10-Q 1 gd-2013092910q.htm 10-Q GD-2013.09.29 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 29, 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
352,198,231 shares of the registrant’s common stock, $1 par value per share, were outstanding on September 29, 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)
September 30, 2012
 
September 29, 2013
Revenues:
 
 
 
Products
$
4,967

 
$
4,796

Services
2,967

 
3,000

 
7,934

 
7,796

Operating costs and expenses:
 
 
 
Products
4,012

 
3,742

Services
2,507

 
2,591

General and administrative (G&A)
510

 
506

 
7,029

 
6,839

Operating earnings
905

 
957

Interest, net
(39
)
 
(22
)
Other, net
(3
)
 
5

Earnings before income taxes
863

 
940

Provision for income taxes, net
263

 
289

Net earnings
$
600

 
$
651

 
 
 
 
Earnings per share
 
 
 
  Basic
$
1.71

 
$
1.86

  Diluted
$
1.70

 
$
1.84

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)
September 30, 2012
 
September 29, 2013
Revenues:
 
 
 
Products
$
14,672

 
$
14,132

Services
8,763

 
8,979

 
23,435

 
23,111

Operating costs and expenses:
 
 
 
Products
11,712

 
11,108

Services
7,418

 
7,702

G&A
1,570

 
1,537

 
20,700

 
20,347

Operating earnings
2,735

 
2,764

Interest, net
(115
)
 
(63
)
Other, net
(8
)
 
6

Earnings before income taxes
2,612

 
2,707

Provision for income taxes, net
814

 
845

Net earnings
$
1,798

 
$
1,862

 
 
 
 
Earnings per share
 
 
 
  Basic
$
5.08

 
$
5.31

  Diluted
$
5.04

 
$
5.27

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
Nine Months Ended
(Dollars in millions)
September 30, 2012
 
September 29, 2013
September 30, 2012
 
September 29, 2013
Net earnings
$
600

 
$
651

$
1,798

 
$
1,862

Gains (losses) on cash flow hedges
7

 
12

(34
)
 

Unrealized gains on securities
5

 

7

 
7

Foreign currency translation adjustments
129

 
152

91

 
(92
)
Change in retirement plans' funded status
56

 
95

177

 
299

Other comprehensive income before tax
197

 
259

241

 
214

Provision for income tax, net
52

 
39

86

 
108

Other comprehensive income, net of tax
145

 
220

155

 
106

Comprehensive income
$
745

 
$
871

$
1,953

 
$
1,968

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
 
September 29, 2013
ASSETS
 
 
 
Current assets:
 
 
 
Cash and equivalents
$
3,296

 
$
4,065

Accounts receivable
4,204

 
4,365

Contracts in process
4,964

 
5,113

Inventories
2,776

 
2,986

Other current assets
504

 
589

Total current assets
15,744

 
17,118

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

 
3,365

Intangible assets, net
1,383

 
1,248

Goodwill
12,048

 
12,008

Other assets
1,731

 
1,732

Total noncurrent assets
18,565

 
18,353

Total assets
$
34,309

 
$
35,471

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

 
$
2,443

Customer advances and deposits
6,042

 
6,266

Other current liabilities
3,109

 
3,356

Total current liabilities
11,620

 
12,065

Noncurrent liabilities:
 
 
 
Long-term debt
3,908

 
3,908

Other liabilities
7,391

 
6,893

Commitments and contingencies (See Note L)


 


Total noncurrent liabilities
11,299

 
10,801

Shareholders' equity:
 
 
 
Common stock
482

 
482

Surplus
1,988

 
2,161

Retained earnings
17,860

 
19,131

Treasury stock
(6,165
)
 
(6,500
)
Accumulated other comprehensive loss
(2,775
)
 
(2,669
)
Total shareholders' equity
11,390

 
12,605

Total liabilities and shareholders' equity
$
34,309

 
$
35,471

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)
September 30, 2012
 
September 29, 2013
Cash flows from operating activities:
 
 
 
