Form 10-Q for the quarterly period ended October 4, 2009
Table of Contents

 

LOGO

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 4, 2009

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-3671

 

       GENERAL DYNAMICS CORPORATION       
   (Exact name of registrant as specified in its charter)   

 

Delaware     13-1673581

State or other jurisdiction of

incorporation or organization

   

I.R.S. employer

identification no.

 

2941 Fairview Park Drive, Suite 100

Falls Church, Virginia

    22042-4513
Address of principal executive offices     Zip code

 

  (703) 876-3000  
 

Registrant’s telephone number,

including area code

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes  þ     No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer  þ    Accelerated Filer  ¨    Non-Accelerated Filer  ¨    Smaller Reporting Company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨    No  þ

385,801,290 shares of the registrant’s common stock, $1 par value per share, were outstanding at October 4, 2009.

 

 


Table of Contents

INDEX

 

          PAGE

PART I - FINANCIAL INFORMATION

  

Item 1 -

   Consolidated Financial Statements   
   Consolidated Balance Sheet    3
   Consolidated Statement of Earnings (Three Months)    4
   Consolidated Statement of Earnings (Nine Months)    5
   Consolidated Statement of Cash Flows    6
   Notes to Unaudited Consolidated Financial Statements    7

Item 2 -

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    28

Item 3 -

   Quantitative and Qualitative Disclosures About Market Risk    41

Item 4 -

   Controls and Procedures    41

FORWARD-LOOKING STATEMENTS

   42

PART II - OTHER INFORMATION

  

Item 1 -

   Legal Proceedings    43

Item 1A -

   Risk Factors    43

Item 2 -

   Unregistered Sales of Equity Securities and Use of Proceeds    43

Item 6 -

   Exhibits    44

SIGNATURES

   45

 

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PART I – FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEET

 

(Dollars in millions)    (Unaudited)
October 4
2009
    December 31
2008
 

ASSETS

                

Current assets:

    

Cash and equivalents

   $ 1,409      $ 1,621   

Accounts receivable

     3,851        3,469   

Contracts in process

     4,472        4,341   

Inventories

     2,112        2,029   

Other current assets

     384        490   

Total current assets

     12,228        11,950   

Noncurrent assets:

    

Property, plant and equipment, net

     2,874        2,872   

Intangible assets, net

     1,846        1,617   

Goodwill

     12,410        11,413   

Other assets

     417        521   

Total noncurrent assets

     17,547        16,423   

Total assets

   $ 29,775      $ 28,373   

LIABILITIES AND SHAREHOLDERS’ EQUITY

                

Current liabilities:

    

Short-term debt and current portion of long-term debt

   $ 705      $ 911   

Accounts payable

     2,316        2,443   

Customer advances and deposits

     4,078        4,154   

Other current liabilities

     2,728        2,852   

Total current liabilities

     9,827        10,360   

Noncurrent liabilities:

    

Long-term debt

     3,159        3,113   

Other liabilities

     5,071        4,847   

Commitments and contingencies (See Note K)

                

Total noncurrent liabilities

     8,230        7,960   

Shareholders’ equity:

    

Common stock

     482        482   

Surplus

     1,457        1,346   

Retained earnings

     14,626        13,287   

Treasury stock

     (3,412     (3,349

Accumulated other comprehensive loss

     (1,435     (1,713

Total shareholders’ equity

     11,718        10,053   

Total liabilities and shareholders’ equity

   $ 29,775      $ 28,373   

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of this statement.

 

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CONSOLIDATED STATEMENT OF EARNINGS

(UNAUDITED)

 

     Three Months Ended  
(Dollars in millions, except per share amounts)    October 4
2009
    September 28
2008
 

Revenues:

    

Products

   $ 5,180      $ 4,828   

Services

     2,539        2,312   
       7,719        7,140   

Operating costs and expenses:

    

Products

     4,515        4,113   

Services

     2,330        2,094   
       6,845        6,207   

Operating earnings

     874        933   

Interest, net

     (40     (11

Other, net

     (6     —     

Earnings from continuing operations before income taxes

     828        922   

Provision for income taxes, net

     253        288   

Earnings from continuing operations

     575        634   

Discontinued operations, net of tax

     (3     —     

Net earnings

   $ 572      $ 634   

Earnings per share

    

Basic:

    

Continuing operations

   $ 1.49      $ 1.60   

Discontinued operations

     (0.01     —     

Net earnings

   $ 1.48      $ 1.60   

Diluted:

    

Continuing operations

   $ 1.48      $ 1.59   

Discontinued operations

     (0.01     —     

Net earnings

   $ 1.47      $ 1.59   

Supplemental information:

    

General and administrative expenses included in operating costs and expenses

   $ 452      $ 414   

Dividends per share

   $ 0.38      $ 0.35   

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of this statement.

 

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CONSOLIDATED STATEMENT OF EARNINGS

(UNAUDITED)

 

     Nine Months Ended  
(Dollars in millions, except per share amounts)    October 4
2009
    September 28
2008
 

Revenues:

    

Products

   $ 16,516      $ 14,792   

Services

     7,567        6,656   
       24,083        21,448   

Operating costs and expenses:

    

Products

     14,432        12,727   

Services

     6,927        6,006   
       21,359        18,733   

Operating earnings

     2,724        2,715   

Interest, net

     (117     (42

Other, net

     (3     3   

Earnings from continuing operations before income taxes

     2,604        2,676   

Provision for income taxes, net

     815        828   

Earnings from continuing operations

     1,789        1,848   

Discontinued operations, net of tax

     (9     (1

Net earnings

   $ 1,780      $ 1,847   

Earnings per share

    

Basic:

    

Continuing operations

   $ 4.64      $ 4.63   

Discontinued operations

     (0.02     —     

Net earnings

   $ 4.62      $ 4.63   

Diluted:

    

Continuing operations

   $ 4.62      $ 4.60   

Discontinued operations

     (0.02     —     

Net earnings

   $ 4.60      $ 4.60   

Supplemental information:

    

General and administrative expenses included in operating costs and expenses

   $ 1,471      $ 1,295   

Dividends per share

   $ 1.14      $ 1.05   

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of this statement.

 

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CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

 

     Nine Months Ended  
(Dollars in millions)    October 4
2009
    September 28
2008
 

Cash flows from operating activities:

    

Net earnings

   $ 1,780      $ 1,847   

Adjustments to reconcile net earnings to net cash provided by operating activities –

    

Depreciation of property, plant and equipment

     257        223   

Amortization of intangible assets

     161        103   

Stock-based compensation expense

     87        78   

Deferred income tax provision

     189        83   

Discontinued operations, net of tax

     9        1   

(Increase) decrease in assets, net of effects of business acquisitions –

    

Accounts receivable

     (324     (207

Contracts in process

     (80     (18

Inventories

     (56     (125

Increase (decrease) in liabilities, net of effects of business acquisitions –

    

Accounts payable

     (146     (259

Customer advances and deposits

     (238     759   

Other current liabilities

     (218     (139

Other, net

     (64     (27

Net cash provided by operating activities from continuing operations

     1,357        2,319   

Net cash used by discontinued operations – operating activities

     (12     (5

Net cash provided by operating activities

     1,345        2,314   

Cash flows from investing activities:

    

Business acquisitions, net of cash acquired

     (805     (303

Capital expenditures

     (251     (314

Sales/maturities of available-for-sale securities

     234        1,341   

Purchases of available-for-sale securities

     (129     (1,365

Other, net

     30        31   

Net cash used by investing activities

     (921     (610

Cash flows from financing activities:

    

Repayment of commercial paper, net

     (904     —     

Proceeds from fixed-rate notes, net

     747        —     

Dividends paid

     (430     (397

Purchases of common stock

     (109     (1,047

Proceeds from option exercises

     68        148   

Repayment of fixed-rate notes

     —          (500

Repayment of senior notes

     —          (150

Other, net

     (8     (32

Net cash used by financing activities

     (636     (1,978

Net decrease in cash and equivalents

     (212     (274

Cash and equivalents at beginning of period

     1,621        2,891   

Cash and equivalents at end of period

   $ 1,409      $ 2,617   

Supplemental cash flow information:

    

Cash payments for:

    

Income taxes

   $ 614      $ 728   

Interest

   $ 114      $ 100   

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of this statement.

 

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per share amounts or unless otherwise noted)

 

A. Basis of Preparation

Basis of Consolidation and Classification

The unaudited Consolidated Financial Statements included in this Form 10-Q include the accounts of General Dynamics Corporation and our wholly owned and majority-owned subsidiaries. We eliminate all inter-company balances and transactions in the consolidated statements.

Consistent with defense industry practice, we classify assets and liabilities related to long-term production contracts as current, even though some of these amounts are not expected to be realized within one year. In addition, some prior-year amounts have been reclassified among financial statement accounts to conform to the current-year presentation.

Interim Financial Statements

The unaudited Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. These rules and regulations permit some of the information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) to be condensed or omitted.

Our fiscal quarters are 13 weeks in length. Because our fiscal year ends on December 31, the number of days in our first and fourth quarters varies slightly from year to year. Operating results for the three- and nine-month periods ended October 4, 2009, are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

In our opinion, the unaudited Consolidated Financial Statements contain all adjustments, that are of a normal recurring nature, necessary for a fair presentation of our results for the three- and nine-month periods ended October 4, 2009, and September 28, 2008.

We have evaluated material events and transactions that have occurred after the balance sheet date and concluded that no subsequent events have occurred through November 3, 2009, that require adjustment to or disclosure in this Form 10-Q.

These unaudited Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2008.

 

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B. Acquisitions, Intangible Assets and Goodwill

In the first nine months of 2009, we acquired two businesses in the Information Systems and Technology group for an aggregate of $805 in cash.

 

   

Axsys Technologies, Inc. (Axsys), of Rocky Hill, Connecticut, on September 2. Axsys designs and manufactures high-performance electro-optical and infrared (EO/IR) sensors and systems and multi-axis stabilized cameras.

 

   

A business that performs work for our classified customers.

In 2008, we acquired five businesses for an aggregate of approximately $3.2 billion in cash.

Aerospace

 

   

Jet Aviation of Zurich, Switzerland, on November 5. Jet Aviation performs aircraft completions and refurbishments for business jets and commercial aircraft, aircraft support services, and management and fixed-base operations (FBO) services for a broad global customer base.

Combat Systems

 

   

AxleTech International (AxleTech) of Troy, Michigan, on December 19. AxleTech is a global manufacturer and supplier of highly engineered drive train components and aftermarket parts for heavy-payload military and commercial customers.

Marine Systems

 

   

HSI Electric, Inc. (HSI), of Honolulu, Hawaii, on July 23. HSI is a marine and industrial electrical company specializing in electrical apparatus installation, maintenance, troubleshooting and repair.

