General Dynamics Corporation

Thank you, operator, and good morning, everyone. Welcome to the General Dynamics third quarter 2024 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 gap measures, please see the slides that accompany this webcast, which are available on the Investor Relations page of our website, investorrelations.gd.com. On the call today are Phoebe Novakovic, Chairman and Chief Executive Officer, and Kim Correa, Chief Financial Officer. I will now turn the call over to Phoebe. Thank you, Nicole.

Good morning, everyone, and thanks for being with us. Earlier this morning, we reported earnings of $3.35 per diluted share on revenue of $11.67 billion, operating earnings of $1.18 billion, and net income of $930 million. Across the company, revenue increased $1.1 billion, a strong 10.4%, led by a 22% increase in our aerospace segment and a 20% increase in marine systems. We enjoyed revenue increases at three of our four business segments compared to the year-ago quarter. Only combat systems was flat. This is strong growth by any reasonable standard. Importantly, operating earnings of $1.18 billion are up $124 million, or 11.7%. Similarly, net earnings increased $94 million, or 11.2%. and earnings per share are up 31 cents, or 10.2% over the year-ago quarter. When earnings are up at a greater rate than revenue in a growth environment, the business is demonstrating solid operating leverage. We are doing just that. On a year-to-date basis, revenue of $34.4 billion is up $3.77 billion, or 12.3% over last year. Operating earnings of $3.37 billion are up 14.1%. Net earnings of $2.63 billion are up 14% despite a higher tax rate. Nevertheless, we missed street EPS consensus by a fair amount because we were able to deliver only four G700s in the quarter. So without further ado, let me move right into aerospace and give you as much insight into this issue as I can. and its implications for the remainder of the year. At the outset, let me give you some comparative numbers that are quite good despite the shortfall of anticipated G700 deliveries. Then I will put all of this in some reasonable context for you. Aerospace had revenue of $2.48 billion and operating earnings of $305 million with a 12.3% operating margin. Revenue is $450 million more than last year's third quarter, a solid 22% increase. The revenue increase was driven by the four G700 deliveries, higher service center and special missions volume, and higher FBO and MRO volume, particularly in the Asia-Pacific region of jet aviation. We delivered 28 aircraft, including four G700s this quarter. This is 11 fewer G700s than we expected to deliver. We also delivered one less G600, G500, and G280 than we did a year ago quarter. But deliveries of these aircraft are at a reasonably steady state, and the modest shortfall is a typical variance, having to do largely with timing and customer convenience. Operating earnings of $305 million are up $37 million or 13.8% over the year-ago quarter. The 12.3% operating margin was 90 basis points lower than the year-ago quarter for a host of reasons, including inefficiencies caused by supply chain deficiencies. So despite a very good quarter, we had planned to do better and Southside consensus reflected our expectations. You might recall that I told you we expected to deliver 50 to 52 G700s this year and that the deliveries would be more or less evenly divided over the last three quarters of the year. Well, we planned 15 for Q2 and delivered 11. We planned 15 to 16 for Q3 and delivered four. Three weeks before the end of the quarter, we still had a reasonable belief that we would deliver at least 11 in the quarter. So what happened? Whenever we miss our forecast so badly, it is almost always for a number of reasons that all play a part. So let me identify the most important and impactful ones. First, due to the timing of engine certification, aircraft engines arrived late to schedule. We painted the aircraft before the engines arrived and then painted and installed the engines. This led to a significant amount of repaint that resulted in increased cost and time spent. Second, many of the aircraft planned for delivery in this quarter have highly customized interiors, first of type intricacies. These intricacies are considered to be major changes for regulatory purposes. This resulted in longer than anticipated efforts to finalize and achieve supplemental type certificates. Related to this, the size and complexity of the G700 cabins has also elongated the customer reviews during final delivery of these planes. Third, and maybe most important, late in the quarter, a supplier quality escape on a specific component caused the exchange of several components on each planned aircraft delivery, up to 16 per aircraft. The supplier is fully cooperative and is providing components for all our needs, but this rework has increased the number of test flights necessary to obtain the final certificate of airworthiness for each aircraft. So the removal and replacement of these components has impacted labor costs and schedule adversely. We are nonetheless working our way nicely through this problem with the cooperation of the vendor. Finally, if that wasn't enough, we lost four days of productivity as a result of Hurricane Helene. Several customers who were in Savannah working with us to accept delivery left and went home to avoid the storm. So, given that there is always risk in precise estimates, I will describe our delivery cadence a bit later and provide some monthly forecasts so that you can monitor the quarter from publicly available data. All right, back to some good numerical comparisons. For the year to date, aerospace revenue is up $1.63 billion, an increase of 27.7%. Operating earnings are up $146 million, an increase of almost 20%. I recite these figures, which will reflect even more growth by the end of the year, so that we do not get lost in the third quarter delivery issue. This is still eye-watering growth. So what impact should we now expect for the fourth quarter in the year given the fewer than planned G700 deliveries in the second quarter and third quarters? You may recall that we expected to deliver 50 to 52 G700s this year. We now expect to deliver around 42 for the year with 27 in the fourth quarter. This number is not without risk, but there's also some opportunity to bring plans forward. The real issue here is supply chain support during this critical period. Let me give you some insight into the sequencing of the 27 planned deliveries in the quarter. We anticipate five in October, nine in November, and 13 in December, recognizing there is some risk as these numbers could vary a little bit up or down through the quarter. You can, as I have said, follow this with fairly accurate, but not perfect, publicly available data. Turning