Net earnings
$
1,798

 
$
1,862

Adjustments to reconcile net earnings to net cash provided by operating activities –
 
 
 
Depreciation of property, plant and equipment
286

 
288

Amortization of intangible assets
172

 
127

Stock-based compensation expense
104

 
90

Excess tax benefit from stock-based compensation
(24
)
 
(19
)
Deferred income tax provision
53

 
47

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

 
(166
)
Contracts in process
91

 
(119
)
Inventories
(340
)
 
(218
)
Increase (decrease) in liabilities, net of effects of business acquisitions –
 
 
 
Accounts payable
(368
)
 
(26
)
Customer advances and deposits
257

 
16

Other current liabilities
(105
)
 
(167
)
Other, net
(156
)
 
(165
)
Net cash provided by operating activities
1,907

 
1,550

Cash flows from investing activities:
 
 
 
Capital expenditures
(286
)
 
(271
)
Business acquisitions, net of cash acquired
(426
)
 
(1
)
Other, net
44

 
56

Net cash used by investing activities
(668
)
 
(216
)
Cash flows from financing activities:
 
 
 
Purchases of common stock
(602
)
 
(696
)
Proceeds from option exercises
121

 
484

Dividends paid
(533
)
 
(394
)
Other, net
2

 
46

Net cash used by financing activities
(1,012
)
 
(560
)
Net cash used by discontinued operations
(2
)
 
(5
)
Net increase in cash and equivalents
225

 
769

Cash and equivalents at beginning of period
2,649

 
3,296

Cash and equivalents at end of period
$
2,874

 
$
4,065

Supplemental cash flow information:
 
 
 
Cash payments for:
 
 
 
Income taxes
$
805

 
$
713

Interest
$
135

 
$
66

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 nine-month periods ended September 29, 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 nine-month periods ended September 30, 2012, and September 29, 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 $45 ($0.09) and $203 ($0.39) for the three- and nine-month periods ended September 30, 2012, and $105 ($0.19) and $296 ($0.54) for the three- and nine-month periods ended September 29, 2013, respectively. While no revisions on any one contract were material to our unaudited Consolidated Financial Statements in the third quarter and first nine months of 2013, the amounts increased from 2012 largely due to improved performance in the Combat Systems group.
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 nine months of 2013. In 2012, we acquired seven businesses for an aggregate of $444, funded by cash on hand, including six in the first nine months of 2012 for an aggregate of $426.

The changes in the carrying amount of goodwill by reporting unit for the nine months ended
September 29, 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

 
(1
)
 
1

 
2

Other (c)
10

 
(39
)
 

 
(13
)
 
(42
)
September 29, 2013
$
2,707

 
$
2,924

 
$
289

 
$
6,088

 
$
12,008

(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
 
September 29, 2013
Contract and program intangible assets*
$
2,066

$
(1,165
)
$
901

 
$
2,069

$
(1,271
)
$
798

Trade names and trademarks
494

(87
)
407

 
500

(99
)
401

Technology and software
180

(108
)
72

 
160

(114
)
46

Other intangible assets
175

(172
)
3

 
166

(163
)
3

Total intangible assets
$
2,915

$
(1,532
)
$
1,383

 
$
2,895

$
(1,647
)
$
1,248

* Consists of acquired backlog and probable follow-on work and related customer relationships.
Amortization expense was $57 and $172 for the three- and nine-month periods ended September 30, 2012, and $38 and $127 for the three- and nine-month periods ended September 29, 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
Nine Months Ended
 
September 30, 2012
September 29, 2013
September 30, 2012
September 29, 2013
Basic weighted average shares outstanding
350,470

349,337

354,168

350,774

Dilutive effect of stock options and restricted stock/RSUs*
2,356

3,581

2,351

2,348

Diluted weighted average shares outstanding
352,826

352,918

356,519

353,122

* Excludes the following outstanding options to purchase shares of common stock because the effect of including these options would be antidilutive: 2012 - 23,777 and 2013 - 10,992.

