10-Q 1 gd-2013063010q.htm 10-Q GD-2013.06.30 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 June 30, 2013
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
349,867,839 shares of the registrant’s common stock, $1 par value per share, were outstanding on June 30, 2013.

1


INDEX

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

2


PART I – FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)

 
Three Months Ended
(Dollars in millions, except per-share amounts)
July 1, 2012
 
June 30, 2013
Revenues:
 
 
 
Products
$
4,987

 
$
4,877

Services
2,935

 
3,034

 
7,922

 
7,911

Operating costs and expenses:
 
 
 
Products
3,936

 
3,837

Services
2,491

 
2,590

General and administrative (G&A)
525

 
524

 
6,952

 
6,951

Operating earnings
970

 
960

Interest, net
(37
)
 
(18
)
Other, net
(5
)
 
1

Earnings before income taxes
928

 
943

Provision for income taxes, net
294

 
303

Net earnings
$
634

 
$
640

 
 
 
 
Earnings per share
 
 
 
  Basic
$
1.79

 
$
1.82

  Diluted
$
1.77

 
$
1.81

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


3


CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)

 
Six Months Ended
(Dollars in millions, except per-share amounts)
July 1, 2012
 
June 30, 2013
Revenues:
 
 
 
Products
$
9,705

 
$
9,337

Services
5,796

 
5,978

 
15,501

 
15,315

Operating costs and expenses:
 
 
 
Products
7,700

 
7,366

Services
4,911

 
5,111

G&A
1,060

 
1,031

 
13,671

 
13,508

Operating earnings
1,830

 
1,807

Interest, net
(76
)
 
(41
)
Other, net
(5
)
 
1

Earnings before income taxes
1,749

 
1,767

Provision for income taxes, net
551

 
556

Net earnings
$
1,198

 
$
1,211

 
 
 
 
Earnings per share
 
 
 
  Basic
$
3.37

 
$
3.45

  Diluted
$
3.34

 
$
3.43

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
Six Months Ended
(Dollars in millions)
July 1, 2012
 
June 30, 2013
July 1, 2012
 
June 30, 2013
Net earnings
$
634

 
$
640

$
1,198

 
$
1,211

Losses on cash flow hedges
(55
)
 

(41
)
 
(12
)
Unrealized gains (losses) on securities
(3
)
 
3

2

 
7

Foreign currency translation adjustments
(207
)
 
(66
)
(38
)
 
(244
)
Change in retirement plans' funded status
64

 
104

121

 
204

Other comprehensive income (loss) before tax
(201
)
 
41

44

 
(45
)
Provision (benefit) for income tax, net
(11
)
 
36

34

 
69

Other comprehensive income (loss), net of tax
(190
)
 
5

10

 
(114
)
Comprehensive income
$
444

 
$
645

$
1,208

 
$
1,097

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, 2012
 
June 30, 2013
ASSETS
 
 
 
Current assets:
 
 
 
Cash and equivalents
$
3,296

 
$
3,757

Accounts receivable
4,204

 
4,289

Contracts in process
4,964

 
5,110

Inventories
2,776

 
2,935

Other current assets
504

 
447

Total current assets
15,744

 
16,538

Noncurrent assets:
 
 
 
Property, plant and equipment, net
3,403

 
3,351

Intangible assets, net
1,383

 
1,270

Goodwill
12,048

 
11,909

Other assets
1,731

 
1,663

Total noncurrent assets
18,565

 
18,193

Total assets
$
34,309

 
$
34,731

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
2,469

 
$
2,444

Customer advances and deposits
6,042

 
6,113

Other current liabilities
3,109

 
3,284

Total current liabilities
11,620

 
11,841

Noncurrent liabilities:
 
 
 
Long-term debt
3,908

 
3,907

Other liabilities
7,391

 
7,227

Commitments and contingencies (See Note L)


 


Total noncurrent liabilities
11,299

 
11,134

Shareholders' equity:
 
 
 
Common stock
482

 
482

Surplus
1,988

 
2,043

Retained earnings
17,860

 
18,677

Treasury stock
(6,165
)
 
(6,557
)
Accumulated other comprehensive loss
(2,775
)
 
(2,889
)
Total shareholders' equity
11,390

 
11,756

Total liabilities and shareholders' equity
$
34,309

 
$
34,731

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


6


CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
Six Months Ended
(Dollars in millions)
July 1, 2012
 
June 30, 2013
Cash flows from operating activities:
 
 
 
Net earnings
$
1,198

 
$
1,211

Adjustments to reconcile net earnings to net cash provided by operating activities –
 
 
 