to market demand, the interest level of buyers and the expiration of accelerated depreciation at year's end suggests a reasonably strong order intake in the fourth quarter, and that is what we are seeing. After some slowing in the U.S. during the second and third quarters, we are seeing improved interest across all models in the fourth quarter. Europe and Middle East activity is quite strong, but current activity in Southeast Asia and China has slowed. Interestingly, the overall number of prospects in all areas continues to increase. The overall number of prospects in our pipeline is at an all-time high, with the most active models being the G500, 600, and 700. We have a good cross-section of U.S. businesses in this mix. In summary, the aerospace team had a very good quarter, albeit disappointing from the perspective of G700 deliveries. We look forward to a strong finish to the year in the fourth quarter, but we'll fall somewhat short of our mid-year forecast. So let's move on to the defense businesses. As a collective, we once again saw strong growth and good operating performance across the portfolio. Let me walk you through each segment in turn. First, combat systems. Combat systems had revenue of $2.2 billion for the quarter, similar to a year ago. Earnings of $325 million are up 8.3%, and margins at 14.7% represent a 120 basis point increase over Q3 last year. Each of the businesses increased earnings with particularly strong operating leverage in munitions and customer service businesses. On a sequential basis, while revenue decreased 3%, earnings rose almost 4%. Year-to-date, revenue of $6.6 billion is up almost 12%, and earnings of $920 million are up $124 million, or almost 16%. Combat saw robust order activity, over $3.3 billion awarded in Q3, resulting in a book to bill of 1.5 to 1 for the quarter. Orders came from across the portfolio, with notable orders in munitions and air defense vehicles for the U.S. Army. Overall, demand remains solid across combat, particularly in our ordnance and international combat vehicle businesses. In the U.S., we are increasing production of 155-millimeter ammunition projectiles, as well as expanding our support to the U.S. Army across several other areas, including final loading and assembly of artillery. Our combat systems backlog at roughly 18 billion reflects this strong demand. All in all, a strong performance quarter for combat. Turning to marine systems, once again, our shipbuilding group is demonstrating strong revenue growth. Marine systems revenue of $3.6 billion is up $597 million, 20% against the year-ago quarter. Columbia-class construction and engineering volume, as well as Virginia-class volume, drove the growth. DDG 51 revenue also increased somewhat. Just to put this in some context, this 20% growth follows 15% growth in Q4 of 23, 11% growth in Q1 of 24, and 13% growth in Q2 of 24. Impressive growth by any standard. Operating earnings are $258 million, up $47 million over the year-ago quarter, with a 20 basis point increase in operating margins. However, margins continue to be adversely affected by additional delays from the submarine industrial base, partially offset by improved margin performance at NASCOE. Sequentially, revenue increased 4.2% and earnings improved 5.3% in Q3, driven by volume at EB. Year-to-date, marine revenue of $10.4 billion is up 14.7%. and earnings of $735 million are up 12%. So across the business, we have seen rapid growth of revenue and earnings, but stagnant margin performance. As I noted last quarter, although the supply chain is improving in places, EB continues to be severely impacted by late deliveries from major component suppliers, which has delayed schedule and is continuing to impact costs. Our out-of-sequence work on modules weighing thousands of tons is time consuming and therefore expensive, sometimes up to eight times the cost of in-sequence work. The operating metrics tell us that we have, in fact, increased our productivity to somewhat offset cost. As I noted last quarter, throughput, a significant measure of productivity, continues to improve. And while we will continue to work on improved productivity, there is no point hurrying portions of the boat only to have to stop and wait increasingly extended periods of time for major components to arrive. It is neither good for the boat, over time, nor cost. Given the recent projections from the supply chain on deliveries, we need to get our cadence in sync with the supply chain. and take costs out of the business if we are to hope to see incremental margin growth. Put another way, the supply chain is not getting better at a fast enough rate as we had hoped. Through our internal efficiency, we have now outpaced them. This is the reality of the post-COVID environment for many of our most important suppliers. Finally, to be clear, Current submarine delivery projections are not incrementally impacted since they already reflect the anticipated delays from the supply chain. We will, of course, carefully monitor supply chain performance and accelerate our work should their deliveries to us improve. And lastly, technologies. It was another strong quarter with revenue of almost $3.4 billion, which is up 2% over the prior year. Operating earnings in the quarter were $326 million, up 3.5%, on a margin of 9.7%. That is a 20 basis point improvement in the year-over-year. The year-to-date comparisons are similar. Revenue at $9.9 billion is up 1.2%, but earnings of $941 million are up almost 5% on a 30 basis point improvement in operating margins. The growth for this quarter and the first nine months was driven by GDIT's investments in their digital accelerators. Mission Systems was flat year over year as they continued to transition from legacy programs to new franchises. Strong operating performance across the group more than offset the relative growth in services at GDIT compared to hardware at Mission Systems. The group grew 2.5%, spread relatively evenly over both businesses, with margins steady at 9.7%. Order activity was particularly strong in the quarter with a book-to-bill of 1.3 to 1. That resulted in backlog at the end of the quarter of $14.4 billion, up 13.5% from the year-ago quarter. Through the first nine months, the group achieved a book-to-bill ratio of 1.2 to 1. more than keeping pace with the strong revenue growth across the business. GDIT and mission systems have shared in the robust order activity so far this year, demonstrating the strength of this portfolio. And prospects remain strong with a large qualified funnel of more than $120 billion in opportunities they are pursuing across the group. That concludes my comments about the defense businesses. Let me now turn the call over to our CFO, Kim Correa, and then we'll wrap up with our guidance for the remainder of the year.

