General Dynamics Corporation

Good morning and welcome to the General Dynamics fourth quarter and full year 2021 earnings conference call. All participants will be in listen-only mode. If you would like to ask a question during the presentation, you may do so by pressing star 1 on your telephone keypad. Please note, this event is being recorded. I would now like to turn the conference over to Howard Rebell, Vice President of Investor Relations. Please go ahead.

Thank you, Operator, and good morning, everyone. Welcome to the General Dynamics fourth quarter and full year 2021 conference call. 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, 10-Q, and 8-K filings. We will also refer to certain non-GAAP financial measures for additional disclosures about these non-GAAP measures, including reconciliations to comparable GAAP measures, please see the slides that accompany this webcast, which are available on the Investor Relations page on our website, InvestorRelations.gd.com. Now, I'd like to turn the call over to our Chairman and Chief Executive Officer, Phoebe Novakovic.

Good morning, and thank you, Howard. Earlier today, we reported fourth quarter revenue of $10.3 billion, net earnings of $952 million, and earnings per diluted share of $3.39. This is, in most respects, consistent with our previous guidance and sell-side consensus. The results in comparison with prior periods are rather straightforward and set out on our press release. I'll go through some of that detail quite briefly as I give you my thoughts on the business segments. As we indicated it would be, the final quarter is our strongest quarter of the year in both revenue and earnings. In fact, earnings, operating margin, net earnings, and return on sales improved quarter over the prior quarter throughout the year. It was a nice steady progression of sequential improvements. On a sequential basis, suffice it to say that revenue is up $724 million. Operating earnings are up $106 million, and earnings per share are up $0.32. So, all in all, a solid quarter with good operating performance. For the full year, we had revenue of $38.5 billion, up 1.4% from 2020. Net earnings of $3.26 billion, up 2.8%. and earnings per fully diluted share of $11.55, modestly better than consensus, and up 55 cents over 2020. We ended the year with a total backlog of $87.6 billion and total estimated contract value of $127.5 billion. Our business was strengthened by significant growth in aerospace backlog to $16.3 billion. I'll have more to say about that when we get to the business segment comments. The total company booked the bill is 1 to 1 for the quarter and the year, led by the powerful order performance of Gulfstream. Our cash performance for the quarter and the year is very strong. The conversion rate for the quarter is 136% of net income and 104% for the year. Jason will have more fulsome comments on this subject and backlog in his remarks. Now let me turn to reviewing the quarter and paying some attention to quarter-over-quarter and sequential comparisons as well as the full year in the context of each group and provide color as appropriate. So first, aerospace. Aerospace revenue of $2.6 billion is up 5.1% over the year-ago quarter on the delivery of 39 aircraft, 35 of which were large cabin. While this was the strongest delivery quarter of the year, it fell short of our expectation by one aircraft, which has flipped into 2022. For the full year, revenue of $8.14 billion is up modestly from the prior year, even though we delivered 119 aircraft, eight fewer aircraft than we did in 2020. The increase was driven by higher service revenue at Gulfstream and a nice increase in revenue at Jet Aviation. Fourth quarter aerospace earnings of $354 million are down $47 million from the year-ago quarter, even though revenue was $125 million higher, resulting in a 270 basis point reduction in operating margins. The major source of the variance is a $50 million increase in net R&D costs driven by the certification effort on the G700 and G800 and accelerated work on the G400. The year-ago quarter was also helped by a significant launch assistant payment that was an offset to gross R&D. Nevertheless, aerospace operating earnings and margins are better than anticipated by consensus. The same can be said for the full year result. I should also point out that aerospace margins improved throughout the year, and that was true with respect to both Gulfstream and Jet Aviation. At mid-year last year, we told you to expect revenue of about $8.2 billion, operating margin around 12.4%, with earnings of $1.01 billion. We finished the year with revenue of $8.14 billion, operating earnings of $1.03 billion, and a 12.7% operating margin. In sum, we were slightly better on earnings and margin, but very close to our forecast on revenues. Far and away the most important story in the quarter for aerospace and frankly for the company was the extraordinary order activity at Gulfstream. Last quarter I told you that orders in the third quarter boarded on the spectacular. This quarter they were significantly better. Order activity in the quarter was beyond anything we had seen since 2008 with the introduction of the G650. Demand that turned very good in mid-February and continued through the Second and third quarters was red hot in the fourth quarter. Let me give you the particulars. The aerospace group, in dollar-denominated orders, had a book-to-bill of 1.7 to 1. Gulfstream alone was 1.8 to 1. In unit terms, it was over two times. Remember that these multiples are off of an increased denominator with 39 deliveries. This translates into very significant backlog growth. Aerospace added $1.6 billion to backlog in the quarter and $4.7 billion for the year. As we go into the new year, the sales pipeline remains robust and sales activity is brisk. The buildup in backlog and the pace of current demand leaves us with the rich problem, but a problem nonetheless. How do we satisfy the demand manifest in our current backlog supplemented by continuing brisk activity having previously turned down production? Can the supply chain support us? Are we ready? Well, the answer is we will increase production in 2022, but not to where it needs to be. Remember also that some of our increased production in 22 will be in building G700s and G800s that will not deliver on 22, a pre-build, if you will. As it turns out, the long pole in the tent is manufacturing wings, which we do ourselves. You may recall that we previously vertically integrated wing supply because of failures in the supply chain. So what do we need