Erin Linnihan - Staff Vice President, Investor Relations Phebe N. Novakovic - Chairman & Chief Executive Officer Jason W. Aiken - Chief Financial Officer & Senior Vice President.

Peter J. Arment - Sterne Agee CRT Samuel J. Pearlstein - Wells Fargo Securities LLC David E. Strauss - UBS Securities LLC Robert M. Spingarn - Credit Suisse Securities (USA) LLC (Broker) George D. Shapiro - Shapiro Research LLC Doug Stuart Harned - Sanford C. Bernstein & Co. LLC Myles Alexander Walton - Deutsche Bank Securities, Inc.

Howard Alan Rubel - Jefferies LLC Carter Copeland - Barclays Capital, Inc. Cai von Rumohr - Cowen & Co. LLC Ronald Jay Epstein - Bank of America Merrill Lynch Robert Stallard - RBC Capital Markets.

Good day, ladies and gentlemen, and welcome to the General Dynamics Corporation Fourth Quarter and Full Year 2015 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Erin Linnihan, Staff Vice President of Investor Relations. Please go ahead..

Thank you, Abigail, and good morning everyone. Welcome to the General Dynamics fourth quarter conference call. As always, any forward-looking statements made today represent our estimates regarding the company's outlook. These estimates are subject to some risks and uncertainties.

Additional information regarding these factors is contained in the company's 10-K and 10-Q filings. With that, I would like to turn the call over to our Chairman and Chief Executive Officer, Phebe Novakovic..

Thanks, Erin, and good morning, all. Earlier today we reported fourth quarter earnings from continuing operation of $2.40 per fully diluted share on revenue of $7.81 billion and earnings from continuing operations of $764 million. Incidentally, we beat analyst consensus by $0.02, which is hard to do this late in the year.

Revenue and operating earnings were down against the year-ago quarter by 6.6% and 2.9% respectively. Earnings from continuing operations, however, were up $27 million on the strength of a 50-basis-point improvement in operating margin and a lower tax rate. Similarly, earnings per diluted share from continuing operations were up $0.21, almost 10%.

By the way, in connection with the comparisons to the year-ago quarter, let's remember that the fourth quarter 2014 was and remains the strongest revenue performance of any quarter in the last four years and by no small measure. So it is a very difficult comparison. And that will be true in the business segments as well.

Sequentially, the quarters were very similar. Revenue was down $185 million or 2.3%, but operating earnings were up $2 million on a 40-basis-point improvement in margin rate. So all in all, a solid quarter with particularly good performance in the Aerospace group, which I'll speak about in a little bit more detail.

So, for the year, where does that leave us? We had fully diluted earnings per share of $9.08 on revenue of $31.47 billion and earnings from continuing operations of $2.97 billion. Return on sales was 9.4%. Revenue for the year was up $617 million or 2%.

Operating earnings were up $289 million or 7.4% on a 70-basis-point improvement in operating margins. Earnings from continuing operations were up $292 million or 10.9% helped by a 200-basis-point improvement in the effective tax rate. This, together with share repurchases activity led quite naturally to a 16% improvement in earnings per share.

So all in all, 2015 was a great year, improving significantly over a very good 2014. It was a year of further progress from an operating perspective and revenue growth consistent with our guidance to you at this time last year. Turning to cash. Free cash flow from operations was $120 million in the quarter.

For the year, we had free cash flow from operations of $1.93 billion, which is 65% of earnings from continuing operations. As we advised you at the beginning of the year, free cash flow from operations was not going to reach 100% of net earnings for three reasons.

First, we are working off the very large advanced payments received in 2014 on a major Combat Systems program. Second, we have an increase in operating working capital at Gulfstream consistent with building numerous aircraft for test and preproduction parts in connection with the G500 and G600 program.

And third, we were also working off large advanced payments received in 2014 at NASSCO for commercial shipbuilding programs. All of this will normalize and unwind quite positively, but not until 2017. In 2016, we will continue to have less than our usual robust free cash flow.