Thank you, Phoebe, and good morning. We had a solid quarter from an orders perspective with an overall book-to-bill ratio of 1.1 for the company. This is particularly impressive with the continued strong revenue growth in the quarter. Combat systems and technologies led the way with book-to-bills of 1.5 times and 1.3 times, respectively. This order activity led to our backlog increasing to $92.6 billion at the end of the quarter. Our total estimated contract value, which includes options and IDIQ contracts, ended the quarter at a record level of $137.6 billion. Moving to our cash performance, this was another good story in the quarter. Cash flow improved as anticipated over the prior two quarters. We produced $1.4 billion of operating cash flow. All segments contributed to the results with particularly strong cash generation in technologies. Including capital expenditures, our free cash flow was $1.2 billion for the quarter, or 131% of net income. For the fourth quarter, we are expecting free cash flow to again be greater than 100% of net income, but we now expect the full year to fall short of our 100% conversion target, as G700 deliveries push into 2025. As a reminder, total free cash flow generation between 2021 and 2023 was quite strong with a three-year conversion rate of 107%. Looking at capital deployment, capital expenditures were $201 million in the quarter, or 1.7% of sales. We're still targeting to be around 2% of sales for the full year given the commitments that remain. We paid $390 million in dividends and repurchased a little over 150,000 shares of stock for $44 million during the quarter. We ended the quarter with a cash balance of over $2.1 billion. That brings us to a net debt position of $7.2 billion, down over $700 million from last quarter. As a reminder, we have an additional $500 million of fixed rate notes maturing in the fourth quarter that we plan to repay with cash on hand. Net interest expense in the quarter was $82 million, bringing interest expense for the first nine months of the year to $248 million, down from $265 million for the same period in 2023. Finally, the tax rate in the quarter was 16.5%, bringing the rate for the first nine months to 17%. The rate was slightly lower than expected principally due to increased U.S. and foreign tax credits and benefits and other timing items. As a result, for the year, we believe our full year tax rate will be closer to 17%. Now let me turn it back over to Phoebe for some final remarks.

