Erin Linnihan - Staff VP for IR Jason Aiken - CFO Kim Kuryea - VP and Controller.

Jason Gursky - Citigroup Sam Pearlstein - Wells Fargo Securities Peter Arment - Robert W. Baird Myles Walton - Deutsche Bank Ron Epstein - Bank of America Merrill Lynch Cai von Rumohr - Cowen and Company Carter Copeland - Barclays Capital David Strauss - UBS Howard Rubel - Jefferies.

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 with the quarter. For the year, we had fully diluted earnings per share from continuing operations of $9.87, on revenue of $31.35 billion and earnings from continuing operations of $3.06 billion.

We had full-year margins of 13.7%, a record for GD. Revenue for the year is down $116 million, somewhat less than 0.5%. Operating earnings on the other hand are up $131 million or 3.1%, on a 40 basis point improvement in operating margins. Earnings from continuing operations are up $97 million or 3.3%.

This, together with share repurchase activity and a lower than anticipated effective tax rate, led quite naturally to an 8.7% improvement in diluted earnings per share. This was a very good year, a year of continuing improvement, a year of accomplishment. Free cash flow from operations is $678 million in the quarter.

For the year, we had free cash flow from operations of $1.81 billion which is 59% of earnings from continuing operations. As we had advised you at the beginning of the year, free cash flow from operations was not going to be as robust as is typical for us. It was in fact less than 100% of net earnings. This happened for two reasons.

First, we were working off the very large advanced payments received in late 2014 on a major combat systems program. And second, we expected an increase in operating working capital at Gulfstream, consistent with building numerous test aircraft and pre-production parts in connection with the G500 and G600 programs.

All of this will normalize and unwind quite positively, beginning this year. In 2017 we expect free cash flow to be approximately 100% of net income give or take a little. We should keep this kind of cash performance up throughout the planning horizon. Let me briefly give you some color on the quarter in each of the business groups. First, aerospace.

Revenue was up both quarter over quarter and sequentially. Against the year-ago quarter, sales are up $82 million or 3.8% and operating earnings are up $26 million or 6.3%, as a result of a 50 basis point improvement in margins.

On a sequential basis, revenue was up $207 million or 10.3% and operating earnings are essentially flat, as a result of the anticipated compression in operating margin. For the year, revenue is $8.36 billion and operating earnings are $1.72 billion, with an operating margin of 20.5%.

This is a year-over-year reduction of 5.5% in sales, almost $500 million, but operating earnings are up $12 million for the year on 120 basis point improvement in margins. All in all, a very good year at aerospace, with strong operating leverage and decent order intake, particularly good in the last half of the year.

This result was consistent with our guidance to you that we would hold earnings even with 2015. As I mentioned, earnings were actually up $12 million over 2015. Order activity in the quarter was good and pipeline activity was actually robust.

The book-to-bill at aerospace in the fourth quarter was 0.8 to 1 dollar-based and 0.9 to 1 in units of green delivery at Gulfstream. All in all, the order activity going into the first quarter of this year is quite good.

The second half of 2016 was actually strong from a pace of activity standpoint and interest in the G500 and G600 is increasing nicely, as we get closer to entry into service with these aircraft.

At combat systems, revenue was $1.68 billion and is up $160 million or 10.5% and operating earnings are up $25 million or 10.7% on a quarter-over quarter basis. Sequentially, the story is even better. Sales are up $354 million or 26.6% and operating earnings are up $40 million or 18.3%.

For the full year, sales are down $38 million or 0.7%; however operating earnings are up $32 million or 3.6%, on a 70 basis point improvement in operating margin. By the way, this performance is reasonably consistent with the guidance we provided at this time last year.

We actually achieved a better result on somewhat lower revenue and stronger operating margins. Overall, combat systems is a story of revenue reasonably consistent with expectations and outstanding cost and margin performance.

As you'll learn later in my remarks, this is a business group poised for quite significant growth in the 2017 to 2020 time frame, as we begin delivering on our backlog. Marine group revenue of $2.04 billion in the quarter is up $59 million or 3%, compared to the year-ago quarter and essentially flat on a sequential basis.

Operating earnings are up $14 million or 8.1% against the year-ago quarter and up $20 million or 12% sequentially. Revenue for the year is up $189 million or 2.4%. Recall that this year's $189 million increase in annual revenue follows a $701 million increase in 2015 and a $600 million increase in 2014.

That's more than 20% growth for the group over that three-year period. On the other hand, operating earnings for the year are down $3 million on a 30 basis point reduction in operating margins, so the story here is a good quarter on both a quarter-over quarter and sequential basis.

On an annual basis, we experienced better than anticipated revenue, but not as good as expected operating margin which left us relatively flat year over year. In the information systems and technology group, revenue in the quarter is $2.28 billion up $123 million or 5.7% against the year ago quarter.

Operating earnings of $244 million in the quarter are 6.1% better than the fourth quarter a year ago. On a sequential basis, operating earnings are down $12 million or 4.7% on a 20 basis point reduction in margins and a 2.4% reduction in sales.