Depreciation of property, plant and equipment
189

 
191

Amortization of intangible assets
115

 
89

Stock-based compensation expense
69

 
61

Excess tax benefit from stock-based compensation
(22
)
 
(16
)
Deferred income tax provision
3

 
42

(Increase) decrease in assets, net of effects of business acquisitions –
 
 
 
Accounts receivable
(110
)
 
(90
)
Contracts in process
194

 
(125
)
Inventories
(316
)
 
(167
)
Increase (decrease) in liabilities, net of effects of business acquisitions –
 
 
 
Accounts payable
(342
)
 
(25
)
Customer advances and deposits
226

 
(54
)
Income taxes payable
67

 
50

Other current liabilities
(114
)
 
(156
)
Other, net
46

 
72

Net cash provided by operating activities
1,203

 
1,083

Cash flows from investing activities:
 
 
 
Capital expenditures
(176
)
 
(168
)
Purchases of available-for-sale securities
(100
)
 
(43
)
Business acquisitions, net of cash acquired
(165
)
 
(1
)
Other, net
(65
)
 
48

Net cash used by investing activities
(506
)
 
(164
)
Cash flows from financing activities:
 
 
 
Purchases of common stock
(592
)
 
(485
)
Proceeds from options exercised
111

 
212

Dividends paid
(353
)
 
(198
)
Other, net
28

 
16

Net cash used by financing activities
(806
)
 
(455
)
Net cash used by discontinued operations

 
(3
)
Net (decrease) increase in cash and equivalents
(109
)
 
461

Cash and equivalents at beginning of period
2,649

 
3,296

Cash and equivalents at end of period
$
2,540

 
$
3,757

Supplemental cash flow information:
 
 
 
Cash payments for:
 
 
 
Income taxes
$
506

 
$
468

Interest
$
78

 
$
46

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 unaudited 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.
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 six-month periods ended June 30, 2013, are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.
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 six-month periods ended July 1, 2012, and June 30, 2013.
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, 2012.
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 on a diluted per-share basis) from the favorable impact of revisions in contract estimates totaled $90 ($0.17) and $158 ($0.30) for the three- and six-month periods ended July 1, 2012, and $83 ($0.15) and $191 ($0.35) for the three- and six-month periods ended June 30, 2013, respectively. In the second quarter and first half of 2013, no revisions on any one contract were material to our unaudited 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
We did not acquire any businesses in the first six months of 2013. In 2012, we acquired seven businesses for an aggregate of $444, funded by cash on hand, including two in the first half of 2012.

The changes in the carrying amount of goodwill by reporting unit for the six months ended
June 30, 2013, were as follows:

 
Aerospace
 
Combat Systems
 
Marine Systems
 
Information Systems and Technology
 
Total Goodwill
December 31, 2012 (a)
$
2,697

 
$
2,961

 
$
290

 
$
6,100

 
$
12,048

Acquisitions (b)

 
2

 

 
2

 
4

Other (c)
(56
)
 
(66
)
 

 
(21
)
 
(143
)
June 30, 2013
$
2,641

 
$
2,897

 
$
290

 
$
6,081

 
$
11,909

(a)
Goodwill on December 31, 2012, in the Information Systems and Technology reporting unit is net of $1,994 of accumulated impairment losses.
(b)Includes adjustments during the purchase price allocation period.
(c)Consists primarily of adjustments for foreign currency translation.
Intangible assets consisted of the following:

 
Gross Carrying Amount
Accumulated Amortization
Net Carrying Amount
 
Gross Carrying Amount
Accumulated Amortization
Net Carrying Amount
 
December 31, 2012
 
June 30, 2013
Contract and program intangible assets*
$
2,066

$
(1,165
)
$
901

 
$
2,067

$
(1,239
)
$
828

Trade names and trademarks
494

(87
)
407

 
487

(96
)
391

Technology and software
180

(108
)
72

 
161

(113
)
48

Other intangible assets
175

(172
)
3

 
166

(163
)
3

Total intangible assets
$
2,915

$
(1,532
)
$
1,383

 
$
2,881

$
(1,611
)
$
1,270

* Consists of acquired backlog and probable follow-on work and related customer relationships.
Amortization expense was $58 and $115 for the three- and six-month periods ended July 1, 2012, and $42 and $89 for the three- and six-month periods ended June 30, 2013, respectively. We expect to record amortization expense of $165 in 2013.


