Good morning, and welcome to the General Dynamics Third Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. After the speakers' remarks, there will be a question-and-answer session. Please note, this event is being recorded. I would now like to turn the conference over to Nicole Shelton, Vice President of Investor Relations. Please go ahead.

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 GAAP 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 Phebe Novakovic, Chairman and Chief Executive Officer; and Kim Kuryea, Chief Financial Officer. I will now turn the call over to Phebe.

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 over $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 from 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 is 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 $0.31 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 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 delivery. 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 at 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. The 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 sell-side 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. While 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 tight 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 have also elongated the customer reviews during final delivery of these planes. Third, and maybe most importantly, 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 schedules 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. Alright, 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 were 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 tremendous growth. So what impact should we now expect for the fourth quarter and the year given the fewer-than-planned G700 deliveries in the second 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 planes 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, G600, and G700. 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 will fall somewhat short of our midyear 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. I may 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 1.5:1 for the quarter. Orders came from across the portfolio with notable orders in munitions and near defense vehicles for the U.S. Army. Overall, demand remains solid across Combat, particularly in our ordinance 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 the 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 2023, 11% growth in Q1 of 2024, and 13% growth in Q2 of 2024, 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 margin. However, margins continue to be adversely affected by additional delays from the submarine industrial base, partially offset by improved margin performance at NASCO. Sequentially, revenue increased 4.2%, and earnings improved 5.3% in Q3 driven by volume at Electric Boat. 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, Electric Boat continues to be severely impacted by late deliveries from major component suppliers, which has delayed schedules 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 costs. 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 in hurting portions of the boat only to have to stop and wait increasingly extended periods of time for major components to arrive. It is not good for the bulk 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 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 margin. 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 continue to transition from legacy programs to new franchises. Strong operating performance across the group more than offset the relative growth in services of GDIT compared to hardware at Mission Systems. Sequentially, 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 1.3:1, resulting in a 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 1.2:1, 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 Kuryea, and then we'll wrap up with our guidance for the remainder of the year.

Thank you, Phebe, 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-bill 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 pushed 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 Phebe 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've 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 $0.45 below our previous expectations. That concludes my remarks, and we will be happy to take your questions.

Thank you, Phebe. 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'll take our first question from Seth Seifman at J.P. Morgan.

Hey, hi, thanks and good morning.

Good morning, Seth.

Phebe, I was wondering if you could talk a little bit about this year being kind of an unusual year in terms of the various things that have come up with the G700. But as we think about going forward and where the profitability can go in the Aerospace segment, 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 taking into account also the introduction of the G800 and kind of what the progression looks like?

As we've discussed throughout this year, we are still facing supply chain challenges at Gulfstream that require some out of station work, and we continue to experience late deliveries of materials. The situation has improved significantly, as shown by our ability to increase production, but we still have more work to do. Until we stabilize the supply chain quality and delivery timing, we will keep having out of station work. However, we expect to overcome this hurdle fairly soon. Now, regarding the 700, while we've mentioned the margin pressures from the first lot, we anticipate a gross margin improvement of about 600 to 700 basis points moving forward, and that outlook remains unchanged. In the Aerospace Group, we're optimistic about strong margins in the future and expect good margins in Q4, though they will be lower than our initial expectations due to delays in many 700s being pushed into next year. Nevertheless, we expect to see solid margin expansion as we progress into next year. For the 800, we anticipate a strong launch and positive margin impacts throughout its first year. Overall, we are quite optimistic about the margin performance of Aerospace starting next year and beyond.

Thank you. I have a follow-up on Combat. I understand that the growth rate is slowing down in the second half. How much of this is due to the end of the facilitization process for the 155-millimeter shells? How should we consider the relationship between growth and margin moving forward? It seems like the backlog positions us as one of the faster-growing businesses in the industry; is that accurate? Additionally, has this quarter shown that some of the margin pressure from facilitization is easing?

So look, if we look at our backlog and the threat environment and the performance at Combat in general, over time, I think we expected 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 Stallard at Vertical Research Partners.

Thanks so much, good morning.

Good morning.

First of all, a question on Marine. Phebe, 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 the 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 a typical number of manufacturing sectors. 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 span and added pressure on some of our suppliers at the same time, almost quintupling the throughput on, and the demand on submarines. So there's been a lot of pressure, 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 we're going to adjust our pace to align with what we now see as more predictable supply chain schedules that have elongated. It will take costs 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.

Yes. And just as a quick follow-up, do you think the 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 Wolfe Research.

Thanks, good morning. Phebe, if I could follow up 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 7's? I don't know if there's a positive EAC you might have taken? And then looking to 2025, 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 and near term, so I apologize in advance. But in October to date, have you gotten more than one G700 out the door?

Yes, we have, and I've provided some clear expectations for October, which are on track. I've also shared insights for November and December. I'm trying to be transparent so you can understand our anticipations, and as you know, you can confirm some of that with publicly available data, which is generally accurate.

We'll go next to David Strauss at Barclays.

Thanks, good morning. Phebe, following up on the items that you highlight in terms of what's impacting the G700 delivery. I guess just to clarify, are roles 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?

Yes, we have control over the interiors, and we are confident in our projections regarding them. I'm not worried about our interiors. The engines on the stations have improved, which is definitely a positive development. I tried to provide some insight about that specific issue in my remarks, and there is indeed improvement.

Okay. And a quick follow-up. Can you provide more details about the announcement regarding the partnership with Lockheed this quarter and how it might impact our numbers over the next couple of years? Thanks.

Yes, we plan to invest in the coming years. While I don't have a specific start date at the moment, the number of motors will ultimately depend on the demand for the rock itself. However, we are quite confident that this is well within our capabilities, and we will collaborate closely with our partner to address this.