Let me give you some color on the quarter and the year in each of the business groups. First, Aerospace, revenue was down modestly over the year-ago quarter. Sales were down $98 million, but earnings were down just $2 million as a result of a 70-basis-point improvement in margin; very nice operating performance.

For the year, revenue was $8.85 billion and operating earnings were $1.71 billion with an operating margin of 19.3%. This is a year-over-year improvement of 2.3% on sales, 5.9% on earnings, and 70 basis points on operating margin. All in all, a very good year at Aerospace with strong operating leverage and good order intake.

During the quarter, we took down the production rate of the G550 to what will be the sustaining rate through 2016. The G450 will come down modestly in the first quarter of 2016.

By the same token, the production rate of the G650 and G650ER were taken up during the second half of 2014 and will be taken up again in 2016 to reflect current demand and our sizable backlog. The production rate on the G650 and G650ER is clearly sustainable for this year and next.

So, contrary to what many investors seem to have anticipated, order activity in the quarter was quite good. The book-to-bill at Gulfstream was at least one to one, both dollar base, one to one, and in units of green delivery, 1.1 to 1, with particularly strong demand for the G650 and G650ER.

By the way, an interesting data point is that there were more orders for in-production aircraft in 2015 than 2014. All in all, the order activity going into the first quarter of this year is quite good. Let me say a few words about the large-cabin business jet market in general. We find demand to be reasonable.

We see no evidence at Gulfstream of a cyclical decline. The order activity is good, but not frenetic, and North America is particularly good. More than 50% of our orders for the year were from North America. I should also point out that, despite the hand-wringing by some, our orders from Asia Pacific improved by more than 60% over 2014.

In short, this market is not ebullient, but it is steady from our perspective. We also seem to be picking up some share from other OEMs. Combat Systems. Combat revenue was down $90 million, or 5.6%, and earnings were down $37 million, or 13.7%, on a 140-basis-point reduction in operating margin over the year-ago quarter.

Nevertheless, a 15.4% operating margin was more than respectable and consistent with our expectations for the group. Sequentially, the story begins to foretell the future. Sales were up $179 million and earnings were up $16 million. That is 13.3% and 7.3%, respectively.

For the full year, sales were down $92 million, or 1.6%, and earnings were up $20 million, or 2.3%, on a 60-basis-point improvement in operating margin. This margin expansion is the result of restructuring at both our European and Ordnance and Tactical Systems businesses.

By the way, this performance is reasonably consistent with the guidance we provided at this time last year. You may recall that we had guided to flat revenue and earnings. Overall, Combat Systems is a story of revenue reasonably consistent with expectations and outstanding cost and margin performance.

By the way, in just a moment, Jason's going to give you a little bit more color on this group's revenue performance. This is a business poised for modest growth in 2016 and quite significant growth in the 2017 through 2019 timeframe as we begin delivering on our $19 billion backlog. Now, Marine Systems.

The group's revenue of $1.98 billion in the quarter was down $58 million, or 2.8%, compared to the year-ago quarter, and down $105 million, or 5%, sequentially. Revenue for the year, however, was up $701 million, a rather extraordinary 9.6%. And recall that this increase in annual revenue follows a $600 million increase in 2014.

Operating earnings were down $21 million, or 10.9%, against the year-ago quarter, and down $9 million, or 5%, sequentially. For the full year, earnings were up $25 million, or 3.6%, despite a 50-basis-point decline in operating margin.

In the Marine Group, we guided you at this time last year to revenue growth of 2% to 2.5%, which we exceed by a fair measure. We forecasted margins at 9.5% and wound up at 9.1%.

So the story here was better-than-anticipated revenue, but not as good as expected operating margin, which left us relatively consistent with our guidance for operating earnings.

The growth in revenue in the year was driven by Electric Boat on two Virginia-class construction, sub – two Virginia-class submarine construction and increased engineering work for the Ohio Replacement Program.

This group's margins are the result of a mix shift; higher engineering work transitioning to Block IV from Block III and increased work on commercial Jones Act ships at NASSCO. IS&T is a business group where, once again, we saw less-than-expected revenue decline coupled with improved operating performance.