C. EARNINGS PER SHARE
Earnings per Share. We compute basic earnings per share (EPS) using net earnings for the period and the weighted average number of common shares outstanding during the period. Diluted EPS generally 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):


9


 
Three Months Ended
Six Months Ended
 
July 1, 2012
June 30, 2013
July 1, 2012
June 30, 2013
Basic weighted average shares outstanding
355,048

351,110

356,017

351,492

Dilutive effect of stock options and restricted stock/RSUs*
2,325

1,822

2,349

1,732

Diluted weighted average shares outstanding
357,373

352,932

358,366

353,224

* Excludes the following outstanding options to purchase shares of common stock and nonvested restricted stock because the effect of including these options and restricted shares would be antidilutive: 2012 - 23,847 and 2013 - 16,484.

D. FAIR VALUE OF FINANCIAL INSTRUMENTS
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:
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.
We did not have any significant non-financial assets or liabilities measured at fair value on December 31, 2012, or June 30, 2013, except for long-lived assets that were impaired in December 2012, including goodwill in our Information Systems and Technology business group.
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. The carrying values of cash and equivalents, accounts receivable and payable, and short-term debt 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, 2012, and June 30, 2013, 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, 2012
Other investments
$
150

 
$
150

 
$
96

 
$
54

Derivatives
22

 
22

 

 
22

Long-term debt,
     including current portion
(3,909
)
 
(3,966
)
 

 
(3,966
)
 
 
 
 
 
 
 
 
 
June 30, 2013
Other investments
$
149

 
$
149

 
$
100

 
$
49

Derivatives
1

 
1

 

 
1

Long-term debt,
     including current portion
(3,908
)
 
(3,775
)
 

 
(3,775
)
(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, 2012, or June 30, 2013.

10



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, 2012
 
June 30, 2013
Contract costs and estimated profits
$
8,162

 
$
8,871

Other contract costs
1,089

 
1,148

 
9,251

 
10,019

Advances and progress payments
(4,287
)
 
(4,909
)
Total contracts in process
$
4,964

 
$
5,110

Contract costs consist primarily of labor, material, overhead and G&A expenses. 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.

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, 2012
 
June 30, 2013
Work in process
$
1,518

 
$
1,657

Raw materials
1,109

 
1,160

Finished goods
69

 
56

Pre-owned aircraft
80

 
62

Total inventories
$
2,776

 
$
2,935


11



G. DEBT
Debt consisted of the following:
 
 
December 31, 2012
 
June 30, 2013
Fixed-rate notes due:
Interest Rate
 
 
 
January 2015
1.375%
$
500

 
$
500

July 2016
2.250%
500

 
500

November 2017
1.000%
895

 
895

July 2021
3.875%
499

 
499

November 2022
2.250%
990

 
991

November 2042
3.600%
498

 
498

Other
Various
27

 
25

Total debt
 
3,909

 
3,908

Less current portion
 
1

 
1

Long-term debt
 
$
3,908

 
$
3,907

Our fixed-rate notes are fully and unconditionally guaranteed by several of our 100-percent-owned subsidiaries (see Note O 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.
On June 30, 2013, we had no commercial paper outstanding, but we maintain the ability to access the market. We have $2 billion in committed 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 2016 and a $1 billion multi-year facility expiring in July 2018 that replaces a facility that expired in July 2013. These facilities are required by the rating agencies to support our commercial paper issuances. We may renew or replace, in whole or part, these credit facilities at or prior to their expiration dates. Our commercial paper issuances and the bank credit facilities are guaranteed by several of our 100-percent-owned subsidiaries. In addition, we have approximately $285 in committed bank credit facilities to provide backup liquidity to our European businesses.
Our financing arrangements contain a number of customary covenants and restrictions. We were in compliance with all material covenants on June 30, 2013.

12



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

 
December 31, 2012
 
June 30, 2013
Salaries and wages
$
835

 
$
754

Workers' compensation
578

 
529

Retirement benefits
318

 
328

Deferred income taxes
173

 
207

Other (a)
1,205

 
1,466

Total other current liabilities
$
3,109

 
$
3,284

 
 
 
 
Retirement benefits
$
5,671

 
$
5,606

Customer deposits on commercial contracts 
849

 
724

Deferred income taxes
144

 
136

Other (b)
727

 
761

Total other liabilities
$
7,391

 
$
7,227

(a)Consists primarily of dividends payable, taxes 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.
 
The increase in the June 30, 2013, other current liabilities amount is primarily due to $196 of dividends payable. We did not have any dividends payable on December 31, 2012, because we paid our first quarter 2013 dividend in December 2012.