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 September 29, 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 September 29, 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
)
 
 
 
 
 
 
 
 
 
September 29, 2013
Other investments
$
142

 
$
142

 
$
100

 
$
42

Derivatives
14

 
14

 

 
14

Long-term debt,
     including current portion
(3,936
)
 
(3,800
)
 

 
(3,800
)
(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 September 29, 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
 
September 29, 2013
Contract costs and estimated profits
$
8,162

 
$
8,479

Other contract costs
1,089

 
1,174

 
9,251

 
9,653

Advances and progress payments
(4,287
)
 
(4,540
)
Total contracts in process
$
4,964

 
$
5,113

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
 
September 29, 2013
Work in process
$
1,518

 
$
1,674

Raw materials
1,109

 
1,200

Finished goods
69

 
60

Pre-owned aircraft
80

 
52

Total inventories
$
2,776

 
$
2,986


11




G. DEBT
Debt consisted of the following:
 
 
December 31, 2012
 
September 29, 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

 
53

Total debt
 
3,909

 
3,936

Less current portion
 
1

 
28

Long-term debt
 
$
3,908

 
$
3,908

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.
While we had no commercial paper outstanding on September 29, 2013, we issued approximately $500 of commercial paper subsequent to the end of the quarter to bolster liquidity in the current business environment. 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 $280 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 September 29, 2013.

12




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

 
December 31, 2012
 
September 29, 2013
Salaries and wages
$
835

 
$
765

Workers' compensation
578

 
520

Retirement benefits
318

 
326

Deferred income taxes
173

 
343

Other (a)
1,205

 
1,402

Total other current liabilities
$
3,109

 
$
3,356

 
 
 
 
Retirement benefits
$
5,671

 
$
5,292

Customer deposits on commercial contracts 
849

 
680

Deferred income taxes
144

 
131

Other (b)
727

 
790

Total other liabilities
$
7,391

 
$
6,893

(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 September 29, 2013, other current liabilities amount is primarily due to $198 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. The decrease in the September 29, 2013, noncurrent retirement benefits amount is primarily due to over $500 of contributions to our pension plans in 2013.

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
 
September 29, 2013
Current deferred tax asset
$
44

 
$
36

Current deferred tax liability
(173
)
 
(343
)
Noncurrent deferred tax asset
1,251

 
1,240

Noncurrent deferred tax liability
(144
)
 
(131
)
Net deferred tax asset
$
978

 
$
802

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. We do not expect the resolution of tax matters for open years to have a material impact on our results of operations, financial condition, cash flows or effective tax rate.

13



Based on all known facts and circumstances and current tax law, we believe the total amount of unrecognized tax benefits on September 29, 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 $1.53 for the three- and nine-month periods ended September 30, 2012, and $0.56 and $1.68 for the three- and nine-month periods ended September 29, 2013. Cash dividends paid were $180 and $533 for the three- and nine-month periods ended September 30, 2012, and $196 and $394 for the three- and nine-month periods ended September 29, 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. The tax effect for each component of other comprehensive income (OCI) consisted of the following:
 
Gross Amount
Tax Effect
Net Amount
 
Gross Amount
Tax Effect
Net Amount
Three Months Ended
September 30, 2012
 
September 29, 2013
Gains on cash flow hedges
$
7

$
(3
)
$
4

 
$
12

$
(3
)
$
9

Unrealized gains (losses) on securities
5

(2
)
3

 



Foreign currency translation adjustments
129

(27
)
102

 
152

(2
)
150

Change in retirement plans' funded status
56

(20
)
36

 
95

(34
)
61

Other comprehensive income
$
197

$
(52
)
$
145

 
$
259

$
(39
)
$
220

 
 
 
 
 
 
 
 
 
Gross Amount
Tax Effect
Net Amount
 
Gross Amount
Tax Effect
Net Amount
Nine Months Ended
September 30, 2012
 
September 29, 2013
Losses on cash flow hedges
$
(34
)
$
4

$
(30
)
 