Thanks, Kim. In light of the things I have just discussed, let me give you some clarity for the remainder of the year. The figures I am about to give you are all compared to our July update. which will be posted along with today's guidance on our website. In aerospace, we expect sales to be about $12.3 billion with a 13.2% margin. We are expecting 150 versus 160 deliveries, with 10 of the deliveries slipping into next year. This will, of course, benefit next year. With respect to the defense businesses, combat systems and technology remain unchanged from July. Marine systems revenue should be about $13.9 billion with margins of 6.9% for all the reasons I previously noted. On a company-wide basis, we see annual revenue of around $48 billion and margins of around 10.3%. All up, that indicates EPS guidance of approximately $14 per share, about 45 cents below our previous expectations. That concludes my remarks and we will be happy to take your questions.

Thank you, 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. We will now begin the question and answer session. If you have dialed in and would like to ask a question, please press star 1 on your telephone keypad to raise your hand and join the queue. If you would like to withdraw your question, simply press star 1 again. We ask that you please limit yourself to one question and one follow-up to allow everyone an opportunity to ask a question. We'll take our first question from Seth Seifman at JPMorgan.

Hey, thanks very much, and good morning.

Good morning, Seth.

Phoebe, I was wondering if you could talk a little bit about, you know, this year is kind of a, you know, unusual year in terms of the various things that have come up with the G700. As we think about going forward and, you know, where the profitability can go in the aerospace segment, you know, I know it's early for 2025, but maybe even qualitatively talking about the things that are weighing down margin this year and how things can evolve, you know, taking into account also the introduction of the G800 and kind of what the progression looks like.

So I think as we've discussed through most of this year, we still have supply chain challenges that require at Gulfstream that require out-of-station work. We still have late deliveries of material. The supply chain has gotten much better as evidenced by our ability to ramp up production, but they've still got a ways to go. And until we get that supply chain quality as well as delivery timing, stabilized will continue to have out-of-station work. That, however, should be behind us, you know, before too terribly long. Let's talk about the 700. So the 700, we've talked throughout the year about some of the margin pressures of the first lots. But when we look forward, as we've talked about before, we see gross margin improvement of about 600 to 700 basis points. That remains the same. You know, as I look forward in the aerospace group, we see very, very strong margins going forward, and we'll see good margins in Q4, not as high as we expected because we'll have 700 flip into next year, but we'll have very nice margin expansion as we go into next year. With respect to the 800, we expect it to come out of the block pretty good and have some nice margin impacts over the course of its years. So I would say that we're pretty optimistic over starting about next year and into the future of the margin performance at aerospace.

Thanks. And maybe just to follow up on combat with the, you know, understand the growth trajectory kind of flowing down here in the second half, you know, how much of that reflects kind of the end of the facilitation process for the 155-millimeter shells? And, you know, how do we think about kind of the interplay of growth and margin going forward? It would seem that the backlog here would allow this to be, as we look across the industry, you know, maybe one of the faster-growing businesses across the industry. you know, a fair assessment, and then have we, has this quarter indicated that some of the margin pressure from facilitation is behind us?

So, look, if we look at our backlog and the threat environment and the performance of combat in general over time, I think we expect that in our market space we will continue to grow and perform very well. Facilitization for increased munition production is largely behind us. We're moving into production. We'll see increased revenue from our combat vehicle business and so we do see a pretty good solid growth pattern as we go forward. This year we accelerated growth into the first half. So we expect fourth quarter to be relatively flat, but still have about 5.9% growth for the group in the year. And we expect to see very nice growth going forward. I would add this. In a high-performing organization like Combat Systems, variability in revenue and margin is almost always a question of timing. So just to give you a little context on that score.