to do? We need to expand our new line wing facility and acquire another set of tools and fixtures. All of this is underway and will be in place to satisfy our needs for 23 and beyond. This leads to the question of what are the implications of this for 2022 guidance. I'll address 22 guidance a little later. Further, given the robust and enduring backlog at Gulfstream, we also feel comfortable with giving you a look at what is anticipated for 23 and 24 as well. Finally, on the new product development front, all 5G 700 flight test aircraft are flying and have over 2200 flight test hours. We have completed over 65% of all required testing. Next, combat systems. Revenue in the quarter of $1.89 billion is off 3.7% from the year-ago quarter. Operating earnings of $281 million are off $28 million on a 90 basis point decrease in operating margin. Let me point out, however, that a 14.9% margin in the quarter is highly respectable. For the full year, revenue of $7.35 billion is up $128 million, a 1.8% increase after strong growth in 2019 and moderate growth in 2020. Operating earnings for the year of $1.07 billion are up $26 million, a 2.5% increase. By the way, this performance is in line with the guidance we provided earlier in the year. As we look forward for the next few years, we believe that combat volume will soften somewhat in the increasingly constrained budget environment faced by the U.S. Army. While our platform programs remain critical to the Army war fight, we may see some contraction, in part offset by international growth in Abrams and wheeled combat vehicles. We will continue to drive margins as we always have, Remember that Combat Systems has had very good margins in much more constrained revenue environments. In short, this group has had a positive revenue growth for several years now, continued its history of strong margin performance, has good order activity, and has a strong pipeline of opportunity as we go forward. Next, Marine Systems. The Marine Systems growth story continues. Fourth quarter revenue of $2.9 billion was up less than 1% over the year-ago quarter. However, revenue is up 8.8% sequentially and 5.5% for the full year. Similarly, operating earnings are down somewhat in the quarter, but up sequentially and for the full year. Once again, this is the highest full year of revenue and earnings ever for the Marine Group. In our initial guidance to you, we anticipated revenue of about $10.3 billion, operating margin of 8.3%, and operating earnings of $855 million. We came in above that for both revenue and earnings and spot on the predicted operating margin. Our shipyards have continued to perform well, overcoming most of the challenges that COVID lay in our path, first continuing to operate without ceasing throughout COVID, and more recently managing labor shortages, part shortages, supply chain disruptions, and increasing commodity prices. Importantly, on the latter point, our long-term shipbuilding contracts provide protection from material escalation. I'm happy to report that we are working very well with the BATH unions and workforce, and together we have worked to put the past behind us and concentrate on improving schedule and performance. As a result, staff has begun to see improvement on both scores. In response to significant increased demand from our needy customer that you'll see in these results, we continue to invest in each of our yards, particularly at EB to prepare for Virginia Block 5 and the Columbia Ballistic Missile Submarine. Suffice it to say that we are poised to support our needy customer as they increase the size of the fleet and deliver value to our shareholders as we work through this very large backlog. Finally, the technologies group, which consists of GDIT and mission systems. Just to remind you, this is the group in the defense segment that had had the most impact from COVID-19, with the most remote participation from employees and the most difficulty accessing customer locations whose employees also have been working remotely. It is also where we had the most impact from the short supply of chips and other key components at mission systems. With that said, let's turn to the results and commentary on the group and the specific businesses. For the quarter, technologies had revenue of $2.98 billion off 7.9% from the year-ago quarter. Operating earnings, however, of $334 million are off only 5.1% on a 30 basis point improvement in margin. The operating margin of 11.2% is the strongest since the formation of this group. Revenue for the full year at $12.46 billion is off 1.5%, but earnings are up $64 million or 5.3% on a 60 basis point improvement in operating margin. All considered, the group performance showed good strength and earnings are in line with guidance from us. Revenue came in at $543 million below our guidance, driven by mission system challenges that we have discussed last quarter. offset in part by 2.2% growth at GDIT. Margins at both companies were very good, enabling us to meet our earnings forecast, so very good operating leverage in a very challenging environment. The group enjoyed a nice order quarter with significant wins and a book to bill of one to one, a little bit stronger at GDIT and a little bit lower at Mission Systems. Mission Systems did a very good job overcoming many of their supply chain challenges, working hard to satisfy the pent-up demand that was driven by a significant backup of work orders in some customer sites and by supply chain shortages. Turning to IT, our Fed and civilian division had a particularly strong year in 21 and helped drive a 60 basis point improvement in margin over 2020. And as has been the case since the acquisition, GDIT's cash performance was outstanding, well in excess of 100% of their imputed net income. GDIT's backlog at the end of 2021 was $8.7 billion, 4% higher than year-end 2020. Book-to-bill was 1.1 to 1 on sales growth at 2.2%. This is notable. in light of the dollar value of GDIT wins ensnared in protests that went from about 800 million at the end of 2020 to a whopping 6 billion at the end of 21. While we expect these protests will resolve in our favor, protest resolution timing is outside our control. As we look into 22, we have a healthy pipeline of opportunities to pursue as customers focus on digital modernization and over $32 billion of bids, largely all new work, awaiting customer decisions. So all in all, we expect a good year for the business. Let me turn the call over now to Jason Aiken, our CFO, for additional commentary, and then return with our guidance for next year. Jason?