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, 2012
 
June 30, 2013
Current deferred tax asset
$
44

 
$
33

Current deferred tax liability
(173
)
 
(207
)
Noncurrent deferred tax asset
1,251

 
1,157

Noncurrent deferred tax liability
(144
)
 
(136
)
Net deferred tax asset
$
978

 
$
847

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.
We participate in the Internal Revenue Service (IRS) Compliance Assurance Process, a real-time audit of our consolidated corporate federal income tax return. The IRS has examined our consolidated federal income tax returns through 2011.

13


Based on all known facts and circumstances and current tax law, we believe the total amount of unrecognized tax benefits on June 30, 2013, 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. SHAREHOLDERS' EQUITY
Dividends per Share. Dividends declared per share were $0.51 and $1.02 for the three- and six-month periods ended July 1, 2012, and $0.56 and $1.12 for the three- and six-month periods ended June 30, 2013. Cash dividends paid were $184 and $353 for the three- and six-month periods ended July 1, 2012, and $198 for the six-month period ended June 30, 2013. We did not pay any dividends in the first three months of 2013 because we paid our first quarter 2013 dividend in December 2012.
Other Comprehensive Income (Loss). The tax effect for each component of other comprehensive income (OCI) consisted of the following:
 
Gross Amount
Benefit (Provision) for Income Tax
Net Amount
 
Gross Amount
Benefit (Provision) for Income Tax
Net Amount
Three Months Ended
July 1, 2012
 
June 30, 2013
Losses on cash flow hedges
$
(55
)
$
14

$
(41
)
 
$

$

$

Unrealized gains (losses) on securities
(3
)
1

(2
)
 
3


3

Foreign currency translation adjustments
(207
)
16

(191
)
 
(66
)
1

(65
)
Change in retirement plans' funded status
64

(20
)
44

 
104

(37
)
67

Other comprehensive income (loss)
$
(201
)
$
11

$
(190
)
 
$
41

$
(36
)
$
5

 
 
 
 
 
 
 
 
 
Gross Amount
Benefit (Provision) for Income Tax
Net Amount
 
Gross Amount
Benefit (Provision) for Income Tax
Net Amount
Six Months Ended
July 1, 2012
 
June 30, 2013
Losses on cash flow hedges
$
(41
)
$
7

$
(34
)
 
$
(12
)
$
4

$
(8
)
Unrealized gains on securities
2


2

 
7

(2
)
5

Foreign currency translation adjustments
(38
)
(1
)
(39
)
 
(244
)
3

(241
)
Change in retirement plans' funded status
121

(40
)
81

 
204

(74
)
130

Other comprehensive income (loss)
$
44

$
(34
)
$
10

 
$
(45
)
$
(69
)
$
(114
)
The changes, net of tax, in each component of accumulated other comprehensive loss (AOCL) consisted of the following:

14


 
Gains (Losses) on Cash Flow Hedges
Unrealized Gains on Securities
Foreign Currency Translation Adjustments
Changes in Retirement Plans’ Funded Status
AOCL
Balance, December 31, 2012
$
6

$
7

$
1,092

$
(3,880
)
$
(2,775
)
OCI before reclassifications

5

(241
)

(236
)
Amounts reclassified from AOCL
(8
)


130

122

Other comprehensive loss
(8
)
5

(241
)
130

(114
)
Balance, June 30, 2013
$
(2
)
$
12

$
851

$
(3,750
)
$
(2,889
)

Significant amounts reclassified out of each component of AOCL consisted of the following:

Six Months Ended June 30, 2013
Amount Reclassified from AOCL
Consolidated Statement of Earnings Line Item
Losses on cash flow hedges of foreign exchange contracts
$
(12
)
Operating costs and expenses
 
4

Tax benefit
 
(8
)
 
Changes in retirement plans' funded status
 
 
Recognized net actuarial loss
224

*
Amortization of prior service credit
(26
)
*
 
(68
)
Tax expense
 
130

 
Total reclassifications, net of tax
$
122

 
* These AOCL components are included in our net periodic pension and other post-retirement benefit cost. See Note M for additional details.

K. 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.

15


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 June 30, 2013, we held $3.8 billion in cash and equivalents, but held no marketable securities.
Hedging Activities. We had $2.5 billion in notional forward exchange contracts outstanding on December 31, 2012, and $2.2 billion on June 30, 2013. We recognize derivative financial instruments on the Consolidated Balance Sheets at fair value (see Note D).
We record changes in the fair value of derivative financial instruments in operating costs and expenses in the Consolidated Statements of Earnings or in 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 six-month periods ended July 1, 2012, and June 30, 2013. 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.
We had no material derivative financial instruments designated as fair value or net investment hedges on December 31, 2012, or June 30, 2013.
Foreign Currency Financial Statement Translation. We translate foreign-currency balance sheets from our international businesses' functional currency (generally the respective local currency) to U.S. dollars at the end-of-period exchange rates, and statements of earnings 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' results 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 six-month periods ended July 1, 2012, or June 30, 2013. In addition, the effect of changes in foreign exchange rates on non-U.S. cash balances was not material in the first three months or six months of either 2012 or 2013.