We'll move next to Robert Stollard at Vertical Research Partners.

Thanks so much. Good morning. Good morning. First of all, a question on marine, Phoebe. You mentioned about the supply chain issues there. I was wondering if you could elaborate on why it's not improved as much as you would have hoped. And also, at what point does this start to negatively impact submarine schedules?

Well, I think that it already has impacted schedule and that's been pretty well publicized by the Navy. Until recently, we had a reasonable hope and it was a reasonable set of expectations based on the indicators that the supply chain would continue to get better. But most recently, we've seen that, in fact, that's not the case. And they're not getting better at the rate at which we had hoped for a whole series of reasons. And I think that, and some of those have been very well documented. The Navy and Congress have been well aware of that, so they've been pumping additional support into parts of the supply chain. And some parts are doing well, but others are continuing to struggle. And I'd say that it was not atypical of a number of manufacturing sectors. You know, if you go back from December of 2019, the PPI for manufacturing has increased by 25%. Overlay that with the demographic challenges that we've had with the smaller cohort of new hires. and wage growth that's been an added pressure on some of our suppliers at the same time, almost quintupling the throughput and the demand on submarines. So there's been a lot of pressure on parts of the supply chain. I think that's well understood by our customer and the Congress, so we're going to continue to work with them and help where we can. But in the meantime, we're going to control what we can control. And that is, you know, we're going to adjust our pace to align with what we now see as more, you know, predictable supply chain schedules that have elongated. We'll pay cost out of our business and we'll continue to work productivity on the debt plates with an increasingly capable and skilled and experienced workforce. So you can control what you can control, and we're simply in the moment adjusting to what we see as the inability of the supply chain to improve at the rate that we had hoped and that, frankly, I believe our customer had hoped.

Yeah. And just as a quick follow-up, do you think these supply chain issues jeopardize the aspiration to move back to two boats a year on the Virginia class?

Well, I think that in the short term, there's going to be pressure on that, considerable pressure on that. So, I think that's something for us to work through with our customer and, frankly, the customer to work with the supply chain. I think it's a well-known issue.

We'll go next to Myles Walton at Wolf Research.

Thanks. Good morning. Phoebe, if I could follow up on... On Rob's question there, the implied fourth quarter margin at mid-6% range for marine, is there something in the third quarter positively offsetting to get to the low sevens? I don't know if there's a positive EAC you might have taken. And then looking to 25, is the mid-6% margin the right run rate that you're looking for now in that business?

So this quarter we had some strong performance out of NASCO. We had some good performance at Electric Boat. But that's going to, in this environment, vary quarter by quarter. So we anticipate some more supply chain impacts in the fourth quarter. And as we project next year, and I'll give you that clarity about in our regular order in January, but as we project next year, the ability to continue to drive incremental margins in the short term is just how fast we can take our pace down at cost and improve our productivity. So we'll work through all that with the shipyard and give you a sense of what we're seeing in margins. I'd say they are going to be kind of lumpy. probably through next year and maybe even beyond.

Okay. And then one clarification. I know it's super granular in near term, so I apologize in advance, but in October to date, have you gotten more than, you know, one G7 out the door?

Yeah, I think I was... Yes, we have. And I think I've given you some pretty good clarity of what we expect for October. That's pretty much on schedule. And then November and December, I gave you that clarity as well. I'm trying to be as transparent with you all so that you can better understand where we anticipate. And as you well know, you can follow some of that with the publicly available data, which is directionally correct.

We'll go next to David Strauss at Barclays.

Thanks. Good morning. Good morning, David. Phoebe, following up on the items that you highlighted in terms of what's impacting the G700 deliveries, I guess just to clarify, is rolls from an engine perspective, are they behind? Is that part of the issue? And then On the interior side, do you view this as kind of a temporary issue or could it linger just given a much larger cabin here and I would assume a lot more in the way of complexity on the interior side on a go-forward basis?

Yeah. So we control the interiors. So we're very comfortable in our projections on how we work those interiors. I'm not worried or even concerned about our interiors. Engines on station have improved, so that is definitely a benefit, and I tried to give you some color around that particular issue in my remarks, but there's improvement.