For the year, revenue was up $222 million or 2.5% and earnings are up $89 million or 9.9%, on the strength of a 70 basis point improvement in margins, very good operating performance. Recall that at this time last year, we forecast flat operating earnings for the group, so this was a very strong year for IS&T.

On this call a year ago, on a Company-wide basis, our guidance for 2016 was to expect revenue of $31.6 billion to $31.8 billion, an operating margin rate of 13.3% and a tax rate of 29.5% and return on sales of 9.1%.

We wound up the year light on revenue with $31.35 billion, but we exceeded our earnings expectation with operating margins of 13.7%, an effective tax rate of 27.6% and a return on sales of 9.8%. Last year at this time, we provided EPS guidance of $9.20. We wound up at $9.87, $0.67 better.

About $0.23 of the improvement came from better than planned operating performance, $0.25 from a lower than planned tax rate and the balance, about $0.19, from a lower share count as a result of share repurchases. Certainly, a very solid year by any measure.

So before we go to guidance, I want Kim to make a few remarks and then talk about the fundamentals of our accounting rule adoption for 2017 and the restatement of 2016 under these new revenue recognition rules.

All of the guidance I'll offer you for 2017 and for 2018 through 2020 as well, will flow from the restatement of 2016 which is found in Exhibits K-1 through K-3 of the press release.

Kim?.

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 to our capital deployment activities which I'll walk through in just a minute. Our effective tax rate was 27.6% for the year, very consistent with our 2015 effective rate of 27.7%.

Our 2016 outcome was lower than anticipated, principally due to the higher than expected benefits from increased international activity and employee stock option exercises during the year.

As we look forward to 2017, we expect an effective tax rate of about 28%, reflecting the fact that our international activity continues to increase and the tax benefit associated with stock options being a permanent part of the tax landscape. Let's move on to our pension plans. We contributed about $200 million to our plans in 2016, as forecast.

For 2017, we expect that amount to be about the same, to be contributed mostly during the third quarter. A quick note on discontinued operations. In the fourth quarter, we had a net $10 million loss in discontinued operations to record an accrual for an environmental matter related to a business we divested back in the early 1980s.

Finally, to summarize our activities on the capital deployment front for the year, we spent approximately $2 billion to repurchase 14.2 million shares in 2016, at an average price of a little less than $143 per share.

When you combine our share repurchases with our dividend payments, we disbursed $2.9 billion in shareholder-friendly actions in 2016 or 1.6 times our free cash flow from operations for the year. Okay, that wraps up the discussion of 2016's financial performance and some expectations for interest expense, tax and pension contributions.

Now, I'd like to move on to an explanation of our 2017 accounting change. On January 1 of this year, we adopted a new revenue recognition standard, ASC topic 606 which addresses revenue from contracts with customers. This new standard outlines a five-step model to determine how and when to recognize revenue on a contract-by-contract basis.

For the vast majority of our contracts, we will continue to recognize revenue over time, similar to what we've done in the past, under the percentage of completion method. But for contracts that don't qualify for overtime revenue recognition, we'll recognize revenue at a single point in time.

As we disclosed in our third quarter Form 10-Q and in today's press release exhibits, we expect this new standard to have two notable impacts on our contract portfolio. The first change relates to how we will account for adjustments in our estimates associated with our long term contracts.

Starting in 2017, we'll utilize what's called the cumulative catch-up method for recognizing changes in profit on our contracts. This is similar to what others in our industry have done for many years. In 2016 and prior, we use what's called the reallocation method for recognizing changes in profit on our contracts.

This meant that any changes in profit we anticipated on our long term contracts were recognized prospectively over the remaining contract term, rather than immediately when identified under the cumulative catch-up method.

As a result of this change, we may see larger and more variable impacts from period to period from adjustments in contract estimates, particularly on our contracts of greater value and with a longer performance period, such as in our marine systems group.

The second notable change that the new standard will have on our financial statements is in our aerospace group, specifically at Gulfstream. Starting in 2017, we'll have one revenue recognition point for Gulfstream aircraft, when the customer accepts the outfitted aircraft at entry into service.

This is different than the revenue recognition model we utilized in 2016 and before. Our past practice had two revenue recognition points at two distinct contractual milestones, green aircraft delivery and final outfitted delivery.

It's important to note that these two changes and any other changes brought about by the standard impact only the timing of when we recognize revenue and earnings and do not alter our cash flows or the overall profitability of our contracts.

Now to prepare for an effective discussion of our 2017 guidance which is based on the new method of revenue recognition, we need a consistent foundation as a point of comparison. Therefore, we restated our 2016 results as if we had been on the new revenue recognition standard for all of 2016.

You can see the restated results for 2016 in Exhibits K-1 through K-3 of our press release. Throughout 2017, as we speak with you and report in our Form 10-Qs, we'll compare our 2017 financial information to the restated 2016 results, so all of our comparisons will be on the same basis.

I don't intend to walk you through all of the changes that you can see by examining the exhibits to our press release, but as you can see on Exhibit K-1 for 2016, as restated, both our consolidated revenue and operating earnings decline against the as-reported numbers. Similarly, the margin rate and diluted earnings per share follows suit.