L. 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.

16


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.
Recently, the government and the contractors have initiated discussions that could, if successful, lead to a settlement of this longstanding dispute. The government has submitted to Congress proposed legislation that would authorize the Navy to receive and retain payment in-kind for settlement of the A-12 litigation. Congress has not yet acted on the proposed legislation, and the parties have not reached agreement on the specific terms of any potential settlement of the case.

If settlement efforts are not successful and the case proceeds, 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. Interest was approximately $1.6 billion on June 30, 2013. 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 $840, or $2.38 per share, which would be recorded in discontinued operations. Our after-tax cash cost would be approximately $745. We believe we have sufficient resources to satisfy our obligation if required.
Other. Various claims and other legal proceedings incidental to the normal course of business are pending or threatened against us. 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

17


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 liabilities. 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. In 2012, the Portuguese Ministry of National Defense notified our Combat Systems group's European Land Systems business that it was terminating the contract to provide 260 Pandur vehicles based on an alleged breach of contract. Subsequently, the customer drew $75 from bank guarantees for the contract. We have asserted that we are not in breach of the contract and that the termination of the contract was invalid, and we are currently in arbitration with the customer. Given the uncertainty of receiving further payments, we reserved the receivables and contracts in process balances and accrued an estimate of the remaining costs related to the close-out of the contract, totaling $258 in 2012. As of June 30, 2013, approximately $195 of bank guarantees relating to the program and its related offset requirements remained outstanding. The bank guarantees could be drawn upon by the customer through 2014 and, therefore, have a possible impact on our future operating results and cash flows. 
Letters of Credit and Guarantees. In the ordinary course of business, we have entered into letters of credit, bank guarantees, surety bonds and other similar arrangements with financial institutions and insurance carriers totaling approximately $1.8 billion on June 30, 2013. In addition, from time to time in the ordinary course of business, we contractually guarantee the payment or performance obligations of our subsidiaries arising under certain contracts.
Government Contracts. As a government contractor, we are subject to U.S. government audits and investigations relating to our operations, including claims for fines, penalties, and compensatory and treble damages. 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 file claims or requests for equitable adjustment (REAs). 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.

18


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. Our other warranty obligations, primarily for business-jet aircraft, are included in other current and noncurrent liabilities on the Consolidated Balance Sheets.
The changes in the carrying amount of warranty liabilities for the six-month periods ended July 1, 2012, and June 30, 2013, were as follows:

Six Months Ended
July 1, 2012
 
June 30, 2013
Beginning balance
$
293

 
$
319

Warranty expense
35

 
52

Payments
(35
)
 
(29
)
Adjustments*
(8
)
 

Ending balance
$
285

 
$
342

* Includes reclassifications.


19


M. 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 six-month periods ended July 1, 2012, and June 30, 2013, consisted of the following:

 
Pension Benefits
Other Post-retirement Benefits
Three Months Ended
July 1, 2012
 
June 30, 2013
July 1, 2012
 
June 30, 2013
Service cost
$
71

 
$
80

$
3

 
$
4

Interest cost
131

 
124

14

 
13

Expected return on plan assets
(147
)
 
(148
)
(8
)
 
(7
)
Recognized net actuarial loss
66

 
106

3

 
6

Amortization of prior service (credit) cost
(11
)
 
(15
)
2

 
2

Net periodic cost
$
110

 
$
147

$
14

 
$
18

 
Pension Benefits
Other Post-retirement Benefits
Six Months Ended
July 1, 2012
 
June 30, 2013
July 1, 2012
 
June 30, 2013
Service cost
$
142

 
$
160

$
6

 
$
8

Interest cost
262

 
248

28

 
26

Expected return on plan assets
(294
)
 
(296
)
(15
)
 
(14
)
Recognized net actuarial loss
132

 
212

5

 
12

Amortization of prior service (credit) cost
(22
)
 
(30
)
4

 
4

Net periodic cost
$
220

 
$
294

$
28

 
$
36

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. As a result, pension costs allocable to our contracts are expected to increase beginning in 2014 when the 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 submitted REAs of approximately $165 for these contracts in 2012.