Thank you, Phoebe, and good morning. The first thing I'd like to address is our cash performance for the quarter and the year. As you can see from our press release exhibits, we generated $1.3 billion of free cash flow in the fourth quarter, or 136% of net income, with strong cash performance across all four segments. That resulted in free cash flow for the year of $3.4 billion, a cash conversion rate of 104%. That was nicely ahead of our anticipated 95% to 100% of net income, and again, reflective of solid performance across the company, but in particular, the strong order activity at Gulfstream. That strong performance enabled us to continue our balanced and robust capital deployment activities. To that point, capital expenditures were $385 million in the quarter or 3.7% of sales. That's up more than 10% from the prior year and brings us to $887 million for the full year. Of course, Marine Systems continues to drive the elevated CapEx with facilities investments in support of the unprecedented growth the group is experiencing now and for the next decade plus. The full year total for capital investments at 2.3% of sales is slightly below our original expectation of 2.5%. That's due strictly to the timing of the phasing of those projects. While our investments to support the Navy's submarine programs have peaked, we expect capital expenditures to remain somewhat elevated at about 2.5% of sales in 2022, slightly higher than 2021. before returning as we forecast for some time to our more typical 2% range in 2023 and beyond. We also paid $332 million in dividends in the fourth quarter, bringing the full year to $1.3 billion. And we repurchased 1.8 million shares of stock in the quarter, bringing us to just over 10 million shares for the year for $1.8 billion at just under $179 per share. With respect to our pension plans, we contributed $135 million in 2021, and we expect that to decrease to approximately $40 million in 2022 as a result of the ARPA funding release. As we've discussed for some time, we expect to continue to generate cash in the 100-plus percent conversion range in 2022 and beyond. Our outlook assumes the unfavorable impact of the capitalization and amortization of research and development expenditures for tax purposes beginning in 2022 as called for under current law. There's proposed legislation to delay the effective date of this requirement, but we'll have to wait and see if it's approved by Congress and signed into law. Assuming there is a deferral of the R&D capitalization provision, we would expect our free cash flow to be in the 110% conversion range. We ended the year with a cash balance of $1.6 billion and no commercial paper outstanding, leaving us with a net debt position of $9.9 billion, down approximately $300 million from last year, and the first time we've ended the year with net debt below $10 billion since 2018. Our net interest expense in the fourth quarter was $93 million, bringing interest expense for the full year to $424 million. That compares to $120 million and $477 million in the respective 2020 periods. The year-over-year reduction in interest expense is due to the retirement of $1.5 billion of long-term debt back in May. Our next scheduled debt maturity is $1 billion in the fourth quarter of this year. And based on the declining net debt balance, we expect interest expense to drop to approximately $380 million in 2022. Turning to income taxes, we had a 15.9% effective tax rate in the fourth quarter and for the full year, consistent with our previous guidance. Looking ahead to 2022, we expect the full year effective tax rate to remain around 16%. The rate for 2022 is not impacted by the R&D matter I discussed earlier because that legislation impacts cash taxes, not the effective tax rate. The 2022 rate also assumes there's no other enacted legislation impacting corporate tax rates. From a quarterly phasing perspective, we expect the first quarter rate to be lower due to the timing of certain tax items, so the rate for the remainder of the year will naturally be higher given the full year forecast. Order activity and backlog were once again a strong story with a one-to-one ratio for the company in the fourth quarter and for the full year. As Phoebe mentioned, order activity in the aerospace group led the way with a 1.7 times book to bill in the quarter and 1.6 times for the full year. As a result, the group's backlog was up 40% in the past year. Technologies recorded a book-to-bill of 1 to 1, and within that group, GDIT was 1.1 times. We finished the quarter with a total backlog of $87.6 billion and total estimated contract value, which includes options and IDIQ contracts, of over $127 billion. That concludes my remarks, and I'll turn it back over to Phoebe to give you guidance for 2022 and wrap-up remarks.