The biggest driver of this change is in aerospace. Please refer to Exhibit K-3 in our press release. Since under the new standard, revenue at Gulfstream is now driven by outfitted deliveries, our restated 2016 revenue is lower, as we had fewer outfitted deliveries than green deliveries. Operating earnings are similarly impacted.

Likewise, operating margins go down due to mix shift between outfitted deliveries and the green deliveries. On the other hand, as we disclosed in our third quarter Form 10-Q, the impact on 2015 would have been just the opposite, because in that year, there were more outfitted deliveries than green deliveries.

There is no other change in cost, pricing, R&D, SG&A spend or services revenue or margins. This is strictly related to the timing of the aircraft deliveries.

So the question is, how will all of this impact aerospace in 2017? Well, Jason will give you detailed guidance shortly, but in general, some of the 2016 green deliveries, in excess of the completed deliveries, should deliver in the first quarter, thereby giving the first quarter a boost versus the restated fourth quarter.

That will be offset later in the year as we experience planned green deliveries that do not enter into service during the year. This natural phenomenon will be exacerbated by a number of green G500s that will not have revenue recognized at green delivery because of the new rule. So on balance, for the year, a modest accounting headwind for 2017.

In short, the impact of these changes depends on the number and the mix of green versus outfitted deliveries, in any period. Okay, let me wrap up by reminding you of something that I mentioned earlier in this discussion.

This is about an accounting change that in some circumstances alters when we recognize revenue and earnings, but does not impact our operations, our cash flows or the overall profitability of our contracts.

When you sit back and think about the restatement of 2016 and prior, everything that's occurred and been reported up to that point, may have shifted around between the quarterly and annual reporting period, but if you look to the end of 2016 and recognize that the operating activities and cash flows of the Company are unchanged up to that point, this is all about timing.

We just have to look at the past through a new lens, so that we can have a meaningful comparison to our future results. Jason, that concludes my remarks. I'll turn it back over to you to address the 2017 guidance. .

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 is expected to have revenue of $7.9 billion, a reduction of 2.6% against 2016, as restated.

Operating earnings in 2017 are anticipated to be $680 million to $685 million, with an operating margin rate around 8.6%. The 2016 to 2020 sales CAGR is expected to be 5%, with the strongest year-over-year growth in 2018. The expected earnings CAGR for the marine group for 2016 to 2020 is about 9%.

Finally in IS&T, we expect a modest improvement in revenue in 2017 and operating earnings of $1 billion to $1.05 billion, with a margin rate of around 11%. For this group, we see a 2016 to 2020 CAGR for sales and earnings of 4.5% and 5.3% respectively.

So Company-wide, all of this rolls up to $31.35 billion to $31.4 billion of revenue, up over 2016 restated numbers by more than 2.5%. Operating earnings of $4.15 billion to $4.2 billion, up over 2016 by about 11.5%. And operating margin around 13.3%, about 110 basis points above 2016 restated. Let me emphasize that this plan is purely from operations.

It assumes a 28% tax provision as Kim mentioned and assumes we buy only enough shares to hold the share count steady with year-end figures, so as to avoid dilution from option exercises. This rolls up to an EPS guidance of $9.50 to $9.55 for fully-diluted shares, up about 10% over 2016 under the new accounting rules.

With respect to the quarterly progression for EPS, it's a bit more balanced than most years. Divide our guidance by four, then take $0.10 off the first quarter, $0.05 off the second quarter, add $0.05 to the third quarter and add $0.10 to the fourth quarter and that should give you the rough progression.

So much like last year, beating our EPS guidance must come from outperforming the operating plan, achieving a lower effective tax rate and the effect of capital deployment.

With respect to capital deployment, we anticipate using all of our free cash flow in 2017 for dividends and share repurchases which will give a boost to the EPS guidance I've just given you. The amount of that boost will depend on the timing and share price.

For the period 2016 to 2020, we see a consolidated sales CAGR of 5.6% and an operating earnings CAGR of 7.1%. This is simply a roll up of the projections I've given you for the business groups, so we're quite bullish about 2018 through 2020 in all segments. Now, let me end my remarks there and we'll start taking your questions. .

[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 actually only had one aircraft left to sell so we should get that behind us this quarter which by the way I think is a great testament to this transition and the way Gulfstream has handled this.

When you think about it from both sides of the spectrum, on the one end there was the speculation about could we get the 500 into service when we said we could and doing what we said it would? And certainly, the test program it's demonstrating so far that it's meeting if not exceeding all of our expectations for what the airplane can do and Phebe mentioned a quarter ago, we've now officially pulled that EIS in from first quarter 2018 to fourth quarter 2017.

So that's on one end of the spectrum, but this point about one 450 left, possibly the more difficult aspect of this transition was managing the supply chain, the order activity, the inventories and so on to close that out in a timely and secure fashion, without exposing the Company and manage this transition and so far so good.

So that is really encouraging, so that's what we see on the horizon from an EIS perspective for the various aircraft. .

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. .

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