GD-2012.09.30 10Q

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 September 30, 2012
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 ü 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 ü 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 ü 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 ü
353,069,806 shares of the registrant’s common stock, $1 par value per share, were outstanding on September 30, 2012.




INDEX

 
 
 
PART I -
PAGE
Item 1 -
 
 
 
 
 
 
Item 2 -
Item 3 -
Item 4 -
 
PART II -
Item 1 -
Item 1A -
Item 2 -
Item 4 -
Item 6 -
 
            




PART I – FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)

 
Three Months Ended
(Dollars in millions, except per-share amounts)
October 2, 2011
 
September 30, 2012
Revenues:
 
 
 
Products
$
5,070

 
$
4,967

Services
2,783

 
2,967

 
7,853

 
7,934

Operating costs and expenses:
 
 
 
Products
3,991

 
4,012

Services
2,372

 
2,507

General and administrative
492

 
510

 
6,855

 
7,029

Operating earnings
998

 
905

Interest, net
(38
)
 
(39
)
Other, net
(8
)
 
(3
)
Earnings before income taxes
952

 
863

Provision for income taxes, net
287

 
263

Earnings from continuing operations
665

 
600

Discontinued operations, net of tax
(13
)
 

Net earnings
$
652

 
$
600

 
 
 
 
Earnings per share
 
 
 
Basic:
 
 
 
Continuing operations
$
1.84

 
$
1.71

Discontinued operations
(0.03
)
 

Net earnings
$
1.81

 
$
1.71

Diluted:
 
 
 
Continuing operations
$
1.83

 
$
1.70

Discontinued operations
(0.03
)
 

Net earnings
$
1.80

 
$
1.70

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.


3


CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)

 
Nine Months Ended
(Dollars in millions, except per-share amounts)
October 2, 2011
 
September 30, 2012
Revenues:
 
 
 
Products
$
15,186

 
$
14,672

Services
8,344

 
8,763

 
23,530

 
23,435

Operating costs and expenses:
 
 
 
Products
12,005

 
11,712

Services
7,143

 
7,418

General and administrative
1,506

 
1,570

 
20,654

 
20,700

Operating earnings
2,876

 
2,735

Interest, net
(103
)
 
(115
)
Other, net
34

 
(8
)
Earnings before income taxes
2,807

 
2,612

Provision for income taxes, net
858

 
814

Earnings from continuing operations
1,949

 
1,798

Discontinued operations, net of tax
(26
)
 

Net earnings
$
1,923

 
$
1,798

 
 
 
 
Earnings per share
 
 
 
Basic:
 
 
 
Continuing operations
$
5.31

 
$
5.08

Discontinued operations
(0.07
)
 

Net earnings
$
5.24

 
$
5.08

Diluted:
 
 
 
Continuing operations
$
5.26

 
$
5.04

Discontinued operations
(0.07
)
 

Net earnings
$
5.19

 
$
5.04

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.



4


CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

 
Three Months Ended
(Dollars in millions, except per-share amounts)
October 2, 2011
 
September 30, 2012
Net earnings
$
652

 
$
600

Net gain (loss) on cash flow hedges
(146
)
 
7

Unrealized gains (losses) on securities
(2
)
 
5

Foreign currency translation adjustments
(475
)
 
129

Change in retirement plans' funded status
40

 
56

Other comprehensive income (loss) before tax
(583
)
 
197

Provision (benefit) for income tax, net
(102
)
 
52

Other comprehensive income (loss), net of tax
(481
)
 
145

Comprehensive income
$
171

 
$
745


 
Nine Months Ended
(Dollars in millions, except per-share amounts)
October 2, 2011
 
September 30, 2012
Net earnings
$
1,923

 
$
1,798

Net loss on cash flow hedges
(64
)
 
(34
)
Unrealized gains (losses) on securities
(1
)
 
7

Foreign currency translation adjustments
(61
)
 
91

Change in retirement plans' funded status
93

 
177

Other comprehensive income (loss) before tax
(33
)
 
241

Provision (benefit) for income tax, net
(28
)
 
86

Other comprehensive income (loss), net of tax
(5
)
 
155

Comprehensive income
$
1,918

 
$
1,953

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.


5


CONSOLIDATED BALANCE SHEETS

 
 
 
(Unaudited)
(Dollars in millions)
December 31, 2011
 
September 30, 2012
ASSETS
 
 
 
Current assets:
 
 
 
Cash and equivalents
$
2,649

 
$
2,874

Accounts receivable
4,452

 
4,339

Contracts in process
5,168

 
5,031

Inventories
2,310

 
2,661

Other current assets
789

 
688

Total current assets
15,368

 
15,593

Noncurrent assets:
 
 
 
Property, plant and equipment, net
3,284

 
3,345

Intangible assets, net
1,813

 
1,734

Goodwill
13,576

 
13,986

Other assets
842

 
845

Total noncurrent assets
19,515

 
19,910

Total assets
$
34,883

 
$
35,503

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Short-term debt and current portion of long-term debt
$
23

 
$
1,001

Accounts payable
2,895

 
2,540

Customer advances and deposits
5,011

 
5,523

Other current liabilities
3,216

 
3,129

Total current liabilities
11,145

 
12,193

Noncurrent liabilities:
 
 
 
Long-term debt
3,907

 
2,924

Other liabilities
6,599

 
6,114

Commitments and contingencies (See Note K)


 


Total noncurrent liabilities
10,506

 
9,038

Shareholders' equity:
 
 
 
Common stock
482

 
482

Surplus
1,888

 
1,971

Retained earnings
18,917

 
20,170

Treasury stock
(5,743
)
 
(6,194
)
Accumulated other comprehensive loss
(2,312
)
 
(2,157
)
Total shareholders' equity
13,232

 
14,272

Total liabilities and shareholders' equity
$
34,883

 
$
35,503

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.


6


CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
Nine Months Ended
(Dollars in millions)
October 2, 2011
 
September 30, 2012
Cash flows from operating activities:
 
 
 
Net earnings
$
1,923

 
$
1,798

Adjustments to reconcile net earnings to net cash provided by operating activities –
 
 
 
Depreciation of property, plant and equipment
259

 
286

Amortization of intangible assets
176

 
172

Stock-based compensation expense
96

 
104

Excess tax benefit from stock-based compensation
(22
)
 
(24
)
Deferred income tax provision
63

 
53

Discontinued operations, net of tax
26

 

(Increase) decrease in assets, net of effects of business acquisitions –
 
 
 
Accounts receivable
(143
)
 
139

Contracts in process
(252
)
 
91

Inventories
(346
)
 
(340
)
Increase (decrease) in liabilities, net of effects of business acquisitions –
 
 
 
Accounts payable
(171
)
 
(368
)
Customer advances and deposits
(7
)
 
257

Other current and noncurrent liabilities
(257
)
 
(184
)
Other, net
(129
)
 
(77
)
Net cash provided by operating activities
1,216

 
1,907

Cash flows from investing activities:
 
 
 
Business acquisitions, net of cash acquired
(1,143
)
 
(426
)
Capital expenditures
(273
)
 
(286
)
Purchases of held-to-maturity securities
(428
)
 
(260
)
Sales of held-to-maturity securities

 
211

Maturities of held-to-maturity securities
322

 
54

Purchases of available-for-sale securities
(350
)
 
(201
)
Maturities of available-for-sale securities
227

 
96

Other, net
188

 
144

Net cash used by investing activities
(1,457
)
 
(668
)
Cash flows from financing activities:
 
 
 
Purchases of common stock
(1,449
)
 
(602
)
Dividends paid
(504
)
 
(533
)
Proceeds from option exercises
186

 
121

Proceeds from fixed-rate notes
1,497

 

Repayment of fixed-rate notes
(750
)
 

Net proceeds from commercial paper
200

 

Other, net
(6
)
 
2

Net cash used by financing activities
(826
)
 
(1,012
)
Net cash used by discontinued operations
(6
)
 
(2
)
Net increase (decrease) in cash and equivalents
(1,073
)
 
225

Cash and equivalents at beginning of period
2,613

 
2,649

Cash and equivalents at end of period
$
1,540

 
$
2,874

Supplemental cash flow information:
 
 
 
Cash payments for:
 
 
 
Income taxes
$
804

 
$
805

Interest
$
112

 
$
135

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.

7


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in millions, except per-share amounts or unless otherwise noted)
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation and Classification. The unaudited Consolidated Financial Statements 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 Financial 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 may not 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 September 30, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.
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 of operations and financial condition for the three- and nine-month periods ended October 2, 2011, and September 30, 2012.
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, 2011.
Revenue Recognition. We account for revenues and earnings using the percentage-of-completion method. Under this method, contract costs and revenues are recognized as the work progresses, either as the products are produced or as services are rendered. We estimate the profit on a contract as the difference between the total estimated revenue and costs to complete a contract and recognize that profit over the life of the contract. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the loss in the quarter it is identified.
We review and update our contract estimates regularly. We recognize changes in estimated profit on contracts under the reallocation method. Under the reallocation method, the impact of a revision in estimate is recognized prospectively over the remaining contract term. The net increase in our operating earnings (and earnings per share) from the quarterly impact of revisions in contract estimates totaled $113 ($0.22) and $299 ($0.56) for the three- and nine-months periods ended October 2, 2011, and $45 ($0.09) and $203 ($0.39) for the three- and nine-months periods ended September 30, 2012, respectively. In the third quarter and first nine months of 2012, no revisions on any one contract were material to our Consolidated Financial Statements.
Subsequent Events. We have evaluated material events and transactions that have occurred after the balance sheet date and concluded that no subsequent events have occurred that require adjustment to or disclosure in this Form 10-Q.


8


B. ACQUISITIONS, INTANGIBLE ASSETS AND GOODWILL
In the first nine months of 2012, we acquired six businesses for an aggregate of $426, funded by cash on hand:
Aerospace
A fixed-base operator at Houston Hobby Airport that provides fuel, catering, maintenance, repair and overhaul services to private aircraft (on February 29).
Combat Systems
The defense operations of Gayston Corporation, a business that supplies precision metal components used in several munitions program (on August 27).
Marine Systems
The Ship Repair and Coatings Division of Earl Industries, an East Coast ship-repair company that supports the U.S. Navy fleet in Norfolk, Virginia and Mayport, Florida (on July 31).
Information Systems and Technology
IPWireless, Inc., a provider of 3G and 4G Long Term Evolution (LTE) wireless broadband network equipment and solutions for public safety and military customers (on June 8).
Open Kernel Labs, Inc., a provider of virtualization software for securing wireless communications, applications and content for mobile devices and automotive in-vehicle infotainment systems (on August 17).
Fidelis Security Systems, Inc., a company that provides cyber security tools that offer real-time network visibility, analysis and control (on August 27).
In 2011, we acquired six businesses for an aggregate of $1.6 billion, funded by cash on hand:
Combat Systems
Force Protection, Inc., a provider of wheeled vehicles, survivability solutions and vehicle sustainment services for the armed forces of the United States and its allies (on December 19).
Marine Systems
Metro Machine Corp., a surface-ship repair business in Norfolk, Virginia, that supports the U.S. Navy fleet (on October 31).
Information Systems and Technology
A provider of enterprise services and cloud computing to the U.S. Department of Defense (on July 15).
A provider of secure wireless networking equipment for the U.S. military and other government customers (on July 22).
A provider of information assurance and security software (on August 12).
Vangent, Inc., a provider of health information technology services and business systems to federal agencies (on September 30).
The operating results of these acquisitions have been included with our reported results since their respective closing dates. The purchase prices of these acquisitions have been allocated preliminarily to the estimated fair value of net tangible and intangible assets acquired, with any excess purchase price recorded as goodwill.