We'll move next to Peter Arment at Baird.

Good morning, Phebe. I want to focus on Combat. You have demonstrated impressive growth during the first three quarters of the year, and your profit margins indicate strong execution. How do you view the long-term outlook in this area? What potential do you see for the bookings environment? You mentioned the Middle East and Europe; could you elaborate on the visibility you have regarding Combat in those regions?

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 with good margin performance.

Yes. Then my follow-up is on the margin front, I mean almost 14% for the first nine months. I mean, are there opportunities to further enhance margins? I know there are 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 kind of what actually this business can generate?

Historically, we've indicated that this is typically a 14.5% margin business, although there can be some variability from quarter to quarter, mainly due to mix. I anticipate that this will remain within that range. Some margins might outperform, but I'm not currently seeing a possibility for long-term structural improvements. However, there are always opportunities to explore, and we will keep pursuing them. This company has consistently shown high operating leverage, and across the three main groups, I believe we will continue to achieve solid growth along with strong earnings expansion.

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

Good morning. So maybe back to the supply chain. If we look at the supply chain for the shipyards, I mean, 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 in the shipyards?

So I think it's a function of the type of material that we use in Combat Systems versus the scope, size of the material and inputs we use both at Marine Group and particularly submarine and Gulfstream. I mean, Gulfstream supply chain got perturbed 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. Materials, the inputs for Aerospace and for Gulfstream and the Marine Group are one-of-a-kind. They don't replicate anywhere else in the industry. So I think 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 what that is.

Yes. As a follow-up regarding Marine, I know it's a key focus at the moment. When we discuss Marine, supply chain is a significant concern. We have a solid understanding in Aero about where the challenges are. What are the specific issues in Marine? Can you provide insight into which components are affected? Where are the suppliers falling short? Is it bearings, or something else?

We have several smaller components that are produced by single-source suppliers, often small ones, which continue to be a challenge. The larger components tend to be highly complex, and costs have increased significantly, with many areas facing a less experienced workforce. This represents a large group of issues. I believe that provides a good overview of our challenges, as the Navy has been quite clear in some instances about these matters, which is a better context for understanding the situation.

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

Yeah, hi, good morning. Thanks for taking the questions. Maybe first, Phebe, on services within Aerospace, you had nice growth here again. You've sort of reset, it looks like, at 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 the aircraft side within this segment?

We have always stated that the growth of our services will match the growth of the fleet. Consider this: we capture between 85% and over 90% of all Gulfstream service. Therefore, as the fleet grows, our service offerings also grow. The impact on overall margins can vary; in some cases, it can be relatively even, so it doesn't significantly dilute our margins and hasn't for a while. This area is experiencing steady growth.

Okay. Regarding the quality escape, considering the current delivery trends and your level of confidence, do you believe that risk can be resolved? It seems there is still some caution for the latter half of the year, but are you optimistic about that specific supplier and returning to schedule?

Yes. They're working very cooperatively with us, but 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 and 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. Going back to Marine and Electric Boat. When you look at the supply chain issues there and the delays in the programs, 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 yes, by definition, Virginia gets 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 to Navy but the overall Defense, you have 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 the manufacturing business in particular and by extension into the submarine industrial base. So costs are increasing. Back to life cost or economic realities. And the funding is going to have to adjust to these fundamental changes in inputs, and that will need to happen over time.

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

Yeah, thank you. Good morning. So just to follow up on Marine. I know that you guys are in negotiations with the Navy on the Columbia-class, 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?

Cash is not expected at this time. The impact on margins will develop gradually as we start implementing those programs. I don’t have a clear timeline for that. I anticipate that the ships for fiscal year 2024, which are not yet under contract, may be finalized in the next few months. However, I lack clarity on the timing for the ongoing negotiations regarding Block 6, the contract for Block 6, or Built 2 of Columbia. Securing these contracts will be challenging due to the significant cost increases in various input materials across the economy. As I mentioned earlier, the manufacturing Producer Price Index is high, and those input costs have risen. We will need to address this with our customers and Congress.

As a follow-up, I'm wondering if there is any expectation for relief regarding the higher labor inflation that everyone has been experiencing on boats that are already in production as part of that negotiation.

I'm not sure if that relates directly to the negotiations; I wouldn't necessarily connect it to those discussions. However, we are always negotiating with our customers on various contracting actions, and that remains true now. We also have entitlements in our contracts that we will pursue. There are many ongoing discussions with our customers regarding these cost and labor increases, along with the remedies we are entitled to. We will continue addressing both of these issues with our customers.

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

Thanks, good morning. Phebe, you of course have delivered some G700s out of inventory this year and maybe some out of inventory again next year. Can you help us with what the underlying...

We are out of inventory. Help me with what you mean by out of inventory. I mean, we don't have G700 in inventory. And G700s that are in some stage of production, but just picking a nit there with you.

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

Yes. 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 will 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 frequently, we 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 have 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. 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 are kind of spending the most amount of your time as it relates to technology investments and the business development pipeline across...?

In technology?

In the defense business as a whole.

Yes. 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. There's a lot to be excited about in terms of performance of the company.

Yes, understood. Okay. It's helpful to understand the prioritization. Maybe we can involve Kim in this question as well, but philosophically, how are you approaching the balance sheet, capital structure, and leverage? As we consider the future of the company, where do 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 externs of leverage. I'm just kind of curious how you're thinking about?

Yeah. I don't think at this point in time; I think we're continuing to work the growth environment that we're in and determining 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 Audrey, I think we have time for one more question.

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

Hey, good morning. Phebe, 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 derisk 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. Does that answer the question?

Yes. 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, in Eastern and Western Europe remains very, very strong.

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.