Several of our major ground and maritime programs were all funded beyond our plan, improving our sales performance. Margin improvement was the result of greater efficiencies than planned in business unit consolidation and continuing operating performance across all the portfolio.

Revenue in the quarter was $2.16 billion, down $307 million, or 12.4%, against the year-ago quarter, a very difficult comparator as I had mentioned previously. On the other hand, operating earnings of $230 million in the quarter were 8.5% better than the fourth quarter a year ago.

On a sequential basis, operating earnings were up $11 million, or 5%, on the strength of 10.6% margins, 70 basis points better than last quarter. For the year, revenue was down $194 million or only 2.1%. Remember, this is dramatically less than the 5.5% revenue decline we forecasted in our guidance to you at this time last year.

For the year, earnings were up $118 million or 15%; very good operating performance in the face of a 2% revenue decline. On this call a year ago, I gave you guidance with respect to operating margins in this – in the 9% range, which we beat by 110 basis points. All-in-all, we beat forecasted revenue and operating margin.

When that happens, the result is significant upside to the forecast. On this call a year ago, on a company-wide basis, our guidance for 2015 was to expect revenue of $31.3 billion to $31.5 billion, an operating margin rate of 12.8%, a tax rate of 30.5%, and a return on sales of 8.7%.

We wound up the year with revenue at $31.47 billion, an operating margin rate of 13.3%, an effective tax rate of 27.7%, and a return on sales of 9.4%. Last year at this time, we provided EPS guidance of $8.05 to $8.10. We wound up at $9.08.

About 46% of the improvement came from better-than-planned operating performance, $0.05 from the gain on the sale of a small business, $0.30 from a lower-than-planned tax rate, and the balance from a lower share count as a result of share repurchases. Certainly a great year by any measure.

So let me provide some thoughts about 2016, initially by group and then on a company-wide roll-up. In Aerospace we expect revenue to be approximately $8.9 billion, up very modestly. Margin rate should be down 10 basis points to 20 basis points and operating earnings flat to last year.

2017 should look a lot like 2016 with upside in revenue and earnings if we can deliver the G500 in the fourth quarter. Revenue and earnings growth will resume with full scale production and delivery of the G500 in 2018 (13:59) and the G600 the following year.

In Combat, we expect revenue to be up $160 million and the margin rate similar to 2015 with more vigorous growth of both revenue and earnings in 2017, 2018, and 2019. The Marine group is expected to have revenue similar to 2015 but improved operating earnings as a result of operating margins in the mid-9% range.

Revenue in 2017 and 2018 will have growth of a couple of hundred million a year, an additional $0.5 billion in 2019 growth.

Finally in IS&T we expect a modest improvement in revenue and a 20 basis point to 30 basis point decline in operating margin that remind you again that a gain on the sale of a business was included in 2015's operated earnings and margin rate. This will result in essentially flat operating earnings year-over-year.

Once again, we should see more solid revenue growth in 2017 and 2018. All of this rolls up to $31.6 billion to $31.8 billion of revenue, operating margin of around 13.3%, and return on sales of roughly 9.1%. Let me emphasize that this plan is purely from operations.

It assumes a 29.5% tax rate, and assumes we buy only enough shares to hold the share count steady with year-end figures so as to avoid dilution from option exercise. This rolls up to an EPS guidance of around $9.20 per fully diluted share. This compares with last year's guidance of $8.05 to $8.10 at the same time on the same basis.

Let me also reconcile this forecast of $9.20 to our 2015 year-end result at $9.08. In 2016 we will not have the operating gain from the sale of a business. That gain was $0.05 of EPS. In 2016, we will have higher interest expense with a $0.02 negative impact to 2016 EPS.

We will also have a higher effective tax rate in 2016 that will cost us $0.23 per share. Foreign exchange headwinds at current FX rates will cost another $0.04 of EPS compared to 2015. On a pro forma basis, this suggests 2015 to $8.74 and gives us a 5% adjusted growth in forecasted 2016 EPS before deployment of capital.