9


Intangible assets consisted of the following:

 
Gross Carrying Amount
Accumulated Amortization
Net Carrying Amount
 
Gross Carrying Amount
Accumulated Amortization
Net Carrying Amount
 
December 31, 2011
 
September 30, 2012
Contract and program intangible assets*
$
2,393

$
(1,060
)
$
1,333

 
$
2,407

$
(1,207
)
$
1,200

Trade names and trademarks
477

(70
)
407

 
481

(80
)
401

Technology and software
175

(110
)
65

 
251

(125
)
126

Other intangible assets
174

(166
)
8

 
174

(167
)
7

Total intangible assets
$
3,219

$
(1,406
)
$
1,813

 
$
3,313

$
(1,579
)
$
1,734

* Consists of acquired backlog and probable follow-on work and related customer relationships.
The amortization lives (in years) of our intangible assets on September 30, 2012, were as follows:

 
Range of
Weighted Average
 
Amortization Life
Amortization Life
Contract and program intangible assets
7-30
17
Trade names and trademarks
30
30
Technology and software
7-13
9
Other intangible assets
7-15
11
Total intangible assets
 
19
We amortize intangible assets on a straight-line basis unless the pattern of usage of the benefits indicates an alternate method is more representative of the usage of the asset. Amortization expense was $60 and $176 for the three- and nine-month periods ended October 2, 2011, and $57 and $172 for the three- and nine-month periods ended September 30, 2012. We expect to record amortization expense of $231 in 2012 and over the next five years as follows:

2013
$
196

2014
173

2015
168

2016
140

2017
124


10


The changes in the carrying amount of goodwill by reporting unit for the nine months ended September 30, 2012, were as follows:

 
Aerospace
 
Combat Systems
 
Marine Systems
 
Information Systems and Technology
 
Total Goodwill
December 31, 2011
$
2,644

 
$
2,839

 
$
229

 
$
7,864

 
$
13,576

Acquisitions (a)
14

 
87

 
38

 
227

 
366

Other (b)
(5
)
 
40

 
1

 
8

 
44

September 30, 2012
$
2,653

 
$
2,966

 
$
268

 
$
8,099

 
$
13,986

(a)
Includes adjustments during the purchase price allocation period.
(b)
Consists primarily of adjustments for foreign currency translation.

C. EARNINGS AND DIVIDENDS PER SHARE
Earnings per Share. We compute 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 additional shares issuable upon the assumed exercise of stock options and the release of restricted shares and restricted stock units (RSUs). Basic and diluted weighted average shares outstanding were as follows (in thousands):

 
Three Months Ended
Nine Months Ended
 
October 2, 2011
September 30, 2012
October 2, 2011
September 30, 2012
Basic weighted average shares outstanding
359,710

350,470

366,783

354,168

Dilutive effect of stock options and restricted stock/RSUs
3,175

2,356

3,438

2,351

Diluted weighted average shares outstanding
362,885

352,826

370,221

356,519

Dividends. Dividends declared per share were $0.47 and $1.41 for the three- and nine-month periods ended October 2, 2011, and $0.51 and $1.53 for the three- and nine-month periods ended September 30, 2012. Cash dividends paid were $171 and $504 for the three- and nine-month periods ended October 2, 2011, and $180 and $533 for the three- and nine-month periods ended September 30, 2012.

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 December 31, 2011, or September 30, 2012.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between marketplace participants. Various valuation approaches can be used to determine fair value, each requiring different valuation inputs. The following hierarchy classifies the inputs used to determine fair value into three levels:

11



Level 1 – quoted prices in active markets for identical assets or liabilities;
Level 2 – inputs, other than quoted prices, observable by a marketplace participant either directly or indirectly; and
Level 3 – unobservable inputs significant to the fair value measurement.
The carrying values of cash and equivalents, accounts receivable and payable, and short-term debt (commercial paper) on the Consolidated Balance Sheets approximate their fair value. The following tables present the fair values of our other financial assets and liabilities on December 31, 2011, and September 30, 2012, and the basis for determining their fair values:

 
Carrying
Value
 
Fair
Value
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
(a)
Financial assets (liabilities) (b)
December 31, 2011
Marketable securities:
 
 
 
 
 
 
 
Available-for-sale
$
70

 
$
70

 
$
8

 
$
62

Held-to-maturity
178

 
175

 

 
175

Other investments
145

 
145

 
89

 
56

Derivatives
34

 
34

 

 
34

Long-term debt,
     including current portion
(3,930
)
 
(4,199
)
 

 
(4,199
)
 
 
 
 
 
 
 
 
 
September 30, 2012
Marketable securities:
 
 
 
 
 
 
 
Available-for-sale
$
7

 
$
7

 
$

 
$
7

Held-to-maturity (c)
170

 
170

 

 
170

Other investments
150

 
150

 
95

 
55

Derivatives
16

 
16

 

 
16

Long-term debt,
     including current portion
(3,925
)
 
(4,160
)
 

 
(4,160
)
(a)Determined under a market approach using valuation models that incorporate observable inputs such as interest rates, bond yields and quoted prices for similar assets and liabilities.
(b)We had no Level 3 financial instruments on December 31, 2011, or September 30, 2012.
(c)We sold $211 of held-to-maturity securities in the first nine months of 2012. The net carrying amount of these securities on the date of sale was $210.

E. CONTRACTS IN PROCESS
Contracts in process represent 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:
 
December 31, 2011
 
September 30, 2012
Contract costs and estimated profits
$
18,807

 
$
20,550

Other contract costs
959

 
1,074

 
19,766

 
21,624

Advances and progress payments
(14,598
)
 
(16,593
)
Total contracts in process
$
5,168

 
$
5,031


12


Contract costs consist primarily of labor, material, overhead and general and administrative (G&A) expenses. Contract costs also may include estimated contract recoveries for matters such as contract changes, negotiated settlements and claims for unanticipated contract costs. We record revenue associated with these matters only when the amount of recovery can be estimated reliably and realization is probable. Assumed recoveries for negotiated settlements and claims for unanticipated contract costs included in contracts in process were not material on December 31, 2011, or September 30, 2012.
Other contract costs represent amounts that are not currently allocable to government contracts, such as a portion of our estimated workers’ compensation obligations, other insurance-related assessments, pension and other post-retirement benefits and environmental expenses. These costs will become allocable to contracts generally after they are paid. We expect to recover these costs through ongoing business, including existing backlog and probable follow-on contracts. 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 contracts-in-process balance as of September 30, 2012, during the next 12 months, with the exception of these other contract costs.

F. INVENTORIES
Our inventories represent primarily business-jet components and are stated at the lower of cost or net realizable value. Work-in-process represents largely labor, material and overhead costs associated with aircraft in the manufacturing process and is based primarily on the estimated average unit cost of the units in a production lot. Raw materials are valued primarily on the first-in, first-out method. We record pre-owned aircraft acquired in connection with the sale of new aircraft at the lower of the trade-in value or the estimated net realizable value. Inventories consisted of the following:

 
December 31, 2011
 
September 30, 2012
Work in process
$
1,202

 
$
1,457

Raw materials
1,031

 
1,065

Finished goods
77

 
82

Pre-owned aircraft

 
57

Total inventories
$
2,310

 
$
2,661


G. DEBT
Debt consisted of the following:
 
 
December 31, 2011
 
September 30, 2012
Fixed-rate notes due:
Interest Rate
 
 
 
May 2013
4.250%
$
1,000

 
$
1,000

February 2014
5.250%
998

 
999

January 2015
1.375%
499

 
499

August 2015
5.375%
400

 
400

July 2016
2.250%
499

 
500

July 2021
3.875%
499

 
499

Other
Various
35

 
28

Total debt
 
3,930

 
3,925

Less current portion
 
23

 
1,001

Long-term debt
 
$
3,907

 
$
2,924


13


Fixed-rate Notes. On September 30, 2012, we had outstanding $3.9 billion aggregate principal amount of fixed-rate notes. The fixed-rate notes are fully and unconditionally guaranteed by several of our 100-percent-owned subsidiaries. See Note N for condensed consolidating financial statements. We have the option to redeem the notes prior to their maturity in whole or part for the principal plus any accrued but unpaid interest and applicable make-whole amounts.
Commercial Paper. On September 30, 2012, we had no commercial paper outstanding, but we maintain the ability to access the market. We have $2 billion in bank credit facilities that provide backup liquidity to our commercial paper program. These credit facilities include a $1 billion multi-year facility expiring in July 2013 and a $1 billion multi-year facility expiring in July 2016. These facilities are required by rating agencies to support our commercial paper issuances. We may renew or replace, in whole or in part, these credit facilities prior to their expiration. Our commercial paper issuances and the bank credit facilities are guaranteed by several of our 100-percent-owned subsidiaries.
Our financing arrangements contain a number of customary covenants and restrictions. We were in compliance with all material covenants on September 30, 2012.

H. OTHER LIABILITIES
A summary of significant other liabilities by balance sheet caption follows:

 
December 31, 2011
 
September 30, 2012
Salaries and wages
$
845

 
$
794

Workers' compensation
575

 
570

Retirement benefits
275

 
283

Deferred income taxes
131

 
134

Other (a)
1,390

 
1,348

Total other current liabilities
$
3,216

 
$
3,129

 
 
 
 
Retirement benefits
$
4,627

 
$
4,328

Customer deposits on commercial contracts 
1,132

 
895

Deferred income taxes
170

 
178

Other (b)
670

 
713

Total other liabilities
$
6,599

 
$
6,114

(a)Consists primarily of 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.
 