$

$
1

$
1

Unrealized gains on securities
7

(2
)
5

 
7

(2
)
5

Foreign currency translation adjustments
91

(28
)
63

 
(92
)
1

(91
)
Change in retirement plans' funded status
177

(60
)
117

 
299

(108
)
191

Other comprehensive income
$
241

$
(86
)
$
155

 
$
214

$
(108
)
$
106

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
10

5

(91
)
(3
)
(79
)
Amounts reclassified from AOCL
(9
)


194

185

Other comprehensive income
1

5

(91
)
191

106

Balance, September 29, 2013
$
7

$
12

$
1,001

$
(3,689
)
$
(2,669
)

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

Nine Months Ended September 29, 2013
Amount Reclassified from AOCL
Consolidated Statement of Earnings Line Item
Losses on cash flow hedges of foreign exchange contracts
$
(14
)
Operating costs and expenses
 
5

Tax benefit
 
(9
)
 
Changes in retirement plans' funded status
 
 
Recognized net actuarial loss
336

*
Amortization of prior service credit
(40
)
*
 
(102
)
Tax expense
 
194

 
Total reclassifications, net of tax
$
185

 
* 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 September 29, 2013, we held $4.1 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 billion on September 29, 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 nine-month periods ended September 30, 2012, and September 29, 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 September 29, 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 nine-month periods ended September 30, 2012, or September 29, 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 nine 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.
In May 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 in June 2009, and in November 2009 the court of appeals denied the contractors’ petitions for rehearing. In September 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.
In May 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. In July 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.
The government and the contractors are now pursuing efforts that could, if successful, finally and fully settle this longstanding dispute. A written settlement agreement between the contractors and the Navy has been signed that provides for in-kind consideration to be provided by the contractors in exchange for dismissal of the case. Under the settlement agreement we would provide a credit to the Navy in the amount of $198 toward the design, construction and delivery of portions of a ship in the DDG-1000 program. The settlement agreement is contingent largely upon approval by Congress of legislation that would authorize the Navy to receive and retain payment in-kind for the settlement. If the legislation is ultimately not adopted by Congress, the settlement agreement will become null and void. We do not know the timing of any potential Congressional action to adopt the legislation, and the case is stayed pending Congressional action.
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 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, a settlement is not reached and 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 September 29, 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.

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 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 September 29, 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 September 29, 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

18



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.
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 nine-month periods ended September 30, 2012, and September 29, 2013, were as follows:

Nine Months Ended
September 30, 2012
 
September 29, 2013
Beginning balance
$
293

 
$
319

Warranty expense
60

 
84

Payments
(47
)
 
(51
)
Adjustments*
(5
)
 
(4
)
Ending balance
$
301

 
$
348

* 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 nine-month periods ended September 30, 2012, and September 29, 2013, consisted of the following:

 
Pension Benefits
Other Post-retirement Benefits
Three Months Ended
September 30, 2012
 
September 29, 2013
September 30, 2012
 
September 29, 2013
Service cost
$
71

 
$
80

$
3

 
$
4

Interest cost
131

 
124

15

 
13

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

 
106

2

 
6

Amortization of prior service (credit) cost
(11
)
 
(16
)
2

 
2

Net periodic cost
$
110

 
$
146

$
15

 
$
18

 
Pension Benefits
Other Post-retirement Benefits
Nine Months Ended
September 30, 2012
 
September 29, 2013
September 30, 2012
 
September 29, 2013
Service cost
$
213

 
$
240

$
9

 
$
12

Interest cost
393

 
372

43

 
39

Expected return on plan assets
(441
)
 
(444
)
(22
)
 
(21
)
Recognized net actuarial loss
198

 
318

7

 
18

Amortization of prior service (credit) cost
(33
)
 
(46
)
6

 
6

Net periodic cost
$
330

 
$
440

$
43

 
$
54

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. We submitted REAs of approximately $165 for these contracts in 2012. These REAs remain outstanding on September 29, 2013, and are subject to negotiation with our customer, the U.S. Department of Defense.