Information Systems and Technology

 

   

ViPS, Inc. (ViPS), a wholly owned subsidiary of HLTH Corporation, of Towson, Maryland, on July 22. ViPS is a leading provider of high-end healthcare technology solutions, including data management, analytics, decision support and process automation, that support both U.S. federal government agencies and commercial healthcare organizations.

 

   

Integrated Defense Systems, Inc. (IDSI), of Glen Rock, Pennsylvania, on February 29. IDSI produces advanced filtering technologies and broadband power amplifiers for tactical communications applications for military and other government customers.

We funded the above acquisitions using cash on hand and commercial paper borrowings. The operating results of these businesses have been included with our reported results since the respective closing dates of the acquisitions. The purchase prices of these businesses have been allocated to the estimated fair value of net tangible and intangible assets acquired, with any excess purchase price recorded as goodwill. Some of the estimates related to the Jet Aviation and Axsys acquisitions were still preliminary at October 4, 2009. We are in the process of identifying and valuing intangible and other assets and liabilities acquired. The completion of these analyses could result in an increase or decrease to the preliminary value assigned to these acquired assets and liabilities, as well as to future periods’ amortization expense. We expect the analyses to be completed during 2009 without any material adjustments.

 

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Intangible assets consisted of the following:

 

     October 4 2009    December 31 2008
      Gross
Carrying
Amount
   Accumulated
Amortization
    Net
Carrying
Amount
   Gross
Carrying
Amount
   Accumulated
Amortization
    Net
Carrying
Amount

Contract and program intangible assets

   $ 1,965    $ (714   $ 1,251    $ 1,580    $ (613   $ 967

Other intangible assets

     897      (302     595      892      (242     650

Total intangible assets

   $ 2,862    $ (1,016   $ 1,846    $ 2,472    $ (855   $ 1,617

Contract and program intangible assets represent primarily acquired backlog and probable follow-on work and related customer relationships. We amortize these assets over seven to 40 years. The weighted-average amortization life of these assets on October 4, 2009, was 16 years. Other intangible assets consist primarily of aircraft product design and customer lists, amortized over nine and 21 years, respectively, and software and licenses, amortized over three to 24 years. We amortize intangible assets on a straight-line basis unless the pattern of usage of the benefits indicates an alternative method is more representative of the usage of the asset.

Amortization expense was $53 and $161 for the three- and nine-month periods ended October 4, 2009, and $36 and $103 for the three- and nine-month periods ended September 28, 2008. We expect to record annual amortization expense over the next five years as follows:

 

2010

   $     230

2011

   $ 223

2012

   $ 218

2013

   $ 183

2014

   $ 155

The changes in the carrying amount of goodwill by business group for the nine months ended October 4, 2009, were as follows:

 

      Aerospace    Combat
Systems
    Marine
Systems
   Information
Systems and
Technology
   Total
Goodwill

December 31, 2008

   $ 2,316    $ 2,638      $ 192    $ 6,267    $ 11,413

Acquisitions (a)

     257      (80     1      575      753

Other (b)

     79      131        5      29      244

October 4, 2009

   $ 2,652    $ 2,689      $ 198    $ 6,871    $ 12,410

 

  (a) Includes adjustments to preliminary assignment of fair value to net assets acquired.

 

  (b) Consists primarily of adjustments for foreign currency translation.

 

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C. Earnings per Share and Comprehensive Income

Earnings per Share

We calculate basic earnings per share using net earnings for the period and the weighted average number of common shares outstanding during the period. Diluted earnings per share incorporates the incremental shares issuable upon the assumed exercise of stock options and the release of restricted shares.

Basic and diluted weighted average shares outstanding were as follows (in thousands):

 

     Three Months Ended    Nine Months Ended
      October 4
2009
   September 28
2008
   October 4
2009
   September 28
2008

Basic weighted average shares outstanding

   385,243    396,748    385,374    398,666

Dilutive effect of stock options and restricted stock

   2,845    3,029    1,840    3,135

Diluted weighted average shares outstanding

   388,088    399,777    387,214    401,801

In addition to the method described above, we are required to calculate earnings per share under the “two-class” method, as our nonvested restricted stock awards are deemed participating securities under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 260, Earnings Per Share. However, the application of the two-class method had no measurable impact on our earnings per share for the three- and nine-month periods ended October 4, 2009, and September 28, 2008.

Comprehensive Income

Our comprehensive income was $796 and $2.1 billion for the three- and nine-month periods ended October 4, 2009, respectively, and $501 and $1.7 billion for the three- and nine-month periods ended September 28, 2008, respectively. The primary components of our comprehensive income are net earnings, and foreign currency translation adjustments of $211 and $257 for the three- and nine-month periods ended October 4, 2009, respectively, and ($110) and ($58) for the three- and nine-month periods ended September 28, 2008, respectively.

 

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D. Fair Value of Financial Instruments

Our financial instruments include cash and equivalents, marketable securities and other investments; accounts receivable and accounts payable; short- and long-term debt; and derivative financial instruments. We did not have any significant non-financial assets or liabilities measured at fair value on October 4, 2009.

The carrying values of cash and equivalents, accounts receivable and payable, and short-term debt (commercial paper) on the Consolidated Balance Sheet approximate their fair value. The following table presents the fair values of our other financial assets and liabilities on October 4, 2009, and December 31, 2008, and the basis for determining their fair values:

 

Financial assets (liabilities)    Fair
Value
    Quoted Prices
in Active
Markets for
Identical Assets
   Significant
Other
Observable
Inputs
 

October 4, 2009

                       

Marketable securities*

   $ 29      $ 29    $ —     

Other investments*

     111        111      —     

Derivatives*

     12        —        12   

Long-term debt, including current portion

     (4,099     —        (4,099

December 31, 2008

                       

Marketable securities*

   $ 143      $ 143    $ —     

Other investments*

     98        98      —     

Derivatives*

     (77     —        (77

Long-term debt, including current portion

     (3,168     —        (3,168

 

  * Reported on the Consolidated Balance Sheet at fair value.

 

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E. Contracts in Process

Contracts in process represents recoverable costs and, where applicable, accrued profit related to long-term contracts that have been inventoried until the customer is billed, and consisted of the following:

 

      October 4
2009
   December 31
2008

Contract costs and estimated profits

   $   15,266    $   12,904

Other contract costs

     1,038      1,078
     16,304      13,982

Less advances and progress payments

     11,832      9,641

Total contracts in process

   $ 4,472    $ 4,341

Contract costs consist primarily of labor and material costs and related overhead and general and administrative (G&A) expenses. Contract costs also include contract recoveries for matters such as contract changes, negotiated settlements and claims for unanticipated contract costs, which totaled approximately $50 on October 4, 2009, and approximately $40 on December 31, 2008. We record revenue associated with these matters only when recovery can be estimated reliably and realization is probable. Contract costs on December 31, 2008, included approximately $215 associated with our contract to provide Pandur II wheeled vehicles to the Czech Republic. In the first quarter of 2009, we signed a renegotiated contract with the Czech Republic for the purchase of 107 vehicles, including 17 previously completed vehicles. Under the terms of the revised contract, we billed and collected the majority of the December 31, 2008, contracts-in-process balance and expect to recover the remaining balance over the course of the revised contract.

Other contract costs represent amounts recorded under GAAP that are not currently allocable to government contracts, such as a portion of our estimated workers’ compensation, other insurance-related assessments, pension and other post-retirement benefits, and environmental expenses. Some of these liabilities are discounted at contractual rates agreed to with our U.S. government customers. These costs will become allocable to contracts generally when they are paid. We expect to recover these costs through ongoing business, including existing backlog and probable follow-on contracts. This business base includes numerous contracts for which we are the sole source or are one of two suppliers on long-term U.S. defense programs. However, if the backlog in the future does not support the continued deferral of these costs, the profitability of our remaining contracts could be adversely affected. We expect to bill substantially all of our October 4, 2009, contracts-in-process balance, with the exception of these other contract costs, during the next 12 months.

 

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F. Inventories

Inventories represent primarily commercial aircraft components and consisted of the following:

 

      October 4
2009
   December 31
2008

Raw materials

   $ 1,124    $ 1,001

Work in process

     890      876

Pre-owned aircraft

     62      100

Other

     36      52

Total inventories

   $ 2,112    $ 2,029

 

G. Debt

Debt consisted of the following:

 

      Interest Rate     October 4
2009
   December 31
2008

Fixed-rate notes due:

       

August 2010

   4.500   $ 700    $ 700

July 2011

   1.800     747      —  

May 2013

   4.250     999      999

February 2014

   5.250     996      995

August 2015

   5.375     400      400

Commercial paper, net of unamortized discount

   —          —        905

Other

   Various        22      25

Total debt

       3,864      4,024

Less current portion

           705      911

Long-term debt

         $ 3,159    $ 3,113

Fixed-rate Notes

On October 4, 2009, we had outstanding $3.8 billion aggregate principal amount of fixed-rate notes. This included $750 of two-year fixed-rate notes issued on June 24, 2009, and $1 billion of five-year fixed-rate notes issued on December 15, 2008, pursuant to a Form S-3 Registration Statement filed with the Securities and Exchange Commission under the Securities Act of 1933 on December 8, 2008. The fixed-rate notes are fully and unconditionally guaranteed by several of our 100-percent-owned subsidiaries. We have the option to redeem the notes prior to their maturity in whole or in part at 100 percent of the principal plus any accrued but unpaid interest and any applicable make-whole amounts. See Note N for condensed consolidating financial statements.

 

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Commercial Paper

On October 4, 2009, we had no commercial paper outstanding but maintain the ability to access the market. We have approximately $1.8 billion in bank credit facilities that provide backup liquidity to our commercial paper program. These credit facilities consist of an $815 364-day facility expiring in July 2010 and a $975 multi-year facility expiring in December 2011. These facilities are required by rating agencies to support the A1/P1 rating of our commercial paper issuances. Our commercial paper issuances and the bank credit facilities are guaranteed by several of our 100-percent-owned subsidiaries. Additionally, a number of our international subsidiaries have available local bank credit facilities aggregating approximately $970.

Other

On October 4, 2009, other debt consisted primarily of a capital lease arrangement and debt assumed in connection with our recent acquisitions.

Our financing arrangements contain a number of customary covenants and restrictions. We were in compliance with all material covenants on October 4, 2009.

 

H. Liabilities

A summary of significant liabilities, by balance sheet caption, follows:

 

      October 4
2009
   December 31
2008

Salaries and wages

   $ 650    $ 613

Workers’ compensation

     500      469

Retirement benefits

     394      566

Other (a)

     1,184      1,204

Total other current liabilities

   $ 2,728    $ 2,852

Retirement benefits

   $ 3,117    $ 3,063

Customer deposits on commercial contracts

     1,013      1,174

Deferred income taxes

     350      99

Other (b)

     591      511

Total other liabilities

   $ 5,071    $ 4,847

 

  (a) Consists primarily of income tax liabilities, dividends payable, environmental remediation reserves, warranty reserves, liabilities of discontinued operations and insurance-related costs.