With respect to the quarterly progression for EPS, it looks like most years. So divide our guidance by four, then take $0.20 off of Q1, $0.10 off Q2, leave Q3 even, and about $0.30 up in Q4. So much like last year, beating our guidance must come from outperforming the operating plan and the effect of capital deployment.

With respect to the deployment of capital, we anticipate using all of our free cash flow in 2016 for dividends and share repurchase.

While we don't anticipate a robust year from a free cash flow perspective for the reasons I have previously described, we will use balance sheet cash to some degree to supplement our free cash flow for share repurchase activity.

I'll have more to say on this subject at the end of the first quarter as our planning becomes more refined and is approved by our board. I'd now like to turn the call over to our Chief Financial Officer, Jason Aiken..

Thank you, Phebe, and good morning. As we discussed previously, we felt more of an impact on our financial results from foreign exchange rate volatility in 2015 than we have in the past. In particular, this issue has had a negative impact on the growth experienced in our Combat Systems group given their increasing international activity.

As Phebe pointed out, the group's full-year revenue was down 1.6% compared to 2014. But had foreign exchange rates, particularly the U.S. dollar to the euro and to the Canadian dollar, held constant from 2014 to this year, the group's sales would have actually increased by 6.4% in 2015.

For the company as a whole this would have taken our 2% top line growth over 2014 to almost 4%. As a reminder, this has nothing to do with any economic exposure or losses. This is merely the translation of our various international indigenous businesses into U.S.

dollars for consolidated reporting purposes, and the negative effect on that translation that comes with a strengthening dollar. Given where we see the mix of Combat Systems programs in the years ahead, we expect foreign currency fluctuations to be an ongoing part of the group's story.

Net interest expense in the quarter was $19 million, consist with the fourth quarter of 2014. For the year, interest expense was $83 million, $3 million less than the year before due to the repayment of $500 million of fixed rate notes that occurred in 2015. For 2016 we expect net interest expense of around $95 million.

And the increase is due primarily to less interest income as we've deployed cash off the balance sheet. As we've deployed that cash over the year, we've moved from a net cash position, that's cash in excess of debt, of $1 billion at the end of 2014 to a net debt position of $614 million.

And I'll walk through those capital deployment activities in just a minute. Our effective tax rate was 27.7% for the year, right in the ballpark, slightly lower than the 28% we forecasted at the end of the third quarter.

The lower outcome is attributable to favorable contract closeouts with the IRS and Congress' enactment of tax extenders in late December; in particular, the research and experimentation credit.

For the year, the research tax credit extension benefited our rate by about 50 basis points, but was offset by some one-time unfavorable effects of other provisions in the extenders law. The combined effect was a 20-basis-point reduction in the 2015 effective rate, or about $0.02 per share.

You may recall at this time last year that, given our increasing international presence, we considered the new normal for our effective tax rate to be in the 30% to 30.5% range. For 2016 with the research tax credit now permanent, we expect an effective tax rate in the mid-29% range.

Moving on to our pension plans, we contributed about $185 million to our pension plans in 2015, as forecast. And for 2016, we expect that amount to be approximately $200 million to be contributed mostly during the third quarter.

And finally on the capital deployment front, to summarize our activities for the year, we spent approximately $3.2 billion on share repurchases; and when you combine those share repurchases with our dividend payments, we used $4.1 billion in shareholder-friendly actions in 2015 or 2.1 times our free cash flow from operations for the year.

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

Thanks, Jason. As a quick reminder, we ask participants to ask only one question so that everyone has a chance to participate. If you have additional questions, please get back into the queue.

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

Certainly. Our first question comes from the line of Peter Arment with Sterne Agee. Your line is open..

Yes. Good afternoon, Phebe and Jason..

Good afternoon..

Good afternoon..

Phebe, maybe this is a good opportunity just since we haven't spoke since the budget deal, and maybe you could just give us your overview how you see that impacting domestically? And also, related to that, are you seeing any changes on the international order front just given what has happened with the oil prices with any of your customers? Thanks, Phebe..