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
September 30, 2012
September 29, 2013
September 30, 2012
September 29, 2013
Aerospace
$
1,836

$
2,152

$
261

$
369

Combat Systems
1,956

1,367

274

224

Marine Systems
1,670

1,697

186

170

Information Systems and Technology
2,472

2,580

201

216

Corporate*


(17
)
(22
)
 
$
7,934

$
7,796

$
905

$
957


 
Revenues
Operating Earnings
Nine Months Ended
September 30, 2012
September 29, 2013
September 30, 2012
September 29, 2013
Aerospace
$
5,051

$
5,983

$
789

$
1,068

Combat Systems
6,016

4,469

799

657

Marine Systems
4,928

5,082

554

507

Information Systems and Technology
7,440

7,577

645

599

Corporate*


(52
)
(67
)
 
$
23,435

$
23,111

$
2,735

$
2,764

*Corporate operating results primarily consist 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 September 30, 2012
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
Revenues
$

$
6,684

$
1,250

$

$
7,934

Cost of sales
(7
)
5,476

1,050


6,519

G&A
22

388

100


510

Operating earnings
(15
)
820

100


905

Interest, net
(38
)
(2
)
1


(39
)
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

Three Months Ended September 29, 2013
 
 
 
 
 
Revenues
$

$
6,924

$
872

$

$
7,796

Cost of sales
3

5,628

702


6,333

G&A
19

410

77


506

Operating earnings
(22
)
886

93


957

Interest, net
(21
)
(1
)


(22
)
Other, net
1

2

2


5

Earnings before income taxes
(42
)
887

95


940

Provision for income taxes
(15
)
291

13


289

Equity in net earnings of subsidiaries
678



(678
)

Net earnings
$
651

$
596

$
82

$
(678
)
$
651

Comprehensive income
$
871

$
610

$
235

$
(845
)
$
871



22



CONDENSED CONSOLIDATING STATEMENTS OF EARNINGS (UNAUDITED)
Nine Months Ended September 30, 2012
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
Revenues
$

$
19,485

$
3,950

$

$
23,435

Cost of sales
(16
)
15,834

3,312


19,130

G&A
66

1,196

308


1,570

Operating earnings
(50
)
2,455

330


2,735

Interest, net
(118
)
1

2


(115
)
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

Nine Months Ended September 29, 2013
 
 
 
 
 
Revenues
$

$
20,244

$
2,867

$

$
23,111

Cost of sales
11

16,454

2,345


18,810

G&A
56

1,229

252


1,537

Operating earnings
(67
)
2,561

270


2,764

Interest, net
(68
)
3

2


(63
)
Other, net
1

1

4


6

Earnings before income taxes
(134
)
2,565

276


2,707

Provision for income taxes
(35
)
804

76


845

Equity in net earnings of subsidiaries
1,961



(1,961
)

Net earnings
$
1,862

$
1,761

$
200

$
(1,961
)
$
1,862

Comprehensive income
$
1,968

$
1,794

$
94

$
(1,888
)
$
1,968




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)
September 29, 2013
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
ASSETS
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and equivalents
$
3,057

$

$
1,008

$

$
4,065

Accounts receivable

1,408

2,957


4,365

Contracts in process
572

3,193

1,348


5,113

Inventories
 
 
 
 
 
Work in process

1,663

11


1,674

Raw materials

1,105

95


1,200

Finished goods

26

34


60

Pre-owned aircraft

52



52

Other current assets
52

329

208


589

Total current assets
3,681

7,776

5,661


17,118

Noncurrent assets:
 
 
 
 
 
Property, plant and equipment
156

5,738

1,312


7,206

Accumulated depreciation of PP&E
(62
)
(3,019
)
(760
)

(3,841
)
Intangible assets

1,675

1,220


2,895

Accumulated amortization of intangible assets

(1,144
)
(503
)

(1,647
)
Goodwill

7,661

4,347


12,008

Other assets
650

717

331

34

1,732

Investment in subsidiaries
35,366



(35,366
)