 

  (b) Consists primarily of liabilities for warranty reserves and workers’ compensation.

 

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I. Income Taxes

Our net deferred tax asset (liability) was included in the Consolidated Balance Sheet as follows:

 

      October 4
2009
    December 31
2008
 

Current deferred tax asset

   $ 60      $ 57   

Current deferred tax liability

     (54     (62

Noncurrent deferred tax asset

     62        111   

Noncurrent deferred tax liability

     (350     (99

Net deferred tax (liability) asset

   $ (282   $ 7   

On November 27, 2001, we filed a refund suit in the U.S. Court of Federal Claims, titled General Dynamics v. United States, for the years 1991 to 1993. We added the years 1994 to 1998 to the litigation on June 23, 2004. The suit sought recovery of refund claims that were disallowed by the Internal Revenue Service (IRS) at the administrative level. On December 30, 2005, the court issued its opinion regarding one of the matters in the case. The court held that we could not treat the A-12 contract as complete for federal income tax purposes in 1991, the year the contract was terminated. (See Note K for more information regarding the A-12 contract.) On the other issues in the case, we reached a settlement in 2008 with the U.S. Department of Justice acting on behalf of the United States. As a result of the settlement, we reduced our tax provision in the second quarter of 2008 by $35, or $0.09 per share. In the fourth quarter of 2008, we received a refund of $45, including taxable interest, and the court dismissed the case.

In the third quarter of 2009, we reached agreement with the IRS on the examination of our federal income tax returns for 2005 and 2006. The resolution of this audit had no material impact on our results of operations, financial condition, cash flows or effective tax rate. With the completion of this audit, the IRS has examined all of our consolidated federal income tax returns through 2006.

The IRS has begun its examination of our 2007 to 2009 tax returns. We have recorded liabilities for tax uncertainties for all years that remain open to review. We do not expect the resolution of tax matters for these years to have a material impact on our results of operations, financial condition, cash flows or effective tax rate.

With respect to income tax uncertainties, based on all known facts and circumstances and current tax law, we believe the total amount of unrecognized tax benefits on October 4, 2009, is not material to our results of operations, financial condition or cash flows. We also believe that the total amount of unrecognized tax benefits on October 4, 2009, if recognized, would not have a material impact on our effective tax rate. We further believe that there are no tax positions for which it is reasonably possible that the unrecognized tax benefits will significantly increase or decrease over the next 12 months producing, individually or in the aggregate, a material effect on our results of operations, financial condition or cash flows.

 

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J. Derivative Instruments and Hedging Activities

We are exposed to market risk, primarily from foreign currency exchange rates, interest rates, commodity prices and investments. We may use derivative financial instruments to hedge some of these risks as described below. We do not use derivatives for trading or speculative purposes.

Foreign Currency Risk

Our foreign currency exchange rate risk relates to receipts from customers, payments to suppliers and inter-company transactions denominated in foreign currencies. We periodically enter into derivative financial instruments, principally foreign currency forward purchase and sale contracts with terms of less than three years. These instruments are designed to fix, or limit the adverse impact on, the amount of firmly committed and forecasted foreign currency-denominated payments, receipts and inter-company transactions related to our ongoing business and operational financing activities.

Interest Rate Risk

Our financial instruments subject to interest rate risk include variable-rate commercial paper and short-term investments. However, the risk associated with these instruments is not material.

Commodity Price Risk

We are subject to risk of rising labor and commodity prices, primarily on long-term fixed-price contracts. To the extent possible, we include terms in our contracts that are designed to protect us from this risk. Some of the protective terms included in our contracts are considered derivatives but are not accounted for separately because they are clearly and closely related to the host contract. We have not entered into any material commodity hedging contracts but may do so as circumstances warrant. We do not believe that changes in labor or commodity prices will have a material impact on our results of operations or cash flows.

Investment Risk

Our investment policy allows for purchases of fixed-income securities with an investment-grade rating and a maximum maturity of one year. On October 4, 2009, we held $1.4 billion in cash and equivalents and marketable securities to be used for general corporate purposes. Our marketable securities have an average duration of two months and an average credit rating of AA. Historically, we have not experienced material gains or losses on these instruments due to changes in interest rates or market values.

Hedging Activities

On October 4, 2009, and December 31, 2008, we had $2.1 billion and $2.4 billion, respectively, in notional forward foreign exchange contracts outstanding. We recognize derivative financial instruments on the Consolidated Balance Sheet at fair value (see Note D). The fair value of these derivative contracts recognized in the Consolidated Balance Sheet consisted of the following:

 

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      October 4
2009
    December 31
2008
 

Other current assets:

    

Designated as cash flow hedges

   $ 35      $ 40   

Not designated as cash flow hedges

     9        11   

Other current liabilities:

    

Designated as cash flow hedges

     (25     (119

Not designated as cash flow hedges

     (7     (9

Total

   $ 12      $ (77

We had no material derivative financial instruments designated as fair value or net investment hedges on October 4, 2009, or December 31, 2008.

Changes in the fair value of derivative financial instruments are recorded in operating costs and expenses in the Consolidated Statement of Earnings or in accumulated other comprehensive income (AOCI) within shareholders’ equity on the Consolidated Balance Sheet, depending on whether the derivative is designated and qualifies for hedge accounting. Gains and losses related to derivatives that qualify as cash flow hedges are deferred in AOCI until the underlying transaction is reflected in earnings. We adjust derivative financial instruments not designated as cash flow hedges to market value each period and record the gain or loss in the Consolidated Statement of Earnings. The gains and losses on these instruments generally offset losses and gains on the assets, liabilities and other transactions being hedged. Gains and losses resulting from hedge ineffectiveness are recognized in the Consolidated Statement of Earnings for all derivative financial instruments, regardless of designation.

Net gains and losses recognized in earnings and AOCI, including gains and losses related to hedge ineffectiveness, were not material for the three- and nine-month periods ended October 4, 2009, and September 28, 2008. We do not expect the amount of gains and losses in AOCI that will be reclassified to earnings during the next 12 months to be material.

Foreign Currency Financial Statement Translation

We translate foreign-currency balance sheets from our international business units’ functional currency (generally the respective local currency) to U.S. dollars at the end-of-period exchange rates, and earnings statements at the average exchange rates for each period. We do not hedge the fluctuation in reported revenues and earnings resulting from the translation of these international operations’ income statements into U.S. dollars. The impact of translating our international operations’ revenues and earnings into U.S. dollars was not material to our results of operations for the three- and nine-month periods ended October 4, 2009, or September 28, 2008.

 

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K. Commitments and Contingencies

Litigation

Termination of A-12 Program. In January 1991, the U.S. Navy terminated our A-12 aircraft contract for default. The A-12 contract was a fixed-price incentive contract for the full-scale development and initial production of the Navy’s carrier-based Advanced Tactical Aircraft. We and McDonnell Douglas, the contractors, were parties to the contract with the Navy. (McDonnell Douglas is now owned by The Boeing Company.) Both contractors had full responsibility to the Navy for performance under the contract, and both are jointly and severally liable for potential liabilities arising from the termination. As a consequence of the termination for default, the Navy demanded the contractors repay $1.4 billion in unliquidated progress payments. The Navy agreed to defer collection of that amount pending a decision by the U.S. Court of Federal Claims (the trial court) on the contractors’ challenge to the termination for default, or a negotiated settlement.

On December 19, 1995, the trial court issued an order converting the termination for default to a termination for convenience. On March 31, 1998, a final judgment was entered in favor of the contractors for $1.2 billion plus interest.

On July 1, 1999, the U.S. Court of Appeals for the Federal Circuit (the appeals court) remanded the case to the trial court for determination of whether the government’s default termination was justified. On August 31, 2001, following the trial on remand, the trial court upheld the default termination of the A-12 contract. In its opinion, the trial court rejected all of the government’s arguments to sustain the default termination except for the government’s schedule arguments, as to which the trial court held that the schedule the government unilaterally imposed was reasonable and enforceable, and that the government had not waived that schedule. On the sole ground that the contractors were not going to deliver the first aircraft on the date provided in the unilateral schedule, the trial court upheld the default termination and entered judgment for the government.

On January 9, 2003, an appeal was argued before a three-judge panel of the appeals court. On March 17, 2003, the appeals court vacated the trial court’s judgment and remanded the case to the trial court for further proceedings. The appeals court found that the trial court had misapplied the controlling legal standard in concluding the termination for default could be sustained solely on the basis of the contractors’ inability to complete the first flight of the first test aircraft by December 1991. Rather, the appeals court held that to uphold a termination for default, the trial court would have to determine that there was no reasonable likelihood that the contractors could perform the entire contract effort within the time remaining for performance.

On May 3, 2007, the trial court issued a decision upholding the government’s default termination. We appealed the trial court’s decision. On June 2, 2009, a three-judge panel of the appeals court affirmed the trial court’s decision. We have petitioned the appeals court for a rehearing of its decision, either by the panel or by the full appeals court. The appeals court requested a response from the government, which was filed on October 20, 2009. We continue to believe that the law and facts support a determination that the government’s default termination was not justified.

If, contrary to our expectations, the default termination is ultimately sustained, the contractors could collectively be required to repay the government as much as $1.4 billion for progress payments received for the A-12 contract, plus interest, which was approximately $1.5 billion at October 4, 2009. This would result in a liability to us of half of the total, or approximately $1.4 billion pretax. Our after-

 

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tax charge would be approximately $795, or $2.05 per share, to be recorded in discontinued operations. Our after-tax cash cost would be approximately $710. We believe we have sufficient resources to satisfy our obligation if required.

Other. Various claims and other legal proceedings incidental to the normal course of business are pending or threatened against us. While we cannot predict the outcome of these matters, we believe any potential liabilities in these proceedings, individually or in the aggregate, will not have a material impact on our results of operations, financial condition or cash flows.

Environmental

We are subject to and affected by a variety of federal, state, local and foreign environmental laws and regulations. We are directly or indirectly involved in environmental investigations or remediation at some of our current and former facilities, and at third-party sites that we do not own but where we have been designated a Potentially Responsible Party (PRP) by the U.S. Environmental Protection Agency or a state environmental agency. Based on historical experience, we expect that a significant percentage of the total remediation and compliance costs associated with these facilities will continue to be allowable contract costs and, therefore, reimbursed by the U.S. government.

As required, we provide financial assurance for certain sites undergoing or subject to investigation or remediation. Where applicable, we seek insurance recovery for costs related to environmental liabilities. We do not record insurance recoveries before collection is considered probable. Based on all known facts and analyses, as well as current U.S. government policies relating to allowable costs, we do not believe that our liability at any individual site, or in the aggregate, arising from such environmental conditions, will be material to our results of operations, financial condition or cash flows. We also do not believe that the range of reasonably possible additional loss beyond what has been recorded would be material to our results of operations, financial condition or cash flows.