20


N. 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 services; 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
July 1, 2012
June 30, 2013
July 1, 2012
June 30, 2013
Aerospace
$
1,592

$
2,053

$
257

$
389

Combat Systems
2,149

1,549

322

218

Marine Systems
1,653

1,759

183

178

Information Systems and Technology
2,528

2,550

226

198

Corporate*


(18
)
(23
)
 
$
7,922

$
7,911

$
970

$
960


 
Revenues
Operating Earnings
Six Months Ended
July 1, 2012
June 30, 2013
July 1, 2012
June 30, 2013
Aerospace
$
3,215

$
3,831

$
528

$
699

Combat Systems
4,060

3,102

525

433

Marine Systems
3,258

3,385

368

337

Information Systems and Technology
4,968

4,997

444

383

Corporate*


(35
)
(45
)
 
$
15,501

$
15,315

$
1,830

$
1,807

*Corporate operating results primarily consists of stock option expense.



21


O. 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 (UNAUDITED)
Three Months Ended July 1, 2012
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
Revenues
$

$
6,504

$
1,418

$

$
7,922

Cost of sales
(4
)
5,273

1,158


6,427

G&A
22

397

106


525

Operating earnings
(18
)
834

154


970

Interest, net
(40
)
2

1


(37
)
Other, net
(1
)
(3
)
(1
)

(5
)
Earnings before income taxes
(59
)
833

154


928

Provision for income taxes
(44
)
308

30


294

Equity in net earnings of subsidiaries
649



(649
)

Net earnings
$
634

$
525

$
124

$
(649
)
$
634

Comprehensive income
$
444

$
520

$
(98
)
$
(422
)
$
444

Three Months Ended June 30, 2013
 
 
 
 
 
Revenues
$

$
6,932

$
979

$

$
7,911

Cost of sales
3

5,604

820


6,427

G&A
19

411

94


524

Operating earnings
(22
)
917

65


960

Interest, net
(23
)
5



(18
)
Other, net
(1
)

2


1

Earnings before income taxes
(46
)
922

67


943

Provision for income taxes
(11
)
283

31


303

Equity in net earnings of subsidiaries
675



(675
)

Net earnings
$
640

$
639

$
36

$
(675
)
$
640

Comprehensive income
$
645

$
637

$
(20
)
$
(617
)
$
645



22


CONDENSED CONSOLIDATING STATEMENTS OF EARNINGS (UNAUDITED)
Six Months Ended July 1, 2012
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
Revenues
$

$
12,801

$
2,700

$

$
15,501

Cost of sales
(9
)
10,358

2,262


12,611

G&A
44

808

208


1,060

Operating earnings
(35
)
1,635

230


1,830

Interest, net
(80
)
3

1


(76
)
Other, net
(2
)
(2
)
(1
)

(5
)
Earnings before income taxes
(117
)
1,636

230


1,749

Provision for income taxes
(62
)
546

67


551

Equity in net earnings of subsidiaries
1,253



(1,253
)

Net earnings
$
1,198

$
1,090

$
163

$
(1,253
)
$
1,198

Comprehensive income
$
1,208

$
1,086

$
103

$
(1,189
)
$
1,208

Six Months Ended June 30, 2013
 
 
 
 
 
Revenues
$

$
13,320

$
1,995

$

$
15,315

Cost of sales
6

10,830

1,641


12,477

G&A
39

816

176


1,031

Operating earnings
(45
)
1,674

178


1,807

Interest, net
(46
)
4

1


(41
)
Other, net
(1
)
1

1


1

Earnings before income taxes
(92
)
1,679

180


1,767

Provision for income taxes
(20
)
513

63


556

Equity in net earnings of subsidiaries
1,283



(1,283
)

Net earnings
$
1,211

$
1,166

$
117

$
(1,283
)
$
1,211

Comprehensive income
$
1,097

$
1,185

$
(142
)
$
(1,043
)
$
1,097




23


O. CONDENSED CONSOLIDATING BALANCE SHEET
December 31, 2012
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
ASSETS
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and equivalents
$
2,248

$

$
1,048

$

$
3,296

Accounts receivable

1,254

2,950


4,204

Contracts in process
439

3,199

1,326


4,964

Inventories
 
 
 
 
 
Work in process

1,507

11


1,518

Raw materials

1,020

89


1,109

Finished goods

32

37


69

Pre-owned aircraft

80



80

Other current assets
45

249

210


504

Total current assets
2,732

7,341

5,671


15,744

Noncurrent assets:
 
 
 
 
 
Property, plant and equipment
155

5,556

1,292


7,003

Accumulated depreciation of PP&E
(56
)
(2,850
)
(694
)

(3,600
)
Intangible assets

1,693

1,222


2,915

Accumulated amortization of intangible assets

(1,068
)
(464
)