Thanks Jason and and with that i'll turn to our expectations for 2022 so let me provide our operating forecast for 22 initially by business group and then a company wide roll up. In aerospace we expect 2022 revenue to be around 8.4 billion up around 4% over 2021 with about 123 deliveries up from 119 last year. Operating margin will be around 12.8%. So a little color here about what is driving this forecast. While anticipated deliveries are up only four units from 21, production of completed aircraft is considerably more than in 2021. Last year, we produced fewer than 119 aircraft that were delivered. We delivered a number of test aircraft that were either produced and completed in prior periods as well as a few demonstrators, all up about 11 aircraft. In 2022 production, we are building some G700s and G800 test articles that will not deliver this year. Finally, our ability to ramp up further in 22 is limited by the wing supply issue I described earlier, which will be remedied for 23. This leads me to a quick look at 23 and 24. In 2023, we expect to deliver 148 airplanes, 25 more than in 2022, and have revenue of approximately $2 billion more than 2022, with margin improvement around 200 basis points. In 2024, we expect to deliver around 170 airplanes, up another 22, driving another $1.6 billion of revenue over 2023 and another 100 basis points of margin growth. So all up over that two year near term timeframe, we expect to see 3.6 billion of revenue growth over 22 and 300 basis points of higher operating margins. Mind you, none of this is supported by heroic assumptions about continuing demand. We assume a book to bill of around one to one during the period, a notable reduction from this year's demand. If demand is greater, it will impact favorably 24 and 25. In short, we fully expect aerospace to be a significant growth engine for both revenue and earnings in 2023 and 2024. In combat systems, we expect revenue in the range of $7.15 billion to $7.25 billion, a modest reduction against 21. We expect operating margin to be about the same at 14.5%. Growth should resume later in our planned period as developmental programs move into production and several anticipated international orders should be received. The Marine Group is expected to have revenue of approximately $10.8 billion, a $300 million increase over 21. Operating margin in 22 is anticipated to improve to around 8.6%. The long-term driver of growth here is submarine work. which will expand as the supply chain improves its efficiency and delivers modules to the Groton waterfront in a more timely fashion. Our biggest upside opportunity in this group is to increase margins in the period. We expect revenue and technologies in the range of $12.8 to $13 billion. This is a growth of around 2.5 to 4.5%. We expect operating margins around 10%. So for 2022, company-wide, we expect to see approximately $39.2 billion to $39.45 billion of revenue and an operating margin of 10.8%. This all goes up to a forecast range of $12 to $12.15 per fully diluted share. On a quarterly basis, we expect EPS to play out much like it has in prior years. with Q1 about $2.45 and progressively stronger quarters thereafter. Let me emphasize that this forecast is purely from operations that assumes a 16% tax provision 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. So much like last year, beating our EPS guidance must come from outperforming the operating plan, achieving a lower effective tax rate, and the effective deployment of capital.

Thanks, Phoebe. As a reminder, we ask participants to ask one question and one follow-up so that everyone has a chance to participate. Operator, could you please remind participants how to enter the queue?

Thank you. If you'd like to ask a question, please press star followed by one on your telephone keypad. If you'd like to remove your question, please press star followed by two. When preparing to ask your question, please ensure your phone is unmuted locally and please submit your questions to one question and one follow-up question. So that is star followed by one to ask a question. We take our first question from Ron Epstein from Bank of America. Please go ahead.

Good morning. I know you're going to get bombarded with Gulf Stream questions, so I'm not going to go there. I'll let everybody else do that. I just wanted to jump in. How about that? Maybe on land systems at first, right? I mean, you know, the Ukraine and everything going on with Russia has been in the headlines. Now, what does that mean for your international land systems business, particularly in Eastern Europe?

Well, for some time now, the Eastern European demand for combat vehicles has been at an elevated level. But I have to tell you that speculation about the considerable tension in Eastern Europe and any subsequent impact on budgets is just ill-advised given the high-threat environment. So we are hopeful for a peaceful resolution, but that is a national security issue for the U.S. and its allies.