Okay. Okay. And quick follow-up, the Salt Rocker Motor announcement with partnership with Lockheed in the quarter. Can you just give some color around that and how that might materialize over the next couple of years in terms of numbers? Thanks.

Yeah, so we'll make some investment over the next couple of years, and then I think that – and I don't have an exact start date off the tip of my tongue – But a lot of the number of motors will be driven by overall by the demand for the rocket itself. But we're pretty comfortable that, you know, this is well within our capability set and we'll work through that with our partner.

Thanks very much.

We'll move next to Peter Arment at Baird.

Hey, good morning, Phoebe. Morning. Maybe just to focus on combat, you guys have had really strong growth through the first three quarters of the year, and obviously your profit margins reflect a lot of really good execution. Just how are you thinking about the long-term visibility here? How big of a business do you see in terms of the bookings environment? You mentioned Middle East and Europe. Maybe just describe, I think, how you're seeing the visibility on combat. Yeah.

So our book-to-bill and backlog supports nice growth. The unfortunate threat environment also continues to drive demand, and we see our pipeline is pretty robust both domestically and outside the United States. So at least for the foreseeable future, we see nice, steady growth in combat, right away with good margin performance.

Yeah, my follow-up is on the margin front. I mean, almost 14%, you know, for the first nine months. I mean, is there opportunities to further enhance margins? I know there are, you know, some limits here and mix is a factor, but you've got a lot of growth and a lot of us are just focused on, you know, kind of what actually this business can generate.

So historically, when we've talked about this before in previous calls over the years, this tends to be a 14.5% margin business, given some margin variability quarter to quarter, again, largely driven by mix. And I suspect that we'll continue in that range. Again, some margins will be better. Could we make long-term incremental structural improvement in that? I don't see that at the moment, but there's always opportunity, so we'll continue to pursue this. As I said, this has always been a very high operating leverage company and groups of companies, the three of them. So, I think we'll continue to see both nice growth and good earnings expansion.

We'll take our next question from Ron Epstein at Bank of America.

Hey, Anne. Good morning. Good morning, Ron. So maybe back to the supply chain stuff. If we look at the supply chain for the shipyards, we all kind of know that's been an issue. And if we look at the land systems business, I mean, it's growing. Do you worry about the supply chain there? And I guess broadly, what has the supply chain in your munitions business and the businesses that are growing in land systems doing better than the supply chain and the shipyards?

So I think it's a function of the type of material that we use in combat systems versus the scope size and of the material and inputs we use both at Marine Group and particularly submarines and Gulfstream. I mean, Gulfstream's supply chain got perturbated by a lot of factors that have been well reported, but I think it's really a question of just the types of materials we use and the overall demand, even outside of the combat, particularly vehicle business, that tends to be a more robust supply chain on component parts, given that there's other uses for a lot of that material. the inputs for aerospace or for Gulfstream and the Marine Group are one of a kind. They don't replicate anywhere else in industry. So I think that that explains why we've had fewer issues. I mean, we had some issues with supply at combat, but those are largely behind us, and I think that I tried to give you some color on why that is.

Yeah, and then maybe as a follow-on, Back to marine, sorry, kind of what everybody's focusing on at the moment. When we look at marine, you say supply chain. Supply chain is a huge thing, right? And I think we all have a good understanding in Arrow where the tight points are. What in marine is the issue? I mean, what kind of component, if we just kind of broadly want to understand, if we peel back the onion, where are the suppliers not supplying? Is it bearings? What is it?

Well, we have a number of smaller parts that remain. They get produced by single-source suppliers and often small ones that remain an issue. I think it's large component parts, and I think the Navy has reported on some of that, that tend to be highly complex, costs have risen significantly, and you've got green workforce. in a lot of these areas. So those are, while it's a large group, I think that's all about the most color I'm going to give you on where some of the challenges are because the Navy's been kind of explicit in some instances about that, and I think that's just a better place to be.

We'll go next to Ken Herber at RBC Capital Markets.

Yeah, hi, good morning. Thanks for taking the question. First, Phoebe, on services within aerospace, you had nice growth here again. You've sort of reset, it looks like, at a sort of a much higher level. I know you've added capacity. Is this a good run rate to think about for the services business within this? And maybe if you could talk about how dilutive this part of the business is relative to, you know, relative to the aircraft side within the segment.

