Welcome to the General Dynamics Fourth Quarter and Full-Year 2016 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Erin Linnihan, Staff VP for Investor Relations. Please go ahead.

Thank you, Gary and good morning, everyone. Welcome to the General Dynamics fourth quarter and full-year 2016 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'd like to turn the call over to our Chief Financial Officer, Jason Aiken.

Thanks, Erin and good morning. I'd like to open by congratulating Phebe on welcoming her first grandchild into the world yesterday. Mother, son and grandmother are all doing well. Phebe is with the newest edition to her family right now, but she left us well-prepared to report our results on this call. I'd also like to welcome Kim Kuryea, our Vice President and Controller to the call and thank her for joining me today. Congratulations Phebe, welcome Kim, now let's get started. Earlier today, we reported fourth quarter earnings from continuing operations of $2.62 per fully diluted share, on revenue of $8.23 billion and earnings from continuing operations of $807 million. The results for the quarter beat analyst consensus by $0.08, mostly on a lower than anticipated tax provision. Revenue and operating earnings are up significantly against the year-ago quarter, by 5.4% and 7.8% respectively. Earnings from continuing operations are also up $43 million on the strength of a 30 basis point improvement in operating margin, offset in part by a lower effective tax rate in the year-ago quarter. Similarly, earnings per diluted share from continuing operations were up $0.22 or 9.2%. So in summary, against the fourth quarter of 2015, revenue is up 5.4%, operating earnings are up 7.8%, earnings from continuing operations are up 5.6% and fully diluted earnings per share are up 9.2%. Sequentially, the story is just as wholesome. Revenue is up $502 million or 6.5% and operating earnings are up $48 million or 4.5%. Earnings from continuing operations are also up by $40 million and similarly, earnings per fully diluted share are up $0.14. So all-in all a very solid quarter, with good performance all around. The marine group's improved performance, both quarter over quarter and sequentially, is notable. In short, we were very pleased…

Thanks, Jason and good morning. I'll start out by touching on just a few miscellaneous items related to 2016's financial performance. The first thing I'll note is the foreign exchange rate volatility that we've seen throughout 2016. In particular, this issue has had a negative impact on the growth experienced in our combat systems group, given their increasing international activity. As Jason pointed out, the group's full year revenue was down 0.7% compared to 2015, but had foreign exchange rates, particularly the U.S. dollar to the Euro and the Canadian dollar, held constant from 2015, the group sales would have actually increased by 1.5% in 2016. As a reminder, this has nothing to do with any economic exposure or losses. What we're talking about is merely the translation of our various international businesses into U.S. dollars for consolidated reporting purposes and the negative effect on that translation that comes with the strengthening U.S. dollar. Net interest expense in the quarter was $23 million, compared with $19 million in the fourth quarter of 2015. For the full year, interest expense was $91 million, versus $83 million in 2015. The increase was due to a $500 million increase in our outstanding debt, yielding more interest expense and about a $450 million reduction in our cash balance associated with capital deployment activities which resulted in slightly lower interest income. For 2017, we expect net interest expense of around $110 million. The increase is due to the full-year effect of the increased debt and the lower cash positions. We ended 2016 with a cash balance of $2.3 billion on the balance sheet and a net debt position of $1.6 billion. That compares with cash of almost $2.8 billion and net debt of about $600 million at the end of 2015. Those changes are attributable…