Got it. And then maybe my follow-on question, if I can. I might shift back a little bit towards Gulfstream. You mentioned in your prepared remarks you've got a little bit of a bottleneck in wind production. Have you thought about re-outsourcing a wing, or do you look at the wing as just something you guys want to keep because it's just a key part of the plan?

Outsourcing is sort of out of the question given the problems in the supply chain on wings, which then drove us to internally source. And, frankly, our wing production efficiency is – not equal by any. This is just simply a question of expanding a wing facility just a touch, and we need another set of tools. But we are very good at wing production, so I think that that's a capability set that reduces a lot of risk and, frankly, provides opportunity for the program.

The next question comes from Kai Von Rummel from Cohen. Please go ahead.

Yes, thanks so much, and congratulations on the good results. So, Phoebe, net R&D was up 50 million in the fourth quarter. What do you expect it to be up going forward? And, you know, as I look out there, the 100 bps margin uptake, I haven't calculated exactly, looks like less than a 25% incremental margin. So how come it's not better as we get out to 2024?

Well, R&D is expected to be about $100 million for next year, but let Jason give you a little bit of color.

Yeah, so as Phoebe said, roughly a $100 million increase in the Gulfstream R&D for 2022 as we continue to progress, as you'd expect, through the flight test program on the G700. If you normalize for that delta, margins for next year would be roughly 14% for the aerospace group. So that really does kind of answer the question on incremental margins, I think, from our perspective. Otherwise, we do continue to see, as you'd expect, the incremental profit from the in-production airplanes, 500 and 600 in particular, continuing to be additive to the group's margin.

So... Drew, and the last one... These are pretty good margins in the out years.

They are. R&D credit, how big are you assuming?

So as I said, we're looking without the R&D credit deferral, meaning assuming existing law persists, we'll be in the call it 100 plus percent conversion range. If the R&D credit is deferred, current law is deferred, we're talking more in the 110% range. So that kind of gives you a size on what we're expecting.

The next question comes from George Shapiro from Shapiro Research. Please go ahead.

Yes. Phoebe, the four higher deliveries in 22 that you spoke about, are they G700s or What's the status, because I knew you thought that you'd deliver some G700s in the fourth quarter?

What we said, I think, is that we expected the certification in the fourth quarter. But I think the way, as I noted in my remarks, we're going to have some pre-bill to both the 700s and the 800s, which will deliver shortly thereafter. The 700s will shortly thereafter the certification.

A little more color on that, George. I mean, just to think about it, obviously, we talked about, as Phoebe said, fourth quarter certification in the EIS of the 700. But there's also, obviously, with 2021, you had 500, excuse me, 550s that were delivered in the early part of the year. That doesn't replicate. So the incremental four is an offset of that decline, as well as the test airplanes that Phoebe mentioned that we delivered last year and some demonstrators. But otherwise, steady increases in all of the in-production models, particularly 600 and 500. So I think overall, if you look at in-production airplanes, 650, 600, 500, 280, we're looking at somewhere in the 15% year-over-year increase in production in those models. So that should give you some color on what's driving that increase.

Okay. And then one follow-up. There's a $211 million difference between what you have as gross orders and effectively just the Now, were there any cancellations there reflecting the fact that some customers are getting the planes later than they would like to get?

No, I don't think there was any particular driver. We had, I think, three cancellations, but for no particular reason other than idiosyncratic customer issues.

The next question comes from Miles Walton from UBS. Please go ahead.

Thanks. Morning. Phoebe, could you comment on the pricing environment for building out the backlog? And I imagine you're now coming pretty close to lists on all of your programs. And maybe give us an impression of the skyline or the lead time for the large cabin models at this point. Thanks.

So we've enjoyed some pricing increases, and that's all good and wholesome. And we're quite comfortable where prices are. And our lead times within all production aircraft are well within the 18 months, more around 18 months to 24 in that range that we like to see.

Okay, great. And at 500 versus 600, can you just give a color on the two differences in demand there? I know one might be particularly accretive on the 600, given the assembly commonality with the 500.

Yeah, so just to give you a little bit of background there, the 600 led the parade in orders in the fourth quarter, followed by the 650 and the 500 order. The 600 margins are obviously quite nice, and 500 are improving. And of course, 600, we've always enjoyed good, or 650, we've always enjoyed good margins. So we're seeing some very nice operating margins at the gross margins at the airplane level.

The next question comes from Robert Stallard from Vertical Research. Please go ahead.

Thanks very much. Phoebe, maybe to touch on some other issues, I was wondering if you could maybe give us some more clarity on the supply chain at this point and some of the obstacles you've been facing across the company and whether they're getting any better.