I. INCOME TAXES
Deferred Tax Assets. Our net deferred tax asset was included on the Consolidated Balance Sheets in other assets and liabilities as follows:

 
December 31, 2011
 
September 30, 2012
Current deferred tax asset
$
269

 
$
43

Current deferred tax liability
(131
)
 
(134
)
Noncurrent deferred tax asset
310

 
390

Noncurrent deferred tax liability
(170
)
 
(178
)
Net deferred tax asset
$
278

 
$
121


14


Tax Uncertainties. For all periods open to examination by tax authorities, we periodically assess our liabilities and contingencies based on the latest available information. Where we believe there is more than a 50 percent chance that our tax position will not be sustained, we record our best estimate of the resulting tax liability, including interest, in the Consolidated Financial Statements. We include any interest or penalties incurred in connection with income taxes as part of income tax expense. The Internal Revenue Service (IRS) has examined all of our consolidated federal income tax returns through 2010.
We participate in the IRS’s Compliance Assurance Process, a real-time audit of our tax return. We have recorded liabilities for tax uncertainties for the 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.
Based on all known facts and circumstances and current tax law, we believe the total amount of unrecognized tax benefits on September 30, 2012, is not material to our results of operations, financial condition or cash flows, and 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 vary over the next 12 months, producing, individually or in the aggregate, a material effect on our results of operations, financial condition or cash flows.

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. To the extent possible, we include terms in our contracts that are designed to protect us from this risk. Otherwise, we enter into derivative financial instruments, principally foreign currency forward purchase and sale contracts, designed to offset and minimize our risk. The one year average maturity of these instruments matches the duration of the activities that are at risk.
Interest Rate Risk. Our financial instruments subject to interest rate risk include fixed-rate long-term debt obligations and variable-rate commercial paper. 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 up to five years. On September 30, 2012, we held $3.1 billion in cash and equivalents and marketable securities. Our marketable securities had 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. We had $4 billion in notional forward exchange contracts outstanding on December 31, 2011, and $3 billion on September 30, 2012. We recognize derivative financial instruments

15


on the Consolidated Balance Sheets at fair value (see Note D). The fair value of these derivative contracts consisted of the following:

 
December 31, 2011
 
September 30, 2012
Other current assets:
 
 
 
Designated as cash flow hedges
$
64

 
$
33

Not designated as cash flow hedges
20

 
34

Other current liabilities:
 
 
 
Designated as cash flow hedges
(33
)
 
(35
)
Not designated as cash flow hedges
(17
)
 
(16
)
Total
$
34

 
$
16

We had no material derivative financial instruments designated as fair value or net investment hedges on December 31, 2011, or September 30, 2012.
We record changes in the fair value of derivative financial instruments in operating costs and expenses in the Consolidated Statements of Earnings or in other comprehensive income (OCI) within the Consolidated Statements of Comprehensive Income 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 OCI 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 Statements 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 Statements of Earnings for all derivative financial instruments, regardless of designation.
Net gains and losses recognized in earnings and OCI, including gains and losses related to hedge ineffectiveness, were not material to our results of operations for the three- and nine-month periods ended October 2, 2011, and September 30, 2012. We do not expect the amount of gains and losses in OCI 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. The resulting foreign currency translation adjustments are a component of OCI.
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 2, 2011, or September 30, 2012. In addition, the effect of changes in foreign exchange rates on non-U.S. cash balances was not material in the first three or nine months of either 2011 or 2012.


16


K. COMMITMENTS AND CONTINGENCIES
Litigation
Termination of A-12 Program. The A-12 aircraft contract was a fixed-price incentive contract for the full-scale development and initial production of the carrier-based Advanced Tactical Aircraft with the U.S. Navy and a team composed of contractors General Dynamics and McDonnell Douglas (now a subsidiary of The Boeing Company). In January 1991, the U.S. Navy terminated the contract for default and demanded the contractors repay $1.4 billion in unliquidated progress payments. Following the termination, the Navy agreed to defer the collection of that amount pending a negotiated settlement or other resolution. 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.
Over 20 years of litigation, the trial court (the U.S. Court of Federal Claims), appeals court (the Court of Appeals for the Federal Circuit), and the U.S. Supreme Court have issued various rulings, some in favor of the government and others in favor of the contractors.
On May 3, 2007, the trial court issued a decision upholding the government’s determination of default. This decision was affirmed by a three-judge panel of the appeals court on June 2, 2009, and on November 24, 2009, the court of appeals denied the contractors’ petitions for rehearing. On September 28, 2010, the U.S. Supreme Court granted the contractors’ petitions for review as to whether the government could maintain its default claim against the contractors while invoking the state-secrets privilege to deny the contractors a defense to that claim.
On May 23, 2011, the U.S. Supreme Court vacated the judgment of the court of appeals, stating that the contractors had a plausible superior knowledge defense that had been stripped from them as a consequence of the government’s assertion of the state-secrets privilege. In particular, the U.S. Supreme Court held that, in that circumstance, neither party can obtain judicial relief.
In addition, the U.S. Supreme Court remanded the case to the court of appeals for further proceedings on whether the government has an obligation to share its superior knowledge with respect to highly classified information, whether the government has such an obligation when the agreement specifies information that must be shared (as was the case with respect to the A-12 contract), and whether these questions can safely be litigated by the courts without endangering state secrets. On July 7, 2011, the appeals court remanded these issues to the trial court for further proceedings consistent with the U.S. Supreme Court’s opinion. These issues remain to be resolved on remand.
We believe that the lower courts will ultimately rule in the contractors’ favor on the remaining issues in the case. We expect this would leave all parties where they stood prior to the contracting officer’s declaration of default, meaning that no money would be due from one party to another. Additionally, even if the lower courts were to ultimately sustain the government’s default claim, we continue to believe that there are significant legal obstacles to the government’s ability to collect any amount from the contractors given that no court has ever awarded a money judgment to the government. For these reasons, we have not recorded an accrual for this matter.
If, contrary to our expectations, the government prevails on its default claim and its recovery theories, the contractors could collectively be required to repay the government, on a joint and several basis, as much as $1.4 billion for progress payments received for the A-12 contract, plus interest, which was approximately $1.6 billion on September 30, 2012. This would result in a liability to us of half of the total (based upon The Boeing Company satisfying McDonnell Douglas’ obligations under the contract), or approximately $1.5 billion pretax. Our after-tax charge would be approximately $835, or $2.37 per share, which would be recorded in discontinued operations. Our after-tax cash cost would be approximately $740. We believe we have sufficient resources to satisfy our obligation if required.

17


Other. Various claims and other legal proceedings incidental to the normal course of business are pending or threatened against us. These matters relate to such issues as government investigations and claims, the protection of the environment, asbestos-related claims and employee-related matters. The nature of litigation is such that we cannot predict the outcome of these matters. However, based on information currently available, 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 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, recoverable under U.S. government contracts.
As required, we provide financial assurance for certain sites undergoing or subject to investigation or remediation. We accrue environmental costs when it is probable that a liability has been incurred and the amount can be reasonably estimated. Where applicable, we seek insurance recovery for costs related to environmental liability. We do not record insurance recoveries before collection is considered probable. Based on all known facts and analyses, 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
Portugal Program. Our European Land Systems business has a contract with the Portuguese Ministry of National Defense to provide 260 Pandur vehicles over the course of seven years. We have been engaging with the customer regarding a potential restructuring of the contract.  Recently, the Minister of National Defense stated publicly that he intends to terminate the program based upon a breach of the contract. We have not been officially notified of any such termination or breach, nor do we believe that we are in breach of the contract. To protect our rights under the contract, we have filed a demand for arbitration. We cannot predict at this time whether the contract will be restructured or terminated or the results of the arbitration proceeding. Further, we cannot predict when the matter will be resolved or the outcome it may have on our operating results or cash flows.  As of September 30, 2012, we had a balance of approximately $130 in accounts receivable and contracts in process related to this contract. 
Securities and Exchange Commission (SEC) Request. On September 23, 2011, the SEC’s Division of Enforcement requested that we provide certain information, documents and records relating to accounting practices for revisions of estimates on contracts accounted for using the percentage-of-completion method. We are cooperating with the SEC staff. We cannot predict the outcome of this request.
Letters of Credit and Guarantees. 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 $1.3 billion on September 30, 2012. These include letters of credit for our international subsidiaries, which are backed by available local bank credit facilities aggregating approximately $830. 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 a material nature that would require us to satisfy these guarantees.
Government Contracts. As a government contractor, we are subject to U.S. government audits

18


and investigations relating to our operations, including claims for fines, penalties, and compensatory and treble damages. 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.
In the performance of our contracts, we routinely request contract modifications that require additional funding from the customer. Most often, these requests are due to customer-directed changes in scope of work. While we are entitled to recovery of these costs under our contracts, the administrative process with our customer may be protracted. Based upon the circumstances, we periodically will file a claim or a request for equitable adjustment (REA). In some cases, these requests are disputed by our customer. We believe our outstanding modifications and other claims will be resolved without material impact to 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 outstanding options with some customers to trade in aircraft as partial consideration in their new-aircraft transaction. These trade-in commitments are 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 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.
Product Warranties. We provide warranties to our customers associated with certain product sales. 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 generally based on the number of months of warranty coverage remaining for products delivered and the average historical monthly warranty payments. Warranty obligations incurred in connection with long-term production contracts are accounted for within the contract estimates at completion (EACs). Our other warranty obligations, primarily for business-jet aircraft, are included in other current liabilities and other liabilities on the Consolidated Balance Sheets.
The changes in the carrying amount of warranty liabilities for the nine-month periods ended October 2, 2011, and September 30, 2012, were as follows:

Nine Months Ended
October 2, 2011
 
September 30, 2012
Beginning balance
$
260

 
$
293

Warranty expense
45

 
60

Payments
(44
)
 
(47
)
Adjustments*

 
(5
)
Ending balance
$
261

 
$
301

* Includes reclassifications.