Other

Letters of Credit. In the ordinary course of business, we have entered into letters of credit and other similar arrangements with financial institutions and insurance carriers totaling approximately $2.0 billion on October 4, 2009. From time to time in the ordinary course of business, we guarantee the payment or performance obligations of our subsidiaries arising under certain contracts. We are aware of no event of default that would require us to satisfy these guarantees.

Government Contracts. As a government contractor, we are subject to U.S. government audits and investigations relating to our operations, including claims for fines, penalties, and compensatory and treble damages. Based on currently available information, we believe the outcome of such ongoing government disputes and investigations will not have a material impact on our results of operations, financial condition or cash flows.

Aircraft Trade-ins. In connection with orders for new aircraft in funded contract backlog, our Aerospace group has offered options to some customers to trade in aircraft as partial consideration in the new-aircraft transaction. These options were historically structured as predetermined minimum trade-in options with a fair value determined at contract signing. As the group’s contract backlog grew and the period from contract signing to scheduled entry into service extended, all new trade-in commitments were structured to establish the fair market value of the trade-in aircraft at a date generally 120 or fewer days preceding delivery of the new aircraft to the customer. At that time, the customer is required to either

 

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exercise the option or allow its expiration. Any excess of the pre-established trade-in price above the fair market value at the time the new aircraft is delivered is treated as a reduction of revenue in the new-aircraft sales transaction.

As of October 4, 2009, we have three fair market value trade-in options associated with aircraft scheduled to deliver in the fourth quarter of 2009, two of which have been exercised by the customer. Beyond these commitments, additional fair market value trade-in options remain outstanding, including six scheduled to deliver in 2010. Two options offered at a predetermined minimum trade-in price remained unexercised on October 4, 2009. These commitments, totaling $48, are associated with aircraft scheduled to deliver in 2010. The estimated decline in fair market value from the date of commitment through October 4, 2009, for these two aircraft is not material.

Product Warranties. We provide product warranties to our customers associated with certain product sales, particularly business-jet aircraft. We record estimated warranty costs in the period in which the related products are delivered. The warranty liability recorded at each balance sheet date is based on the number of months of warranty coverage remaining for products delivered and the average historical monthly warranty payments, and is included in other current liabilities and other liabilities on the Consolidated Balance Sheet.

The changes in the carrying amount of warranty liabilities for the nine-month periods ended October 4, 2009, and September 28, 2008, were as follows:

 

Nine Months Ended    October 4
2009
    September 28
2008
 

Beginning balance

   $ 221      $ 237   

Warranty expense

     49        54   

Payments

     (46     (36

Adjustments (a)

     3        (40

Ending balance (b)

   $ 227      $ 215   

 

  (a) Includes warranty liabilities assumed in connection with acquisitions, foreign exchange translation adjustments and reclassifications.

 

  (b) Warranty obligations incurred in connection with long-term production contracts are accounted for within the contract estimates at completion (EACs) and are excluded from the above amounts.

 

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L. Retirement Plans

We provide defined-benefit pension and other post-retirement benefits, as well as defined-contribution benefits, to eligible employees.

We made a $250 contribution to our pension plans in the third quarter of 2009. Net periodic pension and other post-retirement benefit costs for the three- and nine-month periods ended October 4, 2009, and September 28, 2008, consisted of the following:

 

     Pension Benefits    

Other

Post-retirement Benefits

 
Three Months Ended    October 4
2009
    September 28
2008
    October 4
2009
    September 28
2008
 

Service cost

   $ 52      $ 51      $ 2      $ 4   

Interest cost

     123        111        16        16   

Expected return on plan assets

     (144     (148     (8     (7

Recognized net actuarial loss (gain)

     7        1        (2     —     

Amortization of prior service credit

     (12     (12     —          —     

Net periodic cost

   $ 26      $ 3      $ 8      $ 13   
     Pension Benefits    

Other

Post-retirement Benefits

 
Nine Months Ended    October 4
2009
    September 28
2008
    October 4
2009
    September 28
2008
 

Service cost

   $ 156      $ 153      $ 6      $ 12   

Interest cost

     368        333        48        49   

Expected return on plan assets

     (431     (446     (24     (21

Recognized net actuarial loss (gain)

     21        3        (6     1   

Amortization of prior service (credit) cost

     (35     (36     —          1   

Net periodic cost

   $ 79      $ 7      $ 24      $ 42   

Our contractual arrangements with the U.S. government provide for the recovery of contributions to our pension plans covering employees working in our government contracting businesses. With respect to post-retirement benefit plans, our government contracts provide for the recovery of contributions to a Voluntary Employees’ Beneficiary Association trust and, for non-funded plans, recovery of claims paid. The cumulative pension and post-retirement benefit cost for some of these plans exceeds our cost currently allocable to contracts. To the extent recovery of the cost is considered probable based on our backlog, we defer the excess in contracts in process on the Consolidated Balance Sheet until the cost is paid, charged to contracts and included in revenues. For other plans, the amount contributed to the plans, charged to contracts and included in revenues has exceeded the plans’ cumulative benefit cost. We have deferred recognition of these excess earnings to provide a better matching of revenues and expenses. These deferrals have been classified against the prepaid benefit cost related to these plans. (See Note E for discussion of our deferred contract costs.)

 

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M. Business Group Information

We operate in four business groups: Aerospace, Combat Systems, Marine Systems and Information Systems and Technology. We organize and measure our business groups in accordance with the nature of products and services offered. These business groups derive their revenues from business aviation; combat vehicles, weapons systems and munitions; shipbuilding design and construction; and information systems, technologies and services, respectively. We measure each group’s profit based on operating earnings. As a result, we do not allocate net interest, other income and expense items, and income taxes to our business groups.

Summary operating results for each of our business groups follows:

 

     Revenues    Operating Earnings  
Three Months Ended    October 4
2009
   September 28
2008
   October 4
2009
    September 28
2008
 

Aerospace

   $ 1,120    $ 1,372    $ 125      $ 281   

Combat Systems

     2,347      1,850      316        262   

Marine Systems

     1,518      1,404      155        140   

Information Systems and Technology

     2,734      2,514      296        270   

Corporate*

     —        —        (18     (20
     $ 7,719    $ 7,140    $ 874      $ 933   
     Revenues    Operating Earnings  
Nine Months Ended    October 4
2009
   September 28
2008
   October 4
2009
    September 28
2008
 

Aerospace

   $ 3,990    $ 3,980    $ 540      $ 757   

Combat Systems

     7,159      5,862      895        803   

Marine Systems

     4,812      4,176      486        389   

Information Systems and Technology

     8,122      7,430      869        822   

Corporate*

     —        —        (66     (56
     $ 24,083    $ 21,448    $ 2,724      $ 2,715   

 

  * Corporate operating results include our stock option expense and a portion of the operating results of our commercial pension plans.

 

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N. Condensed Consolidating Financial Statements

The fixed-rate notes described in Note G are fully and unconditionally guaranteed on an unsecured, joint and several basis by certain of our 100-percent-owned subsidiaries (the guarantors). The following condensed consolidating financial statements illustrate the composition of the parent, the guarantors on a combined basis (each guarantor together with its majority-owned subsidiaries) and all other subsidiaries on a combined basis.

Condensed Consolidating Statement of Earnings

 

Three Months Ended October 4, 2009    Parent     Guarantors
on a
Combined
Basis
    Other
Subsidiaries
on a
Combined
Basis
    Consolidating
Adjustments
    Total
Consolidated
 

Revenues

   $ —        $ 6,278      $ 1,441      $ —        $ 7,719   

Cost of sales

     —          5,202        1,191        —          6,393   

General and administrative expenses

     23        336        93        —          452   

Operating earnings

     (23     740        157        —          874   

Interest expense

     (42     —          —          —          (42

Interest income

     —          —          2        —          2   

Other, net

     —          (4     (2     —          (6

Earnings from continuing operations before income taxes

     (65     736        157        —          828   

Provision for income taxes

     39        208        6        —          253   

Discontinued operations, net of tax

     —          —          (3     —          (3

Equity in net earnings of subsidiaries

     676        —          —          (676     —     

Net earnings

   $ 572      $ 528      $ 148      $ (676   $ 572   
Three Months Ended September 28, 2008                                    

Revenues

   $ —        $ 6,275      $ 865      $ —        $ 7,140   

Cost of sales

     2        5,090        701        —          5,793   

General and administrative expenses

     18        345        51        —          414   

Operating earnings

     (20     840        113        —          933   

Interest expense

     (23     —          (4     —          (27

Interest income

     8        —          8        —          16   

Other, net

     —          —          —          —          —     

Earnings from continuing operations before income taxes

     (35     840        117        —          922   

Provision for income taxes

     65        196        27        —          288   

Equity in net earnings of subsidiaries

     734        —          —          (734     —     

Net earnings

   $ 634      $ 644      $ 90      $ (734   $ 634   

 

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Condensed Consolidating Statement of Earnings

 

Nine Months Ended October 4, 2009    Parent     Guarantors
on a
Combined
Basis
    Other
Subsidiaries
on a
Combined
Basis
    Consolidating
Adjustments
    Total
Consolidated
 

Revenues

   $ —        $ 19,504      $ 4,579      $ —        $ 24,083   

Cost of sales

     8        16,053        3,827        —          19,888   

General and administrative expenses

     63        1,110        298        —          1,471   

Operating earnings

     (71     2,341        454        —          2,724   

Interest expense

     (122     —          (5     —          (127

Interest income

     1        2        7        —          10   

Other, net

     —          (2     (1     —          (3

Earnings from continuing operations before income taxes

     (192     2,341        455        —          2,604   

Provision for income taxes

     (31     756        90        —          815   

Discontinued operations, net of tax

     —          —          (9     —          (9

Equity in net earnings of subsidiaries

     1,941        —          —          (1,941     —     

Net earnings

   $ 1,780      $ 1,585      $ 356      $ (1,941   $ 1,780   
Nine Months Ended September 28, 2008                                    

Revenues

   $ —        $ 18,701      $ 2,747      $ —        $ 21,448   

Cost of sales

     2        15,189        2,247        —          17,438   

General and administrative expenses

     54        1,066        175        —          1,295   

Operating earnings

     (56     2,446        325        —          2,715   

Interest expense

     (84     —          (14     —          (98

Interest income

     32        (1     25        —          56   

Other, net

     (1     3        1        —          3   

Earnings from continuing operations before income taxes

     (109     2,448        337        —          2,676   

Provision for income taxes

     1        749        78        —          828   

Discontinued operations, net of tax

     —          (1     —          —          (1

Equity in net earnings of subsidiaries

     1,957        —          —          (1,957     —     

Net earnings

   $ 1,847      $ 1,698      $ 259      $ (1,957   $ 1,847   

 

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Condensed Consolidating Balance Sheet

 

October 4, 2009    Parent     Guarantors
on a
Combined
Basis
    Other
Subsidiaries
on a
Combined
Basis
    Consolidating
Adjustments
    Total
Consolidated
 

ASSETS

          