Okay thanks, Kim. So let me provide some guidance for 2017 and some commentary on 2018 through 2020, initially by business group and then a Company-wide roll up. This year, we did a more detailed and extensive planning exercise around the three-year period subsequent to 2017, so I want to take this opportunity to share with you our expectations for that period, as well. In Aerospace, we expect 2017 revenue to be $8.3 billion to $8.4 billion, up 6.4% from 2016 as restated, but coincidentally similar to 2016 as reported. Operating earnings will be approximately $1.6 billion, with an operating margin rate of 19.1% to 19.2%. The margin rate is somewhat lower than prior experience under the legacy accounting rules, as a result of mix shift and increased R&D spending, as well as an anticipated increase in pre-owned aircraft sales. In aerospace for the five year period, 2016 through 2020, that is 2016 as restated, we expect the sales CAGR of 5.3%. That CAGR rolls up modest sales increases in 2018 and 2019, with significant growth in 2020. For the same period, the operating earnings CAGR is expected to be 5.9%. These percentages are of course imply a degree of precision that isn't possible in out-year forecasting, however, we believe they are directionally accurate. In combat systems, we expect revenue to be up 6.6% to 6.7% in 2017, with operating earnings of $920 million to $925 million. This implies a margin rate of around 15.6%. For the period 2016 to 2020, the expected sales CAGR is about 8.7% and earnings CAGR about 9.6%. Combat systems is in a period where several of our international programs are migrating from development, prototyping and low rate initial production, into full scale production. This supports the growth rates I just discussed. The marine group…

[Operator Instructions]. Our first question comes from Jason Gursky with Citigroup.

Jason, maybe you could just provide a little bit more color on the dynamics that you've seen at Gulfstream, starting off with the perhaps order activity on the 500 and 600, what you saw in the quarter? You talked a little bit about a robust pipeline and then just talk about the profitability there and the trajectory for that into the out years. We talked about $1.6 billion for this year with a nice CAGR going forward. So what does the shape of that hockey stick look like as we move out into 2020? Thanks.

Sure, so look as it relates to order activity, as I mentioned, we really saw a very encouraging increase in velocity in the second half of the year and that really is representative across the entire model portfolio, including the new products. I think what we're seeing here is, as we expected, as both the G500 and G600 get closer to entry into service, we're starting to see that order interest continue to pick up, so we feel very good about where those airplanes are as they get closer to the EIS, their respective EIS dates. Overall as I said it's not just order activity which again we felt very good about in both the third and fourth quarters, but it's the velocity into what we think of as the pipeline. What comes in sometimes is not the same as what goes out. We have talked about extended or protracted contract negotiations and the timing it takes to get aircraft contracts signed and completed and as good as we saw the second half from an order perspective, we saw just as encouraging velocity from the pipeline perspective going into Q1 which gives us a good bit of optimism as we start this year from an order perspective. With respect to your question about the out years, as I mentioned you saw you heard the remarks on 2017 and the CAGR for the out year period, I think what we see is, as we're transitioning with the real ramp of the 500 starting in 2018 and the 600 starting in 2019, we'll see modest growth in each of those years from their respective entries into service and we'll see more of the acceleration of the growth starting in 2020, when both of them are fully up and have ramped into the production.

The next question comes from Sam Pearlstein with Wells Fargo.

Jason, can you talk a little bit about the free cash flow conversion you mentioned, returning to 100% in 2017? It's a multi-part but does it continue through the planning period and can you address CapEx specifically over that period? Because I'm just trying to think about how CapEx ramps around the Columbia class ramp-up during that period.

Sure, certainly, as we've been signaling through this couple of year period, where we have seen lighter than our traditional cash flow conversion, it has been our expectation, our forecast that we would be back to our traditional 100% conversion rate starting in 2017. We have a high degree of confidence in that and we actually do see that as a sustaining trend. This is not a one-time thing, but we do expect to be able to keep up that level of conversion in that range throughout this planning horizon that I described. As it relates to free cash flow or excuse me, CapEx, typically somewhere in the ballpark of 2% of revenues is where we tend to end up around CapEx. That of course depends upon the timing and phasing of various projects across the business, so it can perturbate a little bit back and forth. But certainly what's coming on the horizon with Ohio will bring with it some investment. We're still in the very early phases of discussing what the profile and timing of that looks like with the Navy and so I don't think we're prepared to discuss any type of outsized CapEx investment in any one year, beyond what I just described. But it certainly, we do not see it affect any of that overall conversion rate through the planning horizon that I just described.

The next question comes from Peter Arment with Baird.