(1,532
)
Goodwill

7,661

4,387


12,048

Other assets
700

738

328

(35
)
1,731

Investment in subsidiaries
33,324



(33,324
)

Total noncurrent assets
34,123

11,730

6,071

(33,359
)
18,565

Total assets
$
36,855

$
19,071

$
11,742

$
(33,359
)
$
34,309

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Customer advances and deposits
$

$
3,052

$
2,990

$

$
6,042

Other current liabilities
394

3,743

1,441


5,578

Total current liabilities
394

6,795

4,431


11,620

Noncurrent liabilities:
 
 
 
 
 
Long-term debt
3,881

27



3,908

Other liabilities
4,121

2,704

566


7,391

Total noncurrent liabilities
8,002

2,731

566


11,299

Intercompany
17,069

(17,388
)
319



Shareholders' equity:
 
 
 
 
 
Common stock
482

6

44

(50
)
482

Other shareholders' equity
10,908

26,927

6,382

(33,309
)
10,908

Total shareholders' equity
11,390

26,933

6,426

(33,359
)
11,390

Total liabilities and shareholders' equity
$
36,855

$
19,071

$
11,742

$
(33,359
)
$
34,309



24


O. CONDENSED CONSOLIDATING BALANCE SHEET (UNAUDITED)
June 30, 2013
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
ASSETS
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and equivalents
$
2,729

$

$
1,028

$

$
3,757

Accounts receivable

1,468

2,821


4,289

Contracts in process
534

3,190

1,386


5,110

Inventories
 
 
 
 
 
Work in process

1,644

13


1,657

Raw materials

1,077

83


1,160

Finished goods

15

41


56

Pre-owned aircraft

62



62

Other current assets
64

192

191


447

Total current assets
3,327

7,648

5,563


16,538

Noncurrent assets:
 
 
 
 
 
Property, plant and equipment
155

5,668

1,284


7,107

Accumulated depreciation of PP&E
(60
)
(2,959
)
(737
)

(3,756
)
Intangible assets

1,674

1,207


2,881

Accumulated amortization of intangible assets

(1,117
)
(494
)

(1,611
)
Goodwill

7,660

4,249


11,909

Other assets
426

735

303

199

1,663

Investment in subsidiaries
34,573



(34,573
)

Total noncurrent assets
35,094

11,661

5,812

(34,374
)
18,193

Total assets
$
38,421

$
19,309

$
11,375

$
(34,374
)
$
34,731

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Customer advances and deposits
$

$
3,187

$
2,926

$

$
6,113

Other current liabilities
739

3,782

1,207


5,728

Total current liabilities
739

6,969

4,133


11,841

Noncurrent liabilities:
 
 
 
 
 
Long-term debt
3,882

25



3,907

Other liabilities
4,051

2,599

577


7,227

Total noncurrent liabilities
7,933

2,624

577


11,134

Intercompany
17,993

(18,392
)
399



Shareholders' equity:
 
 
 
 
 
Common stock
482

6

44

(50
)
482

Other shareholders' equity
11,274

28,102

6,222

(34,324
)
11,274

Total shareholders' equity
11,756

28,108

6,266

(34,374
)
11,756

Total liabilities and shareholders' equity
$
38,421

$
19,309

$
11,375

$
(34,374
)
$
34,731



25


O. CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended July 1, 2012
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
Net cash provided by operating activities
$
(34
)
$
1,254

$
(17
)
$

$
1,203

Cash flows from investing activities:
 
 
 
 
 
Capital expenditures
(1
)
(155
)
(20
)

(176
)
Business acquisitions, net of cash acquired

(139
)
(26
)

(165
)
Purchases of held-to-maturity securities
(160
)



(160
)
Purchases of available-for-sale securities
(64
)
(36
)


(100
)
Other, net
60

35



95

Net cash used by investing activities
(165
)
(295
)
(46
)

(506
)
Cash flows from financing activities:
 
 
 
 
 
Purchases of common stock
(592
)



(592
)
Dividends paid
(353
)



(353
)
Proceeds from option exercises
111




111

Other, net
22

(20
)
26


28

Net cash used by financing activities
(812
)
(20
)
26


(806
)
Cash sweep/funding by parent
1,136

(939
)
(197
)


Net decrease in cash and equivalents
125


(234
)

(109
)
Cash and equivalents at beginning of period
1,530


1,119


2,649

Cash and equivalents at end of period
$
1,655

$

$
885

$

$
2,540

Six Months Ended June 30, 2013
 
 
 
 
 