Current assets:

          

Cash and equivalents

   $ 485      $ —        $ 924      $ —        $ 1,409   

Accounts receivable

     —          1,802        2,049        —          3,851   

Contracts in process

     367        3,042        1,063        —          4,472   

Inventories

          

Raw materials

     —          868        256        —          1,124   

Work in process

     —          792        98        —          890   

Pre-owned aircraft

     —          62        —          —          62   

Other

     —          29        7        —          36   

Other current assets

     4        134        246        —          384   

Total current assets

     856        6,729        4,643        —          12,228   

Noncurrent assets:

          

Property, plant and equipment

     139        4,363        1,066        —          5,568   

Accumulated depreciation of PP&E

     (35     (2,226     (433     —          (2,694

Intangible assets

     —          1,635        1,227        —          2,862   

Accumulated amortization of intangible assets

     —          (774     (242     —          (1,016

Goodwill

     —          8,229        4,181        —          12,410   

Other assets

     86        151        180        —          417   

Investment in subsidiaries

     26,647        —          —          (26,647     —     

Total noncurrent assets

     26,837        11,378        5,979        (26,647     17,547   

Total assets

   $ 27,693      $ 18,107      $ 10,622      $ (26,647   $ 29,775   

LIABILITIES AND SHAREHOLDERS’ EQUITY

          

Current liabilities:

          

Short-term debt

   $ 700      $ 1      $ 4      $ —        $ 705   

Customer advances and deposits

     —          1,570        2,508        —          4,078   

Other current liabilities

     383        3,158        1,503        —          5,044   

Total current liabilities

     1,083        4,729        4,015        —          9,827   

Noncurrent liabilities:

          

Long-term debt

     3,142        11        6        —          3,159   

Other liabilities

     2,511        1,954        606        —          5,071   

Total noncurrent liabilities

     5,653        1,965        612        —          8,230   

Intercompany

     9,239        (9,639     400        —          —     

Shareholders’ equity:

          

Common stock, including surplus

     1,939        6,772        3,666        (10,438     1,939   

Retained earnings

     14,626        14,993        1,299        (16,292     14,626   

Other shareholders’ equity

     (4,847     (713     630        83        (4,847

Total shareholders’ equity

     11,718        21,052        5,595        (26,647     11,718   

Total liabilities and shareholders’ equity

   $ 27,693      $ 18,107      $ 10,622      $ (26,647   $ 29,775   

 

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Condensed Consolidating Balance Sheet

 

December 31, 2008    Parent     Guarantors
on a
Combined
Basis
    Other
Subsidiaries
on a
Combined
Basis
    Consolidating
Adjustments
    Total
Consolidated
 

ASSETS

          

Current assets:

          

Cash and equivalents

   $ 746      $ —        $ 875      $ —        $ 1,621   

Accounts receivable

     —          1,532        1,937        —          3,469   

Contracts in process

     402        2,675        1,264        —          4,341   

Inventories

          

Raw materials

     —          907        94        —          1,001   

Work in process

     —          785        91        —          876   

Pre-owned aircraft

     —          100        —          —          100   

Other

     —          60        (8     —          52   

Other current assets

     190        33        267        —          490   

Total current assets

     1,338        6,092        4,520        —          11,950   

Noncurrent assets:

          

Property, plant and equipment

     133        4,199        1,008        —          5,340   

Accumulated depreciation of PP&E

     (30     (2,057     (381     —          (2,468

Intangible assets

     —          1,444        1,028        —          2,472   

Accumulated amortization of intangible assets

     —          (690     (165     —          (855

Goodwill

     —          7,646        3,767        —          11,413   

Other assets

     872        (448     97        —          521   

Investment in subsidiaries

     23,355        —          —          (23,355     —     

Total noncurrent assets

     24,330        10,094        5,354        (23,355     16,423   

Total assets

   $ 25,668      $ 16,186      $ 9,874      $ (23,355   $ 28,373   

LIABILITIES AND SHAREHOLDERS’ EQUITY

          

Current liabilities:

          

Short-term debt

   $ 905      $ 5      $ 1      $ —        $ 911   

Customer advances and deposits

     —          1,771        2,383        —          4,154   

Other current liabilities

     542        3,090        1,663        —          5,295   

Total current liabilities

     1,447        4,866        4,047        —          10,360   

Noncurrent liabilities:

          

Long-term debt

     3,094        8        11        —          3,113   

Other liabilities

     2,513        1,991        343        —          4,847   

Total noncurrent liabilities

     5,607        1,999        354        —          7,960   

Intercompany

     8,561        (8,972     195        216        —     

Shareholders’ equity:

          

Common stock, including surplus

     1,828        6,134        3,091        (9,225     1,828   

Retained earnings

     13,287        12,612        1,951        (14,563     13,287   

Other shareholders’ equity

     (5,062     (453     236        217        (5,062

Total shareholders’ equity

     10,053        18,293        5,278        (23,571     10,053   

Total liabilities and shareholders’ equity

   $ 25,668      $ 16,186      $ 9,874      $ (23,355   $ 28,373   

 

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Condensed Consolidating Statement of Cash Flows

 

Nine Months Ended October 4, 2009    Parent     Guarantors
on a
Combined
Basis
    Other
Subsidiaries
on a
Combined
Basis
    Consolidating
Adjustments
   Total
Consolidated
 

Net cash provided by operating activities

   $ (225   $ 1,220      $ 350      $ —      $ 1,345   

Cash flows from investing activities:

           

Business acquisitions, net of cash acquired

     (636     (168     (1     —        (805

Other, net

     114        (175     (55     —        (116

Net cash used by investing activities

     (522     (343     (56     —        (921

Cash flows from financing activities:

           

Repayment of commercial paper, net

     (904     —          —          —        (904

Proceeds from fixed-rate notes

     747        —          —          —        747   

Dividends paid

     (430     —          —          —        (430

Other, net

     (45     (2     (2     —        (49

Net cash used by financing activities

     (632     (2     (2     —        (636

Cash sweep/funding by parent

     1,118        (875     (243     —        —     

Net decrease in cash and equivalents

     (261     —          49        —        (212

Cash and equivalents at beginning of period

     746        —          875        —        1,621   

Cash and equivalents at end of period

   $ 485      $ —        $ 924      $ —      $ 1,409   
Nine Months Ended September 28, 2008                                   

Net cash provided by operating activities

   $ (215   $ 2,480      $ 49      $ —      $ 2,314   

Cash flows from investing activities:

           

Purchases of available-for-sale securities

     (1,293     (39     (33     —        (1,365

Sales/maturities of available-for-sale securities

     1,274        34        33        —        1,341   

Capital expenditures

     (3     (277     (34     —        (314

Business acquisitions, net of cash acquired

     —          (303     —          —        (303

Other, net

     —          31        —          —        31   

Net cash used by investing activities

     (22     (554     (34     —        (610

Cash flows from financing activities:

           

Purchases of common stock

     (1,047     —          —          —        (1,047

Repayment of fixed-rate notes

     (500     —          —          —        (500

Dividends paid

     (397     —          —          —        (397

Other, net

     179        (2     (211     —        (34

Net cash used by financing activities

     (1,765     (2     (211     —        (1,978

Cash sweep/funding by parent

     1,886        (1,924     38        —        —     

Net decrease in cash and equivalents

     (116     —          (158     —        (274

Cash and equivalents at beginning of period

     1,875        —          1,016        —        2,891   

Cash and equivalents at end of period

   $ 1,759      $ —        $ 858      $ —      $ 2,617   

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Dollars in millions, except per share amounts or unless otherwise noted)

Business Overview

General Dynamics offers a broad portfolio of products and services in business aviation; combat vehicles, weapons systems and munitions; shipbuilding design and construction; and information systems, technologies and services. We operate through four business groups – Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology. Our primary customers are the U.S. military, other U.S. government organizations, the armed forces of other nations, and a diverse base of corporate, government and individual owners of business aircraft. We operate in two primary markets: defense and business aviation. The majority of our revenues derive from contracts with the U.S. military. The following discussion should be read in conjunction with our 2008 Annual Report on Form 10-K, filed with the Securities and Exchange Commission, and with the unaudited Consolidated Financial Statements included in this Form 10-Q.

Results of Operations

Consolidated Overview

 

Three Months Ended    October 4
2009
    September 28
2008
    Variance  

Revenues

   $ 7,719      $ 7,140      $ 579      8.1

Operating earnings

     874        933        (59   (6.3 )% 

Operating margin

     11.3     13.1              
Nine Months Ended    October 4
2009
    September 28
2008
    Variance  

Revenues

   $ 24,083      $ 21,448      $ 2,635      12.3

Operating earnings

     2,724        2,715        9      0.3

Operating margin

     11.3     12.7              

General Dynamics’ revenues increased in the third quarter and first nine months of 2009 compared to the same periods in 2008 with strong contributions from each of our defense businesses. The Combat Systems group generated the most significant increase in revenues in the third quarter and first nine months of 2009 as a result of higher volume in its U.S. and European military vehicle programs and the acquisition of AxleTech International in December 2008. In Marine Systems, increases in shipbuilding and repair activity at each of the group’s shipyards resulted in the tenth consecutive quarterly increase in the group’s revenues. Revenues increased in Information Systems and Technology on higher volume in each of the group’s U.S. operations as well as recent acquisitions. In the Aerospace group, revenues were down in the third quarter, but remained steady year-to-date compared to 2008. Lower sales of Gulfstream aircraft and reduced aircraft services activity were offset somewhat by the November 2008 acquisition of Jet Aviation.

Our operating earnings decreased in the third quarter but remained steady for the first nine months of 2009 compared to the same periods in 2008. All of our defense businesses generated solid

 

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earnings growth in the three- and nine-month periods compared with 2008. Shifting contract mix in Combat Systems and Information Systems and Technology resulted in margin fluctuation from 2008 to 2009. In Combat Systems, 2009 third-quarter and year-to-date margins were down from historic highs in 2008. Margins in Information Systems and Technology were down year-to-date but improved in the third quarter both year-over-year and sequentially. In Marine Systems, improved operating performance at each of the group’s shipyards led to increased margins in the three- and nine-month periods in 2009. The Aerospace group’s earnings declined in both periods due to reduced aircraft deliveries and some losses associated with pre-owned aircraft. These factors, along with the addition of lower-margin business from Jet Aviation, reduced the group’s margins significantly in the third quarter and first nine months of 2009. As a result, our overall operating margins decreased by 180 basis points in the third quarter and 140 basis points in the first nine months of 2009.

General and administrative (G&A) expenses as a percentage of sales for the first nine months of 2009 were 6.1 percent compared with 6.0 percent in the same period in 2008. We expect G&A expenses as a percentage of sales for the full-year 2009 to be approximately 6 percent.