So we have long said that services is going to grow at the rate of the fleet expansion. And think about it this way. We gather, we garner between 85, maybe 90 plus percent of all Gulfstream service. And so as the fleet expands, service expands. Its impact on overall margins tends to be rather lumpy, but it is in some instances, in some quarters, it's about even. So it's certainly not any large dilution impact and hasn't been for some time. So this is a nice, steady growth business.

Okay. And on the quality escape, I guess, with how deliveries are trending in this month and your confidence, you feel good about that risk getting retired or is there anything that sounds like there is clearly still some caution into the back half of the year, but do you feel good about that particular supplier and getting back on schedule?

Yes, they're working very cooperatively with us but, you know, I think it's emblematic or at least descriptive of the fact that we don't have all of these risks behind us and that we're slipping airplanes into next year. So I've tried to give you my best estimate both on cadence and timing. and of what we see, but for the remainder of this year and then, as I said, some of these airplanes will go into next year. But we've worked well with the supplier, understand the scope, so that is not any particularly long-term issue, nor is it a complete anomaly just in terms of the type of thing that happened here. So we're just fixing that in the regular order. It was a timing problem, but not a systemic one. Think about it that way.

Okay. Thank you.

We'll go next to Doug Harned at Bernstein.

Good morning. Thank you. Morning. Going back to marine and electric boat, when you look at the supply chain issues there and the delays in the program, How do you think of the Virginia class and Columbia class in a sense separately? How do you prioritize work or are you making decisions to prioritize one over the other?

Well, that is a national security decision dictated by the Navy. So Columbia has across the entirety of the industrial base priority and it has since its inception. So by definition, Virginia is behind in terms of Priority Columbia and that has ramifications for Virginia. It's well understood by our customer, particularly in an environment in which supply chain material is constrained. Columbia gets the first of the pick. Again, given its national security imperative.

Well, given the importance of these programs, not just the Navy, but the overall defense. I agree. You know, you got money in the supplemental for supporting the shipbuilding industrial base, but when you work with your customer, How is that helping, and are there subsequent steps that can be taken within the budget to help build this industrial base better?

So the Navy and the Congress have recognized that there are portions of the industrial base that need help, and that's what the... Shipbuilding and submarine industrial-based funding is intended to address both expanding the capacity and shoring up the capacity. There has been significant cost growth, as I noted earlier, across manufacturing business in particular and by extension. into the submarine industrial base. So costs are increasing. Fact-of-life costs are economic realities, and funding is going to have to adjust to these fundamental changes in inputs, and that will need to happen over time.

Thank you.

We'll move next to Gautam Khanna at TD Cowan.

Yeah, thank you. Good morning. Morning. So just to follow up on Marine, I know that you guys are in negotiations with the Navy on the Columbia class, the five of those, and I think it's 10 or 12 Virginia class boats. I was curious what sort of your expectation is for the timing of when those contracts get agreed to? And is there any cash or margin implications once those are signed to what's in the yard now? And just if you could talk about that.

So cash, no. Margin impact happens over time if we begin to execute those programs. I don't have a good sense of timing. I expect that the FY24 ships that are not yet under contract will happen maybe in the next few months, but I don't have a good sense of timing for the remainder of the negotiations on Block 6, the contract on Block 6, or Bill 2 of Columbia. It's going to be hard to get those ships under contract, given that we've had... the kind of, you know, cost increases in inputs, frankly, throughout the economy. But as I noted earlier, manufacturing keeps the eyes high, and those costs have increased for inputs. So we're going to have to work that with our customer and Congress.

And just as a follow-up, I guess what I'm asking is, is there any expectation that there would be relief provided for, you know, higher labor inflation that everyone's experienced on boats that are already in production as perhaps part of that negotiation?

Well, I don't know if part of that negotiation, I wouldn't link it necessarily to those negotiations, but we are constantly in negotiation with our customer on a whole on any number of contracting actions and now is no different. We also have entitlements in our contracts for which we will seek remedy. So, there's a lot of ongoing discussions with our customer about these cost... These fact of life cost increases and labor costs increases and, you know, that plus the remedy to which we're entitled. We're going to continue to work both of those issues with our customer.