Jason, on Gulfstream is there a way that looks like to quantify how many jets have shifted out of 2016 into 2017? Looks like from a completion standpoint it's more like 10 aircraft. Is there a way you can help us bridge that? And then also regarding just a clarification on the G500 expecting certification this year and initial green deliveries, are we expecting any completed deliveries? Thanks.

Sure. So you're pretty much right as it relates to the green aircraft shifting from 2016 into 2017 and that's really what Kim was alluding to. Again do keep in mind that green aircraft will shift, including G500 green aircraft, will shift from 2017 into 2018. So this is something that I think is more of an issue in this immediate transition as you try to think about 2016 prior to restatement and 2016 under the restatement and then how you take that restated 2016 to then project 2017. I will point out one notion. Of the number you see in those exhibits around the difference, the delta between the green and outfitted airplanes. We do have a number of, I don't have the exact number off the top of my head, but a number of aircraft that are associated with special mission programs and those get inducted directly into the special mission process and don't go through a completion, so there's a natural delta there and I'm sure Erin can give you numbers after the call, if we need to get into that level of detail. As it relates to the G500 certification, we're still on track this year. Everything is going well with the flight test program and we're still targeting certification and entry into service, meaning outfitted delivery prior to the end of the year.

The next question comes from Myles Walton with Deutsche Bank.

Jason, the restatement in the accounting had a material impact on the non Aerospace businesses on 2016, but I think in the Q, as related to the restatement of 2015, it didn't really. So can you walk us through why the restatement had the effect on 2016 but not on 2015 in a material way and walk us through that one?

Sure. Look, as Kim described there really is just one primary meaningful difference that we're talking about as it relates to the defense businesses. Don't get me wrong, I don't want to understate what the team has done here to go through this process, because there's a lot of smaller puts and takes, but the big ticket item is this move from the prospective method of accounting for these changes in our long term estimates, to the cumulative catch up method. So the issue there is there's no one thing you can point to, that can say this is directionally indicative from a trend perspective. Because what's happening here, every quarter every year across the portfolio of these programs, we're performing updates to our estimates to complete and we're making adjustments across that portfolio to our profit booking rate margins on those programs. So as we do that in a given quarter, you're going to have some programs go up, some programs go down. As you've seen with a number of our peers who have pretty much all been on this method, even prior to this point, that can lead to somewhat more volatility under the cumulative catch up method than we have experienced under the perspective method. I think you can reasonably expect somewhere in the reporter of magnitude, if you compare them to us historically, 2 times or so the level of quarterly profit adjustment-type impacts on the results. Am I saying, that's what we will see in the future? I wouldn't be foolish enough to try and predict that but it's all going to depend what happens in a given quarter. What you saw in 2016 was that there were a handful more profit rate adjustments that had little to any impact under the prospective method in those periods, but when you take them all in one lump sum, they just drove a little bit more of that anomaly, a little bit more of that perturbation from quarter to quarter. So this is what we're going to frankly have to get into in a little more detail with you in the future, when and if these things happen. And as we said, we fully expect that somewhat increased level on volatility on a quarterly basis, to be part of our story in the future.

The next question comes from Ron Epstein with Bank of America.

Just maybe a broader big picture question, when you're willing to offer a plan like that, that goes out a couple years, a lot of companies won't do that and it's a change for you, obviously. How do we think about the conservatism that's built in as you step out over year one, year two, year three? Given I'm certain you are conservative, but how should we think about the conservatism built in that you are willing to share that with us? Does that make any sense?

It does. I would suggest this up front. There's nothing that's changed about anything you can infer about the historic current or future conservatism of this Company. It is what it is. I think the couple key points, those longer term out year CAGRs and forecasts that I directionally gave you, those are strictly rolled up from the operating plan, as submitted by our business units. So this is what each of those individual business unit presidents sees, as they look out over their horizon, mine their backlog and determine the trajectory of their businesses. We're seeing, frankly, a very good news story that we're bullish on across that period and so given the restatement here in the period and the fact that you're having to retune 2016 as you now look at and evaluate 2017, we frankly just thought it would be useful for you to get a little bit more of a picture, so you weren't left in isolation with the two data points make a trend or not, because that could be a tough expectation for anybody assessing the results. So we wanted to show you a little bit more directional color on where we see the businesses going. And we think as we see that type of growth now coming over that period across the Company and really shared by all four of our business groups, that combined with the demonstrated operating leverage we think we've been able to bring to bear, really offers us some great earnings trajectory over that midterm planning horizon.