So, let me go group by group. In combat, we haven't seen any particular supply chain issues at Gulfstream. We've managed the supply chain, and I think they were benefited by our reduction in production last year, so we're quite comfortable with where they are. We reported pretty fulsomely on the emission systems challenges that they had with chip shortages and other key product material. An electric boat, in particular, we've seen some challenges in the submarine supply chain, largely manifest in Virginia schedule variants. So we've pretty widely reported that. But we're continuing to work with the Navy to kind of shore up that supply chain so we can get normalized Virginia schedules.

Okay, then maybe a follow-up to Miles's question on the aerospace lead times. I think you just said 24 months is what you're seeing in some case. That sounds a bit longer than what we've maybe heard in recent years. Are you seeing any customers essentially saying that's too long and maybe going somewhere else to get their jets?

No, we haven't. And as I said, 18 to 24. But 24 is only in a handful of cases. But we haven't had any customers say, well, I'll go elsewhere because we're in the backlog. I'm going to go elsewhere, cancel my order because I want my airplane faster. And frankly, we're ramping up production to accommodate that demand, that backlog, and what we see as nice, solid demand going forward. So we're quite comfortable where we are in our lead times.

The next question comes from Robert Spingarn from Mellius Research. Please go ahead.

Hi, good morning. Morning. Just sticking with supply chain and labor, can you frame the risk to entry into service for the three new aircraft programs, the 700, 800, and the 400, and how we should think about potential slippage or whether you've got that covered at this point.

Well, with respect to labor, we've seen some wage increases in engineering for SAC Gulfstream, but we have covered those. We have some increasing prices to offset that. But we don't see any labor issues with respect to the delivery of these airplanes. And as I say, the supply chain has been pretty stable here.

So not an issue. Is labor affecting or clearances affecting technologies at all? Is it limiting growth?

So, gee, particularly in the tech industry, any company that's got large exposure to technology experts has certainly had their challenges in mobility, but I will say GDIT is holding up very nicely. Attrition is at pre-pandemic levels. So we're holding our own, but very mindful. This is a valuable workforce and coveted by many.

Okay. Thank you.

The next question is from Doug Harned from Bernstein. Please go ahead.

Good morning. Thank you. At Gulfstream, you described a pretty high class problem here in terms of demand. When you get out to 2023 and 2024 though, you have a pretty diverse set of programs at that point. How do you look at this in terms of both your operations and the supply chain just to manage that complexity?

So one thing that Gulfstream, one of the many things that Gulfstream has been quite good at is managing its operations and having very strong operating leverage. And we have brought the supply chain along with us. So all of our estimates that we're giving you are fully accounting for what we expect the supply chain to be able to manage as well as our own operations. So we're quite comfortable that we do not have an operating challenge.

So, no, you're not really seeing any additional issues with this mix when you get out in that timeframe?

No.

The next question comes from Sheila Kaluga from Jefferies.

Please go ahead. Good morning, guys. Thank you. Phoebe, I'll take a stream in 24 months. I'll wait for it. Hi. So I'm going to ask about Aero because it is a lot of the ETF expansion we have between 21 and 24. So you've been so generous with your comments, but I can't quite square away aerospace margins for 2022. And I was wondering if you could help a little bit with that, just given pricing should be a tailwind. And I think NICS improves from 21. You have the 500, 600 going up the curve. And I think you previously talked about the G700 being accretive to margins right away. So maybe... Can you talk about what's changed and how do we think about that improvement into 23 and 24? And I know you already guided, but if you could square it away a little bit more.

Yeah, I mean, I think you've got a lot of the basic building blocks. We probably have to compare spreadsheets to see what's driving the ultimate outcome. I think the single biggest issue is probably the period to period fluctuation in our net R&D expenditures, right, between supporting the development programs and and the net offsets that we get from time to time from suppliers. As I mentioned before, we've got about $100 million increase in R&D in 22 relative to 21. So if you normalize for that, you're up from 12.7 in 2021 to 14 plus percent in 2022. There's other Puts and takes within that, as you know, pricing's a little better. The improvements along the manufacturing lines for 500 and 600 continue to get better. Growth in service business, obviously, which continues a pace year over year, while at good margins, does come at margins that are in an aggregate dilutive to the overall group margin and certainly to new aircraft production margins. And so that's really the story, I think, in terms of the puts and takes going into 2022. I think we can get into your details or your question maybe after the fact on 23 and 24, but I think 200 basis point improvement in 23 and another 100 basis point in 24, that kind of gives you that trajectory that we've talked about for some time about returning to the mid to high teens margins for the group. You know, when you combine that with the pretty significant top line growth that Phoebe described, I think it's a pretty significant compelling story.

