remarks. So I think another tranche perhaps of LAV from the Middle East. So we've got a lot that's pending that we're confident will come across. It's just a question of the timing space, 4Q or into next year.

Operator

Your next question comes from the line of George Shapiro with Access 3:42.

George D. Shapiro - Access 3:42, LLC

Jay, if you looked at IS&T, where it's down 2% or 3%, I'm assuming Vangent's $200 million in revenues. So you're looking for, without Vangent, another relatively weak quarter. Is that all due to the tactical communications area? And how much is that area actually declining by itself? It must be a pretty substantial amount.

Jay L. Johnson

Well, honestly, George, I think what you're seeing in a lot of it here is -- I would call it a combination of CRA timing and customer behavior. What does that mean? That means that what we're seeing -- and I alluded to it, or -- quite directly, I think, in my remarks, you're seeing prolonged acquisition cycles, shall we say. The time between bid and proposal, and then actually award or task order has increased 50%, 100%, 150%. I mean, for example, one of the large awards that we've received in this space, we were the only bidder and it still took over a year to bring that award forward. So that's just a timing reality that they're all dealing with in it. Particularly important, as I said in my remarks, is some of the mobile computing and ruggedized equipment: the tactical, the products and systems piece. The services piece is holding its own. I don't see, honestly -- well, let me add something else to that. I think what you're also seeing in this space, back to the customer behavior, is we've read pieces of -- well, read quotes from people I have great respect for, like the DNI, General Clapper, who speak to the IT space right now. And my take on that is that what you've got is an environment whereby the things that must be dealt with right now, okay, the high-priority stuff, either for the war or for cyber or for something that cannot be deferred, you're seeing those awards come forward. A lot of the rest of it, the back office, the admin-type IT business, I think you're seeing deferred or reevaluated. The prioritizations are taking place and the impact of that is being felt in our businesses right now. How long will that last? My view is that it will last probably until we either get ourselves through a CR or through the next election. I mean, I don't think this is going to go away anytime soon, and I think the whole industry -- the whole information technology space sees that.

Operator

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

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Jay, just to touch on Marine -- actually, just to touch actually and expand a little bit on your efforts at sort of managing costs. And it's not just at Marine, it's also at Combat, these sort of levels of profitability. What other opportunities are you doing that's just looking for opening the aperture to do things, either like what you're doing with Marine on service or booking of other Combat vehicles that you can bring technology to for upgrading?

Jay L. Johnson

Well, we're always -- look, as I said earlier, we, Howard -- particularly as it applies to Combat Systems, we compete very favorably for all the new stuff, okay, all the new development programs. That's why we're players in Ground Combat Vehicle. But we also know how to work with our customer to service what's already there. Our incumbency puts us in a very strong position there. Double-V hull, Stryker V is a classic example of something that was already there that needed to be enhanced. We enhanced it for the customer. So we're constantly looking for things like that. As to the businesses, and I think to your earliest point, look, you know our model. It's very decentralized. There's great authority and responsibility at the business unit level, and they are working very diligently to manage for profitability. And we've reduced headcounts, we've reduced overhead. And we'll continue to go do that as we go forward to make sure that we can still deliver the results we need for our shareholders.

Operator

Your next question comes from the line of Joseph Nadol with JPMorgan.

Joseph Nadol - JP Morgan Chase & Co, Research Division

Jay, just back to the tactical communications. How much of the shortfall in what you maybe expected 6 or 9 months ago is, do you think, just reduced demand from the field as OCO outlays slow? And how much of it is just program-specific delays? And to the degree that it's program-specific delays, could you talk a bit about which programs? I mean, is this HMS? Is this WIN-T? Is it others? Is it a whole bunch of things? And then finally, just looking at OCO in general, what do you guys estimate your OCO spending exposure is in 2011?

Jay L. Johnson

The OCO number in 2011 I don't have off the top of my head, honestly. But I'll just say it's not substantive, in the broader sense. And we've said before that a lot of the OCO that moved away, for us, because of the incumbency that we have, moved back into base budgets. So I mean, our programs are fairly well supported in that regard. To your point about the reduced pull from the field, look, we're very -- our JTRS HMS and WIN-T are very much, shall we say, in demand. You know that #1 priority that the Army has right now is for their network, and that's what we're talking about. So there's another network integration exercise here next month. We are already in LRIP on producing 6,250, as I recall, Rifleman radios, and 100 Manpack PRC-155s. That will come to another production decision earlier in the year after this next exercise. And so we're very bullish on those products. Some of the others, to your first point, it has been manifest because of the acquisition delays that I talked about. But we feel very strongly that our WIN-T and JTRS HMS programs are being very well supported and pushed by the Army. They need them.

Operator

Your last question will come from the line of Rob Spingarn with Crédit Suisse.

Robert Spingarn - Crédit Suisse AG, Research Division

Jay, 2 quick things. First, the talk about potential expansion of Virginia class to 40, 50 boats. What kind of impact benefit might that have for you? And then I have a quick one on Gulfstream.

Jay L. Johnson

A good one. I'm not being smart-aleck about it. Look, we've talked before, Rob, that right now, there are 30 Virginia-class boats in the plan. That clearly does not meet the requirement that the combatant commanders need out there. So going beyond that, I think, is a very logical national security priority. You might expect a former Navy guy to say that, but in point of fact, I believe the combatant commanders validate that virtually every day. So I think the likelihood of expansion beyond 30 is very real. How that all feathers in, how it mixes with SSBN, what you do, when you do it, all that to be determined. But I think from a strategic prioritization, that makes sense at 2 per year, okay, Virginia class.

Robert Spingarn - Crédit Suisse AG, Research Division

Could that somehow or another improve cost in the near term? Somehow something gets deferred out into later boats if we get a decision in that direction? And then the last thing I wanted to ask you...

Jay L. Johnson

Rob, just a second. The cost piece, to me, the best way to manage the cost on that program is to stay at 2 a year.

Robert Spingarn - Crédit Suisse AG, Research Division

Okay. And then quickly, what would be the timing on the G450, G550 refresh? And is there some R&D already flowing on that?

Jay L. Johnson

Oh now, Rob, you know I'm not going to answer that question.

Robert Spingarn - Crédit Suisse AG, Research Division

Honeywell is already talking about some anticipated avionics awards, so...

Jay L. Johnson

Look, here -- you know that we are very consistent in product development commitment at Gulfstream. That's my answer. We nominally take 2% of sales, whether the top line's going up or down, and commit to product development. We continue to do so. And there'll come a day when the 450 sees a new airplane out there, and the 550; and many, many years from now, the 650. But we continue to refresh these aircraft. Example, out at NBAA, we have something we call Phoenix, which is basically an upgrade enhancement to the interior of the 450 and 550 that is really, really nice, if I do say so myself. That basically puts the cabin management system and the cabin itself -- the galley's upgraded, in the same package, if you will, as you see in the 650 and the 280. So we continue to do that even with the in-production aircraft as we develop product going forward. And we'll stay with that. That's how you stay as the premier brand, and that's how you continue for the long haul in this business. And we've been capitalizing smartly our Gulfstream business since we got it in '99, and we'll continue to do that going forward.

Nicole Shelton

I'd like to thank everyone for joining our call today. If you have additional questions, I can be reached at (703) 876-3152. Have a great day.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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