One follow on, if I may. When you look back over what happened in the fourth quarter, did you see a pick up in pipeline activity, tire kicking, however you want to call it, post the election at Gulfstream?

I have not heard anything anecdotal specific to that from the guys down at Gulfstream. As I said, the fourth quarter was very encouraging both from order and pipeline activity standpoint, but I certainly don't think I have enough color to attribute that either to post election or otherwise.

The next question comes from Cai von Rumohr with Cowen and Company.

So in aerospace, you noted that the accounting change would have a negative impact on 2017 and yet looking at the numbers, it looks like there are 16 more green deliveries of large biz jets where you make your money, so that if those catch up you pick up 16, that's the math, in 2017 and if you are really going to get a G500 out the door and booked into revenue in 2017, by my math, it would look like this would actually have a positive impact, because there's 16 planes where the greens happen, the greens happened already, so you basically pick up the 80% on those 16 planes. So help us understand that, if you could.

Sure, so the planes you refer to, as I mentioned, the 16 is a little bit of an overstatement because they were somewhere in the ballpark of a half dozen or more handful of these special mission airplanes that don't flow into completions so they are done and out. But again I think the key to remember is, what we're trying to do here in the moment and this I believe is last time we'll do this, because green deliveries, will just fade out of the discussion from this point forward. But when you're trying to think about in the moment, as we transition between the old rules and the new rules, some of the instinct might be, as you've articulated, that wow you get to recount the value associated with these green airplanes that didn't deliver outfitted at the end of 2016. But you have to keep in mind, that was going to happen at the end of 2017 as well, so there's an output on the other end that's that natural flow of the business. And if you think of this as a steady in production model, the 650 to 550 to 450 to 280, you'd expect that similar cadence coming out the other end. So if you just leave it at that, it's essentially a net neutral or close to it anyway, where Kim articulated it as a modest headwind and when I say headwind, it's an accounting artifice headwind, it's not a business headwind. What's happening there is we would have had, if you imagine a G500 entry into service before the end of the year, there's quite naturally a handful of green G500s that are incremental to those in production aircraft, that are also going to tilt out of 2017 and into 2018, so on balance, we would see more of an outflow if you will or a tilt out of the year in 2017 on the back end, because of that phenomenon around the entry into service of the G500. Even then we're seeing as a tilt in flow from the end of 2016 into 2017. So hence our attempt to try to high pressure you understand in the moment, as we transition, what the impact of the shift of the new rules is on Gulfstream.

The next question comes from Carter Copeland with Barclays.

Jason, I wondered if you could just clarify the adjustments in marine on the restatement were obviously quite large and the go-forward margin that you're implying for 2017 in the mid 8s is a bit different than we've seen in recent years. Was there something about a booking rate change or anything from the shift away from perspective there, that's a go-forward difference that we should be noting or is that just coincidental?

I think really there's nothing, as I mentioned before. In the moment, when you look at individual quarterly performance and in this case try to examine the difference between how the results looked under the perspective method and the [indiscernible] catch up method it's really a function of what were the booking rate changes on those programs, in that portfolio, in the moment. So when you look at it, the third quarter was actually higher because we had on balance favorable booking rate changes in the fourth quarter across that portfolio, on balance had some negative booking rate changes. Again under the prospective method, as you are well aware and we talked about many types that gets cast out over the future, so there's virtually nil effect in the moment when you make those changes. You can see in the results, it had more volatile effect under the cume catch up method. I don't think you can take that and translate or extend that into what does it mean for the margin rates or the business in 2017 and beyond. Those are pretty much disconnected, I think. Really it's a function of, as you know, we've experienced some cost growth at the Bath shipyard on the settlement of the A12 program and some of the work we're doing on the DDG1000, as well as restart of the 51 program there. So that's well documented and discussed and we're working our way through that and we have every expectation we'll get that shipyard back to where we want it to be, as quickly as we can. So that's one influence and the other is of course, as we add more and more volume around the cost-plus Columbia class development effort, that of course is going to be dilutive in terms of margins, with respect to how it compares to fixed price full rate production programs, so that's really more what you're seeing going forward.