Can I just ask a follow-up on the R&D? Obviously, it peaks for G700 this year. When do we see that for the 400 and the 800?

So, obviously, the 800 comes into play shortly after the 700, so you should kind of expect to see that fall in a similar pattern, and I think we said the 400 enters service in 2025. So keep in mind the 400 is an airplane that benefited significantly from commonality with the 500 and 600 in the way those airplanes were designed and engineered. So you won't necessarily see as much of a blip associated with that. But all of this fits over time within the profile of our ongoing commitment to R&D and roughly 2% of sales for R&D. Again, it can fluctuate from quarter to quarter and year to year, but that's how you ought to see it play out.

The next question is from Peter Arment from Baird. Please go ahead.

Yes, good morning, Phoebe, Jason. Nice results. Phoebe, I wanted to ask you a question about marine. How are they doing in terms of battling kind of the labor shortages out there? I know Pratt yesterday talked about having a shortage of welders. Maybe you could give some commentary how you're seeing that.

So we have worked for many years with our state and local governments to provide some pretty robust training programs that are still up and running. We are hiring this year at an accelerated rate over what we had anticipated, largely because of the backlog in terms of hiring in COVID, obviously constrained. These are hiring levels for 22 at levels we have seen before and executed before. So the question is all about the efficiency of your training programs, and we're pretty comfortable that once we get these people in the door, we can get them trained and have them go with new shipbuilders. They've got learning curves, obviously, as they get more proficient and become veterans. But we factored all of that in our thinking.

Appreciate that. And just as a follow-up just on aerospace, you know, it sounds like the customer base continues to expand. How would you kind of characterize it? Is it a lot of the corporates that are renewing, or are you seeing just a complete expansion during this kind of, you know, post-COVID period?

So I'll give you a little bit of additional color on that. Demand was quite good in the United States and also increased throughout the rest of the world. We saw, as we had begun to see earlier, a return of the Fortune 500 as well as private companies, as well as smaller companies. So it's pretty robust across the portfolio on the kinds of both individuals that we see, but also companies that we see. But I don't see any structural change here, if that's kind of what you're poking at, in terms of new entrants. Go ahead, I'm sorry.

Apologies. The next question comes from Seth Seifman from JP Morgan. Please go ahead.

Hey, thanks very much, and good morning. Maybe if I could dig in for a couple of more aerospace details. Is there any comments you could give about the services assumptions underlying the guidance and also the CAPEX impact and timing of completion of the additional wing capacity?

So, I'll answer those in the inverse order. Almost negligible CAPEX. So this is just simply a timing issue of expanding an existing building somewhat and getting in place the tools and fixtures to effectuate the increased production. On the service side, we expect 22 to see some nice service growth at Gulfstream as well as Jet Aviation should have a nice a nice year as well. And we expect the service volume, quite naturally, to grow with the expanding fleet. And we have included those assumptions on a going forward basis.

Great. Thanks. And just as a follow-up, definitely heard earlier and appreciate the commentary about the multi-year outlook being conservative. I guess, you know, any other sort of concerns you know, support you can give to that characterization would be great. You know, if we look at, I guess, if the backlog remains stable at about 16 billion, looking at like 1.3 times coverage out in 2024, and if that's kind of, you know, what you're aiming for, and, you know, any other color that kind of gives you confidence in the conservatism of the outlook.

Yes, so think about it this way. What I wanted to explain is that the guidance we were giving you for 23 and 24 was based on a one-to-one book to bill. Clearly, if it's better than that, we'll increase production accordingly. But for planning purposes, that's what we have assumed, and I think that's prudent planning.

The next question comes from David Strauss. Go ahead.

David?

The next question comes from David Strauss from Barclays. Please go ahead.

Phoebe, can you hear me? Yep. I'm clear. So you gave us a little bit of a longer-term outlook off of Gulfstream. One that's about marine and combat. I think, you know, marine, you had previously said, expect kind of $400 million to $500 million in incremental revenue a year. You know, last year, you were at the high end of that. This year, you're forecasting a little bit below that. So maybe if you could update us there on kind of the longer-term thinking, and then on On combat, I think you had said kind of low growth over the next couple of years. Now you're talking about a decline. So what's the longer-term view, I guess, on combat and how much could the fiscal 22 budget that's still yet to be decided but looks pretty good for you guys, how that might influence things?