So the budget deal provided us funding in line with – exactly in line with what we anticipated, so no surprises there; and some upside, frankly, in a couple of areas. But that stability is critical and, I think, very helpful as we think through the defense portfolio for the next year or two. So that was, I think, very helpful.

But as I said, it was consistent with what we had anticipated. With respect to international orders, we have continued to increase – and particularly on the Combat Systems side, increase our order activity internationally. And so far, we have yet to see any impact from oil prices in the Mid-East.

You know, as we've talked a lot in the past, from my perspective, defense spending is completely determined by the threat. And the threat environment in that world has gotten nothing but worse. So we're very sensitive to our customers' needs and requirements.

And we work carefully with them to ensure that we can provide them what they need when they want it and terms that are favorable to us and which they can accommodate. I would also remind you, by the way, that most of our orders in that part of the world are government to government, which provides some stability.

So that is a benefit to us as well as we look forward..

Next question?.

Thank you. Our next question comes from the line of Sam Pearlstein with Wells Fargo. Your line is open..

Good morning..

Hi, Sam..

Hi. You had talked a little bit about free cash flow not being that robust this year. And you had talked about last – I guess, in 2015 because of the Aerospace investments.

Can you just walk through what kind of expectations and then what changes as you go into 2017 that makes it start to see us return to 100% conversion?.

Well, it's all three. It's a reversal, an unwinding of all three of the factors that we've talked about impacting 2015 and 2016, but let's take Gulfstream. We're continuing to build demonstration and test aircraft, test aircraft for both the G500 and G600.

Our capital deployment – or our CapEx is largely done at Gulfstream, but that buildup in inventory will continue until we begin to take – or deliver the G500 and G600. So that will help unwind that buildup of working capital at Gulfstream. NASSCO will have completed its Jones Act ships in 2017.

And then we anticipate a number of orders coming into the Marine group that, of course, carry cash. And in Combat Systems, we will begin to get additional cash as we ramp up to full-rate production on a number of our international orders. So 2015, 2016, lighter than we're used to.

But 2017, it'll be above; every expectation we have is it'll be above 100% of net income..

Any way to quantify what percentage of net income you're expecting this year?.

It'd be about similar to last year..

Okay..

Think about cash similar to last year..

Thank you..

Thank you. Our next question comes from the line of David Strauss with UBS. Your line is open..

Good morning..

Morning..

Phebe, on Gulfstream, can you just talk about what you're expecting actually for the actual number of large cabin deliveries you're expecting in 2016? And then can you talk about what the reducing rate on the G450 and G550, what that's done to shrink or to expand the lead time? Thank you..

So let me take those in inverse order. We've been reducing the G450 very immaterially for the last about seven or eight quarters, so in line again with what we saw in demand and what we predicted in demand. And as to be expected, we reduced the G550 production rate in the fourth quarter, again, in line with demand.

Our wait times are essentially the same, three to fourth quarters in those lines of business. In 2016, you asked about what are our production and delivery – what are our delivery targets in our plan. Large cabin about 104, medium cabin 34. That compares to 2015, large cabin of 112 and medium cabin of about – mid cabin about 35.

So down eight large and one medium cabin, with a better mix, I might add. And that's what you would expect, a better mix as we enter this year of transition, more G650s, fewer G450s and G550s..

Thank you. Our next question comes from the line of Robert Spingarn with Credit Suisse. Your line is open..

Good morning, Phebe, Jason. I wanted to ask for just a follow-on to David's question just on the pricing environment. Then I had a more technical question on your share authorization. Last year you did this twice and you had one in December and mentioned there might be something coming at the end of Q1.

Is twice the norm going forward?.

Let me talk about the pricing environment. We have held our prices very consistently, and to the extent that others are having pricing pressure, it hasn't affected us materially. So I think that's the full and short answer to that question. Jason, you want to....

Okay..

... share repurchases..

Yeah, the share repurchase authorization, so you're right. We did a total of $20 million authorized last year in two tranches. We got $10 million authorized late in the year by the board. Certainly wouldn't want to get out ahead of them in terms of the plans for the coming year but we'll address that as it comes.