Net cash provided by operating activities from continuing operations was $1.4 billion in the first nine months of 2009, compared with $2.3 billion in the same period in 2008. We used our cash to fund acquisitions and capital expenditures, repurchase our common stock, pay dividends and repay maturing debt. Our net debt – debt less cash and equivalents and marketable securities – was $2.4 billion at the end of the third quarter of 2009 compared with $2.3 billion at the end of 2008. Net debt increased slightly after giving effect to $805 spent on acquisitions, $430 of dividends paid, $397 of company-sponsored research and development, $251 of capital expenditures, more than $250 of contributions to our retirement plans and $109 of share repurchases during the first nine months of the year.

Net interest expense in the first nine months of 2009 increased by $75 to $117 over the same period in 2008 due to the issuance of additional debt in 2008 and 2009 and lower interest income on a reduced invested cash balance. We expect full-year net interest expense of approximately $160.

Our effective tax rate for the nine-month period ended October 4, 2009, was 31.3 percent compared with 30.9 percent in the same period in 2008. The 2008 rate included a $35 – or approximately $0.09 per-share – benefit from the settlement of a tax refund suit, which reduced the tax rate for the first nine months of 2008 by 130 basis points. We anticipate an effective tax rate of approximately 31.5 percent for the full-year 2009, compared with 31.2 percent in 2008. For additional discussion of tax matters, see Note I to the unaudited Consolidated Financial Statements.

Our total backlog was $66.2 billion as of October 4, 2009, up 10 percent from a year ago, but down 2 percent from the second quarter. Funded backlog was $46.8 billion at the end of the third quarter, also down 2 percent from the end of the second quarter. The backlog for the Combat Systems and Information Systems and Technology groups increased during the quarter on strong order activity. Our total backlog does not include work awarded under unfunded indefinite delivery, indefinite quantity (IDIQ) contracts, unexercised options associated with existing firm contracts or options to purchase new aircraft, which we refer to collectively as estimated potential contract value. As of the end of the third quarter 2009, management’s estimate of this potential contract value, which we expect to realize over the next 10 to 15 years, was approximately $18.2 billion, up 3 percent from $17.7 billion at the end of the second quarter.

 

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Aerospace

 

Three Months Ended    October 4
2009
    September 28
2008
    Variance  

Revenues

   $ 1,120      $ 1,372      $ (252   (18.4 )% 

Operating earnings

     125        281        (156   (55.5 )% 

Operating margin

     11.2     20.5              

Gulfstream aircraft deliveries (in units):

        

Green

     17        39        (22   (56.4 )% 

Outfitted

     24        38        (14   (36.8 )% 
Nine Months Ended    October 4
2009
    September 28
2008
    Variance  

Revenues

   $ 3,990      $ 3,980      $ 10      0.3

Operating earnings

     540        757        (217   (28.7 )% 

Operating margin

     13.5     19.0              

Gulfstream aircraft deliveries (in units):

        

Green

     74        115        (41   (35.7 )% 

Outfitted

     89        114        (25   (21.9 )% 

The Aerospace group’s revenues were down in the third quarter of 2009 but remained steady in the first nine months of the year compared to the same prior-year periods. These results reflect the net effect of a significant decline in Gulfstream revenues – 39 percent in the third quarter and 22 percent in the first nine months of the year – and the addition of Jet Aviation, acquired in the fourth quarter of 2008.

Starting in late 2008, the business-jet market was disrupted by the global economic crisis and the resulting tightening of credit markets. In response to these conditions, we scaled back Gulfstream’s aircraft production and delivery schedule to bridge the market downturn, including a planned five-week workforce furlough in the months of July and August. As a result, aircraft-manufacturing revenues were down 46 percent in the third quarter and 25 percent in the first nine months of 2009 compared with the prior year. The group’s aircraft-services business has also felt the effects of the market dislocation, as customers have deferred optional aircraft maintenance activities and price competition has intensified. As a result, organic aircraft-services revenues were down 22 percent in the third quarter and 17 percent year-to-date in 2009. Pre-owned aircraft revenues increased in 2009, slightly offsetting the decline in manufacturing and services revenues. The group sold five pre-owned aircraft for $119 in the first nine months of 2009 compared with two sales for $17 in the same period in 2008.

Driven largely by the factors noted above, the group’s operating earnings for the third quarter and first nine months of 2009 decreased compared to the prior-year periods. The net reduction in earnings consisted of the following factors:

 

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Table of Contents
      Third Quarter     Nine Months  

Aircraft manufacturing and completions

   $ (123   $ (105

Pre-owned aircraft

     (10     (35

Aircraft services

     (8     (7

Other

     (15     (70

Total decrease in operating earnings

   $ (156   $ (217

Aircraft manufacturing and completion earnings were down in the third quarter and first nine months of 2009 because of lower new aircraft deliveries. The addition of Jet Aviation’s completions business partially offset the impact of the Gulfstream production cuts. Despite the volume decline, aircraft manufacturing margins improved in the quarter and year-to-date because of cost-reduction initiatives, a favorable mix of aircraft deliveries and liquidated damages received on defaulted contracts. The group continues to focus on reducing costs through production improvements and operational efficiencies to maintain operating margins in the aircraft manufacturing process.

An increase in the global supply of pre-owned aircraft put significant pressure on the pre-owned aircraft market, resulting in a sharp decline in pre-owned prices in 2009. As a result, the group wrote down the carrying value of its pre-owned aircraft inventory in 2009. The group has worked to minimize its pre-owned aircraft exposure and as a result, has reduced its pre-owned aircraft inventory to four units with a value of $62 at the end of the third quarter from six units at a value of $125 in the second quarter.

Aircraft services earnings, which include Jet Aviation’s maintenance and repair activities, fixed-base operations and aircraft management services, decreased slightly in the third quarter and first nine months of 2009 compared with 2008. The group is experiencing competitive pressure on its aircraft services margins because of the market-wide reduction in maintenance and repair volume.

The group’s operating earnings in 2009 were also negatively impacted by severance costs associated with workforce reduction activities and intangible asset amortization related to the Jet Aviation acquisition.

As a result of the factors discussed above and the addition of the lower-margin Jet Aviation business, the group’s overall operating margins were down 930 basis points in the quarter and 550 basis points in the first nine months of 2009 compared to the same prior-year periods.

We expect Aerospace revenues for 2009, including a full year of Jet Aviation, to be down approximately 4 percent compared with the group’s 2008 results because of the impact of the reduced aircraft-production schedule. We expect the group’s full-year operating margins to be down from 2008 to a range between 13.2 and 13.4 percent due to the addition of Jet Aviation, losses incurred to date in the pre-owned market and pressures on pricing in the group’s services business.

 

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Combat Systems

 

Three Months Ended    October 4
2009
    September 28
2008
    Variance  

Revenues

   $ 2,347      $ 1,850      $ 497    26.9

Operating earnings

     316        262        54    20.6

Operating margin

     13.5     14.2             
Nine Months Ended    October 4
2009
    September 28
2008
    Variance  

Revenues

   $ 7,159      $ 5,862      $ 1,297    22.1

Operating earnings

     895        803        92    11.5

Operating margin

     12.5     13.7             

The Combat Systems group was our revenue growth leader in the third quarter and first nine months of 2009. The group’s organic growth rate was 22 percent in the third quarter and 17 percent in the first nine months of 2009. The increase in the group’s revenues consisted of the following:

 

      Third Quarter     Nine Months

U.S. military vehicles

   $ 282      $ 811

Weapons systems

     131        341

Munitions

     (3     54

European military vehicles

     87        91

Total increase in revenues

   $ 497      $ 1,297

The U.S. military vehicle business contributed over half the group’s revenue growth in the third quarter and first nine months of 2009 due to increased activity on the Stryker wheeled combat vehicle and Abrams main battle tank programs. The Stryker activity related to continued vehicle production, logistics services and engineering efforts for the U.S. Army. The increased Abrams work resulted from the group’s progress in upgrading the remaining M1A1 tanks to the M1A2 System Enhancement Package (SEP) configuration, as well as production of Abrams tank kits for Egypt. The acquisition of AxleTech International in the fourth quarter of 2008 also contributed to Combat Systems’ revenue growth in 2009. In the group’s European military vehicle business, revenues were up as a result of increased activity on several vehicle production programs, including the Piranha wheeled armored vehicle contract for Belgium and the Eagle wheeled armored vehicle program for Germany, as well as higher volume on arms and munitions and mobile bridge programs.

The Combat Systems group’s operating earnings increased in the third quarter and first nine months of 2009. While the group’s margins have improved sequentially each quarter in 2009, operating margins decreased 70 basis points in the quarter and 120 basis points year-to-date when compared to 2008. The group’s margins in 2008 were unusually high because of a favorable program mix, most notably within the mine-resistant, ambush-protected (MRAP) vehicle program. The 2009 sequential margin expansion resulted from productivity improvements in each of the group’s businesses.

 

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We expect revenue growth for the full-year 2009 in Combat Systems of approximately 21 percent compared to 2008 with operating margins between 12.5 and 12.7 percent.

Marine Systems

 

Three Months Ended    October 4
2009
    September 28
2008
    Variance  

Revenues

   $ 1,518      $ 1,404      $ 114    8.1

Operating earnings

     155        140        15    10.7

Operating margin

     10.2     10.0             
Nine Months Ended    October 4
2009
    September 28
2008
    Variance  

Revenues

   $ 4,812      $ 4,176      $ 636    15.2

Operating earnings

     486        389        97    24.9

Operating margin

     10.1     9.3             

The Marine Systems group’s revenues and operating earnings increased significantly in the third quarter and first nine months of 2009 over the same prior-year periods. Each of the group’s shipyards contributed to this growth. The increase in the group’s revenues consisted of the following:

 

      Third Quarter     Nine Months

Multi-year Navy ship construction

   $ 72      $ 438

Other Navy ship design, construction, engineering and repair

     47        157

Commercial ship construction

     (5     41

Total increase in revenues

   $ 114      $ 636

The group’s multi-year ship-construction programs for the U.S. Navy include submarines (Virginia Class), combat-logistics ships (T-AKE) and destroyers (DDG-51 and DDG-1000). Increased activity on the Virginia-class program has been the principal driver of the group’s revenue growth to-date in 2009. The group continued building the remaining five submarines under the Block II contract and began construction on the first submarine under the Block III contract, which was awarded in the fourth quarter of 2008. Deliveries on the Block II and III contracts are scheduled through 2019.

Activity on the group’s 14-ship T-AKE program was down slightly in the third quarter, consistent with expectations, but remained steady compared with the year-to-date 2008 level as construction continued on the ninth through 12th ships. The group delivered the seventh and eighth T-AKE ships in 2009, the ninth ship is scheduled for delivery in the first quarter of 2010 and deliveries of the remaining ships are scheduled through 2012.

Destroyer construction revenues were up as activity increased on the group’s design and production contracts for the DDG-1000 next-generation destroyer, while the workload on the DDG-51 Arleigh Burke program decreased slightly, in line with our expectations. The remaining three DDG-51s under contract are scheduled for delivery through 2011, and the first DDG-1000 delivery is scheduled in 2013.