Net cash provided by operating activities
$
(36
)
$
1,182

$
(63
)
$

$
1,083

Net cash used by investing activities
2

(147
)
(19
)

(164
)
Cash flows from financing activities:
 
 
 
 
 
Purchases of common stock
(485
)



(485
)
Other, net
30




30

Net cash used by financing activities
(455
)



(455
)
Net cash used by discontinued operations
(3
)



(3
)
Cash sweep/funding by parent
973

(1,035
)
62



Net decrease in cash and equivalents
481


(20
)

461

Cash and equivalents at beginning of period
2,248


1,048


3,296

Cash and equivalents at end of period
$
2,729

$

$
1,028

$

$
3,757



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 is an aerospace and defense company that offers a broad portfolio of products and services in business aviation; combat vehicles, weapons systems and munitions; 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 (DoD), intelligence community and other U.S. government customers; international governments; and a wide range of corporate and individual customers for 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 2012 Annual Report on Form 10-K and with the unaudited Consolidated Financial Statements included in this Form 10-Q.

DEFENSE BUSINESS ENVIRONMENT

Over the past several years, the level of U.S. defense spending has been negatively impacted by the country's fiscal shortfall. The Budget Control Act of 2011 (BCA) mandated a $487 billion, or approximately 8 percent, reduction to previously-planned defense funding over the next decade. In addition, the BCA included a sequester mechanism that imposed additional defense cuts of $500 billion, or approximately 9 percent, over nine years starting in fiscal year (FY) 2013 if the Congress did not identify a means to reduce the U.S. deficit by $1.2 trillion. Because these means were not identified, the sequester mechanism took effect on March 1, 2013.

The FY 2013 defense budget of $528 billion, which was passed in March 2013, incorporated the reductions mandated by the BCA but did not include the $37 billion of cuts required by the sequester mechanism. These mandated sequester cuts have since been identified by the DoD, providing some understanding of how our customers may address sequestration in the remaining two months of FY 2013.

The President's FY 2014 budget request was submitted to the Congress in the second quarter of 2013. The FY 2014 request complies with the $527 billion amount mandated by the BCA, but does not include the $52 billion of FY 2014 cuts imposed by sequestration. Although it is unclear whether the mandated cuts will ultimately be included in the budget when it is approved by the Congress, the Secretary of Defense recently provided a preliminary high-level approach to implementing the cuts in FY 2014 at the Congress' request.
 
In the event that the budget is not approved and a continuing resolution (CR) is in effect during the fourth calendar quarter of 2013, funding will be prescribed at prior-year levels. Our financial outlook for our defense business (Combat Systems, Marine Systems and Information Systems and Technology) anticipates our estimates of the likely impact of 2013 sequestration reductions and a fourth quarter CR structured by the Congress and executed by the DoD in accordance with past practice.

27


RESULTS OF OPERATIONS
INTRODUCTION
An understanding of our accounting practices is important to an evaluation of our operating results. 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 groups.
In the Aerospace group, contracts for new aircraft have two major phases: the manufacture of the “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 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 or programs. Year-over-year variances attributed to volume are 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, the estimated costs to complete or both. 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. 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
July 1, 2012
 
June 30, 2013
 
Variance
Revenues
$
7,922

 
$
7,911

 
$
(11
)
 
(0.1
)%
Operating costs and expenses
6,952

 
6,951

 
(1
)
 
 %
Operating earnings
970

 
960

 
(10
)
 
(1.0
)%
Operating margins
12.2
%
 
12.1
%
 
 
 
 
Six Months Ended
July 1, 2012
 
June 30, 2013
 
Variance
Revenues
$
15,501

 
$
15,315

 
$
(186
)
 
(1.2
)%
Operating costs and expenses
13,671

 
13,508

 
(163
)
 
(1.2
)%
Operating earnings
1,830

 
1,807

 
(23
)
 
(1.3
)%
Operating margins
11.8
%
 
11.8
%
 
 
 
 
Our revenues and operating costs were down slightly in 2013 compared with the prior-year periods driven by lower volume in the Combat Systems group across all of our land forces-related businesses. This decrease was partially offset by increased aircraft deliveries in our Aerospace group. Operating margins were steady in 2013 on lower volume compared with the prior-year periods.
PRODUCT REVENUES AND OPERATING COSTS

Three Months Ended
July 1, 2012
 
June 30, 2013
 
Variance
Revenues
$
4,987

 
$
4,877

 
$
(110
)
 
(2.2
)%
Operating costs
3,936

 
3,837

 
(99
)
 
(2.5
)%
Six Months Ended
July 1, 2012
 
June 30, 2013
 
Variance
Revenues
$