19


L. RETIREMENT PLANS
We provide defined-contribution benefits, as well as defined-benefit pension and other post-retirement benefits, to eligible employees.
Net periodic cost associated with our defined-benefit pension and other post-retirement benefit plans for the three- and nine-month periods ended October 2, 2011, and September 30, 2012, consisted of the following:

 
Pension Benefits
Other Post-retirement Benefits
Three Months Ended
October 2, 2011
 
September 30, 2012
October 2, 2011
 
September 30, 2012
Service cost
$
64

 
$
71

$
3

 
$
3

Interest cost
129

 
131

16

 
15

Expected return on plan assets
(150
)
 
(147
)
(8
)
 
(7
)
Recognized net actuarial loss
40

 
66

1

 
2

Amortization of prior service (credit) cost
(11
)
 
(11
)
1

 
2

Net periodic cost
$
72

 
$
110

$
13

 
$
15

 
Pension Benefits
Other Post-retirement Benefits
Nine Months Ended
October 2, 2011
 
September 30, 2012
October 2, 2011
 
September 30, 2012
Service cost
$
191

 
$
213

$
10

 
$
9

Interest cost
388

 
393

46

 
43

Expected return on plan assets
(450
)
 
(441
)
(24
)
 
(22
)
Recognized net actuarial loss
120

 
198

3

 
7

Amortization of prior service (credit) cost
(33
)
 
(33
)
4

 
6

Net periodic cost
$
216

 
$
330

$
39

 
$
43

Our contractual arrangements with the U.S. government provide for the recovery of contributions to our pension and other post-retirement benefit plans covering employees working in our defense business groups. For non-funded plans, our government contracts allow us to recover claims paid. Following payment, these recoverable amounts are allocated to contracts and billed to the customer in accordance with the Cost Accounting Standards (CAS) and specific contractual terms. For some of these plans, the cumulative pension and post-retirement benefit cost exceeds the amount currently allocable to contracts. To the extent recovery of the cost is considered probable based on our backlog and probable follow-on contracts, we defer the excess in contracts in process on the Consolidated Balance Sheets until the cost is allocable to contracts. See Note E for discussion of our deferred contract costs. For other plans, the amount allocated 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 plan assets on the Consolidated Balance Sheets.
In late 2011, changes were made to the CAS to harmonize the regulations with the Pension Protection Act of 2006 (PPA). As a result, pension costs allocable to our contracts are expected to increase beginning in 2014 when the full impact of the CAS regulations begins to take effect. For certain contracts awarded prior to February 27, 2012, we are entitled to recovery of these additional pension costs from our customers. We expect to submit REAs of approximately $170 for these contracts in the fourth quarter of 2012.


20


M. BUSINESS GROUP INFORMATION
We operate in four business groups: Aerospace, Combat Systems, Marine Systems and Information Systems and Technology. We organize 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; military and commercial shipbuilding; and communications and information technology, 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 financial information for each of our business groups follows:

 
Revenues
Operating Earnings
Three Months Ended
October 2, 2011
September 30, 2012
October 2, 2011
September 30, 2012
Aerospace
$
1,412

$
1,836

$
217

$
261

Combat Systems
2,140

1,956

319

274

Marine Systems
1,621

1,670

173

186

Information Systems and Technology
2,680

2,472

310

201

Corporate*


(21
)
(17
)
 
$
7,853

$
7,934

$
998

$
905


 
Revenues
Operating Earnings
Nine Months Ended
October 2, 2011
September 30, 2012
October 2, 2011
September 30, 2012
Aerospace
$
4,141

$
5,051

$
656

$
789

Combat Systems
6,216

6,016

895

799

Marine Systems
4,873

4,928

501

554

Information Systems and Technology
8,300

7,440

885

645

Corporate*


(61
)
(52
)
 
$
23,530

$
23,435

$
2,876

$
2,735

*Corporate operating results primarily consists of stock option expense.


21


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 STATEMENTS OF EARNINGS
Three Months Ended October 2, 2011
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
Revenues
$

$
6,262

$
1,591

$

$
7,853

Cost of sales
(2
)
5,059

1,306


6,363

General and administrative expenses
23

368

101


492

Operating earnings
(21
)
835

184


998

Interest expense
(40
)
(1
)


(41
)
Interest income
1

2



3

Other, net
1

(12
)
3


(8
)
Earnings before income taxes
(59
)
824

187


952

Provision for income taxes
(21
)
267

41


287

Discontinued operations, net of tax
(13
)



(13
)
Equity in net earnings of subsidiaries
703



(703
)

Net earnings
$
652

$
557

$
146

$
(703
)
$
652

Comprehensive income
$
171

$
541

$
(336
)
$
(205
)
$
171

Three Months Ended September 30, 2012
 
 
 
 
 
Revenues
$

$
6,684

$
1,250

$

$
7,934

Cost of sales
(7
)
5,476

1,050


6,519

General and administrative expenses
22

388

100


510

Operating earnings
(15
)
820

100


905

Interest expense
(40
)



(40
)
Interest income
2

(2
)
1


1

Other, net
(2
)
1

(2
)

(3
)
Earnings before income taxes
(55
)
819

99


863

Provision for income taxes
(12
)
244

31


263

Equity in net earnings of subsidiaries
643



(643
)

Net earnings
$
600

$
575

$
68

$
(643
)
$
600

Comprehensive income
$
745

$
577

$
170

$
(747
)
$
745



22


CONDENSED CONSOLIDATING STATEMENTS OF EARNINGS
Nine Months Ended October 2, 2011
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
Revenues
$

$
19,007

$
4,523

$

$
23,530

Cost of sales
(7
)
15,399

3,756


19,148

General and administrative expenses
67

1,118

321


1,506

Operating earnings
(60
)
2,490

446


2,876

Interest expense
(112
)
(3
)


(115
)
Interest income
8

3

1


12

Other, net
2

30

2


34

Earnings before income taxes
(162
)
2,520

449


2,807

Provision for income taxes
(53
)
790

121


858

Discontinued operations, net of tax
(26
)



(26
)
Equity in net earnings of subsidiaries
2,058



(2,058
)

Net earnings
$
1,923

$
1,730

$
328

$
(2,058
)
$
1,923

Comprehensive income
$
1,918

$
1,740

$
257

$
(1,997
)
$
1,918

Nine Months Ended September 30, 2012
 
 
 
 
 
Revenues
$

$
19,485

$
3,950

$

$
23,435

Cost of sales
(16
)
15,834

3,312


19,130

General and administrative expenses
66

1,196

308


1,570

Operating earnings
(50
)
2,455

330


2,735

Interest expense
(123
)

(1
)

(124
)
Interest income
5

1

3


9

Other, net

(5
)
(3
)

(8
)
Earnings before income taxes
(168
)
2,451

329


2,612

Provision for income taxes
(74
)
790

98


814

Equity in net earnings of subsidiaries
1,892



(1,892
)

Net earnings
$
1,798

$
1,661

$
231

$
(1,892
)
$
1,798

Comprehensive income
$
1,953

$
1,659

$
273

$
(1,932
)
$
1,953



23


CONDENSED CONSOLIDATING BALANCE SHEET
December 31, 2011
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
ASSETS
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and equivalents
$
1,530

$

$
1,119

$

$
2,649

Accounts receivable

1,659

2,793


4,452

Contracts in process
292

3,182

1,694


5,168

Inventories
 
 
 
 
 
Work in process

1,168

34


1,202

Raw materials

898

133


1,031

Finished goods

36

41


77

Other current assets
320

247

222


789

Total current assets
2,142

7,190

6,036


15,368

Noncurrent assets:
 
 
 
 
 
Property, plant and equipment
153

5,181

1,184


6,518

Accumulated depreciation of PP&E
(49
)
(2,604
)
(581
)

(3,234
)
Intangible assets

1,767

1,452


3,219

Accumulated amortization of intangible assets

(976
)
(430
)

(1,406
)
Goodwill

9,287

4,289


13,576

Other assets
10

629

203


842

Investment in subsidiaries
33,450



(33,450
)

Total noncurrent assets
33,564

13,284

6,117

(33,450
)
19,515

Total assets
$
35,706

$
20,474

$
12,153

$
(33,450
)
$
34,883

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Short-term debt
$

$
21

$
2

$

$
23

Customer advances and deposits

2,483

2,528


5,011

Other current liabilities
537

3,729

1,845


6,111

Total current liabilities
537

6,233

4,375


11,145

Noncurrent liabilities:
 
 
 
 
 
Long-term debt
3,895

9

3


3,907

Other liabilities
3,443

2,541

615


6,599

Total noncurrent liabilities
7,338

2,550

618


10,506

Intercompany
14,599

(15,240
)
641



Shareholders' equity:
 
 
 
 
 
Common stock
482

6

44

(50
)
482

Other shareholders' equity
12,750

26,925

6,475

(33,400
)
12,750

Total shareholders' equity
13,232

26,931

6,519

(33,450
)
13,232

Total liabilities and shareholders' equity
$
35,706

$
20,474

$
12,153

$
(33,450
)
$
34,883



24


CONDENSED CONSOLIDATING BALANCE SHEET
September 30, 2012
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
ASSETS
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and equivalents
$
1,987

$

$
887

$

$
2,874

Accounts receivable

1,390

2,949


4,339

Contracts in process
421

3,176

1,434


5,031

Inventories
 
 
 
 
 
Work in process

1,441

16


1,457

Raw materials

952

113


1,065

Finished goods

34

48


82

Pre-owned aircraft

57



57

Other current assets
197

239

252


688

Total current assets
2,605

7,289

5,699


15,593

Noncurrent assets:
 
 
 
 
 
Property, plant and equipment
154

5,445

1,281


6,880

Accumulated depreciation of PP&E
(54
)
(2,792
)
(689
)

(3,535
)
Intangible assets

1,857

1,456


3,313

Accumulated amortization of intangible assets

(1,082
)
(497
)

(1,579
)
Goodwill

9,637

4,349


13,986

Other assets
2

668

175


845

Investment in subsidiaries
35,597



(35,597
)

Total noncurrent assets
35,699

13,733

6,075

(35,597
)
19,910

Total assets
$
38,304

$
21,022

$
11,774

$
(35,597
)
$
35,503

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Short-term debt
$
1,000

$

$
1

$

$
1,001

Customer advances and deposits

2,954

2,569


5,523

Other current liabilities
549

3,694

1,426


5,669

Total current liabilities
1,549

6,648

3,996


12,193

Noncurrent liabilities:
 
 
 
 
 
Long-term debt
2,897

27



2,924

Other liabilities
3,137

2,358

619


6,114

Total noncurrent liabilities
6,034

2,385

619


9,038

Intercompany
16,449

(16,805
)
356



Shareholders' equity:
 
 
 
 
 
Common stock
482

6

44

(50
)
482

Other shareholders' equity
13,790

28,788

6,759

(35,547
)
13,790

Total shareholders' equity
14,272

28,794

6,803

(35,597
)
14,272

Total liabilities and shareholders' equity
$
38,304

$
21,022

$
11,774

$
(35,597
)
$
35,503



25


CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
Nine Months Ended October 2, 2011
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
Net cash provided by operating activities
$
(305
)
$
1,708

$
(187
)
$

$
1,216

Cash flows from investing activities:
 
 
 
 
 
Business acquisitions, net of cash acquired

(1,143
)


(1,143
)
Purchases of held-to-maturity securities
(428
)



(428
)
Maturities of held-to-maturity securities
215


107


322

Purchases of available-for-sale securities
(264
)
(86
)