 

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In addition to these ship-construction programs, volume increased significantly in the third quarter and first nine months of 2009 on engineering and repair programs for the Navy. In commercial shipbuilding, volume was down slightly on the group’s five-ship product carrier program in the third quarter but increased year-to-date. The first two ships under contract were delivered in the first nine months of 2009, and construction is in process on the remaining three ships. The third ship is scheduled to be delivered in the fourth quarter of 2009. The current construction plan includes deliveries through the fourth quarter of 2010.

The group generated substantial operating earnings growth in the third quarter and first nine months of 2009 on improved performance at each of the group’s shipyards. Based on labor and material cost reductions achieved through ongoing operational efficiency efforts at all three locations, the group has increased earnings rates on several key programs in 2009, including the Virginia-class, DDG-51, DDG-1000 and commercial product carrier programs. As a result, the group’s operating margins increased 20 basis points in the third quarter and 80 basis points in the first nine months of 2009 compared with 2008. This performance follows 24 percent earnings growth and 100 basis points of margin improvement in the full-year 2008 over 2007.

We expect Marine Systems to generate revenue growth of approximately 15 percent for the full-year 2009 with operating margins of approximately 10 percent.

Information Systems and Technology

 

Three Months Ended    October 4
2009
    September 28
2008
    Variance  

Revenues

   $   2,734      $   2,514      $ 220    8.8

Operating earnings

     296        270        26    9.6

Operating margin

     10.8     10.7             
Nine Months Ended    October 4
2009
    September 28
2008
    Variance  

Revenues

   $   8,122      $   7,430      $ 692    9.3

Operating earnings

     869        822        47    5.7

Operating margin

     10.7     11.1             

The Information Systems and Technology group’s revenues increased in the third quarter and first nine months of 2009 compared with the same periods in 2008. As a result of this growth, the group reported its highest quarterly revenues and operating earnings to date in the third quarter. The group generated organic revenue growth of 6 percent in the third quarter and 7 percent in the first nine months of 2009 with the remainder of the growth provided by acquisitions in the group’s information technology (IT) services and intelligence mission systems businesses. Each of the group’s market segments contributed to the increase in revenues in 2009:

 

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Table of Contents
      Third Quarter    Nine Months

Information technology and mission services

   $ 78    $ 277

Tactical and strategic mission systems

     57      245

Intelligence mission systems

     85      170

Total increase in revenues

   $ 220    $ 692

The largest driver of the revenue growth in the IT services business in 2009 was recent acquisitions. In the third quarter and first nine months of 2009, approximately one-third of the group’s IT services revenue growth was organic and resulted from higher volume on several of the group’s IT infrastructure programs. These programs included the New Campus East (NCE) contract for the National Geospatial Intelligence Agency and the Warfighter Field Operations Customer Support (FOCUS) contract. A decline in commercial wireless infrastructure activity tempered this business’s growth.

In the group’s tactical systems business, revenues were up in 2009 as a result of increased activity on several long-term contracts to supply the U.S. military with mobile command-and-control, communications and computing capabilities, including the Warfighter Information Network – Tactical (WIN-T) and Common Hardware/Software III (CHS-3) programs. Higher sales of encryption products also contributed to the revenue growth in 2009.

The intelligence systems business had the group’s strongest revenue growth rate in the third quarter and first nine months of 2009. Increased volume across all areas of the intelligence systems business drove this revenue growth in 2009. The most notable drivers were several integrated combat systems contracts, cyber security programs and a contract to build the spacecraft for NASA’s Landsat Data Continuity Mission. The acquisition of Axsys Technologies, Inc., in September 2009, also contributed to the group’s revenue growth.

Operating earnings in the Information Systems and Technology group increased in the third quarter and first nine months of 2009. A favorable shift in contract mix, particularly within the intelligence systems business, resulted in a 10-basis-point increase in the group’s operating margins over the third quarter of 2008. Year-to-date in 2009, the group’s contract mix included a higher percentage of lower-margin services contracts. As a result, the group’s operating margins for the first nine months of 2009 decreased 40 basis points compared to the same period in 2008.

We expect full-year 2009 revenue growth in the Information Systems and Technology group of approximately 8 to 9 percent. Based on the group’s scheduled program mix for 2009, we expect full-year operating margins in the 10.4 to 10.5 percent range.

Corporate

Corporate results consist primarily of compensation expense for stock options and a portion of the results from our commercial pension plans. Corporate operating expenses totaled $18 in the third quarter of 2009 compared with $20 in the third quarter of 2008. The Corporate third quarter 2009 operating results included a $5 gain from the sale of real estate. Year-to-date Corporate operating expenses were $66 in the first nine months of 2009 compared with $56 in the same period in 2008. The year-to-date increase is due primarily to higher stock option expense. We expect 2009 Corporate expense to be approximately $90.

 

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Backlog

The following table details the backlog and the total estimated contract value of each business group at the end of the third and second quarters of 2009:

 

October 4, 2009    Funded    Unfunded    Total
Backlog
   Estimated
Potential
Contract
Value
   Total
Estimated
Contract
Value

Aerospace

   $ 18,811    $ 444    $ 19,255    $ 1,361    $ 20,616

Combat Systems

     11,508      1,355      12,863      2,645      15,508

Marine Systems

     8,011      15,479      23,490      1,170      24,660

Information Systems and Technology

     8,467      2,174      10,641      13,024      23,665

Total

   $ 46,797    $ 19,452    $ 66,249    $ 18,200    $ 84,449
July 5, 2009                              

Aerospace

   $ 19,306    $ 570    $ 19,876    $ 1,633    $ 21,509

Combat Systems

     11,494      1,364      12,858      2,451      15,309

Marine Systems

     8,645      15,724      24,369      1,241      25,610

Information Systems and Technology

     8,208      2,297      10,505      12,372      22,877

Total

   $ 47,653    $ 19,955    $ 67,608    $ 17,697    $ 85,305

Aerospace

Aerospace funded backlog represents orders for which we have definitive purchase contracts and deposits from the customer. Aerospace unfunded backlog consists of agreements to provide future aircraft maintenance and support services. Aerospace estimated potential contract value represents options to purchase new aircraft, including long-term agreements with fleet customers. The group ended the third quarter of 2009 with $19.3 billion of backlog compared with $19.9 billion at the end of the second quarter, as aircraft deliveries combined with customer defaults to offset increasing order activity.

The pace of aircraft orders has improved steadily since the first quarter of 2009 after a substantial decline in late 2008. Excluding the introduction of the G650 in 2008, the group generated its highest quarterly order total since the second quarter of 2008. The increased orders resulted in a book-to-bill ratio (orders divided by revenues) of 1.5 in the third quarter, bringing the year-to-date ratio to 1.0.

Large-cabin orders continued to improve over the past two quarters, which has helped to solidify the large-cabin backlog and, in turn, our production planning. Conditions in the mid-size market remain challenging; however, we began to see positive signs in the third quarter with an increase in mid-size order activity. In addition, orders continue for the new G650 and G250 models, which were introduced last year. These aircraft passed their scheduled roll-out milestone in late September and early October, respectively, and initial green deliveries are scheduled to begin in 2011.

While risk remains in the group’s backlog, particularly in the event of additional economic shocks, we will continue to work to mitigate any further backlog deterioration. We continually assess

 

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aircraft production requirements and will modify the group’s production and delivery schedule as necessary based on the state of the backlog and the business-jet market.

Defense Businesses

The total backlog for our defense businesses represents the estimated remaining sales value of work to be performed under firm contracts. The funded portion of this backlog includes items that have been authorized and appropriated by the Congress and funded by the customer, as well as commitments by international customers that are similarly approved and funded by their governments. The unfunded backlog for the defense businesses represents firm orders that do not meet these criteria. While there is no guarantee that future budgets and appropriations will provide funding for a given program, we have included in the backlog only firm contracts we believe are likely to receive funding. Our backlog does not include work awarded under unfunded indefinite delivery, indefinite quantity (IDIQ) contract awards or unexercised options. The estimated potential contract value represents our estimate of the potential value we will receive under these arrangements.

IDIQ contracts are used when the customer has not defined the exact timing and quantity of deliveries that will be required at the time the contract is executed. These agreements, which set forth the majority of the contractual terms, including prices, are funded as delivery orders are placed. A significant portion of our IDIQ value represents contracts for which we have been designated as the sole-source supplier to design, develop, produce and integrate complex products and systems over several years for the military or other government agencies. We believe the customers intend to fully implement these systems. The estimated potential contract value also includes our estimate of the value we will receive under multiple-award IDIQ contracts in which we are one of several companies competing for task orders under the contract. Because the value of these arrangements is subject to the customer’s future exercise of an indeterminate quantity of delivery orders, we recognize these contracts in backlog only when they are funded.

Contract options in our defense businesses represent agreements to perform additional work beyond the products and services associated with firm contracts, if the customer exercises the option. These options are negotiated in conjunction with a firm contract and provide the terms under which the customer may elect to procure additional units or services at a future date. We recognize contract options in backlog when the customer exercises the option and establishes a firm order.

Our defense businesses received more than $6 billion of new awards during the third quarter of 2009. The Information Systems and Technology group has generated particularly strong order activity in 2009, achieving a book-to-bill ratio (orders divided by revenues) of 1.1 in both the third quarter and first nine months of the year. The group’s book-to-bill ratio has exceeded 1.0 for eight of the past nine quarters. The orders in the defense businesses in the third quarter included several notable contract awards.

Combat Systems awards included the following:

 

   

Approximately $950 from the U.S. Army for the production of Stryker wheeled armored vehicles, related support and reset of vehicles.

 

   

Approximately $115 from the Canadian government to supply various calibers of training and tactical ammunition.

 

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Approximately $80 from the Army for the production of Hydra-70 rockets. This order brings the total contract value to date to over $1 billion.

 

   

Approximately $45 from the Army for small-caliber ammunition and other munitions in support of the Afghanistan National Forces. This contract has a potential value of $300.

 

   

Combat Systems was selected as the prime contractor and systems integrator for the Canadian government’s LAV III upgrade program. The program has a potential value of $850.

Marine Systems awards included the following:

 

   

Approximately $160 from the Navy for Class Common Equipment (CCE) material for the DDG 1000 destroyer program.

 

   

Two contracts from the U.S. Navy with a combined potential value of approximately $100 for repair work on USS Hartford, a Los Angeles-class submarine.

Information Systems and Technology awards included the following:

 

   

Approximately $155 in orders under the Network-Centric Solutions (NETCENTS) program, bringing the total contract value to almost $1 billion.

 

   

Approximately $90 under the Warfighter Field Operations Customer Support (FOCUS) program to provide life-cycle contractor and training support worldwide.

 

   

Approximately $20 from the Navy to develop commercial-off-the-shelf software and hardware upgrades to integrate improved tactical control capabilities for multiple submarine classes. This contract has a potential value of approximately $400.