And as the opportunistic approach to share repurchase works down that current authorization, we'll see where it goes midway through the year..

But there's no mechanical plan here that continues like this? There's nothing to it? It's just coincidental?.

Exactly. It's coincidental. And as we said, as always, more of an opportunistic approach and we'll see where that takes us..

Got it. Thank you..

Thank you. Our next question comes from the line of George Shapiro with Shapiro Research. Your line is open..

Good morning..

Morning, George..

Phebe, the usual question I'll ask would go through. You had much better Gulfstream margin in the fourth quarter than the third even though the revenues were down. Maybe if you could explain a little more what happened there. And then going forward with G650s being up, I would think they probably have the highest margin at this point.

So why would the margin deteriorate a little bit in 2016? Thanks..

So let me talk about revenue. As we noted before, we reduced the G550 rate for the fourth quarter. We had less preowned revenue than anticipated and somewhat less than anticipated service revenue. But Gulfstream was up and their backlog was up.

Jet was down 5% in revenue and that was mix driven as we increased our engineering work in anticipation of the production work that we're starting this year. And we had lower FBO revenue because of fuel prices. We also had reduced business jet completions in St. Louis. So that sort of ties the bow on revenue.

In margins, it's the same old stuff we always get, right?.

Right..

From the usual suspects. We had mix shift. We had liquidated damages, launch assistant. And by the way, you quite rightly point out we had improved margins in the G650. So we anticipate roughly comparable margins. Those aren't what we (30:57) leading you to, guiding you to is – are not sufficient or significant material degradations in the margin rate.

But what we are focused on and have been laser focused on and have been telling our investors for some time, we are going to keep earnings flat. And that's what we've signed up for and we see the path forward to clearly do that..

Thank you..

Okay. Thanks..

Our next question comes from the line of Doug Harned with Bernstein. Your line is open..

Thank you. On IS&T, Phebe, about a year ago or so, I think you were – you sounded pleasantly surprised at how well IS&T was holding up, and it has held up quite well while others in some similar businesses have had a lot of issues. The backlog's down a little bit in this quarter.

If you look inside that business and look forward and you separate into Mission Systems and GDIT, how do you see those two outlooks going now over the next couple years?.

Okay. Let me talk a little bit about the book-to-bill. With the exception of the fourth quarters in 2014 and 2015, our IS&T book-to-bill has been approximately one to one every other quarter in both years. Q4 in those lines of businesses tends to be more of an issue, a timing issue than anything else.

And we expect book-to-bill for 2016 about one to one. These are businesses that are performing extremely well and winning more than their fair share based on their ability to increase their operating leverage by decreasing costs, and their performance has been outstanding. So it's more of the same for them going forward.

So ruthless dedication to cost cutting, operating performance, must perform on that backlog. And that then quite nicely leads to the kinds of book-to-bill that we've seen in these businesses. So I see that as more goodness to come..

Do you see Mission Systems and GDIT behaving somewhat differently? They have somewhat different drivers..

Well, they're different margin businesses. Mission Systems tends to be more heavily product oriented in nature, and product tends to carry higher margins. Our IT business is services; services have lower margins. But as I like to tell everybody, they got great cash performance. In fact, by the way, both of those businesses have a great cash performance.

And with our services business, terrific return on invested capital. So there's no invested capital. But think about our information – our IT services businesses. When they go to market, they go to market in their core, and they are very competitive in their core both through past performance and cost competitiveness.

So I like where they're positioned, and that hasn't changed for us. They continue to win and they're a big dog in the barnyard, not to make too many metaphors..

Okay. Thank you..

Thank you. Our next question comes from the line of Myles Walton with Deutsche Bank. Your line is open..

Thanks. Good morning, or I guess good afternoon now. I wanted to follow up on Gulfstream for a second, and on the G650 in particular.

Could you comment on where this skyline currently reaches to? And also a little bit on the pre-owned or, I guess, the available for sale G650s that are in the market and at what point do you see that as being more of a threat to production, because there's always going to be a battle of if the like-new starts to approach price points of your aircraft coming off the line? Thanks..