(350
)
Other, net
232

(39
)
(51
)

142

Net cash used by investing activities
(245
)
(1,268
)
56


(1,457
)
Cash flows from financing activities:
 
 
 
 
 
Proceeds from fixed-rate notes
1,497




1,497

Purchases of common stock
(1,449
)



(1,449
)
Repayment of fixed-rate notes
(750
)



(750
)
Dividends paid
(504
)



(504
)
Net proceeds from commercial paper
200




200

Other, net
203

(20
)
(3
)

180

Net cash used by financing activities
(803
)
(20
)
(3
)

(826
)
Net cash used by discontinued operations
(6
)



(6
)
Cash sweep/funding by parent
433

(420
)
(13
)


Net decrease in cash and equivalents
(926
)

(147
)

(1,073
)
Cash and equivalents at beginning of period
1,608


1,005


2,613

Cash and equivalents at end of period
$
682

$

$
858

$

$
1,540

Nine Months Ended September 30, 2012
 
 
 
 
 
Net cash provided by operating activities
$
(523
)
$
2,275

$
155

$

$
1,907

Cash flows from investing activities:
 
 
 
 
 
Business acquisitions, net of cash acquired
(101
)
(299
)
(26
)

(426
)
Capital expenditures
(1
)
(251
)
(34
)

(286
)
Purchases of held-to-maturity securities
(260
)



(260
)
Sales of held-to-maturity securities
211




211

Purchases of available-for-sale securities
(140
)
(61
)


(201
)
Other, net
233

61



294

Net cash used by investing activities
(58
)
(550
)
(60
)

(668
)
Cash flows from financing activities:
 
 
 
 
 
Purchases of common stock
(602
)



(602
)
Dividends paid
(533
)



(533
)
Proceeds from option exercises
121




121

Other, net
24

(20
)
(2
)

2

Net cash used by financing activities
(990
)
(20
)
(2
)

(1,012
)
Net cash used by discontinued operations
(2
)



(2
)
Cash sweep/funding by parent
2,030

(1,705
)
(325
)


Net increase in cash and equivalents
457


(232
)

225

Cash and equivalents at beginning of period
1,530


1,119


2,649

Cash and equivalents at end of period
$
1,987

$

$
887

$

$
2,874



26


(Dollars in millions, except per-share amounts or unless otherwise noted)
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

BUSINESS OVERVIEW

General Dynamics offers a broad portfolio of products and services in business aviation; combat vehicles, weapons systems and munitions; military and commercial shipbuilding; and communications and information technology. We operate through four business groups: Aerospace, Combat Systems, Marine Systems and Information Systems and Technology. Our primary customers are the U.S. government, including the Department of Defense, Department of Homeland Security, the intelligence community and other civilian agencies; international governments; and a diverse base of corporate and individual buyers of business jets. We operate in two primary markets, defense and business aviation, with the majority of our revenues from contracts with the U.S. government. The following discussion should be read in conjunction with our 2011 Annual Report on Form 10-K and with the unaudited Consolidated Financial Statements included in this Form 10-Q.

DEFENSE BUSINESS ENVIRONMENT

As a defense contractor, our financial performance is impacted by the allocation and prioritization of U.S. defense spending. Several factors are currently impacting U.S. defense spending, including the fact that the Congress has not approved the President's fiscal year (FY) 2013 budget request. Consequently, the U.S. government, including the Department of Defense, is operating under a continuing resolution (CR) that provides funding at FY 2012 levels through March 2013. However, a CR does not fund new contract starts or multi-year contracts and historically has slowed the pace of funding for our existing contracts.

Additionally, U.S. defense spending has been negatively impacted by the Budget Control Act of 2011. The Budget Control Act of 2011 has two primary parts that affect future defense spending. The first part mandates a $487 billion reduction to previously-planned defense spending over the next decade. These cuts are incorporated into the FY 2013 proposed defense budget. The second part is a sequester mechanism that would impose an additional $500 billion of cuts on defense spending between FY 2013 and FY 2021 if the Congress does not identify a means to reduce the U.S. deficit by $1.2 trillion by year end. As of October 30, 2012, the means have not been identified by Congress. Given the uncertainty regarding how the Congress will reduce the U.S. deficit and a lack of specifics on how cuts will be implemented, we are unable to predict the impact, which could be material, on our programs or financial outlook, including our revenues, operating earnings and margins, cash flow, orders and backlog and recovery of long-lived assets. However, funding reductions of the magnitude imposed by the sequester mechanism as written could have material operational consequences to our employee base, facilities and suppliers.

RESULTS OF OPERATIONS
INTRODUCTION
We recognize the majority of our revenues using the percentage-of-completion method of accounting. The following paragraphs explain how this method is applied in recognizing revenues and operating costs in our Aerospace and defense business groups. An understanding of our practices is important to an evaluation of our operating results.
In the Aerospace group, contracts for new aircraft have two major phases: the manufacture of the

27


“green” aircraft and the aircraft’s outfitting, which includes exterior painting and installation of customer-selected interiors. We record revenues on these contracts at the completion of these two phases: when green aircraft are delivered to and accepted by the customer, and when the customer accepts final delivery of the outfitted aircraft. Revenues in the Aerospace group’s other original equipment manufacturers (OEMs) completions and services businesses are recognized as work progresses or upon delivery of services. Changes in revenues result from the number and mix of new aircraft deliveries (green and outfitted), progress on aircraft completions and the level of aircraft service activity during the period.
The majority of the Aerospace group’s operating costs relates to new aircraft production for firm orders and consists of labor, material and overhead costs. The costs are accumulated in production lots and recognized as operating costs at green aircraft delivery based on the estimated average unit cost in a production lot. While changes in the estimated average unit cost for a production lot impact the level of operating costs, the amount of operating costs reported in a given period is based largely on the number and type of aircraft delivered. Operating costs in the Aerospace group’s other OEMs completions and services businesses are generally recognized as incurred.
For new aircraft, operating earnings and margins are a function of the prices of our aircraft, our operational efficiency in manufacturing and outfitting the aircraft and the mix of aircraft deliveries between the higher-margin large-cabin and lower-margin mid-cabin aircraft. Additional factors affecting the group’s earnings and margins include the volume, mix and profitability of completions and services work performed, the market for pre-owned aircraft and the level of general and administrative (G&A) and net research and development (R&D) costs incurred by the group.
In the defense groups, revenue on long-term government contracts is recognized as work progresses, either as products are produced or services are rendered. As a result, changes in revenues are discussed generally in terms of volume, typically measured by the level of activity on individual contracts. Year-over-year variances attributed to volume indicate increases or decreases in revenues due to changes in production or service levels and delivery schedules.
Operating costs for the defense groups consist of labor, material, subcontractor and overhead costs and are generally recognized as incurred. Variances in costs recognized from period to period primarily reflect increases and decreases in production or activity levels on individual contracts and, therefore, result largely from the same factors that drive variances in revenues.
Operating earnings and margins in the defense groups are driven by changes in volume, performance or contract mix. Performance refers to changes in profitability based on revisions to estimates at completion on individual contracts. These revisions result from increases or decreases to the estimated value of the contract or the estimated costs to complete. Therefore, changes in costs incurred in the period do not necessarily impact profitability. It is only when total estimated costs at completion change that profitability may be impacted. Contract mix refers to changes in the volume of higher- vs. lower-margin work on individual contracts and when aggregated across the contract portfolio. On an individual contract, higher or lower margins can be inherent in the contract type (e.g., fixed-price/cost-reimbursable) or type of work (e.g., development/production).

28


CONSOLIDATED OVERVIEW

Three Months Ended
October 2, 2011
 
September 30,
2012
 
Variance
Revenues
$
7,853

 
$
7,934

 
$
81

 
1.0
 %
Operating costs and expenses
6,855

 
7,029

 
174

 
2.5
 %
Operating earnings
998

 
905

 
(93)

 
(9.3
)%
Operating margins
12.7
%
 
11.4
%
 
 
 
 
Nine Months Ended
October 2, 2011
 
September 30,
2012
 
Variance
Revenues
$
23,530

 
$
23,435

 
$
(95
)
 
(0.4
)%
Operating costs and expenses
20,654

 
20,700

 
46

 
0.2
 %
Operating earnings
2,876

 
2,735

 
(141
)
 
(4.9
)%
Operating margins
12.2
%
 
11.7
%
 
 
 
 
Our revenues and operating costs were up in the third quarter of 2012 compared with the prior-year period driven primarily by the Aerospace group’s green deliveries of G650 aircraft, which commenced in the fourth quarter of 2011. These increases were largely offset by lower volume in the Information Systems and Technology group’s tactical communications systems business and on several U.S. and international wheeled vehicle contracts in the Combat Systems group. In the first nine months of 2012, the volume decreases in the Information Systems and Technology and Combat Systems groups described above exceeded the impact of G650 aircraft deliveries. Operating earnings and margins in the third quarter and first nine months of 2012 were down primarily due to the shift in volume from higher margin tactical communications products to lower margin information technology services in the Information Systems and Technology group.
PRODUCT REVENUES AND OPERATING COSTS

Three Months Ended
October 2, 2011
 
September 30,
2012
 
Variance
Revenues
$
5,070

 
$
4,967

 
$
(103
)
 
(2.0
)%
Operating costs
3,991

 
4,012

 
21

 
0.5
 %
Nine Months Ended
October 2, 2011
 
September 30,
2012
 
Variance
Revenues
$
15,186

 
$
14,672

 
$
(514
)
 
(3.4
)%
Operating costs
12,005

 
11,712

 
(293
)
 
(2.4
)%

Product revenues were lower in the third quarter and the first nine months of 2012 compared with the prior-year periods. The decrease in product revenues consisted of the following:


29


 
Third Quarter
 
Nine Months
Aircraft manufacturing, outfitting and completions
$
412

 
$
906

European vehicles production
(103
)
 
(200
)
Tactical communications products
(237
)
 
(893
)
Ship construction
(73
)
 
(146
)
Other, net
(102
)
 
(181
)
Total decrease
$
(103
)
 
$
(514
)
In 2012, aircraft manufacturing, outfitting and completions revenues increased due to green deliveries of G650 aircraft, which began in the fourth quarter of 2011. Offsetting this increase were lower European vehicles production revenues largely due to multiple wheeled vehicle contracts for various international customers that are nearing completion. Tactical communication products revenues decreased due to protracted customer acquisition cycles and a slower than expected transition to follow-on work on several programs. Ship construction revenues decreased due to lower volume on the T-AKE combat-logistics ship program, which is nearing completion, and timing on the Virginia-class submarine program as the group transitions from the Block II to the Block III contract.
Product operating costs were higher in the third quarter but lower in the first nine months of 2012 compared with the prior-year periods. The change in product operating costs consisted of the following:

 
Third Quarter
 
Nine Months
Volume:
 
 
 
  Aircraft manufacturing, outfitting and completions
$
322

 
$
681

  European vehicles production
(81
)
 
(163
)
  Tactical communication products
(144
)
 
(653
)
  Ship construction
(67
)
 
(178
)
Other changes, net
(9
)
 
20

Total increase (decrease)
$
21

 
$
(293
)
As the table above demonstrates, the primary driver of the changes in product operating costs in the third quarter and first nine months of 2012 was volume. No other changes were material.
SERVICE REVENUES AND OPERATING COSTS

Three Months Ended
October 2, 2011
 
September 30,
2012
 
Variance
Revenues
$
2,783

 
$
2,967

 
$
184

 
6.6
%
Operating costs
2,372

 
2,507

 
135

 
5.7
%
Nine Months Ended
October 2, 2011
 
September 30,
2012
 
Variance
Revenues
$
8,344

 
$
8,763

 
$
419

 
5.0
%
Operating costs
7,143

 
7,418

 
275

 
3.8
%

Service revenues increased in the third quarter and first nine months of 2012 compared with the prior-year periods. The increase in service revenues consisted of the following:


30


 
Third Quarter
 
Nine Months
Ship engineering and repair
$
144

 
$
265

Tactical communications support
11

 
82

Other, net
29

 
72

Total increase
$
184

 
$
419

In 2012, the increase in ship engineering and repair revenues was driven by the acquisition of two East Coast surface-ship repair operations and higher volume on the U.S. Navy’s Ohio-class replacement engineering program. Tactical communications support revenues increased in 2012 primarily due to higher service volume on the U.K.-based Bowman communications systems program, which has transitioned to maintenance and long-term support.
Service operating costs increased in the third quarter and first nine months of 2012 compared with the prior-year periods. The increase in service operating costs consisted of the following:

 
Third Quarter
 
Nine Months
Volume:
 
 
 
  Ship engineering and repair
$
120

 
$
221

  Tactical communications support

 
57

Other changes, net
15

 
(3
)
Total increase
$
135

 
$
275

As shown above, the primary driver of the changes in service operating costs in the third quarter and first nine months of 2012 was volume. No other changes were material.
OTHER INFORMATION
G&A Expenses
As a percentage of revenues, G&A expenses were 6.7 percent in the first nine months of 2012, compared with 6.4 percent in the prior-year period.
Interest Expense
Net interest expense in the first nine months of 2012 was $115 compared with $103 in the same period in 2011. The increase in interest expense is due to the $750 net increase in fixed-rate notes beginning in July 2011. We expect full-year 2012 net interest expense to be approximately $155.
Other, Net
In 2011, other income included a gain from the sale of the detection systems portion of the weapons systems business in our Combat Systems group in the second quarter. The sale resulted in a pretax gain of $38.
Effective Tax Rate
Our effective tax rate for the first nine months of 2012 was 31.2 percent compared with 30.6 percent in the same period in 2011. We anticipate a full-year 2012 effective tax rate slightly below 32 percent, compared with 31.4 percent in 2011, an increase primarily due to less income from international operations in jurisdictions with lower tax rates and the expiration of the R&D tax credit that Congress has not yet extended for 2012. For additional discussion of tax matters, see Note I to the unaudited Consolidated Financial

31


Statements.
Discontinued Operations
In 2011, we recognized a $13 loss, net of taxes, in discontinued operations from the settlement of an environmental matter associated with a former operation of the company in the third quarter. Additionally, the results for the first nine months of 2011 reflect our estimate of the legal costs associated with the A-12 litigation recorded in the second quarter as a result of the U.S. Supreme Court's decision that significantly extended the timeline associated with the litigation. See Note K to the unaudited Consolidated Financial Statements for further discussion of the A-12 litigation, which has been ongoing since 1991.

REVIEW OF BUSINESS GROUPS
Following is a discussion of operating results and outlook for each of our business groups. For the Aerospace group, results are analyzed with respect to specific lines of products and services, consistent with how the group is managed. For the defense groups, the discussion is based on the types of products and services each group offers with a supplemental discussion of specific contracts and programs when significant to the groups’ results. Information regarding our business groups also can be found in Note M to the unaudited Consolidated Financial Statements.
AEROSPACE

Three Months Ended
October 2, 2011
 
September 30,
2012
 
Variance
Revenues
$
1,412

 
$
1,836

 
$
424

 
30.0
 %
Operating earnings
217

 
261

 
44

 
20.3
 %
Operating margin
15.4
%
 
14.2
%
 
 
 
 
 
 
 
 
 
 
 
 
Gulfstream aircraft deliveries (in units):
 
 
 
 
 
 
 
Green
25
 
34
 
9

 
36.0
 %
Outfitted
26
 
17
 
(9
)
 
(34.6
)%
Nine Months Ended
October 2, 2011
 
September 30, 2012
 
Variance
Revenues
$
4,141

 
$
5,051

 
$
910

 
22.0
 %
Operating earnings
656

 
789

 
133

 
20.3
 %
Operating margin
15.8
%
 
15.6
%
 
 
 
 
 
 
 
 
 
 
 
 
Gulfstream aircraft deliveries (in units):
 
 
 
 
 
 
 
Green
72

 
88

 
16

 
22.2
 %
Outfitted
72

 
57

 
(15
)
 
(20.8
)%
Operating Results
The Aerospace group’s revenues increased in the third quarter and first nine months of 2012 compared with the prior-year periods. The increase consisted of the following:


32


 
Third Quarter
 
Nine Months
Aircraft manufacturing, outfitting and completions
$
412

 
$
906

Aircraft services
(13
)
 
23

Pre-owned aircraft
25

 
(19
)
Total increase
$
424

 
$
910

Aircraft manufacturing, outfitting and completions revenues include Gulfstream business-jet aircraft as well as completions of aircraft produced by other OEMs. Aircraft manufacturing, outfitting and completions revenues increased in 2012 primarily due to green deliveries of the new G650 aircraft, which began in the fourth quarter of 2011.
The growing global installed base of aircraft has led to increased demand for aircraft services, resulting in higher revenues in the first nine months of 2012. However, lower volume in our maintenance business at Jet Aviation in the third quarter of 2012, particularly in Europe, resulted in decreased aircraft services revenues compared with the prior-year period. Jet Aviation's maintenance business continues to be negatively impacted by an increasingly competitive marketplace.
Pre-owned aircraft sales increased in the third quarter but decreased in the first nine months of 2012. While the group sold fewer aircraft in both periods, the type of aircraft sold in the third quarter resulted in higher revenues when compared with the same period of 2011.
The group's operating earnings increased in the third quarter and first nine months of 2012 compared with 2011. The increase consisted of the following:

 
Third Quarter
 
Nine Months
Aircraft manufacturing, outfitting and completions
$
53

 
$
161

Aircraft services
6

 
6

Pre-owned aircraft
1

 
(1
)
G&A/other expenses
(16
)
 
(33
)
Total increase
$
44

 
$
133

Aircraft manufacturing, outfitting and completions earnings increased in the third quarter and first nine months of 2012 compared with the prior-year periods primarily due to the additional G650 green deliveries discussed above. These earnings were partially offset by fewer outfitted aircraft deliveries. We expect outfitting earnings to increase in the fourth quarter, driven in part by delivery of several outfitted G650 aircraft.
Aircraft services earnings were up slightly in the third quarter and first nine months of 2012 due to a favorable mix of service work.
In the first nine months of 2012, G&A and other expenses were negatively impacted by higher net R&D expenses, including lower supplier reimbursements of R&D costs.
The group’s operating margins decreased 120 and 20 basis points in the third quarter and first nine months of 2012, respectively, compared with the prior year periods as higher R&D expenses offset growth in the group's higher-margin manufacturing business.
Outlook
We expect an increase of approximately 16 to 17 percent in the group’s revenues in 2012 compared with 2011. The expected increase is due to additional green deliveries and initial outfitted deliveries of the G650

33


which received type certification from the FAA in the third quarter of 2012. We expect the Aerospace group’s margins to be in the mid-15 percent range, up from 2011 due to continued strong performance at Gulfstream and improved performance in Jet Aviation’s completions business.
COMBAT SYSTEMS

Three Months Ended
October 2, 2011
 
September 30, 2012
 
Variance
Revenues
$
2,140

 
$
1,956

 
$
(184
)
 
(8.6
)%
Operating earnings
319

 
274

 
(45
)
 
(14.1
)%
Operating margins
14.9
%
 
14.0
%
 
 
 
 
Nine Months Ended
October 2, 2011
 
September 30, 2012
 
Variance
Revenues
$
6,216

 
$
6,016

 
$
(200
)
 
(3.2
)%
Operating earnings
895

 
799

 
(96
)
 
(10.7
)%
Operating margins
14.4
%
 
13.3
%
 
 
 
 
Operating Results
The Combat Systems group’s revenues decreased in the third quarter and first nine months of 2012 compared with the prior-year periods. The decrease consisted of the following:

 
Third Quarter
 
Nine Months
U.S. military vehicles
$
(12
)
 
$
203

Weapon systems and munitions
(69
)
 
(160
)
European military vehicles
(103
)
 
(243
)
Total decrease
$
(184
)
 
$
(200
)
In the first nine months of 2012, revenues were up in the group’s U.S. military vehicles business due to the December 2011 acquisition of Force Protection, Inc., increased volume on several international export light armored vehicle (LAV) programs and the start of the technology development phase of the Army’s Ground Combat Vehicle (GCV) program. These revenues were partially offset by lower volume on the domestic Stryker, Abrams and Mine-Resistant, Ambush-Protected (MRAP) vehicle programs consistent with our expectations. The decrease in MRAP volume was primarily in the third quarter of 2012 and due to the completion of upgrade kit deliveries, which resulted in lower overall revenues compared with the third quarter of 2011.
Revenues were down in the third quarter of 2012 in the weapons systems and munitions business due to lower armor kit production and axle sales. In the first nine months of 2012, lower volume across several armament and munitions programs combined with the sale of the detection systems business in the second quarter of 2011 resulted in the decrease in revenues.
In the group’s European military vehicle business, revenues were down in 2012 due to lower volume on multiple wheeled vehicle contracts for various international customers that are nearing completion. Final deliveries under several of these contracts are scheduled in the fourth quarter of 2012, including Piranha vehicles for the Belgian Army, Duro vehicles for the Swiss government and EAGLE vehicles for the German government.
The Combat Systems group’s operating margins decreased 90 basis points in the third quarter of