The next question comes from David Strauss with UBS.

Jason, with regard to the long term forecast for the defense businesses, obviously, you guys have had to make some assumption around the budget over the next couple of years. Can you talk about what you assume there, if it's just sequestration or not? And then on aerospace, it might be helpful just to kind of calibrate us, if you could talk about over that planning period what the ranges of completed deliveries, I guess more importantly, large cabin completed deliveries? Thanks.

Sure, so look as it relates to the Defense budget, I don't know that there's anything more fundamental assumed than what we're seeing which is notionally upward directional budgets that underpin and support the defense programs across-the-board. Really what it's about more so is what's in the backlog. We've developed a historically high backlog across the Company and now we're all about executing that backlog. So a good share of what you see, particularly in combat systems and in marine systems is all about just executing on that backlog and continuing to perform the way we have. So that gives us a great deal of confidence about that trajectory that I described. As it relates to aerospace, so I alluded to before, if I had to guess and I don't want to commit Phebe but I'm fairly certain, this will probably be the last time we talk about green deliveries, because it's all about outfitted deliveries in the future. So to your point right now as we look at 2017, we're projecting somewhere in the range from a large cabin perspective of call it 90 to 95 outfitted deliveries and from a mid-cabin perspective, somewhere in the range of 25 to 30 deliveries. As you are well aware, we tend not to look out beyond one year because we set production rates and work through those customer contracts on an annual basis, so we'll continue to update that on an annual basis, but that gives you a sense of what we're seeing as we head into 2017.

The next question comes from Howard Rubel with Jefferies.

On your backlog, it's down a little bit sequentially and I know some of that's attributable to timing. Could you do two things for us, Jason? One, provide us with a little bit of an indication of the pipeline for combat systems? We know there's a lot of things in the FMS pipeline. And then second, how do you see, you talked a little bit about Gulfstream, but where are some of the open slots for opportunities for sales?

Sure. So you mentioned the backlog is down just slightly sequentially and something important to point out there, particularly as it relates to combat systems. Kim alluded to the foreign exchange impact in that group, as it relates to our annual sales. You have to keep in mind there's equally, if not more so, an impact on what you will, the balance sheet for sales, that is the backlog. And so we saw something on the order of magnitude of a $700 million reduction in combat systems backlog in 2016, as a result of that FX headwind. So that gives you a sense of what's happening there. In terms of opportunities in the pipeline, you're right. It is quite robust, both on the domestic and the international front. We've got a number of competitions. There's an 8x8 vehicle in the UK, there's opportunities in Poland and the Czech Republic, follow-on work in Austria. Really the list goes on and on throughout both Europe and the Middle East for combat systems, as it relates to international programs. Domestically, we're looking forward to the ramp up with recapitalization efforts and so on, as it relates to Stryker ECP, Stryker Lethality, with the 30-millimeter gun, Abrams upgrades, Marine Corps Labs, really it's just a very encouraging and robust list for this group, again both domestically and across-the-board internationally. So really exciting to see. Your last part of your question, aerospace slots, I think fundamentally the thing, the way to think about this is, with the good order activity we saw in the quarter, we continue to be encouraged by our EIS next available slots for the various aircraft. The 650 remains essentially consistent with where we were last time, 24 months or so. The 550 remains in the 12 month range, 450, we…

Great. Thank you for joining our call today. If you have additional questions, Erin can be reached at 703-876-3583. Have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.