Let me answer that in the inverse order. We have seen and don't anticipate seeing any impact from the planes that are in the used market. It really hasn't impacted us at all, because the guidance of the demand for that airplane has been, and we believe will continue to be, very, very wholesome.

Despite taking up our production rates slightly, we are still at first quarter 2018 first available. So that tells you that is a strong, sustainable backlog for a very powerful airplane..

Okay. Great. Thanks..

Thank you. Our next question comes from the line of Howard Rubel with Jefferies. Your line is open..

Thank you very much. I want to turn to Marine for a moment, Phebe. There's a number of dynamics going on there. You have a new agreement at Bath. You've got a couple of new opportunities. And then, at the same time, you've been working through the Jones Act backlog.

Could you describe a little bit of the working parts there and what might the Navy also do in terms of service going forward?.

So, yeah, let me talk about all three of those businesses and give you a little bit of color. We have achieved a very significant agreement with our partners, our workforce in Maine at Bath that will allow Bath to be increasingly competitive going forward in all of its competitions.

And we're very proud of our workforce there, and we are very optimistic about our ability to compete on a going-forward basis. So I like what I see at Bath. And by the way, you didn't ask, but on the DDG-1000, the first one is 98% done; so almost out the door.

The second one's 84% done; and again, with the kinds of issues that you might expect on the first-of-class ships, but nothing that has been particularly surprising to us. The third ship, I think, is only about 40% done, but it has a deck house that we entirely designed and built, so that reduces the risk going forward.

So I see the future for Bath very nice. At NASSCO, we are continuing to work off the backlog of Jones Act ships, as you quite rightly point out. There is, we believe, significant demand going forward because of the age of the fleet that has to be replaced for more Jones Act ships.

Our experience in the Jones Act market is it's highly lumpy, but there is demand out there. And because of NASSCO's performance and because of its good cost structure, they have been very competitive in their Jones Act competitions and won a nice backlog; and we continue to believe we're going to add to that backlog.

Their service business has been performing very, very nicely. The Navy is, what we believe, quite rightly moving to fixed price service contracts, and we know how to work those and we've been working closely with our Navy customers.

So we like what we see in service, particularly out west in San Diego; little bit of lightness in the Norfolk area as the Navy re-jiggers some of its porting of some major ships, but we anticipate service to grow reasonably well on the surface ship side, single digit, low-single digit with a nice operating performance.

We also anticipate additional submarine service at Electric Boat. Nothing too significant, but, again, right in our sweet spot. And, again, at Electric Boat, it's a story about Virginia and Ohio.

Right?.

Yes..

But I (39:10) think a once over of that entire portfolio..

Thank you very much for the rundown..

Thank you. Our next question comes from the line of Carter Copeland with Barclays. Your line is open..

Hey. Good afternoon, Phebe, Jason..

Hi.

Hi..

I didn't know – just a quick clarification and a question. I didn't know if you mentioned the year-over-year impact from pension in that apples-to-apples comparison. If you could give us that, that'd be helpful as well. And then, just really appreciated the commentary on 2017, 2018, 2019.

If you look – I know you talked about revenues in Marine and IS&T. And as you think about margins there, obviously, you talked about margins being up as part of the vigorous earnings growth in Combat.

But when you look at potential for margins in the defense businesses in aggregate, and mainly IS&T and Marine, what's the outlook for those similar to the comments you made for Combat?.

Sure. Let me have Jason ask the first part of your question on pension..

Sure. And Carter, if I understand your question, you're talking about the sort of the walk forward on EPS from 2015 to 2016. And really when you think about our pension plans and our accounting for those plans, especially in the defense businesses, that is a muted effect in EPS.

So it really just isolated to the commercial pension side which had a negligible effect..

Yep..

I haven't calculated it, but it's nothing that would be materially....

Extremely modest positive is what you're saying?.

There you go..

Okay..

So let's talk about the businesses. On a going-forward basis, we anticipate the IS&T group to be at around a 10% margin business. That may vary from quarter to quarter, or year to year depending on how much revenue the service business brings in. But for our foreseeable future that's about a 10% business.