34


2012 due to lower volume on mature, high-margin production programs, including the U.S. Stryker and Abrams programs, and unfavorable overhead absorption in our European military vehicles business. In the first nine months of 2012, margins were down 110 basis points compared with 2011 due to the negative impact of $67 of prior period adjustments recorded in the first quarter of 2012 at one of our subsidiaries in the European military vehicles business. 
Outlook
We expect the Combat Systems group’s revenues to approximate $8.5 billion in 2012. Lower volume in our domestic U.S. and European military vehicles businesses is expected to be mitigated by growth in international vehicle exports and revenues from the acquisition of Force Protection, Inc. Given the group’s operating results in the first nine months of the year, we expect the group’s full-year operating margin to approximate the mid-13 percent range. This operating margin outlook does not include any potential impact from uncertainties related to the group's Portugal contract. See Note K to the unaudited Consolidated Financial Statements for additional information regarding this contract.
MARINE SYSTEMS

Three Months Ended
October 2, 2011
 
September 30, 2012
 
Variance
Revenues
$
1,621

 
$
1,670

 
$
49

 
3.0
%
Operating earnings
173

 
186

 
13

 
7.5
%
Operating margins
10.7
%
 
11.1
%
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
October 2, 2011
 
September 30, 2012
 
Variance
Revenues
$
4,873

 
$
4,928

 
$
55

 
1.1
%
Operating earnings
501

 
554

 
53

 
10.6
%
Operating margins
10.3
%
 
11.2
%
 
 
 
 
Operating Results
Revenues increased in the Marine Systems group in the third quarter and first nine months of 2012 compared with the prior-year periods. The increase consisted of the following:

 
Third Quarter
 
Nine Months
Navy ship construction
$
(73
)
 
$
(146
)
Navy ship engineering, repair and other services
122

 
201

Total increase
$
49

 
$
55

The group’s U.S. Navy ship-construction programs include Virginia-class submarines, DDG-1000 and DDG-51 destroyers, and T-AKE combat-logistics and Mobile Landing Platform (MLP) auxiliary support ships. Revenues were down on the Virginia-class submarine program in the third quarter and first nine months of 2012 compared with the prior-year periods due to timing as the group transitions from the Block II to the Block III contract. Deliveries of the remaining nine Virginia-class submarines under contract are scheduled through 2018, and the Navy has requested proposals for the next block of submarines under the program expected to be awarded in the second half of 2013.
Revenues were up on the DDG-1000 and DDG-51 destroyer programs in the third quarter and first nine months of 2012. Deliveries of the three DDG-1000 ships under contract are scheduled for 2014, 2015

35


and 2018. Two destroyers awarded under the Navy’s restart of the DDG-51 program, including one awarded in the first quarter of 2012, are scheduled for delivery in 2016 and 2017, respectively. In the third quarter of 2012, we submitted a bid for a multi-ship, multi-year DDG-51 contract expected to be awarded in the first half of 2013.
Volume increased on the MLP program in 2012 as the group continued construction on the first ship and began construction of the second ship. The group was awarded a construction contract for the third MLP ship in the first quarter of 2012. Delivery of one ship per year is scheduled beginning in 2013. Additionally, the Navy's long-term shipbuilding plan includes a fourth MLP ship. On the group’s T-AKE program, activity was down in 2012 as the program nears completion. The 13th ship was delivered in the second quarter of 2012 and the 14th and final ship was delivered in October.
Revenues were up on engineering and repair programs for the Navy in 2012. The increase in revenues was driven by the acquisition of two East Coast surface-ship repair operations and higher volume on the Ohio-class replacement engineering program.
Growth in operating earnings outpaced revenues, resulting in a 40- and 90-basis point increase in operating margin in the third quarter and the first nine months of 2012, respectively, compared with the prior-year periods. This margin improvement was primarily due to increases in the T-AKE profit rate as the mature program continues to experience favorable cost performance.
Outlook
We expect the Marine Systems group’s 2012 revenues to decrease slightly from 2011. Given strong performance in the first nine months of the year, operating margins are expected to be in the mid-11 percent range in 2012.
INFORMATION SYSTEMS AND TECHNOLOGY

Three Months Ended
October 2, 2011
 
September 30, 2012
 
Variance
Revenues
$
2,680

 
$
2,472

 
$
(208
)
 
(7.8
)%
Operating earnings
310

 
201

 
(109
)
 
(35.2
)%
Operating margins
11.6
%
 
8.1
%
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
October 2, 2011
 
September 30, 2012
 
Variance
Revenues
$
8,300

 
$
7,440

 
$
(860
)
 
(10.4
)%
Operating earnings
885

 
645

 
(240
)
 
(27.1
)%
Operating margins
10.7
%
 
8.7
%
 
 
 
 
Operating Results
The Information Systems and Technology group’s revenues decreased in the third quarter and first nine months of 2012 compared with the prior-year periods. The decrease consisted of the following:
 

36


 
Third Quarter
 
Nine Months
Tactical communication systems
$
(225
)
 
$
(810
)
Information technology (IT) services
25

 
27

Intelligence, surveillance and reconnaissance (ISR) systems
(8
)
 
(77
)
Total decrease
$
(208
)
 
$
(860
)
The decrease in revenues in the tactical communication systems business was driven by protracted U.S. customer acquisition cycles and a slower than expected transition to follow-on work on several contracts. This resulted in lower revenues in 2012 on key programs, including Warfighter Information Network – Tactical (WIN-T) and Common Hardware Systems (CHS), and for encryption and ruggedized hardware products. In addition, approximately 10% of the decline in the group’s revenues in both periods was due to lower volume on the U.K.-based Bowman communications system program, which has been successfully fielded and has now moved into maintenance and long-term support.
In the group’s IT services business, revenues were higher in the third quarter and first nine months of 2012 compared with the prior-year periods. Decreased volume on several completed large-scale IT infrastructure and support programs for the intelligence community and the Department of Defense, including the New Campus East and Walter Reed National Military Medical Center programs, was more than offset by revenues from the 2011 acquisition of Vangent, Inc.
Revenues were down in 2012 compared with the prior-year periods in the group’s ISR business primarily due to lower optical products sales. Demand for optical products continues to be negatively impacted by pressured defense budgets and the economic downturn. We anticipate orders in the fourth quarter that will stabilize production volume in the optical products business. However, if these awards are delayed or are for lower quantities than expected, it would impact the business' projected operating results and, therefore, may require the review of related long-lived assets for possible impairment, including specifically identified intangible assets of $125 and property, plant and equipment of $20.
In addition to the decrease in the group’s 2012 operating earnings due to volume, operating margins decreased 350 basis points in the third quarter and 200 basis points in the first nine months of 2012 compared with the prior-year periods. This decrease was driven primarily by a shift in the mix of the group’s revenues to lower-margin IT services, which increased from approximately 40 to 45 percent of the group’s total revenues in both periods. Contributing to this shift has been lower demand for encryption products and ruggedized hardware in our tactical communications business over the past year. Consequently, in the third quarter of 2012, we announced that we will cease production of several of these ruggedized hardware products. In addition, the group reduced the value of its existing ruggedized hardware inventory by $25 based on the anticipated remaining demand for these products. If orders do not materialize as expected, we may experience further inventory reductions.
Outlook
We expect 2012 revenues in the Information Systems and Technology group to be down 8 to 9 percent from 2011 due to continued award delays and lower demand in our tactical communication systems business. Given operating results in the first nine months of the year, the group’s operating margins are expected to approximate 9 percent in 2012.
CORPORATE
Corporate results consist primarily of compensation expense for stock options. Corporate operating costs totaled $17 in the third quarter of 2012 compared with $21 in the third quarter of 2011 and $52 in the first nine months of 2012 compared with $61 in the 2011 period. We expect 2012 full-year Corporate

37


operating costs of approximately $70.

BACKLOG
Our total backlog, including funded and unfunded portions, was $51.5 billion on September 30, 2012, compared with $52.4 billion at the end of the second quarter of 2012. Our estimated potential contract value includes our assessment of the ultimate value we expect to be awarded under unfunded indefinite delivery, indefinite quantity (IDIQ) contracts or unexercised options associated with existing firm contracts. At the end of the third quarter of 2012, our estimate of this potential contract value was $26.1 billion, compared with $26.2 billion at the end of the second quarter.
The following table details the backlog and the total estimated contract value of each business group at the end of the second and third quarters of 2012:
 
Funded
 
Unfunded
 
Total Backlog
 
Estimated Potential Contract Value
 
Total Estimated Contract Value
 
July 1, 2012
Aerospace
$
16,058

 
$
241

 
$
16,299

 
$

 
$
16,299

Combat Systems
8,854

 
905

 
9,759

 
3,090

 
12,849

Marine Systems
11,666

 
5,339

 
17,005

 
1,377

 
18,382

Information Systems and Technology
7,348

 
1,951

 
9,299

 
21,774

 
31,073

Total
$
43,926

 
$
8,436

 
$
52,362

 
$
26,241

 
$
78,603

 
 
 
 
 
 
 
 
 
 
 
September 30, 2012
Aerospace
$
15,827

 
$
215

 
$
16,042

 
$

 
$
16,042

Combat Systems
8,259

 
1,101

 
9,360

 
2,627

 
11,987

Marine Systems
10,909

 
5,036

 
15,945

 
1,382

 
17,327

Information Systems and Technology
8,224

 
1,887

 
10,111

 
22,052

 
32,163

Total
$
43,219

 
$
8,239

 
$
51,458

 
$
26,061

 
$
77,519


AEROSPACE
Aerospace funded backlog represents aircraft orders for which we have definitive purchase contracts and deposits from customers. Funded backlog includes the group’s newest aircraft models, the G280 and G650, which each received type certification from the FAA in the third quarter of 2012. Aerospace unfunded backlog consists of agreements to provide future aircraft maintenance and support services.
The group ended the third quarter of 2012 with $16 billion of backlog, down from $16.3 billion at the end of the second quarter as we deliver on our G650 backlog. Order activity included demand for products across our portfolio. Orders were up from the first and second quarters of 2012. Consistent with our expectations, we received several North American multi-aircraft orders we had anticipated in the first half of 2012. Customer defaults remain at the lowest level in four years. In the group’s large-cabin segment, backlog remains well-positioned with an approximate 18-month period between customer order and delivery of in-service aircraft and approximately five years of backlog for the G650.
Approximately 60 percent of the group’s orders in the first nine months of 2012 were from North American customers, with strong demand from Fortune 500 companies. While the installed base of aircraft is predominantly in North America, international customers represented nearly 60 percent of the group’s backlog at the end of the third quarter.