Total noncurrent assets
36,110

11,628

5,947

(35,332
)
18,353

Total assets
$
39,791

$
19,404

$
11,608

$
(35,332
)
$
35,471

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

$
3,245

$
3,021

$

$
6,266

Other current liabilities
778

3,832

1,189


5,799

Total current liabilities
778

7,077

4,210


12,065

Noncurrent liabilities:
 
 
 
 
 
Long-term debt
3,883

25



3,908

Other liabilities
3,721

2,591

581


6,893

Total noncurrent liabilities
7,604

2,616

581


10,801

Intercompany
18,804

(19,116
)
312



Shareholders' equity:
 
 
 
 
 
Common stock
482

6

44

(50
)
482

Other shareholders' equity
12,123

28,821

6,461

(35,282
)
12,123

Total shareholders' equity
12,605

28,827

6,505

(35,332
)
12,605

Total liabilities and shareholders' equity
$
39,791

$
19,404

$
11,608

$
(35,332
)
$
35,471



25



O. CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30, 2012
Parent
Guarantors
on a
Combined
Basis
Other
Subsidiaries
on a
Combined
Basis
Consolidating
Adjustments
Total
Consolidated
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

Nine Months Ended September 29, 2013
 
 
 
 
 
Net cash provided by operating activities
$
(445
)
$
1,983

$
12

$

$
1,550

Net cash used by investing activities
1

(188
)
(29
)

(216
)
Cash flows from financing activities:
 
 
 
 
 
Purchases of common stock
(696
)



(696
)
Proceeds from option exercises
484




484

Dividends paid
(394
)



(394
)
Other, net
19


27


46

Net cash used by financing activities
(587
)

27


(560
)
Net cash used by discontinued operations
(5
)



(5
)
Cash sweep/funding by parent
1,845

(1,795
)
(50
)


Net decrease in cash and equivalents
809


(40
)

769

Cash and equivalents at beginning of period
2,248


1,048


3,296

Cash and equivalents at end of period
$
3,057

$

$
1,008

$

$
4,065



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 systems 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, U.S. defense spending has been reduced. 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, if the Congress did not identify a means to reduce the U.S. deficit by $1.2 trillion, 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. Because these means were not identified, the sequester mechanism took effect on March 1, 2013.
When the U.S. government's new fiscal year began on October 1, 2013, the President's FY 2014 budget request had not been approved by the Congress. Subsequently, following a 16 day partial U.S. government shutdown (the shutdown), a continuing resolution (CR), which prescribes defense funding at prior-year levels of $497 billion, including $37 billion of sequestration cuts, was approved through January 15, 2014. If the Congress does not approve a FY 2014 budget and a second CR is not approved by that date, the government may again shut down. It is unclear how and to what extent any additional BCA-related cuts would be applied to a second FY 2014 CR or a FY 2014 appropriation.
Our financial outlook for our defense business (Combat Systems, Marine Systems and Information Systems and Technology) assumes the current CR is in effect during our fourth calendar quarter, which, if executed by the DoD in accordance with past practice, should not have a material impact on our operating results. Additionally, our outlook does not reflect any lingering impacts from the shutdown, which could impact a few of our businesses.

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.

27



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
September 30, 2012
 
September 29, 2013
 
Variance
Revenues
$
7,934

 
$
7,796

 
$
(138
)
 
(1.7
)%
Operating costs and expenses
7,029

 
6,839

 
(190
)
 
(2.7
)%
Operating earnings
905

 
957

 
52

 
5.7
 %
Operating margins
11.4
%
 
12.3
%
 
 
 
 
Nine Months Ended
September 30, 2012
 
September 29, 2013
 
Variance
Revenues
$
23,435

 
$
23,111

 
$
(324
)
 
(1.4
)%
Operating costs and expenses
20,700

 
20,347

 
(353
)
 
(1.7
)%
Operating earnings
2,735

 
2,764

 
29

 
1.1
 %
Operating margins
11.7
%
 
12.0
%