 

   

A task order to provide enterprise information technology support to the U.S. Coast Guard under the Enterprise Acquisition Gateway for Leading-Edge Solutions (EAGLE) IDIQ contract. This task order has a potential value of approximately $140 if all options are exercised.

 

   

One of three IDIQ contracts under the Advanced Technical Exploitation Program (ATEP), which has a potential value of $600 among all awardees, to provide intelligence analysis, software systems development and support, sensor exploitation research, and development of space-based and airborne sensor data for the U.S. Air Force.

 

   

One of six IDIQ contracts from the Navy to provide engineering and technical services in support of hull, mechanical, electrical and electronics (HME&E) systems. The total contract has a potential value of $475 among all awardees.

Following the end of the quarter, the Combat Systems group was selected by the Army Tank Automotive Research, Development and Engineering Center as one of 14 awardees under an IDIQ program to provide engineering and manufacturing services. The IDIQ program has a potential value of $430 among all awardees over five years. In addition, the Information Systems and Technology group was awarded a contract worth approximately $150 for production and deployed-systems support for the

 

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U.S. and United Kingdom SSBN submarine fire control system and the SSGN submarine Attack Weapon Control System (AWCS). Information Systems and Technology was also awarded a task order by the Army worth approximately $110 to modernize classroom technology training under the Information Technology Enterprise Technology Solutions-2 Services (ITES-2Q) IDIQ contract.

Financial Condition, Liquidity and Capital Resources

We ended the third quarter of 2009 with a cash balance of $1.4 billion, compared with $1.6 billion at the end of 2008. Our net debt was $2.4 billion, up slightly from $2.3 billion at the end of 2008. Following is a discussion of the major components of our operating, investing and financing activities, as classified on the Consolidated Statement of Cash Flows, in the first nine months of 2009 and 2008.

Operating Activities

We generated cash from operating activities from continuing operations of $1.4 billion in the first nine months of 2009 compared with $2.3 billion in the same period in 2008. Operating cash flow in the first nine months of 2009 can be attributed primarily to net earnings, offset by a decrease in customer deposits in the Aerospace group. In the first nine months of 2008, net earnings and a build-up of customer deposits associated with aircraft orders, including the introduction of the G650, were the major components of operating cash flow. The third quarter 2009 operating cash flows also included a $250 contribution to our pension plans.

As discussed further in Note K to the unaudited Consolidated Financial Statements, litigation on the A-12 contract termination has been ongoing since 1991. If, contrary to our expectations, the default termination ultimately is sustained, we, along with The Boeing Company, could collectively be required to repay the U.S. government as much as $1.4 billion for progress payments received for the A-12 contract, plus interest, which was approximately $1.5 billion at July 5, 2009. If this were the outcome, we would owe half of the total, or approximately $1.4 billion pretax. Our after-tax cash obligation would be approximately $710. We believe we have sufficient resources to pay such an obligation, if required.

Investing Activities

Net cash used for investing activities was $921 for the first nine months of 2009, compared with $610 in the same period in 2008. The primary uses of cash in investing activities were business acquisitions and capital expenditures. We completed two acquisitions for $805 in the first nine months of 2009 and three acquisitions for $303 in the same period in 2008. We used cash on hand to fund these acquisitions. See Note B to the unaudited Consolidated Financial Statements for further discussion of acquisition activity. We expect full-year capital expenditures to be less than 2 percent of revenues.

Financing Activities

We used $636 for financing activities in the nine-month period ended October 4, 2009, compared with $2 billion in the same period in 2008. Our typical financing activities are issuances and repayments of debt, payment of dividends and repurchases of common stock. Net cash from financing activities also includes proceeds received from stock option exercises.

On June 24, 2009, we issued $750 of two-year fixed-rate debt pursuant to a Form S-3 Registration Statement filed with the Securities and Exchange Commission under the Securities Act of

 

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1933 on December 8, 2008. We used the proceeds to repay borrowings under our commercial paper program and for other general corporate purposes.

Net repayments of commercial paper in the first nine months of 2009 were $904. We did not have any commercial paper outstanding at either the end of the third quarter of 2009 or the end of the third quarter of 2008. We have approximately $1.8 billion in bank credit facilities that have not been drawn upon, but which back up our commercial paper program. In the first nine months of 2008, we repaid $500 of fixed-rate debt and $150 of senior notes on the scheduled maturity dates. There are no material repayments of long-term debt scheduled until the third quarter of 2010.

On March 4, 2009, our board of directors declared an increased quarterly dividend of $0.38 per share – the 12th consecutive annual increase. The board had previously increased the quarterly dividend to $0.35 per share in March 2008.

In the first nine months of 2009, we repurchased 2.1 million of our outstanding shares on the open market. In the first nine months of 2008, we repurchased 14.4 million shares. As of October 4, 2009, approximately 2.7 million shares remained authorized for repurchase by our board of directors.

Free Cash Flow

Our free cash flow from operations for the first nine months of 2009 was $1.1 billion compared with $2 billion for the same period in 2008. We define free cash flow from operations as net cash provided by operating activities from continuing operations less capital expenditures. We believe free cash flow from operations is a useful measure for investors, because it portrays our ability to generate cash from our core businesses for purposes such as repaying maturing debt, funding business acquisitions, repurchasing our common stock and paying dividends. We use free cash flow from operations to assess the quality of our earnings and as a performance measure in evaluating management. The following table reconciles free cash flow from operations with net cash provided by operating activities from continuing operations, as classified on the unaudited Consolidated Statement of Cash Flows:

 

Nine Months Ended    October 4
2009
    September 28
2008
 

Net cash provided by operating activities from continuing operations

   $ 1,357      $ 2,319   

Capital expenditures

     (251     (314

Free cash flow from operations

   $ 1,106      $ 2,005   

Cash flows as a percentage of earnings from continuing operations:

    

Net cash provided by operating activities from continuing operations

     76     125

Free cash flow from operations

     62     108

We expect to continue to generate funds from operations in excess of our short- and long-term liquidity needs. We believe we have adequate funds on hand and sufficient borrowing capacity to execute our financial and operating strategy.

 

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Additional Financial Information

Environmental Matters and Other Contingencies

For a discussion of environmental matters and other contingencies, see Note K to the unaudited Consolidated Financial Statements. We do not expect our aggregate liability with respect to these matters to have a material impact on our results of operations, financial condition or cash flows.

Application of Critical Accounting Policies

Management’s Discussion and Analysis of our Financial Condition and Results of Operations is based on our unaudited Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of financial statements in accordance with GAAP requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including those related to long-term contracts and programs, goodwill and other intangible assets, income taxes, pensions and other post-retirement benefits, workers’ compensation, warranty obligations, pre-owned aircraft inventory, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions. For a full discussion of our critical accounting policies, see our Annual Report on Form 10-K for the year ended December 31, 2008.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes with respect to this item from the disclosure included in our Annual Report on Form 10-K for the year ended December 31, 2008.

ITEM 4. CONTROLS AND PROCEDURES

Our management, under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) on October 4, 2009. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, on October 4, 2009, our disclosure controls and procedures were effective.

There were no changes in our internal control over financial reporting that occurred during the quarter ended October 4, 2009, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q contains forward-looking statements that are based on management’s expectations, estimates, understandings, projections and assumptions. Words such as “expects,” “anticipates,” “plans,” “believes,” “scheduled,” “estimates” and variations of these words and similar expressions are intended to identify forward-looking statements. These include but are not limited to projections of revenues, earnings, segment performance, cash flows, contingent liabilities, contract awards, aircraft production, deliveries and backlog stability. Forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended. These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to predict. Therefore, actual future results and trends may differ materially from what is forecast in forward-looking statements due to a variety of factors, including, without limitation:

 

   

general U.S. and international political and economic conditions;

 

   

changing priorities in the U.S. government’s defense budget (including the outcome of supplemental defense spending measures, and changes in priorities in response to terrorist threats, continuing operations in Afghanistan and Iraq, and improved homeland security);

 

   

termination or restructuring of government contracts due to unilateral government action;

 

   

differences in anticipated and actual program performance, including the ability to perform under long-term fixed-price contracts within estimated costs, and performance issues with key suppliers and subcontractors;

 

   

expected recovery on contract claims and requests for equitable adjustment;

 

   

changing customer demand or preferences for business aircraft, including the effects of economic conditions on the business-aircraft market;

 

   

potential for changing prices for energy and raw materials; and

 

   

the status or outcome of legal and/or regulatory proceedings.

All forward-looking statements speak only as of the date of this report or, in the case of any document incorporated by reference, the date of that document. All subsequent written and oral forward-looking statements attributable to the company or any person acting on the company’s behalf are qualified by the cautionary statements in this section. We do not undertake any obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date of this report.

 

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PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

For information relating to legal proceedings, see Note K to the unaudited Consolidated Financial Statements contained in Part I, Item 1 of this quarterly report on Form 10-Q.

ITEM 1A. RISK FACTORS

There have been no material changes with respect to this item from the disclosure included in our Annual Report on Form 10-K for the year ended December 31, 2008.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table provides information about our third quarter repurchases of equity securities that are registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended:

 

Period

   Total Number
of Shares
Purchased
   Average
Price Paid
per Share
   Total Number of
Shares Purchased as
Part of Publicly
Announced Program (1)
   Maximum Number of
Shares that May Yet
Be Purchased Under
the Program (1)

Pursuant to Share Buyback Program

           

7/6/09 - 8/2/09

   —      $ —      —      2,747,700

8/3/09 - 8/30/09

   —      $ —      —      2,747,700

8/31/09 - 10/4/09

   —      $ —      —      2,747,700

Shares Delivered or Withheld Pursuant to Restricted Stock Vesting (2)

           

7/6/09 - 8/2/09

   —      $ —        

8/3/09 - 8/30/09

   249    $ 56.20      

8/31/09 - 10/4/09

   —      $ —        
             

Total

   249    $ 56.20      
             

 

  (1)

On October 1, 2008, our board of directors authorized management to repurchase up to 10 million shares of common stock on the open market. Unless terminated or extended earlier by resolution of the board of directors, the program will expire when the number of authorized shares has been repurchased.

 

  (2)

Represents shares withheld by, or delivered to, us pursuant to provisions in agreements with recipients of restricted stock granted under our equity compensation plans that allow us to withhold, or the recipient to deliver to us, the number of shares with a fair value equal to the minimum statutory tax withholding due upon vesting of the restricted shares.

We did not make any unregistered sales of equity securities in the third quarter.

 

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ITEM 6. EXHIBITS

 

31.1    Certification by CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2    Certification by CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32.1    Certification by CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
32.2    Certification by CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
101    Interactive Data File*

 

* Filed herewith.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

GENERAL DYNAMICS CORPORATION
by  

/s/ John W. Schwartz

  John W. Schwartz
  Vice President and Controller
  (Authorized Officer and Chief Accounting Officer)

Dated: November 3, 2009

 

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