We'll take our next question from Gavin Parsons at UBS.

Thanks. Morning. Morning. Phoebe, of course you'll deliver some G700s out of inventory this year and maybe some out of inventory again next year. Can you help us with what the underlying... Out of inventory.

Help me with what you mean by out of inventory. We don't have 700 sitting in inventory. We have 700 that are in some stage of production, but just picking on that there with you.

Yeah, fair. I guess, can you help us with the underlying production rate?

Yeah, so I try to be as explicit as I could be for the remainder of the year. Some of these airplanes will go into next year. That'll help next year. And then we'll give you a lot of clarity around what next year looks like in our ordinary course when we give you our guidance in January. The airplane is performing very well, but we still, as I've noted, you know, frequently we've still got out of station work that needs to get behind us.

Okay. And I'll try one more. I don't know if this is just an accounting question, but... You called out all the elevated cost on paint, interiors, component replacement on G700. How does the 600 to 700 basis point margin step up remain intact?

Well, that will happen. I don't have exact clarity on when those gross margin improvements will happen, but I think relatively soon and over the course of potentially the next year. We ought to see some really nice margin expansion. We're seeing it in the fourth quarter right off the bat. And I expect to see that margin expansion continue throughout next year and beyond.

We'll go next to Jason Gursky at Citi.

Hello there. Good morning, everybody. Good morning. Citi, what's going on? I was wondering if you could just step back for a minute and maybe talk a little bit about the things that you're most excited about and where you're kind of spending the most amount of your time as it relates to technology investments and the business development pipeline across the defense business as a whole.

Yeah. So I would say that we need to continue to capitalize on the very strong growth profile we see going forward in the marine group. We spend an awful lot of time on improving our own capability within our own shipyards. I think the technologies group in general has shown nice growth and they have positioned themselves in faster currents within their highly competitive businesses. So, we're pretty excited about what we see there and then I think combat systems performance continues to be strong and how we then translate demand into revenue in the out years and continue the strong operating performance we've had there is sort of where we focus our time right there's a lot to be you know there's a lot to be excited about in terms of performance of the company yeah understood okay it's helpful to understand the prioritization

And then maybe this is a question where we get Kim involved as well, but just kind of philosophically how you guys are, how you all, excuse me, are approaching the balance sheet and the capital structure and leverage. Just kind of as we think about, you know, the future of the company, where you want to operate.

Yes. Well, obviously we have a very strong balance sheet. We were recently upgraded in terms of our, credit rating, and we have some debt repayments coming due that we expect to pay on schedule. And we'll consistently look at where we stand, but we feel pretty good about where we stand right now.

Right. And just philosophically, you want to keep your leverage under X terms of leverage? I'm just kind of curious how you're thinking about that.

Yeah, I don't think, you know, at this point in time, I think we're continuing to work the growth environment that we're in and determining, you know, in terms of where the cash is going to come out for 2025 especially. And I think it's a matter of time in terms of taking a look at where we stand.

So, Audra, I think we have time for one more question.

Thank you. We'll take that question from Scott Deutschel at Deutsche Bank.

Hey, good morning. Phoebe, just to clarify your response to David's question earlier, do the certifications you're getting this year on those highly customized interiors for G700, do those de-risk this as an item from being a constraint next year?

Yes. I mean, these are the first ones out of the block, so we don't see that as a constraining item next year.

Okay, great.

Can I ask another question?

Yeah. Does Combat Systems have many products that are approved for export on a direct commercial sale basis? And then are you seeing much traction for DCS sales, either in terms of the bookings you put up recently at Combat or in terms of orders that are in the pipeline?

Not out of the United States, but out of our European businesses, yes. Those tend to be direct sales, and that's been true for 25 years. And the demand for those products in Europe, even Eastern and Western Europe, remains very, very strong.

Thank you.

Great. Well, thank you everyone for joining our call today. As a reminder, please refer to the General Dynamics website for the third quarter earnings release and highlights presentation. If you have additional questions, I can be reached at 703-876-3152.

And this concludes today's conference call. Thank you for your participation. You may now disconnect.