So let's talk about Marine. We have for some time said that we expected revenue growth in the $400 to $500 range. million dollar range, we still expect that. Next year is a little bit later, a $300 million increase, and that's largely just workload timing. When I go to combat, so I think what we are anticipating is some decrease in pressure on the Army budget. We're pretty, in 23 in particular, so we're pretty early on in the budget for that fiscal year. We don't have full OMB or OSD passbacks. But I think that the pressures on the Army budget have been very well articulated. And while we expect that ultimately the funding levels for our platform programs will be, sufficient and relatively stable, we will see some rather dramatic drop-offs in O&M-funded accounts, like maintenance, for example. So we are factoring all of that into what I see as that increased Army pressure. We're factoring all of that into our estimate for between 1% and 3% lower growth this year, but we anticipate growth returning as a number of these international orders come in in a couple of years, as well as new army starts. So I think we have given you a balanced and realistic view of combat.

Okay. A quick follow-up. What are you assuming for the CR this year in terms of, you know, what you have baked into your defense guidance?

So for this particular CR, given our portfolio and the prior year funding levels, we don't see a material impact at all, almost nothing.

The next question comes from David Strauss from Barclays. Please go ahead.

You already got me. Thank you.

He's already got David.

But he could go for an encore at some point.

My apologies. We have Matt Akers from Wells Fargo. Please go ahead.

Hi, guys. Thanks for the question. There was some commentary around the budget discussions about potentially going to three a year on Virginia class. Could you comment on how feasible that is and sort of what further investments require, what kind of timeframe that might be possible?

So we've been talking to our Navy customer, and clearly some investments would be required. But I think, too, at the moment, we need to get the supply chain stabilized on the two-year cadence before we actually think about really ramping up to three. It is doable. We just need some time for that supply chain to adjust from the ravages of COVID.

Great, thanks. And I guess a couple of details within the cash flow outlook for 22. Can you say how big the impact of that pre-build is that you discussed at Gulfstream? And then also, can you just update what's the latest on the large international receivable and is that meaningful as an impact for 2022?

Yeah, I think on the Gulfstream side, while we are having, you know, as CB mentioned, the ramp up on the 700 and the pre-build on the 800, that's not a material impact that we see in terms of a headwind. Gulfstream ought to be a nice producer of cash again this year. Obviously, not quite to the extent that last year, as we mentioned, we sold off a lot of the inventory in particular in the test airplane, so it won't have quite the trajectory it did last year, but it will still be a nice contributor on cash. So, Don't see that as a headwind. On the international side, the International Canadian Wheeled Vehicle Program we've talked about for some time remains on track. That program is in a great position, both in terms of the performance of the vehicle and the performance of the production line. And we continue to receive payments as scheduled for the renegotiated extension of that contract that occurred back in 2020. So all in a good place in that regard.

Operator, we will take one last question. Please go ahead.

Thank you. So, our final question then comes from Richard Safran from Seaport Global. Please go ahead.

Hi. Good morning, Phoebe, Jason, and Howard. How are you? Good morning. So, on technologies, I was impressed by that $32 billion comment that you made. What percent of that is adjudicated in 22? Is it all of it? And would you be able to tell me how much of that is re-competes? And I ask because I'm assuming that re-competes come with a bit of a higher win probability.

Those are largely new work in the $32 billion. And the customer adjudicates that as they get to it. But I think we've recognized as well that not only is it the customer decision cycle, but it's also – this environment of rampant protests that affect the timing of any of these wins. And they're significant.

Yeah. And just as a very quick follow-up here, Jason, I heard your opening comments about what you were going to do with debt. And I wanted to know, just to be clear, your fourth quarter maturities, is that the extent of debt reduction this year? And if you would, longer term, could you just tell me what your overall debt reduction target is and when you think you might be able to get there?

Yeah, the billion that matures in November of this year is the only maturity this year, so you've got that right. In terms of the longer term, we'll obviously play that out as it goes. We've indicated that we have a reasonable debt ladder out over the next several years that offers us the opportunity to continue to step down the debt and call it a billion to billion and a half increments over time. That said, we've never indicated we were going to go back to the essentially zero net debt that we had before the CSRA acquisition. So somewhere in that period, with flexibility remaining open, we'll decide where the right point is to settle out on that. And frankly, if there's an overarching sort of guiding light that we have around that. It's continuing to target and try to sustain a mid-A credit rating, and obviously there's a lot of factors that go into that, but that's really sort of the compass that we have around the debt trajectory.

Well, thank you all for joining our call today. And as a reminder, please refer to our website for the fourth quarter earnings release and our highlights presentation, which will now include our outlook. If you have any additional questions, I can be reached at 703-876-3117. Thank you. Katie.

Thank you all for joining. This now concludes today's call. You may now disconnect your lines.