Combat, we see in the mid-15%, 15.5% pretty steady eddy. We may have, and we do, I believe, have margin expansion opportunity at the platform businesses. But remember, that will be somewhat offset by the short cycle business of OTS which we had terrific margins out of that business after we consolidated two units in 2014.

With all things at defense, some of that goodness needs to go back to our customer, quite appropriately so. So that'll cause some margin compression for them. But from right now what we're planning for, for Combat, steady state 15%, 15.5% margin. We will, of course, strive for higher.

And then the Marine group will be a 9.5% to 10% margin business depending on mix. As we've talked about before, performance at shipyards is, well performing shipyards, is all about the mix and we've got a number of mix shift issues which we've kind of articulated. But I think that gives you a sense of how we see our business going forward..

Thanks, Phebe..

Thank you. Our next question comes from the line of Cai von Rumohr with Cowen & Co. Your line is open..

Yes, Phebe, thanks so much, and good performance..

Thank you..

So at Gulfstream I guess two issues. One is if you could give us any help in terms of where the R&D and launch aid is in your plan for 2016? And secondly I guess more importantly, you had a 7% layoff you announced in December.

Maybe walk us through if there's any severance impact in the fourth quarter and the types of benefits you expect to realize from that in 2016..

Let me talk a little bit about the reduction, then I'll turn it over to Jason. We've been talking for the last year or so about this transition period from moving from the G450, G550 to G500 and G600. Well, we're in it now, and quite appropriately you would expect us to size for that.

So our head count reductions were all about sizing appropriately for what we see in terms of revenue and our promise to keep margins, well, keep earnings flat year-over-year. So we did some pruning.

Headcount reductions were just a part of our cost cutting effort as we improved our operating performance, took a fair amount of overhead out and touch labor. And we'll continue to do so, on a going-forward basis..

So on the R&D question, as you can imagine, the pace of that will sort of follow the cadence of the flight test program. So we expect that to pick up modestly in the next year and a little bit more in 2017 as we continue through that program.

But I say modestly immaterially, still well within the range of our normal collar that we would normally expect R&D to flow in. Your question around the launch of systems payments, they'll continue to flow. I don't have the exact schedule of that, but it'll cause that quarterly amount to be lumpy as it's always been.

And we'll report that to you when it gets out of line. But expect, net-net, a modest immaterial growth in R&D next year and then again the following year..

Thank you..

Thank you. Our next question comes from the line of Ron Epstein with Bank of America. Your line is open..

Hello. Good morning..

Hi..

Hey. Just totally changing gears to the balance sheet. As you well know, right, the balance sheet's extraordinarily strong.

Do you have any thoughts on maybe levering it up a little bit? Or what you think about that? Or what do you think the proper capital structure is for General Dynamics?.

So I think consistent with the position we've held in the past is levering up really is not something we're interested in, particularly as it relates to our current capital deployment approach of share repurchase and dividends.

Incurring debt for the proper long-term strategic opportunity is certainly out there, but that's something that we'll continue to hold as dry powder until that type of opportunity shows up..

Okay. Yeah. Thank you..

And, Abigail, I think we have time for one more question..

Okay. Our next question comes from the line of Robert Stallard with Royal Bank of Canada. Your line is open..

Thanks very much. To follow up actually from what Ron was asking, does this imply that the acquisition pipeline out there is not particularly attractive in your point of view? And maybe in relation to this, there's a little bit of stickiness going on in fed IT at the moment.

Do you think this has any implications for you?.

So fed IT, I think what you're seeing is – what we anticipate is seeing the same players just with new t-shirts on, new brands. In the pipeline, it is what it has been. And I think to Jason's point, it has always been our view that if we found something attractive and very accretive, we would lever up for it.

But we haven't been there, and we don't see that as we stand in the moment. I don't think anything has fundamentally changed in the broader portfolio, defense and Aerospace portfolio. Service, a little bit, but that's – I gave you my view of that..

Okay. Thanks, Phebe..

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

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day..