38



DEFENSE GROUPS
The total backlog for our defense groups 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. While there is no guarantee that future budgets and appropriations will provide funding for a given program, we have included only firm contracts at the amounts we believe are likely to receive funding.
Total backlog in our defense groups was $35.4 billion on September 30, 2012, down 2 percent from the second quarter. Backlog increased in our Information Systems and Technology group, which booked the highest amount of orders since the second quarter of 2010, including several significant contract awards on major programs. Backlog decreased in our Marine Systems group, which typically has significant variations in quarterly order intake. The Combat Systems group anticipates several notable contract awards in the fourth quarter of 2012 or early 2013.
Our defense groups each received notable contract awards in the quarter.
Combat Systems awards included the following:
$395 from the U.S. Army to begin engineering development efforts for the Abrams main battle tank modernization program.
$135 from the Canadian government to supply various calibers of ammunition.
$50 from the Army to produce M31A2 propellant.
Marine Systems awards included the following:
$105 from the U.S. Navy to renovate and modernize the dock landing ship USS Comstock (LSD 45).
$95 from the Navy for advance planning and preliminary execution of fire-restoration efforts on USS Miami (SSN 755).
Information Systems and Technology awards included the following:
$340 from the Army under the Warfighter Information Network-Tactical (WIN-T) program for Increment 2 equipment production.
$265 for wireless network systems and support from several commercial customers.
$95 from the Army for ruggedized computing equipment under the Common Hardware Systems-4 (CHS-4) program.
$85 from the U.S. Air Force for networking and computing products and support under the Network-Centric Solutions (NETCENTS) program.
$80 from the U.S. Department of State to provide supply chain management services. The program has a maximum potential value of $1.2 billion over 5 years.

39


$75 from the Army under the WIN-T program for Increment 1 technical support services and upgrades.
$70 from the Army for production of over 13,000 Rifleman radios and accessory kits under the Joint Tactical Radio System (JTRS) Handheld, Manpack and Small Form-Fit (HMS) program.
$65 for the Army's Warfighter Field Operations Customer Support (FOCUS) program to provide support for live, virtual and constructive training operations.
$65 to supply 64 radio-telescope antennas for South Africa's MeerKAT radio telescope program.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
We ended the third quarter of 2012 with a cash balance of $2.9 billion, up $225 from the end of 2011. Our net debt, defined as debt less cash and equivalents and marketable securities, was $874 at the end of the third quarter of 2012, down $159 from the end of 2011. 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 2011 and 2012.
OPERATING ACTIVITIES
We generated cash from operating activities of $1.9 billion in the first nine months of 2012 compared with $1.2 billion in the same period in 2011. The primary driver of cash flows in both periods was net earnings. Contributions to our pension plans, which were approximately $430 in the first nine months of 2012 compared with $300 in the prior-year period, also impacted cash from operating activities.
As discussed further in Note K to the unaudited Consolidated Financial Statements, litigation on the A-12 program termination has been ongoing since 1991. If, contrary to our expectations, the default termination ultimately is sustained and the government prevails on its recovery theories, 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 $1.6 billion on September 30, 2012. If this were the outcome, we would owe half of the total, or approximately $1.5 billion pretax. Our after-tax cash obligation would be approximately $740. We believe we have sufficient resources, including access to capital markets, to pay such an obligation, if required.
INVESTING ACTIVITIES
We used $668 for investing activities in the first nine months of 2012 compared with $1.5 billion in the same period in 2011. The primary uses of cash for investing activities were acquisitions, capital expenditures and purchases of marketable securities.
We completed six acquisitions for $426 in the first nine months of 2012 and four acquisitions for $1.1 billion in the first nine months of 2011. 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 up slightly from 2011 largely due to Gulfstream’s $500 seven-year Savannah, Georgia, facilities expansion project started in 2010.
Our investments in available-for-sale and held-to-maturity securities are focused on ensuring financial flexibility to deploy cash resources. To bolster liquidity in the uncertain business environment caused by the continuing resolution and the looming sequester mechanism, we received cash of $42 from the net sales and maturities of these securities in the first nine months of 2012, including $211 from the

40


sale of held-to-maturity securities.
In 2011, investing activities also included proceeds from the second quarter sale of the detections systems portion of the weapons systems business in our Combat Systems group.
FINANCING ACTIVITIES
Net cash used for financing activities was $1 billion in the nine-month period ended September 30, 2012, compared with $826 in the same period in 2011. Our financing activities include payment of dividends and repurchases of common stock. Net cash from financing activities also includes proceeds received from stock options exercises.
We had no commercial paper outstanding on September 30, 2012. We have $2 billion in bank credit facilities that remain available. These facilities provide backup liquidity to our commercial paper program. We also have an effective shelf registration on file with the Securities and Exchange Commission. The next material repayment of long-term debt is $1 billion of fixed-rate notes scheduled to mature in May 2013. We are evaluating current market conditions and various alternatives with respect to outstanding debt, including issuing debt to redeem one or more series of our existing fixed-rate notes. See Note G to the unaudited Consolidated Financial Statements for additional information regarding our debt obligations, including scheduled debt maturities.
On March 7, 2012, our board of directors declared an increased quarterly dividend of $0.51 per share – the 15th consecutive annual increase. The board had increased the quarterly dividend to $0.47 per share in March 2011.
In the first nine months of 2012, we repurchased 9.1 million of our outstanding shares on the open market at an average price of $66 per share. In the first nine months of 2011, we repurchased 20 million shares at an average price of $69 per share. On September 30, 2012, approximately 10.9 million shares remain authorized by our board of directors for repurchase – about 3 percent of our total shares outstanding.
NON-GAAP MANAGEMENT METRICS – FREE CASH FLOW
Our free cash flow from operations for the first nine months of 2012 was $1.6 billion, or 90 percent of earnings from continuing operations, compared with $943 and 48 percent for the same period in 2011. We define free cash flow from operations as net cash provided by operating activities 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 of the business.
The following table reconciles the free cash flow from operations with net cash provided by operating activities, as classified on the unaudited Consolidated Statements of Cash Flows:

Nine Months Ended
October 2, 2011
 
September 30,
2012
Net cash provided by operating activities
$
1,216

 
$
1,907

Capital expenditures
(273
)
 
(286
)
Free cash flow from operations
$
943

 
$
1,621

Cash flows as a percentage of earnings from continuing operations:
 
 
 
Net cash provided by operating activities
62
%
 
106
%
Free cash flow from operations
48
%
 
90
%

41


We expect to continue to generate funds 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.
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 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.
Accounting for long-term contracts and programs involves the use of various techniques to estimate total contract revenues and costs. Contract estimates are based on various assumptions that project the outcome of future events that often span several years. We review our performance monthly and update our contract estimates at least annually and often quarterly as well as when required by specific events and circumstances. We recognize changes in estimated profit on contracts under the reallocation method. Under this method, the impact of revisions in estimates is recognized prospectively over the remaining contract term. The net increase in our operating earnings (and earnings per share) from the quarterly impact of revisions in contract estimates totaled $113 ($0.22) and $299 ($0.56) for the three- and nine-months periods ended October 2, 2011, including the revision in estimate on the Marine Systems’ T-AKE contract discussed in the second quarter of 2011. The net increase in our operating earnings (and earnings per share) totaled $45 ($0.09) and $203 ($0.39) for the three- and nine-months periods ended September 30, 2012, respectively. No revisions on any one contract were material to our unaudited Consolidated Financial Statements in the first nine months of 2012.
Other significant estimates include those related to goodwill and other intangible assets, income taxes, pensions and other post-retirement benefits, workers’ compensation, warranty obligations and contingencies and litigation. We make our best estimates based on historical and current experience and on various 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.
We will complete our required annual goodwill impairment test during the fourth quarter of 2012. Current uncertainties in the defense business environment, including slowed spending and the threat of sequestration, may impact the fair value of our reporting units. Given recent operating trends, we believe the reporting unit which most likely could be impacted is Information Systems and Technology.
We believe that our judgment is applied consistently and produces financial information that fairly depicts the results of operations for all periods presented. For a full discussion of our critical accounting policies, see our Annual Report on Form 10-K for the year ended December 31, 2011.


42


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, 2011.

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) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended) on September 30, 2012. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, on September 30, 2012, our disclosure controls and procedures were effective.
There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2012, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q contains forward-looking statements that are based on management’s expectations, estimates, projections and assumptions. Words such as “expects,” “anticipates,” “plans,” “believes,” “scheduled,” “outlook,” “should,” “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, operating margins, segment performance, cash flows, contract awards, aircraft production, deliveries and backlog. 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 the risk factors discussed in Item 1A of our Annual Report on Form 10-K. These factors include, without limitation:
general U.S. and international political and economic conditions;
decreases in U.S. government defense spending or changing priorities within the defense budget and the impacts of the Budget Control Act of 2011;
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 except as expressly required to do so by law.

43



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
Other than the revision to the following risk factor concerning risks relating to the U.S. government’s defense budget, we do not believe there are any material changes to the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2011.
We depend on the U.S. government for a significant portion of our revenues. More than two-thirds of our revenues are from the U.S. government. U.S. defense spending has been driven by perceived threats to national security. While the country has been under an elevated threat level for the past decade, competing demands for federal funds could pressure all areas of spending. A decrease in U.S. government defense spending or changes in spending allocation could result in one or more of our programs being reduced, delayed or terminated, which would impact our financial performance.
The Budget Control Act of 2011 has two primary parts that affect future defense spending. The first part mandates a $487 billion reduction to previously-planned defense spending over the next decade. These cuts are incorporated in the fiscal year (FY) 2013 proposed defense budget. The second part is a sequester mechanism that would impose an additional $500 billion of cuts on defense spending between FY 2013 and FY 2021 if the Congress does not identify a means to reduce the U.S. deficit by $1.2 trillion by year end. As of October 30, 2012, the means have not been identified by Congress. Given the uncertainty regarding how the Congress will reduce the U.S. deficit and a lack of specifics on how cuts will be implemented, we are unable to predict the impact, which could be material, on our programs or financial outlook, including our revenues, operating earnings and margins, cash flow, orders and backlog and recovery of long-lived assets. However, funding reductions of the magnitude imposed by the sequester mechanism as written could have material operational consequences to our employee base, facilities and suppliers.

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

On June 7, 2012, with 2.4 million shares remaining under a prior authorization, the board of directors authorized management to repurchase an additional 10 million shares of common stock on the open market. We did not repurchase any shares in the third quarter and approximately 10.9 million shares remain authorized for repurchase. 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.
We did not make any unregistered sales of equity securities in the third quarter.

ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.


44


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.

45


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/ Kimberly A. Kuryea
 
 
Kimberly A. Kuryea
 
 
Vice President and Controller
 
 
(Authorized Officer and Chief Accounting Officer)

Dated: October 30, 2012
 
 
   

46